Perspectives



Economic Review & Outlook: Implications for the UK

At the time of writing this piece (September), the Bank of England had just voted to maintain the UK interest rate at 0.5 percent whilst, on the same day, the European Central Bank had reduced its benchmark rate to 0.05 percent — one order of magnitude lower than the UK — illustrating the gulf that exists between the UK’s economic recovery and the Eurozone’s continued stagnation. As the Eurozone is the UK’s largest single trading partner, this is mixed news. The UK’s Office for National Statistics (ONS) has also applied a new methodology (the 2014 blue book) to the calculation of gross domestic product (GDP) and concluded that the recession was not as deep or as long as previously thought. This is also mixed news as, had they known, UK companies may have been tempted to invest more in their businesses earlier.

Further uncertainty for the economy in the form of the Scottish independence referendum was removed when Scotland voted by 55 percent to 45 percent to remain in the UK. However, the high turn-out at over 80 percent, unheard of at a general election, has already been seized on by politicians of all parties as a clear signal for them to change how politics is conducted in the UK if they are to engage those eligible to vote. How this manifests itself is yet to be seen but with a general election in May 2015, there appears to be a six-month window of opportunity.

Some uncertainty continues. A general election will see a new government installed and depending on how the electorate votes, we may or may not have majority government, we may or may not be holding a referendum on whether to stay in the European Union, and we may or may not see a continuation of the current economic policies that have, at least until now, placed the UK in a relatively better position than its western counterparts in terms of economic growth. Only one thing is certain in this world — there are no certainties!

The same comment can also be applied to the UK’s infrastructure sector, and that is itself a concern. With long planning and investment lead-in times, and as a long-term benefit provider, large infrastructure projects require early commitment to accelerate returns to society and provide certainty to investors and the supply chain to enable forward planning and reduction in costs. Does our current system produce optimal returns on infrastructure investment? Infrastructure UK, the government’s specialist infrastructure department within the Treasury, has put steps in place to reduce out-turn costs by critically reviewing the various steps that characterize the development of our infrastructure from concept to reality. One of the key steps in this process is procurement. Good projects are always characterized by good people yet, in many procurements, it is cost rather than people that appears to differentiate bids, even though most agree that best value does not equal lowest cost. Instead, lowest cost can represent poor value if it constrains innovation, collaboration, and stakeholder engagement.

Amidst this background of uncertainty and review, the supply chain is also taking action and the summer was characterized by consolidation, with various mergers and acquisitions hitting the headlines. Infrastructure consultants are getting larger and more global whilst construction companies consider a variety of different operating models from full life cycle integration through to a focus on core capabilities.

For the UK at least, the infrastructure market over the next five years will look markedly different from the previous five. How different, only time will tell. But there will be new projects, particularly in the energy and transport sectors, changing supply chain characteristics as consolidation continues, and hopefully more optimal processes to improve certainty and achieve better value — knowing which projects will definitely proceed will help! However, the pace at which reforms are delivered will all be dependent upon the UK’s continued economic recovery, and indeed how it is affected by the economies of its trading partners.

The UK’s Economic Recovery

The UK’s quarter-over-quarter GDP growth continued its strong growth of 0.8 percent per quarter for this year giving an annual growth rate of 3.1 percent for the previous 12 months, as shown in Box 1.

As previously referenced, the ONS has recently (September 2014) applied a new methodology to the calculation of GDP that is more consistent with international practice. These changes, which are not reflected in Box 1, have raised the level of GDP at current prices by an average of £50 billion a year or 4 percent between 1997 and 2012. However, revisions to the average annual rate of real GDP growth are small, leaving it only 0.1 percentage points higher at 2 percent, as shown in Box 2.

The effect of these changes means that the downturn in 2008 to 2009 was shallower than previously estimated and subsequent growth was stronger. The peak-to-trough decline in GDP is now estimated at 6.0 percent, shallower than the previously published estimate of 7.2 percent, whilst annual GDP growth from 2008 to 2012 has been revised up each year. However, it remains the case that the UK experienced the deepest recession since ONS records began in 1948 and the subsequent recovery has also been the slowest.

