Is the UK economy making the same old mistakes? Today offers a glimmer of hope…

Yesterday produced some news which initially looked really good for the UK economy so let me go straight to the revision of the UK economic growth figures.

UK gross domestic product (GDP) in volume terms was estimated to have increased by 0.8% between Q2 2013 and Q3 2013, unrevised from the Preliminary Estimate

GDP in volume terms increased by 1.5% when comparing Q3 2013 with Q3 2012

The 0.8% increase in GDP in the latest quarter follows increases of 0.7% in Q2 2013 and 0.4% in Q1 2013.

So the news remains good and if we look back we see that it looks like it is singing along to the Beatles.

It’s getting better all the time

Whilst these are true it is also true that looking at it just like that is the equivalent of taking the Blue pill in the Matrix series of films. However if we asked Morpheus to be our guide he would point out that there are some troubling influences at play here.

The Balance of Payments

This is a long running issue for the UK economy as we moved into deficit on our current account back in 1985 and have run persistent deficits ever since. We had an apparent improvement in the mid-90s after Black Wednesday lead ironically considering its name to better times for the UK economy. However after that the position was summarised thus by the Office for National Statistics.

Overall, exports of goods and services grew by an average 1.2 per cent each quarter during this period, but imports by a higher rate of 1.6 per cent.

So it is not true to say that the UK has nothing to export as we do quite well at it but it is much more true to say that however well we do our demand for imports seems to exceed it. Some might say our lust for imports. If there is a British economic problem one of the main signals of it is there. Also over the last decade or two it was exacerbated by the entry of places such as China to the wider world economy which led to something described as this.

 The ‘Great Doubling’, calculating that the global labour force increased from 1.46 billion to 2.93 billion. As a result the global capital-labour ratios halved,

As an aside we get a strong hint as to why real wages are under such pressure in so many areas but if we stick to today’s theme the advent of this led to cheaper and thus more imports being available to the UK. With our lust for imports there was only one likely result.

Briefly the credit crunch helped as the UK current account deficit fell but it then began to rise leading to us being in deficit by 3.6% of our economic output in 2012. Now let me bring this up to date.

The deficit in net trade was £8.9 billion in Q3 2013 with exports falling by 2.4% between Q2 2013 and Q3 2013 and imports growing by 0.4% over the same period. This follows a net trade deficit of £5.5 billion in Q2 2013

So a troubling picture where an existing problem is being exacerbated. The most worrying is the way that exports actually fell.

UK Domestic Demand

This was following a regular pattern for UK booms which then turn to bust as we can see below.

Household final consumption expenditure rose by 0.8% in Q3 2013, an eighth consecutive quarter on quarter increase (see Figure 5) following the longer-term trend. The level of household expenditure is now 2.4% higher than in Q3 2012.

So we find ourselves concerned about domestic demand rising and sucking in imports in a regular theme if you look at UK economic history. Actually perhaps there is a glimmer of hope here in that we did not suck in even more imports.

Economics 101

The economics textbooks have told us many things which have not turned out to be true. Let me offer you one from the reign of Mervyn King as Governor of the Bank of England. Our trade weighted exchange rate fell from 97.09 to 80.26 over the ten years of his term which ended in June. Yet we did not gain much in trade terms did we? Even if we allow for the decline of North Sea oil output the response was disappointing. I have come to the conclusion that just like for interest-rates the timing of an exchange rate move matters much more than economic theory assumes so Mervyn was either just unlucky or not very good.

Of course an alternative theory is that the UK pound sterling needs to fall by a lot more! Personally I am not convinced by that as the depreciation we had in 2007/08 gave us an inflation problem which eroded any competitive gains. Also our success in the pre credit crunch era came here.

The UK increased its share in global exports of smaller high technology manufactures such as medical and pharmaceuticals, communication equipment, office machinery and computers

If I was in charge I would be encouraging such areas and making sure that schools and universities were producing individuals equipped to help such areas.

