BREXIT RECESSION?

SUMMARY

A slowdown is under way and there is some probability that a BREXIT recession is coming.

The UK economic engine spluttered in early 2018, faced with some cold east winds and persistent policy doubts. There should be some rebound from adverse weather effects, but other uncertainties will last a while longer.

It is always a matter of concern when the inflation rate is higher than the growth rate. It tends to mean a sluggish economy and constrained living standards. With inflation rates easing and some signs of earnings growth, we must hope that this imbalance (see chart below) does not last long.

Sadly, the consensus is that a modest outlook will persist. For example, the OBR’s March forecast has real GDP growth at or below 1.5% per annum over the next five years with investment at 2.5% p.a. or less.  Given normal forecasting errors, it doesn’t take much of a ‘shock’ to push 1.5% growth down to zero.

We are experiencing the ‘wrong’ kind of growth. Rather than productivity-led, long-term sustainable, ‘green’ growth fuelled by investment, innovation, skills, entrepreneurship and competitiveness, we have growth held back by 1) subdued consumption – high debts, low real wages, an ageing population, 2) an unsupportive policy mix – too loose money and high fiscal debt, and 3) an uncertain global outlook – Brexit unknowns and President Trump’s mercantilism.

Against this background, many businesses seem focused on the here and now and micro rather than macro prospects.  Some firms/sectors strive hard to fill near-term order books and manage skills shortages, whilst others fear unfavourable EU supply chain shifts from March 2019 (Brexit) onwards.  Unfortunately, messages from used car sales, garden centres, and other leisure and retail services suggest final (consumer) demand has softened in recent months. Household spending is not growing robustly, especially in real terms. This has affected retailers in the high street, tourism and other consumer services, and elements of discretionary construction. In contrast, high-end manufacturers and most business services remain relatively buoyant. Current trading and investment seem to be driven by capital replacement and capacity maintenance rather than building future growth potential.

The UK Economy

LATEST EVIDENCE

  Annual (2017) Quarterly Monthly
Real GDP (%ch, yoy) +1.9 +1.2 (Q1) n.a.
CPI inflation (%ch, yoy) +2.7 +2.7 (Q1) +2.5 (Mar)
LFS unemployment (%) 4.4 4.4 (Q4) 4.2 (Dec-Feb)
Current Account (£bn) -82.9 -18.4(Q4) n.a.
Base rate (%) 0.29 0.5 (Q1) 0.5 (Apr)

Source: ONS

The UK economy (see table above) slowed through 2017 and has started 2018 sluggishly – just 0.1% qoq growth in the first three months. There have been signals of weak consumption and investment growth, dampened by modest expectations about future earnings and profits. Surveys of consumer confidence have been softening.

The international environment has not helped, with a number of trade and diplomatic factors adding uncertainty – threatening a ‘cold war’ and a ‘trade war’. The US President is risking a return of mercantilism: the belief that it is the share of the cake, rather than the size of the cake, that matters. Such economic policies were abandoned a century and a half ago – their revival now would be a retrograde step.

Meanwhile, all this political controversy has been reflected in a stock market correction, commodity price swings and volatile exchange rates, adding market uncertainty to political and policy uncertainty. No wonder more people are back to a ‘wait and see’ mode of thinking, planning and commitment.

The essence of the problem, with or without Brexit, is that the UK economy has experienced the ‘wrong’ kind of growth for a number of years, almost to the point of establishing a ‘new normal’. The monetary and fiscal policy mix adopted to deal with the risks of debt and depression at the start of this decade seem intractable. At the same time, household and business prospects are constrained, and constraining, in an economy not built on productivity but on debt and cheap labour.

Crucially, the UK growth/inflation mix (discussed earlier and below) and the debt/deficits mix are unfavourable. The current account deficit remains large (3.6% of GDP in Q4 2017) and the public debt ratio huge at 86% (fiscal 2017/18). An ageing population, falling household living standards, weak investment incentives also contribute to the ‘wrong’ kind of growth, with low creative destruction and poor competitive aspiration.

Although some improvement was experienced in the second half of 2017, the “productivity puzzle” persists, with output per hour still about 20% below trend and the ‘gap’ with our competitors not shrinking. In essence, we have too many low value jobs in a weak investment cycle and not enough robust supply chains based on ‘collaborative yet competitive’ business relationships.

OBR FORECASTS

The Spring release by the OBR in March barely changed its forecasts from November. The key messages were: the cyclical economy is weak: growth is not expected to exceed 1.5% per annum between now and 2022; the structural economy is weak: growth potential remains modest by historical standards because productivity is still poor and the fiscal economy is weak: the public finances remain precarious – the deficit is shrinking but the debt burden is not.

Essentially, the OBR is predicting more of the same over the forecast period: growth not fuelled enough by investment, productivity and real earnings.   The economy is operating near to potential and there is little spare capacity. In the near term, Brexit uncertainty may dampen domestic and foreign direct investment, whilst reducing net positive immigration, compared with what otherwise might have occurred.

The wider consensus is the same. The latest HM Treasury compilation has growth of 1.5% in 2018 and 1.4% in 2019. The UK economy is precariously balanced with low growth and higher inflation (2.3% and 2.1% respectively). Historically, if it persists, the latter being at a higher rate than the former has proved uncomfortable for growth and jobs.

ECONOMIC STABILITY

Interest rates remain very low and are only expected to increase slowly over the next few years. At some point, base rates probably need to get back to about 3.0-3.5% (roughly equivalent to underlying nominal GDP growth), if pre-Great Recession ‘normality’ is to be restored.

As long as this is done in small, slow steps, such an adjustment need not hurt overall economic growth. There may be some pain for over-extended household and corporate debtors who may not have planned properly for higher rates, but a gradual process of change to more ‘normal’ interest levels will improve resource allocation for and by most economic actors in time – a likely condition for getting the economy working sustainably towards the ‘right’ kind of growth.

The question, however, is whether pre-2010 ‘normality’ is a viable target or only of academic/historical interest. The west’s policy response to the debt crisis, including zero interest rates and ballooning central bank balance sheets (quantitative easing – QE), avoided a Great Depression. But, the resulting, persistent debt pile (worldwide over $230trn and over 300% of GDP), was merely shifted from private to public balance sheets. This implies a risk of a renewed funding default if creditors lose confidence in the ability of debtors to repay, particularly as the costs of borrowing (bond yields) edge higher.

