An Ageing Population

The world is getting older and this has significant implications for the working population, those who have retired and those about to enter employment. The country facing the most immediate crisis is Japan with its rapidly ageing population. Those over 65 years old now account for 28% of their population and their life expectancy is 84 – the highest in the world. It is predicted that over half of the babies born there today will live to over 100 years old.  In addition, it has the lowest birthrate since its records began 120 years ago and therefore its population is falling. In the UK the population is ageing. The proportion aged 65 or over in 2016 was 18% of the population (11.8 million) and the ONS predict that by 2066 this figure will have increased to 26% of the total population (20.4 million).

We can expect this to result in an increasing budget deficit as pension payments increase because of longer life expectancy. Governments will face increasing costs of health care as people live longer and consume more health care which is becoming increasingly expensive for those in later life as medical science has improved. Linked to this, the tax burden on those of working age will increase as the proportion of the population not working increases. Partially offsetting this, there has been an increase in the proportion of older people working as their health has improved; for example, in the UK, the proportion of over 70s working has more than doubled in the last ten years but it is still only one in twelve. However if people are working longer, their ability to provide care for elderly relatives will diminish. A key concept to consider is the “Old age dependency ratio” (OADR) – the number of people of State Pension age (SPA) per 1,000 people of working age. In the UK this is forecast to increase significantly beyond 2030, therefore suggesting either increased taxes, reduced levels of care, increased immigration,reduced real pensions or making the elderly pay an increased proportion of costs currently paid by the state.

The impact on the structure of the economy is also significant. Many older people live in houses which are too large for them, bought when they had children who have now left home. A shortage of suitable smaller accommodation, combined with the relatively high costs of down-sizing prevents some of them from moving, thereby restricting the supply of housing for younger families. There is also an increasing need for workers in the NHS and care industries to look after the rising number of elderly people. There is also a regional impact since proportionately more elderly people live in rural and coastal areas, placing a proportionately higher burden on local authorities and the NHS in those areas. Another issue is that over the past few years, the relative income of UK pensioners has increased due to the introduction of the “Triple Lock” in 2011 – a government commitment to increase pensions annually by the highest of average earnings, the rate of inflation or a minimum of 2.5%.  Since then both inflation and earnings growth have been low and the 2.5% increase has therefore increased pension incomes relative to earnings. This is supported by a government study which looked at the percentage of people in 2015/16 of different age groups reporting it “quite or very difficult to get by financially” which showed that the lowest percentage of those in difficulty were the two highest age groups, 65 – 74 and 75 and over, which reported 3.1% and 1.4% respectively. These returns compare with the next lowest, the 16 – 24 age group, who reported 5.8% in difficulty.

 

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A Confusing Tale of Two Economies (with apologies to Charles Dickens).

What is going on in the UK economy is currently hard to understand. Are we doing well or badly? There are many conflicting pieces of evidence and, in some ways, it is like an abstract painting – different people can look at it and see different pictures.

Consider the labour market – in the last three months of 2018, employment rate reached 76.1%, or 32.71 million, the highest since 1971, rising by 220,000 workers, of which 144,000 were female. Over the same period, unemployment fell to 1.34 million or 3.9%, the first time it has dropped below 4% since 1975. While some people see this as a positive sign of economic progress, others present three reasons why the data actually shows an economic problem for the UK.

Firstly, there is a view that the rise in employment is because of an increase in zero hours contracts, with workers working far less than they would like, suggesting that we have rising under-employment instead of unemployment. Secondly some suggest, similarly, that self-employment has been responsible for some of the fall in unemployment, with many of the newly-self-employed working less than they would like. Finally, others argue that the reason for falling unemployment is that employers have cut back on investment, preferring to meet additional demand by hiring more workers, knowing that they can get rid of them if the economy stagnates after Brexit. This last explanation dovetails well with the UK’s poor productivity record, with productivity actually falling by 0.2% in the last quarter of 2018.

Turning now to earnings and inflation; with unemployment so low, we would expect both earnings and inflation to be rising rapidly. In fact, last month, average earnings growth fell from 3.5% to 3.4% and the CPI only increased from 1.8% to 1.9%, due to prices for some food and alcoholic drink items increasing more in price this year than they did a year ago, and core inflation (which ignores the price of food and energy because they are highly volatile) fell by 0.1% to 1.8% in February. Nevertheless, some economists regard this as only a temporary respite, suggesting inflation will rise to 2.5% in the next few months because of higher oil prices and rising wages, with a further jump possible if tariffs rise after Brexit (whenever that is!).

