Britain has escaped recession, but its economy remains weak. The house-building industry explains why, and also suggests how the slump might be ending

WHEN narrowly avoiding a triple-dip recession is the best that could have been hoped for, it is clear that an economy is in the doldrums. On April 25th statisticians estimated that Britain’s economy grew by 0.3% in the first quarter of this year. That is well within the margin of error, and may be revised away. It is not growth so much as a bump.

Other countries are struggling, too. But in the G20 club of big economies, Britain’s performance ranks second worst over the past five years, above only Italy’s. No slump in two centuries has been this bad.

Britain is an economic laggard for a variety of reasons. It is highly dependent on financial services, which have suffered. The public sector, once another big growth area, is being cut in an attempt to balance the books. To cap it all, more than half of Britain’s exports are to sickly Europe.

But the most important explanation is Britain’s hobbled banking sector. The big lenders make more loans than they have deposits, plugging the gap by borrowing in markets. But in 2008 that funding dried up. Only HSBC, a bank with a large wall of Asian deposits, was immune. Lenders scrambled to borrow money at higher prices, or cut their lending to narrow the funding gap. The economy suffered as a result: since 2009 lending to businesses has been in constant decline. And despite the fact that the Bank of England’s interest rate has been held at 0.5%, average mortgage rates are close to 4%.

A look at the construction industry shows how the credit crunch has damaged the economy. The industry is still shrinking. Counting firms that build houses, offices and civil projects together, its contribution to GDP was a disappointing minus 2.5% in the first three months of 2013 (see chart). Although construction accounts for just 7% of national output, it is a drag on the whole economy: growth in the biggest chunk, services, was a fairly healthy 0.6%. If all were well, private house-building would be on the up, says David Thomas of Barratt Homes, Britain’s biggest builder. Each year 230,000 or so new homes are needed partly because Britons are living longer and in smaller households. But even before the crisis, the supply of new houses fell short, averaging 190,000 per year. There is thus lots of demand. But British homes are expensive. The average house costs £163,000 ($250,000) according to Nationwide, a building society. That is around six times a typical worker’s pay. When banks were willing to lend up to 95% of the value of a property, this was not a grave problem. But such loans disappeared in the credit crunch. As lenders refused to lend more than 75% of a property’s price, deposit requirements jumped from £8,000 to £40,000. Demand fell, followed by supply: the number of new private houses completed per year fell by almost half between 2007 and 2011. The fate of Britain’s builders also illustrates another trend: the travails of small firms. There are many small builders, says Jeff Fairburn of Persimmon, another big firm. Industry data show that the top 20 companies account for only about half of all construction. If the sector is to expand, both large and small need to be healthy.

Tight credit is choking small firms. In house-building, as in many other industries, bigger outfits tend to have more of their own cash and more ways to borrow. Persimmon is cash-rich: it can use earnings to pay dividends and fund investments. Barratt has strength in diversity: it issues equity to shareholders, sells bonds in public markets and borrows from banks too. Small builders, by contrast, typically rely on bank borrowing alone.

In response to the squeeze, the Bank of England announced a souped-up lending scheme on April 24th. Funding for Lending, which lowers banks’ own borrowing costs so that they can pass on the savings to their customers, is to be extended and sharpened. Banks that trim lending will be denied more discount funding, whereas those that provide more credit to smallish firms in 2013 will get £10 of extra funding support for each £1 they lend. This should help all firms, including builders: a survey by the Royal Institute of Chartered Surveyors shows that 88% think that tight credit continues to hold back construction.

For the optimistic, this could be the point at which Britain turns. There are certainly signs of life in the house-building sector. Mortgage rates are falling, and higher loan-to-value ratios are more freely available. Quantity surveyors, who are involved in the early stages of construction projects, expect their businesses to blossom. Builders like Barratt and Persimmon report that inquiries are growing.

And if private house-building picks up, wider benefits should follow. Renting is now an expensive option, according to recent analysis by Steven Bryce of Credit Suisse, a bank. As 85% and 90% mortgages reappear, Britons can switch out of the expensive rental market. This would liberate demand for goods and services, swelling other parts of the economy.

But in flat-line Britain, growth predictions always come with a safety warning. The construction pipeline is long, warns Patrick Law of Barratt: it can take 73 weeks from finalising a project plan to beginning building. That means the full benefits of recent policies may not appear until the middle of 2014. For a government that must hold a general election by 2015, that timing could prove very tight.