The pound goes awry

You might think that such issues might have the pound under downwards pressure. Not a bit of it! In fact it had a really good day yesterday and this morning has pushed above US $1.63, Euro 1.20 and 167 Yen. This continued a trend which started when the current Governor of the Bank of England Mark Carney announced his policy of Forward Guidance as since then the pound has risen by around 5%. So we end up hoping that our exports as as unresponsive to price rises as they were to falls.

The current pound rally seems driven by the fact that the UK has relatively good economic growth figures right now.

England

Yesterday’s discussion about the economic impact of a possible Scottish departure from the UK left a troubling thought for England. Scottish oil and gas production would no longer count as a export or an import substitute implying that the balance of payments for England (and Wales and Northern Ireland) would be dreadful.

I can help with some data on trade in goods which the HM Revenue and Customs suggests was in deficit by some £25.9 billion in the second quarter of 2013. England exported some £56.9 billion and imported £85.8 billion. This does not include services which are a strength.

London

I wondered in yesterday’s analysis of Scottish independence if the trend spread if London might consider becoming a City State. Perhaps Allister Heath was thinking along similar lines as he has published this today in City-AM.

Most remarkably of all, if London were a City-state, it would be running the sixth largest current account surplus of any rich nation………  Looking at the current account as a whole, which is bolstered by huge flows of income, London’s surplus is around 8 per cent of GVA, and the rest of the UK’s deficit a massive 7 per cent.

Some care is needed with such numbers as Gross Value Added numbers are certainly disputable as for example as pointed out on twitter by @Hotairmail the  numbers are inflated by head offices being in London. Actually that makes London a rather similar business model to Ireland does it not?

The HM Revenue trade figures are the ying to the above yang however. In the second quarter of 2103 it has a trade deficit of £5.8 billion with exports of £7.1 billion exceeded by quite a distance by imports of £12.9 billion.

Comment

There are always caveats with an analysis of the balance of payments as the numbers can be revised years and even decades later. For example nearly two decades later it became apparent that the 1967 pound £ devaluation was not anything like as necessary as it appeared at the time. Ooops! However over two decades of sizeable current account deficits does leave the UK vulnerable in my view. Ironically the current consumption based boom reinforces this with the danger that it sucks in imports at a time when the external environment especially in Europe is not helping exports. We have been down this road before and should perhaps be grateful that currency markets look at balance of payments deficits these days with the equivalent of Nelson’s blind eye.

My suggestion is that we look at something very fundamental and start with our education system to make sure that we are providing as many skilled individual’s as we can to our successive industries. This is a slow burner but the truth about quick fixes is that they rarely work!

Also let me give the announcement by the Bank of England this morning a well done! Here is the crucial bit.

The FLS (Funding for Lending Scheme) extension will continue to allow participants to draw from the scheme from February 2014 until January 2015, but household lending in 2014 will no longer generate any additional borrowing allowances. Instead additional allowances will now only reflect lending to businesses in 2014.

Let us hope that there is a genuine boost to business lending which is in line with my theme above. Also boosts to the housing market are a function of our past problems as domestic demand hits a trade constraint and ends the boom. It has taken it some five years of mistakes but finally the Bank of England looks as though it is giving something useful a try.

Let me end by wishing a Happy Thanksgiving to those of you celebrating it.

This entry was posted in Bank of England, Current Accounts, General Economics, House Prices, Quantitative Easing and Extraordinary Monetary Measures, UK Inflation Prospects and Issues and tagged , , , , . Bookmark the permalink.
Subscribe Find an Adviser
  • forbin

    Hello Shaun,

    Merv the Swerve leaves

    Economy improves

    Hmmm,,, food for thought…..

    Forbin

  • Drf

    Hi Shaun,

    “So it is not true to say that the UK has nothing to export as we do
    quite well at it but it is much more true to say that however well we do
    our demand for imports seems to exceed it.” Then “So a troubling picture where an existing problem is being exacerbated. The most worrying is the way that exports actually fell.” There seems to be a contradition in these two statements?

    “The economics textbooks have told us many things which have not turned out to be true.” Surely that (with politics lumped on top of it) is the root of the problem? A guy I know with a Masters degree in Economics from a Russell group university said to me not long ago: “The fact is that Economics as presently understood does not work. If it did work we would not be in the economic mess we are now in!”

