A confusing week for economists

This week has seen a considerable amount of contradictory economic information. On the positive side, employment in Britain reached a record high in the three months to April, 2018, with an employment rate of 75.6%. Unemployment has remained at its current low of 4.2% and the inactivity rate, those people, such as students, of working age, but not in the labour force, is also at a record low. Retail sales grew by a record 4.1% in May

However the rate of increase in earnings, which we would expect to be high given the low unemployment figures (as suggested by the Phillips Curve), has dropped from 2.6% to 2.5%. In real terms, the rate of growth in real earnings was only 0.1%, implying that future consumption growth will be low.

Other disappointing news was an announcement from Land Rover that they are moving production of the Discovery from the UK to Slovakia and news that Poundland and House of Fraser have collapsed, putting thousands of jobs at risk. However even these news items are not clearcut. One of the reasons behind Land Rover’s actions is that, once production has moved out of the UK, the site will be used to produce new, more high-tech, more expensive hybrid and electric models and the decline in traditional retailing is happening as on-line purchases increase, creating delivery and warehouse jobs.

However possibly the most disappointing pieces of news were firstly the latest data on manufacturing output for April, showing the fastest fall for 6 years and secondly, the deterioration in the UK’s trade deficit which grew by £1.6bn to a deficit of £9.7bn, the worst monthly figure since October 2016.

Possibly the best way to evaluate the data is to look at what the markets thought and they were pessimistic, thinking that the weakness of the economy will make an interest rate rise less likely and therefore sterling fell in the foreign exchange markets.

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Productivity and the Economy

By definition, productivity is the measure of output per unit input. Inputs include labour and capital while output is typically measured in revenue. Between July and December data shows that output per hour rose by 1.7% – the fastest rise since 2005. However, part of the rise was due to the fact that the number of hours worked has fallen. Labour productivity grew by 0.7% in Quarter 4 2017 and it was the second quarterly increase in a row leaving productivity at 1.8% above its peak in Quarter 4 2007 (before the financial crisis). However, the output per worker and output per job only grew by 0.1% showing that there has been a fall in the average hours worked. The fall in average hours worked also suggests that workers incomes are stagnating and so due to inflation, their real incomes may be falling.

Productivity plays an important role in the economy as there are many benefits that come with higher productivity. If a firm is more productive, it will have lower costs of production as they are able to produce more goods and services in a set amount of time. This means that the firm can become more competitive, assuming ceteris paribus, the lower costs of production means that a firm can decrease their prices. This decrease in prices can lead to an increase in demand and mean that UK goods and services could become more competitive in global markets. This can also lead to an increase in revenue for the firms and so these can be reinvested back into the firm to make it even more productive. These benefits can also lead to economic growth as output increases due to higher productivity, which in turn brings benefits to the country. If workers are receiving higher wages – as they work the same hours to produce more output meaning that a firm’s costs of production lowers and so firms are able to afford wage increases – this can also cause a further shift outwards of AD due to the multiplier effect. If a worker receives a pay rise, he will then spend some of his extra income on goods and services and so this in turn increases AD.

So the big question that occurs is why is the productivity in the UK so low? It has been a question that is very hard to answer. New machines and technology can make workers more productive, however companies’ capital spending is only 5% above its pre-crisis peak, compared with a 60% increase over the decade after the 1980s recession. This could explain a reason as to why productivity in the UK has remained so low as workers haven’t got the capital they need to become more productive. Another reason that could have caused low productivity is that firms have been retaining relatively (unproductive) workers rather than investing in machines. Helen Miller from the Institute for Fiscal Studies commented that “changes to state pensions and benefits are likely to have contributed” showing that people have been more willing to work in this financial crisis compared to other recessions. Therefore, firms have avoided large costs by investing in machinery and have instead increased the number of workers in order to meet demand. This is supported by the fact that the UK now has the highest employment rate since 1971 at 75.3%. With real pay (after accounting for inflation) down 0.2% in 2017 compared to the same time in 2016 – it shows that it is easier for firms to increase workers due to a low wage demand as inflation is not at a high rate relative to wages. This means output becomes more labour intensive which often have a lower productivity.

