TEN DAYS ago on this page, Matthew Parris challenged me to explain one of the strangest and most important social phenomena of modern Britain — the combination of evident prosperity, which has now spread even to formerly depressed industrial regions, with bafflement about the sources of this sudden good fortune and a sense of foreboding about a day of reckoning which must surely follow.
Matthew is usually an eloquent spokesman for the subliminal hopes and fears of Middle England and in this case his forebodings about a day of reckoning are certainly shared by millions — probably tens of millions — of people across the land. Indeed, his article was drawn to my attention by a worried friend, as we sat around the pool last week at my French holiday house (bought by remortgaging my London home).
An abstruse and complex subject such as economics can be brought to life with concrete examples and Matthew does this by focusing on Chesterfield, in Derbyshire where he lives. After describing how Margaret Thatcher’s policies destroyed the town’s traditional industries in the 1980s, he draws attention to the fact that it has not experienced the bleak future of economic decline that he had feared. Instead, Chesterfield is buzzing with busy shopping complexes and restaurants. “There is a good college, a swanky modern hospital, a swish new railway station, a range of supermarkets and giant DIY stores, a good bookshop and a beautifully restored marketplace around which crowd smart boutiques. New private housing estates abound. People dress well and drive around in 4x4s.”
But he wonders what Chesterfield’s apparent prosperity is based on now that the coal industry is gone and little is left of steel and engineering. He writes: “I cannot but share with my countrymen this nagging feeling that a nation of homeowners energetically bidding up the value of each other’s property, borrowing on the basis of the inflated figures, then spending money in hypermarkets buying Chinese power-tools, Brazilian hardwood, Swedish furniture and Australian wine . . . such a country is somehow riding for a fall.”
As I am one of the few economic commentators who has consistently made light of the anxieties about a “day of reckoning” for British homeowners and consumers, Matthew challenges me to explain why it will never come, adding: “Perhaps he has already, but I missed the point.”
I have often discussed this apparent paradox of rising consumption alongside falling production, but if Matthew has “missed the point” he is in good company, since I constantly encounter the same bewilderment about Britain’s “unearned prosperity” from politicians and businessmen, as well as dozens of readers. I will try to answer Matthew’s question in two articles. Today I will examine the main reason for the public scepticism about Britain’s present prosperity. Next week I will try to explain the underlying economic forces which have brought this prosperity about.
The most frequent objection is the problem of invisible production, illustrated by Matthew’s examples of power-tools from China and hardwood from Brazil. It seems that Britain no longer makes anything that one can lay one’s hands on. Everything we buy in the shops is made in China, Germany or Japan. It is understandable that people who have always measured their wealth by the ownership of consumer goods, tend to see an apparent prosperity based on “invisible earnings” from finance, law or entertainment as some kind of statistical trickery.
As Matthew puts it: “Maybe it is all to do with invisible earnings from the City. Maybe we can really all live by taking in each other’s washing, cutting each other’s hair, compiling books and glossy magazines and eating in each other’s restaurants.”
But his implication is that we cannot.
The fundamental objection to “taking in each other’s washing” was answered 200 years ago by Adam Smith, who explained that division of labour is what a market economy is all about. But the real anxiety reflected in Matthew’s argument, is not about the growth of a service economy, which is now widely accepted. It is about Britain’s position in international trade. Services may account for the bulk of the new economy, but if everything in the shops is imported surely our mutual back-scratching will not be sufficient for Britain to pay its way in the world?
There are many flaws in this argument, some of which I will return to next week, but the most important objection is also the simplest and the least understood. While it is true that everything we buy these days seems to be labelled “made in China”, this does not mean that the money we spend on these goods ends up in China and drains resources from the British economy. Far from it. The best way to see this is to consider an extreme example — say, a toy based on the Harry Potter stories.
If you buy a plastic model of Professor Dumbledore in a toyshop, it may cost you about £10 and it will doubtless be labelled “made in China”. But how much of this money will the Chinese actually receive? Roughly half the retail price will go to the retailer and distributor, with another £2 or so paid to Matell, a US toy company, which in turn will spend much of this money on toy design, advertising, promotion and distribution in the UK. A further 10 per cent or more will go to Warner Brothers, which owns the Harry Potter film rights, and additional royalties will be paid to J.K. Rowling and her British publishers. Then there will be the costs of shipping the plastic toys from China, leaving only a small remnant of your purchase price for the toy manufacturer in China, who will then have to spend a goodly portion on chemicals, paints and plastic moulding machines, probably made in Korea or Japan. In the end, only 50p of the £10 you paid for the Harry Potter toy may end up as wages for Chinese workers or profits for Chinese manufacturers — the “value added” implied by the words “made in China”. Meanwhile, the retail and wholesale margins, royalties, design, advertising and promotion will probably contribute £7 or £8 to Britain’s GDP.
This lengthy example illustrates why a country’s economic output cannot be estimated by the number of “made in . . . ” labels found on the supermarket shelves. The way to measure the true economic output of British workers and businesses is to follow through the entire chain of value creation. Luckily the Office of National Statistics undertakes this tedious task every three months when it publishes the quarterly national accounts.
These show that Britain’s deficit with the rest of the world, taking into account the “invisible” earnings from finance, law, tourism and other services, is — contrary to the saloon-bar philosophers’ assertions — very small. Last year it was only 1.7 per cent of GDP. Given that the British economy has been booming, while our biggest trading partners in Europe have yet to emerge from recession, this modest deficit is far from a threat to the country’s well-being.
In sum, the almost universal belief that Britain, as a nation, is living far “beyond its means” is simply untrue. Some individuals may be borrowing too much, but this is not true of Britain as a nation. In this sense, at least, the present prosperity is real and sustainable.
But there is another, deeper reason for the sense that Britain’s newfound prosperity is some kind of new Labour conjuring trick or bull-market illusion. Britain’s economic success, especially in relation to other European countries, represents the reversal of a hundred-year trend. For anyone born before the mid-1980s, belief in the country’s continuing prosperity means abandoning a century-old assumption about Britain’s inevitable decline. Are there genuine economic forces which justify such a reversal? This is the question I will try to answer next week.
Join the Debate at comment@thetimes.co.uk
