Enjoy the festive season. Let’s hope there’s still a reason
to look into the future with a smile
The uncertainty of BREXIT. Who knows how we’ll fix it?
Be merry and happy … meanwhile
Enjoy the festive season. Let’s hope there’s still a reason
to look into the future with a smile
The uncertainty of BREXIT. Who knows how we’ll fix it?
Be merry and happy … meanwhile
On 20th December, ONS released the latest regional and sub-regional gross value added (GVA) figures, including historical revisions. For the first time, it produced ‘balanced’ data between the incomes and production methods.
GVA is the standard measure of total ‘output’ generated in a particular place (below the national level) over a particular period. The new numbers are for 2016 and provide a structural benchmark for most local economic analyses. (Given the sluggish performance of the UK and local economy this year, the relative scores are unlikely to have shifted markedly in 2017.)
Total GVA and GVA per Head
Dorset’s total GVA was £16,130mn in 2016 (current prices), placing Dorset 32nd out of the 38 LEP areas. Given the area’s relatively small size (economically), this ranking is roughly to be expected. These standings do not change much from year-to-year because all UK areas tend to grow or fall together. However, there can be lags between the different parts of the country when significant changes in trends are taking place (such as periods of recession). Also, in the long run, there can be bigger changes in position as industries wax and wane and local specialisms grow or fade.
In terms of GVA per head (see first table below), a better measure of relative performance because it takes total population into account, Dorset still did not fair that well. Ignoring some commuting effects, this is a broad measure of productive performance. It shows Dorset to be below regional and national averages (see table).
GVA per head (new balanced approach)
|£’000||2015||2016||UK = 100||2015||2016|
Dorset’s index measure of 79.3 (compared with the UK average = 100) was down on the previous year. Indeed, for the first time, Dorset was more than 20 percentage points (pps) below the national average, continuing a downward trend that has existed since, at least, 1997. Dorset ranked 24th out of the 38 LEP areas on this measure.
In historical terms, this ‘middling’ ranking is roughly where one might expect Dorset to be, given that nowhere is standing still and given the sector and infrastructure characteristics of the county. Nevertheless, it is disappointing that recent slippage in comparable standing continues. Dorset GVA per head dropped from just 8.7pps below the UK average in 2000 to 20.7pps below average in 2016. This suggests a significant erosion of relative living standards for Dorset residents over the last 15 years. (N.B. it is not an absolute decline. The numbers are not inflation adjusted and all areas can still be growing. It is the relative change over time that is unfavourable.)
In mitigation, some of this relative decline is caused by the more general widening of the gap between Greater London and most of the rest of the country. London has pulled the UK average up compared with the more economically peripheral areas. Nonetheless, the basic story remains one of a poor local productivity performance in Dorset (and elsewhere): a “lost” decade or so of potential growth in living standards.
Broad Industrial Breakdown
The next table shows the broad industrial breakdown of local value added.
Share of Dorset GVA by industry (SIC classification, % of total)
|Public services||18.2||20.5||All private services (except L)||36.1||40.8|
Definitions: ABDE = agriculture, forestry & fishing, mining and quarrying, utilities-fuels, water & waste. C = manufacturing. F = construction. GHI = distribution services (retail, wholesale, transport, accommodation). J = information & communications. K = financial and insurance activities. L = real estate. MN = business services (professional, scientific, technical, administration & support). OPQ = public services (administration, defence, education, health & social). RST = leisure & culture, household and other personal services).
In industrial terms, all recent growth in Dorset GVA (1997 onwards) has been in services, with most growth (in nominal terms) in business and financial services and least growth in manufacturing and the land-based/fuels producers. The table above shows the broad movement over time in major sector shares. Production has gone from 23.5% in 1998 to 18.5% of the economy in 2016: a drop of 5% in less than two decades. This 5% share has shifted largely to private services (excluding real estate – L climbing from c36% to c41%.