The blog also mentions that the government imposed an apprenticeship levy, with the idea to increase skills and training workers receive and this can in turn increase their productivity – the workers can develop the skills needed to produce more goods/services in a set period of time. The scheme was introduced in 2015 and aims to create 3 million new apprenticeships by 2020. However, in January 2018 there were 25,400 apprentices in training compared to 36,700 a year earlier showing that the scheme may not be as effective. However, this is focusing on human capital rather than physical capital such as machines. In some industries, such as construction, it is easy to run an apprenticeship scheme and train labour but in the services industry it has proven much more difficult to provide apprenticeship training. This supports the idea that it is easier to increase and improve labour than capital as the government have focused on encouraging firms to increase apprenticeship programmes. In the long term it is more important to focus on increasing capital than it is labour. This is because as technology advances, capital becomes more advance and so it can aid workers to produce more goods/services in a set amount of time. It is also more important than an increase in skilled labour as if you increase capital – the worker can become more productive too and so produce more goods and services. However, an increase in skills doesn’t affect how productive the capital is and so there may be a limit to how productive a worker can be without an increase in the capital available to them. An increase or improvement of capital means that LRAS will shift outwards and the sustainable output of the economy will increase.

The UK productivity is only above one other G7 country. All of the other G7 countries have a higher GDP per hour worked than the UK. This is shown in the graph below. Here you can see that the UK is the second lowest country despite all being at the same rate in 2007. There has been a slow down in labour productivity in the G7 countries, however there seems to be a higher slowdown in the UK. The UK’s nominal productivity gap in output per worker terms narrowed from 16.9% in 2015 to 16.6% in 2016, compared with the average for the rest of the G7. Compared with the rest of the G7, the UK had below average real productivity growth in both output per hour and output per worker terms in 2016. The UK has the largest gap between pre-downturn productivity trend and post-downturn productivity performance was 15.6% in 2016 which is double the average of 8.7% across the rest of the G7. This shows that the UK has suffered a larger productivity problem compared to the other G7 countries.

 

Lower productivity levels are detrimental to the UK. If the economy remains unproductive, it will not be able to benefit from lower average costs (unless wages remain low) as firms won’t be able to produce as much as more productive firms in the same time period. This means that UK goods will be less competitive on a global market – due to that prices of UK goods will be higher as costs of production remain higher due to lower productivity. This could worsen the balance of payments as exports remain low, and result in lower Aggregate Demand as the balance of payments is one of the components. The higher priced goods are also bad for UK consumers as demand for goods and services will fall due to the high prices. This means that there will be little, if any, increase in output and employment as demand levels remain the same. Higher prices, and lower demand, will mean that businesses retain lower profit from sales. This means that they don’t have as much money to reinvest into the firm which could be spent on training or capital in order to become more productive. The government will also not receive an increase in tax receipts if productivity remains low, as firms will not be selling as many goods and services and so the amount of Value Added Tax and Corporation tax that they receive won’t change.

Low productivity also means that workers wages will not rise as much as the firms cannot increase wages due to a lower demand and profit. This also means that the government will receive less tax receipts from VAT and income tax. Economic growth is also impacted by low productivity. This is because without an increase in productivity the Long Run Aggregate Supply curve will not shift outwards and so the sustainable output for the economy will not increase.

A world trade war moves closer

President Trump has tweeted both  that “Protection will lead to great prosperity and strength” and that “We have a MASSIVE trade deficit with Germany. Very bad for U.S. This will change.”
He now seems to be taking steps to attempt to do this. On 1st June, the USA imposed a  25% tariff  on imports of steel  and a 10% tariff on aluminium  imports from the EU, Canada and Mexico with the aim of reviving the USA steel industry. However, the main public argument for the tariffs was of the need to protect the steel industry on the grounds of  national security since this is an acceptable argument for protection under World Trade Organisation rules.

The countries affected are planning to appeal to the WTO, arguing that the national security argument is false, and are also planning  possible retaliation on US products such as Levi jeans, bourbon whiskey and Harley Davidson motorcycles.