As the central banks start to unwind the ‘2010-model’, it is not clear that a return to the ‘old normal’ is possible. The risk is that another crisis hits when the authorities have less room for manoeuvre: a drop of interest rates of the scale seen at the start of the decade to support activity levels is not now feasible. With growth at no more than 1.5% per annum, a fairly small negative ‘shock’ could push the UK towards recession and the Bank of England has less room to do anything about it. In this respect, current evidence of a softening of final demand is worrying. Moreover, it makes a shift towards more sustainable investment and productivity-led growth even more urgent.

 

 

 

More Wrong Kind of Growth

Summary

The UK economy experienced another year of modest economic performance in 2017. Despite the technological drive for change across a range of industries, political, public sector, business investment and consumer factors held back the pace of economic development.

The consensus is that there will be ‘more of the same’ in 2018, with the ‘wrong kind of growth’ persisting unless productivity accelerates. Inflation is expected to stay above target but ease back from its exchange rate highs. The risk of recession is higher than the risk of a boom but an improving world economic outlook suggests some upside to offset BREXIT uncertainties.

Even if the forecasters are correct, there should be considerable interest in major structural changes that will be negotiated or get underway this year, especially those related to future trade patterns and industrial strategy.

Against this background, local businesses are confident, operating at high capacity and continuing to face constraints from infrastructure and skills. The need for investment in competitive productivity has never been stronger.

The UK Economy

LATEST EVIDENCE

UK Annual Quarterly Monthly
Real GDP (%ch, yoy) +1.8 (’17) +1.5 (Q4) n.a.
CPI inflation (%ch, yoy) 2.7 (’17) 3.0 (Q4) 3.0 (Dec)
LFS unemployment (%) 4.9 (’16) 4.3 (Q3) 4.3 (Aug-Oct)
Trade deficit* (£bn) -40.7 (’16) -5.8 (Q3) -2.8 (Nov)
Base rate (%) 0.29 (’17) 0.41 (Q4 17) 0.5 (Jan 18)

Source: ONS   *goods and services

The UK economy (table above) ended 2017 with modest growth, high inflation and low unemployment. The trade deficit was probably shrinking a bit and interest rates were starting to edge higher, along the yield curve. There were signs of good activity in some manufacturing and export sectors but the overall mood in many industries was more sombre, with uncertainty about the future weighing on business decision making. At the same time, consumers were restrained by falling real incomes whilst net government and net trade’s contributions were unhelpful, at best.

For 2018, the questions are whether unemployment has troughed, inflation has peaked and growth can be maintained. Most forecasters suggest a slight move away from the ‘wrong kind of growth’ towards more productivity-led activity but the extent of the improvement is expected to be modest. In particular, the consensus of current forecasts is for 1.4% growth and 2.4% inflation, both slower than in 2017.

OBR FORECASTS

There were three key messages from the OBR in November:

  • The cyclical economy is weaker than previously thought: growth projections fell (not forecast to reach 2%p.a. over next 5 years).
  • The structural economy is weaker than previously thought: growth potential dropped to c1.4% per annum (because productivity worse).
  • The fiscal economy is weaker than previously thought: public finances in deficit until 2019/20. (Debt burden stays close to 80% of GDP.)

Essentially, the OBR is predicting more of the same over the forecast period. This can be summed up as “the wrong kind of growth” – growth not fuelled by enough investment, productivity and real earnings.   The economy is operating near to potential and there is little spare capacity. In the near term, BREXIT uncertainty dampens domestic and foreign direct investment, whilst reducing net immigration, compared with what otherwise might have occurred.

There are two broad risks to this OBR central outlook:

  • Fears about BREXIT disruption may be over-stated. New technological innovation, skills and investment may add value more quickly than anticipated. Also, a buoyant world economy could provide more of a local boost, as long as the pound remains competitive and UK trading patterns can be adjusted smoothly. Output and productivity growth may get back to 2% p.a. or more sooner than we think.
  • The forecasts are now so low, however, that the chance of a shock to confidence causing a further slowdown, even recession, cannot be ruled out. Investment and consumption may stagnate because of constrained living standards/high debt burdens, new trade barriers/corporate realignment of capacity and operations, and higher interest rates.

The future is always uncertain but the current UK outlook is particularly so.

ECONOMIC STABILITY

Interest rates remain very low and are only expected to increase slowly over the next few years. Base rates probably need to get back to about 3.5% at some point (roughly equivalent to underlying nominal GDP growth), if pre – Great Recession ‘normality’ is to be restored.

As long as this is done in small, slow steps, such an adjustment need not hurt overall economic growth. There may be some pain for over-extended households and corporate debtors who have not planned properly for higher rates, but a gradual process of change to more ‘normal’ interest levels will improve resource allocation in time – a necessary condition for getting the economy working well and sustainably.

The fiscal side of stabilisation policy remains constrained by historical and projected levels and ratios of debt. Political imperatives may allow some easing of the immediate fiscal stance, but the room for manoeuvre is limited in a low productivity, low growth economy that is losing clarity about access to important international markets.

Structural reform of the public finances is warranted but may be difficult in the current febrile environment of BREXIT and minority government.

The Dorset Economy

LATEST DATA & SURVEYS

The evidence is that the local economy lost a little momentum in the second half of 2017, reflecting the uncertainty about how BREXIT will evolve. It is unclear as to whether this is a real effect or a convenient scapegoat and some local firms are still quite sanguine. Whatever the truth, the impact is the same – more modest growth in 2018.

For example, the collapse of Carillion (15/1/18) suggests construction and public services may lose output in the near term whilst worrying statements from Airbus (FT 16/1/18) about the prospects for aerospace cast something of a cloud over local supply chains. Similarly, there have been a number of reports, notably from the CBI (FT 26/1/18), that contingency plans for “no deal” are being implemented by externally orientated businesses and this will involve a loss of UK jobs.

The latest Federation of Small Businesses Survey (FT 5/1/18) found a high number (1 in 7) of respondents planning to downsize, close or sell the business in 2018. The overall confidence index was negative for only the second time in five years – the other time was just after the BREXIT referendum day 2016. Falling profits were highlighted, as costs increased and demand, especially consumer demand, weakened.

Similarly, the most recent Chamber of Commerce Survey casts a subdued shadow over the business atmosphere. It shows waning confidence in manufacturing and services at a national level. In Dorset, the mood was steadier about current activity and prospects. Locally, in the latest quarter, sales and orders remained positive and employment and exports grew. In the year ahead, more Dorset respondents expect turnover and profitability to rise than to decline. The prospects were steady compared with the previous quarter – an outlook a bit more confident than seen in the country as a whole.

The various Purchasing Managers’ surveys continue to send mixed signals but there was a softening of activity through 2017 in the SW region, including Dorset. The December report showed business confidence about the near future resilient yet the output and employment measures, whilst still positive, were lower. Compared with a year ago, last month’s output reading was down 11% (from 58.7 to 52.2).

