Perspectives



Economic Review & Outlook: Implications for the UK

It would be refreshing to write that something has changed with the UK economy, but sadly the characteristics are largely unchanged from this time last year in terms of growth, control of public spending, and general levels of economic confidence. The outlook continues to suggest flat or limited growth for the short to medium term whilst the problems within Europe, the UK’s largest trading partner, continue with Cyprus being the latest country in the eurozone to request a bail-out. It is the first bail-out to penalise those with savings above €100,000, sending a clear message through Europe of the seriousness of the situation. Although Cyprus is a relatively small economy, the precedent set by the particular requirements of this bail-out was noted with some concern in Spain, Greece, and Italy. More recently, the European Central Bank reduced interest rates from 0.75 percent to 0.5 percent, possibly in response to manufacturing output having shrunk in April across the 17-country bloc, including Germany.

The UK government has long cherished its AAA credit rating, but two of the three main credit rating agencies have now downgraded the UK to the same level as the US, although Standard and Poor’s recently re-confirmed its AAA rating. The differing views of the credit rating agencies are a reasonable indication of the split views that exist generally about the future direction of the UK economy. Some are arguing that the reason the deficit has not reduced significantly is because there has been no increase in public spending to stimulate the economy. It is a fact that the UK economy in 2013 is smaller now than it was in 2008, while some other countries, notably the US, have managed to grow their economies back to 2008 levels. However, there are others, including individuals in the UK government, who argue that increasing the deficit to stimulate economic activity would be counterproductive, compromising the low rates of interest the UK currently pays on its debt.

In the midst of all this, the UK government is trying to drive through major reform programmes in the energy, education, and health sectors. Capital spending in these sectors has largely stalled, although there are signs that the education sector in particular will see some accelerated capital spending in the short term, primarily driven by the shortage of primary school places and continued spending by universities. There are many observers watching the energy sector with interest as the adoption of electricity market reforms should lead to an upsurge in capital spending. For the moment, however, there is much uncertainty, reflected in the ongoing negotiations between the government and EDF Energy (one of the largest UK home and business energy suppliers) over the tariff to be paid for energy generated from the first of the proposed new nuclear plants at Hinkley Point.

UK Economic Performance

Box 1 shows the UK’s quarter-by-quarter GDP growth from 1990 through the first quarter of 2013. This illustrates the depth and extent of the current economic crisis with what appears to be an oscillating convergence on zero growth following the massive falls in 2008. The increase of 0.3 percent in the first quarter of 2013 was above expectations but the general view amongst economists is that the UK economy is bumping along the bottom or “flatlining.”

The government’s independent Office for Budget Responsibility (OBR) has estimated future growth figures (Box 2).

The OBR expects employment to rise in every year of its forecast period, reaching 30.5 million by 2017, and expects total private sector employment to rise by around 2.6 million between the start of 2011 and the start of 2018. The OBR revised down its unemployment forecast by 0.3 percent to 7.9 percent in 2013 and by 0.2 percent to 6.9 percent in 2017. However, the Office for National Statistics (ONS) recently confirmed that unemployment between November 2012 and January 2013 had risen by 7,000 to 2.52 million.

The OBR has also revised its inflation forecast up slightly. The OBR attributes this to higher oil prices and higher import prices but it expects inflation to return to target by early 2016. As a point of reference, inflation in February 2013 rose by 0.1 percent to an annual rate of 2.8 percent.

Public sector net borrowing for the financial year ending in April 2013 was on forecast at £120 billion. Public sector net debt as a share of GDP is forecast to peak at 85.6 percent of GDP in 2016-17, before falling to 84.8 percent in 2017-18.

Prospects for UK Infrastructure

There are increasing signs that the government sees growth in physical infrastructure as a sound basis for the UK’s economic recovery but, at the same time, it is reluctant to increase public sector borrowing to finance such schemes. There is a continued debate about incentivising the private sector to invest in such infrastructure whilst not compromising value for money. A £50-billion infrastructure guarantees programme has been established to help the private sector but direct investment of public funds into new infrastructure is more modest: the government’s March 2013 budget announced an increase of £3 billion per year, but this increase is not coming into force until 2015.

A year earlier in a widely reported speech to the Institution of Civil Engineers, the Prime Minister had delivered his vision for the UK’s infrastructure and how it might be financed.

However, his flagship announcement of a new study to look at ownership and financing options for the strategic road network in England, due to report in Autumn 2012, remains unpublished. This delay illustrates the complexities that exist politically, fiscally, and practically.

The Energy Bill, so important for providing clarity to investors in the UK’s privatised electricity sector, is making its way through Parliament and, if the detail that follows is right, will unlock significant new investment in the power sector. Lord Heseltine, the former Cabinet Minister under the late Baroness Thatcher’s government, has prepared a series of recommendations for accelerating growth in the UK, the majority of which have been accepted by the government. The main thrust of his recommendations is to allow local economies access to the funds normally managed by various separate central government ministries as a “single pot” so that decisions can be made more quickly and bureaucracy reduced. However, the “single pot” won’t be introduced until 2015 and there is some speculation that it may not be as large as some commentators first thought.

Medium-Term Outlook for Infrastructure Spending

Looking forward to 2015 and beyond, the UK power sector is likely to see a rapid increase in construction industry services with extensive investment in offshore wind, gas, and—provided agreement is reached on tariffs—new nuclear. The rail sector, partially funded by the taxpayers and partially by the travelling public, continues to provide some stability. Studies are proceeding on HS2, the new high speed rail line between London and the North of England. Significant rail projects are in design or construction, including the Northern Hub in Manchester; the electrification of the Great Western main line from London and Leeds/York to Liverpool, two important east-west routes; and Crossrail, the largely underground route providing a direct connection between the radial main lines to the west and east of London. Thoughts are now turning to Crossrail 2, a new underground railway between the southwest and northeast of London.

Investment in new roads and schools remains at significantly lower levels than under the previous government, but there are indications that some increase can be expected in 2015 following the recent budget announcement of limited increases in infrastructure spending and the “single pot.”

Conclusions

There has been a change of language from governments across Europe indicating that austerity without growth is not sustainable. The question that all governments are grappling with is: how do you achieve growth without increasing public debt? We have a new governor of the Bank of England, Canadian Mark Carney, and his responsibilities at the bank have been extended to include growth as well as inflation. That begs the question of whether growth will be pursued at the expense of inflation. Higher inflation of course helps shrink past debts.

The infrastructure sector is urgently seeking growth to reverse the recent downward trend in construction output, but there are still some big questions out there. The biggest is: When will everything be in place to rebuild confidence and propel sustained economic growth? The new policies emerging from the Bank of England, the passage of the Energy Bill through Parliament, and delivery of Lord Heseltine’s growth plan will influence that answer.

 

Image Header Source: Nicolas de Camaret (Creative Commons)


Geographies: United Kingdom & Europe
Sectors: Other
Topics: Economics