The buoyant state of the UK economy has gotten a lot of tongues wagging recently, including those whose predictions of a Leave vote aftermath have fallen on stony ground. Remainers got their short-term economic forecasts wrong, and have had to learn humility. Soon it will be the turn of Leavers.
So what went wrong with the darker forecasts and how robust is the economy?
The economy expanded by 2.4% at an annualised rate in the quarter both before and after the referendum. Judged by manufacturing and services survey data, housebuilding and car registrations at the end of 2016, it looks as though GDP in the final quarter was running at about 2%. The first estimate will be published on January 26.
The principal reason for the forecast “miss” was that forecasters got household consumption wrong. The Bank of England cut interest rates and relaunched its bond-buying programme known as QE. Sterling fell sharply, propelling the stock market up and generating a wealth effect.
Most important of all, the savings rate dropped from 6.1% before the referendum to 5.6% afterwards – all the more notable for the future because real disposable income actually fell by 0.6%. The counterpart of this was a rise in household borrowing, with November’s rise of nearly £2 billion pushing annual growth to nearly 11%, the highest since 2005. So far the debt to income ratio is only just starting to levitate, but it clearly won’t continue for very long – and when it stops rising, consumption could become a drag on the economy.
Remember that the UK was not alone. The US, China, Germany, France, Italy and even Greece all finished 2016 better than they started. In any event, looking in the rear view mirror and out the side windows at the economy makes no sense for either side of the Brexit debate as a guide to the next 1-2 years.
Looking forward, most agree that inflation will rise, perhaps to about 3% over the coming year, crimping people’s real incomes and consumption. The trade deficit has been widening again in a fractious world trade environment, and business investment, which is key to the overall outlook and productivity growth, remains trendless, and over 2% weaker in the third quarter than a year earlier.
Output per hour is only just back to where it was before the financial crisis. Public borrowing is expected to be £150 billion more than previously forecast for the period 2016/17-2020/21, and the funding crisis in the NHS and social care systems is getting steadily worse. These are not auspicious times, whatever the macro headlines say.
Enter the Brexit factor
To top it, Brexit will now become a significant factor, with Article 50 probably triggered in March. Following on from the prime minister’s recent statement, businesses will have to prepare for life outside the EU’s single market, and most likely outside the customs union. Leading financial services companies are doing so already, and we should expect automobile and other major companies to reflect hard on their future investment location and production priorities.
The government will not be able to strike a satisfactory trade agreement with the EU by 2019 and this will dampen the things that determine our trend growth, such as trade, investment, migration, and associated productivity enhancements. The government will of course try to make trade agreements with the US, Australia, New Zealand, India and China, for example, but most of the countries in the government’s “queue: are either too small to matter or too big to let us have the trade we want. Trump’s America will be looking to cut our trade surplus with the US, and sell agricultural and pharmaceutical products that we might not want or favour.
The government could, of course, mitigate all these consequences by implementing a strategy to boost investment, improve the corporate governance system, secure finance for the scaling up of small businesses, strengthen skills and create more sustainable health systems for an ageing society. But none of this is on the table.
Cheer the economy at the moment by all means. But looking to the future, you either have to have belief, which belongs in your preferred place of worship, or you have to have coherent ideas about what drives growth and living standards. Belief may make you feel better, but won’t make things happen.
George Magnus is the former Chief Economist of UBS and Associate at Oxford University’s China Centre
Edited by Hugo Dixon