From an economic, as opposed to a political standpoint, the tariffs make little sense. Many US producers and consumers will suffer, not only from retaliation, but more importantly because the price of steel will increase, thereby increasing the price of anything, such as cars, made with steel. The US is also planning significant infrastructure works which will be come more expensive  since they have a significant steel content. The imposition of tariffs also goes against the logic of comparative advantage where one imports goods and services from countries which can produce them most cheaply while specialising in the products one is relatively most efficient at, thereby increasing world output and living standards.

Worrying for the UK where the steel industry employees approximately  31,000 workers and exports 7%  output to the USA, is the impact on areas where steel is a major industry. They will experience a strong local negative multiplier effect, with  shops, pubs, local suppliers and transport companies being affected. The measures will also do nothing to restrict world  steel over-capacity and the possibility that some steel which would have gone to the USA being sold in the UK at reduced prices, thereby reducing domestic steel production. Finally, if the EU does retaliate, UK consumers will face increased prices for  USA imports, with the size of the price rise  depending on the size of the tariff and how much is passed on compared to the amount absorbed by importers and retailers.

 

Economic Man meets the Royal Wedding

One of the features of being an economist, particularly in the internet age, is that one does not need a vast quantity of facts at one’s disposal; instead the study of economics is much more about learning how to apply economic principles to everyday situations. Although not an everyday occurrence, it is interesting to consider the wedding’s impact on economic objectives from an economist’s perspective.

Firstly, prior to the wedding we can speculate about the impact on the UK economy from the production of wedding memorabilia such as fridge magnets, tea towels, plates and mugs. The vast majority of these will be produced by companies already in the business, for example making similar products for beach shops in Southend or tourist shops in London and therefore all  we would expect to see would be an increase in profits and overtime, rather than in long-term employment, as these firms expand their production (and move along their SR supply curve). The extent of the rise in  profits will be determined by the additional costs incurred compared to the additional revenues received. Given the rarity of such events, it would be safe to assume that demand will be inelastic and therefore prices might be high. However not all products on sale are modifications of existing items. The Daily Mirror, Daily Mail and even Radio 4 reported on special royal wedding commemorative condoms which have a picture of Meghan and Harry on the outside and microchip inside and  play God Save the Queen and The Stars and Stripes when the box is opened! There will also be an increase in interest in the businesses making more traditional wedding essentials such as for the designer making the wedding dress.

The wedding itself will create an increase in activity in the Windsor area, leading to a regional multiplier effect, as tourists come in, stay in nearby hotels, eat in local restaurants and buy goods in the Windsor shops. However, judging by some newspaper articles, some visitors featured seemed to have ignored hotels and camped on the route of the Royal Wedding procession. If you were working in Windsor in the tourism industry, you would almost certainly have worked overtime this weekend and there would probably have been an increase in temporary employment. On a national scale, the impact will be much smaller than for William and Kate’s wedding which took place on a weekday which was made an additional bank holiday. Therefore their wedding had street parties with all the associated expenditure on food and drink which was offset against the loss of output from the extra bank holiday.

Finally we should consider the impact on the UK’s balance of payments with the influx of overseas visitors, particularly from the USA, who have come over specifically for the wedding. Not only does their spending in the UK counts as a UK export, it is possible that they might have flown over on a British plane or come over on a British boat, boosting the service section of the balance of payments accounts. However, given the economics is sometimes referred as the “dismal science” we ought to consider the offsetting impact on the balance of payments and UK economy of British citizens fleeing overseas in order to escape the wedding.

The economy today

Current information about key areas of the economy is important for those taking exams this summer. The following highlights key areas.

Economic Growth – Manufacturing output rose by 1.3%in the last quarter of 2017 with Boeing announcing it will build a new factory in Sheffield.; It has also announced closer links with Sheffield University, guaranteeing to employ 19 apprentices trained at the Advanced Manufacturing Research Centre in Rotherham which is linked to Sheffield University.  At the other end of the scale, Alpkit, an outdoor equipment company in Nottingham, has increased its exports by 50% because of the EU recovery and the fall in the value of sterling. However UK car manufacturing fell by 3% in 2017, with part of the drop being caused by a reluctance to buy new diesel cars.