So has the UK performance recovered to pre-recession levels yet? In GDP terms yes, as illustrated in Box 3. However, the level of output per hour worked at the end of 2012 was still around 12 percent below the projected path if the pre-downturn trend in growth had been maintained; this reduction in productivity, which continues in 2014, is difficult to explain when annual growth is returning to pre-2008 levels.

The ONS has also revealed that the unemployment rate fell to 6.2 percent over the three months to the end of July, its lowest level since 2008. The number of people without employment is now 2.02 million, falling by 146,000 over the quarter whilst those claiming Jobseeker’s Allowance (JSA) fell below one million for the first time in six years.

However, average earnings in the May to July period rose by only 0.7 percent from a year earlier and with the current rate of inflation of 1.5 percent there is a significant lag. In addition, the Bank of England halved its forecast for average wage growth in 2014 to 1.25 percent, reducing pressure on early interest rate rises.

Infrastructure Trends

In the UK, the three principal infrastructure investment sectors — energy, transport, and social — have their own unique character in terms of looking forward over the next five years.

Energy

The energy sector faces two major challenges: ensuring adequate security of supply in the short-term, following unplanned withdrawals from service of EDF Energy’s nuclear fleet after discovery of a crack in the boiler at one of their sites; and successfully implementing the Energy Act, which will be critical to attracting investment for the new generations of gas, nuclear, and renewable power generation that are urgently required to maintain energy security and reduce carbon emissions.

The Energy Act, through its two primary policy levers of Contracts for Difference to pay for new low-carbon generation and the Capacity Mechanism to pay for new back-up capacity that can be drawn upon at short notice, has been passed and the necessary secondary legislation enacted. The challenge now is to balance the constraints of the Levy Control Framework, which controls how much subsidy can be provided in the electricity market, with the appetite of investors and developers in taking the initial investment risks to advance a project to the stage where it can qualify for such subsidies. The next year will be an important one with the initial allocation of Contracts for Difference being determined and the first auction to be held for the Capacity Mechanism. Watch this space!

Transport

Transport also faces an interesting year, albeit for different reasons. Network Rail, the not-for-profit organization charged with owning and maintaining the UK rail network, has been returned to the public sector, bringing with it £34 billion of debt. It will continue to operate independently following its five-year spending programmes overseen by an independent regulator, Office of Rail Regulation. The rail sector is home to some of the UK’s largest projects including the electrification of the Great Western Main Line, the construction of Crossrail in London, and Manchester’s Northern Hub, and the planning that is ongoing with the High Speed 2 (HS2) route from London to the north.

The highways sector is seeing renewed investment from government; and the Highways Agency, the body responsible for the strategic road network in England, is being transformed into an independent government-owned company (GoCo) with its own five-year plan. This represents a significant change, freeing the national road network from the constraints of annual expenditure controls. There is more concern about the investment, or lack of it, going into the local road network, administered by local authorities who are increasingly constrained financially.

The UK’s aviation sector is focused on how best to resolve the lack of runway capacity in and around London. An independent Airports Commission has been established to resolve the issue but is not due to report until the middle of next year. It has, however, announced the shortlist of options that it is considering. This excludes the option for a new major airport hub and instead focuses on three options to expand the existing London airports of Heathrow and Gatwick.

Social

Social infrastructure investment has been relatively quiet over the past five years but the next five years will see the construction of a major new sewer in London, the £4 billion Thames Tideway Tunnel, as well as increasing demand for new housing, schools, water supplies, and other infrastructure driven by the UK’s rising population, currently 60 million but forecast to rise to 68 million by 2021, according to the Office for National Statistics.

Conclusions

Whilst uncertainties continue to come and go, the UK is making progress in returning its economy to performance levels last seen before 2008. However, it is still exposed to an unexpected shock to the global economy and to uncertainties related to domestic decisions, particularly if a referendum on Europe resulted in the UK leaving the European Economic Community.

Last year at this time, I wrote about the call for forward planning of climate change adaptation measures, and the winter storms that followed underpinned the urgency of this. We wait to see what this winter will bring in terms of unusual weather and how it impacts our infrastructure. Uncertainties come in all shapes and forms—climate, political, economic, and war—and how we manage their impacts in the year ahead make these interesting times, as they will directly influence our future infrastructure requirements.

 

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Image Header Source: Trevor Cummings (Creative Commons)


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