So how is the economy doing?

This week has seen the publication of considerable economic data and much of it is contradictory, making it hard to tell exactly how well the UK economy is (or is not) doing.

In the year to March 2017, household spending in real terms returned to levels not seen since before the financial crisis, reaching £554 per week. The UK budget deficit has fallen and was £2.6bn in December, compared with £5.1bn in December 2016, and almost half economists’ expectations. This was partly due to higher than expected tax revenues from income tax receipts because of higher employment, higher VAT receipts and a refund on contributions to the EU. The positive news on the budget deficit means that government borrowing is likely to be at its lowest level since the financial crisis. Before celebrating too much, be aware, firstly, that the higher VAT receipts were due to higher inflation as well as to the growth in consumption and, secondly,  the refund from the EU was because the UK share of the EU budget has been revised downwards as a result of slower growth in the UK than the rest of the EU.

Another boost for the UK economy  was news that the employment rate had risen to a record high of 75.3% or 32.2 million, confounding forecasters who had predicted that the employment boom was over, based on the fall in October 2017 which is now being treated as a temporary fluctuation. At the same time as the employment level rose, the unemployment rate remained at 4.3% or 1.4 million, a 42-year record low. Equally encouraging was the shift from part-time work to full-time work which occurred over the period.

Further positive news  was that the economy grew at 0.5% in the last three months of 2017, faster than expected, largely because of the resilient service sector which makes up about 80% of the economy. As a result, growth last year was 1.8%, significantly higher than the 0.5% prediction by some disappointed economists following the Brexit vote. However, it is worth noting that the UK has dropped from being a growth leader to a laggard among the G7 countries, its growth rate is now at its lowest rate for the last five years and, given more rapidly rising incomes among our main trading partners, a slowdown in UK growth is disappointing.

On the downside, wage growth continues to be slow, meaning that real incomes are falling, the number of people starting apprenticeships fell by a quarter in the three months between August and October compared to last year, and sterling rose to its highest level since the Brexit vote. While this is good for importing businesses and holiday makers, it is less good news for exporters who have enjoyed the benefits of a low pound. It has also hit the share prices of companies with significant dollar earnings which are now worth less when converted into sterling.

Finally a word of caution; some of the figures, such as consumption spending, relate to the previous financial year while others, such as the growth in GDP, are subject to significant revision over time. Most recently, the figures for UK productivity have been questioned because the ONS might have significantly over-estimated inflation in the telecommunications industry and therefore underestimated the increases in its output. As a former Governor of the Bank of England pointed out, “trying to control the economy is like steering a car by looking in the rear view mirror”.


The exchange rate and the economy.

The traditional view of a fall in the value of a developed country’s currency was that it would lead to an increase in the value of their exports and a fall in the value of their imports, hence improving the balance of payments and, via the resultant increase in aggregate demand, cause an increase in employment and growth.

However the above analysis needs considerable qualification. Although a fall in the value of a currency will almost always increase the VOLUME of exports and reduce the VOLUME of imports, whether the values change in the same way will depend on the elasticities of demand for exports and imports. For a developing country whose exports are commodities with an inelastic demand, a fall in the value of the currency might worsen its balance of payments. Over time the UK’s exports have moved up-market and therefore it can be argued that they have become less price sensitive since factors such as design and quality become more important.

Secondly, the analysis assumes that firms can increase their production of exports to meet higher demand and this will depend on the state of the domestic economy, the availability of labour, raw materials and components. This is unlikely to be easy in the short term and economists talk of the “J Curve effect” whereby a devaluation initially leads to a worsening balance of payments as quantities of exports and imports do not change much, possibly because of long-term contracts or the difficulties in increasing output of export and import-substitutes and, only over time, will the balance of payments improve. While this might not apply to tourism, where people can switch their holiday destinations relatively quickly, high tech exports and imports of manufactured exports will be much slower to adjust. Firms need to take a view as to the permanence of any change in the exchange rate. In my last post, I wrote that the £:$ exchange rate fluctuated from $1.71 in July 2014, $1.32 after the Brexit vote, then to $1.21 in January, 2017, and was at $1.38 (20th January 2018) but at the time of writing (27th January 2018) it had risen to $1.42. Firms planning long-term contracts will need to take a view as to the likely long-term exchange rate and largely ignore short-term fluctuations.

