Threats to UK Economic Recovery

1. Threats to UK Economic Recovery and long term Economic Growth Geoff Riley April 2014

2. Threats on the Horizon? • After several years of weak expansion, the UK economy is enjoying a relatively strong cyclical recovery • Can the UK continued to experience a recovery in output, jobs and investment? • Will the recovery be balanced and sustainable? • How resilient is the UK? What are some of the major threats to growth in 2014 and beyond?

3. IMF World Economic Forecast for 2014

4. Macro objectives Falling unemployment, declining inflation and stronger growth – a better picture for the UK in 2014? But can it last?

5. Reminder of key objectives of macroeconomic policy Price Stability – i.e. Low Positive Inflation A Sustainable Growth of Real GDP (National Output) Falling Unemployment / Full Employment? Higher Average Living Standards (Income per capita) Improved Global Competitiveness / Trade Balance A More Equitable Distribution of Income and Wealth

6. Is the UK achieving a Balanced Recovery from the Recession? 1. Re-balancing away from consumption and imports towards exports and business investment 2. Re-balancing away from dependence on the housing market towards manufacturing 3. Improving regional balance of output & jobs

7. State of the UK Economy 2009-2014 2014 data is a forecast 2009 2010 2011 2012 2013 2014 Real GDP - % change -5.2 1.7 1.1 0.1 1.4 2.4 Unemployment rate - % of labour force 7.6 7.9 8.1 7.9 7.8 7.5 Fiscal balance - % of GDP -11 -10 -8.0 -6.2 -6.9 -5.9 Consumer price inflation – % 2.2 3.3 4.5 2.8 2.6 2.4 Current account balance (BoP) - % of GDP -1.4 -2.7 -1.5 -3.8 -3.4 -2.5

12. Threats to the UK Recovery Inequality and Immobility Stagnant Productivity Rising Costs of Production Public and Private Debt Continuing Euro Crisis Another Housing Bubble

13. Inequality of Income & Wealth • Widening wealth and income gap • Social immobility Median income = £21,400 Mean income = £30,100 Mean income for top 1% = £150,000 Mean income for poorest 1% = £8,430

14. Some Threats to the UK Recovery Inequality and Immobility Stagnant Productivity Rising Costs of Production Public and Private Debt Continuing Euro Crisis Another Housing Bubble

15. The Productivity Puzzle • UK productivity has fallen since 2008 • Persistent productivity gap with leading nations • Holds back growth of potential GDP • Why is this happening? Britain's productivity gap with its main developed country rivals is at its widest in 20 years –if productivity stagnates, wages are less likely to rise and growth could disappoint

16. Threats to the UK Recovery Inequality and Immobility Stagnant Productivity Rising Costs of Production Public and Private Debt Continuing Euro Crisis Another Housing Bubble

17. Could rising costs de-rail recovery? Energy prices Climate change policies Labour costs Financing costs Cost pressures on UK businesses have eased in recent years But volatile costs cause uncertainty Higher costs hit profits and planned capital investment

19. Crude oil prices

23. Over-dependence on low interest rates? “Investors are becoming dangerously reliant on rock-bottom interest rates, with many becoming so indebted they will face serious problems when borrowing costs rise, the International Monetary Fund (IMF) has warned. The IMF said that the amount of cash spent on leveraged loans - the high-debt instruments with financial problems - now exceeds the level in 2007 before the crisis.” – Ed Conway, Sky News, April 2014

25. UK Household Debt Mountain Household (personal) debt

26. UK Household Debt Mountain Household (personal) debt

27. Public Sector Debt

29. European Risks

30. Deflation risk Adjustment and recovery in southern Europe cannot be taken for granted, especially if Euro Area-wide inflation remains low, or even turns into deflation. (IMF, April 2014)

32. House Prices

33. Housing Bubble? Poor housing affordability is a major issue for the UK – both property prices and housing rents

34. Housing boom threatens growth

35. Legacy of Recession: Hysteresis v Creative Destruction When an economy is disabled by recession – risk of permanent loss of national output Loss of productive capacity due to low investment / business closures High rates of long-term structural unemployment – shrinking labour force Hysteresis Recessions can cast a dark shadow but capitalist economies usually bounce back Recessions prompt emergence of new business models and an increase in start-ups New technologies can act as a catalyst for renewed growth and investment Creative Destruction

