The UK economy: Good news…bad news

14 mins. to read
The UK economy: Good news…bad news

“Despite Brexit” (as the BBC says) the UK economy is growing faster than many of our European neighbours and unemployment is still falling. Public finances are improving. The automotive sector is a worry. But always look on the bright side, says Victor Hill.

Outstanding employment numbers

There has been a slew of upbeat economic numbers recently in the UK. “Despite Brexit”! On 19 February the ONS announced that employment hit a record high in December with more British and foreign workers in work than ever before. There were 32.7 million people in the UK workforce (employed and self-employed) at the end of last year – a rise of 444,000 on the year (that’s 1,200 per day). Of these, 3.6 million were non-UK nationals (2.3 million from EU countries and 1.3 million from elsewhere).

Master Investor Magazine

Never miss an issue of Master Investor Magazine – sign-up now for free!

Read the latest Master Investor Magazine

The number of EU workers in the UK climbed by 42,000 in Q4 2018 – exposing the claims of a Brexodus in the mainstream media as a falsehood. True, the number of EU workers overall was down by 61,000 on the year, but that is a natural transition as, for example, Polish citizens who have contributed to the UK economy for a decade-and-a-half return to their much more prosperous mother country – the standard of living of which has risen unrecognisably since first they began to leave, and which now enjoys high employment.

UK unemployment is at a steady 4 percent – the lowest level since 1975 (before the inflationary crisis that engulfed the then Labour government and its Thatcherite aftermath). The demand for labour in an economy with nearly full employment is pushing wages higher. Average pay in Q4 2018 was up 3.4 percent on the previous year – well above inflation. That is the strongest rhythm of rising wages since the financial crisis.

Right now in the UK the problem is not a lack of jobs, but a dearth of workers. And, as the leader in last week’s Spectator pointed out, the unemployment rate for women is the lowest since statistics began. For all the endless debating about the gender pay gap (especially among highly paid presenters at the BBC) less has been made of the transformation in employment opportunities for women right across the job market and at all pay scales.

Public finances improve

Tax revenues received by HMRC were up by an extraordinary 9.7 percent in January, creating a record surplus in a month when the government usually collects more money than it spends. (January and July are the months when Britain’s army of 5 million or so self-employed people have to cough up their taxes – plus when City types get their bonuses.) Public borrowing was running at 46 percent lower than in January last year.

Stamp Duty revenues were down for the year in January. Excessively high rates are helping to paralyse the UK residential property market. As someone currently in the process of buying a bolthole in the English countryside for my dotage, I bitterly resent this unjust tax. The government should cut the excessive rates of stamp duty on second homes to help the market: it would then harvest more cash from this source.

On the plus side, the exemption for first-time buyers from stamp duty has helped to push the number of people gaining the first rung of the property ladder to the highest level since 2006. Last year 370,000 mortgages were advanced to first-timers according to UK Finance. In fact, there were more first-time buyer transactions than existing home owners moving house last year for the first time since 1995. Property taxes overall, especially business rates, are particularly damaging at a time when the digital shopping revolution is devastating the traditional high street.

January’s record surplus, thanks to a surge in income tax payments, will cut Chancellor of the Exchequer Philip Hammond some slack when he delivers his final pre-Brexit Spring Statement which (as I write) is still scheduled for Wednesday, 13 March. (That is also the date when MPs will supposedly vote whether to take no-deal off the table. We should then know if Brexit is to be postponed or if no-deal is still the most likely outcome.) Reportedly, there is currently disagreement between Mr Hammond and DEFRA Secretary Michael Gove over what level of tariffs should be imposed on food imports in the event of no-deal. Either way I’ll provide an analysis of the Spring Statement immediately after it takes place.

Britain ran a budget surplus of £14.9 billion in January – a figure well beyond most economists’ forecasts. This was a £5.6 billion increase on the previous January and the highest since records began in 1993. The government’s budget (fiscal) deficit is likely to fall to its lowest level since 2001-02 at just over 1 percent of GDP this financial year. That’s down from nearly 10 percent just after the global banking crisis in 2008-09. Public sector borrowing from April 2018 through to January was £21.2 billion – £18.5 billion less than in the previous year.

Master Investor Magazine

Never miss an issue of Master Investor Magazine – sign-up now for free!

Read the latest Master Investor Magazine

All this still leaves the Chancellor with headroom of at least £15 billion under his fiscal rules. If a Brexit deal were to be secured, the size of that headroom would probably increase as renewed investment stimulates growth. If there is a no-deal outcome then the Chancellor could, in Project After, seek to boost the economy by cutting VAT (a measure that would be partially financed by levying import tariffs on French truffles and Belgian chocolates) and possibly corporation tax too.

