2015 revisited – 2016 considered

The latest numbers show UK real GDP growth slowing from 2.9% in 2014 to 2.2% in 2015.  The year ended with a 0.5% quarter-on-quarter rate of increase in the last three months of the year: services continued to thrive but manufacturing and construction were soft.  At the same time, there was no inflation (CPI average) last year whilst unemployment dropped towards 5%.

In simple terms, the UK economy is being driven by employment growth and, with little or no productivity growth and adverse external factors – (China, oil and stock markets, Middle East and immigration, Brexit etc), current economic momentum is not sustainable.  Further slowing of growth is expected in 2016.  We are not yet talking about a return to recession but, with our real growth forecast now expected to be 1.6%, it looks like being a sluggish year ahead.

New Year Blues – Waves of Uncertainty

In early 2016, the world economy appears to be floundering. The imbalances of financial, trade and other flows that were exposed by the “Great Recession” have never been properly resolved. Waves of new uncertainties are taking their toll, breeding fear into business and investor confidence at a time when stabilisation policy options are stretched and seemingly ineffective.

The first uncertainty concerns the Chinese Economy.  China is still growing faster than many others and there is no particular reason why the slowing of Chinese real GDP growth to what are still relatively fast rates (over 5% per annum) should affect the mood right now as opposed to in any other period – past or future.  A correction, however, is underway, as a) the Chinese currency falls, b) Chinese political risk rises – pushing its claims over various offshore islands, c) accusations are made about Chinese product dumping in US and EU markets, and d) financiers worry about China’s ability (and will) to continue propping up subsidised industries and banks carrying bad debts.

The second uncertainty reflects events across the Middle East and North Africa to do with Syrian and other civil and religious wars and terrorism, population disruption and exodus, and relations between Iran and Saudi Arabia.  Russia and the West are also at loggerheads and relations between the EU and its near neighbours are strained to east and south.  Some of these issues look irredeemable at the moment. The failure to constrain the effects of the conflict to a small geographical area could be serious.

The third (and partly related) uncertainty is the oil and other commodity markets. The drop in prices undermines fiscal stability, growth and earnings in a number of countries, led by Russia, Brazil and even Australia.  Oil prices have fallen below US$30 a barrel. It is not unusual for oil prices to have periods of high volatility and wide swings as the demand and supply balance adjusts. Although there are significant lags in the process of adjustment, what goes down will come up. Already, there is talk of the supply chain drowning in oil. This will lead to stoppages, closures and mothballing at the wellhead. Supply will fall again and, since world demand continues to grow, oil prices will get back to US$100 a barrel – not now, but eventually.   Meanwhile, low oil prices are good for most of the business economy, at least in the short term. Why are investors panicking about something that should be boosting non-oil profits now? Methinks, it is another case of too much contagion for the markets’ own good.

The fourth uncertainty is about equities themselves. Was the run up in share prices over the previous three years or more a ‘sugar high’ related to the enormous liquidity pumped into the system through various bouts of Quantitative Easing and related monetary largesse by the West’s central banks? Is there real value in the corporate world or is it all built on sand? Today, the markets seem to believe the latter. But, they may be wrong. First, a lot of the excess liquidity was never made active. Second, technological progress and innovation is gathering rather than losing pace. Despite some demographic ageing, the medium to long-term prospects for growth and development do not seem diminished. Yes, we need to get western productivity rates up to support living standards but that calls for more investment and net inward migration, not less. There is a positive story to tell about the underlying economy that should outweigh the short-term ‘bears’, eventually.

The fifth uncertainty surrounds politics in America and Europe. The possibility of a Clinton-Trump contest for the US presidency in next November’s election is alarming many. One is reminded of Churchill’s famous statement along the lines of “America will always do the right thing … after it has flirted with all the other options”.   There may be scope, therefore, for a political bounce in economic prospects, as we approach the election and a rational outcome seems more likely. Meanwhile, there is the matter of UK-EU negotiations for ‘real’ reform and the UK’s in-out referendum. The current betting is on some sort of ‘offer’ kicking off the full referendum debate in late February and being resolved by a vote in the summer. The polls are close and the reform proposed is unlikely to satisfy the sceptics. The question is whether the majority of middle-ground Brits will “do the right thing” in the end? No one knows. But, I worry about the investment delaying and diverting effects of the debate and the vote itself. In the short term, why would companies invest in UK industries until a resolution of ‘BREXIT’ emerges? In the long term, why would you expand UK operations if access to the single EU market is no longer guaranteed on competitive terms? To a regional development economist, borders and boundaries are always a constraint on economic potential and performance.

