The next Chancellor is about to inherit some very sticky circumstancesby George Magnus / May 5, 2015 / Leave a comment
The election in the UK is only two days away. Whatever the shape and composition of the government that emerges, the Chancellor of the Exchequer, having feigned perfect knowledge during the campaign, will gather his or her advisers and want an answer to a serious question: “What on earth is going on in the economy here, and overseas?”
Consider this. Less than a month ago, the International Monetary Fund’s flagship World Economic Outlook publication told us that this year, global growth would be driven by “a rebound in advanced economies, supported by the decline in oil prices, with the United States playing the most important role.” Weighing in, the IMF’s chief, Christine Lagarde, praised the UK’s economic performance as her staff predicted our economy would grow by 2.7 per cent in 2015 and 2.3 per cent in 2016, second only to the US.
In the interim, first estimates of the first quarter’s economic activity rates in both the UK and the US suggested that economic activity had ground to a shuddering halt—in spite of the slide in oil prices. “Nowcasting,” which is the practice of feeding thousands of observations into models designed to tell us what’s going on in the economy in real time anticipated this development far ahead of those doing forecasting, who are now racing to catch up with the weaker start to the year. The second quarter “nowcasts” are pointing to a better second quarter, but not substantially better.
In this country, the output estimate of GDP was 0.3 per cent, a little less than half of what economists expected, and the slowest since the end of 2013, and before that, the two negative quarters of 2012. In April, the Purchasing Managers Index, a measure of industrial activity, dropped to 51.9 from 54 in March, suggesting a further slowdown.
It is certainly true that the first output estimate is based on sparse data, and tends to be revised upwards. It is also fair to argue that the election campaign could certainly be having a negative effect on business and consumer spending, given both its unpredictability and fanciful promises. And we still have exceptionally high levels of employment. Then again, there is no denying that business investment has failed to lift off, productivity growth is in a funk, and though wages and salaries are rising when adjusted for inflation, there’s no real bite in income formation or in the willingness of households to spend. We start the year with GDP estimated at 2.4 per cent higher. If quarterly rates of growth don’t match last year’s 0.8 per cent in the second quarter, and 0.6 per cent in the last two quarters of the year, it’s hard to see how we will get near to official targets.
In the US, GDP rose by just 0.2 per cent at an annualised rate. Even though there were some exceptional factors, such as the West Coast ports strike that disrupted supply chains, extreme winter weather, the rising US dollar and the sharp fall in oil sector capital spending, including oil drilling, related to the slump in oil prices. These factors could have lowered GDP by 0.8 per cent. Moreover, consumers went to ground, with consumer spending growing by less than 2 per cent per annum, and the savings rate bouncing back up to 5.5 per cent from 4.6 per cent. These factors should reverse or cancel out in the second quarter to some extent. Also although the US created only 591,000 jobs in the first quarter, compared to 973,000 in the final quarter of 2014, the country is close to full employment, technically speaking.
The final days of the election in pictures:
Looking ahead, the high level of inventories in the first quarter—about the same sort of level reached in early 2010 as the economy surged back after the slump the previous year—will probably reverse this spring. Moreover, as in the UK, there are weaknesses that remain rather worrying. Income formation—wages and salaries—is starting to get a bit of a lift but it’s too early to be sure that a turning point has arrived. Investment performance is better than in the UK and other advanced economies, but is still on a weak trajectory, especially now because of energy. Housing is moving along but at levels that remain historically depressed.
Warren Buffett said recently that any firm that employs an economist has one employee too many. Your scribe would be pleased to debate that, and the Treasury staff can’t just make stuff up. There’s no question, though, that the next Chancellor will need better information about why the economic recovery here in the UK and also in the US and Europe seems so fragile. Prospects in the UK’s major exports in Europe are brighter than they were but by no means good, and elsewhere, large emerging markets such as Brazil and Russia are in recession, while China is unquestionably continuing to slow down, under the shadow of over-investment, and over-indebtedness.
Growth will most likely come back in the second quarter in the UK, and because we don’t really have major problems of excess when it comes to credit, inventories or inflation, the chances are that the cycle will persist into 2016. But equally, there is little doubt this post-financial crisis recovery is going to remain tepid for a while, and that our trend growth rate—the rate we can potentially achieve and sustain – is a good deal lower than it was before 2008—whatever politicians may tell us.
The next Chancellor will need better information and forecasts and he will need to develop two sets of coping mechanisms quickly. One to deal with the longer-term challenge of boosting productivity growth, the other to address the deficit and debt consequences of weaker than expected growth.