Meanwhile, in the year to September 2017, Dorset enjoyed virtually full employment, with most local places’ ratios below national and many below SW regional averages (see next table – SW averages 78% and 3.5% respectively).

Local Labour Indicators (Oct 2016 – Sep 2017)

Emp % Unemp % Emp % Unemp %
Bournemouth 76.4 3.8 Dorset 78.5 2.7
Poole 75.3 3.2 Somerset 74.8 4.0
Christchurch 80.7 2.3 Devon 78.3 3.0
East Dorset 80.6 2.4 Wiltshire 81.0 3.1
North Dorset 83.7 2.5 Southampton 73.3 4.9
Purbeck 85.2 2.3 Portsmouth 74.0 4.3
West Dorset 79.4 2.7 Hampshire 81.1 3.0
Weymouth & Portland 62.8 4.0 Isle of Wight 71.8 4.3

Source: ONS: employment 16-64 age groups, APS. unemployment 16+ economically active

The local labour market is tight and living costs high, making it hard to find and attract new and replacement skills as long as companies are unwilling or unable to pay higher wages. Skills acquisition and retention is a key area in need of improvement if Dorset is to move towards more sustainable, productivity-led growth.

There is also an issue about a shrinking of the ‘middle’ market, with new entrants (16-25 years old) finding it hard to enter and progress along a desired career path (see Prince’s Trust Survey released 24/1/18 – said to reveal “a staggering deterioration of young people’s confidence in themselves and in their future”).

STRUCTURAL FEATURES

In December, the ONS released latest numbers on the GVA breakdown for 2016 for Dorset.  Total GVA was £16.1bn in 2016 (current prices), placing the county 32nd out of the 38 LEP areas – roughly as expected given its relative size. In terms of GVA per head, taking population into account, Dorset achieved £20,900. This broad measure of productive performance showed Dorset to be below regional and national averages, ranking 24th out of the 38 LEPs.

Dorset’s index of GVA per head was 79.3 (UK average = 100) – down on the previous year. For the first time, Dorset was more than 20 percentage points (pps) below the national average, continuing a long-term downward trend.

This slippage in comparable standing is disappointing. Although it reflects a widening gap across the country (Greater London versus the rest), it also indicates a poor relative local productivity record: Dorset GVA per head dropped from just 8.7pps below the UK average in 2000 to 20.7pps below average in 2016.

This fall in the relative GVA per head index is similar to the experience of other south coast areas. Amongst the 12 “southern” LEPs listed in the next table, Dorset ranked 10th on GVA per head. Only four of twelve have seen a positive change over the last two decades.

GVA per head by LEP area, UK = 100 2016 & pps change since 1998

index change   index change
Cornwall & IoS 64.8 -0.5 Solent 91.7 -8.9
Heart of the SW 75.2 -4.7 Oxfordshire 126.6 +6.9
Dorset 79.3 -9.4 Coast to Capital 95.6 -10.5
Gloucestershire 99.1 +3.0 Bucks Thames Valley 114.3 -12.7
Swindon & Wilts 96.9 -12.2 Enterprise M3 122.3 +2.1
West of England 111.5 +4.5 Thames Valley Berks 158.4 -6.1

Source ONS.

Recent growth in Dorset GVA has been in services, with most growth in business and financial services and least in manufacturing and resources. Production has gone from 23.5% of the economy in 1998 to 18.5% in 2016. This 5% loss has shifted largely to private services (not including real estate).  Within Dorset, about two-thirds of the GVA was generated in the east Dorset conurbation – Bournemouth, Poole, Christchurch and East Dorset (next table shows details).

GVA & GVA per head within Dorset: All industries

£mn £/head GVA % share
Bournemouth 4,145 20,971 25.7
Poole 3,964 26,167 24.6
Christchurch 1,019 20,596 6.3
East Dorset 1,693 18,999 10.5
North Dorset 1,233 17,354 7.6
Purbeck 879 18,962 5.5
West Dorset 2,322 22,905 14.4
Weymouth & Portland 875 13,386 5.4

Source: ONS

The Government’s recently announced Industrial Strategy (below) aims to correct some of the imbalances and inadequacies displayed by the latest GVA statistics.

The annual GVA regional performance publication will always be one of the areas where future analysts will observe whether the Industrial Strategy is having the desired effect.

The Development Outlook

BREXIT & TRADE

More open trade deals between customs unions/countries are intended to increase economic welfare for all partners to the agreement by reducing barriers to exchange in the markets and sectors covered by the agreement, i.e. by increasing economic efficiency, productivity and wealth.

Economic analysis shows decisively, in theory and in practice, that movement towards open (freer and fairer) trade is a net ‘good’ for all concerned. It is one of the things on which virtually all economists agree: more open trade increases competition, raises productivity and boosts living standards for trading partners as resources are re-allocated to reflect absolute and comparative advantage. Although there may be internal distribution issues, all macro parties are better off.

Historically, most trade deal activity has been based on trade in products rather than services but, increasingly, more agreements are likely to be made about the latter. It is important, however, to remember that trade deals are political as well as economic animals. Sadly, the spirit of mercantilism – the view that trade is a zero-sum game with winners (surplus generators) and losers (deficit generators) – is far from dead. In a world of “America First” and “Deutsche vorherrshaft”), Ricardian views of trade – that efficient and mutual specialisation means it is not a zero-sum game) – need to be defended.

This is what is worrying about BREXIT. For example, one of the UK’s comparative advantages is in financial services. Shifting capacity from London to Paris, because of reduced EU access freedoms/passports for the former, merely diminishes both countries’ ability to create total wealth most effectively: a potentially negative reallocation of resources.

The problem is that BREXIT does the opposite to ‘normal’ trade negotiations. For any likely eventual UK-EU terms, it leads to a constraint on trade rather than a liberalisation. Even if, in the long run, ‘freer’ trade deals are agreed with other trading blocs, it will be many years for the near-term losses to be compensated for. There are costs of losing ‘single access’ for both sides.

Also, under BREXIT, failure to set a trade deal with the EU does not mean, as it usually does, a return to the status quo. It results in a less open move to WTO rules. Countries that have a ‘better than WTO’ trade deal with the EU – e.g. Norway, Switzerland, Canada, South Korea – and those further along in the trade negotiations – over 50 in total – would have better access to EU markets than the United Kingdom after a ‘hard’ BREXIT.