So, there are five reasons to be unsure about the external environment for UK economic prospects. How do domestic factors play into this mix?

First, 2015 was a year of slowdown. Real GDP growth was barely on trend (c 2.3%) and was weaker at the end of the year than at the start. There was no inflation overall, although this hid wide swings between segments, such as houses (+7.7% year to November) and energy (-7.3% year to December). Meanwhile, unemployment fell to 5.1% overall (September-November). The employment-led recovery is intact but, inherently, it is unable to spark a strong upturn without support from higher productivity, which remains in the doldrums – at a level only just above its previous peak. The demand chain is propped up by the effects of modest real earnings growth on private consumption but, unless and until it is supported by other demand factors (business investment and net trade), this is not going to last – especially if, as expected by the forecasters, the labour market is now leveling off.

Second, the economy is not rebalancing. The trade deficit remains huge and volatile, and the current account is being worsened by a collapse in returns from UK FDI abroad. At about 5% of GDP, the current account deficit remains unsustainable for the long term. Also, manufacturing continues to struggle against global headwinds, as typified by the headline loss of capacity in the steel industry. Manufacturing output is still some 6% below its previous peak (Q1 2008). Since the recession, there seems to have been a permanent loss of productive capacity and a worrying erosion of viable supply chains.

Third, the policy environment is tortured. The public deficit is responding very slowly to fiscal austerity. As yet, ‘crowding in’ of private activity as the public sector retreats is a myth. The monetary environment remains incredibly loose, with low interest rates continuing to dampen investment’ (saver and investor) spirits and, thereby, prospects for underpinning sustained growth. Lost in an austere liquidity trap, the stabilisation policy mix is not supporting growth.

Against this background, the forecast consensus is for a weaker economy in 2016. The January collection of independent forecasts issued by HM Treasury sees growth averaging 2.2% this year after 2.3% last. This represents a downward adjustment by the forecasters from late last year, but still seems modest. Given what’s happening in the financial markets, it would be astonishing if these forecasts were not revised below 2% for 2016 over the next few months. My own current estimate is 1.75% for growth in UK real GDP this year. Importantly, as highlighted above, the downside risks are significant and potentially bigger than the upside.

Other current consensus forecasts include:

  • Inflation is expected to rebound a bit: +1.3% for this year after zero in 2015, largely because of previous ‘bigger’ falls dropping out of the index.
  • Unemployment is predicted to average 5.1% – a rate it has already reached, suggesting no further progress in 2016.
  • The current account deficit is expected to improve barely at all – from £81.5bn in 2015 to £77.6bn in 2016. This is also a “no change” view.

The UK economy is losing momentum and, in several ways, 2016 already looks like a ‘lost year’. Given the waves of uncertainty crashing on the economic beach at the moment, the fear is that the outlook deteriorates from something fairly benign into something worse.

There are some more hopeful signs. It is entrepreneurs, workforce skills, innovation and competitiveness that drives the growth process, not the financiers and panicky markets. There is no evidence that these factors are diminished. Indeed, they are what have been keeping the recovery going despite the headwinds of poor policy and politics. Some of the new technologies will be disruptive for jobs – aspects of artificial intelligence and new consumer interfaces (clouds, hand-held information and communication outlets and driver-less cars). Nevertheless, let us pray that the value-creating songs of the inventors and the risk-takers are not drowned out by the New Year Blues now so prominent in our ears

Regional GVA in 2014

In December, the ONS releases the gross value added (GVA – income based) and GVA per head data for the UK regions, devolved administrations and lower geographies. This provides our basic comparative measure of local economic performance.  It is a corner stone of most UK applied economic analysis below the national level. The table below summarises the new, local data for 2014.

