Read the key highlights from our interview here
Jay Elwes: After the 2008 crisis, a debate sprung up about the need for Britain’s economy to rebalance, away from consumption and credit, and more towards manufacturing and exports. That rebalancing didn’t seem to happen.
John Cridland, Director of CBI: Well in the famous winter of 2008/9, I remember a business dinner table conversation and the question at that point was: “which was the blip—the crisis caused by Lehman Brothers’ collapse or the ten years that preceded it?” which Mervyn King described as the “nice decade”—non inflationary and continually expanding. Although the answer now is obvious—that decade was the blip not the crash—it wasn’t obvious in the heat of battle. It might have been that we would get back to that sort of growth, but it became apparent that it wasn’t going to return. And when you look at the decade from 1998 to 2008, UK growth, which looked positive when we were living through it, was almost entirely dependant on consumption. So there was an imbalance.
There was an imbalance between consumption and the other factors of growth, because business investment and trade were not key dynamos of growth in that decade. The problem of the consumption growth we had, with hindsight, is that too much of it was debtor, both households—we were maxing out our credit cards—and government spending through borrowing.
In that regard it’s vital that we do get to a rebalanced economy. We want a healthy consumption element. We want sensible public spending: infrastructure spending, capital spending by the government needs to be strong. We need consumption but we need to get back to earning an honest dime around the world with our exports, and we need business investment to be strong. So the question is how far have we got down that journey, and the honest answer is, we are still in the foothills.
Look at last year, when we had the beginnings of a return to growth—90 per cent of it still came from consumption, predominantly household consumption. It was great that we as consumers began to feel just that little more inclined to spend, but the savings ratio fell from something like 9 per cent to 5 per cent. And that can’t continue this year. If we only have that element of consumption, then growth will fall away. But the good news is, I think we are seeing a rebalancing. I think those who say it’s not happening are looking at the short term. It’s a long run game.
Take the two elements I have described: exports and business investment. Exports were not going to turn around quickly for two reasons. If you have 50 per cent of your exports going to Western Europe and you’ve got a Eurozone crisis, you need an awful lot of entrepreneurs getting on planes to Jakarta before you make a material difference to our overall trade performance. Yet in all of those key emerging economies, there has been a significant improvement in our export performance in recent years. Clearly each market is different, India has been delayed while people were waiting for the improved political climate after the elections. Brazil’s been tricky, but Mexico’s been strong. China’s still a strong market, notwithstanding a slow down by Chinese standards. And lots of these markets that lie behind the BRICs have been doing even better.
The other thing that has held back our aggregate export performance is what’s been happening to imports. The old model of making something in Britain, putting it on a ship or a plane, and taking it to a foreign market doesn’t quite work any longer. If you export more you are liable to import more because of integrated supply chains. If the consumer field is better, you import more. So in looking at our growth forecast, we see a genuine improvement in our export performance, but in net terms, trade still makes only a modest contribution to aggregate growth because imports are going up as well.
The other pillar – business investment - needs some explanation. A lot of commentators who were talking about rebalancing the economy expected investment to turn quicker. Quite frequently over the last year, the challenge to me from the journalistic community has been why isn’t business investing its huge cash piles. Business won’t invest if it doesn’t see demand and if it doesn’t have confidence. That turn has been in the last four to five months. I first saw it in when I had the privilege of being in Davos in January, where people were talking about capital investment in a way that they weren’t in 2013. They were talking about new capacity rather than existing capacity.
I think the evidence is that the business investment figures are turning quite significantly and we expect business investment to grow in the order of 8 per cent this year. It’s come because demand has picked up, and if demand has picked up after five sluggish years, you have to invest in some new capacity. But it was never going to be a leading indicator of this recovery, as this recovery was credit constrained because of what happened in the banks, because it was a financial crisis and because it was confidence lacking. This combination constrained business investment. We are seeing a slow rebalancing of the economy but I think we will get to a place where the consumption model is balanced better by an investment and trade model.
JE: Have you ever had reason to look askance at any of the ONS’s numbers, relating to business investment, or any of their other metrics?
JC: So, we have seen some quite fundamental changes in business models over the last decade, which have been exacerbated by the crisis, so the pace of change in business models has sped up. Take one example, look what is happening on the high street with the impact of the internet, and the move from physical retailing to a mixed model of physical and digital retailing. That was always going to happen as the impact of the internet spread, but at a time when there has been very little domestic consumer demand and physical retailers have had large amounts of incumbent property, that has been exacerbated: something that was going to happen had been sped up by the crisis, and the recovery from the crisis. That is one example, there are others.
The net result of that is that I have every sympathy with the ONS: they are measuring a rather different economy. They are not alone in having had challenges. The Bank of England had challenges with what would happen with inflation because the old model concerned domestic generated inflation, and we’ve had globally generated inflation. Business investment figures tried to capture a different form of business model. In 2008/9, businesses didn’t do in Britain what we’ve done in every other recession. We did not cut and slash, we did not get rid of large slabs of labour. Unemployment went up and that was very serious for the individuals concerned. Most economists expected unemployment to go through 3m—it stuck at 2.5m, because the skills were more valuable.