36. Legacy of Recession: Hysteresis v Creative Destruction When an economy is disabled by recession – risk of permanent loss of national output Loss of productive capacity due to low investment / business closures High rates of long-term structural unemployment – shrinking labour force Hysteresis Capitalist economies usually bounce back Recessions prompt emergence of new business models and an increase in start-ups New technologies can act as a catalyst for renewed growth and investment Creative Destruction

37. Legacy of Recession: Hysteresis v Creative Destruction When an economy is disabled by recession – risk of permanent loss of national output Loss of productive capacity due to low investment / business closures High rates of long-term structural unemployment – shrinking labour force Hysteresis Capitalist economies usually bounce back Recessions prompt emergence of new business models and an increase in start-ups New technologies can act as a catalyst for renewed growth and investment Creative Destruction

38. Evaluating Coalition Policies for Economic Recovery

39. Fiscal Austerity Welfare Reform Competition Policy Infrastructure Employment Incentives Other Supply- Side

40. Coalition Policies Austerity measures, cutting govt spending, welfare caps, reducing the number of public sector jobs Desired Effect: • To reduce borrowing requirements • To reduce debt servicing costs • To maintain / reclaim AAA credit rating Winners: Losers: Borrowers – cheaper interest rate Businesses and consumers – less jobs lower incomes, more hardship Tax payers paying off debt in future

41. UK budget deficit is forecast to be £108bn this year

42. Forecast is that a budget surplus will return in 2018-19

43. Coalition Policies Public sector redundancies, cutting spending for local government, privatisation (e.g. Royal Mail and the Tote) Desired Effect: • To encourage more private sector activity • To reduce inefficiencies in government departments • Belief that government sector is less innovative and dynamic / low value for money Priority: Less public sector activity SHOULD encourage “crowding in” of private sector activity.

45. Coalition Policies £375 billion of planned public and private sector infrastructure investment has been announced by the government. Desired Effect: • Address problems created by ageing infrastructure • Capital spending designed to improve competitiveness and growth Possible Diagram: Investment as a component of AD LRAS effects import too Time • Very long time lags – will pension fund / insurance companies continue to fund into the long term?

46. Key Infrastructure Projects • 2nd Forth Road Bridge • Argyll wind farm array • Cross Rail • High Speed Rail 2 • London Gateway Port • Network Rail’s £28bn infrastructure plan for the UK rail network • London’s new super sewer • Nuclear power plants e.g. the proposed one at Hinkley Point

47. Coalition Policies New Competition and Markets Authority, Privatisation, further liberalisation of markets such as energy, postal services, banking Desired Effect: • To address widespread “market failures” • To boost productive, allocative and dynamic efficiency • To provide incentives for extra investment as a driver of growth Efficiency: Will regulators be sufficiently powerful and decisive? Substantial barriers to entry exist in many utility industries

48. Coalition Policies Patent box incentive, cuts in corporation tax, reforms to immigration policy, launch of the Green Investment Bank Desired Effect: • To rebalance the economy away from just service sector growth • To increase injections into the circular flow and create multiplier effects • To seek markets beyond Europe and North America to diversify risk Wider Context: Shifting sands of globalisation – not just a BRIC story anymore Trans-Pacific Partnership, US-European trade talks The rise of South-South trade Greater use of managed currencies by countries as a macro policy instrument

49. Selected Competitiveness Rankings for 2013 1: Switzerland 2: Singapore 3: Finland 4: Germany 5: United States 10: UK Competitiveness Indicators 1. Institutions and Infrastructure 2. Macroeconomic stability 3. Health/education systems 4. Financial markets (including strength/stability of banks) 5. Technological readiness 6. Market size (linked to population size and per capita incomes) 7. Business sophistication (quality of supply chains, industrial clusters) and rate of innovation

52. 10/04/2014 Loads of Revision Help on Twitter: @tutor2u_econ

53. Key Supply-Side Challenges for the UK Economy Persistent Productivity Gap High youth unemployment Deep regional economic divide Structural trade deficit (BoP) Low trend growth of GDP Rise of Emerging Nations Low investment & research spending Rising inequality / relative poverty

61. Long run supply side growth • Analysis - Identify 3 policies that might boost the supply side of the UK economy in the long term • Evaluation – What factors might limit the effectiveness of your suggestions?

