Questioning the UK’s Economic Recovery - Exam Style

A lot has been made of the recent set of growth figures recently published of the UK economy. Despite the seemingly positive 0.5% quarterly growth and 2.6% annual growth, the overall impression is of disappointment and despondence. I am part of this crowd, a believer that the UK economy is only partially on the road to recovery. Several obstacles remain on this path ahead and some are already slowing us down including:1) Poor real wage inflation2) Poor productivity3) A ever bulging current account deficit4) National debts at record levels despite 'austerity'. Austerity set to continue5) Huge economic and political uncertainty in the Eurozone6) Consumer and Business confidence no more than pre-crisis levels and increasing survey data showing how households' perception of their financial situation is far below pre-crisis levels7) Long term and youth unemployment above pre-crisis levels8) Private indebtedness at record levels manageable through record low interest rates9) Banks remain unwilling to lend despite huge rounds of QE - Deflation risks putting banks off even more10) National election uncertainty11) Credit fuelled consumption the key avenue promoting growth. Manufacturing, construction and the trade sector are not contributing substantially to growth and in some senses are shrinking12) A rise in interest rates which could cause our debt time bomb to explodeThese points make for excellent evaluation for an exam style question on the UK recovery, particularly for OCR's Global Economy paper. But can students actually effectively get these points down answering the question in the detail and clarity required to score fully? The difference between grasping a concept, applying it and reading about it in this case and writing formally can be stark. Here is my attempt to get students to see the light when it comes to transferring these real evaluation points on paper referring specifically to extract 1 of the OCR stimulus material to an evaluation question of whether UK recovery can be sustained.

Point (1)

There are concerns that even though unemployment in the UK is falling, the long term unemployed are accounting for an ever increasing share of the unemployment figure. Professor John van Reenen in the extract is concerned that 36% of the unemployed have been unemployed for more than one year. A major negative impact of this is hysteresis where unemployment can lead to permanent unemployment in the future due to the loss of skills and human capital as that person becomes detached from the working environment. As a consequence, labour supply may be permanently lower in the medium term as growth picks up in the economy harming future potential growth curbing aggregate supply (a waste of resources) and aggregate demand through reduced incomes and spending. The recovery therefore may not be sustained.

Point (2)

Although growth has increased, real wages in the economy have yet to increase at any pace, that is wage growth beyond the rate of inflation. This is because productivity levels in the economy remain low and firms are not yet fully confident in increasing their costs when the economic climate is uncertain. Consequently, incomes and therefore spending in the economy maybe more subdued in the future if growth begins to slow halting the recovery.

Point (3)

To deal with mounting national debt, the UK government has implemented a strict deficit reduction plan which may conflict with UK economic recovery. This plan has involved heavy reductions in government spending accompanied by increases in taxation such a rise in VAT from 17.5% to 20% in 2011. Further austerity measures may reduce aggregate demand in the economy and reduce the chances of sustained economic growth and therefore recovery.

Point (4)

There are also concerns that UK growth is unbalanced with credit fuelled consumption still dominating. Personal levels of indebtedness are very high, corporate and public sector debt is also at record highs with this debt needing servicing. The longer the UK continues to grow based on borrowing, the more difficult it will be to sustain as money becomes more difficult to service and pay back. No where is this more evident than by looking at the UK’s current account position. Net trade is negative and has been negative for a large period of time and this deficit is growing. To finance this, the UK is borrowing large sums abroad adding to indebtedness. It is argued that for the recovery to be sustained, growth should be pursued from more investment and trade, which requires an improvement in international competitiveness.

Evaluation

Whether the UK recovery can be sustained depends on the nature of growth. If the UK economy is reliant on debt fuelled consumption to buy UK goods and services or imports (increasing the current account deficit), there is a risk that as interest rates begin to rise debts become so hard to service and repay that spending in the economy may grind to a halt. However if the UK can diversify and stimulate the trade sector, exporting more and importing less coupled with sustainable approaches to increase growth like increasing investment and productivity in the economy, these concerns may be limited.

Judgement

Based on the evidence, the UK economic recovery may well be sustained in the future. Inward growth from consumption as a result of higher incomes and falling unemployment will keep growth increasing as consumption is the major driving factor of UK GDP accounting for approximately 66% of growth. However there are significant risks to this recovery such as unsustainable levels of indebtedness, unbalanced growth and of real wages not increasing quickly enough which could scupper recovery if the UK suffers an unexpected economic shock, perhaps emanating from economic troubles in the Eurozone.