Economic Review & Outlook: Implications for the UK

Since my last EFR article published in June of this year, the Olympic Games have come and gone and the coalition government is midway through its five-year term. The UK has gone from drought restrictions to severe floods, but there is a reduction in the rate of inflation and growth has returned, albeit temporarily. In spite of this, UK’s Office for Budget Responsibility has revised down the 2012 forecasts to reflect the flat performance of the economy in 2012. However, debt continues to grow as a percentage of GDP and growth and debt forecasts for 2013 are not very different from what has been experienced in practice in 2012. Most commentators expect 2013 to be particularly challenging, as many of the previously announced cuts in public spending by the legislature are set to be implemented in the first half of the year. The key question is: Will growth and inflation continue to oscillate or will they stabilise and provide a firm foundation for longer term sustainable growth?

One unusual piece of news has been the appointment of Mark Carney, the head of the Canadian Central Bank, to be the next governor of the Bank of England. He will serve a five-year term from June 2013.

These are unusual times as the UK’s Office for Budget Responsibility (OBR) has confirmed when analysing the accuracy of its previous forecasts against actual performance in the UK economy.In its October 2012 forecast evaluation report the OBR concluded:

“Along with many other forecasters, we significantly overestimated economic growth over the past two years. This likely reflected several factors, including the impact of stubborn inflation on real consumer spending, deteriorating export markets on net trade, and impaired credit conditions, euro area anxiety and demand uncertainty on business investment. Fiscal consolidation may also have done more to slow growth than we assumed.

“Nonetheless, public sector net borrowing fell much as expected. Nominal consumer spending and the labour market performed more strongly than the real economy, helping to sustain receipts from labour taxes and VAT while restraining social security bills. Central government departments and local government also spent less than they had budgeted for and less than we expected they would on public services and administration.”

Underlying the question of growth and inflation is the management of the public sector debt and whether the austerity policies being implemented are allowing sufficient room for growth. The OBR forecasts for debt and public sector borrowing as a percentage of GDP are shown in Boxes 1 and 2, respectively. These forecasts underline the necessity to control debt, but the flat level of receipts shown in Box 3 show why it is not just about controlling costs but also stimulating growth.

UK Economic Performance

The UK’s quarter-by-quarter GDP growth from 1990 through the third quarter of 2012 is shown in Box 4 on the following page. The OBR’s March 2012 forecast predicted that GDP would grow by 0.8 percent in 2012 (the same rate as in 2011) with growth of 2.0 percent in 2013, picking up to 2.7 percent in 2014 and 3.0 percent in the final two years of the forecast. The latest (December 2012) forecast revises these figures down to -0.1 percent for 2012, 1.2 percent in 2013, two percent in 2014, 2.3 percent in 2015, and 2.7 percent in 2016. The key risks identified in the forecasts are the situation in the Euro area and a further spike in oil prices.

What has happened in practice is that the UK continued in recession for the second quarter with a 0.4 percent reduction in GDP before the Olympic effect revealed itself with a one percent increase in GDP in the year’s third quarter. Commentators have suggested the London Olympics contributed over 50 percent of that quarter’s growth.

Employment figures have produced some equally contradictory results. The Office for National Statistics (ONS) reported that unemployment fell by 49,000 (to 2.51 million) in the three months to September, with the unemployment rate falling to 7.8 percent from 7.9 percent. A decline in youth unemployment was chiefly responsible for the fall. The number of employed people is at a record high of almost 30 million, an employment rate rise to 71.9 percent. However the unemployment benefit claimant count rose by 10,100 in October to 1.58 million and long-term unemployment is also up. The term “underemployment” is becoming increasingly used, with the ONS reporting that one in 10 of all workers in the UK is now officially underemployed, with 3.05 million workers wanting to work more hours each week out of a total workforce of 29.41 million. The number of workers in this position has significantly increased by 980,000 in the four years since the start of the economic recession in 2008.

The ONS, in its annual survey of hours and earnings, found that the average annual earnings of full-time workers in the UK rose by 1.4 percent to £26,500 in the year to April 2012. However, this translates into a cut in the real value of pay, as inflation was higher during the same period, at 3.5 percent.

