Everything we thought we knew about the economy was wrong

Annual GDP growth in the 1997-2012 period is now estimated to have been 2pc, up slightly from the 1.9pc previously thought. That’s not a significant change and, in fact, growth between 1997 and 2007 is deemed unchanged at 3pc per year. The big difference is that the economy has done much better since, to the tune of an extra 0.5 percentage points of growth a year between 2007 and 2012, thanks to faster growth in measured investment. Remember, nothing real has changed but the new way of classifying research and development spending has meant that the recovery was much stronger than previously thought.

Until now, we were told that the economy expanded by 1.7pc in 2010, 1.1pc in 2011 and 0.3pc in 2012. The picture now looks much healthier, with 1.9pc growth in 2010, 1.6pc in 2011 and 0.7pc in 2012.

Politically, the detail of the changes is even more explosive. As Andrew Lilico of Europe Economics points out, it appears that the present recovery was tracking that of the 1980s recovery until mid-2011 (14 quarters after peak), when it stalled somewhat. This coincided with the downgrade of the US economy and the eurozone veering into crisis, strongly reinforcing the Coalition’s claim that it was external shocks that halted the recovery. It was also around that time that the Chancellor infamously abandoned his target of eliminating the current structural deficit over a parliament, Lilico reminds us.

The new figures show that GDP returned to its pre-crisis peak by the third quarter of last year and is now 2.7pc above that level. Given that 2013 data has yet to be revised, we could have grown by even more since then.

What is especially devastating about this is that the return to the pre-crisis peak came so soon after credit rating agencies started to worry about the UK, that the Coalition’s critics were warning of double-dip recessions or worse and that lots of usually level-headed individuals and organisations started to lose their nerve over austerity. Had we known then what we know today, recent political history would have been very different.

Even the UK’s woefully weak productivity is partly rectified by the new figures. Sure, the performance is still abysmal but much less so than previously thought. The revised figures suggest that productivity fell by just over 4pc from the first quarter of 2008 to the fourth quarter of 2009, before regaining its pre-crash level by mid-2011. Output per hour subsequently fell back again.

The actual behaviour of consumers hasn’t changed but the shake-up in the way employers’ pension contributions are accounted for bolstered the household saving ratio between 1997 and 2009 by two to five percentage points a year. It all looks much better now, even though the simple truth remains that millions of people who don’t enjoy final salary pensions are still saving far too little. They shouldn’t be lulled into a false sense of security.

The new figures matter for two main reasons.

It is now even harder to argue that “cuts” wrecked the recovery, especially given that actual, overall real-terms reductions have in fact been much smaller than almost anybody realises. My own view is that the cuts should have proceeded at a faster rate, focusing on current expenditure, and that it was a mistake to hike VAT but the point is that the Labour narrative on all of this is now well and truly defunct. Many of the journalistic and political debates of the time now look utterly absurd and one wonders what the endless (and wrongheaded) talk of double-dip and triple-dip recessions did to business confidence and thus investment.

The other big lesson is that the Bank of England’s refusal to hike interest rates is even less defensible than before. The old policy of forward guidance, as originally introduced by Mark Carney when he was appointed, was immediately obsolete; the economy was already in recovery mode. And if we accept the new methodology – and everybody will eventually fall into line, as they always do – then it means that the economy has rebounded much more than previously thought and that there is therefore far less spare capacity remaining. Interest rates need to start going up, and fast.

allister.heath@telegraph.co.uk

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