threats to uk economic recovery

Threats to UK Economic Recovery and long term Economic Growth

Geoff RileyApril 2014

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?

IMF World Economic Forecast for 2014

Macro objectives

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

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

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

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

Threats to the UK Recovery

Inequality and Immobility

Stagnant Productivity

Rising Costs of Production

Public and Private Debt

Continuing Euro Crisis

Another Housing Bubble

Inequality of Income & Wealth

• Widening wealth and income gap

• Social immobility

Median income = £21,400Mean income = £30,100Mean income for top 1% = £150,000Mean income for poorest 1% = £8,430

Some Threats to the UK Recovery







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

http://www.theguardian.com/business/2014/feb/20/britain-productivity-gap-widens

Threats to the UK Recovery







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

Crude oil prices

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

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

UK Household Debt MountainHousehold (personal) debt

Public Sector Debt

http://www.huffingtonpost.co.uk/2014/04/08/uk-public-debt-ons-george-osborne_n_5109645.html

European Risks

Deflation riskAdjustment 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)

House Prices

http://www.telegraph.co.uk/finance/economics/10739124/London-house-price-boom-could-unravel-warns-Deutsche-Bank.html

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

Housing boom

threatens growth

http://www.ft.com/cms/s/0/214a3bf8-bff7-11e3-9513-00144feabdc0.html

http://www.bbc.co.uk/news/business-26957600

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

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

HysteresisCapitalist 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

Evaluating Coalition Policies for Economic Recovery

Fiscal Austerity Welfare Reform

Competition Policy

Infrastructure Employment Incentives

Other Supply-Side

Coalition Policies1. DEBT CONTROL / REDUCTIONAusterity 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 hardshipTax payers paying off debt in future

44

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

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

Coalition Policies2. SHRINK SIZE OF THE PUBLIC SECTORPublic 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.

Coalition Policies3. NATIONAL INFRASTRUCTURE PLAN£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 ADLRAS effects import too

Time• Very long time lags – will pension fund / insurance companies continue to fund into

the long term?

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

Coalition Policies

4. COMPETITION POLICY 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

Coalition Policies5. IMPROVING GLOBAL COMPETITIVENESSPatent 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 anymoreTrans-Pacific Partnership, US-European trade talksThe rise of South-South tradeGreater use of managed currencies by countries as a macro policy instrument

44

Selected Competitiveness Rankings for 2013

1: Switzerland

2: Singapore

3: Finland

4: Germany

5: United States

10: UK

Competitiveness Indicators1. Institutions and

Infrastructure2. Macroeconomic stability3. Health/education systems4. Financial markets (including

strength/stability of banks)5. Technological readiness6. Market size (linked to

population size and per capita incomes)

7. Business sophistication (quality of supply chains, industrial clusters) and rate of innovation

http://www.bbc.co.uk/news/correspondents/lindayueh/

http://www.bbc.co.uk/news/special_reports/uk_economy/

http://www.theguardian.com/business/economicgrowth

10/04/2023

Loads of Revision Help on Twitter: @tutor2u_econ

http://tutor2u.net/acatalog/Economics-Revision-Guides.html

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

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?

Improving labour supplyAnalysis

• 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

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

Improving labour mobilityAnalysis

• 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

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?

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’.

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

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

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

To what extent could supply side improvements improve UK competitiveness?

Knowledge Applicatio

n

•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.

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

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?

10/04/2023

Loads of Revision Help on Twitter: @tutor2u_econ

http://tutor2u.net/acatalog/Economics-Revision-Guides.html

threats to uk economic recovery

Economy & Finance

uk economy

volatile costs

uk recovery inequality

uk businesses

uk economic recovery

costs derail recovery

uncertainty higher costs

costs of production