Southern England 2014

2014 GVA

(£mn)

GVA per head (£) GVA per head (UK = 100)
Bournemouth & Poole 7941 23254 94.5
Rest of Dorset 8248 19719 80.1
Somerset 10641 19648 79.8
Plymouth 5195 19864 80.7
Torbay 2066 15354 63.1
Rest of Devon 15418 20146 81.8
Swindon 6551 30357 123.3
Rest of Wiltshire 9841 20369 82.7
Southampton 5782 23572 95.8
South Hampshire 11048 24568 99.8
Central Hampshire 14164 26479 107.6
Portsmouth 5381 25735 104.5
Isle of Wight 3071 22074 89.7

Source ONS

The new data confirms many of the descriptive characteristics that we already know about local southern economies. The relative performance of the regional economy seldom changes significantly over time.

  • Last year, was one of relatively good GVA growth, with averages for the UK as a whole of 3.6%), for SW England of 3.1% and for SE England of 2.8%.  Given negligible inflation, these are virtually real rates of growth.
  • Within southern England, north and east tends to perform ‘better’ than south and west. Also, urban areas tend to perform better than more rural areas.  This is normal, reflecting the workplace basis of the data, sector spatial characteristics and a typical concentration of high value economic activity in the more urban parts of any area.
  • Relative to the UK as a whole, southern GVA per head tends to be below average, but this reflects the effect of the ‘black hole’ that is Greater London on that average rater than any underlying weakness or fragility.

As well as providing new data, the ONS revises its numbers for previous years. This can change history quite markedly, although this time the revisions have, generally, been reasonably modest. Summarising the latest long-term series for GVA per head indices,

  • Relative performance has been fairly flat over the last two decades. The comparative scores have tended to sag a fraction.  The SE index tends towards 110 (10% above) versus the UK average whereas the SW index tends to 80 (20% below).
  • Generally, the historical series are remarkably consistent. It seems to be difficult to shift these fundamental measures of relative local economic performance over time, despite cyclical ‘booms and busts’ and profound structural changes to industry, technology and demographics.

A third aspect of the new local information is the sector breakdown by major industries.  The sector data for 2014 confirms that:

  • In aggregate terms, SW manufacturing and construction were only 11.9% and 6.8% of GVA respectively.
  • Amongst services, 17.9% of total SW GVA were distribution, 34.2% were financial and business, and 20.6% were mainly in the public sector.

GVA is our base indicator of economic performance. The latest figures show southern areas holding their own (within the regional economic league tables) and maintaining their industrial structure.  2014 was a good economic year.  There has been some loss of momentum in 2015.  Nonetheless, it would be a surprise if the relative score has moved much in aggregate terms and in terms of industrial structure over the last twelve months

The development community may wish and is tasked to shift its relative economic score over time. This means a relative improvement in measures such as GVA per head. This may be a worthy aspiration but it needs to be tempered by a healthy dose of realism. Without radical change in the economic fundamentals (including major investment in infrastructure, innovation and skills, competitiveness, and the wider capital base), the best that might be achieved is running to stand still.

Radical change means an emphasis on private sector productivity, engagement with markets and technologies, and a focus on the quality of our environmental and human capital.  In the years ahead, that would be a sound, strategic vision for growth of, and development in, the southern economies.

 

Autumn Statement – fortune favours the brave

In headline terms, the Chancellor’s Autumn Statement/Comprehensive Spending Review surprised many commentators, from its withdrawal from cutting tax credits to its lower than expected percentage cuts in many departmental expenditure settlements.  Nevertheless, overall, it remained an austerity budget based on higher taxation and lower public spending.  It is a settlement that, if fully enacted, will, itself, tend to detract from economic growth over the next five years.  Some of the measures, however, will re-direct activity to the private sector and, in theory, might ‘crowd in’ more private activity.

These ideas should be evident in the macroeconomic forecasts published by the Office of Budget Responsibility at the same time as the statement.  In fact, the forecasts offered are remarkably flat.  If the OBR is right, we are in for a period of rather boring overall macro trends with subdued growth in output and investment, in inflation, and in employment and productivity, leading to a gradual improvement in the public finances (see table).

