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Feeling snowed under?

    Today’s  ONS growth figures come as quite a shock – and coupled with recent inflation and employment statistics, suggest a gloomy picture for the UK economy. Forecasters had predicted that growth would be somewhere between 0.2-0.6% for the fourth quarter of 2010, whereas the ONS’s provisional figures suggest a 0.5% contraction in economic activity. That this figure is so vastly out of sync with most other forecasts suggests that it must be examined with caution, but that won’t stop the new Shadow Chancellor Ed Balls from claiming that these figures expose the coalition’s economic policies.

    Cutting the deficit over the next five years is still the right course to take. Just today, the IMF warned that the failure to implement credible fiscal plans would risk longer-term growth prospects. And many of the cuts that Mr Balls is fighting against have not yet been brought into effect, and so would not have had a bearing on today’s figures. The question therefore becomes, what is driving these growth figures? And what can be done to rectify them?

    According to the ONS’s own bulletin, the effect of the ‘extremely bad weather’ in December is likely to have contributed to most of the decline.  They estimate that if this had not occurred, GDP would most likely have been flat. Indeed, if we examine some of the sectors which contracted most quickly within the quarter: construction by 3.3%, transport, storage and communications by 0.8% and distribution, hotels and restaurants by 0.5%, we can see that these are heavily influenced by the forces of nature. As Stephanie Flanders rightly points out, the timing of the snow over the Christmas period meant that retail sales were strongly affected.

    Even if we put aside the effects of the bad weather - and assume the ONS are right – no economic growth for the last quarter is not the sort of result that the coalition government would have hoped for. The task of deficit reduction would be much easier if growth was higher: stimulating tax receipts and minimising welfare payments. Yesterday the former director general of the CBI, Sir Richard Lambert , argued that the government did not appear to have a coherent growth strategy -evidenced by its failure to produce the Green Paper on growth last autumn.

    Here at the Centre for Policy Studies, we have argued that the government needs to be much bolder in its approach to growth: starting with abolishing regulations which hamper businesses. Yesterday, Jill Kirby set out how this might take shape – starting with burdens imposed via the Equalities Act. In addition, the government should seek to reform the tax system to encourage risk-taking and entrepreneurship. It should abolish the punitive 50p rate of income tax whilst making a clear commitment to cut corporation tax rates as low as 20% over the next five years.  Finally, it must curtail the shockingly high youth unemployment rate.

    The figures also represent somewhat of a headache for the Bank of England’s Monetary Policy Committee – who are now having to contend with rising inflation and falling GDP. If they stick to their remit of keeping CPI inflation at 2%, then they are likely to have to start increasing interest rates sooner rather than later. This will make borrowing more expensive, and is likely to negatively affect growth. But if they fail to act on inflationary pressures, then people are going to see the real cost of living spiralling upwards whilst unemployment is expected to rise as a result of public sector cuts.  As Jeremy Warner  concludes, the ONS’s GDP figures are likely to turn the terms of trade in favour of those advocating maintenance of low interest rates to counter sluggish growth. A rate rise given today’s news would probably have damaging consequences, but long-term inflationary pressure must be watched very carefully if the Bank is to maintain any sort of credibility in its inflation-targeting.

    Despite all of the doom and gloom, there were some positives from today’s figures and hope for the future. Manufacturing growth of 1.4% was again strong, and Britain’s export markets will benefit from the fall in the value of the pound brought about by revisions of interest rate expectations. There is also likely to be some bounce-back effect in the next quarter, although diminished somewhat by the increase in VAT. It is also worth noting that GDP figures are historically volatile as an economy comes out of recession.

    However, the conclusions of the day are clear: the Government needs to express a more coherent growth strategy, and the MPC needs to think carefully about the best way to approach the possibility of stagflation.

     

    Ryan joined the Centre for Policy Studies in January 2011, having previously worked for a year at the economic consultancy firm Frontier Economics.

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