62. Improving labour supply Analysis • A labour shortage is often a reason limiting the economy’s scope for growth • Additional labour can be obtained from overseas, or by boosting participation rates of the native UK labour force. Evaluation • Immigration is politically controversial – depends on nature of migration • Tax and welfare systems can create disincentives for people to take paid work

64. Longer Term Dynamic Effects of Migration Labour Market Fiscal Effects Consumption Competitiveness Waves of inward migration can have structural effects on a country’s macroeconomic performance Increase in the labour supply which might cause lower unit labour costs for host country Inward migration increases pressure on govt spending but will also lead to rising tax revenues • Human capital helps generate new ideas • Many migrants start businesses – possible exporters • Knowledge spillovers • Increase in population size • Rising demand for public services • If housing stock is fixed, can lead to higher prices and rising rents

69. Improving labour mobility Analysis • The UK housing market often makes it difficult to overcome problems of geographical immobility of labour • Big differences in house prices and poor transport links prevent labour movement Evaluation • Tackling the housing market and transport infrastructure problems Britain faces is a huge task • Interventions are often hugely expensive with significant time lag problems

70. Improving labour productivity Analysis • It’s vitally important that the UK doesn’t just have more labour, but better labour – that can produce higher value output • Investment in skills, training and equipment are all possible routes to higher productivity Evaluation • This is a long term problem that can take a generation to tackle. • Who is responsible? Firms or government? • Who should pay?

71. Improving innovation and enterprise Analysis • By creating the conditions in which innovation and enterprise thrive, new businesses will start-up, new products will be developed and new markets pioneered • The greater the incentive, the bigger the gains Evaluation • Tax cuts to incentivise entrepreneurial wealth might cause increases in inequality. • Innovation often has high failure rates, making it hard for governments to ‘pick winners’.

72. Improving infrastructure Analysis • Improved infrastructure could help reduce the ‘bottlenecks’ that prevent the economy from expanding • Improved transport can aid labour mobility, cheaper energy reduces costs across the economy. Evaluation • Transport and energy infrastructure is expensive and are subject to significant time-lag effects. • Infrastructure provision sometimes conflicts with other policy goals, such as reducing environmental impacts

73. Economic Importance of Infrastructure Investment Examples of UK infrastructure projects • 2nd Forth Road Bridge • Cross Rail and the High Speed Rail project • London Gateway Port & new London super sewer • Nuclear power plants including Hinkley Point Economic significance of infrastructure • Potentially high multiplier effects from multi- billion investment projects – boosts AD and jobs • Lack of infrastructure may discourage FDI • Increases the capital stock / productive potential

74. Economic Importance of Infrastructure Investment Examples of UK infrastructure projects • 2nd Forth Road Bridge • Cross Rail and the High Speed Rail project • London Gateway Port & new London super sewer • Nuclear power plants including Hinkley Point Economic significance of infrastructure • Potentially high multiplier effects from multi- billion investment projects – boosts AD and jobs • Lack of infrastructure may discourage FDI • Increases the capital stock / productive potential

75. Examples of UK Government Supply-Side Policies Privatisation of Royal Mail Patent Box Incentive Modern Apprenticeships Welfare Caps / Reforms Shale Gas Tax Cuts Corporation Tax Cuts National Infrastructure Plan Launch of Green Investment Bank

76. To what extent could supply side improvements improve UK competitiveness? Knowledge Application • Refer to supply side problems that raise UK business costs and restrict competitiveness Analysis • Identify supply side policies and explain how they might work. Use an AS/AD diagram to show the impact of changes in AS on real income, and especially the price level. Evaluation • Discuss the problems and limitations of supply side policies. Introduce other factors that influence competitiveness, such as the exchange rate.

77. Threats to the Recovery - Overall • Domestic threats: – Continued weak productivity – Damaging effects of high debt levels – Vulnerability to a rise in interest rates – Doubts about level of spare capacity – Falling real wages for millions – Evidence of renewed housing / consumer credit boom – Regional imbalances continue to widen – UK running a historically high current account deficit

78. Threats to the Recovery - Overall • External threats: – Deflation / slowdown in European Union – Geo-political risks including Ukraine crisis and risk of rising world food prices – Appreciating sterling – damaging exports? – World economy perhaps over dependent on ultra- low interest rates – will global growth slump if interest rates start to rise?

79. 10/04/2014 Loads of Revision Help on Twitter: @tutor2u_econ

Threats to UK Economic Recovery

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