    The old peddled concept that we need a weaker and weaker Pound Sterling to solve all of our problems just does not wash. We have used up most of our indigineous resources already in the UK; so to manufacture marketable goods (even if we any longer had the necessary skills, capital and facilties, which for the most part we no longer now do ) we would need to import materials, sub-assemblies and now also unskilled human resources; thus the effect on our balance of payments deficit would be potentially only the value added after funding costs – and we also have now the most expensive energy supplies in the civilised world to add to our woes. So I am afraid that a weaker Pound Sterling makes things overall worse rather than better, because we are now a net importing Economy. Since Thatcher destroyed most of our real-wealth creating capacity it is only North Sea oil and gas which has kept us afloat; now the profitable fields have been almost exhausted, yet our public spending has increased! That cannot continue indefinitely. Germany manages to export with a relatively high Euro and does not want or need a weaker Euro to be able to export.

    The only hope would be a return to sanity in the UK, an end of printing money Zimbabwe style, an end to fictitious ONS published statistics for purely political purposes, an end of public spending which is not fully-funded by taxes in real time and is well near the origin on the rising side of the Laffer curve, and starting again from the beginning to develop sound Ecoonomic theory which actually works. This of course will never voluntarily happen, because it would destroy present politics and end the careers many of the deluded Economists (not Shaun of course who is one of the few realists).

  • Anonymous

    Sorry, OT: can’t believe all the fuss over the end of FLS. It wasn’t strong enough to kick off house price inflation so the govt did help2buy instead to get new entrants to the pyramid scheme. SVR was going up regardless, the BoE were pushing on a string.

    Reminds me of the children’s book “A squash and a squeeze”.

  • Anonymous

    Hi Drf,

    Thatcher helped to bring in Nissan – a successful car manufacturer. I didn’t regard British Leyland as wealth generating – I thought they were a subsidy grabbing lemon akin to today’s RBS.

    Can you give examples how Thatcher destroyed wealth generating capability ?

  • Rods

    Hi Shaun,

    Another great blog.

    If you look at the international league table for education standards, we are unfortunately dropping faster than a lead balloon against our competitors. Where one of the UKs growth areas has been computer software the number of British graduates has been steadily falling, which does not bode well for the future.

    Where many people look down their noses at services compared to traditional manufacturing, what they need to remember that both have one to one and one to many segments. One to one in both is always going to have limited potential. To me manufacturing and services in the one to many for domestic market and exporting are just as valuable as each other. In fact it could be argued that in many cases that services are more valuable as the margins and profits for successful products are much higher.

    The UK I think is going to struggle along with other EU countries in the future due to excessive EU regulation and their scarce high energy policies. Our demographics are better than many European countries but most Asian countries have much younger populations and the global population ratios are: Asia 4bn, Europe 1bn, Americas 1bn and Africa 1bn, so as Asia continues their industrialisation, it is inevitable that Europe’s and the Americas proportion of world trade will drop, but as the recent summit in Warsaw has left the EU as the only trading block pursuing these high priced scarce energy policies and there is also their ever increasing micromanagement of peoples lives I think that their percentage of world trade will be dropping much more than most.

  • Noo 2 Economics

    Just to interject- coal and the sell off of the energy industry, which would help us very nicely now given spiralling energy costs and the growing potental for brown outs leading to furtherproductivity falkls not to mention the inconvenience for the population and of course seriouds problems for hospitals etc and of course the boost to Government revenues from energy profits.

    On Nissan I remember speaking to you once before on this issue about a Nissan my mother owned from new. Suffice to say that following her ownership experience neither she nor I will buy another Nissan ever again, and yes I know there are stats saying Nissans are in the top 10 most reliable cars but my mother’s experience was entirely different….

  • Anonymous

    Hi Shaun,

    I agree that education is really important. The old grammar school system which separated children on exam results looks good, where modern Britain separates children based on their parents ability to pay.

    In the 1990′s we saw many well educated young Bulgarian scientists & mathematicians being awarded green cards and immigrating to the USA. Immigration can cover weaknesses in education – but it’s rather unfair for the natives.

