Balanced economy

A balanced economy suggests that economic growth is sustainable, and the economy is growing across different sectors. A balanced economy has several key features.

  • Low inflation – avoiding an unsustainable boom and bust period of economic growth.
  • A balance between saving and consumption. An unbalanced economy would consume a  high % of income. A more balanced economy would be saving a significant percentage of income to finance investment and future productive capacity. Without sufficient savings and investment, long-term growth will be constrained.
  • Trade balance. A balanced economy would have a balance between exports and imports – a low current account deficit. If the economy is relying on imports and running a current account deficit. This is a sign of imbalance. The current account deficit would need to be financed by capital inflows.
  • Housing market which is stable. A stable housing market helps to balance the economy. A rapid rise in house prices could cause a positive wealth effect and a temporary rise in spending – which later proves unsustainable.
  • Sustainable bank lending. A balanced economy needs a strong and stable finance sector. Firms need access to credit, but unlike the credit crunch, the bank lending needs to be sustainable and not dependent on other bank loans.
  • Growth across different sectors. An economy relying on the primary sector for growth is more at risk of fluctuating commodity prices. An economy reliant on growth in only services may struggle to gain sufficient export revenues.
  • Growth evenly distributed across income spectrums and across different geographical regions.

Warning signs of unbalanced economy

  • Large current account deficit – especially if financed by borrowing or volatile short-term capital flows.
  • Inflationary growth causing demand pull inflation
  • Economic growth caused by higher consumer spending, which in turn is financed by higher credit and a falling saving ratio.
  • Rapid income growth amongst some sectors and income groups and falling income amongst lower income groups.
  • Unsustainable rise in asset prices, such as houses, which could fall causing economic hardship for banks and home owners
  • Unsustainable rises in credit and debt levels both private and government.
  • Reliance on government spending and decline in private sector.
  • Lack of public sector investment to provide necessary public goods.
  • Falling productivity and decline in investment.
  • Reliance on extreme monetary / fiscal stimulus.

Is the UK economy a balanced economy?

Firstly, services which accounts for nearly 79% of the economy is showing good growth. The Index of Services increased by 2.0% in April 2013 from April 2012 (ONS) Service sector output only 1% below pre-crisis peak.

Manufacturing output by contrast has taken bigger fall in output.

manufacturing-2000-2012

Saving ratio and balance of consumer spending

 savings-ratio-q1-2013

We can see in Q3 2007, the UK was dangerously unbalanced with the household savings ratio falling close to 0% – it was symptomatic of the UK’s unbalanced growth – relying on credit, rising house prices and high spending. The recession saw a sharp rebalancing – with a rise in the savings ratio. But, this dramatic fall in consumer spending was at a cost of a deep recession. (A reminder that unbalanced economies can be difficult to rebalance). However, in the last two quarters we have seen a worrying trend with the savings ratio plummeting from over 7% to 4%.

In the first Q1 of 2013, private consumption spending rose 0.3%, but this was managed by a declining saving ratio and higher consumer credit. Personal disposable income, in this period fell  1.7%. It is a classic example of UK economy being boosted by higher spending financed by borrowing and running down savings.

Current account balance

UK-current-account-quarterly-2000-2012

The UK current account shows that the UK has had a persistent current account deficit for the past decade. (More graphs at UK current account)

The worrying part, is the deterioration in the current account towards the end of 2012. A current account deficit of 3% of GDP is worrying because :

  • This deficit is despite a 25% depreciation in the value of sterling. In theory, a depreciation should make UK exports more competitive and help to rebalance the economy.
  • The deficit is despite a deep recession, which usually leads to an improvement in the current account due to lower import spending.
  • (In evaluation, it could be pointed out that Europe, our main trading partner, is experiencing a deeper recession – hence there is one reason for relatively poor export growth)

Investment

Business investment is down  34% in real terms since 2008. Even government investment has fallen 6%. This fall in investment is particularly a cause for concern because many business leaders are expressing fears about supply constraints in transport and infrastructure. It is usual for investment to fall in a recession. But, this decline in investment is very prolonged – lasting over 5 years. It hints at future supply constraints and lower growth opportunities.

Bank Lending

The one good piece of news for the UK economy is that stricter rules on bank liquidity ratios has meant banks are no longer lending money based on borrowing. It is a return to a more sustainable form of lending backed by deposits. However, it has been at the cost of a big fall in lending to business – explaining part of the fall in investment.

Monetary stimulus

Some may claim the UK economy is being ‘propped up’ by artificially low interest rates and a massive expansion in the monetary supply from quantitative easing. The extent of this would be a whole article in itself.  In short, the stimulus effect of Q.E. has been limited. But, when interest rates rise from zero, some homeowners and business may struggle to meet rising loan costs. (See when will interest rates rise?)

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