Should the government take comfort from the fact that fiscal tightening in 2010 did not derail the recovery

Should the government take comfort from the fact that fiscal tightening in 2010 did not derail the recovery ; By a large majority of 14:2, City economists thought the fiscal retrenchment would hit the economy hard in 2011, even if many supported the cuts and none predicted a double-dip recession. Alan Clarke, of BNP Paribas, said the recent strong official data for the third quarter gave him little comfort. “The fact that the breakdown by output shows that growth has been supported by construction and government output – neither of which are likely to persist – makes me worry more, not less.”

A likely decline in household disposable income as taxes rise and spending cuts bite has led economists to revise down forecasts for 2011 growth. Richard Jeffrey, of Cazenove, said a slowdown would arise as “the consequence of a weak labour market due to public sector layoffs and the pernicious combination of relatively high price inflation and very low wage inflation”.

Last week the Local Government Association estimated that the front-loading of the spending cuts would bring 140,000 job losses next year in local authorities, significantly higher than an earlier estimate of 100,000.

David Kern, chief economist of the British Chambers of Commerce, said: “The recovery is still fragile and recent positive developments do not guarantee that we will avoid a nasty setback.”

The better-than-expected performance of the economy in 2010 is part of the problem, economists say, as households have already reduced their savings rates and cannot easily spend more as their income is expected to fall next year.

“If we could rely on robust demand in the rest of the world, we might be less concerned about the impact of the fiscal shock, but there is a whole lot of uncertainty out there,” said Peter Dixon, of Commerzbank.

Not all economists were pessimistic. Ben Broadbent, of Goldman Sachs, and Neville Hill, of Credit Suisse, argued that a good part of the fiscal tightening could be absorbed. “Fiscal tightening needn’t be a problem for an economy if it has an independent monetary policy and floating currency; is competitive; and has a private sector in surplus. The UK has exhibited all of those qualities,” Mr Hill said.

What are the main sources of medium-term UK growth and what policies could encourage expansion?

If City economists showed an unusual degree of consensus over the most likely effect of fiscal tightening in 2011, their views on the drivers of medium-term growth were as disparate as could be. A few thought the OBR and Bank of England’s ambition for investment and net trade would come to fruition, but more hoped that Britain would find a route towards higher productivity growth.

Michael Dicks, of Barclays Wealth, said: “We need to adopt best-in-class techniques . . . our productivity performance is miserable. Raising skill levels is one important policy.”

But George Buckley, of Deutsche Bank, cautioned against raising hopes that investment and productivity would bounce back quickly. “As we’ve seen in the past, especially with measures designed to raise productivity, this is easier said than done.”

Some supported higher immigration of skilled workers and less reliance on the public sector for economic underpinning. Ross Walker, of RBS, said: “I simply do not believe that more intrusive regulation and state direction is the way forward for the wider economy.” Copyright The Financial Times Limited 2010. You may share using our article tools.