Britain’s Calamitous Economy and A Cautionary Tale

July 25, 2012

According to the Cameron government’s first estimate, British real GDP contracted for a third straight period in the second quarter and at an intensifying annualized rate of 2.7%.  That drop was twice as rapid as the pace sustained from October 2011 to March of this year and depressed on-year growth to negative 0.8% from four-quarter decreases of 0.1% between 4Q10 and 4Q11 and 0.2% in the year to 1Q12.  British GDP also fell in the final quarter of 2010 and the second quarter of 2011, so the economy is enmeshed in a seven-quarter sequence that includes five quarters of contraction.  

In the U.K., the earliest estimate of quarterly GDP is released in the first month of the ensuing quarter and is based on incomplete data encompassing less than half of all relevant information that will emerge eventually.  A breakdown of the main components of aggregate demand is not yet available, but all the major industry aggregates fell, so it’s clear that the economy experienced broadly shared weakness.  Output from production industries fell 1.3% on quarter and by 3.2% from a year earlier after having dipped 0.1% in the year to 2Q11.  Construction sank 5.2% last quarter on top of a 4.9% decrease  in the first quarter.  In on-year terms, construction plunged 9.7% versus a slide of 0.8% between 2Q10 and 2Q11.  Agricultural output slumped another 2.6% following declines of 1.8% in the final quarter of 2011 and 2.2% in 1Q12. 

The British economy never had the chance to regain a proper footing after the worldwide financial market crisis.  Britain was hammered during the Great Recession, contracting by 1.0% in 2008 and 4.0% in 2009.  The massively adverse transformation is highlighted in the abrupt shift of of the long-term trend in economic growth.  Real GDP had expanded at annualized rates of 3.6% in the five years to 1997, 3.2% per annum in the next five years through 2002, and 3.1% over the five years to 2007, but the five-year growth rate through 2012 will be negative by at least 0.5% per year and possibly marginally more.

Britain is suffering deeply even though the U.K. is not a member of the euro area and in spite of considerable and proactive monetary accommodation from the early days of the crisis.  Not sharing the euro gave Britain enormous advantages compared to Continental Europe.  The British 10-year gilt yield is only 20 basis points higher than its German counterpart, and the Bank of England was more aggressive than the ECB, slashing its base rate from 5.75% to 0.50% in the space of 15 months and progressively expanding quantitative easing as needed since March 2009. 

The inability of the British economy to gain traction despite such advantages has cautionary lessons for everyone.  The U.K. was ahead of the crowd espousing the need for reducing the budget deficit as soon as possible, even though a significant part of the deterioration in public finances was attributable to weak demand.  In a voluntary way, the U.K. government implemented the same kind of toxic fiscal medicine that’s being imposed on Euroland’s peripheral members by its creditors.  In both instances, the ensuing drag on economic growth has undermined the ability to meet fiscal goals.  A second lesson is the danger of unchecked household debt.  Corporate debt is integral to long-term business health, and it’s tempting to infer that good business practices can bestow equally advantageous benefits for families.  Alas, this metaphor  is a dangerously faulty one.  Unchecked family indebtedness was a core factor behind the multitude of interconnected economic problems that nations are still struggling to defuse

Copyright 2012, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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