Double Dip Deniers take note: this is going badly wrong. There's still time for a Plan B.
This is an expanded and updated version of my recent column in the Birmingham Post on the UK's recent GDP figures.
"Disappointing" was George Osborne's reaction to the recent GDP figures showing a 0.7% decline in national output in the second quarter. "Shockingly bad" might be a more apt description.
Of course, the fact that GDP fell again shouldn't really have come as too much of a surprise. The Bank of England had anyway predicted that Jubilee bank holidays would negatively impact on quarterly growth.
Factor in dismal weather and an already double-dipping economy (down by 0.3% in the first quarter of 2012 and 0.4% in the final quarter of 2011) and a contraction of around 0.5% was anyway in the offing - as Capital Economics had predicted. But a fall of 0.7% was jaw-droppingly shocking.
Quite a few city analysts and commentators were caught on the hop again (they had expected 'just' a 0.2% drop in GDP) and have been saying that the initial figures are wrong and will be revised upwards.
Er no. Firstly, let's leave aside the fact that generally these 'analysts' are the same people who supported the government's misplaced austerity drive and so would say that the figures are 'wrong' anyway.
Secondly and more to the point, as I've pointed out before in Post columns, the ONS actually has quite a good track record on preliminary GDP estimates, and if anything the figures are as likely to be revised down as up, as we've seen with recent figures being revised downwards. What's genuinely more difficult to square is the message coming from business surveys which give a more positive take on things.
But what's not in doubt is that after the UK's worst post-war recession, its recovery has been more anaemic even than that after the 1930s Great Depression. It leaves UK output still some 4.5% below pre-recession levels (unlike Germany and the US which have surpassed 2008 pre-recession levels), with the UK performing worse than any other G8 country other than Italy, which has been unable to devalue like the UK. In fact, UK growth is worse over the last year than in Spain.
The economy has now contracted by a total of 1.4% over the last three quarters, and before this was anyway flatlining - with four GDP quarterly drops out of the last five and five out of the last seven. At this point after the recessions of the 1990s and 1980s, the economy was rapidly picking up speed. Not this time. Overall, GDP in Q2 of 2012 was 0.8% lower than a year before.
That recent IMF forecast of 0.2% growth for 2012 already looks too optimistic, and the Bank of England's forecast of zero growth in 2012 requires quite strong growth in the latter part of this year which may well not materialise - we may well end up with negative growth in 2012 overall.
The Q2 contraction affected all areas: services (-0.1%), construction (down by a whopping 5.2%) and industrial production (-1.3%). Perhaps the most telling statistic is that the UK economy is now smaller than it was when the coalition came to power in 2010. This is dismal, especially when you consider a base rate of 0.5% and £375 billion of QE so far (and more to come most likely).
In fact, as David Blanchflower has rightly stressed, it's government current spending which has continued to prop up output. Manufacturing has now made a negative contribution to growth in each of the past four quarters.
Construction made the biggest negative contribution in the past two quarters, with declines of roughly 5% in each quarter. As Blanchflower shows (see here) this was largely driven by declines in the value of public housing and non-infrastructure public spending ( down 11% and 17%, respectively, quarter on quarter; and down 18% per cent and 20% respectively, year on year). See also the BBC's Stephanie Flanders here for similar figures.
The Chancellor's line that public investment crowds out private investment looks completely wrong on such trends - in fact the opposite seems the case.
Let's remember that back in 2010 when the coalition came in, there was a tentative recovery underway. The economy was growing. Osborne recklessly compared the UK to Greece, said that a bankrupt UK had 'maxed out on it credit card' and then embarked on an eye-wateringly tight fiscal gamble all in the name of maintaining 'market confidence'.
These actions had the effect of trashing confidence in the broader economy and reducing aggregate demand at a time when consumption and investment was fragile. The fiscal gamble was especially short-sighted in the context of a tight squeeze on real incomes and a eurozone crisis which has crippled several of the UK's major export markets.
Even on the government's own terms (i.e. cutting the deficit), things are now seriously off track. The Prime Minister has had to admit that austerity could last until 2020, twice as long as the initial plan, and that there are more spending cuts to come.
In fact, with a shrinking economy, the government's deficit was again larger than expected in June, at £14.5 billion as against £13.9 billion a year ago, with borrowing so far in the fiscal year 2012 nearly 12% up on the same period last year.
The Chancellor's gamble simply isn't paying off, and what's needed is for Osborne to do what numerous other chancellors have done down the years and execute a speedy change of course so as to get the economy moving - think Lawson jettisoning money supply targeting or Lamont putting in place a new framework post-ERM (and singing in the bath). He famously didn't regret anything.
I've sketched out what a genuine 'Plan B' for growth could look like here in my columns at the Post (see here for example). It could look to ease the pace of cuts and temporarily reduce VAT.
Other elements should include: a genuine programme of 'credit easing' through the creation of new small business investment bank; a modestly funded national investment bank, with wider powers to leverage funding from the private sector to boost investment in infrastructure and green manufacturing; and a temporarily cut in national insurance contributions for the low paid and for younger workers. These could then be withdrawn, and signaled as such in advance, when economic growth gets moving and unemployment falls.
Remember, the government's target set out last year was to balance the cyclically adjusted current budget five years in the future. So neither a genuinely "timely, targeted and temporary" tax cut, or an increase in capital spending, would have any direct impact at all on the government's target anyway.
Yet the Chancellor's riposte in the face of dire GDP figures has been that he needs to "stay the course" and keep the ratings agencies happy. If he didn't, he argues, the agencies would downgrade the UK and would lead to higher long-term interest rates, in turn hurting the economy.
This argument simply doesn't stack up. The reality is that the UK has considerable fiscal manoeuvre and if we chose to use that space in a modest way the ratings agencies wouldn't blink and bond yields wouldn't rocket, as the IMF have usefully pointed out (see paragraph 43 on page 38 of their recent report on the UK here).
That IMF report should be interpreted as effectively giving Osborne cover for executing a change of tack given global circumstances if only he had the political nerve to do so.
I do agree with the Chancellor on one thing: he has said that he thinks that the UK economy has "deep seated problems". It does indeed. His own economic policy is one of them.
Professor David Bailey works at Coventry University Business School.