Both the EU and the UK lose trade opportunities from a failure to agree favourable terms. Currently, the EU takes c40% of UK exports. The UK takes c10% of EU exports. At the margin, it is not easy for either to substitute these patterns with new markets quickly.

Finally, there are the psychological effects on supply chains – club members tend to deal more with themselves than outsiders – even at an economic cost. There are already reports that UK companies are finding it hard to get onto the list of potential suppliers in the EU after March 2019 and attracting EU ‘talent’ is getting tougher.

There are always winners and losers when trading structures change but BREXIT, by meaning less open trade, means the average UK citizen will be poorer than would otherwise have been the case – unless there is speedy substitution elsewhere. Future politics will be judged on whether this price is material or not and on whether it turns out to be a price worth paying. It is hoped we do not have a populist, more closed economy by the early 2020s.

INDUSTRIAL STRATEGY

Turning to the Industrial Strategy released in November One of the government’s key ‘antidotes’ to BREXIT trade affects, the key point is that it presents a worthy intention to tackle the UK’s long-established and widening productivity ‘gap’ (with its closest competitors) by rebuilding the underlying capacity and export competitiveness of UK sectors, places and workers. The issue is whether it yet amounts to more than throwing everything into the kitchen sink and seeing if anything floats!

The Industrial Strategy is a long-term plan to boost productivity and earnings, based on five foundations – re-packaging the drivers of productivity as follows:

  • Ideas (innovation): raise R&D as a percentage of GDP, turn more inventions into markets, and preserve and extend collaboration between economic actors.
  • People (skills): advance technical education, STEM and retraining – raising quality, filling gaps, and spreading spatial capacity and opportunity.
  • Infrastructure (investment): expand transport, housing and digital infrastructure and use public procurement to build resource efficiency.
  • Business Environment (entrepreneurship and competitiveness):
    generate government-industry sector deals, make UK the place to start and grow businesses, and develop a fiscal system that supports scale-ups and exports.
  • Places (local capacity and competitiveness): produce local industrial and transforming cities strategies that narrow regional productivity differentials and other disparities through local leadership and co-operation between places.

The Strategy announces sector deals for the life sciences, construction, artificial intelligence, and automotive industries and proposes ones for creative industries, industrial digitalisation, and nuclear. It also intends to form a team that will support future (emerging and disruptive) sectors.

The Strategy presents four Grand Challenges for the industries of the future – aspiring to a fourth industrial revolution of technological fusion. The four are: artificial Intelligence & big data, future mobility, clean growth, and ageing society. If engaged, Dorset can feature positively in each of these areas.

The Strategy also promises a review of LEP roles. The Industrial Strategy requires Dorset to produce its own Local Industrial Strategy under the LEP’s guidance, although when, what and how this will be done is not yet clear.

The Strategy talks about the composition of the UK economy, with its world class heights but much mediocrity, as being a major cause of relatively low productivity. Any new policies to address this need to emphasize how sustained growth is generated: globally competitive productivity growth on the supply side and greater trading engagement on the demand side.

The Industrial Strategy discusses many of the ‘right’ issues and proposes to act on many of the ‘right’ levers. The timescales, resourcing and processes are unresolved, but it is a reasonable framework for future development, based, as it is, on improving national and local productivity performance.

As with all UK government’ approaches to sub-national development, however, the uncertainties are about long term political commitment and consistency, especially in an era of changing international economic relationships, and about private sector and local buy-in across industry and place.

For Dorset and its neighbours, the important thing is to improve existing economic linkages – markets, supply chains and wider connectivity – and to develop new ones. We need more connective agglomeration, higher aspirations and a positive attitude towards personal, business and community development.

Wrong Kind of Growth

UK inflation hit 3% in September (CPI) and it doesn’t look like reversing downwards soon.  Growth (real GDP) is running at no better than 2%.  Whenever inflation rate > growth rate, it makes one nervous.

Moreover, we have the “wrong kind of growth”: driven by employment growth that is not productivity-led.  Real wages are falling, interest rates and exchange rates are still too low.  The trouble is that cheap labour and cheap money tends to fuel mediocre growth, at best.  Incentives to invest in new capital, innovation and skills are depressed, made worse by current trading uncertainty (BREXIT plus Trump).  Creative destruction is stalled, supporting unproductive ‘zombie’ companies.  Weak sterling offers competitive advantages but can also lower the incentive to do so.

The consensus is that growth will remain subdued through 2018 and  beyond.  Suppressed trade/investment and stretched household/public finances reflect the fundamental productivity gap.  To delay the next recession, we need more investment in the digital revolution in services and, thus, the adjustments needed to skills and innovation that will drive entrepreneurship and competitiveness.  And, that means better inter and intra regional connectivity and higher business aspiration.

The upcoming UK budget/industrial strategy (and the BREXIT negotiations) should focus on these areas of regional development.

A ‘new’ Industrial Strategy

The UK economy is at a crossroads.  A turning point for growth, inflation and employment is apparent in recent data.  The BREXIT vote might have been the trigger for the change of mood because it adds a new layer of uncertainty but the economy was already going that way.  Moreover, the fundamental imbalances of the UK economy – exhibited by huge trade and fiscal deficits, now ineffective monetary policy and poor comparative productivity – have yet to be addressed – whether we voted in or out of Europe.

The ‘new world’ of external relationships, as evidenced by the 18% drop in sterling since July, implies an adjustment of costs (up) and investment (down) that will probably mean lower growth and higher inflation than would otherwise have occurred over the next few years.  Further out, the UK business sector has the ability and scope to mitigate such negative effects and, indeed, more than offset any adverse changes.  British firms and people are still inventive, innovative, skilled, entrepreneurial and competitive.  With change comes opportunity.  The big question is whether the policy regimes adopted over the next few years facilitate that process of market-led adjustment.

In the UK Autumn Statement, next month, it is expected that the Chancellor of the Exchequer will promote a new Industrial Strategy.  It is tempting to say that there is nothing new in the world of sub-national development.  A re-hash of established intervention strategies is probable, which may be no bad thing.

It is likely that the SW LEPs will be tasked to support major national investments (including power stations, runways and railways) through their activities towards future growth deals, enterprise zones and/or wider business support.  The target, as always, will be more productivity and export-led growth backed by a strong business voice.

We await the government’s ideas with both trepidation and expectation.  We hope the LEPs and their development partners are ready for the task ahead.  We will blog on the ‘new’ strategy after November 23rd, assuming enough details about the new policy approach are forthcoming.

By then, we will have a new US president-in-waiting.  With this and BREXIT dominating the macro world, these are exciting times for analysts of the regional economy and the world of local development.