Turning now to GDP, it grew by 0.2% in the three months to January 2019 with the service sector expanding while manufacturing and construction contracted. This meant that growth for 2018, was only 1.4%, the slowest rate for 10 years. Also suggesting that the outlook is poor was a survey of consumer confidence showing that it had fallen over the last year and data showing that we currently have the lowest annual house price growth in the UK for six years. However, government borrowing is at a 17 year low because of rising tax receipts – £200m in February 2019 compared to £1.2bn in February, 2018, meaning that the government is on course to meet its target for structural borrowing to be below 2% of GDP in the financial year 2020/21. Further confusing evidence of our economic situation is provided by the latest UN Annual Happiness Report, which shows the UK has risen from 19th  to 15th out of 156 countries surveyed, with Finland, once again at the top of the table, followed by Denmark, Norway, Iceland and the Netherlands.

It is not surprising that economists find it hard to assess how the economy is doing since some of the indicators discussed above reflect what has happened in the past, rather than what is currently happening. (Imagine steering a car by only looking in the rear-view mirror). Unemployment, for example, shows the state of the economy six months to a year ago since firms do not immediately hire or fire workers when their orders change. Other indicators, such as GDP are subject to frequent revisions as more accurate data becomes available. Therefore some economists prefer more informal guides to the economy. David Smith, Economics Editor of The Sunday Times, uses the number of skips in his road, since more skips suggest more building and home improvements and therefore greater economic activity.  In an attempt to improve our awareness of the current state of the economy, the ONS is introducing new economic indicators such as the volume of road traffic and businesses’ value-added tax returns which will, hopefully, provide a more up-to-date picture of the economy.

Do we have a housing crisis?

Last week it was announced that an American businessman had bought a house in St James’s Park, near Buckingham Palace, for £95 million. As you might expect, the house has a pool, gym, staff quarters and private gardens. At the other end of the scale, the Institute for Fiscal Studies recently reported that 40% of 25 – 34 year olds are not able to afford a 10% deposit to buy the cheapest house in their neighbourhood. In London, approximately twenty years ago, 90% would be able to afford the deposit whereas today only 33% can afford the deposit. Because of the difficulty faced by people getting on to the housing crisis, newspapers have been talking about a housing crisis for some time.

A sign of the housing crisis is the high price of housing, signifying either excess demand or restricted supply. Focusing first on the demand for housing, for many years buying a house was an ideal way of building up wealth for potential homeowners, thus increasing the demand for housing. Not only did borrowers previously receive tax remission for mortgage payments, the price of houses increased more or less continuously and so one could borrow, knowing that when the mortgage was repaid, the increase in the value of the house would more than have covered the cost of the mortgage. More recently the Government introduced the ‘Help to Buy Scheme’ in 2013, (now extended to 2023) which lends, interest fee, up to 20% of the cost of a new build home (40% in London) to borrowers who have been able to raise a 5% deposit, meaning they only need a mortgage for 75% of the value. It has helped to finance the construction of 170,000 homes of which 140,000 have been purchased by first-time buyers. But it has been expensive, costing taxpayers nearly £8 billion since 2013, and providing considerable profits for house builders as demand increased more than supply, thereby pushing up prices. Another criticism has been that the scheme has not helped the low-paid since they have not taken as much advantage of the scheme as those with higher incomes. In addition, we are seeing that buyers of homes using the scheme who now wish to sell, have found that their property has fallen in value since future buyers are not eligible for the help to buy assistance. There have also been a number of suggestions to boost supply. These include allowing more building on green belt land and introducing measures (not yet introduced) to help older buyers down-size and therefore free up larger homes.

Why are we so concerned about declines in house building and house purchases? Apart from the social and political issues which result from people not being able to afford to buy their own house, having to pay excessive rents or sleeping on the streets, there are significant economic implications of a failing housing market. Firstly, if  building slows, bricklayers, electricians, plumbers, etc, lose their jobs and firms making bricks, providing carpets, furniture, ovens, fridges, etc, also experience a decline for their products and services and subsequently cut back on labour. As a result, incomes fall and, given the multiplier effect, the impact on the economy will be significant. It is worth noting that the multiplier effect will be large since so much of the expenditure involved in housing is domestic – i.e. there is relatively little leaked out of the economy in the form of imports.