Amongst the 12 “southern” LEPs (as highlighted in the next table below – first column), Dorset ranked 10th on GVA per head, with only the two furthest west SW areas below it. Overall, across southern England, there were clear ‘east-west’ (peninsula) and ‘north-south’ (coastal) divides in productive performance, overlaying the more usually recognised ‘urban-rural’ one. The divergence across southern England remains significant: fully 93.6pps across the patch from Berkshire to Cornwall. Sadly, Dorset has slipped towards the relegation zone.
GVA per head by LEP area, UK = 100 2016 & pps change since 1998
|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|
It is interesting that eight of the LEP areas in the table above have experienced a relative decline in performance since 1998 (second column). Over this period, Dorset’s 9.4% drop in its GVA per head index is similar to the experience of the other south coast areas – Devon (HoSW -4.7%), Hampshire (Solent -8.9%) Sussex (Coast to Capital -10.5%). Cornwall (-0.5%) has just about held its own, (perhaps, because of the substantial development funding that has poured in under EU regional policies) whilst Kent (part of the South East LEP -8.1% – not listed) was also down.
Clearly, there is an issue about relatively weak economic achievement along the English south coast, probably explained by changes in industrial structures – sector and technological specialisation and employment and skills distribution.
Perhaps, the “South Coast Corridor” deserves support from development agents and funding as much as the “Midlands Engine” and the “Northern Powerhouse”.
Within Dorset, about half of the GVA was generated in Bournemouth and Poole (combined £8.2bn in 2016) and half in the rest of the county (£8.0bn). If we include Christchurch and East Dorset with Bournemouth and Poole), the split would be £10.8bn for the main Dorset conurbation and (£5.3bn) for the rest (roughly 2/3rds to 1/3rd). The following table shows the GVA and GVA per head breakdown within Dorset in detail
Because Dorset has a distinct urban and rural diversity, commuting patterns are important inside the county and between it and its neighbours (mostly to the east). Some GVA produced in the Dorset towns is made by non-residents, but GVA per head is calculated on residents alone. Some Dorset residents’ output is recorded in the Greater South East and some output in the conurbation is generated by labour commuting in from outside. This is why the GVA per hour series for Dorset that relate value output to worker effort – scheduled for release in January – are a better measure of underlying labour productivity.
GVA & GVA per head within Dorset: All industries
|£mn||£/head||GVA % share|
|Weymouth & Portland||875||13,386||5.4|
By broad industry (SIC Codes as before), the distribution of GVA is shown in the next table. Unsurprisingly, it confirms the importance of the conurbation for many industries, with the per resident head measure ranging from over £26,000 in Poole to about half that in Weymouth and Portland.
For example, in 2016, B&P contributed 44% of the land based/utility industries, 37% of manufacturing, 41% of construction, 49% of distribution, 58% of information and communications, 86% of financial services, 46% of real estate, 47% of professional services, 53% of public services, and 44% of leisure and other services.
Similarly, it is interesting to note some of the differences in sector importance for different parts of the county. For example, the biggest industries in each area were, respectively, distribution in Weymouth and Portland, public services in West Dorset, Purbeck, North Dorset, Poole and Bournemouth, and real estate in East Dorset and Christchurch.
The table can be used to show were different sectors are important locally. For example, manufacturing is clearly important in Poole but it is also particularly important, albeit at a lesser scale, to activity in East Dorset and West Dorset. Distribution (retailing and transport etc) is important everywhere but some sectors are more concentrated in urban domains, including financial and business services.
GVA Industry Breakdown within Dorset (2016, £mn)
|North Dorset||Purbeck||West Dorset||Weymouth & Portland|
The new data reviewed in this briefing shows the broad ‘league’ tables of economic performance, with Dorset middling, at best. Structural, capacity, skills and market weaknesses remain to be addressed. All the UK needs to raise productivity relative to our overseas competitors. But, within the UK, Dorset needs to raise productivity even more to stop it slipping further behind in the table.
The Government’s recently announced Industrial Strategy aims to correct some of the imbalances and inadequacies displayed by the latest GVA statistics (see our LEB22 for a discussion of the Strategy).
