The Quarterly: New economic environments


The Coalition’s Rebalancing Act

The Coalition’s Rebalancing Act

In the search for blame that followed the global financial crisis the idea of structural imbalance was attractive. After all, things teeter before they crash. But rebalancing meant different things to different people.

For the Conservatives it primarily meant over-reliance on the public sector, with an implied focus on national debt. In his first Budget speech, George Osborne told parliament that the size of the state “crowded out” private endeavour.

For Labour in opposition it meant over-reliance on financial services, with the implied need to refocus on manufacturing and the regions. And an easy conclusion for many was that if the banks hadn’t been so big, things wouldn’t have got so out of control.

In reality neither the size of the British state nor the size of our banks were responsible for the global financial crisis. I cite as evidence the fact that countries with small financial sectors also went into recession, that government debt was low by international standards and projected to fall when the crisis hit, that small institutions – including mutuals – went bust, that some very large international banks did fine and that manufacturing was already larger than financial services in its contribution to GDP before the recession.

The problem was less one of imbalance and more one of a gaping void between the way many complex financial assets were valued – mainly, as the IMF has shown, related to the US housing market – and their underlying worth. In Britain, however, high levels of household borrowing meant that when the crisis hit, families had further to adjust to get themselves back on an even keel.

Since both diagnoses of imbalance were wrong, the economic patient has not behaved in the way either political doctor would have expected. The sharp paring back of the state did not unleash entrepreneurial spirit commensurate with the problem being the need to rebalance from public to private. Rather it drained demand out of the economy and tipped us back into near-recession for a further two years.

And recovery when it finally came was not because manufacturing and the regions were at last able to realise their potential, but because business services, predominately in London and the South East, got their mojo back. The recession has been noticeably harsher in every other part of the UK than in London, even despite the latter’s reliance on financial services, and manufacturing is actually a little weaker now than it was a couple of years ago.

We are left in 2014 with an economy pretty similar to the one of five years ago. The differences are first that the household sector as a whole has less mortgage and other debt, second that the banks are better regulated and more aware of risk, and third that London, if anything, is stronger.

There has been a shift from people working in the public to the private sector, but not in the number of companies employing people. According to BIS’s latest Business Population Estimates, it is the number of sole traders and other non-employing businesses that is on a steady upward trend; the number of businesses that actually employed people fell by 26,000 in the last year.

If you agree with the political diagnosis of the last crash, then, today’s similarities might suggest a repeat is imminent. But that diagnosis confused the general environment with the direct causes of the crisis.

Raising the potential economic contribution that can be made from every part of the UK, having an efficient government, growing the strength and resilience of the private sector in general and manufacturing in particular, and ensuring individuals can maximise their potential in the labour market are all important long-term goals, for both economic and social reasons.  They aren’t correlated to the crisis we’ve just witnessed.

It would be more helpful to shift the debate from rebalancing to sustainability. There will be another shock to the economy, hopefully a long time from now, and it will (by definition) be unexpected and could happen in any sector. Remember the oil price and exchange rate shocks? The dotcom bubble? The trick is to be able to identify it early enough to mitigate the effect;  for either main party a dogmatic policy belief set is unlikely to help