Ahead of A-Level Economics mocks in early 2019, here is an overview and commentary on some of the key macroeconomic statistics and developments in the UK economy in 2018. In addition to the video, I have also produced some summary notes on each key economic indicator which will help students revise the key data and issues.
KEY FEATURE COMMENTARY ON THE UK ECONOMY AT THE END OF 2018
2018 has been a year dominated by increased uncertainty over the possibility of the UK making a disorderly exit from the European Union and, given the instability of domestic politics at the moment, it would be a surprise if 2019 panned out differently.
According to research from the National Institute of Economic and Social Research, If the government’s proposed Brexit deal is implemented, then GDP in the longer term will be around 4 per cent lower than it would have been had the UK stayed in the EU. This is roughly equivalent to losing the annual output of Wales or the output of the financial services industry in London. This is equivalent to a loss of 3 per cent in GDP per head, worth around £1,000 per person per annum to people in the UK.
Growth is slowing
Economic growth in the UK measured by the annual rate of growth of real GDP has been slowing since the middle of 2014. The IMF in their October 2018 World Economic Outlook has forecast growth for the UK of 1.4% in 2018 and 1.5% in 2019. Growth has moderated since the 2016 Brexit referendum, moving the UK from the top to near the bottom of the Group of Seven growth tables.
The IMF argue that there are significant risks to growth if the UK leaves the EU under existing WTO rules (i.e. a no-deal Brexit). Their latest analysis finds that reverting to WTO trade rules would lead to long-run output losses for the UK of around 5 to 8 percent of GDP compared to a no-Brexit scenario although of course there is a great deal of uncertainty about the likely macroeconomic outcomes from EU departure.
Going forward, UK growth is likely to be negatively affected because of higher import tariff and non-tariff trade barriers, lower net inward migration of labour, and reduced domestic and foreign direct investment. The UK economy has enjoyed 24 successive quarters of economic growth, but heading into 2019 how close might we get to a technical recession?
Will the UK’s long term trend growth rate decline following exit from the EU?
The capacity of the economy to continue to grow without generating inflation is diminishing as firms invest less, the number of EU migrants coming to the UK for work declines, and the growth of output per worker remains low.
The Office for Budget Responsibility’s currently estimates that trend UK growth is 1.5%. Taking the average of the NIESR and Treasury estimates, a no-deal Brexit could lower the UK’s long-term trend growth rate from 1.5% to 0.9%. On the same basis a transition deal and a future free trade agreement could reduce trend growth to 1.2% per year.
Inflation and real wages
The Consumer Prices Index (CPI) is the main measure of inflation. It is the measure used for the Bank of England’s 2% inflation target. The CPI inflation rate was 2.4% in October 2018, the same as its level in September 2018.
The post-referendum depreciation of sterling caused an increase in inflation, depressing private consumption because of the impact on real incomes. Inflation is now falling back towards target and, with nominal earnings increasing in excess of 3 per cent, for many people in work real wages are starting to rise again after a lengthy period of stagnation.
The labour market remains a bright spot in any overall assessment of the UK economy. The UK unemployment rate in the summer 2018 was 4.0% of the labour force. This was a 43 year low and this unemployment rate was slightly above the rate of the US (3.9%), below that of France (9.0%) but above that of Germany (3.4%). The UK rate was the 12th lowest of 36 OECD member countries. And the sustained fall in unemployment rates together with a record level of employment is a strong aspect of the UK’s macro performance in 2018.
That said, increasingly, economists are focusing less on job quantity and and instead giving more weight to job quality and inclusiveness whilst emphasising the importance of resilience and adaptability for good economic performance in a rapidly changing world of work.
Youth (aged 15-24) unemployment remains a major issue in many developed economies at present. In Q2 2018 youth unemployment was 39.1% in Greece, 34.5% in Spain and 32.2% in Italy. UK youth unemployment stood at 11.0%.
External trade (including the current account)
Britain continues to run a sizeable trade deficit in goods and services. In 2017, the UK’s exports of goods and services totalled £617 billion and imports totalled £641 billion. Overall, the UK imports more than it exports meaning that it runs a trade deficit. A deficit of £137 billion on trade in goods was partially offset by a surplus of £113 billion on trade in services in 2017. The overall trade deficit was £24 billion in 2017.
The current account, which includes investment income and transfers as well as trade, saw a deficit of £76 billion in 2017, compared with £103 billion in 2016. The current account deficit was 3.7% of GDP in 2017 compared with 5.2% in 2016. The need to finance the large current account deficit makes the UK economy vulnerable to shifts in investors' preferences for UK assets.
At present, the UK remains a favoured venue for inflows of foreign capital which makes it relatively straightforward for the UK to finance an external deficit. Difficult post-Brexit headwinds might change this especially if there is a further decline in sterling and multinationals decide to curtail their planned capital investment in Britain.
Interest rates and QE
Monetary policy seems to have become becalmed in recent years with barely a ripple in the chart showing the main monetary policy interest rate. The Bank of England’s Monetary Policy Committee (MPC) voted unanimously to leave interest rates unchanged at 0.75% at its November policy meeting. The last change occurred at August’s meeting when the MPC raised rates from 0.5% to 0.75%. Interest rates have moved more decisively in the United States where the Federal Reserve has moved rates to 2 per cent – still low by historical standards but their highest rate for the decade since the Global Financial Crisis.