The net result was: it has been very hard for the Bank of England to make judgements on the size of the output gap, because of the productivity paradox. What’s happened to UK productivity? It was been difficult for policy makers as well as statisticians. How do we measure productivity in this new and rather different economy where there is much more value in intangibles than there ever has been before? We still think of productivity in terms of your and my output per hour: it’s quite an old fashioned model. So the productivity figures have been odd and the judgements we’ve had to make on them have been odd. The business investment figures I think have been influenced by the productivity question because there was more spare capacity held longer—there was actually a delay in investment. The ONS is trying to measure an economy that is in more flux than I can remember in a very long time.
JE: Are metrics such as productivity less significant than people assume? Does it need revision?
JC: It’s less numeric than it used to be. If you look at the elements of productivity, economists end up with the bit that they can’t measure and they call it total factor productivity and that’s the bit that is left over when they’ve done all the bits they can measure like, capital intensity, labour inputs. Total factor productivity is becoming more important.
I think in the CBI growth forecast you see a view that consumption will sustain but will change its nature. What I mean by that is that instead of people drawing down on their savings to reflect their increased confidence, they will begin to spend the benefits of productivity gains which will be manifested in earnings growth above inflation which is what I think we will see as 2014 progresses into 2015. But where does that productivity growth come from and why do we have some confidence that we will finally see it? I think it comes back to the business investment figure, so it has political resonance Can earnings exceed inflation?Is there anything government can do to nudge employers to pay higher wages?We saw the leader of the opposition’s recent intervention about targets for the minimum wage against median earnings.
These are all legitimate questions for politicians to ask, but the honest answer, in business terms, my answer, is that productivity comes from greater value added. People earn more if they add more value in their work place and the way they will add more value is if business invests in technology. Look at what technology did before the crash, for a prolonged period, to US productivity. Technology investment led to productivity growth by enhancing the skills of workers and applying those skills in a more productive environment through better work organisation. So greater business investment will, in my view, enhance productivity and should, therefore, enhance earnings.
P: I might ask you to sum up your feelings on the extent to which a rebalancing is possible. It seems to me from what you have described that there are efforts to invest more in business and there is a recognition that it is very important for Britain to sell to the world. But it seems that we will remain as a services based economy. The component of GDP that is down to services is around 80 per cent. Will those proportions remain fixed?
JC: The picture is a tad more complicated. Manufacturing exports are half of UK exports. In every advanced economy, services are predominant in volume and you would expect that. But Britain is still in the world top ten manufacturing exporters. Manufacturing is absolutely vital to business research and development and absolutely vital to exports and is an important multiplier. The distinction between the manufacturing sector, industrial sector and service sectors is becoming an almost false one. Quite a lot of service activity takes place in manufacturing companies. Manufacturing companies produce something but they then have value added on the servicing of those products. You see more and more profit and loss accounts where a lot of the income comes from the servicing of something that was sold as a manufactured good previously.
The CBI has spent a lot of time over the last few years encouraging all political parties to embrace a 21st century industrial strategy. We need to focus on what we are good at. We are good at many things, but we can’t be good at everything, we can’t spread the jam so thinly. So industrial strategy has focused our national effort, including our national export effort.
At the risk of oversimplification, if you look in the last decade, which country in the world was the exporter par excellence, I think many people would look at Germany. At a time when everybody else in the Western world’s proportion of global trade shrank, simply because relatively the move was to the growing economies of east Asia and other emerging parts of the world. Germany maintained their percentage of global trade. They were selling the capital goods that emerging economies needed at that stage in their evolution.
Looking forward I think Britain is in a great position to sell branded goods and services which the emerging middle classes of the emerging economies want to buy from trusted brands like Britain. It doesn’t surprise me if I walk into Shanghai airport, I see a Jaguar Land Rover and I see Burberry fashion and I’m walking through an airport that may well, as is the case with many Chinese airports, have had a British architect, and I might be listening to British music, and I might be watching a British film. There’s a whole range of things. They might want British financial services, or British life insurance. All of those, physical products, creative industries, financial and professional services, they are all versions of British branded goods and services. And I know—as I am often with the Prime Minister helping with the business delegation when we go abroad—that those things are selling better than they ever have before. If we focus in the UK on working on things we are good at, and focus our export effort around those products and services, I think we can make a material difference to rebalancing the economy.
JE: There is a flip side to the globalised markets that you describe, which is the consequence for employees and wages. Do you see a link between a globalised market for goods and services and the increasing sense that wage inequality in Britain has now become embedded?