The UK’s inflation rate rose sharply in the last quarter of 2012 following an increase in tuition fees and food prices. The rise in the Consumer Price Index (CPI) to 2.7 percent in October followed September’s 2.2 percent rise, the lowest inflation rate of the previous three years. The main reasons for the rise in CPI were the rise in university tuition fees after the government lifted the cap on university fees, but food prices, especially vegetables, also rose after record wet weather earlier this year affected crop yields. The Retail Prices Index (RPI) measure of inflation, which includes housing costs, rose to 3.2 percent from 2.6 percent.

Prospects for UK Infrastructure

The outlook for infrastructure in the short term is largely unchanged with annual expenditure at £33bn per year. There is a growing acceptance within government that investment in infrastructure is a highly effective way of producing sustainable long-term growth, but the reality in the short term is a continued dip in capital spending on infrastructure. However, the introduction of three infrastructure-related bills into Parliament over the past six months is a positive sign, alongside the announcement in December 2012 that the government had agreed additional expenditure of £1bn on four new road schemes and £1bn for 100 new schools. The following briefly describes the new bills.

The Infrastructure (Financial Assistance) Bill

Parliament has enacted the Infrastructure (Financial Assistance) Bill as the Infrastructure Act 2012. It authorises the government to incur expenditure in relation to the provision of guarantees and other suitable forms of financial assistance of up to £50 billion in support of infrastructure investment through ”UK Guarantees.” UK Guarantees take advantage of the government’s fiscal credibility to provide guarantees for major infrastructure projects that may otherwise not proceed due to adverse credit conditions. The offer of guarantees will be awarded on a case-by-case basis and will be subject to due diligence and Parliamentary approval processes. A commercial fee will be charged for any guarantee. Parliament enacted the bill in just 55 days.

The Growth and Infrastructure Bill

The Growth and Infrastructure Bill contains a number of provisions designed to encourage greater investment, new infrastructure, and delivery of jobs by reducing perceived obstacles in the planning process. The bill is focused on four key areas: infrastructure, planning reform, employment incentives for Small Medium Enterprises (SMEs), and stability of business rates. Key points relating to infrastructure projects include:

  • consents for energy projects can now be varied if companies want to incorporate the most recent technology or make their plant more energy efficient in the period following the original planning consent;

  • removal of specific planning requirements across local authority boundaries for broadband projects;

  • information requests from planning authorities will have to be proportionate to the scale and nature of the development proposed;

  • nationally significant business and commercial projects will have the opportunity to go through the infrastructure fast-track process, allowing decisions to be made within 12 months (existing requirements to consult local communities are retained, as are democratic checks and balances); and

  • streamlining of the consenting process for projects requiring multiple consents.



Energy Bill

The UK’s Energy Bill has, after some delay, now been introduced into the House of Commonsand will be subjected to debate, review, and amendment before being enacted in 2013, assuming safe legislative passage. The primary thrust of the Energy Bill is to incentivise new low-carbon forms of generation, such as renewable and nuclear power, to enable the UK to meet its legally binding 2050 climate change target of an 80 percent reduction in carbon emissions. The cost of changing the generation mix to a more diverse and low-carbon energy mix has been estimated at £110 billion or more from private sector investment. The current support mechanism for renewables in the electricity market is the Renewable Obligation Certificate, which allows up to £2.35 billion per year to be charged to consumers to support the development of renewable energy projects.

This support mechanism, however, will be replaced by new “contracts for difference” (a form of Feed-in-Tariff) to support new nuclear, carbon capture and storage, and renewable power. The contracts for difference will be accompanied by an increase in subsidy from £2.35 billion to £7.6 billion a year, and this should unlock capital spending in the electricity sector from 2015.

The government also announced in December 2012 that they had reviewed their private finance initiative (PFI) and that this would be replaced by PFI2, which features greater transparency, faster procurement, and changes to risk transfer and facilities management services.


It is proving to be a slow process for both broad economic growth and investment in infrastructure to be realised in practice. The big question is not whether 2013 will be an extension of 2012 (but without the Olympics) as both the Bank of England and OBR forecasts suggest it will, with growth of around one percent, but when and what 2014 will bring. In the infrastructure sector, we watch with interest to see how the UK government will convert its aspirations for new infrastructure into practice.

Image Header Source: Howard Lake (Creative Commons)