 

 

The Economy – After BREXIT

SUMMARY

On 23rd June, the UK electorate voted to ‘leave’ the EU (BREXIT). The immediate economic consequence was a collapse in Sterling, making exports cheaper and imports dearer. Over time, this might help growth and add to inflation. However, the referendum result increased uncertainty about the economic outlook and may reduce net new investment, output and jobs in the months ahead and beyond.

More firms and investors now seem less confident about the outlook for growth. The survey evidence and the forecast consensus has shifted downwards, acknowledging that there is some risk of negative real GDP growth, higher inflation and lower employment.

In addition, upheaval within the leading UK political parties, the lack of terms/a plan to smooth the UK approach to BREXIT, and concerns over the forthcoming presidential election in the United States all encourage a ‘wait and see’ attitude amongst key businesses.

With forward indicators weakening, the economy is still constrained by fundamental weaknesses: low productivity growth and competitiveness (as shown by persistently large trade deficits). For the foreseeable future, uncertainty over BREXIT will not improve these factors.

Latest evidence

  Annual Quarterly Monthly
Real GDP (%ch, yoy) +2.2 (2015) +2.2 (Q2) n.a.
CPI inflation (%ch, yoy) 0.0 (2015) +0.4 (Q2) +0.5 (Jun)
LFS unemployment (%) 5.4 (2015) 5.1 (Q1) 4.9 (Mar-May)
Trade deficit* (£bn) -36.6 (2015) -12.4 (Q1) -2.3 (May)
Base rate (%) 0.5  (2015) 0.5  (Q2) 0.5  (Jul)

Source: ONS   * goods and services

Growth in the UK economy was fairly modest and flat through the first half of 2016. Despite global/national political and economic uncertainty, as the table above indicates, real growth was maintained close to trend (just over 2% year-on-year), inflation remained well below the 2% per annum policy target (though it edged a little higher) and the drop in unemployment may have started to flatten out (at about 5%). The net trade deficit was still enormous and the loose money and austere fiscal policy stance was largely unchanged. Productivity growth remains too low for sustained and sustainable UK growth.

If real GDP growth now slips below 2% per annum, employment growth will ease or reverse and little or no improvement in productivity can be envisaged. Meanwhile, the recent (roughly 9%) drop in Sterling will boost future inflation. The economic outlook, especially in the face of having to unwind or replace trade, regulation and other business-facing agreements within the EU and other partners, has deteriorated.

Local Economy & Development

The latest purchasing managers’ index (PMI) for SW England shows SW output fairly good but employment slipping back in June. These figures were recorded “pre-BREXIT”. Moreover, the SW regional economy tended to soften through the first half of 2016.

For the PMI series, apart from momentum over time, the crucial benchmark is whether the indices are above or below 50. The former indicates growth and the latter stagnation. It will be interesting to see, in response to BREXIT, whether the next reading for SW PMI output, (to be issued mid-August), will edge below the 50-benchmark, as the UK average did in July and the SW employment index already had done in June. Thereafter, the question is whether negative “BREXIT effects” persist.

Other surveys have shown similar recent trends. For example, the British Chamber of Commerce Survey for the latest quarter pointed to “sub-par UK economic growth even prior to the EU-referendum”. With regard to the future outlook, the mood has been generally more cautious than it was, with many sectors from manufacturing, through retailing and car sales, to property and other services declaring a sudden loss of business momentum after the referendum. What little evidence we have suggests there was an immediate drop in household spending, affecting retailing, tourism and leisure locally; a decline in property movements – affecting commercial and housing sales; and a continuation of caution with respect to business investment.  We do not know whether these were temporary or persistent effects.

In response to these developments, and the aggravated risks and eventual opportunities that lie ahead, the development question is how businesses and the various public agents mitigate any negative impacts. The significant drop in sterling will help some (exporters) but not all (importers and exporters dependent on imports of components and materials). In time, the likely increase in a range of input, factory and final prices will affect some supply chains and household budgets. Moreover, there is a fear that the continuing banking malaise (with share values down sharply from already low levels) may dampen the flow of credit – a key ingredient for maintaining growth.

The Bank of England stands ready to support the financial system (e.g. by relaxing banking capital requirements, lowering base rates, and issuing more quantitative easing). It believes the banking and insurance sectors are much more resilient to shocks than they were in 2008. Also, the new “May-Hammond” Treasury has indicated that it may be more willing to borrow and spend than its predecessor. Its ‘new’ industrial/EU-funding policies, however, are far from clear, (especially as the Business Department is being reformed).

Economic Outlook

According to the latest consensus compiled by HM Treasury (see table below), growth will be very sluggish in the next 18 months. The average forecast is for growth rates well below trend in 2016 and 2017 whilst CPI inflation is now expected to exceed the target (2% per annum) during 2017 and unemployment to rise back above 5.5%.

According to these ‘experts’, the outlook has changed dramatically. Indeed, average forecasts for growth in 2017 slumped from 2.1% (June survey) to only 0.8% (July survey) after the BREXIT vote. Moreover, the current account and public debt positions are worse for 2016 and only expected to improve marginally in 2017. The Bank of England perspective (in its forthcoming August Inflation Report) is expected to show a similar warning about a deterioration in economic prospects.

BREXIT has induced a change in mood, with the consensus about economic prospects shifting markedly downwards in recent weeks. Indeed, the drop in forecasters’ expectations has gained real expression with the downgrading of UK debt by the major credit rating agencies, the drop in the value of UK banking and other stocks, and the Bank of England’s FPC recent highlighting of risks to the financial system.

UK Consensus Forecasts: July 2016

  2016 2017
Growth +1.6 +0.8
Inflation +1.3 +2.4
Unemployment 5.3 5.6
  2016/17 2017/18
Current Account (£bn) -103.1 -82.1
PSNB (£bn) 67.4 58.3

Source: HM Treasury

Some of the new negative sentiment may fade after the initial shock but the danger is that the process of extracting the UK from the EU will generate a series of economic and political ‘aftershocks’ to the markets and the real economy and this could deplete confidence at a fundamental level.

As we have written before (see previous posts), the economics of BREXIT are straightforward. In summary, the creation of economic barriers, borders or boundaries, whether real or psychological, always leads to an increase in costs. That increase in costs, exacerbated by broader uncertainty, stalls investment, reduces output and cuts employment compared with what otherwise might have occurred. Thereby, the outlook for productivity and trade deteriorates.

The resulting fall in business profits and household incomes means less revenue for the government, which requires further fiscal austerity unless the government is willing to borrow more and grow the public deficit. In turn, these factors reduce realised and potential economic activity and confidence. At the same time, as higher costs are pushed through the supply chain, more inflation is generated, which, if accompanied by higher state borrowing, means, at some point, higher interest rates – a further dampener on future domestic demand.

