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