Andrew Lilico is Executive Director and Principal of Europe Economics.
On the face of it, the UK economy is in fairly good health. But we face some non-trivial risks, and should expect a modest slowing over the next year or two, and a few bumps on the road out to the end of this Parliament.
The basic numbers are fairly solid. GDP growth in the twelve months to March 2017 was two per cent. That’s probably at about, or perhaps fractionally above, the sustainable growth rate of recent years. The first three months itself showed a bit of a dip, at 0.2 per cent growth over the quarter, but that’s been the first quarter pattern of recent years — growth was 0.2 per cent in the first quarter of 2016 and 0.3 per cent in the first quarter of 2015. As in recent years, 2017 seems to have shrugged off the first quarter dip in the next three months, with standard forward indicators suggesting the April to June 2017 period might have growth of around 0.5 per cent.
Unemployment was at 4.6 per cent in February to April (the latest data available), down from five per cent in the same period in 2016. One has to go back to the early 1970s to find a time when UK unemployment was so low. Salaries are growing at 2.1 per cent, versus 2.2 per cent in the year to April 2016. However, inflation was 2.6 per cent in the year to April 2017 versus only 0.7 per cent in the year to April 2016. So wages are falling in real terms. The Bank of England expects inflation to rise a little further over the second half of 2017, perhaps reaching three per cent or more by September before falling back over the following year. This period of falling real wages will probably bear down on growth a little. The Bank of England expects GDP growth in 2017 as a whole to be 1.9 per cent (about the same as 2016), followed by 1.7 per cent in 2018 and 1.8 per cent in 2019. Steady as she goes.
The pound sterling appreciated quite significantly in value between 2013 and 2015, as other countries around the world enacted quantitative easing and negative interest rates programmes (the so-called “currency wars”) in response to their economic difficulties, but the UK chuntered along steadily. On a trade-weighted basis the pound rose from 77.9 per cent of its January 2005 level (an index level of 77.9) in March 2013 to 94.7 in August 2015 (a rise of 22 per cent). It then started to fall back, particularly from November 2015, reaching 83.5 in April 2016 (a drop of 12 per cent). The EU referendum result then saw a further downleg, with sterling reaching 73.8 in October 2016 (a further drop of 12 per cent), before the pound started to recover. As of end-June 2017 it was 77.5 — almost exactly the same as its March 2013 level, before the currency wars began.
The government budget deficit is now just under three per cent of GDP — back to a “normal” deficit level that would meet the Maastricht Convergence Criteria for joining the euro. In the 2017 budget it was scheduled to go below one per cent over the next two or three years. With the General Election result and the subsequent abandonment of social care reforms, pensioner benefits restrictions and now probably also the public sector pay cap, we should assume there will be little to no further deficit reduction until Brexit is out of the way. Deficits of two to three per cent of GDP will become the norm for a while.
Overall, then, the economic picture is relatively sanguine, though by no means spectacular. The sort of dull picture that keeps economic stories out of the headlines.
There are, however, a series of non-trivial risks. Once we get ahead to around 2022-2027, there are some upside risks such as autonomous vehicles expanding faster than currently anticipated. But for the next two to three years risks lie mainly on the downside.
The first and most serious risk is that of a Jeremy Corbyn government. Indeed, if that scenario were to be realised it would dwarf almost other factors so much as to render them almost irrelevant. His official plans to require all businesses to establish executive boards with majorities of workers on them, to mandate social duties on all private businesses, to introduce maximum multiples of highest pay to lowest pay in companies (a de facto maximum wage), the “excessive pay levy”, the financial transactions tax, and the widespread nationalisation of utilities, not to mention more mundane measures such as the large rise in higher rate tax, would by themselves induce serious capital flight.
But of course no-one believes those measures from the already extraordinarily left-wing 2017 manifesto would be the limit of his ambition. In due course there would surely be capital controls to prevent money being removed from the country, so smarter investors would sell their houses and businesses early, before the big capital taxation rises and capital controls came in. Those wanting to educate their children privately would also doubtless anticipate the inevitable huge rises in fees and then abolition of private schools, and so relocate their families to countries where private education remained available and secure.
Capital flight would lead to a large fall in the pound, inducing inflation and probably necessitate interest rate rises to attempt to stabilise the outflow of capital. Some rate rises may be coming anyway, given that the Bank of England voted only 5-3 against raising rates at its most recent meeting. But a Corbyn victory would entail either accepting much greater inflation or much higher rates. Either way, household budgets would be rapidly squeezed, even setting aside the impact of tax rises.
Other non-trivial risks include Brexit. I am a Conservative, so I do not expect change to be costless. A good Brexit deal with the EU, including common sense transitional arrangements to smooth the path to the new arrangements, should mean we lose only two to three per cent of GDP growth in the transition period. So we might be growing at 1.5 per cent per year for two or three years instead of 2.5 per cent.
But the Brexit deal could go wrong. If it seems like a Corbyn government might come in at any time, seeking almost exactly the opposite deal to a May government (e.g. May would want no state aid and guaranteed free capital flows; Corbyn would want state aid and restrictions on capital flows), the EU could find it difficult to know whom it was dealing with unless there were another General Election to show that Britain had a settled will as to what post-Brexit deal it is after and would stick to. But the consequences of a Corbyn government would be so catastrophic that, if the polls suggested he might win a 2019 General Election, the Conservatives might prefer to hang on until 2022 even if that meant leaving the EU with no deal. There would be economic consequences.
A third important risk comes from Trump. His administration seems set on significantly increasing tariffs on imports — doubling in many cases. The US is the UK’s single largest trading partner country, so big rises in tariffs on our exports there could be a problem. Trump tried to offer us a trade deal in 2017 that would have meant our avoiding such impacts (indeed, we might potentially have gained from his increasing tariffs on other countries than us), but (rightly or wrongly) we’ve turned him down.
So, overall, the economic picture as of mid-2017 remains much as it has been for the past five years. Growth is steady if unspectacular. Unemployment is very low. Wage growth is weak. The budget deficit is falling but only very slowly. Inflation is modest. Interest rate rises, as ever, seem like they are just around the corner (though they never quite arrive).
There are, however, some quite important risks. The biggest is the economic catastrophe that a Corbyn government would constitute. The next is that Brexit could now be less smooth than it should have been (particularly because of the risk of Corbyn). A third is that, because we’ve turned down a trade deal with the US, big rises in tariffs there could harm us.
Don’t panic, though. If the Conservatives can cling on by their fingernails for a while, it all might yet, just about, be okay.