We should also not forget the downside of a devaluation which is that imports become more expensive and therefore living standards fall. Not only does one’s foreign holiday cost more, but imported finished products and anything using imported components or raw materials becomes more expensive, with the increase in price depending upon how easily the supplier can pass on the increased cost to the buyer. As products become more complex and firms take advantage of globalisation, the supply chain becomes longer and there is a greater likelihood of imports being involved in some in the final product. Thus an increase in UK exports of goods is very likely to require an increase in imports needed to make our exports and some of the increased competitiveness will be lost by the higher cost of imported components and raw materials.

Recent examination of the exchange rate and UK trade in goods might suggest that the exchange rate  has a significant impact. In the last year the volume of UK goods exported rose almost 9% which would imply that the fall in sterling post Brexit has had a positive impact until one reflects that UK imports have increased by 7% during the same period, despite their increase in price. What this shows is that the exchange rate is simply one of many factors affecting the demand for imports and exports and we cannot ignore factors such as quality, income, interest rates or anything else which changes the desire to consume goods and services.

Nigeria’s dollar crunch adds to fuel crisis —


Refinery woes, currency controls and militant attacks combine to prolong acute shortage

Source: Nigeria’s dollar crunch adds to fuel crisis —

Inadequate infrastructure means that, despite being Africa’s top oil exporter, Nigeria has to import fuel putting downward pressure on the value of it’s currency, the Naira (see Chart 2 below). Value-added increases when oil is refined to become something more useful, in this case fuel, so the $’s received for each barrel of oil Nigeria exports is worth less than the $’s Nigeria has to pay for the same volume of refined oil, leading to a reduction in foreign exchange reserves (see Chart 1 below).

It is difficult to see how this cycle will end. If the value of the Naira continues to fall, the price of refined oil in Naira terms will continue to rise, further depleting foreign exchange reserves and accelerating the Naira’s depreciation.

There are several solutions, central bank intervention to revalue the Naira, but they need, already dwindling, foreign exchange reserves in order to manipulate the market price for the Naira. Investment in infrastructure, a fiscal supply-side policy, to reduce the reliance on refined oil imports is an alternative, but oil accounts for 90% of Nigeria’s export revenue and, subsequently, a significant proportion of government revenue. The price of oil has collapsed and with it government revenue, a classic example of the dangers of over-reliance on a primary commodity, prone to price volatility. The fall in foreign exchange reserves, the value of the Naira and an increasing budget deficit will make lenders nervous and will lead to an increase in the yield on government borrowing, put simply, the interest rate on government bonds will have to rise to offset the greater risk, increasing government expenditure on debt repayments.

Clearly, these options are not presently viable, but the second should have been enacted when the oil price was high and export earnings plentiful, however, corruption, some $16bn in government oil receipts is unaccounted for in the last year alone, has meant that infrastructure remains undeveloped.

A further consequence of the falling value of the Naira is that despite global oil prices falling, Nigerians have to pay more for petrol at the pump. To combat rising petrol prices the Nigerian government have imposed price controls, however, this has resulted in several-hour long queues and a rise in hidden market activity. Subsequently, Nigerians either face having to pay extortionate prices or waste valuable time queueing. Ultimately, output is lost and Nigeria’s economy suffers.

Nigeria’s relatively new president has a tough task on his hands.

Chart 1

Chart 2


Low and behold | The Economist

Another year of low prices will create strains in the world economy

Source: Low and behold | The Economist

From oil supply in Saudi Arabia to interest rates in the US via the Chinese exchange rate – a wonderful illustration of the interconnected nature of economics. A must read.


A Euro Decline Infographic | Economics | tutor2u

Infographic exploring the causes and consequences of a weakening Euro.

Source: A Euro Decline Infographic | Economics | tutor2u