George’s puzzle

THERE WERE two headline-grabbing statistics published in January, apparently unconnected but in fact very closely linked. The key number was the first estimate of activity in the final three months of 2011. This came in at -0.2%. It was based on a small sample, there are still two more estimates to come and it did seem to contradict results from other sources (such as the PMI surveys). But it was in negative territory and unsurprisingly sparked fears of a double-dip recession. Growth in 2011 was a weak 0.9%, well down on what might be expected in the third year of recovery, and the level of activity still remains 2.5% below the pre-recession peak of 2007.

The fact that it was manufacturing that let the economy down was especially disappointing. For the third of four quarters in 2011 output fell, which probably reflected the turmoil in the key eurozone export market. It also shows how difficult it will be to rebalance the economy, to wean the country off its traditional dependence on household and government consumption and rely more on exports and investment. If these routes to growth are blocked off, and the chancellor sticks to Plan A in his fiscal policy, then 2012 could be as tough a year as 2011.

Also in January came the news that for the first time the UK’s national debt topped £1tn. The debt is now the equivalent of 67% of GDP, and this excludes the “temporary” cost of the interventions in the financial sector. Putting this in a broader context highlights the magnitude of the problem. In the eurozone, for example, markets are nervous about the future of Spain to meet its commitments when its debt is a mere 50% of its GDP. But despite the mind-boggling number, for the UK, crossing the trillion pound threshold was really a more symbolic than policy-changing event.

There is no denying the speed with which the UK’s public finances have deteriorated. Just 10 years ago, debt was £314bn, equivalent to a shade under 30% of GDP. This was as good a shape as the public finances had been in for a generation or more. The ratio then started to edge up even in the good years, before it accelerated in 2008. It looks set to keep rising for another three or four years yet.

There are two reasons why the £1tn figure was more exciting for the media than for economists. First, for a country, company or individual, debt per se is not the issue. Far more important than how much money is owed is how much the debt is costing to service and today, the proportion of GDP accounted for by the country’s debt servicing charge is less than in the 1990s when interest rates were in double figures. Unlike the US and France, the UK has retained its triple-A credit rating, which means at times in recent months the country’s borrowing costs have been lower even than Germany. George Osborne attributes this to the market’s confidence in his Plan A fiscal tightening.

Second, the debt ratio – although high – pales in comparison with the 200% of the 1950s, an era when the country had not even finished paying for the Boer War, let alone two world wars. Yet the 1950s was the decade in which the UK achieved its fastest rate of post-war GDP growth. The three messages from this are obvious: debt need not stifle growth; without growth the debt will rise; and growth is as important a way of reducing debt as raising taxes or cutting spending.

The inter-connection of growth and debt is inescapable and the GDP figure probably caused more consternation at the Treasury than the debt number. Reducing the debt, keeping the triple-A rating and trying to get activity on a sustainable growth path is the economic Rubik’s Cube that Osborne has to manage in the coming months. ?