Businesses in a funk: The real reason GDP fell in Q4 2011
The second estimate of UK GDP (pdf), released today by the Office for National Statistics (ONS), confirms the economy contracted 0.2 per cent in the final quarter of 2011 (see Chart 1). It also provides some details to help us understand why the economy contracted.
It was not the result of the eurozone crisis. Exports increased by a healthy 2.3 per cent in Q4 2011. The national accounts data do not tell us where these exports went, but monthly trade data do.
These do not show a collapse in exports to Europe or a sudden surge in exports to the rest of the world. European demand was almost certainly still positive for growth in the UK at the end of last year.
Imports were up only 0.4 per cent in the final quarter of 2011, so net trade added 0.6 percentage points to growth.
The contraction was not due to retrenchment by households. After declining for four consecutive quarters, real consumer spending was up 0.5 per cent in the final quarter of 2011. This was largely the result of lower inflation. Prices increased by just 0.3 per cent in Q4 2011 – the smallest increase since the second quarter of 2009.
When economists talk of the annual rate of inflation falling during 2012, easing the squeeze on real household income and leading to stronger consumer spending, it is often not understood that this improvement will happen throughout the year. Indeed, it seems that it began in Q4 2011.
The most recent news – oil prices are at a record high in sterling terms – shows once again that nothing is certain in economic forecasting. But if inflation on a quarterly basis remains as low as in Q4 2011, better consumer spending figures will probably be sustained.
The contraction in GDP in 2011Q4 was not due, at least directly, to cuts in government spending on goods and services. This increased by 1.0 per cent and added 0.2 percentage points to growth.
GDP contracted because businesses went into a funk, cut their spending and hoarded cash instead. Weak consumer demand earlier in the year, continued talk about austerity, and the risks – if not yet any direct effects – represented by the eurozone crisis together caused a fall in business confidence and willingness to spend.
This had already shown up in surveys showing they were cutting back on recruitment and investment spending – now it is emerging in the data too.
In Q4 2011, business investment fell by 2.8 per cent (taking 0.4 percentage points off growth), compensation of employees was cut by 0.3 per cent and there was a big fall in inventory building, taking 0.5 percentage points off growth.
Some surveys have suggested business confidence improved in January, pointing to a better outcome for GDP in the first quarter of 2012. However, the Bank of England’s survey of its local agents shows a different picture. In manufacturing and service industries, investment plans and employment intentions fell further in January.
If businesses remain in a funk and continue to hoard cash, it is likely to be touch and go whether we see another contraction in GDP in the current quarter.