Is this time different? It never is, of course, but belief that things are indeed somewhat different with the economy offers the Government the best hope it’s got ahead of next year’s general election, even if a slender one given the revenger’s tragedy that is today’s Tory Party.
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Boris Johnson looking under pressure
This Jacobean-like drama now seems to be into its final, murderous Act, with an incandescent former prime minister, Boris Johnson, seemingly intent on taking the entire ship down with him, and his successor, Rishi Sunak, impotently unable to calm the warring factions.
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Back in the real world, interest rates have meanwhile risen at unprecedented speed in response to Britain’s post-pandemic surge in inflation back to pre-financial crisis levels.
We can expect another increase from the Bank of England this week, almost regardless of what the latest inflation figures, scheduled for Wednesday, have to say.
Normally, you would expect a monetary tightening of such ferocity to induce a recession, together with strongly rising unemployment and a housing market crash to match. Such a moment may be coming, but that it hasn’t already arrived gives ministers at least some cause for optimism.
Could it be that we are experiencing a different kind of recession this time around, one in which the adjustment is felt more through declining real wages, rather than as has historically been the case, surging joblessness?
Admittedly, there hasn’t so far been a recession as such, using the technical definition of two successive quarters of economic contraction. But also true is that there’s been hardly any growth for more than a year now, so we are very definitely in recessionary waters. That we have not already been sunk by them is largely down to the fact that while preaching fiscal austerity, the Government has in fact been practising fiscal expansionism, pushing the day of reckoning out into the future.
In any case, the labour market has remained extraordinarily tight, with very little sign of the distress that would normally be associated with an economy heading into a downturn.
Nor has there been much sign of difficulty in the banking system. On the corporate side, borrowers continue to enjoy the benefits of the additional liquidity that was built up during the pandemic. Similarly, fixed-rate mortgage deals have protected households from the full impact of soaring mortgage rates; around two thirds of mortgage holders have yet to see any effect at all.
More than a million of these contracts fall due for refinancing over the next year, when there is also much corporate refinancing to be done.
So it may be that the feed through from monetary tightening is on a longer fuse than normal. Like pulling a piece of elastic, the brick may suddenly rebound, hitting the economy violently in the solar plexus.
Britain’s amazingly resilient jobs market provides the main explanation of why inflation is proving stickier in the UK than elsewhere.
With the labour force still some 400,000 smaller than it was before the pandemic, workers have more bargaining power than would normally be the case at this stage of the cycle.
Regular pay in the private sector, excluding bonuses, is rising at the rate of 7.6pc per annum according to the latest data, a level of increase which is completely incompatible with a 2pc inflation target.
Vacancies, though around a fifth lower than they were a year ago, are still at historically very high levels, and workers with the required skills are in short supply. Employee retention has therefore become a priority for many firms, again a very unusual characteristic for this state in the cycle when companies would normally be slashing costs.
The contraction in the labour force is in part a Brexit-related phenomenon. Long-term illness and other pandemic-related anomalies account for the rest of the shortfall, but it is still a bit of a mystery as to why the UK is doing so much worse than others in this respect. As a nation, we seem to have lost the will to work.
This has put more bargaining power in the hands of those still willing and able to bust a gut. Even so, it has not been enough in most cases to offset the effects of resurgent inflation. In real terms, total pay is 2pc lower than a year ago.
Unfortunately, this kind of erosion has become par for the course. Real average weekly earnings are no higher today than they were in November 2005, a virtually unprecedented, near 18-year hiatus in earnings growth.
So much for Boris Johnson’s pledge to transform the UK into a “high-wage, high-skill, high-productivity economy”. We have indeed got higher wages, but we’ve also ended up with high inflation, falling living standards and zero growth in productivity.
These latter weaknesses, as we now know, have little or nothing to do with “uncontrolled immigration”, which is what Johnson attributed them to, but are endemic and persistent in the structure of the UK economy.
The price of full employment, it would seem, is falling living standards. This might seem a politically and socially more acceptable trade than the alternative of allowing unemployment to let rip. Yet in the long run, it’s not going to be helpful to the goal of rising economic prosperity.
Recessions are grim, Darwinian occurrences that destroy lives in an often arbitrary and indiscriminate manner, but they are also a part of the creative destruction of the market economy. The weak, obsolete and unproductive are weeded out, freeing up capital and talent for the new and more productive. For a long time now, public policy has conspired to stand in the way, leaving us with an enfeebled economy.
When he became Prime Minister, Sunak set himself five goals. The Labour Party immediately condemned them as so easy that he couldn’t fail to meet them. In the event, they are proving not so easy after all. Two of them, moreover, are in direct contradiction. If the Bank of England is forced to induce a recession to meet the goal of halving inflation, it will destroy Sunak’s separate pledge to grow the economy.
Even as merely an attempt to restore a semblance of stability and common sense to public policy after the chaos of the two previous premierships, Sunak’s goals were always a hostage to fortune, and now conspire to set up a very ugly political dynamic heading into the election.
Sunak and his Chancellor Jeremy Hunt have nailed themselves to the cross of whatever the Bank of England deems necessary to bring inflation back to target. Having lost the plot on the way up, the Bank of England is now almost bound to overtighten on the way down in a vain attempt to reestablish its credibility, whatever the damage to disposable incomes, jobs and house prices. Not a pretty look when facing the ballot box.