The limits of rebalancing

This is the box for my Fund Strategy cover story on Britain’s economic recovery.

One of the government’s central commitments when elected into office in 2010 was to rebalance the British economy. This pledge had several elements to it.

In his first keynote speech as prime minister the newly elected prime minister David Cameron made rebalancing a central theme. The first element of this strategy was to reduce the over-reliance on a few industries – primarily finance – towards a broader economic base.

A second and related element was a regional rebalancing. This meant a relative shift away from London and the South-east. As the prime minister put it:

“Today our economy is heavily reliant on just a few industries and a few regions – particularly London and the South East. This really matters. An economy with such a narrow foundation for growth is fundamentally unstable and wasteful – because we are not making use of the talent out there in all parts of our United Kingdom.”

He went on to elaborate in more detail what he meant. “That doesn’t mean picking winners but it does mean supporting growing industries – aerospace, pharmaceuticals, high-value manufacturing, hi-tech engineering, low carbon technology. And all the knowledge-based businesses including the creative industries.”

Indeed even parts of the speech there were not flagged as being about “rebalancing” suggested a substantial shift was needed. It was also emphasised that the role of the state should be reduced – although Cameron was keen to stress that “government cannot be a bystander – and that the private sector should be allowed to thrive.”

Similar themes were evident the following month in the emergency budget announced by George Osborne , the new chancellor. In his words:

“Our policy is to raise from the ruins of an economy built on debt a new, balanced economy where we save, invest and export. An economy where the state does not take almost half of all our national income, crowding out private endeavour. An economy not overly reliant on the success of one industry, financial services – important as they are – but where all industries grow. An economy where prosperity is shared among all sections of society and all parts of the country.”

More than three years later the government is claiming some success in rebalancing. In a keynote speech on the economy in September the chancellor claimed “growth is balanced across all sectors of the economy”.

He went on to point to the existence of growth in all economic sectors, the importance of net exports relative to consumer spending and the pick-up in investment.

However, such claims are based on a selective reading of the data. For example, it is true that in the last two quarters all of the four main industrial groupings – agriculture, production, construction and services – enjoyed rises. But services are 0.4% higher than their pre-recession peak while manufacturing is 8.9% lower and construction 12.5% lower. In other words, the economy has, if anything, shifted further away from manufacturing since 2008.

Some economists, such as Samuel Tombs, a UK economist, accept the argument that there are tentative signs of rebalancing. Other, including Andrew Milligan of Standard Life Investments, are more sceptical: “For those who are concerned about it, it is not the rebalanced economy that Mr Osborne promised.”

However, Milligan is doubtful that rebalancing in the sense of a shift back towards manufacturing is likely to happen at all. “The trend is the manufacturing sector is not going to be bigger. Not just in the UK but in all advanced economies”

In contrast, RBC’s Larsen – while not necessarily advocating such a move – argues that only sustained government action is likely to lead to a relative shift back to manufacturing. “Unless you put in place an industrial policy that encourages it I don’t think it’s going to happen,” he says.

However, there is one area where rebalancing is expected but it looks unlikely to happen. Despite the talk of reducing public spending there is no trend for any significant decrease in state intervention in the economy.

In terms of public spending it is true that as a proportion of GDP it rose sharply in 2009 and stayed at this higher level for the three subsequent years. But according to the Office for Budget Responsibility spending in 2017-18, after several years of cuts, it is expected to return to about the same level as in 2008. Even this may not be achieved if the assumptions on which the estimates are based turn out to be off.

In addition, the Bank of England has become more interventionist than ever. It has implemented quantitative easing since early 2009 and there are no signs of any imminent winding up of the programme. Forward guidance, if anything, means a continuation of extraordinary measures in monetary policy rather than reining them in.

Rebalancing will certainly not mean a shift away from a heavy economic dependence on the state. If anything the trend may be towards even greater intervention by the authorities.