    Other important reforms for the UK could include making productive share investment more attractive and rent seeking investment less attractive.

  • Anonymous

    Surely GDP per head is the big concern. Scandinavian countries have a good standard of living in spite of a small global footprint. Britain’s problem is always looking to address GDP whilst ignoring GDP per head, which makes boosting population with unskilled immigrants look like a boost when in fact GDP per head drops.

  • Anonymous

    First para, fine, second – that’s an anecdote contradicting qualitative data.

  • Noo 2 Economics

    But true nonetheless.

  • Anonymous

    Come on man…

  • Noo 2 Economics

    OK I was making exactly the point you say. I could have just said “Nissan’s are useless, I know from personal experience” but I was pointing out to any other reader that there is the existence of official stats that contradict my viewpoint, so the reader can take their own fully informed view i.e that qualitative evidence demonstrates that Nissans are in the top 10 most relaible cars in the UK but that it would appear that when they do go wrong they REALLY GO WRONG like my mother’s did.

    This is something to bear in mind when considering your next purchase – do other marques have a reputation of one off major failures? If not, maybe those other marques are worthy of further consideration over the Nissan. For my part once bitten twice shy. Of course British Leyland was a waste of space and deserved to be put to death

  • Anonymous

    There, now everyone feels better :-)

  • Anonymous

    I’d reply that private business has very profitably extracted north sea oil and question the profitability of British coal. Ukraine & China regularly have coal mine fatalities – health & safety isn’t cheap. Their labour is cheap, British labour is not cheap. the Aussies do opencast mining on a vast scale – in the middle of nowhere. Britain is a small crowded island with historic villages who won’t want to be wiped out for an opencast coal mine. I’d suggest if British coal mining was profitable – there would be lots of it going on.

    As to car companies – I think they should contribute taxes toward society, subsidies short change hospitals schools etc.

  • Noo 2 Economics

    From the 1980′s perspective yes but we are in the 2010′s – oil circa $100+ per barrel, gas costs even more relatively and coal, even British coal, is competitive had the mines been maintained, and that is the reason coal mining no longer happens in Britain – Thatcher ordered they be flooded after the strike. I can’t think of a better example of wanton institutional vandalism and wealth destruction. Had the mines been maintained then they could be re -opened cheaply – no subsidy required…..

  • Noo 2 Economics

    Thought it was self explanatory myself….

  • Anonymous

    Hi Noo,

    The expensive German marques Audi, Mercedes & BMW rate badly according to those statistics – when your expensive complicated luxury car goes wrong, expect a large repair bill. I gave up on audi 12 years ago as they cost too much to service.

    I disagree on Nissan, my old Terrano just needs oil changes & cold start diesel additive below -10. we can get -30. It copes with snow, mountain tracks and Bulgarian roads which haven’t seen new tarmac in 20 years.

  • Jerry

    Shaun,
    I see that the BoE is going to end FLS. Does this mean rates will rise? What are you thoughts?
    Regards,
    Jerry

  • Drf

    Hi Shaun,

    As an expert in industrial matters I would remind you of when Thatcher actually stated publicly that she was going to replace all those nasty dirty greasy jobs in industry with nice jobs in banks, leisure centres and shops – and she did! It should be understood that the principal profits of Nissan UK are owned by the Japanese holding Company, so only a small value added mark-up accrues to the UK economy in algebraic balance.

    If I had the time I could research a large list of the industrial companies destroyed either directly or ultimately by the policies of the Thatcher-led governments. Just to mention a few either completely destroyed or permanently weakened as a direct result of her policies (some were forced into take-overs or mergers as a result): ITT Europe, STC, ICI, Hoffman Bearing Co, Marconi Co,, Ultra Electronics, Decca Electronics, Compton Parkinson, March Engineering, Norton Motocycles, AC Cars, Setright Registers Ltd. British Coal, British Aerospace, Plessey Electronics and Racal Electronics. There were many many others.