OBR Forecasts November 2016 2015 2016 2017 2018 2019 2020
Real GDP (%ch pa) 2.4 2.4 2.5 2.4 2.3 2.3
Inflation (%ch pa) 0.1 1.0 1.8 1.9 2.0 2.0
Employment (%ch pa) 1.3 1.3 0.6 0.6 0.3 0.6
Productivity (%ch pa) 1.1 1.1 1.9 1.8 2.0 1.7
Investment (%ch pa) 6.1 7.4 7.1 7.0 6.6 4.5
Unemployment rate (%) 5.5 5.2 5.2 5.3 5.4 5.4
2015-16 2016-17 2017-18 2018-19 2019-20 2020-21
Deficit borrowing/GDP (%) 3.9 2.5 1.2 0.2 -0.5 -0.6
Debt/GDP (%) 82.5 81.7 79.9 77.3 74.3 71.3
Source: OBR

The more interesting facets of the announcements are micro in nature.  The local impacts of the devolution measures on governance and business rates, conformation of local development ‘growth deal’ funding, the creation of more enterprise zones, the infrastructure and house building proposals, and the buy-to-let stamp duty, apprenticeship levy and other taxes may have a profound effect on the way local economy’s develop over the next five years.  Although the central view is that this will not affect very much the underlying potential growth rate of the economy as a whole, there is plenty of cope for unforeseen consequences and distributional effects to be significant.

In SW England, we will be particularly intrigued to see how plans for devolution, (particularly the prospect of local government rationalisation in Dorset), and the new/extended enterprise zones at Dorset Green (Wareham), Bristol and Bath/Somer Valley, and Heart of the SW (Exeter and Bridgwater) will develop.  History suggests our expectations should be cautious … but, perhaps, fortune favours the brave.

 

ASHE 2015

Each year in November, the ONS releases local data on earnings for employees (not including the self-employed) across the country (ASHE – Annual Survey of Hours and Earnings).  This provides important benchmark data for studying our sub-national economies.

Overall, there was a small (nominal and real) increase in pay in 2015, with the UK averages reaching £426 median and £508 mean a week, respectively 1.9% and 1.3% higher than in 2014.  (The averages in this briefing report are a summary mixture of both full-time and part-time pay.)

The table below highlights the data just released for April 2015 across the Local Enterprise Partnership (LEP) areas of SW England and compares them with the English totals.  The first six columns relate to gross average weekly pay by residence and the rest the equivalent by workplace.  The first column in each section shows the jobs in the area covered by this survey in thousands.  The second and fourth columns show median and mean gross Average Weekly Earnings (AWE) respectively.  The third and fifth columns show the figures as indices relative to the SW total = 100.

In nearly every case, SW pay is less than the English average (which is pulled up by pay rates in London and the South East) and the gap between median and mean earnings (where the latter is pulled up by the comparatively few very high earners) is often less severe than elsewhere.  Unsurprisingly, workplace averages are higher than residence averages, reflecting both commuting patterns and business sector concentrations.

Overall, the latest figures suggest that the traditional differentials across SW England remain intact, with pay higher in the North and East than in the South and West.  The highest LEP averages (West of England) are about 8% above the regional average and the lowest (Cornwall) are about 15% below.  Even the LEP total, however, can be misleading.  There are significant differences within LEP areas too.  Generally, urban areas have higher pay than rural ones, both between and within the LEP areas – though there are exceptions (e.g. Torbay in Devon).  The highest pay averages are in Bristol and Swindon and the lowest in Devon (e.g. Torridge and North Devon).

Residence Jobs AWE median index AWE mean index Workplace Jobs AWE median index AWE mean index
West of England 489 435 108.7 502 107.2 West of England 532 422 108.1 492 108.3
Gloucestershire 260 426 106.4 509 108.6 Gloucestershire 255 417 106.7 477 104.9
Swindon & Wiltshire 282 424 106.1 504 107.6 Swindon & Wiltshire 255 412 105.3 485 106.8
Dorset 306 399 99.7 469 100.1 Dorset 303 386 98.8 447 98.3
Heart of the South West 667 376 94.0 432 92.1 Heart of the South West 633 375 96.0 424 93.4
Cornwall & Isles of Scilly 186 345 86.3 399 85.2 Cornwall & Isles of Scilly 164 332 84.9 377 83.0
South West England 2,188 400 100.0 469 100.0 South West England 2,142 391 100.0 455 100.0
England 21,112 430 107.6 516 110.1 England 21,406 430 110.0 516 113.4

Growth & Interest Rates

The SW purchasing managers’ indices (PMI) for October (just released) rebounded a bit from September’s lowish levels.  The UK recovery appears to be intact but it has slowed from the pace set earlier in the year.  Indeed, the PMI series peaked in January 2014 and they have tended to drop since then.  The latest output and employment balances were 54.1 and 52.6 respectively: the former was the eighth highest and the latter tenth highest (of 12), showing that the recovery is softer locally than in most UK regions and devolved administrations.  The slowdown is most evident in the weakness of new orders and business outstanding.