JC: I think openness has been good for the British economy and therefore for British people and society. It has been predominantly good for us. Clearly it has consequences - I think the role of employers is to provide routes for progression. Open economies are ones where relatively unskilled and therefore, sadly, less productive young people can have access to a labour market, women returners who for reasons of family have had a break from the labour market and need to re-enter, or middle aged men who have come to the end of one career and need to find another, can progress.
The British economy has a very strong service sector element and a very strong element of relatively lower skilled and not highly paid jobs, which is why the minimum wage debate is important. But those jobs provide routes for progression. For example, you might start out in a fast food restaurant at the age of 16 when you’ve left school, with few qualifications, and three years later you are the manager of that restaurant. That is a contribution that business makes to tackling inequality. I think it is a unique contribution that business can make.
We have under-performance in our education system where too many young people are leaving school at 16, failed by the system, without the qualifications that they need for working life. It’s business that picks those people up. The test is: do those young people progress, do those women returners achieve the same value added that they were contributing to the economy before they had a family? There is even more that business needs to do, I am a strong advocate because I see it in the CBI member companies that I visit. That is an area where business is adding huge value to tackling inequality.
JE: Turning to infrastructure—there are projects at the ready and finance available, but there is a lack of political will, and it is this last that preventing Britain from closing its infrastructure gap. What do you make of the political environment surrounding infrastructure building?
JC: All the research demonstrates that the two levers that a government has in an advanced economy to influence the growth of that economy are education and infrastructure. They can make a material difference to the growth rate of the economy in the longer term. It is regrettable that in times of austerity, all governments cut capital as well as current spending. I think this government had recognised that it needs to invest more in public sector capital and is now doing that.
It is never going to invest enough—we can’t rely entirely on the taxpayer. I think the new model has to be a national public-private partnership, a national PPP. We need the ability to leverage private sector capital for the public interest. There’s a really good model there – because pensions funds, insurance companies, lots of city funds are looking for quality opportunities that have a regular return. That fits in pretty well with infrastructure. And the challenge is, given that bank balance sheets are constrained, to balance up the role of banks and bank capital which will always be the right way to fund the very risky construction phase of infrastructure which no pension fund can touch.
We felt that government could make a difference through infrastructure guarantees because if you are dealing with pensioners' pensions pots, you want some confidence in that infrastructure project. You're really looking for a triple A rating. The UK government might not have much money in Old Mother Hubbard's cupboard, but it still has the sovereign rating which can help the credit rating of the project if government provides an underwriting rather than a cash investment.
We've been working with government, with Infrastructure UK, and with Paul Deighton, the Infrastructure Minister, to find innovative ways of leveraging private sector capital for the public good to get more infrastructure built at a time of constrained public finances.
JE: So why have so few infrastructure projects got off the ground do you think?
JC: I think the first thing is, government, with the benefit of hindsight, cut public sector capital too far. One particular scheme I have made the arrowhead of the CBI's work has been improvements to the A14. A third of Britain's container traffic comes into Felixstowe and you have a road that goes up to the M1 that's non-motorway standard, and in areas like Cambridge where it hits a very concentrated urban patch, it gets very congested at peak times. We need to do something about that.
In 2010, that scheme to widen the A14 was cancelled at the time of the austerity cuts. The problem was that there was no money, so I suggested tolling it. But tolling lead to a further delay because it is controversial, and requires much public consultation and a new funding model to make sure it is a viable project. Eventually when government decided it would spend a bit more on public sector capital because it could, they are going ahead with the A14 and I think the intention is that diggers will be on the ground by the end of next year, but they've dropped the tolling. That doesn’t matter, I just want the road built.
So that is a microcosm of what the problem has been. The intentions are there, government ministers are absolutely committed to doing something about the national infrastructure, as are opposition spokesmen. So the government has Paul Deighton of Olympic fame helping them and the opposition's got John Armitt, also of Olympic fame. We're all looking at bottling what went well with the Olympics and applying it outside of sport. But it is hard: there's the planning system, there are these new funding models, there's this form of public private partnership and it's been sluggish and business has been critical of slow delivery.
You then have special cases—one area of infrastructure that we absolutely need to get right is energy. But in energy there is the further complexity of policy certainty or policy uncertainty. And that's held up investment. And then the policy uncertainty of politicians having views of competitive markets in the retail energy sector which could well have an impact on wholesale investment and wholesale funding. And then you've got aviation, which is unique in that there is still genuinely a policy difference. So most of my other examples were all moving in the same direction: it's hard and slow. In the example of aviation we haven't yet got the policy decision, we are waiting on the [Sir Howard] Davies commission. What it all adds up to is an honourable effort, less good on delivery.
JE: It was interesting to watch the Astra / Pfizer take-over, where an enormous amount of political pressure and attention was brought to bear on a deal which then collapsed. The Opposition has made it clear that they would take a very rigorous line with the energy companies, if they were to win the next election. They've been very critical of the banks, and have put forward suggestions for how banks should be constrained in future. Is it your sense that political risk for businesses and investment in Britain is increasing?