In global terms, the IMF has upgraded growth forecasts for the next two years for France, Germany and the USA while reducing the forecast for the UK to 1.6% this year and 1.5% next year. In terms of the forecast increases in real GDP per head, the UK is at the bottom of the G7. The IMF highlights weak investment, low productivity and Brexit uncertainty as causes for the UK’s relatively poor performance while the rest of the world benefits from US tax cuts, riding investment and increased international trade (presumably their forecast was written before concern over a US/ China trade war).

The poor figures for growth from Jan – March 2018 (only 0.1% up compared to the previous quarter) were below expectations and the worst for 5 years. While some of the blame for the poor figures can be attributed to the recent poor weather, the ONS was quick to point out that weather was not the cause of these figures and highlighted a slump in construction as a key factor. Sterling fell after the data was published since investors now think that an imminent interest rate increase is less likely. In addition, the Bank of England has now downgraded the UK’s growth forecast for this year from 1.8% (made in February) to 1.4%.

Productivity – April 2018: The latest productivity figures contain some good news for the UK since, between July and December 2017, output per hour rose by 1.7% – the fastest rise since 2005. Note that part of the rise is because of a fall in the number of hours worked. Output per person has hardly changed. The purchase of industrial robots in the UK rose in 2016, the first rise for 5 years.

The apprenticeship levy is a tax on companies (0.5% of their wage and salaries bill) with a turnover of at least £3m; they pay the tax and can then claim back money spent on training over the next two years. The scheme was introduced in 2015 and the aim is to create three million new apprenticeships by 2020 and raise the quality of training. While it has proved relatively easy to provide training in traditional industries such as construction or plumbing where apprentices can learn from current employees, designing courses in service industries has proved more difficult. In Jan 2018, 25,400 apprentices were in training, compared with 36,700 a year earlier with criticism that the scheme is too inflexible and some of the money is going to fund basic training for low-paid staff such as those working in hotels and coffee shops (labelled as apprenticeships to claim the training money).

Incomes, savings & living standards – March 2018: The Bank of England predicts that pay increases in the private sector are expected to reach 3.1% per annum, the highest rate since the financial crisis ten years ago. With inflation expected to drop below 3%, living standards should therefore rise. However pay increases for senior staff are only expected to be between 1 – 2%. The national living wage rose to £7.83 in April. In the three months to February, wages rose in real terms with earnings rising at 2.8% (at an annual rate) while inflation dropped to 2.7%. A recent OECD international comparison of real household disposable income growth since Brexit shows 1.8% growth in Europe compared with a fall of 0.3% in the UK .  The savings ratio fell to 0.9%, its lowest level since 2008, as consumers attempted to keep their consumption up as their REAL disposable income fell in 2017. (The same occurred in 2016). This is not as worrying as the situation between 2004 and 2007 when the savings ratio was negative – borrowing was greater than savings.

Unemployment – Between November and February, unemployment fell to 1.42 million, reducing the rate from 4.3% to 4.2%, the lowest it has been for 43 years. The activity rate reached 75.4% (those of working age in work or looking for work as a percentage of the potential labour force), the highest since 1971.

Inflation – The rate of inflation for March dropped to 2.5%, compared to 2.7% in February, the second consecutive month it has fallen (It was 3.1% in November). Falling inflation has cast doubt on when the next interest rate will occur. However oil prices have reached their highest level for almost four years to $77.32 a barrel,  because of increased demand from US drivers combined with an earlier cold spell in Europe reducing stocks, the long-term impact of OPEC production cuts and most recently, the recent political events in Iran where the threat of sanctions will reduce Iran’s oil sales.

There has been discussion about whether the 2% CPI target for inflation is still appropriate. Some economists are suggesting a higher target would be more appropriate to ensure faster growth and continued low unemployment while others suggest that it should be scrapped and replaced with a nominal GDP target (combining both inflation and growth), which would involve a much greater focus on the components of AD.