The Bank of England’s quantitative easing (QE) programme, where the Bank creates new money to buy financial assets, remains active and unchanged. QE now totals £445 billion of assets, £435 billion of which are government bonds and £10 billion of commercial debt. Mark Carney has agreed to extend his term as Governor of the Bank of England. He will now remain until end January 2020.
Will the housing market experience significantly weaker growth in 2019? House prices, increased by 3.5% between September 2017 and September 2018 but they have been falling in some areas recently including Greater London. There are big regional differences in house prices. The average price is highest in London at roughly £482,000. The lowest prices are found in Northern Ireland and the North East at £135,000 and £132,000 respectively. Prices remain high relative to income, reflecting supply constraints.
Government borrowing and the national debt
Fiscal consolidation in the UK has continued, with the budget (fiscal) deficit falling below 2 percent of GDP in the 2017-18 financial year. Progress towards achieving a balanced budget is slowing because of weakening economic growth and there are also significant long-term risks to government finances from an ageing population which increases demands on health and social care and places growing pressure on pensions.
The yield on ten year UK government debt remains very low having been below 2 per cent since the end of 2015. In part this reflects strong investor demand for UK government gilts including a resilient appetite for new issues of government debt from foreign investors. Financial markets are not expecting any sudden increase in monetary policy interest rates (higher interest rates cause bond prices to fall – there is an inverse relationship between the two) which is another reason for bond yields to remain fairly stable.
For some economists, the low cost of servicing government debt strengthens the argument for the UK government to relax fiscal austerity and increase government spending – as we have seen, the fiscal deficit is now below 2 per cent of GDP although Chancellor Philip Hammond has warned of the need for an emergency budget should the UK end up with a disorderly no-deal Brexit.
Net migration of EU migrants into the UK is now at its lowest level since 2012. Since the 2016 EU referendum, net migration of EU citizens to the UK has fallen from around 200,000 to less than 100,000 per year. Net migration continues to add to the population of the UK as an estimated 273,000 more people moved to the UK with an intention to stay 12 months or more than left in the year ending June 2018. Over the year, 625,000 people moved to the UK (immigration) and 351,000 people left the UK (emigration).
According to a recent Deloitte Monday Briefing (highly recommended for all A-level economists!), over the last ten years, 1.8 million of the extra 2.8 million new jobs created have been filled by overseas born workers. Today this section of the workforce, which makes up 17% of all employment, is shrinking as departures of overseas-born workers exceed arrivals for the first time since the financial crisis.
The UK was ranked 8th in the 2018 Global Competitiveness Rankings published by the World Economic Forum. This makes the UK the fourth most competitive economy in Europe behind Germany, Switzerland and the Netherlands. The 2018 WEF report flagged up relative weaknesses in human capital in the UK including a ranking of 47th for internal labour mobility ( geographical mobility of labour is hampered by unaffordable housing). Ranked 28th for quality of vocational education and 32nd for digital skills. Ranked 59th for pupil-to-teacher ratio in primary education, Britain was ranked 22nd for research and development spending as a percentage of GDP.
Historically, UK labour productivity has grown by around 2% per year but since the 2008/2009 recession it has stagnated. Slow productivity growth remains a major policy issue for the UK economy.
According to Professor Michael Porter in a recent working paper on UK competitiveness, “Productivity is the central measure of competitiveness and a key driver of a nation’s standard of living. The UK’s enduring weaknesses in productivity and productivity growth is the root cause of the nation’s disappointing economic trajectory.”
The level of labour productivity in Q3 2018 was 1.5% above what it was over 10 years earlier in Q4 2007 (the pre-recession peak level). In 2016, ranked on GDP per hour worked, the UK came fifth highest out of the G7 countries, with Germany top and Japan bottom. UK productivity was 16% below the average of the rest of the G7 countries, the largest since at least 1995 (when the ONS data series began). Productivity levels in the UK remain lower than in peer economies such as Germany and the United States.
The Sterling Exchange Rate Index measures sterling’s value against a ‘basket’ of currencies, ‘trade‑weighted’ (based on currencies’ relative importance in UK trade). The pound fell sharply against most major currencies following the EU referendum, for example it depreciated from $1.48 on 23 June 216 to $1.14 in June 2017 – a thirty-one year low. A weaker pound may have helped to bring the current account deficit under control with the deficit having reached a record high of 5.2% of GDP in 2015. But a falling pound has also increased costs and prices for UK business and consumers.
Household debt peaked in Q2 2008 at 148% of household disposable income. It then declined to 127% by late 2015. It has remained steady at around 135% of GDP in recent times. Average UK household debt (including mortgages) was £58,540 in June, according to financial charity The Money Charity. Overall in the UK, people owed nearly £1.6 trillion at the end of June 2018, up from £1.55 trillion a year ago.
The cost of servicing debt for households remains relatively low, due to very low interest rates including mortgage rates. But there are widespread concerns about the surge in unsecured consumer borrowing where the ability to repay is highly sensitive to changes in interest rates, real incomes and employment. Consumer credit includes dealership car finance, personal loans, and credit cards. Commercial banks provide around 80 percent of lending in credit and personal loans, but less than half of dealership car finance.
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