JC: I think we are at a moment of pivot. After several sluggish years in the economy, the economy is now picking up. There is less commercial risk, on corporate risk register, relatively. But there's more political risk and we have a sort of unique cocktail of issues between the European parliament elections, the general election and a potential European referendum. There's a period of relative political uncertainty. Business lives with that, it always lives with an element of political uncertainty.
What I'm saying is, there's probably that much more in that cocktail of issues. What's really important to the CBI is that all of us, businesses and politicians and all political parties, focus on the long term, focus on sustaining and improving the competitive position of an economy and concentrate on the levers that government and politicians can use to help that. As I've already said, infrastructure is one of them, and therefore we should not allow short term political needs to derail long term investment decisions.
P: Can I ask you about the interest rate question? The minutes of the last MPC meeting seemed to suggest that the bank was becoming somewhat more hawkish on rates. The city consensus is saying that there was likely to be an interest rate rise. If there were to be a rise—25 basis points or something of that order—would that have any wider consequences, or is it priced in already?
JC: In the CBI's most recent economic forecast, we brought forward our expectation on an interest rate rise, from third quarter of 2015 into the first quarter, of 25 basis points. I think that is now pretty much built in, I think an earlier rise in interest ratescould slow down a still nascent economic recovery. This is building modestly. It's not the time in my judgment to increase interest rates, nor would it be helpful to do so. Nor is it the right response in areas of pressure in that recovery such as the housing market. There are other more relevant tools and actually interest rate rises, driven by housing judgement, would have wider economic impact on smaller entrepreneurs. I think a quarter per cent rise by 2015 is likely and is built in.
P: Do you see Eurozone deflation as threat?
JC:Obviously, in our economic forecasting, we look at the downside risks, and the Eurozone has been pretty prominent on our downside risks these last two years. If we look at it today, we're in a better position, the short term crisis has been dealt with. Some Eurozone economies are making progress on improving their competitive position; others have more to do. But the position is less concerning than a year or two ago. There are downside risks and you are right, in our judgement, the principle downside risk now is the risk of deflation. It's there but it's not necessarily a likely outcome.
JE: At the recent elections, the European electorate sent a large number of anti-EU politicians to the European Parliament with the express intention of taking it to pieces. Might political obstructionism at the heart of the European political project increase the economic risk posed by the Eurozone.
JC: I think the challenge for business is how it gets heard in areas of European legislation where the predominant responsibility lies with the European Parliament. But these are not the issues of big politics. We're talking about product standards, emission levels, things that require very technical decisions, and there is a very important dialogue between companies in a whole range of sectors and MEPs. That requires an effective set of relationships. Those are the issues that ultimately determine how successful those European companies are.
It was interesting when the CBI consulted its smaller businesses about their views on Europe. I thought they would say, “we need the single market because we need to be able to sell into the single market”. And they did. But they also said, “we need the European Union to set global product standards, because we as a small business can't”. If Europe, as the biggest economic block in the world, has got those standards set in a way that we can sell to, it is a huge benefit for British small businesses, or, say, Spanish small businesses, selling in Latin America or East Asia. But that work is done in the European parliament. So the European parliament is an important part of getting evidence-based policy making with regulatory standards that are not burdensome but are sensibly set according to science and technology.
JE: And finally—is there a housing bubble in Britain?
JC: There are risks in the housing market, but we need to understand where those risks come from. Clearly there is a much more significant issue in London than there is in the north of the country. And there are special factors in London, namely international money, which is not entirely covered by the availability of mortgages to the indigenous population. I still believe that Help to Buy has been predominantly a force for good because a little over a year ago the housing market was stuck. The CBI quite forensically worked with government to see why it was stuck, and it was stuck because first time buyers couldn't build up deposits and that's what Help to Buy has done. Predominantly, Help to Buy has helped first time buyers with lower level, not higher level, mortgages in the north of England, not in London. It has been a relatively small improvement of the housing problem as a whole.
I think the issue is, how can we deal with potential for overheating? There are ways to deal with that in the availability of mortgages and the rules around mortgages. We've seen action by one or two borrowers already this week. We support the view that the Bank of England and the financial policy committee are being vigilant, should be vigilant, and should take appropriate action. But an awful lot of the media debate has been about this demand side issue.
Actually, we need to focus attention on the supply side issue. Because the problem arises if we don't as a country build enough houses. We want to get back to a more normative market, where people who are establishing a new family can buy a house or a flat, or rent a flat or get social housing. The constraint is supply.
So, I would like to focus a bit more on supply and get back to a situation where local authorities, central governmentand housing associations are able to do more to meet the supply side gap. There are a whole range of things there from the planning system through to the potential for garden cities through to the role of stamp duty to the release of more public sector land, to the effectiveness of the private rental market.