Indeed, this ONS regional performance publication will be one of the areas where future analysers of development research will observe whether the Strategy is having the desired impact. The GVA and GVA per head figures will remain a key, annual data source for analysis of regional economic development across the United Kingdom.
The key economic message from (yesterday’s) UK 2017 Budget is that there was something of a loosening of macro fiscal policy with a number of measures aimed at encouraging investment and growth. Analysis of the details is covered by many commentator elsewhere. The main point of our interest here is the changed OBR view of the overall economy’s future. It suggests fiscal policy is not going to do much for absolute or relative UK productivity and competitiveness in the next few years.
The most important OBR message is that growth stays below 2% per annum (averaging about 1.4%) because productivity only increases from just below to just above 1% per annum for the foreseeable future. In consequence, unemployment rates start to rise (though still below 5%) and the inflation rate peaks shortly and falls back to target (2% per annum). Real earnings start to rise modestly, but only from 2019. The rise in business investment is anchored at about 2.4% per annum and household consumption increases at a similar rate to the economy as a whole (averaging 1.4%). Net trade contributes nothing. As a result, the government deficit ratio drops slowly from over 2% to about 1% over five years and the public sector net debt peaks at 86.5% of GDP in 2018/19 but is still as high as 79% by 2022/23.
The message is stark. If the central forecast is for growth below 2% a year, the downside risks could be ominous. If Brexit imposes new barriers to trade, as currently seems likely, the risk of recession becomes far from negligible. The need to fix the ‘broken’ model of UK development is profound. Whether it comes from a domestic resurgence fueled by policy on skills, innovation and investment, from an indigenous spark of entrepreneurship and competitiveness (cheap £), and/or from new trade deals with various parts of the growing world, the productivity deficiency has to be closed. An Industrial Strategy white paper is expected shortly. The economics and development community will need to interrogate this closely and deeply when it comes. The fear is that it’s all too late to avoid a harsh economic period in the years ahead. The broken economy needs mending.
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.
After an indecisive General Election, and with the BREXIT negotiations now underway, the political runes remain hard to read. Meanwhile, the global economic context is unstable and the economic outlook uncertain.
The financial markets and UK and foreign-owned businesses have reacted warily to the process of regulatory and trading change that is now underway. In contrast, many households are over-borrowing whereas many businesses have robust cash reserves. This and other economic imbalances are profound, especially with respect to productivity, trade and the public finances- regardless of how BREXIT proceeds.
Against this background, the latest data show a mixture of below trend growth and above target inflation, with high employment, low unemployment and, still, low interest rates. Consumer and business surveys remain largely positive but there is a marked contrast between negative real wage growth (hurting average households) and, despite poor productivity figures, improving profitability (net rates of return for average businesses).
Meanwhile, the key business issues are ones of skills deficiencies and tight labour markets contrasting with some caution over investment and competitiveness. Generally, the economy is growing but losing some momentum.
|Real GDP (%ch, yoy)||+1.8||+1.7 (Q2 17)||n.a.|
|CPI inflation (%ch, yoy)||+0.7||+2.7 (Q2 17)||+2.6 (Jun)|
|LFS unemployment (%)||4.9||4.6 (Q1 17)||4.5 (Mar-May)|
|Trade deficit* (£bn)||-£37bn||-£8.8bn (Q1 17)||-£3.1bn (May)|
|Base rate (end %)||0.25||0.25 (Q2 17)||0.25 (July)|
Source: ONS *goods and services
Economic growth may be petering out, with household spending constrained by prospects for real incomes (earnings not compensating for higher inflation, despite high employment). Investment remains modest and net trade in massive deficit (overall, price effects outweighing substitution effects despite some headline successes). Longstanding UK economic weaknesses persist.