Another way in which the housing market affects the economy is that a poorly-functioning housing market, causing high prices in booming areas, makes it difficult for firms to expand their labour force because workers cannot afford to move into the area. A final issue occurs via the wealth effect – the idea that households’ consumption is determined not only by their income but also by their wealth. For most people, their house is the main source of their wealth. Therefore, a booming housing market makes existing homeowners feel richer and they therefore spend more, believing that they have less need to save since their increasingly valuable house is adding to the value of their assets. Since the financial crisis, the housing market declined. When house prices dropped, people felt poorer and therefore felt the need to save more. This reduced consumption at a time when aggregate demand was already falling, thereby exacerbating the problems faced by the economy.

However, recently, after ten years of decline, the number of mortgages issued has increased and there was the highest number of first time buyers last year for 12 years, according to the government’s annual English Housing Survey, published in January. The increase was linked to the Help to Buy scheme, loans from parents and grandparents and a relaxation in the mortgage market. However we have also seen the slowest growth in house prices for six years, possibly down to Brexit uncertainty and last year receipts from stamp duty (a tax on house purchases) fell, largely because of the slowdown hitting the top end of the market.

What’s in store for the UK economy in 2018?

Santa has been and gone, the sleigh is parked in the long-stay car park, the reindeer are out to graze for a few months and it is time to think about what 2018 will have in store for the UK.

However economic forecasting is difficult. Unlike the natural sciences, such as physics and chemistry, we cannot base our predictions on previous laboratory experiments. Furthermore, although economists frequently assume “ceteris paribus”, the real world is not like this. For example, we do not know what the outcome of the Brexit negotiations will be, whether the bitcoin bubble will burst, and, if it does, what the impact will be, whether there will be a new Prime minster  or a general election this year or even what will happen to oil prices.

In an article published in the last week of 2017, The Times examined predictions made by key economic bodies (the Bank of England, the CBI, the Office for Budget Responsibility, the Institute of Financial Studies and the British Chambers of Commerce) a year ago for the economy in 2017. As the table below indicates, the results are not encouraging.

  Growth Inflation Unemploy-ment Wage Increase House-hold Spending Increase
End 2016 Figure 1.9% 0.7% 4.9% 2.8% 2.8%
Highest prediction for 2017 1.6% 2.7% 5.4% 2.75% 1.5%
Lowest prediction for 2017 1.1% 2.1% 5.1% 2.1% 0.6%
Actual figure for 2017 (latest estimate) 1.7% 3.1% 4.3% 2.5% 1.0%

 

The UK’s growth performance has dropped from first place among the G7 in 2016 to close to the bottom and, in addition to the data above, we should note that share prices in the USA and the UK are at record highs, as is employment in the UK. However particularly worrying is the fall in real incomes which has impacted on consumption growth.   UK productivity growth has been low, with businesses tending to increase labour rather than spending on capital. Although the very latest figures show an improvement, this is because hours worked have dropped rather than output increasing. In addition, house price growth, particularly in London, has slowed.

In thinking about what might happen to the UK in 2018, there is the old saying that “when America sneezes, the world catches a cold”. This is still applicable but we might include China since the performance of the world’s largest economies will have both direct and indirect effects on the UK, since their faster growth will directly impact on our export sales and indirectly as rapidly growing demand for raw materials overseas pushes up prices for UK firms and consumers. On the other hand, we do not know whether President Trump’s desire to implement policies  focussing on “putting America first”, will have an impact on the rest of the world.

The IMF is positive about the prospects for the world economy in 2018. It predicts that world GDP will grow by 3.7% and this recovery is likely to continue for a further four years. This faster growth is the result of the three main economic areas (North America, Asia and Europe) all recovering rapidly at the same time. Businesses in the USA and France are confident following the election of business-friendly Presidents Trump and Macron, and this confidence should have a positive impact on investment. In addition, even though there have been interest rate rises in the USA and the UK, the level of world interest rates and the positive effects of QE continue to facilitate growth. The IMF therefore expects that average unemployment in the G7 will drop below 5% this year for the first time since the 1970s while inflation will remain below 2%.