    See http://www.telegraph.co.uk/finance/comment/alistair-osborne/9980292/Margaret-Thatcher-one-policy-that-led-to-more-than-50-companies-being-sold-or-privatised.html

    and http://www.ranker.com/list/list-of-failed-businesses-and-company-failures/business-and-company-info

  • Gurjot Rai

    Hi Shaun

    Many thanks for the blog.

    In my view the issue is quite simple, an economy can never grow if wages are stagnating, which they are for a vast number of individuals. My mum is earning the same as she was 20 years ago as she is now but with out the benefits.
    Low skilled migration, coupled with signifcant benefits leads to a disillusioned, lazy and an unemployed population, who are a net cost to society. Increasing retirement ages reduces the churn in employment exacerbating the problem further.
    There are enormous sections of the population who run as cash businesses and never pay tax, whilst claiming benefits, this results in the salaried employee picking up the tab.
    We are also hindered by infantile debate in the media, where special interest groups dictate what analysis is done and what can actually be said.

    The measures used by economists are flawed
    1) debt should be measured against tax revenue
    2) salaries and disposable income are a better measure of growth, if used correctly with employment measures

  • Anonymous

    Hi Forbin

    He is probably claiming the current improvement us due to decisions made in his Governorship. In terms of leads and lags he has a case as attributing too much to Mark Carney after 5 months doesn’t wash. But of course Mervyn King was in charge of plenty of bad years too so overall the picture remains poor.

  • Anonymous

    Hi Drf

    Let me clear up the contradiction element and apologies if I was unclear. The first statement covers the UK’s experience since the mid’1990s whereas the second covers the third quarter of 2013. So they are different time periods and hopefully the third quarter problem will be revised away but if it is not we will be heading for another balance of payments crisis if it becomes persistent.

  • Anonymous

    Hi Progrock

    I think FLS did have an impact. Whilst in the scheme of things these days just under £18 billion is not enormous there was the confidence back-stop that it provided. As in there were (cheap) funds available for banks which lent (and of course some that didn’t…)

    Also it backed one or two dodgy mutuals who will no doubt be re-reading Mark Carney’s speech from a month or two ago that the Bank of England is “open for business”.

  • Anonymous

    Hi ExpatInBG

    Genuine progress in education rarely rises on the political radar because the timescale required is simply too long for them. If Michael Gove has the job of Education Secretary for this Parliament he will be the longest serving one for 100+ years if the list on Wikipedia is accurate.

    I agree that the structure of the joint-stock company needs to be reformed to stop Directors treating them as personal fiefdoms.

  • Anonymous

    Hi Jerry

    I think that at the short end of the curve a base rate cut is as likely for the next move as a rise. As to mortgage rates it will be interesting to see if they begin to rise soon in response to this FLS change. Will some of the better offers disappear for example?

  • Anonymous

    Hi Gurjot

    Thank you and welcome to my part of the blogosphere

    I agree that the behaviour of real wages will have to improve if our mini-boom is to turn into the real thing. We cannot forever live on equity and house price rises.

  • Rods

    I agree, sensible countries taylor immigration to accept people with the skills that are required.

    Mass migration of unskilled labour pushes down wages at the bottom, by companies making staff redundant and new positions with different job titles being offered lower wages, very often with part-time replacing full time. It also means that the unskilled unemployed have more competition and less incentive to look for a job.

    The best way to increase wages is to have labour shortages.

  • Drf

    Hi Shaun,

    Thanks: no dates were originally given which is why it seemed perhaps there was a contradiction there.

  • Anonymous

    That last para has a high density of info and made me smile.

  • Anonymous

    Yes. The UK can’t have wage inflation or the boomers+ would be utterly screwed (they kind of are already).

  • Anonymous

    Thanks for the informative list. In hindsight it would have been better for Scargill & Thatcher to negotiate a settlement that allowed British coal to improve productivity and compete with imports. Both waged open warfare and let the public suffer power cuts etc. I’d attribute blame to both. In comparison the cooperative management-union model in Germany has achieved better results. Britain invented the mini, BMW profits. Britain invented front wheel drive cars – others perfected them. Our would be industrialists can learn lots from German & Japanese quality control methodology.

    North Sea oil made sterling strong, we cannot say whether those companies would have prospered with a weaker sterling making their exports more competitive.

