By Alastair Winter, Chief Economist at Daniel Stewart & Co.
Most of the world’s UK-knockers seem to live here, judging by the endless refrain on superior US commerciality, French infrastructure, German manufacturing, Chinese competitiveness and Scandinavian efficiency.
As we are talking economics, we can at least avoid the subjects of British cuisine, the weather and even football. In the City, there is a long-established tradition of selling the pound when in doubt and this has certainly been happening throughout the last three months. Intriguingly, however, both equities and gilts have done rather well and this suggests that the buyers, albeit with their various different investment objectives, are far from writing off ’dear old Blighty’. They are almost certainly right.
Of course, there are plenty of things wrong with the UK economy.Â Everyone has their favourites but here are four that are fundamental:
- Competitiveness: this, or rather the lack of it, is probably the gravest problem and has taken many years of ‘applied inertia’ to create. Now that the dividends from internet technology and cheap Asian labour are running out it is clear that we pay ourselves too much and have become too dependent on others. As workers in developing countries start to demand higher wages and better public services we are faced with the worst of both worlds: higher import costs and limited ability to substitute, inflation without growth.
- Credit: for long enough there had been too much and since 2008 too little. Lending has become too concentrated, thereby giving rise to periods of feast or famine, of making terms too easy or not offering any at all. Local knowledge to support lending decisions was increasingly either lost or ignored as banks became bigger and more centralised. The market structure and regulations made it difficult for new entrants.
- Unaffordable and inefficient public services:Â this is not a political point. The age of entitlement was created by great socially progressive ideas but has been subverted by subsequent decades of electoral bribes. Responding uniformly to demand that is unlimited by price is impossible in a country with a population the size of the UK and the costs of trying to do so are prohibitive. Even worse, the cost of the bureaucracy attempting to deliver these services has somehow taken precedence over investment in infrastructure or in seed capital for new technologies.
- Flawed approach to investment: this is true of the private sector as well as the public. Short-termism amongst institutional investors, stigma of failure by entrepreneurs (unlike in the US), niggardly incentives and for backers of small business and haphazard support for R & D investment. There appears to be no model in the UK that is able to justify public investment in infrastructure and plenty that reject individual projects.Â Perhaps other countries are in the same situation but just go ahead on the grounds that airports, railways and roads are actually necessary for an economy to function.
There can be no doubt that these four riders of economic apocalypse have been eroding the UK’s prosperity and are currently impeding the recovery in growth. However, there are also wildly unrealistic views, especially amongst Mr Osborne’s anti-fan club (as described above), as to how quickly they can be overcome.Â The debate seems to be degenerating into a kind of street protest:
‘What do we want?’ ……. ‘Growth! Growth! Growth!’
When do we want it?’…..’Now! Now! Now!’
For the more realistic, the huge changes necessary will take at least ten more years to be implemented politically and logistically in a democracy like ours. For the more patient, there are signs of increasing progress being made on all fronts, sometimes with help from the government and sometimes despite its neglect or mismanagement.
And so, it is time to spell out 21 Reasons not to despair:
- GDP: amidst all the talk of triple dip the double dip of Q4 2011/Q1 2012 has almost disappeared in successive revisions and it already has if erratic North SeaÂ Oil and Gas output is excluded. It is important for business and consumer confidence that the worst case is a hesitant recovery. It also ties in with other data that has hitherto been difficult to reconcile. GDP should be positive in Q1 and thereafter.
- Consumption: ONS and BRC data show that, despite the appalling weather, people are out spending money in shops, restaurants, hotels and cinemas. Many are saving and paying down their mortgages but just as many are taking out new loans and mortgages.
- Housing market: perhaps the Brits put too much of their money into their houses but it underpins our sense of personal security and affects our willingness to spend money. There are still huge regional variations but ripples from London now seem to be reaching as far as the Midlands. The overall solidity of the market is helping a much-needed expansion of the rented sector.
- Services Sector: this accounts for almost 80% of GDP and there is an encouraging consistency between the detailed breakdown of 2012 GDP data, the January Index of Services and the first two Markit/CIPS surveys in 2013 (March is due out tomorrow).Â In fact, the Sector has now edged past its pre-crisis peak.
- Financial Services: representing 10% of GDP, the slump has been a major drag on overall GDP, the Services Sector and on Trade. Recruitment figures and other more anecdotal evidence suggest that the worst may be over but, even if the glory days are past, the City looks like contributing to an overall recovery.
- Employment: this has been the best story during the darkest days. More people than ever have jobs, up over 3% from low point in 2009 although there remain worries about unskilled younger people. Hitherto, it has been something of a mystery with suggestions that employers (including ‘zombies’) were holding on to their staff while hoping for the best.Â It now appears that many have been much more gainfully employed in the Services Sector all along.Â Another factor has been the switching of public sector employees to working on a self-employed contract basis (which also helps to explain by public spending has not fallen further).
- N Sea Oil/Shale Gas: a complete turnaround in taxation policy for the former and a new approach to the latter have transformed the outlook for new investment, jobs and the Trade Balance and the industry will start to contribute again to GDP growth.