Jay Elwes: After the 2008 crisis, a debate sprung up about the need for Britain’s economy to rebalance, away from consumption and credit, and more towards manufacturing and exports. That rebalancing didn’t seem to happen.
John Cridland, Director of CBI: Well in the famous winter of 2008/9, I remember a business dinner table conversation and the question at that point was: “which was the blip—the crisis caused by Lehman Brothers’ collapse or the ten years that preceded it?” which Mervyn King described as the “nice decade”—non inflationary and continually expanding. Although the answer now is obvious—that decade was the blip not the crash—it wasn’t obvious in the heat of battle. It might have been that we would get back to that sort of growth, but it became apparent that it wasn’t going to return. And when you look at the decade from 1998 to 2008, UK growth, which looked positive when we were living through it, was almost entirely dependant on consumption. So there was an imbalance.
There was an imbalance between consumption and the other factors of growth, because business investment and trade were not key dynamos of growth in that decade. The problem of the consumption growth we had, with hindsight, is that too much of it was debtor, both households—we were maxing out our credit cards—and government spending through borrowing.
In that regard it’s vital that we do get to a rebalanced economy. We want a healthy consumption element. We want sensible public spending: infrastructure spending, capital spending by the government needs to be strong. We need consumption but we need to get back to earning an honest dime around the world with our exports, and we need business investment to be strong. So the question is how far have we got down that journey, and the honest answer is, we are still in the foothills.
Look at last year, when we had the beginnings of a return to growth—90 per cent of it still came from consumption, predominantly household consumption. It was great that we as consumers began to feel just that little more inclined to spend, but the savings ratio fell from something like 9 per cent to 5 per cent. And that can’t continue this year. If we only have that element of consumption, then growth will fall away. But the good news is, I think we are seeing a rebalancing. I think those who say it’s not happening are looking at the short term. It’s a long run game.
Take the two elements I have described: exports and business investment. Exports were not going to turn around quickly for two reasons. If you have 50 per cent of your exports going to Western Europe and you’ve got a Eurozone crisis, you need an awful lot of entrepreneurs getting on planes to Jakarta before you make a material difference to our overall trade performance. Yet in all of those key emerging economies, there has been a significant improvement in our export performance in recent years. Clearly each market is different, India has been delayed while people were waiting for the improved political climate after the elections. Brazil’s been tricky, but Mexico’s been strong. China’s still a strong market, notwithstanding a slow down by Chinese standards. And lots of these markets that lie behind the BRICs have been doing even better.
The other thing that has held back our aggregate export performance is what’s been happening to imports. The old model of making something in Britain, putting it on a ship or a plane, and taking it to a foreign market doesn’t quite work any longer. If you export more you are liable to import more because of integrated supply chains. If the consumer field is better, you import more. So in looking at our growth forecast, we see a genuine improvement in our export performance, but in net terms, trade still makes only a modest contribution to aggregate growth because imports are going up as well.
The other pillar – business investment - needs some explanation. A lot of commentators who were talking about rebalancing the economy expected investment to turn quicker. Quite frequently over the last year, the challenge to me from the journalistic community has been why isn’t business investing its huge cash piles. Business won’t invest if it doesn’t see demand and if it doesn’t have confidence. That turn has been in the last four to five months. I first saw it in when I had the privilege of being in Davos in January, where people were talking about capital investment in a way that they weren’t in 2013. They were talking about new capacity rather than existing capacity.
I think the evidence is that the business investment figures are turning quite significantly and we expect business investment to grow in the order of 8 per cent this year. It’s come because demand has picked up, and if demand has picked up after five sluggish years, you have to invest in some new capacity. But it was never going to be a leading indicator of this recovery, as this recovery was credit constrained because of what happened in the banks, because it was a financial crisis and because it was confidence lacking. This combination constrained business investment. We are seeing a slow rebalancing of the economy but I think we will get to a place where the consumption model is balanced better by an investment and trade model.
JE: Have you ever had reason to look askance at any of the ONS’s numbers, relating to business investment, or any of their other metrics?
JC: So, we have seen some quite fundamental changes in business models over the last decade, which have been exacerbated by the crisis, so the pace of change in business models has sped up. Take one example, look what is happening on the high street with the impact of the internet, and the move from physical retailing to a mixed model of physical and digital retailing. That was always going to happen as the impact of the internet spread, but at a time when there has been very little domestic consumer demand and physical retailers have had large amounts of incumbent property, that has been exacerbated: something that was going to happen had been sped up by the crisis, and the recovery from the crisis. That is one example, there are others.
The net result of that is that I have every sympathy with the ONS: they are measuring a rather different economy. They are not alone in having had challenges. The Bank of England had challenges with what would happen with inflation because the old model concerned domestic generated inflation, and we’ve had globally generated inflation. Business investment figures tried to capture a different form of business model. In 2008/9, businesses didn’t do in Britain what we’ve done in every other recession. We did not cut and slash, we did not get rid of large slabs of labour. Unemployment went up and that was very serious for the individuals concerned. Most economists expected unemployment to go through 3m—it stuck at 2.5m, because the skills were more valuable.
