Chief Economist’s Weekly Brief

Screen shot of the Treasury website with details of the SPending Review 2015 on it

Underneath the Spending Review headlines was an old, but very important assumption – the UK gets more productive, and fast. Higher productivity means higher wages and thus tax receipts. There are signs of improvement but productivity has fallen short of expectations in recent years. (And Northern Ireland continues to lag the rest of the UK.) Will this time be different?

Slower, smoother. The Chancellor presented his Spending Review last week and took the opportunity to reshape the path for government spending. Better tax receipt projections and savings from lower debt interest payments gave him more room to manoeuvre than expected. He used two thirds of this windfall to slow the pace of spending cuts. Day-to-day departmental spending will now fall by 3% in real terms over the next 5 years, a lot less than the 9% fall in the last 5.

Priorities. But there are big differences across the different areas of public spending. The NHS, defence, aid and schools budgets were all protected so the brunt was borne by other departments. Transport, business and justice fared worst with cuts of between 17%-37%, adding to already deep cuts those areas experienced in the previous Parliament. Proposed changes to tax credits were abandoned and a new tax, the apprenticeship levy, was introduced. We also had a surcharge to stamp duty of 3% for people buying additional homes.

Sore Barnett. Meanwhile Northern Ireland departments will see a cumulative decline of 5% over the next four years in their resource budget. Remember this is the fiscal environment within which a corporation tax cut needs to be funded, which will provide the policy-makers with a head ache. In terms of capital spending, funding available for infrastructure investment via the block grant through to 2020-21 will rise by 12% in real terms, meaning over £600 million more than if it had been held at 2015-16 levels.

The old hope. The Office for Budget Responsibility (OBR) provides the Chancellor’s growth projections and little has changed since its last forecast in July. After expanding by around 2.4%y/y this year, growth is expected to remain at a similar pace right through to 2020. But as with previous forecasts the key assumption is that productivity growth – the Achilles heel of the UK post-crisis recovery – accelerates sharply in the coming years to above 2%. That will be a major challenge, despite signs of an improvement in recent quarters. Once again so much of the forecast, including real wage growth and income tax receipts, hangs on this assumption. It remains the big hope in the Chancellor’s plans.

Spend it. For now at least growth is ticking along nicely thanks to a buoyant consumer. GDP growth in Q3 was confirmed as 0.5% from the previous quarter. Spending by households was up 0.8%. Business investment also had a good quarter rising 2.2%, but the trade deficit deteriorated as imports exceeded exports by £14bn. How sustainable is that mix of growth? Well it’s hard to blame households for splashing the cash. More jobs and higher wages combined to push compensation of employees up 1.1% on the quarter, making it 4.5% higher than a year ago. With inflation so low that cash goes a long way.

Start me up. Northern Ireland continues to lag significantly behind all other UK regions for business start-ups. Overall, the UK’s entrepreneurial streak is alive and well, with the number of new businesses in 2014 numbering 351k, which is the highest figure since comparable records began in 2000. But in 2014 Northern Ireland had the UK’s lowest business birth rate (or start-up rate) at 8.7%.  After Northern Ireland the South West was the next lowest at 11.7%. Northern Ireland also had the lowest business death rate at 8.3% (9.6%). A low business death rate is viewed as a negative as it suggests lack of business churn and competition.

Travel to Work. Net long-term migration to the UK (i.e. net of those leaving the country) totalled 336k in the year ending June 2015, a 32% rise from the previous year and roughly equal to the population of Leicester. In gross terms immigration totalled 636k – more than Leicester and Derby combined. Work is the most common reason for migration. Almost 50% of the 636k migrated for work reasons with 64% of those having a definite job. It’s also worth noting that fewer people are moving out of the UK, too. Emigration in recent quarters is at its lowest level since the turn of the century.

Ready for lift-off?  US data continues to point to decent growth. But as has been the case all year it isn’t screaming that rate hikes are required now. US consumer spending rose less than forecast for the second month running in October, nudging up by just 0.1%. Meanwhile inflation remains far from worrying. The central bank’s preferred measure of inflation showed prices rising 1.3%y/y in October, less than the 1.6% average reading of the past four years.

Mixed. It was a mixed week for the Eurozone economy. On the plus side the composite Purchasing Managers Index – a survey of private sector activity – rose to its highest level since May 2011, suggesting economic growth, although modest, is continuing. On the other hand the number of unemployed in France reached a record level of 3.59 million. And economic threats to the eurozone from overseas remain pronounced. The European Central Bank’s bi-annual Financial Stability Review stated that emerging market vulnerabilities had increased in recent months with China “of particular concern”.

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