It is important to note that in all these economic linkages and trends, we refer to outcomes in net, macro terms. There will be companies and workers in particular sectors that will benefit from the countervailing forces that always occur within any process of economic adjustment. There will be individual ‘winners’ and ‘losers’. The key observation, however, is that the net effect, for the economy as a whole and for the foreseeable future, is one of worsening growth prospects.

BREXIT will affect many Southern businesses and households. Some of these effects will be immediate and obvious; some will be postponed and insidious and some will not have noticeable impacts for several years. But, on average, in due course, less investment means less growth and lower living standards. We must not be distracted by one-off (good or bad) data releases or items of business news over the weeks and months ahead. The important thing is the change to performance potential, and its realisation, over the long run.

In the long run (after 2020), the economy may start to recover (assuming no major global ‘shocks’) from BREXIT.   In the very long term (perhaps, eight years plus), it may be back, or even beyond, where it might have been without BREXIT. The economy is a dynamic creature made up of millions of individual and group actors with diverse characteristics and behaviours. Uncertainty creates opportunity as well as fear. Human beings are inventive, innovative and entrepreneurial, especially as new generations emerge without the baggage of history. It is reasonable, therefore, to remain a long-term optimist about the economy.

For the near future, however, the prognosis is for a period/process of negative adjustment.

  • In the short run, this is likely to harm sectors dependent on current household and business spending first, though these effects may be temporary if incomes and employment hold up over the rest of 2016.
  • In the medium term, it will be the new trading adjustments that matter: 1) sterling depreciation helping exporters unless they are vulnerable to supply chain shifts caused by political uncertainty and higher import prices and 2) trade agreements and new tariff regimes for UK businesses active across the world. Both positive and negative effects are likely to ensue here.
  • In the long run, changes to corporate investment strategies will drive the impact. It is unlikely that global companies will see UK locations and facilities as favoured areas for investment to gain access to the wider European market. Importantly, it is changes at the margin that matter, specifically the potential for erosion of commitment to existing UK operations over time. Behavioural changes will gradually impact replacement and new investment demand. In a decade, the fear is that the next family of aerospace, motors and other engineering and electronics products and services go, at least partially, elsewhere, as trading costs and regulatory frameworks adjust to a new political reality

Analysis of current economic prospects makes regional development activity to boost the drivers of productivity even more vital. The development policy and delivery question is whether the negatives can be mitigated in terms of repairing or building local competitiveness over time. Even as the BREXIT storm rolls over us, we must prepare for better days.

BREXIT

In 2016/17, there will be a UK referendum on whether or not to stay in the EU.  Most of the arguments, particularly currently espoused about what PM Cameron might secure in terms of EU reform, are political.  What about the economics?

  1. In or out, it won’t come cheap.  Some EU-sceptics talk about repatriating funds from the EU worth £50mn a day.  Dream on – that’s gross and the costs of extracting UK from all the current arrangements will cost money.  If there is no Common Agriculture Policy or development funds for Cornwall, do you think the UK government will do nothing to soften the blow for those affected at home?  Just think how much money the lawyers are going to make from re-writing contracts and how many civil servant/ bureaucrats we’ll need to make the change…  It could easily take five years to extract the UK from current contracts and processes and replace them with new ones.
  2. Meanwhile, there will be an investment strike.  If you are a foreign-owned multinational based in the UK, faced with great uncertainty as to the vote and its eventual result, at the very least, you’ll 1) wait and see or 2) you may re-direct investment to facilities still likely to be in the EU or low-cost centres elsewhere and, at worst, 3) you’ll close UK operations and supply the UK market from continental Europe – with potentially disastrous consequences for UK exports  and productivity.
  3. UK borrowing costs and sterling volatility will rise and fiscal. management may be disrupted, at least in the near term.  This will also encourage overseas rather than domestic activity – investment, employment and trade.  Again, uncertainty and borders restrict exchange and wealth creation.
  4. Migration flows will shift – unpredictably.  The UK recovery has benefited from net migration over the last few years – this could reverse, again with a short term negative economic shock and, perhaps, wider politico-social (e.g. NHS) effects.
  5. In the long run, however, it is quite feasible for a good relationship to emerge between an outside UK and an ‘ever closer’ EU, as it does for Norway, Switzerland, et al.  In a decade or so, no economist, let alone politician, can tell you whether we’ll be better or worse off in or out of the EU especially if, as a result, Scotland becomes an unreliable, one-party, independent state.  All we can say is there will be winners and losers and it won’t be easy to spot who will be which, bar the usual suspects.

    The economic issue for me is the short term – by which I mean 3- 5 years after an ‘out’ vote.  BREXIT will cost the UK a lot of economic activity and potential that it might otherwise haveBREXIT still might be the right political and social choice for our island race.

    I only hope the forthcoming debate makes the real costs and benefits of the two options clear to us all in great detail before we get to the actual vote.

The East-West Divide

The ONS has just released its finalised sub-national productivity data for 2013.  The following table shows the main measures for smoothed GVA per hour across local LEP areas, shown as indices based on the UK average being 100.

GVA per hour (smoothed indices, UK =100)
2007 2009 2011 2013
Cornwall & Isles of Scilly 74.4 72.5 71.5 72.0
Heart of the South West 86.3 85.3 83.9 83.8
West of England 101.3 102.4 102.3 101.4
Gloucestershire 98.9 94.6 94.0 94.1
Swindon & Wiltshire 104.8 107.3 105.9 105.0
Dorset 91.8 91.3 91.6 92.7
Solent 104.0 105.6 104.3 103.0
Enterprise M3 115.1 115.2 114.6 116.2

The first message from this data is the wide variety of the numbers, which indicates an east-west divide in southern England and reflects urban-rural divergences, including commuting and demographic distributions.  There is a huge gap (almost 45 percentage points) of relative productivity from Cornwall to Enterprise M3.

The second message is that the productivity gaps tended to widen during the six years of downturn.  The SW peninsula has lost comparative ground against the south central area.  Often, these differentials are expected to narrow when the overall economy is growing more slowly, largely reflecting the reining back of innovative investment and broader growth in the places with highest added value at times of comparatively weak demand.  This time the opposite has happened.  The downturn was one of widening differences reflecting underlying market, competitive engagement and performance.

Why does this matter?  Productivity drives growth and standards of living in the long run.  Relative incomes will reflect differentials in GVA per hour over time.  In theory, these things are like a pendulum and relative costs will encourage a swing back at some point.  In practice, however, such differentials become structural, tend to get cemented in place, and are very difficult to change.  The distributional, inter-regional consequences of this can be significant.

