Rediscovering Growth. Andrew Sentance

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      It is not possible to pinpoint exactly what might drive a new growth phase which could become established later this decade. The experience of previous growth phases can offer only limited insights – we need to look forward rather than back to the past to identify potential new technologies and emerging business and consumer trends. But there are common conditions which have underpinned the two major growth phases we have seen in the modern post-war era – a supportive financial system and confidence in the stability and sustainability of economic policy. These preconditions do not yet seem to be in place to support a return to stronger growth in the major Western economies, though they could be later this decade.

      The final lesson I would highlight from past experience is that some countries and some businesses have been much better at riding the changing tides of economic growth than others. Northern Europe – including the UK – has been an economic powerhouse for the world economy for at least three centuries now. North America and other offshoots of European civilization developed and flourished in the 19th and 20th centuries – led by the United States. And it looks likely that the Asia–Pacific region – led by China and India – will be the driving force for the world economy in the 21st century. Looking ahead, we should expect these three regions to continue to provide the main support for economic growth across the world economy. Elsewhere, economic prospects look more uncertain and more variable.

      The purpose of this book is to shed light on the big tides which underpin economic growth – not to provide detailed forecasts for GDP this year, next year or five years hence. I hope it will provide a map to help readers navigate the changing tides of economic fortune – and to prosper and succeed in these turbulent times.

      In Chapter 1, I discuss how the global financial crisis of 2007–8 brought us down to earth after excessively optimistic assessments of economic prospects for the major Western economies in the mid 2000s. Chapter 2 looks back to the experience of the 1970s and highlights some uncanny parallels with our recent experience. In my view far too much reference has been made to the Great Depression of the 1930s in the economic analysis of the financial crisis, and not enough has been learned from the more recent economic and financial turbulence in the 1970s. That leads on to my view that we are in a New Normal of disappointing economic growth and volatility which is likely to persist for a while. That is the subject of Chapter 3.

      The next two chapters discuss which countries will be the winners and losers in this brave new world (Chapter 4) and how governments might adapt their economic policies to the New Normal economic environment (Chapter 5). This leads on to a discussion in Chapter 6 of the potential drivers of business success in the post-crisis economic environment.

      Chapter 7 focuses on how the major Western economies might exit from this rather disappointing phase in our economic journey. One view is that we can’t or won’t. But I think this is too fatalistic. The successful economies in the 21st century will be those which are prepared to embark on a new phase of economic reform and restructuring – and which recognize that the drivers of a future ‘new growth phase’ will need to be different from the past.

      The final chapter discusses whether we should be optimists or pessimists about the economic outlook. I will not tell you here. You need to read the rest of the book to find out!

      Chapter 1

      The end of the Great Stability

      Our economic world changed dramatically in 2008 – a year which must go down as one of the most turbulent in the modern history of the global economy. The first half of the year was dominated by a strong surge in energy, food and other commodity prices – with the oil price rising to a peak of $147/barrel in July. Inflation and business costs were pushed up in most countries around the world, squeezing consumers and putting pressure on company finances. In the second half of the year, we experienced the full force of the financial crisis, which had been gathering momentum for over a year. Extreme turbulence in the financial system led to the failure of Lehman Brothers in September 2008 and the near collapse of other banks and financial institutions. Around the world, governments and central banks were forced to step in with bailouts and a raft of other emergency measures to prevent a total meltdown of the financial system.

      Two years before this financial turmoil was unleashed in the autumn of 2008, I had left my job as Chief Economist at British Airways (BA) and joined the Bank of England Monetary Policy Committee (MPC) – the body which sets interest rates for the UK economy. While there was some discussion of financial risks on the MPC, the main focus of the economic debate in 2006 and 2007 was not on how unstable the economy might become, but why it had been so stable for so long. The prevailing view at that time was that the United Kingdom and other Western economies were experiencing a period of Great Stability – characterized by steady sustained growth and low inflation.

      I joined the MPC just as this period of stability was coming to an end. With hindsight, I should have been prepared for that as turbulent economic conditions had been following me around throughout my career. I started my first job as an economist at the Confederation of British Industry (CBI) in 1986, just at the start of the major boom–bust cycle which dominated the late 1980s and early 1990s. I was responsible for the CBI’s economic commentary and policy recommendations over a period which saw double-digit inflation, interest rates at 15%, a major recession, record public borrowing and the trauma of the United Kingdom leaving the European Exchange Rate Mechanism (ERM) less than two years after joining.

      This pattern was repeated during my time at BA from 1998 to 2006 – which included the most severe downturn in the history of global aviation following the 9/11 attacks on the World Trade Centre. This massive shock to the airline industry threatened the survival of BA, and radical business surgery was needed to achieve a turnaround – including the loss of 13,000 jobs, nearly a quarter of the company’s total workforce.

      So perhaps I should not have been surprised when the early signs of the financial crisis began to emerge after less than a year of my time at the Bank of England. As the minutes for the August 2007 MPC meeting recorded:

      The main news this month in financial markets had been the sharp deterioration in credit markets and the associated falls in equity prices and changes in market interest rates. A trigger for this turbulence appeared to be renewed concerns about the US sub-prime mortgage market, the losses of some prominent hedge funds, and the revisions to the ratings of some mortgage-backed securities; this had led to a reduction in demand for products such as sub-prime mortgage-backed securities and collateralised debt obligations…. It was not clear how far the downturn in financial markets would go, nor how long it would persist.

      These financial market tensions led to the demise of the UK bank Northern Rock in the autumn of 2007 and major banks like Merrill Lynch, Citibank and UBS started to announce large losses and debt write-downs. Yet, at the start of 2008, views about the growth of the world economy remained remarkably positive. The IMF’s January 2008 economic update predicted that the world economy would grow on average by over 4% in the coming calendar year. That would have been a healthy rate of growth by longer-term historical standards, even though it represented a slowdown from the boom-time global economic conditions of 2004–7.2

      A year later, in January 2009, in the aftermath of the collapse of Lehman Brothers and all the other financial turbulence in autumn 2008, things looked very different. The outlook was for recession across the world economy with sharp declines in output in all the major Western economies. Under the headline ‘Global Economic Slump Challenges Policies’, the IMF predicted that world growth would be just 0.5% in the year ahead, the weakest year for global growth since 1950 at least.3 In fact this was an underestimate of the scale of the downturn – world GDP actually fell in 2009 for the first time since World War II.

      Going back to the start of the 20th century, there are only two other peacetime years when the outlook for the world economy deteriorated as dramatically as in 2008. One is 1930, which marked the onset of a prolonged depression in the United States and Europe after the Wall Street Crash of 1929, bringing to an end the prosperity of the ‘roaring twenties’. The other is 1974, when the long post-war boom came to an end amidst rampant inflation, rocketing oil prices and financial turbulence. That year ushered