For all the good news, the total size of the national debt is still increasing as new borrowing exceeds repayments. According to the National Debt Clock total government debt now stands at £2.150 trillion. (A trillion is a thousand billion.) But so long as the economy grows faster than the national debt so the all-important debt-to-GDP ratio declines. Government debt as a percentage of GDP now stands at just 62 percent if you deduct the Bank of England’s liabilities (which largely arise out of the monetary hocus pocus of QE).

Britain is still uncomfortably exposed to a global downturn with total debt-to-GDP on a conventional basis north of 80 percent. The consolation is that we are less exposed than certain competitor nations in Europe such as France, where the debt-to-GDP ratio is touching the psychologically important 100 percent level.

The UK automotive sector: creeping despair

Despite disappointing news from Nissan – which will not build its X-Trail model in Sunderland – and Honda (which will close its Swindon plant in 2021-22, making 3,500 front-line workers redundant) the news for the UK automotive sector is not all bad. Sales of Nissan’s electric car, the Leaf, built in Sunderland, are doing well. There is talk that Nissan may yet decide to produce an electric version of its premium Infiniti brand there. The announcement by Sir James Dyson that the group’s new electric vehicle will be built in Singapore (and not Swindon) was also a blow; but it arises from the fact that Dyson foresees that the principal market for its products resides in East Asia. Dyson has not ruled out producing electric vehicles in the UK at a later date.

On 25 February, speaking as Peugeot SA (ETR:PSA) revealed its latest strategic plans, CEO Carlos Tavares referred to “extremely chaotic” times for the automotive sector globally. But he indicated that PSA’s UK subsidiary, Vauxhall, will continue to build its Astra model in Ellesmere Port for the foreseeable future.

Moreover, in January Toyota began production of its new Corolla hatchback and estate range at the firm’s UK manufacturing facility near Burnaston, Derbyshire. The production of the Corolla, which is amongst the best-selling car models in the world and for which it already has advance orders, will see European specification models roll off the production line in March. Toyota previously announced that the Corolla (which competes with the Ford Focus) will go on sale in March with a price tag starting at £21,300.

The British automotive sector has been a huge success story in recent decades. It employs nearly one million people and produced 1.7 million cars last year of which 60 percent were exported. However, the news flow over the last six months has been dire.

Persistent bad numbers from Jaguar Land Rover (JLR, owned by Tata Motors (BOM: 500570) of India – the shares of which are down by about 60 percent over 12 months) reflect two major strategic errors under the leadership of CEO Ralf Speth. The first was to continue to orient Land Rover almost entirely to diesel engines (which are now considered environmentally pernicious); the second was to orient Jaguar to saloon cars (sales of which are in terminal decline). Jaguars used to turn heads with their distinctive styling; these days I can see little difference in styling between a Jaguar and a Ford Orion or a Vauxhall Astra.

Master Investor Magazine

Never miss an issue of Master Investor Magazine – sign-up now for free!

Read the latest Master Investor Magazine

It remains to be seen whether the sector has really risen to the challenge of electrification, which is now clearly the future. The UK currently accounts for a very small percentage of global electric vehicle production. While it is true that there is now a worrying trend for Japanese manufacturers to repatriate production to Japan (Honda is closing plants in the UK and Turkey) that could be more than offset by Chinese investment which is holding up well despite Brexit.

That is something which will have to be addressed whatever the next instalment in the Brexit saga. Basically, for automotive manufacturers everywhere, the choice is simple: electrify or die.

Patterns of trade: We have been heading OUT since well before June 2016

Amidst the furore around Brexit the mainstream media has lost sight of the fact that the percentage of total exports sold into the EU has been in remorseless decline for some time. One reason for this is that the economies of Asia and much of the developing world have been growing so much faster than those within the EU since the advent of the single currency 20 years ago. Moreover, our exports are increasingly digital and service-oriented – meaning that geographical proximity counts less than cultural affinity. A popular song written by a UK artist and streamed to Australia is an export too.

In 2018 Britain’s total exports of goods to the EU were up by 4.3 percent on the year amounting to £170 billion. But sales to the rest of the world were up by an even more impressive 7.3 percent to 192 billion. So out of total exports of £392 billion, 47 percent were to the EU – down from 48 percent in 2017. When the UK joined the EU in 1973 the figure was nearer to 70 percent.

In terms of services, in 2017, the last year for which figures are fully available, our exports to the EU amounted to £80 billion out of a total figure of £162 billion – so 49 percent. But even in services the trend was downwards – it was 50.5 percent in 2013.

The fact is that non-EU markets are getting more important to the UK as they grow. Exports to China have grown by 25 percent over the last five years. On present trends China will overtake France as our fourth largest export market soon – possibly as early next year. This is likely to be exacerbated by another period of stagnation in Europe. After a growth spurt in 2017 – partially fuelled by €2 trillion of new money minted by the ECB – Europe is heading back to recession. Italy is already in technical recession; German growth has stalled; and it seems that France may well follow suit.