The net result was: it has been very hard for the Bank of England to make judgements on the size of the output gap, because of the productivity paradox. What’s happened to UK productivity? It was been difficult for policy makers as well as statisticians. How do we measure productivity in this new and rather different economy where there is much more value in intangibles than there ever has been before? We still think of productivity in terms of your and my output per hour: it’s quite an old fashioned model. So the productivity figures have been odd and the judgements we’ve had to make on them have been odd. The business investment figures I think have been influenced by the productivity question because there was more spare capacity held longer—there was actually a delay in investment. The ONS is trying to measure an economy that is in more flux than I can remember in a very long time.
JE: Are metrics such as productivity less significant than people assume? Does it need revision?
JC: It’s less numeric than it used to be. If you look at the elements of productivity, economists end up with the bit that they can’t measure and they call it total factor productivity and that’s the bit that is left over when they’ve done all the bits they can measure like, capital intensity, labour inputs. Total factor productivity is becoming more important.
I think in the CBI growth forecast you see a view that consumption will sustain but will change its nature. What I mean by that is that instead of people drawing down on their savings to reflect their increased confidence, they will begin to spend the benefits of productivity gains which will be manifested in earnings growth above inflation which is what I think we will see as 2014 progresses into 2015. But where does that productivity growth come from and why do we have some confidence that we will finally see it? I think it comes back to the business investment figure, so it has political resonance Can earnings exceed inflation?Is there anything government can do to nudge employers to pay higher wages?We saw the leader of the opposition’s recent intervention about targets for the minimum wage against median earnings.
These are all legitimate questions for politicians to ask, but the honest answer, in business terms, my answer, is that productivity comes from greater value added. People earn more if they add more value in their work place and the way they will add more value is if business invests in technology. Look at what technology did before the crash, for a prolonged period, to US productivity. Technology investment led to productivity growth by enhancing the skills of workers and applying those skills in a more productive environment through better work organisation. So greater business investment will, in my view, enhance productivity and should, therefore, enhance earnings.
P: I might ask you to sum up your feelings on the extent to which a rebalancing is possible. It seems to me from what you have described that there are efforts to invest more in business and there is a recognition that it is very important for Britain to sell to the world. But it seems that we will remain as a services based economy. The component of GDP that is down to services is around 80 per cent. Will those proportions remain fixed?
JC: The picture is a tad more complicated. Manufacturing exports are half of UK exports. In every advanced economy, services are predominant in volume and you would expect that. But Britain is still in the world top ten manufacturing exporters. Manufacturing is absolutely vital to business research and development and absolutely vital to exports and is an important multiplier. The distinction between the manufacturing sector, industrial sector and service sectors is becoming an almost false one. Quite a lot of service activity takes place in manufacturing companies. Manufacturing companies produce something but they then have value added on the servicing of those products. You see more and more profit and loss accounts where a lot of the income comes from the servicing of something that was sold as a manufactured good previously.
The CBI has spent a lot of time over the last few years encouraging all political parties to embrace a 21st century industrial strategy. We need to focus on what we are good at. We are good at many things, but we can’t be good at everything, we can’t spread the jam so thinly. So industrial strategy has focused our national effort, including our national export effort.
At the risk of oversimplification, if you look in the last decade, which country in the world was the exporter par excellence, I think many people would look at Germany. At a time when everybody else in the Western world’s proportion of global trade shrank, simply because relatively the move was to the growing economies of east Asia and other emerging parts of the world. Germany maintained their percentage of global trade. They were selling the capital goods that emerging economies needed at that stage in their evolution.
Looking forward I think Britain is in a great position to sell branded goods and services which the emerging middle classes of the emerging economies want to buy from trusted brands like Britain. It doesn’t surprise me if I walk into Shanghai airport, I see a Jaguar Land Rover and I see Burberry fashion and I’m walking through an airport that may well, as is the case with many Chinese airports, have had a British architect, and I might be listening to British music, and I might be watching a British film. There’s a whole range of things. They might want British financial services, or British life insurance. All of those, physical products, creative industries, financial and professional services, they are all versions of British branded goods and services. And I know—as I am often with the Prime Minister helping with the business delegation when we go abroad—that those things are selling better than they ever have before. If we focus in the UK on working on things we are good at, and focus our export effort around those products and services, I think we can make a material difference to rebalancing the economy.
JE: There is a flip side to the globalised markets that you describe, which is the consequence for employees and wages. Do you see a link between a globalised market for goods and services and the increasing sense that wage inequality in Britain has now become embedded?