It is always regrettable when the inflation rate exceeds the growth rate (see table above). UK growth went from fastest to slowest amongst the G7 over the year to Q1 2017. For April-June, there was a tiny bounce but, it appears to be one of the ‘dead cat’ variety. In the first half of the year, UK real GDP growth was running at half the rate it did in the second half of 2016. Given the uncertainty surrounding BREXIT, most forecasters expect this underlying loss of pace to persist.
On the policy front, the ‘hung’ Parliament suggests some erosion of fiscal austerity might occur. It could also mean a stalling (before it has really begun) of the “Modern Industrial Strategy” – the white paper is now promised before end year. It is to be hoped that uncertainty about the BREXIT negotiations and the government’s lack of a strong electoral mandate do not stand in the way of positive action on public investment at home.
Meanwhile, with inflation above target and expected to remain so, albeit lower in June than May, the Bank of England remains extremely loose. Contrast its unchanged interest rate and QE stance with the actual and pronounced movement to a ‘less loose’ position by the US Federal Reserve, as the US recovery builds. It will be interesting to see if the European Central Bank, already talking about having removed the risk of deflation, abandons its negative interest rates and its QE measures later this year – now that the EU economy is grinding out some forward momentum (at least its better bits).
The Bank of England’s latest Financial Stability Report (June 2017) describes the current domestic financial position as having risks at a “standard level”, which seems to mean ‘broadly normal, no immediate threats”). Nevertheless, the Financial Policy Committee (FPC) is highlighting four main “pockets of risk” that “warrant vigilance”.
Beyond these four risks, the FPC also mentions concern for the banks if disorder from the BREXIT negotiations emerges and vulnerability to cyber-crime is exposed.
Overall, the banks have strengthened their capital positions markedly since the 2008/9 crisis but their profitability remains weak. Stress tests reveal that resilience is good but, given the risks highlighted above, continued vigilance is required. The FPC is right to be watching closely and recommending early action to prevent excesses in UK banking.
Meanwhile, the Monetary Policy Committee (MPC) of the Bank of England is beginning to talk about raising interest rates and starting the process of ‘normalisation’ – by reducing the overhang of liquidity from quantitative easing (QE). In May, the MPC vote was 5-3 in favour of keeping the base rate at 0.25%. The ‘mood’ music is that the Bank wants to prepare the markets and other economic actors for a slow tightening of monetary policy from here.
Although inflation is now above target, the MPC does not expect this to last because, as yet, there is no momentum towards higher inflation from the labour market. The drop in the ‘headline’ inflation rate from May to June (back to 2.6%) was taken as evidence for this view. Accordingly, there will be no major increase in interest rates soon. Thereby, the ‘awkward’ incentives provided by prolonged low interest rates, which continue to hinder the savings/investment process, and to support unsustainable domestic debts and so-called ‘zombie’ firms, look likely to persist.
Since the General Election, there has been some debate about the future of the governments’ ‘austere’ approach to fiscal policy. Some loosening may be seen in the Autumn Budget but the internal Conservative Party conflict between ‘wets and dries’ and ‘brexiteers and remainers’, and about the future leadership makes any prediction on this front futile. Fiscal policy is just another uncertainty for business and households to deal with.
Macro stability also hangs on the ‘success’ of the UK’s trade negotiations with Europe and other major trading blocs. New impediments to free trade, real (tariffs, quotas, regulation or other trade barriers) and psychological (affecting aspiration and trade engagement by UK and foreign companies), would be a major blow to productive potential, trend and achieved growth, and future living standards. As recent discussion of the demands of the strong agricultural and health lobbies in America indicate, the UK willingness to do non-EU trade deals is confronted by the reality of BREXIT transition and the potential need for difficult compromises and unforeseen consequences.
The Economic & Development Outlook
At the time of the pre-election Budget (March 2017), the Office of Budget Responsibility (OBR) set out modest and largely flat economic prospects for the UK economy. Since then, other forecasters, including the OECD and the IMF (down from 2% to 1.7% for 2017 real GDP growth and 1.4% for 2018), have been moderating their views and helping to create a more subdued consensus. For example, the latest (June) HM Treasury monthly survey of independent forecasters shows growth at 1.6% and inflation at 3% in 2017 and 1.4% and 2.5% respectively in 2018. The equivalent unemployment rates are 4.9% and 5.1%. The current account deficit and public-sector net borrowing improve a little but remain excessive.
