This week I attended a briefing by PwC with the ominous title “Coping with uncertain times – UK and global economic update’. I’m not sure that we ever live in certain times and most economic forecasts are wrong but nevertheless I went with open mind and ears. The principal speaker was Dr Andrew Sentance CBE whom I first met when he was still a member of the Bank of England Monetary Policy Committee. He held that post from 2006 to 2011 so he was there through some of the least certain times in modern history. He distinguished himself as the first member to come out in favour of raising interest rates after the worst of the crisis had passed. His argument was and remains that if interest rates are too low, not only does that give rise to distortions in economic activity, but also you have no room to manoeuvre if times get really tough. Eventually two other members joined him but not enough. The Governor Mark Carney would often say that we might increase rates but never has. He sometimes said he would do this when unemployment fell below 7% but it’s now down to 4%, the lowest rate for well over 40 years and he still hasn’t acted. He’s about to move on and my personal view, with which I think Andrew agrees, is that he leaves a terrible legacy behind him.
Over the last two centuries the average annual change in UK GDP has been 2.12%. This held good through all of the Victorian era, fell to about 1.5% in the early part of the 20th century, grew strongly in the 1950s and 1960s to over 3.5%, remained strong in the 1970s and 1980s at 2.6% but since then has slowed down to below 2% and PwC forecasts for the next six years to 2025 is back to 1.6%. If true that would be the slowest rate of growth since the 1940s when the Second World War was raging. When population growth is taken into account recent GDP per capita growth has been and will be glacial.
But this isn’t just a UK phenomenon. GDP growth at the global level is also slowing down. Furthermore what growth there is is increasingly driven by the Asia Pacific region while North America and Europe are taking a declining share of world GDP. Looking at the G7 countries the index of GDP per capita has been modest. Here the UK ranks surprisingly highly. Taking the year 2000 as a base the UK ranks second just behind Germany then the US, Canada and Japan. Some way below them is France while Italy has badly declined in GDP per capita ever since it joined the Euro.
Unemployment, however, is at historic lows, not just in the UK but across the G7 on average. Again this is not the case in France and Italy where unemployment remains high, largely due to the Euro but also to rigid employment laws which discourage employers from taking on full-time staff.
Comparing economic growth in the UK, US and the Euro area all are trending quite closely but it is clear that while all three suffered badly in the 2008-09 recession the UK and the US have grown steadily if slowly ever since while the Euro area went into a second recession in 2011-12 and seems to be facing a third.
Dr Sentance is clearly a Remainer and admits that he and his colleagues were wrongly pessimistic about the immediate impact of the British people’s decision to leave the EU in the 2016 referendum. But he remains circumspect about the outlook. He thinks it unlikely that we can achieve a full free trade deal by the end of 2020, the newly elected government’s stated policy, and expects them to reverse this when the deadline looms. He told us that if we were unable to conclude such a deal with the EU it would be unlikely that we could do so with anyone else. After the meeting I told him that I knew on the evidence of my friend, the Chilean Ambassador, that the UK and Chile had already agreed terms of such a deal.
The fall in the pound after the referendum put some pressure on consumer prices but that was now subsiding. Investment has also slowed but here the strange thing is that foreign investment in the UK has not. UK business investment has performed badly over many years and my own view is that UK business has got used to hiring cheap labour from Eastern Europe rather than invest in new plant and machinery. This has resulted in the poor productivity in the UK, but here Dr Sentance cautioned us that while productivity is relatively easy to measure in manufacturing or construction it is much more difficult in service industries which make up the bulk of the economy.