Looking out over the medium term, the decline of the EU as a major market for our exports might be accelerated by demographic trends. Germany’s population and Italy’s are set to decline precipitously by mid-century. (Though the migrant tide could make up the slack – if it is allowed to happen, in which case those countries will change in character fundamentally.)

UK service exports are growing faster than exports of goods. They have more than doubled since 2008 from £75 billion to £162 billion. The potential upside for high-grade professional service exports to the developing world is massive – be it education, advertising, insurance or IT consulting.

When the history of the Brexit saga is written economic historians will note that Britain had been slowly de-coupling from Europe for decades. As I have written before, the real turning point was not Mr Cameron’s strategic decision to hold a referendum, but Mr Brown’s decision (made against the wish of Prime Minister Blair) not to join the Euro in 2003. That would have been irreversible (as the Greeks have discovered) – but Britain’s membership of the EU isn’t. (Or is it? We shall soon find out.)

Master Investor Magazine

Never miss an issue of Master Investor Magazine – sign-up now for free!

Read the latest Master Investor Magazine

The true impact of the single currency is only now becoming apparent. This week a remarkably illuminating study was published by a German think-tank. The Centre for European Policyhas finally quantified the gainers and losers from the introduction of the European single currency 20 years ago.

The authors of the report, Allessandro Gasparotti and Mathias Kullas, estimated how economic output in eight eurozone countries would have developed if the euro had never come about by comparing their growth paths to comparator countries with similar economic characteristics. Their conclusions are stark. German households, they calculate, are cumulatively €23,000 better off than they would have been if the euro had never happened – and Dutch households by €21,000. In contrast, French households are €56,000 worse off and Italian households poorer by an eye-watering €74,000.

It is a commonplace that the rich surplus nations of the North of the EU – Germany and the Netherlands – have won out while the less developed deficit nations of the South have languished. In fact, on a purchasing power parity basis, Italians enjoy a lower GDP per capita than they did 20 years ago. For them and for most Europeans the single currency has been a deflationary disaster which has shifted the focus of the UK’s trade elsewhere.

Despite self-deprecation

Why has the UK economy proven so resilient?

First of all, we have a highly flexible labour market – meaning a competitive labour market in which good skills are rewarded. Yes, I admit, there are far too many people in low-skilled, low-wage employment. But, as I have argued before, that is largely due to New Labour’s opening the floodgates to low-skilled immigration from Eastern Europe from 2003 onwards which hugely depressed wages at the bottom-end. At the same time, there is much to be said for an employment model which permits large numbers of self-employed people to make a living even if they bring down the overall productivity metrics. I explained this in detail in December 2017. In France, Italy and Spain such people are simply on the dole (and therefore do not impact productivity numbers).

While Britain boasts some of the most prestigious universities in the world, there is a profound skills shortage at the bottom end of the social scale which is restricting social mobility. I’d like to discuss that in some depth soon.

Second, under the Coalition government (and its two successor Tory governments) the UK has made a sterling attempt to get its finances back in order after the profligacy of (the above-mentioned) Mr Brown and the catastrophic financial ramifications of the Credit Crunch of 2008-09 (which was notMr Brown’s fault). Huge progress has been made in getting the fiscal deficit down – but, admittedly, at huge political cost. Austerity has become a toxic term – and it is real. And why a British government would cut the armed forces and the police only to spend billions on promoting girl bands in Africa is beyond me…But (as I shall be sharing as a contributor to a forthcoming book on the future of the Conservative Party), there has not been a true Tory in Number Ten since 1990…

Third, the UK is, as it ever was, home to a stable of world-class companies which continue to make excellent profits and many of which are sitting on huge cash piles. (I’ll identify my favourite cash piles soon.) There is nothing wrong with cash piles per se – but they could suggest to analysts that management is not making sufficient effort to reinvest profits in new high-return ventures. But in this respect many large UK companies resemble their American cousins. One upshot of consistent profitability in recent years is that the dividend yield on the FTSE-100 is, at just shy of five percent, the highest in my lifetime.

I concede that too much of UK manufacturing is ultimately in foreign ownership; but, as a corollary to that, FTSE-350 companies have, collectively, very substantial overseas assets.

On 07 February the Bank of England revised the probability of the UK economy shrinking in 2019 from 13 percent to 22 percent. That’s in line with equivalent forecasts concerning the risk of recession in Europe. I note that the pound rose earlier this week as the boys in braces stated buying again. I’m scanning the horizon for the key event that will send the UK stock market roaring back to more realistic levels. On that – more soon.

Comments (0)

Leave a Reply

Your email address will not be published. Required fields are marked *