Time to feel sorry for economic forecasters.

 

 

The UK Economy – how are we doing?

Since the Brexit vote ten months ago, there have been many reports about the state of the UK economy and its prospects for the future. In an ideal world, we could look at the recently-published data and decide how we are doing. Unfortunately, the picture is unclear with different data sets indicating different things.

On the positive side, unemployment has fallen to 4.7% and employment has risen to almost 75%, both numbers reaching impressive lows and highs respectively. What we would also expect to see simultaneously is an acceleration in wage increases as workers take advantage of a tighter labour market indicated by  low unemployment, high activity rates and employers reporting recruitment difficulties, with the effect magnified by an increasing number of migrant workers returning home because of the fall in their incomes when exchanged into their own currency due to the fall in sterling since June. However, money wages are rising at only 2.3%pa and, as inflation increases, real wages will fall. Possible explanations for the low average increase in wages are the 1% cap on public sector pay increases thereby reducing the average, a possible increase in retired workers returning to the labour force depressing wages and the increase in self-employment since the self-employed are not counted in the data.

Other positives for the economy are our growth rate, the reduction in government borrowing and improvement in the  balance of payments. Our annual GDP growth of 1.8% has been the second highest in the G7 behind only Germany at 1.9%. However there is concern that consumer spending, which has been an important contributor to the UK’s growth, is now slowing.  Further factors which might impact on consumer spending are the expected fall in real income, mentioned above,  and the slowdown in the housing market which, according to the Halifax, grew at its slowest rate for four years.  The housing market is important for an economy in terms of the wealth effect, its impact on consumer confidence and the effect it has on related markets, such as carpets, furniture and household appliances, which people buy when they move.

The slowdown in consumption growth, and therefore probably GDP growth, is such that the Bank of England is now thinking that the increase in interest rates which has been talked about for some time, is likely to be postponed from late 2018 until the middle of 2019. It will then be almost twelve years since the last increase in UK interest rates which took place in July 2007 when they were increased from 5.5% to 5.75%.

The Public Sector Borrowing Requirement (PSBR) has come in below expectations and is now back to levels experienced before the financial crisis. This is largely due to  income and corporation tax revenues being greater than predicted. However, if the economy slows down in the run-up to Brexit, tax revenues will fall and benefit payments increase, increasing the PSBR.

The current account deficit dropped from 5.3% to 2.3% of GDP in the last three months of 2016. Unfortunately this proved to be a temporary improvement and the deficit has widened again this year. This makes it clear that devaluation alone will not be sufficient to improve our balance of payments and significant structural changes will also be necessary to improve the attractiveness of UK products. (Consider Germany which has a current account surplus equivalent to 8.7% of GDP not because of cheap goods but because of high quality, well-designed products). FDI increased in the last quarter of 2016 but a worrying development are recent surveys which have found that the UK has fallen in attractiveness as an overseas country in which to set up compared to other countries.

On the positive side, we could be in Greece where unemployment is 23%, and average wages have fallen approximately 10%, income tax has been increased from 40% to 47%,  the retirement age has been increased from 60 to 67 and  pensions have been cut 14 times compared to 2009.

 

Housing benefit in the UK

Paul Johnson of the IFS explores the changing role and nature of housing benefit in the UK. As a result of successive government policies, housing market forces, and social trends, UK’s housing benefit runs into the tens of billions of £’s every year – more than we spend on policing. Conservative policy in the 1980’s intended to make home ownership more affordable to low income households has the unintended consequences of increasing rents for future generations and higher housing benefit costs for taxpayers. The problem has been exacerbated by subsequent governments policy of leaving house building to the private sector. Furthermore, rising population and smaller family sizes means more demand, insufficient supply, but rooms laying idle as people sit on their assets as prices continue to rise. Analysis looks at the causes of the situation and potential solutions. As ever, there are costs and benefits, and different people hold different views. My personal opinion is that benefit caps and bedroom taxes are going to make little difference. We simply have to build more houses, and if the private sector won’t do it, the state will have to step in.

To listen to the full broadcast click the link below.

http://www.bbc.co.uk/programmes/b06bnbpx