JC: I think openness has been good for the British economy and therefore for British people and society. It has been predominantly good for us. Clearly it has consequences - I think the role of employers is to provide routes for progression. Open economies are ones where relatively unskilled and therefore, sadly, less productive young people can have access to a labour market, women returners who for reasons of family have had a break from the labour market and need to re-enter, or middle aged men who have come to the end of one career and need to find another, can progress.
The British economy has a very strong service sector element and a very strong element of relatively lower skilled and not highly paid jobs, which is why the minimum wage debate is important. But those jobs provide routes for progression. For example, you might start out in a fast food restaurant at the age of 16 when you’ve left school, with few qualifications, and three years later you are the manager of that restaurant. That is a contribution that business makes to tackling inequality. I think it is a unique contribution that business can make.
We have under-performance in our education system where too many young people are leaving school at 16, failed by the system, without the qualifications that they need for working life. It’s business that picks those people up. The test is: do those young people progress, do those women returners achieve the same value added that they were contributing to the economy before they had a family? There is even more that business needs to do, I am a strong advocate because I see it in the CBI member companies that I visit. That is an area where business is adding huge value to tackling inequality.
JE: Turning to infrastructure—there are projects at the ready and finance available, but there is a lack of political will, and it is this last that preventing Britain from closing its infrastructure gap. What do you make of the political environment surrounding infrastructure building?
JC: All the research demonstrates that the two levers that a government has in an advanced economy to influence the growth of that economy are education and infrastructure. They can make a material difference to the growth rate of the economy in the longer term. It is regrettable that in times of austerity, all governments cut capital as well as current spending. I think this government had recognised that it needs to invest more in public sector capital and is now doing that.
It is never going to invest enough—we can’t rely entirely on the taxpayer. I think the new model has to be a national public-private partnership, a national PPP. We need the ability to leverage private sector capital for the public interest. There’s a really good model there – because pensions funds, insurance companies, lots of city funds are looking for quality opportunities that have a regular return. That fits in pretty well with infrastructure. And the challenge is, given that bank balance sheets are constrained, to balance up the role of banks and bank capital which will always be the right way to fund the very risky construction phase of infrastructure which no pension fund can touch.
We felt that government could make a difference through infrastructure guarantees because if you are dealing with pensioners' pensions pots, you want some confidence in that infrastructure project. You're really looking for a triple A rating. The UK government might not have much money in Old Mother Hubbard's cupboard, but it still has the sovereign rating which can help the credit rating of the project if government provides an underwriting rather than a cash investment.
We've been working with government, with Infrastructure UK, and with Paul Deighton, the Infrastructure Minister, to find innovative ways of leveraging private sector capital for the public good to get more infrastructure built at a time of constrained public finances.
JE: So why have so few infrastructure projects got off the ground do you think?
JC: I think the first thing is, government, with the benefit of hindsight, cut public sector capital too far. One particular scheme I have made the arrowhead of the CBI's work has been improvements to the A14. A third of Britain's container traffic comes into Felixstowe and you have a road that goes up to the M1 that's non-motorway standard, and in areas like Cambridge where it hits a very concentrated urban patch, it gets very congested at peak times. We need to do something about that.
In 2010, that scheme to widen the A14 was cancelled at the time of the austerity cuts. The problem was that there was no money, so I suggested tolling it. But tolling lead to a further delay because it is controversial, and requires much public consultation and a new funding model to make sure it is a viable project. Eventually when government decided it would spend a bit more on public sector capital because it could, they are going ahead with the A14 and I think the intention is that diggers will be on the ground by the end of next year, but they've dropped the tolling. That doesn’t matter, I just want the road built.
So that is a microcosm of what the problem has been. The intentions are there, government ministers are absolutely committed to doing something about the national infrastructure, as are opposition spokesmen. So the government has Paul Deighton of Olympic fame helping them and the opposition's got John Armitt, also of Olympic fame. We're all looking at bottling what went well with the Olympics and applying it outside of sport. But it is hard: there's the planning system, there are these new funding models, there's this form of public private partnership and it's been sluggish and business has been critical of slow delivery.
You then have special cases—one area of infrastructure that we absolutely need to get right is energy. But in energy there is the further complexity of policy certainty or policy uncertainty. And that's held up investment. And then the policy uncertainty of politicians having views of competitive markets in the retail energy sector which could well have an impact on wholesale investment and wholesale funding. And then you've got aviation, which is unique in that there is still genuinely a policy difference. So most of my other examples were all moving in the same direction: it's hard and slow. In the example of aviation we haven't yet got the policy decision, we are waiting on the [Sir Howard] Davies commission. What it all adds up to is an honourable effort, less good on delivery.
JE: It was interesting to watch the Astra / Pfizer take-over, where an enormous amount of political pressure and attention was brought to bear on a deal which then collapsed. The Opposition has made it clear that they would take a very rigorous line with the energy companies, if they were to win the next election. They've been very critical of the banks, and have put forward suggestions for how banks should be constrained in future. Is it your sense that political risk for businesses and investment in Britain is increasing?