According to the Bank of England’s latest Inflation Report (November 2015), the softening of growth reflects international factors, especially slower growth in China, emerging markets and the EU.  These dampening effects come directly through physical trade but, more importantly, indirectly through financial exposures and markets: commodities, bonds and equity prices have all fallen in recent months.  Comparatively, the domestic economy is more robust, lead by some emergence of real incomes growth (+3%) and, at last, some positive change in productivity in Q2 2015 – although, so far, most of the recovery has been driven by an increase in hours.

Inflation remains about zero, largely reflecting the decrease in world import prices.  Core UK inflation is said to be more like 1% with wage increases starting to build price expectations.  The Bank says that interest rates will rise over time but, right now, it is signalling a further delay in the needed upward adjustment in base rates.  A return to ‘normal’ base interest rates of 4-5% is considered unlikely for many years.  An increase to a range of 2-3% would be welcome for normal economic working/incentives but is also probably more than two years away.

Inflation will start to rise as last year’s major drop in oil and other global prices fall out of the annual calculation.  This should mean an end to nearly 7 years of 0.5% base rates is imminent.  Central Bankers remain cautious, however, and there is a risk that policy increases come later and then have to be larger than might otherwise be necessary.  A slow rise to 1-1.5% over the next 12-18 months seems advisable but the resistance to action remains strong.  The danger is that tool little too late means more volatile adjustments … even renewed recession … in due course.

The recovery is less strong than it was.  The winter will probably see only modest growth.  SW businesses face a more difficult economy in 2016.

 

SER October 2015

At the top of the list to the right, you will see a link to our latest Strategic Economics Report covering business economic conditions in 2015 to date and the prospects for the rest of the year and 2016.

Although forecasters see the recovery continuing, recent evidence suggests a weakening of official statistics and survey balances across many aspects of sector and geographical economic detail.

Our main finding is that the recovery is slowing and the imbalances in the economy remain unresolved.  With policy stuck in fiscal austerity and monetary accommodation mode, if the recovery is to be sustained, growth needs to be driven more by productivity and international trade rather than just employment and the domestic consumer.

The Living Wage

The government surprised many UK economy watchers with its announcement in the July Budget that it would implement a “living wage” policy.  From April 2016, Chancellor George Osborne said there will be a new, compulsory living wage that will be paid to workers aged 25 and above.

Initially, it will be set at £7.20 an hour, with a target of it reaching more than £9 an hour by 2020.  Part-time and full-time workers will get it. Workers under 25 will still get the minimum wage, currently to be increased to £6.70 an hour from next month (October 2015).  The Low Pay Commission will review and recommend what the living wage will be for April each year thereafter.

The Living Wage will give a significant pay rise (7.5% in percentage terms and 50p an hour) to six million workers.  Those who keep their jobs and hours will see a welcome rise in incomes and spending power.

But, the Office of Budget Responsibility estimates that it will forfeit 60,000 jobs and reduce hours worked by four million a week.  A lot of business comment has concluded that the Living Wage policy is a “gamble” that will cut employment opportunities for low-paid people because it will undermine profitability for many vulnerable SME businesses.

What is the economics here?  Well, in simple terms, yes, an increase in labour costs tends to reduce employment, increase prices and reduce overall economic activity.  It is not, however, quite that simple.  It depends where you are starting from and heading to.

First, timing is everything.  If wage rates are increased when the economy is strong, (i.e. good growth in orders, outputs and incomes generally), then the change can be absorbed by many firms with relatively little disruption to investment and product or service plans and activity levels.