- Trade: the recession in the EMU has been very damaging but somehow Germany is developing into our most important trading partner.Â Forced to look further afield, exporters have managed to increase sales outside the EU by 30% in four years but the BRICS countries still only account for 6%. The Coalition government have stepped up support for exporters with high-profile delegations and credit finance for them and, most helpfully, their customers. The depreciation of the pound is taking longer to benefit manufacturing as not enough UK companies either makeÂ what we and foreigners want to buy or they make it overseas.Â However, the depreciation has been enough for some companies to introduce new mid- and high-value products in the UK and/or re-source production. Any recovery in North Sea Oil production and in the City will also be very helpful to the Trade Balance.
- Infrastructure: the shovels are still not doing much shovelling, although there are some high-level projects underway and/or soon will be. The Treasury still seems obsessed with keeping finance off-balance sheet and sticking the private sector with risks that belong to the public sector. The political shilly-shallying over airport capacity is pretty disgraceful but the economic argument is being won. Sooner rather than later the serious money will start to flow, both public and private.
- Investment: this is another area where the government is starting to walk the walk after a lot of talking. The house building sector has been given a shot in the arm in the recent budget and just out this week is news of a major venture in residential property by the Prudential. The tax-breaks for external investors are being enhanced in the unquoted sector and in the area closest to Daniel Stewart’s heart, ISA’s should soon be able to invest in AIM-listed companies.Â Hurrah!
- Seed capital: the US government has been doing this for years in selected technologies and now at last the UK is cottoning on. This is one area where the Coalition parties are in complete accord.
- Taxation: this is something of a success story for Mr Osborne. With very little to play with he has sent out strong signals to existing companies, potential inward investors, higher and standard rate taxpayers that he wants to reduce the burden.Â The switch to rely more on Vat has been made to stick. Some simplification of deductions and rationalising of Vat would help but Taxation is one area in which the UK is already competitive.
- IPO Market: this has burst into life with esure, Crest Nicholson, Countrywide and an increasing number of smaller companies (including clients of Daniel Stewart). An important psychological barrier has been breached.
- Banks: the US authorities have led the way but it now seems the major UK banks are ‘only’ Â£25bn away from meeting all solvency requirements. Mr Osborne’s acceptance of most of the recommendations of the Vickers and Parliamentary Commissions on Banking should ensure that the UK banks should not cause much trouble for a while. This is in complete contrast to the situation in many countries in Europe where the worms are still coming out of the woodwork thick and fast.
- New lenders: this is a most welcome development. Examples include insurers M & G and L & G lending at the top end, Aldermore and Handelsbank to the middle and Peer to Peer groups to small and very small companies. The Bank of England may also step up its game by targeting its FLS and perhaps buying bundles of corporate loans as part of its QE programme.
- Low interest rates: these seem to be taken for granted and there is some debate as to whether they have made much difference so far. Base Rate look like staying at 0.5% for at least another two years and remain historically low for at least two more after that. As business and consumer confidence picks up the benefits will start to flow.
- Public borrowing: by any measure, the continuing increase in public debt is disappointing but how worrying is this? A lot of comfort can be taken from its relatively low cost. The Debt Management Office has been highly successful in securing long-term money that will keep debt service affordable for at least the next 20 years and counting. There are two other grounds for comfort that are somewhat politically incorrect to mention: inflation will erode the value of the principal amounts owed and the ‘true’ net amount of public debt involves deducting the Â£375bn (and counting?) currently held by the Bank of England.
- Previous reforms: as European countries with varying degrees of distaste grapple with structural reforms of employment law, trade union rights and pension funding it is worth remembering that the UK has already got through most of the pain. This is essential for any country trying to compete with and trade with the developing economies.
- Difficult decisions: there are still many more to be taken but the Coalition government has a reasonable track record so far.Â The new policies on retirement age and pensions are very sensible as well as timely and a start has been made on care for the aged and welfare benefits. Only Germany and Scandinavia are ahead of us
- Growing realism: at the risk of entering into a mystic zone, it is possible to see a growing consensus that the Education and Health services are deficient. Out of office, Labour has been reluctant to admit that the money thrown at these sacred cows in the Blair-Brown year has not been well-spent. Mr Cameron is stuck with his pledge that the NHS is safe with him but Mr Gove is making progress. Alas, the real action may not be possible until after the election in 2015 but at least for now it has been promoted to being a rather large elephant in the room.
- Gilt market: as with other countries, the downgrade (still only by Moody’s) has made little difference. UK pension funds must always be purchasing gilts to match their liabilities and will have no shortage of contributions as people work longer and rely less on the State Scheme. Events in Europe are likely to keep foreign investors rating UK paper almost as highly as German bunds and the latter are in decreasing supply. All these investors need is a Plan, whether it is Plan A, Plan A+ or – or Plan B. Mr Osborne has at the very least delivered on that front and no doubt, if in office and despite all the huffing and puffing, Mr Balls will come up with something almost identical.
Overall, there may be plenty to fret over but despair is dangerously self-fulfilling and should be set aside in ‘this sceptred isle’, albeit that there is a long, long way to reach ‘demi-Paradise’.