Sadly, the (political) loss of regional development investment at a time of macroeconomic downturn has probably served to broaden the East-West divide.  The LEPs have yet to fill the gap or influence the underlying comparative competitive and differential trends.

New Kid in “Development” Town

The BRICS (Brazil, Russia, India, China and South Africa) have announced that they will set up a “New Development Bank” (NDB) to fund economic development in their countries. The aim is to start with US$50bn of equal contributions in an infrastructure loan fund, to grow that over time, and to establish a US$100bn Contingency Reserves Arrangement for handling financial/payments crises.

The NDB stems:
i) partly from a frustration with the lack of reform at the World Bank/IMF nexus in recognition of all the comparative and absolute economic change of the last few decades and
ii) partly from a positive desire to develop new funding streams for the growing networks of economic interaction between and across the “south”.

The stated intention is that other ’emerging’ economies could contribute to and benefit from the NDB over time.

The NDB might well be an inherent ‘good’ for these countries and their partners.  Anything that potentially supports sound, value adding, infrastructure development could be very welcome. There are, however, five main issues that will need to be addressed.

1. Politics – how will the institution affect geopolitics?  It could be highly divisive, adding to the worrying strains (Ukraine) that already exist between ‘north’ and ‘south’?  Also, are these five contributors politically stable and aligned enough to be able to pursue their goals efficiently, effectively and honestly or are they going to fall out over the real world application of their aspiration?  There is a danger that the economics will be abused with the politics.  Rule of law and a ‘free trade’ approach are vital ingredients to successful, long-term, economic development.  Sadly, some BRICS do not always display these characteristics well.
2. Economics – the countries involved vary so much in the scale and scope of their investment processes.  South Africa is in a much smaller, poorer and vulnerable economic state than the Chinese global behemoth.  Moreover, they are competitors as well as partners – can they manage the stresses these differences will imply?  One member’s priorities could be to another’s disadvantage without fair procedures for handling disputes over aims and method.  The NDB will need careful management of internal expectations.
3. Finances – why is the pooling of this money better than the spending of it individually? Will the infrastructure that is produced be better or worse (economically, in terms of productivity enhancing skills and investment locally, as well as physically) as a result?  How will they handle the letting of contracts? There is a danger of circularity here: India donates funds to the NDB which is spent with Indian companies on Indian projects – why set up an institution in Shanghai to act as a ‘middleman’ in this?  Why not do it yourself? I n essence, why would the sum of these parts make for better outcomes than the individual pots?  There is a risk that projects end up taking longer and are more expensive than they could be.
4. Technicals – who is going to do the appraisal and evaluation of investment proposals and outcomes?  There is a need for robust monitoring and surveillance of the projects and the funds. They will need high paid, highly qualified, experienced, objective, analytical researchers, economists, planners and developers.  This could mean that all the problems of an expensive bureaucracy, with the potential for corruption, will emerge during the institutional ‘learning’ phase.  There is a risk that they will want to show quick but suboptimal results.
5. Relationships – is the NDB set up in competition or partnership with the IMF/WB and other bodies?  Will it lead to separate funding streams that are vying for the same or similar projects, risking duplication or inefficiency?  Competition may be good between competing developers but it can also be divisive and, ultimately, ineffective.  Is China going to act as guarantor as, effectively, the USA has done for the Bretton Woods institutions for nearly 70 years?  How will the existing institutions now evolve – decline, disappear or be revitalised into more of a ‘developed’ world club?

At this point, we can not answer these questions. Good intentions now need to be backed up with practical implementation. We will need to watch closely as the NDB is born, grows and struggles for maturity.

Regional Household Disposable Income

The ONS has just released its latest statistics on gross disposable household income (GDHI) at a regional and sub-regional level. The new figures are for 2012 and they reveal some interesting facts about the structure of our regional economy.

In SW England as a whole, GDHI was £90.3 billion in 2012, broken down 45% in Gloucestershire, Wiltshire and Bristol/Bath, 25% in Dorset and Somerset, and 30% in Devon and Cornwall and the Isles of Scilly.  It is more interesting, however, to look at the GDHI figures in terms of a ratio to the size of the population: it would be silly to compare the rural Dorset total to that of urban Bristol without considering the number of people that the income totals are spread over.

At a regional level, in 2012, the SE average GDHI per head was £19,126 whereas the SW total was £16,914.  These compared with an England average of £17,066 i.e. above and below average respectively.  Across South West England, the range was from a GDHI per head figure of £18,237 in Dorset (not including Bournemouth and Poole) to £14,564 in Plymouth.

In index terms (UK average = 100), SW England’s GDHI per head ranked fourth out of twelve in the United Kingdom and was very close to the average (100.7). However, again, the range is wide from 8.6 points above average in Dorset to 13.3 points below average in Plymouth.  The indices for the twelve SW areas are shown in the table below.

SW places 2012 GDHI per head index (UK=100) SW places 2012 GDHI per head index (UK=100)
Dorset 108.6 Devon 99.3
Wiltshire 107.0 Swindon 97.6
Gloucestershire 107.0 Bristol city 93.5
Bath&NESom, NSom, & SGloucs 106.1 Cornwall & Isles of Scilly 93.2
Somerset 101.6 Torbay 91.7
Bournemouth & Poole 99.9 Plymouth 86.7

We need to bring out the economic stories behind the raw data. There are two main ones.

1. The more rural areas tend to outperform their neighbouring conurbations on the income measures: on this data, populations in more rural areas can appear ‘richer’ than those in neighbouring towns and cities.  This is at odds with the equivalent output data (gross value added or GVA per head) for which urban areas usually outperform more rural areas.  It can also seem odd intuitively – surely, most of the high paying jobs are in the cities?  We square this circle by considering commuting and employment status.

a) In many places, there is quite a lot of commuting in and out of local conurbations.  In simple terms, high earners often work in town but live in the country.  Hence, GDHI per head, which is measured at the place of residence, can bias the numbers one way (towards rural) whereas GVA per head, which is measured at the place of work, can push the other way (towards urban).

b) The employment structure is often very different in urban and rural areas. There are high and low paid jobs in both but the mix may vary significantly.  Moreover, from the unemployment statistics, we know there are proportionately more jobless living in towns and cities and there can be more low earners at the two ends of the age range – proportionately more low income young and old people in the towns.

