Good news for the Chancellor?

Friday’s papers contained news which might make life easier for the Chancellor when he prepares for his budget on 22nd November. Government borrowing in August fell faster than expected, meaning that the Chancellor will have approximately £10bn more to spend on helping reduce student debt, boosting public sector salaries, spending on the NHS, improving our infrastructure, etc. At £5.7bn, the Government’s August deficit has fallen to its lowest level for a decade. The reason for the fall is twofold. VAT receipts have soared because of  high consumer spending while current government spending, particularly local authority spending, has fallen.

However all is not rosy. Firstly, when interest rates rise, which is likely to happen sooner rather than later, government debt interest payments will increase, as will interest paid on index-linked borrowing because of higher inflation rates (borrowing where the rate of interest is linked to the rate of inflation). Furthermore, there are certain commitments which have already been made, particularly with regard to public sector pay, which will necessitate higher government spending. If these factors are not to increase government borrowing then either taxes will  increase, other areas of government spending fall or the UK economy must grow sufficiently strongly to generate enough extra tax revenue.

Secondly Moody’s, one of the major ratings agencies, last week downgraded the UK’s credit rating from Aa1 (the top rating, sometimes referred to as triple A) to Aa2 on the grounds that leaving the European Union was creating economic uncertainty at a time when the UK’s debt reduction plans were in danger because of the decision to raise spending in certain areas. This follows a downgrading in 2016 by the other major agencies, Fitch and S&P. The downgrade might affect how much it will cost the government to borrow money, particularly on foreign financial markets. The Labour Party has called the downgrade a “hammer blow” to the economic credibility of the Conservatives.

Thirdly the stronger than expected level of consumer spending which boosted VAT receipts is unlikely to be sustainable as real incomes fall because of the low levels of wage increases combined with the higher levels of inflation. The forecast for the growth in retail sales compared to a year ago was 1.1% whereas the actual number was 2.4%, with last month showing particularly strong growth. There are many possible reasons for this. Possibly the weak pound caused more people stayed at home instead of going overseas for a holiday, possibly the falling unemployment had an effect and possibly the figures will reverse next month since they are extremely volatile.

Finally it is worth noting that the OECD (the Organisation for Economic Co-operation and Development, an organisation comprising the world’s major economies) forecasts that we will fall from being the second fastest growing  G7 economy to the second slowest as the other main economies improve and we do not.

If the UK economy is to flourish, an increase in the rate of growth, an improvement in productivity and a satisfactory agreement with the EU are all crucial.

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Productivity and the election

Many of my recent posts have focused on productivity and the UK’s poor record when compared to other countries. As mentioned before, in general terms, UK workers produce in five days what workers in the USA, France, Germany and Italy produce in four. Although GDP growth has been good until recently (only 03% in the last quarter) and employment data in the UK is extremely positive with the employment rate standing at 74.6%, the highest since data was first collected in 1971, it has been accompanied by poor productivity growth with the increase in UK productivity since 2008 (the period immediately before the recession) being only 1.1%. This means that pay, and therefore living standards, will be lower in the UK than in more productive countries. The Bank of England’s latest Inflation Report suggests that incomes will rise 2% this year and inflation will rise to 2.8%, therefore implying a fall in real incomes.
There are many explanations for this. One explanation, which neatly sidesteps the problem, is that the main issue is not that the UK has low productivity, but is that we are simply poor at measuring it in the service sector, a key area in the UK economy. In manufacturing, it is relatively simple. One can count the number of goods produced; however, in services it is trickier particularly as the digital economy grows. 10 years ago, if I wanted directions, I would buy a map and eight years ago I bought a satnav and put it in the car (both are easy to measure). Today I  use my smartphone and these additional services are not easy to measure.
Nevertheless, most economists accept that there is a  productivity issue in the UK. Andy Haldane, chief economist at the Bank of England, suggests that poor management is a key factor, particularly in sectors where competition is low, allowing x-inefficiency to flourish. Lord Browne, former Chief Executive of BP, suggests three key factors. Firstly our service economy is not sufficiently professional compared with the USA; secondly there is a shortage of finance available in the UK for entrepreneurs wishing to start new businesses and, finally, he cites the anti-science culture in the UK where it is acceptable to profess an ignorance of mathematics and science. However almost all economists would agree that the UK’s low level of investment is a contributory factor and the uncertainty around Brexit and the election itself could cause businesses to delay their investment plans until the future is more certain. There is already anecdotal evidence of many financial institutions looking to open offices overseas.
There has been little focus specifically on the issue in the election. Labour plans to increase Corporation Tax to 26%. (It is currently 19% but due to fall to 17% over the next two years) which might impact on investment in the future but some of their spending plans might, in the long term, improve productivity. They also intend to renationalise the railways, water, the national grid and Royal Mail and borrow £250 billion to create a fund for infrastructure projects. The Conservative’s statement that “no (Brexit) deal is better than a bad deal” and a reluctance to remain in the Single Market has also caused anxiety among businesses, while a focus on grammar schools is not the best way to tackle Lord Brown’s concern over the UK educational system. However they do present themselves as a more pro-business, low tax government and hope that such sentiments will encourage investment. They are also committed to spend 2.4% of GDP on R & D by 2027 and to create a national productivity investment fund of £23 billion.
The IFS, an independent think tank focus on Labour’s additional infrastructure spending which would boost GDP in the near-term and would increase the productive capacity of the UK economy in the long term, although their increased labour market regulations such as a higher minimum wage would have the opposite effect as would four additional bank holidays and their higher rate of corporation tax. The Conservatives’ commitment to reduce net immigration would also weaken growth, although no specific timescale has been announced. Most disappointingly, the IFS suggest that there will be NO overall impact on productivity from either party. It is difficult to take into account the impact of Labour’s plans to take significant parts of the economy back into public ownership, not least because of the time which such measures would need to come into effect.

Roll on Thursday!