Overall, the UK and local economies are forecast to slow down further over the year ahead, with a small increase in unemployment and still weak productivity. There is a strong real and policy need to break this pattern (see our Local Economy briefing 19 – Productivity Revisited – released with this report). The promised “Modern Industrial Strategy”, including significant real investment in productivity-growing capacities, is sorely needed.
During this summer of uncertainty, UK macro stability is being tested by a global and domestic environment that is undergoing profound structural and psychological change.
Thoroughbred or Plough Horse
With the UK’s economic performance better than feared in the last half year, fuelled by robust consumer spending, but with a number of clouds on the horizon, it is a good time to look ahead and see how the economy stands.
The economy is rather like the Grand National horse race. It’s an endurance test with a number of barriers to overcome where the steeds generally move forward carefully. Sometimes the gallop cannot be sustained for long without problems building up: an overheated horse (economy) may well get pulled up. Over a racing career (the economic cycle), the horse needs to be fed (by investment) and it needs occasional periods of recuperation (rebalancing) but, once the race is on, it only stops if there is a reason to make the horse falter. Usually, this occurs because hurdles are put in the way that are too high for the racehorse to jump or the jockey is too heavy for the horse to carry over the distance.
There are four ways the hurdles and jockeys of economic policy can slow the horse down or, indeed, make it fall.
Monetary Policy: Monetary policy, guided by the Bank of England, is about setting interest rates to influence the demand, and setting reserves to influence the supply, of money. Monetary policy can slow the economic horse by setting interest rates too high, too quickly and by restricting access to funds or speed it up by being “loose” on the reins. Effectively, monetary conditions influence the height of the fence to be jumped and the style of the jockey.
Theoretically, base interest rates should relate closely to the nominal growth of GDP, linking money to the real economy. In the UK, given an inflation target of 2% per annum and a trend real growth rate of about the same (as estimated by the OBR), ‘normal’ nominal GDP growth would be about 4.0% per annum. With official interest rates at 0.25%, the Bank is very far from putting interest rates anywhere near this ‘normal’ rate, largely because of excess savings (driven by an ageing population) and a period of persistent slow growth. The UK’s poor productivity performance since 2008 reflects ongoing low interest rates, because these encourage the survival of inefficient enterprise.
In addition, after Quantitative Easing and other efforts to supply money to the economy, we have huge excess reserves in the banking system. These could be a major threat to the horse’s stability (high future inflation) if left intact. Already, they create a ‘brake’ on interest rate increases. Right now, the monetary fences for the horse to jump are almost imperceptible. Moreover, in the foreseeable future, there is little expectation that interest rates will rise and reserves will fall, sufficiently to significantly slow or ‘pull up’ the economic horse. Unless or until inflation accelerates (above target indefinitely), the monetary fence will remain low and, surely, no barrier to growth (completing the race).
Trade Policy: Trade policy sets the conditions of international exchange and regulates access to markets. It is another potential hurdle for the economic horse. Economics teaches us that barriers to trade are ‘bad’ and free trade ‘better’ for keeping the horse running. Trade creates more jobs through supporting a sustained faster running pace of/for output growth.
BREXIT and the policies of President Trump raise the spectre of more protectionism – higher barriers, taxes and tariffs on trade. The key point is that all parties in the global economy are interdependent. Economic rationality suggests both importers and exporters will not wish to put the trading system at risk. Many ‘policy jockeys’ get this. There is clearly, however, some present danger that political actions, couched as popular nationalism, will undermine the global trading system. There is a risk that this trade fence goes up sharply and, at best, may slow and, at worse, unseat the economic horse in the years ahead. There is a clear downward risk to growth from trade protectionism. But, this is not a given. If all the negotiations go well, there could be a big upside – the promised land of the UK as a multi-agreement trading partner with all parts of the world could increase the sustained and sustainable speed of our horse.