Both of these factors (commuting and employment status) tend to bring GDHI per head down in the conurbations relative to their rural hinterlands. To see how common this is, just look at the comparisons in the table above for a) Torbay and Plymouth versus Devon County, b) Bristol versus Gloucestershire and Somerset, c) Swindon versus Wiltshire and d) Bournemouth and Poole versus the rest of Dorset.  Across our patch, rural hinterlands have higher GDHI per head than their urban centres.

2.  The other story has yet to be revealed by our look at the statistics.  There are interesting contrasts in the way the series move across SW England over time.  In Dorset county (DCC), for example, the latest 108.6 index was the highest since 2006 and four points above the 2009 low.  In contrast, the 99.9 index for Bournemouth and Poole (B&P) was the lowest since 1996 and 5.6 points below the peak of 2006.

These contrasting trends are stark, suggesting the Dorset conurbation is slipping down the relative incomes league whereas county Dorset is rising.  Please note, this does not mean B&P’s GDHI per head is falling (although, in real terms, incomes have not increased much in recent years).  It means incomes in B&P are not rising as fast as elsewhere – i.e. B&P residents are relatively ‘poorer’ whereas DCC’s are relatively ‘richer’. The long downturn since 2008, when some wage and non-wage earners have been under severe pressure, is bound to be part of the explanation for this divergence.

A range of such patterns have occurred across the region (see charts below).  Although relative rankings change slowly if at all over the years, some urban areas have struggled to hold their relative positions against their hinterlands – e.g. look at the narrowing gap between Swindon and the rest of Wiltshire.  One exception to that is Torbay, where the index has increased a little over time, although the town remains second lowest overall.  Cornwall’s relative index has also gone up, but its ranking is unchanged.

SW gross domestic household income (1995-2012, UK = 100)

To conclude, we hope an upturn is now underway.  If so, it will be interesting to see whether the SW’s conurbations regain recent lost ground.  Normally, this would be my expectation… but not much has been ‘normal’ recently.  Given the structural and rebalancing changes still needed, it may well take some time to feed through.  Moreover, we are not going to know for some time: 2013 data will not be released until spring 2015 and any bounce from the incipient upturn may not be ‘known’ until 2017!.  Yet again, we are driving the economy by looking in the mirror.

 

Remember the Americans

In the last couple of weeks, we’ve all heard about the shutdown in parts of the US public sector following the failure of Congress to pass a budget.  A number of people have asked me, “So, what does all this stuff in America mean for us.”  Here, I try to highlight the main themes and risks.

Each year, the executive (President Obama’s government) sets out its budget plans and the legislature (Congress) debates and amends it and then votes it through for the Presidency to sign into law.  But, the Senate and/or the House of Representatives, particularly if they have a majority vote for the ‘other’ party (as the House does currently), often table their own budget proposals.  Over the spring/early summer, the different options are argued about, within and between the two parts of Congress, and negotiated with the Executive.  Usually, a single united budget for the next year is set, voted through and signed off before they all go away for the summer… well ahead of the end September deadline.  This year, following the split 2012 elections and the desire of the “tea-party” wing of the Republicans to reverse or delay “Obamacare”, the sides failed to agree by the deadline,  causing the shutdown.  Without a renewed mandate from Capitol Hill, the Executive had no authority to spend on about one third of its current activity after 1st October.

More importantly, America is also approaching its debt ceiling.  Congress sets an absolute US$ amount of debt (government bonds) that the Executive/Treasury can issue to finance US government spending.  Every few years, through the process of growth, inflation and political largesse, Federal America comes up against this ceiling and a higher one has to be approved.  Often, this is a formality but, with the Republican majority in the House wanting to force the Democratic Presidency into more debate about cuts to government spending, not this year.  The next deadline is on or around17th October because that is when the government starts to run out of cash and may not be able to roll over its debts falling due.

Whatever the rights or wrongs of the politics, there are potentially significant economic ramifications for us all if these two matters are not resolved speedily.

  • The immediate effects of the shutdown are relatively minor.  It could shave a few percentage points off US GDP growth directly through the cut in government spending and indirectly through supply chains effects and lower consumption by the federal employees who are not being paid.  But, assuming the furlough is brief (the last and longest was for 3 weeks nearly two decades ago under President Clinton), the effects of the shutdown should be made up before Christmas.   If it were to persist for longer than expected, it would lower US growth this year.  Trade and financial flows would be reduced and the dollar might slip, affecting our exporters and investors. But, again, the lost ground should then be made up in 2014. Although some US individuals and activities can be badly affected in the near term, shutdowns cause little or no damage to the overall macro economy.  Indeed, by focusing public attention on the scale of government, they can have a positive side effect – restricting the rise in federal spending relative to GDP growth over the medium term.
  • Although, again, it depends on how long it lasts, the effects of the debt ceiling barrier are potentially more serious.  Not being able to borrow would affect US spending much more significantly.  It could hit confidence hard, hurting investment and hiring decisions, stock market valuations and the currency.  Moreover, if there was an actual default – a failure to roll over existing US treasury bill or bond debts – the damage to global markets could be severe.  The risk or reality of a default by the world’s biggest debtor – allegedly a ‘safe haven’ – could start a shock wave of distrust that would overwhelm anything we have seen with Spain, Greece, Italy, Cyprus, Portugal or Ireland.  Frightened of losing funds that they thought were safe in America, investors would sell off other non-US assets to recoup liquidity.  In the rush for the exits, many banks would face a fresh and possibly large credit crunch.  Moreover, with monetary policy makers already setting interest rates as low as possible and many treasuries fiscally strapped, the room for counter-action is severely constrained.  Few economies would be safe from such a tsunami.

If the worst happens, the Treasury would run out of cash in about a month, forcing spending cuts worth an estimated 4% of GDP and starting another US recession.  For a while at least, the Federal Reserve can print even more dollars to pay off US$ loans.  But, that would devalue the monetary base and the currency, leading to higher inflation and other economic problems down the line.  There is little doubt who would get the blame – are US politicians suicidal?.  Surely, an actual default will be avoided.

What is happening between the two ends of Pennsylvania Avenue in Washington may seem a long way from your economic life but, if they mess it up, 2008’s credit collapse will be written about as merely the first stage of a deeper and longer malaise in the world economy.  2013 could become the new 1929 and our economy, businesses and jobs, could not remain aloof from such a catastrophe.

Surely, they are not that stupid.  I expect this will all be settled in a few weeks and this blog will pass into myth and legend – at least, until the next time we approach a political impasse.  There could even be an upside to this crisis.  If it forces a real, non-partisan debate about the state of the US public finances and their relationship with the private economy, it could result in a better outcome for us all.  To paraphrase Winston Churchill (and Stephen Stills), “remember the Americans will try all the wrong things before doing the right thing”.