JC: I think we are at a moment of pivot. After several sluggish years in the economy, the economy is now picking up. There is less commercial risk, on corporate risk register, relatively. But there's more political risk and we have a sort of unique cocktail of issues between the European parliament elections, the general election and a potential European referendum. There's a period of relative political uncertainty. Business lives with that, it always lives with an element of political uncertainty.
What I'm saying is, there's probably that much more in that cocktail of issues. What's really important to the CBI is that all of us, businesses and politicians and all political parties, focus on the long term, focus on sustaining and improving the competitive position of an economy and concentrate on the levers that government and politicians can use to help that. As I've already said, infrastructure is one of them, and therefore we should not allow short term political needs to derail long term investment decisions.
P: Can I ask you about the interest rate question? The minutes of the last MPC meeting seemed to suggest that the bank was becoming somewhat more hawkish on rates. The city consensus is saying that there was likely to be an interest rate rise. If there were to be a rise—25 basis points or something of that order—would that have any wider consequences, or is it priced in already?
JC: In the CBI's most recent economic forecast, we brought forward our expectation on an interest rate rise, from third quarter of 2015 into the first quarter, of 25 basis points. I think that is now pretty much built in, I think an earlier rise in interest ratescould slow down a still nascent economic recovery. This is building modestly. It's not the time in my judgment to increase interest rates, nor would it be helpful to do so. Nor is it the right response in areas of pressure in that recovery such as the housing market. There are other more relevant tools and actually interest rate rises, driven by housing judgement, would have wider economic impact on smaller entrepreneurs. I think a quarter per cent rise by 2015 is likely and is built in.
P: Do you see Eurozone deflation as threat?
JC:Obviously, in our economic forecasting, we look at the downside risks, and the Eurozone has been pretty prominent on our downside risks these last two years. If we look at it today, we're in a better position, the short term crisis has been dealt with. Some Eurozone economies are making progress on improving their competitive position; others have more to do. But the position is less concerning than a year or two ago. There are downside risks and you are right, in our judgement, the principle downside risk now is the risk of deflation. It's there but it's not necessarily a likely outcome.
JE: At the recent elections, the European electorate sent a large number of anti-EU politicians to the European Parliament with the express intention of taking it to pieces. Might political obstructionism at the heart of the European political project increase the economic risk posed by the Eurozone.
JC: I think the challenge for business is how it gets heard in areas of European legislation where the predominant responsibility lies with the European Parliament. But these are not the issues of big politics. We're talking about product standards, emission levels, things that require very technical decisions, and there is a very important dialogue between companies in a whole range of sectors and MEPs. That requires an effective set of relationships. Those are the issues that ultimately determine how successful those European companies are.
It was interesting when the CBI consulted its smaller businesses about their views on Europe. I thought they would say, “we need the single market because we need to be able to sell into the single market”. And they did. But they also said, “we need the European Union to set global product standards, because we as a small business can't”. If Europe, as the biggest economic block in the world, has got those standards set in a way that we can sell to, it is a huge benefit for British small businesses, or, say, Spanish small businesses, selling in Latin America or East Asia. But that work is done in the European parliament. So the European parliament is an important part of getting evidence-based policy making with regulatory standards that are not burdensome but are sensibly set according to science and technology.
JE: And finally—is there a housing bubble in Britain?
JC: There are risks in the housing market, but we need to understand where those risks come from. Clearly there is a much more significant issue in London than there is in the north of the country. And there are special factors in London, namely international money, which is not entirely covered by the availability of mortgages to the indigenous population. I still believe that Help to Buy has been predominantly a force for good because a little over a year ago the housing market was stuck. The CBI quite forensically worked with government to see why it was stuck, and it was stuck because first time buyers couldn't build up deposits and that's what Help to Buy has done. Predominantly, Help to Buy has helped first time buyers with lower level, not higher level, mortgages in the north of England, not in London. It has been a relatively small improvement of the housing problem as a whole.
I think the issue is, how can we deal with potential for overheating? There are ways to deal with that in the availability of mortgages and the rules around mortgages. We've seen action by one or two borrowers already this week. We support the view that the Bank of England and the financial policy committee are being vigilant, should be vigilant, and should take appropriate action. But an awful lot of the media debate has been about this demand side issue.
Actually, we need to focus attention on the supply side issue. Because the problem arises if we don't as a country build enough houses. We want to get back to a more normative market, where people who are establishing a new family can buy a house or a flat, or rent a flat or get social housing. The constraint is supply.
So, I would like to focus a bit more on supply and get back to a situation where local authorities, central governmentand housing associations are able to do more to meet the supply side gap. There are a whole range of things there from the planning system through to the potential for garden cities through to the role of stamp duty to the release of more public sector land, to the effectiveness of the private rental market.
