Why the UK will outperform the naysayers in 2018
You wouldn’t credit it to see the queues of traffic coming into London on Boxing Day morning, but post-christmas retail spending seems to have got off to a poor start, with footfall well down on the year before. Ridiculous though it might be to judge the outlook for the coming year on just one day’s experience, the numbers appear to have set the tone; forecasters are generally expecting another downbeat year for the UK economy.
The case for such gloom is easily made. The post-referendum spike in inflation may be largely over, but in the round, wage growth still lags price increases, and will likely continue that way for much of next year.
To date, households have compensated for this shortfall by borrowing more and saving less; even for the famously spendthrift British consumer, the thinking goes, there must be a limit to this propensity. Bank of England action to clamp down on unrestrained growth in consumer borrowing adds another dampener. What is more, the post-crisis jobs boom may finally be running out of steam, removing another potent source of increased spending power.
Mix in the effects on business investment of Brexit and political uncertainty, and as I say, it is easy to make the pessimistic case. Yet despite these obvious headwinds, there are – lurking behind the scenes as it were
– a number of reasons for a more positive view. And no, they have very little to do with the supposed “sunlit” uplands of post-brexit Britain. If those uplands exist at all, they won’t have any meaningful impact for some years yet. The first, and possibly most important, is that the world economy as a whole is firing on all cylinders, with the US, Europe and China all growing relatively strongly alongside each other. This is the first time since the financial crisis we have seen such synchronised growth; given the consequent boost to net trade, it makes it virtually impossible, absent of some unforeseen shock, for Britain to experience even one quarter of negative growth over the year ahead, let alone the two consecutive quarters that qualify as an official “recession”.
Second, the fiscal squeeze of recent years is set to ease off quite considerably over the next two years, with policy becoming mildly positive – £2.7bn next year and £9.2bn the year after. Again, this is the first time since 2010 that there has been backpeddling on fiscal consolidation. The amounts are too small to generate a boom, but it is a significant reversal none the less, with more money being found for the NHS and, in time, for enhanced infrastructure spending.
Third, not everyone is seeing their pay squeezed. Indeed, it is the highest paid who are being squeezed the most. We don’t need to worry too much about them. Given already elevated disposable incomes, they are very unlikely to alter their spending habits by much to compensate. Instead, they will save less. The lowest paid, by contrast, are set for an above inflation pay rise of 4.3pc in April as the National Living Wage reaches £7.83. This increase will admittedly be offset in some cases by planned cuts to benefits. Even so, it is possible that in the round, the low paid could end up better off in real terms next year, not less so.
As for middle income groups, they are already over the worst in terms of the squeeze on real incomes caused by post-referendum devaluation in the pound. This squeeze is set to fade over the course of the next 12 months, with resumption of some real wage growth by the end of the year.
Fourth, there seems good reason to believe that productivity growth will from here on in quite quickly revive to something not so far off the pre-crisis trend. This belief in part reflects growing tightness in the labour market, with increasingly acute skills shortages in some sectors. Full employment both drives up wages, and increases the incentives to invest in labour-saving technology and training. It is true that evidence of such a dynamic has thus far been thin on the ground, even as the labour market tightens, but that doesn’t mean the old “Phillips curve” rules have been permanently suspended.
Previous norms will eventually re-establish themselves; already we see early signs of it, with a pick-up in productivity growth to 1.2pc in the three months to October, driven by fewer hours worked. With enhanced productivity comes more resources for pay rises.
And finally, growth phases are normally brought to an end by the return of inflationary pressures, necessitating interest rate rises to dampen demand. Yet the Bank of England appears in no particular hurry this time around, and with good reason. There is still plenty of spare capacity in Europe and China to help keep the lid on inflation. Automation and artificial intelligence are meanwhile likely to prove a powerfully disinflationary force in the years ahead, taking up where the globalisation of the last two decades left off. Rates may therefore rise a tad over the next year or two, but not by enough to upset the apple cart.
Much could go wrong; the Brexit talks may reach a destructive impasse, the stock market could crash, or possibly some catastrophic geopolitical event could break the present economic calm. But for now, it’s time to bury the pessimism and start investing in the future. Growth is more likely to surprise on the upside than the downside.