Second, sector is everything.  Lots of firms and business groups are complaining and worried about the Living Wage’s effects on profit margins in a non-inflationary environment when cost increases can not be passed on to customers along the supply chain.  It is true that it is harder to absorb in some industries than others.  Of relevance here, is the impact on, low-paid jobs and services in, among others, the leisure industry (catering and tourism etc) and on health and social care.

Perhaps, however, a shift in value shares from profits to wages is warranted right now.  Since the Great Recession of 2008+, wages have gone up very slowly if at all for many workers.  It could be argued that some rebalancing of income shares from profits to wages is overdue and merely starts to restore a fairer and more economically positive situation. Since living wage recipients will tend to spend rather than save, it might even stimulate more consumption and, thereby, help economic growth. In the end, then, business may well get back the Living Wage pay increase through higher sales!

Third, scale is everything.  Economies adjust to new realities in time. In the short term, there may be an adverse shock but, eventually, the effects of the new Living wage will depend on how it is going to be raised thereafter – presumably in line with trends in other real earnings to attain and maintain the desired 60% of median earnings target.

To an extent, the Living Wage will replace internal, annual wage bargaining for many companies once it is part of the annual fabric.  However, the worry is that taking the market out of the basis of labour costs creates a rigidity that will not always be appropriate.  In due course, it could mean a higher ‘natural rate of unemployment’, as observed in some of our peer countries.  Whether that is a price worth paying is as much a political as an economic question.

Fourth, productivity is everything.  The real questions are will low-wage workers respond to being paid more by working harder and better?  Will firms seek other ways to manage costs – fewer jobs in the short term but a boost to capital investment and productivity in the long term?  Given the UK’s parlous productivity record, any incentive to invest in more productive working practices from the higher costs of the Living Wage, might yield positive net benefits over time.

Generally, market economists do not like imposed as opposed to market-determined prices. Moreover, the history of state imposed wages is mixed – there are examples of rapid absorption and of unwelcome disruption.

The problem with this particular policy is it looks like it might impose a big wage increase for firms in a year when growth may already be slowing.  In 2016/17, that is, it may have a dampening effect on jobs and growth compared with what otherwise might have happened.  In time, however, I would expect the economy to adjust well, with the higher wages boosting productivity and sales.

As is so often the case, it is a bit of ‘on the one hand this’ and ‘on the other hand that’.  It will be interesting to see how the policy adapts to changing economic circumstances in the year ahead.

Tory Story – The UK Budget, July 2015

Today, Chancellor Osborne introduced a UK budget that was very party political – a “Tory Story” based on some welcome and some risky economics.  Overall, its impact is to push back the forecasts on fiscal surpluses by a year in an economy with still miserly growth.  This is more realistic than we had before the General Election, but not very much more so. The welcome bit is that the incentive structure is changing in a way that may favour, eventually, more growth based on private sector investment and personal saving.  The risk is that it hurts growth by cutting many household incomes before the hoped-for structural changes can feed through.

It was a net-tax raising budget – less tight than March but still tight – that will dampen demand in near term in the hope that changing incentives will boost private sector performance in long term.  The stated principle of aiming at a higher wage, lower tax, more productive economy is admirable.  Less pleasing is that all the micro fiddling with various measures makes work for the accountants etc but the net macro effect looks minimal.  As the small changes in the OBR forecasts released today suggest (see table below), the macro story is not really altered.  UK growth remains vulnerable to external shocks, weaker domestic demand and poor international competitiveness/productivity growth over the next few years.  Moreover, we must await the detailed pain of the Central Spending Review (CSR) in the autumn before we can really judge ‘who and where’ gets hurt the most and ‘what and where’ the new opportunities may develop.

The micro stuff in the budget will be analysed to death by other commentators over the next 24 hours or so.  The highlights will include focus on five key areas:  a) welfare cuts (to various benefits and credits); b) tax changes (to higher personal thresholds, inheritance taxes and corporate taxes); c) the “living wage” (effectively a higher minimum wage that might cut job prospects of some whilst raising pay of others); and d) the so-called productivity boosting measures (for transport, skills, regions – northern powerhouse – and housing).  Also, there will be lots of comment on the three main commitments: a) to defence and security spending staying at 2% of GDP, b) to the lock on headline tax rates for this parliament and c) to the fiscal charter to set government surpluses in ‘normal’ times into law.