Government debt: Between 2007 and 2017, total government debt (the national debt) rose from £560bn to £1760bn which, as a share of GDP, was a rise from 36% to 85%. It is currently at 76.4% of GDP and predicted to fall to 75.3% by 2025. The latest figures (for the last year to March) show that the UK government ran a surplus of £112m on the current budget (day-to-day services such as pay for soldiers, NHS nurses and civil servants, and welfare payments such as JSA and pensions) FOR THE FIRST TIME IN 15 YEARS. What this means is that the only borrowing undertaken by the government last year was for investment in infrastructure, such as roads, schools, airports and railways. George Osborne, when Chancellor, aimed to achieve this in 2016 but, because of the slow recovery and low productivity, it has taken until 2018. The overall budget deficit was £42.6bn, a drop of £3.5bn compared to last year and the lowest since 2007.

Monetary Policy update: In 2016, post the Brexit vote, base rate was cut from 0.5% to 0.25% and a further £60bn of QE took place. In November 2017, the rate rise was reversed. The BofE introduced the Term Funding Scheme (TFS) to replace the Funding for Lending Scheme. Under the scheme, which will last until 2022, banks are able to borrow up to 5% of their loan book at a very low rate of interest. The BofE has also amended the leverage ratio (equity:assets) by removing central bank deposits from the asset side and increasing the ratio from 3% to 3.25%. Overall, this is seen as making the requirement less onerous.

At the start of 2017, household debt was increasing at its fastest rate since 2006 and the BofE financial Policy Committee (which is responsible for financial stability) was concerned by the increase and has instructed high street banks to add £10bn to their balance sheets in case of default and £11.4bn in case of an economic downturn. The latest figures (March 2018) show a fall in credit provided by high street lenders (overdrafts, credit card borrowing and car finance) from £1.7bn the previous month to £300m, the smallest figure since 2012, creating fears of a significant slowdown in growth. The slowdown in lending is partly the result of reduced consumer confidence but also due to lenders strengthening their balance sheets following warnings from the Bank of England.

Interest rates were expected to be increased on 10th May but, because of the UK’s sluggish economic performance, the Bank of England has left them on hold at 0.5%. However a rate rise later this year is still predicted by the Governor of the Bank of England.

House Prices: The Halifax announced a fall of 3.1% in house prices last month, the largest monthly fall since September 2010 and the second largest since they started their house price index in 1983. Mortgage approvals fell 10% in March. However house price data is extremely volatile.Reasons for this included a loss of confidence in the housing market, foreign demand slowing, and a feeling that the peak of the boom has been reached.

Foreign Trade: UK ran a service sector surplus on the BofP from Oct – Dec 2017 of £20bn with exports of £43.3bn and a service surplus of £80bn for the whole year. The main area of service exports was the EU (40%), hence the importance of obtaining a suitable free trade agreement, post Brexit, which includes services. The USA, at 20%, was the single largest country.  Banking, insurance, travel and business services were the main surplus categories. Trade in goods was negative so overall, in the last quarter, there was a deficit of £11bn.

Given that balance of payments figures are particularly inaccurate, it is no surprise that the 2016 deficit is likely to be revised down in next month’s data by £10bn (£30.9bn v an original estimate of £40.7bn), down from 2.1% of GDP to 1.6%., because of under-estimated earnings from financial traders in the Uk.

The US trade (goods and services) deficit has risen to its largest for almost a decade, rising to $57.6bn in February.

 

What does the future hold?

“Accurate predictions” and “economists” are not words which always go together and the longer the time period, the less accurate are predictions likely to be. Last year, it was predicted that driverless cars would soon be with us and we would be summoning our driver-free Uber with as little worry as ordering a take-away via Deliveroo. However, following the death of a 49-year-old woman in Arizona, as a result of a collision with an Uber vehicle being driven in autonomous mode, (with a human behind the wheel), both Uber and Toyota have suspended trials and a number of American states are reviewing their attitude to trials of driverless vehicles.

