The Realities Of Rebalancing

Following the financial crisis, ‘rebalancing the economy’ became the favourite catchphrase of ministers, MPs and commentators alike. ‘Rebalancing’ became one of the Coalition’s three vaunted economic priorities – along with protecting the fledgling recovery and eliminating the deficit. Three years later the latter have both gone up in flames, victims of a stagnant economy. Yet, ministers have claimed there is ‘progress being made’ in rebalancing. However, the concept is broad and nebulous enough that the definition of progress is pretty flexible. That said, three separate but highly interdependent imbalances exist within the economy. Firstly, a sectoral imbalance between financial services and manufacturing; secondly, an imbalance between the south-east and northern regions; and finally, growth from consumer spending and debt and growth from net trade and investment. Such processes will take many years but early indications suggest that rebalancing hasn’t materialised; indeed the trend is in the other direction – towards further ‘overbalancing’ as it were. This is worrying given that economists have questioned the sustainability of growth in financial services. The UK’s over-reliance on them ensured it was particularly hard-hit in 2008. By spreading the drivers of growth across a wider range of sectors the economy should be more resistant to such shocks. The problem is that the government, inundated by dire GDP forecasts and facing political pressure, is quietly abandoning pursuit of ‘rebalanced growth’ for ‘any-growth-at-all’.In 2009, household and government consumption accounted for 89% of GDP but, with government cuts and households paying down debt, this clearly wasn’t a viable source of growth for the near future. The solution was simple – encourage manufacturing and the ‘March of the Makers’ would export the country to growth. This was accompanied by a variety of policies such as tax breaks and support for entrepreneurs. That march has become more of a stumble. Exports may have increased, but only by a measly average of 0.4% a quarter since 2009, even falling in the final quarter of 2012. Consequently last year’s trade deficit was a record high. Meanwhile, business investment has been erratic and remains some 10% below its 2008 level. There are numerous explanations, including the Eurocrisis crippling the main export market. However, other countries have still managed to increase their exports by more than the UK despite facing the same market conditions. UK exports to China have almost doubled in the last three years (from a very low base) but still only 6.5% of exports go to the high-growth BRICs. Particularly painful has been the sharp drop in exports of financial services, underlining the continued over-reliance upon City services for growth.

Indeed in the two years to June 2012 the output of business/financial services rose 2.4% – larger than increases across the whole economy (0.4%) or manufacturing (1.8%). Its share of the economy is actually increasing. This is problematic because it further shows how manufacturing growth is failing to gain traction. Although the latter still has a larger share of the economy than financial services this figure has declined to just 12% (as opposed to European and global averages of 25% and 31%). And despite all hopes and expectations it has failed to take advantage of the plummeting currency either by boosting exports or, as imports become comparatively more expensive, by recapturing more of the domestic market. Pessimists and doomsayers abound on the issue and argue that manufacturing is irrevocably crippled, handicapped by regulations, outdated infrastructure and high costs. Perhaps they forget that the UK remains the world’s ninth largest manufacturer, provides 55% of UK exports, over 2.5 million jobs and around £140 billion to the economy annually. Exceptional universities and world-leading strengths in areas such as aerospace, electronics and pharmaceuticals are evidence that the sector has huge potential. Indeed, its decline has been relative, not absolute; the sector’s output grew steadily in the pre-crisis decades.

Nevertheless, industry does face major challenges requiring more than just tax breaks and incentives. It’s almost ironic that a country home to the City cannot provide sufficient finance for businesses to expand or invest in their products. Another issue is human capital. A recent report found that UK businesses face an annual shortfall of 40,000 science, technology, engineering and maths graduates, a problem only aggravated by government policies restricting immigration. More apprenticeships are needed – only 3.7% of people are trained technicians, notably lower than the European average. Most importantly, the capabilities of manufacturers have been constrained by government policies that actively prevent regional rebalancing and continue to encourage an economy focused on a preponderant London and south-east. This is damaging because Britain’s industrial capabilities have always been distributed widely throughout the north and midlands. The government has sought to stimulate development in the north through several big eye-catching projects like the £33 billion HS2 line set to reach Manchester and Leeds by 2032. But even HS2 won’t provide major benefits for several years (not even in construction). Greater improvements will come, and sooner, from the newly approved £600 million Northern Hub. Connecting the major northern cities its set to return four times that back into the economy.
But these examples of investment, crucial as they are to long-term growth, belie reality.

Government policy continues to devote resources to London at the expense of the rest of the country. Boosting manufacture is about more than just exports – it’s about research, investment and jobs. Yet for every £37 spent on science and technology in the north, £59 is spent in London. Worse still, there is an urgent need for investment to upgrade the existing transport infrastructure in northern regions to support manufacturing. However, despite its superior infrastructure the south-east received an astonishing 87% of capital spending on transport last year. London alone sucked in £27.3 billion, with Crossrail (£16 billion), Thameslink (£6 billion) and the London Underground extension (£1 billion). One possibility, pursued by the Coalition but largely rejected, was elected mayors. These high-profile figures could have played a leading role in attracting investment and publically ‘fighting the corner’ of their cities. The successes of Boris Johnson demonstrate this, especially with increasing powers over housing and the local economy to shape them according to local need. Moreover, austerity has cast a heavy shadow over ambitions to develop regional enterprise and those programmes which are launched, e.g. City Deals and LEPs, lack sufficient resources and will struggle to make a significant impact. Together, this all means the ‘employment rate gap’ between the south and north has barely budged – if anything, it’s increased.

The economy faces huge challenges yet government policies have been contradictory and self-defeating. Large-scale projects like HS2 cannot exploit their potential unless supported by a wider, far more coherent policy environment. For all the talk of localism and an economic renaissance it isn’t hard to see why northern enterprise struggles to compete with the London-centric economic policies in place. Efforts to preserve London’s unique global position mustn’t mean repressing regional opportunities, not least as this endangers the potential growth of manufacturing. Desperate policies seeking to create growth by any means by replicating the conditions of a decade ago will only exacerbate the tensions that system created. That might improve the GDP figures but let 2008 serve as a warning – overbalancing means one hell of a fall.