To digress a moment, in 2015, it is 900 years since Magna Carta, 700 years since Agincourt, 200 years since Waterloo, and 70 years since the end of World War 2.  In 2016, it will be 950 years since Hastings and 50 years since Wembley  (the FA cup final as well as the other one!).  As the economy moves “once more into the breach”, all I can ask is did we ever live in ‘normal’ times?

 

Anyway, the table below shows the main OBR forecasts based on today’s policy announcements.  They show flat growth and unemployment and subdued inflation for five years – will the real world ever behave as quietly as that for so long?  We have lower employment growth and improved, but still too low, productivity growth.  The debt/GDP ratio drops a little but barely enough to notice.  We do get a fiscal surplus by about 2020 but that’s slower than we were told before.  All-in-all this is a “no change” forecast with a dollop of wishful thinking.  If the forecasters are saying “no change”, the intelligent focus has to be on where the shocks will come and how the forecast will be wrong.

There are plenty of candidates for shocks – Greece (see previous blog), China, Middle East as well as some market risks.  The Treasury must be hoping the world environment improves.  The much vaunted “we are better than the rest” is not much comfort at these low investment levels and low growth rates.  The Chancellor and his party believe reducing government and switching incentives to ‘crowd in’ the private sector is better for economic prospects in the long run.  I have a lot of sympathy with that view and I hope they are right sooner rather than later .  But, I also have a lot of concern about the economy’s resilience at this time.  The future path is bound to be more volatile and precarious than the “Tory Story” we have just been given suggests.

OBR 2015 2016 2017 2018 2019
real GDP 2.4 2.3 2.4 2.4 2.4
inflation 0.1 1.1 1.6 1.8 1.9
unemployment 5.4 5.1 5.2 5.3 5.4
business investment 6.0 7.2 6.9 6.6 6.5
employment growth 1.6 1.0 0.3 0.3 0.6
productivity growth 0.8 1.3 2.1 2.1 1.8
2015/16 2016/17 2017/18 2018/19 2019/20
public net borrowing/GDP 3.7 2.2 1.2 0.3 0.4
public net debt/GDP 80.3 79.1 77.2 74.7 71.5

Greece

Greece has a debt habit which is now completely debilitating.  Further bail outs will only feed the habit and help neither the patient nor the doctors.  The condition has been left untreated so long that there is no longer any easy way out without drastic, painful surgery, especially for the ordinary Greeks.  Sadly, the referendum was irrelevant and Grexit now looks inevitable, whether it comes sooner or later.  It will be a bad example for others – yes, there are some important moral hazard issues for other debtors – but, the euro-zone (EZ) (and Greece) will be better off eventually if it reduces to a sustainable size and structure.

There are many historical examples of default and creating new currencies, especially in what used to be called the third world, then developing countries and now …?  Argentina 2001/2 stands out in my memory but there are many others and some companies and individuals go through bankruptcy all the time.  It is awful to live through but, in the end, there is no choice but to wipe the slates clean and start again.  Countries are not immune to the perils of insolvency if they adopt the wrong incentives and economic cultures.  Sadly, the Greek government’s approach is popular but populist.  It is not helping.

For rest of us, bottom line is Greece is not big (2% of EU GDP?).  As Brian Wesbury of First Trust Portfolios says, Greece going bust in EU is equivalent to Detroit going bust in the USA.  It is manageable and does not matter for overall macro trends.  It needn’t derail the overall economy as long as the markets don’t overreact.  Of course, some EU businesses will be affected badly and wider contagion is a risk but, of itself, it’s not a big economic issue – even if it’s politically toxic.  This should not have been as difficult a problem as the Eurozone has made it.

The path out requires 1) Greece to adopt growth-friendly policies, including fiscal tight and monetary loose stances and, importantly, legal structures and regulations that re-affirm trust in the system of property rights, payments and due process; 2) some debt write-off by EU/IMF and banks with strict conditions about future behaviour (30-50%); 3) some time-limited liquidity support for Greek banks; and 4) a new currency that can depreciate and improve Greek international competitiveness albeit at the cost of higher domestic inflation.

Easy to write – not easy to live through.  There but for the grace of God go us all.  Have other large debtors, including UK, learned the lesson?  This takes us towards Osborne’s budget later today … more on that later.