A worry which has been with us for longer is the impact of technological progress and more recently AI, on employment prospects. Keynes, in 1930, during the Great Depression, wrote an article predicting a 15 hour working week by 2030. For him, this was not a worry since he suggested that the average person would be significantly richer in 2030 than in 1930, since businesses would still be producing goods and services and workers enjoying their increased leisure. However, he did raise the possibility of technological unemployment where the fall in demand for labour from technological progress was greater than the increased demand for labour needed to produce new goods and services. Trying to estimate the costs and benefits of new technology in terms of employment has been a problem since the Luddites in the 19th century – English textile workers and weavers who destroyed machinery which they thought would take their jobs away. On the other hand, technological optimists see the arrival of robots as an advantage since they will allow tedious, repetitive jobs to be undertaken by machines while the humans focus on rewarding, creative areas.

Examples support both views. The rise of online shopping is a cause of the decline in high street retailers. However internet shopping has created jobs in warehouses for workers to fulfil orders and among van drivers. But, in the future, will the goods ordered be collected from the shelves by robots and delivered by drones? What will happen to the number of workers in supermarkets if the technology used in Amazon’s cashless store becomes more widespread? There is a consensus that the types of jobs most at risk are those which are routine and repetitive while the safest are those which involve creativity, judgement and manual dexterity. An area which should be secure, and in which the UK is currently strong, is the creative sector, which covers such things as advertising, film and television programme making, architecture, and fashion, employing two million people and contributing over 5% to GDP. One might also think that teaching is a safe occupation since, so they tell me, it involves judgement, empathy and creativity. But if the school of the future is based round individualised learning with students working in large open-plan spaces, supported by “facilitators”, will so many people be needed? How long before we get the department blog generated with no human involvement? How do we take account of the jobs which have not yet been created?

What is clear is that there will need to be resources put into re-training existing workers to allow those who have lost their jobs to move into new areas and, more importantly, those entering school in September, will need to be taught to be adaptable and creative so they can learn new skills, rather than being trained in the skills in use today.

Are apprenticeships a solution to the UK’s low growth rate?

Last month, in case you missed it, we had National Apprenticeship Week. In 2015 the government set a target of creating three million apprenticeships by 2020 to improve the skills of the labour force and, in 2017, they established an apprenticeship levy which made businesses with a wage bill of £3m or more pay 0.5% of their labour costs into a fund to pay for training.

Apprenticeships are not new, dating back to medieval times, and, in the 1960s, about 1/3 of school leavers took this route into employment. However the raising of the school leaving age, the desire of governments to promote university education and a view that they are inferior to university degrees, have caused a decline in the importance of apprenticeships. More recently, as the cost of university education has risen and the UK’s productivity growth has fallen below our competitors, the government has seen apprenticeships as an alternative to university, which would meet the skill shortages which have plagued the UK economy in recent years and boost productivity.

A survey in March 2018 suggests that the target will not be met and businesses have called for a review of the apprenticeship levy which is intended to fund the scheme. Part of the problem is the low wage offered to apprentices in the first year of training compared to those in work (£3.70 versus £4.20 per hour for those under 18, £5.90 for those aged 18 – 20 and £7.38 or over for those aged over 21). In some cases, apprentices were paying more to travel to work and other expenses than they were receiving and complaints were also received that they were being used as a form of cheap labour, doing the same work and having the same responsibilities as non-trainees.  Poor mathematical and linguistic skills are also a bar to completing an apprenticeship and, despite a desire to help younger workers into employment, there is evidence that some firms are using their apprenticeship fund for re-training older workers or providing management training.

We are still a long way from the success of the German vocational training programme which is seen as an attractive alternative to higher education, catering for about 60 per cent of the country’s young people. Their programmes are three-year schemes, either school-based with work placements or more business-based with training also undertaken in school and result in nationally-recognised qualifications which have the same status as academic qualifications and are not regarded as being second-class and more suitable for the less academic.  Although their schemes are not the only reason, it is worth noting that the German unemployment rate for those under 25 has averaged approximately 1/3 of the EU average.