Since the Brexit vote, i.e. quarter 2 in 2016, consumer spending in the UK has risen by 1.8%, GDP by 1.5% and Government spending by 1.4%. The latter might be surprising to those who still talk about austerity but the fact is that government spending has increased every year since the Conservatives regained partial power in 2010. Business investment, however, in that period has only increased by 0.1%
As I said, Dr Sentance is clearly a Remainer so remains circumspect about the outcome of Brexit, at least in the short term. He thinks there is the possibility of short-term disruption and political turmoil if there is “No Deal” with the EU 27. I would say we have already had all of that with the shenanigans of the UK political and judicial establishment seeking to thwart Brexit. He thinks access to EU labour markets will be more restricted for UK-based businesses but earlier in his presentation he pointed out how this had nstrained UK business investment and I have also seen at first-hand how this had been disastrous for Eastern European nations who talk about emigration as a crisis rather than immigration. He thinks that the UK may be a less attractive location for international business, due to reduced market access outside the EU but in fact since the referendum there has been more foreign investment in the UK than in Germany and France. And he thinks that the UK may lose influence internationally and the EU will lose input from a key market friendly international player. Here I would say that the UK will remain one of the five permanent members of the United Nations Security Council; the second most important member of NATO; the leader of the Commonwealth; and one of the leading soft powers in the world through language, culture, law & order, history and long standing independence and peace.
Dr Sentance‘s outlook for the UK and European economic policy is not particularly controversial. He thinks that interest rates will remain at near-zero level in the UK and across Europe. Negative interest rates in the Eurozone are a potential drag on growth and may be doing more harm than good. The Bank of England missed many good opportunities to raise interest rates gradually during 2013-15. Now the monetary policy opportunities are very limited. There is very little scope to provide stimulus and consequently a very cautious approach to rate rises. If UK interest rates do rise at all post-Brexit, moves are likely to be slow and tentative.
Fiscal policy provides more scope for economic policy stimulus but still-high deficits and debt levels could then become a concern. There may be a need for supply-side/ structural reforms to support medium-term growth.
Dr Sentance presented an interesting slide on government spending in context. The current level of public spending is broadly in line with its average over 40 years at just below 39% of GDP. It peaked at close to 46% in the Gordon Brown years which created the massive deficit from which we are still trying to recover and worse created long term debt through PFIs which were off the balance sheet. But at its present level it is far higher than all of the years from 1985 to 2004.
He discussed what might be the drivers of global growth in the 2020s. However, his thoughts were as negative as they were positive. Firstly there is the issue of demographics with an increasingly aging population and the consequences of the one-child policy in China. But I was first apprised of this on a course at the Institute of Management Development in Lausanne which I attended in the 1990s. Then he pointed to the rapid advances in technology but also said how this rarely showed up in improved productivity. Here I would agree because now when the average person spends 3.5 hours a day on their mobile phone productivity is substantially reduced however clever the technology may be. He then referred to trade and investment policies citing the Trump administration for its protectionism. But the EU Customs Union is the mort protectionist racket in the world. Trump’s protectionist sallies are those of a deal maker and may or may not have the effect he seeks. Those of the EU are designed long term to protect inefficient EU industries and farmers and result in turgid economic growth over decades.
He rightly acknowledges the threat and the opportunity of climate change. It is clearly a massive threat but to the opportunist is a chance to create new technologies and businesses. And he questions whether global politics is developing with a mood for rivalry or co-operation.
He points to further global economic worries. These include weaker growth in China though it is still 5.8%. Europe continues to slow down there is still the impact of Brexit when it actually happens. There is rising protectionism, particularly that stimulated by President Trump. There is an uncertain and changeable political environment. And then there is the maturity of the cycle. At the global level, while modest growth has been continuous for over ten years, history tells us that a degree of correction is inevitable and Dr Sentance would expect this at the latest by the mid-2020s. It is difficult to disagree with any of this but as I said at the beginning I don’t know if we ever live in certain times. Uncertainty is the norm and most economic forecasts are wrong.
In discussion afterwards I explained my theory that much of the sluggishness in growth has been caused by the development of online retailing. Consumer spending is the largest part of the economy. Much of this, over 20% in the UK, has moved online. Here the margins are slim as Amazon particularly uses algorithms to set its pricing so it is always the cheapest. Thus this considerable factor in the economy has been squeezed out. The retailers who die out in their droves are not completely replaced by the online merchants as behaviour changes. Shoppers liked to browse in the bookshops and record stores. That has now gone so these markets are smaller. So both volume and profit have been depressed. Dr Sentance did not buy my argument falling back on economic theory. But I look at practice rather than theory.