Tax Policy: Taxes on business are used to fund public policies that intervene in the economy in order to address market failures and fund socio-environmental priorities. The political debate about how big the public sector should be relative to the wealth creating private sector is a long-established and hard-to-resolve chasm. But, note, public funding comes from taxation or borrowing – both require a drag on the payers. Essentially, high corporate or sales taxes and a complicated tax code are like having a heavy jockey on the back of the business horse.
UK administrations have been reducing some corporate tax rates in recent years. Indeed, there has been a competitive race to the bottom by some of our competitors (notably Ireland) on corporate taxes. Furthermore, President Trump vows to join in (cutting the tax burden – rates and rules – on US corporates). BREXIT raises the possibility of business, sales, or other UK tax rate changes in future. It may mean UK governments have scope to simplify the system or they could be looking for ‘new’ sources of revenue. At present, it is unclear how the UK’s competitive position on tax will evolve post-BREXIT but it is not expected to hinder the horse too much in the near future. The tax jockey is not expected to overburden the business runner – but these could be famous last words.
Spending/Regulation Policy: New technologies and process innovations are fuelling economic growth. Excess regulation and non-productive state spending can hurt this growth process by putting a heavier jockey on the horse. Too much or misdirected state spending or regulation can change a business thoroughbred into a plough horse – cutting its potential speed (of growth) over the medium term. Alternatively, reducing business regulation could be an important mitigation for any negative BREXIT effects through trade policy. Rebalancing from government consumption to government investment could be an important part of a new “Modern Industrial Strategy” in the years ahead.
Overall, then, monetary policies seem set to continue to support the economic horse whilst tax and regulations policies could go either way and trade policies risk hurting it. The net balance of these factors, as the terms of the UK’s new trading relationships emerge, will be key to how the stamina of the economic horse develops in the next five years. There is a risk that trade protectionism sets higher fences: turning our steed into a plough horse – worst case, recession. However, there is an opportunity for a thoroughbred to emerge from good training, especially if trade deals can be done and tax/regulation policies can support growth just as monetary policy becomes ‘less loose’ or even makes a welcome return to ‘normal’.
Place your bets …. But, remember, the Grand National is a lottery. Uncertainty is the main risk right now and the main dictator as to which horse comes first over time.
 Based on a similar approach to the US economy by Bryan Wesbury, Chief Economist, First Trust Portfolios, Chicago, USA
God Save America. 2016 will go down as the year of Brexit and Trump. REM sang, “It’s the end of the world as we know it … and I feel fine.” At the moment, it feels like the end of the global economy as lead by the anglo-countries. It’s hard to feel fine because markets and economies hate uncertainty and we now have uncertainty in profusion.
Why are economists worried? Uncertainty usually puts the brakes on investment. Simply, weaker investment means lower output, fewer jobs, weaker productivity and worse standards of living compared with what might otherwise have been.
Intervention to mitigate these negative effects might be possible … but it’s hard to do that in economies where the public debt is already too high and interest rates are far too low. Without adverse implications, it’s difficult to add to the public debt, spend more and tax less when fiscal policy is over-borrowed. It is very hard to encourage productivity-enhancing private investment when expected returns are so depressed.
President-elect Trump said in his victory statement that his administration would double US growth and hinted that this would be done by recourse to massive infrastructure renewal. That may work but it would be a hard task in good times. Starting from here, it looks impossible without a high risk of scary repercussions – higher taxes, higher inflation and much higher interest rates … eventually.
It feels like the end of the world economic order as we’ve known it over the last sixty years. Maybe, we can look back in ten years time with relief about how well it all went but, right now, it don’t feel fine. God save us all.
Latest review of ‘state of economy’ is now available – see link at the top of the report column to the right of this post.
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.
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.
|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).
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
|Current Account (£bn)||-103.1||-82.1|
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.
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.