    British Leyland is extinct, England is better receiving modest tax from Nissan, Honda, Ford, GM and BMW than otherwise.

    As a youngster I had several Honda & Kawasaki motorbikes which I rode & sometimes rebuilt engines. I found Nortons overpriced with a bad reputation for engine seizures. Japanese engines were much better.

  • Drf

    Hi Expatin,

    As you point out it was both the strong unions and Thatcher together who were responsible for the damage, but she was supposed to be leading, so must bear the greatest responsiblility; instead of confrontation she should have used a different solution. What knowledgeable experts advised Thatcher to do, but she paid no attention whatever, was instead of destroying industrial entities by default or confronting them to the death, to introduce a legal requirement for profit-sharing. If all workers in an entity are entitled to a share of the profits in addition to their wages then it is amazing how they all become concerned with profit rather than strikes, disruption and destruction, because they learn that lessens profits. In general profit-sharing works better than the Co-operative model.

    I think you will find that front-wheel drive vehicles were not first made in the UK. I agree with your point re reliability and qualitity, but that is just another sign of amateur UK management rather than industrial capability; instead of using qualified professionals most UK management is and always has been appointed via nepotism rather than true meritocracy. Hardly any senior managers in the UK are Chartered Managers or have an MBA. (Compare this to auditors of PLCs who must by law be Chartered Accountants.) The result is as demonstrated by the Peter Principle. If the blind shall lead the blind they both fall into a pit.

  • mike

    Drf
    Unfortunately since c1985 the winding down of UK manufacturing and the outsourcing of almost everything to Far Eastern suppliers brings a direct correlation between imports and exports.
    So almost every product that is exported has to be imported first, even our motor industry regarded as ‘world beating’ though foreign owned, is ‘manufactured in UK, yes, but with a huge content of imported parts and/or materials. This is very profitable for the firms and their owners – they’ve never had it so good – the 0.001% syndrome!! But it doesn’t do so much for UK employment nor UK Plc.
    When you see imports dip this is really bad news, expect exports to follow in a couple of months time. The trade balance will probably continue negative until production is repatriated.

  • Anonymous

    Hi Drf,

    I disagree on regulating profit sharing, waged employees will dislike loss-sharing. Different businesses have different incentives – a coal mine or a car manufacturer will have a steady workforce. These people have a long term interest in the business continuity.
    Construction workers do short term contracts – there is no link to long term profitability.

  • DaveS

    Drf

    Reading this a day late – but had to reply – brilliant comment..

    Economists helped create this mess but they can’t get us out of it. You can no longer fiddle your way out with exchange rates or money supply or interest rates. The latter they have already exhausted – although they most definitely haven’t exhausted pumping the money supply.

    The Thatcher service economy was a lie – the UK is living proof – London is world capital of service industry but we still can’t come close to paying for our binge consumption of foreign made goods and worse we won’t be able to pay in future for foreign energy.

    It is paid for with debt, secured against fantasy collateral – our ponzi housing market. I still see commentators claiming private debt levels aren’t a problem because they are backed by private assets i.e. houses. Even after witnessing 50%+ house price crashes in Spain, Ireland they don’t seem to understand your house is only worth what the next debtor in the ponzi chain can borrow from foreign creditors.

    We literally mortgaged our children’s futures – and yes we can theorise about balanced budgets or improved education standards etc etc – but it just isn’t going to happen – the last 5 years have proven that.

  • Drf

    Everyone dislikes loss-sharing, but it is life and you have to take the rough with the smooth! However it is really all about motivation.

  • jerry

    Shaun,
    Thanks. What do you think will cause interest rates to rise?
    Regards,
    Jerry

  • Anonymous

    Thank you for the blog, Shaun.

    As you say, judged by its effects, Black Wednesday might better be called White Wednesday (the then Chancellor of the Exchequer Norman Lamont’s choice) or Bright Wednesday (Norman Tebbit’s suggestion).

    In Canada, we celebrate Thanksgiving Day in October, but there are nevertheless an army of retailers promoting Black Friday sales the day after American Thanksgiving.

    Andrew Baldwin