Sunday, January 29, 2023
Growth is the problem, and there's no obvious solution
Posted by David Smith at 09:00 AM

My regular column is available to subscribers on This is an excerpt. Not to be reproduced without permission.

In the end, it is all about growth. Generating economic growth is the way to boost prosperity, to improve living standards. We have seen in recent months a cackhanded attempt to boost growth, the excruciating but mercifully brief Liz Truss premiership, and That September 23 mini budget from which the mortgage market and many pension funds are still recovering.

The growth debate is exercising the Tory party, with some even urging unaffordable tax cuts, despite the Truss catastrophe. Jeremy Hunt, in a speech on Friday, tried to head off these calls by insisting that he has a long-term plan for growth.

It is tempting to think that worries about growth are a recent phenomenon, but let me quote to you a prime ministerial speech. This prime minister, a Tory, apologised for doing things that were against his party’s instincts, but it was, he said, in a good cause. “I need long-term growth. A stronger, more prosperous country…” he said. “My target is growth every year; higher living standards every year; manufacturing growing every year; public services improving every year – and to do that without fear of inflation.”

That was John Major, speaking to the Conservative spring conference in April 1995. He made two predictions. The first was that “present policies” could double living standards every 25 years, the second that the Tories would win the 1997 election.

I find this quite interesting, and not just because many see parallels between the situation Rishi Sunak finds himself in now and that of Major in the 1990s. The Tories were riven by sleaze and disagreements over Europe, to the point that even four years of strong economic growth in the run-up to the 1997 election did not rescue them from a landslide defeat. People no longer trusted them and doubted their economic competence after earlier episodes, including sterling’s “Black Wednesday” exit from the European exchange rate mechanism (ERM) in 1992.

The other thing is that, in the middle of that strong growth period, which we would now give our eye teeth for, there was dissatisfaction. We would also give our eye teeth for a doubling of living standards every 25 years. It sounds like a mad ambition, but it was not so odd.

We have official figures for real disposable income per head, the nearest proxy for living standards, going back to the start of 1955. Over the following 25 years, to the start of 1980 (when the economy was in recession), this measure rose by 88 per cent. At the end of 1979 it was up by 93 per cent, so not far short of doubling.

Over the next 25 years, to the start of 2005, it rose by a further 88 per cent.

But then, and you know where this story is going, it slowed. We did not yet have a 25-year period from 2005 but in 17 years real disposable income per head is up by 11 per cent, or barely 0.5 per cent a year compounded. Major did not stay around to deliver the policies he hoped might deliver a doubling of living standards, though the rise from 1995 to 2020 was 45 per cent.

He would have strongly opposed Brexit, one key factor reducing growth, and did so from his position as a former PM. Latest figures show real incomes per head last year were running below their levels in the spring of 2016, the eve of the referendum.

Sunday, January 22, 2023
Inflation is far from licked and pay is starting to become a worry
Posted by David Smith at 09:00 AM

My regular column is available to subscribers on This is an excerpt. Not to be reproduced without permission.

Recent days have brought what looks on the face of it to be more good news on the economy. Inflation fell again to 10.5 per cent and appears to be past its peak, which is welcome. We should never forget that, in the absence of government price support, in particular this winter’s freeze on household energy bills at an average of £2,500, we could have been looking at 13 or 14 per cent consumer price inflation by now.

The labour market is softening, but only slightly, with a small rise in unemployment in the latest three months not enough to lift the unemployment rate above a very low 3.7 per cent. There was also tentative evidence in the latest three months that more people in older age groups, 50-plus, are returning to the labour market; becoming “economically active”.

It is early days, but there is no reason as yet to change the story I gave you here on New Year’s Day, which was that this will be a year of mild recession, at worst, and falling inflation. You should not need Jeremy Hunt’s video explaining inflation with the aid of coffee cups to be able to predict a fall in inflation this year.

I hate to be the bearer of bad news, however, but these things are often in the eye of the beholder. What to many would look like a predictable and reassuring set of figures has the capacity to set alarm bells rising amongst others.

Take the inflation figure for a start. Yes, the headline rate fell again but, looked at from the perspective many consumers, or the Bank of England, the picture was much less reassuring.

Food price inflation, as has been widely noted, rose to 16.8 per cent last month, its highest yet in this sequence. A year earlier, in December 2021, it was a mere 1.6 per cent. Combine that with the fact that, in spite of the energy price freeze, household fuel bills were up by 88.7 per cent over the latest 12 months and you can see why people might have decided it was too soon to celebrate.

Indeed, figures on Friday, the widely followed GfK index of consumer confidence, showed a three point fall this month, taking it down to almost its all-time low, reached last September. Most measures in the index fell. People are gloomier about the economy over the next 12 months than most economists and think this is bad time for major purchases. The 1 per cent fall in retail sales last month, for a drop of nearly 6 per cent over the past 12 months, can be seen in that context.

The weakness of consumer confidence in the GFK index is something to behold. It has been running since 1974 and has thus existed through many recessions and crises. For confidence to be weaker now than ever before, including the global financial crisis and the pandemic, is quite something. People expected something better than this post-pandemic squeeze and sharply higher bills.

Those doubts about whether this is a time for major purchases also probably played a role in another strikingly weak survey, this time on the housing market from the Royal Institution of Chartered Surveyors. It tells a story of potential buyers being scared off by higher mortgage rates and of deep gloom on price and expected sales. The balance of surveyors reporting falling prices was the highest since 2010.
Looked at from another angle, that of the Bank from its headquarters in Threadneedle Street, there were also things to worry about in the latest figures.

Yes, inflation is down from the excruciatingly embarrassing to the highly embarrassing but has further to fall before it is merely very embarrassing but there was bad news in the detail.

“Core” inflation, which excludes energy, food, alcohol and tobacco, remained stuck at 6.3 per cent last month, the same as in November. It started the second half of last year at 6.2 per cent, briefly rose to 6.5 per cent but looks so far stuck at a level incompatible with the official 2 per cent inflation target. Economists describe this as inflation persistence and fear that it may be more persistent in the UK than elsewhere. Even when energy and food prices settle down, core inflation has to fall before the job can be said to be done.

Sunday, January 15, 2023
A league table which tells us we need to raise our game
Posted by David Smith at 09:00 AM

My regular column is available to subscribers on This is an excerpt. Not to be reproduced without permission.

It is never too early in the year, dry January or not, to tackle the big issues, and regular readers will know that there are few bigger issues than the UK’s poor productivity performance. It explains the prolonged weakness in real wages, the biggest driver of living standards. As things stand, real wages are still marginally below where they were in early 2008, which adds up to roughly a “lost” decade and a half.

Fortunately, the Office for National Statistics has given me a reason to return to the issue by publishing a few days ago, its annual international comparisons of productivity, comparing the UK with other G7 nations.

Mostly, the exercise compares the UK with five of the other six, because data problems prevent a full assessment of where Japan was on productivity in 2021, the relevant year. That is not a huge problem, because for at least 40 years Japan has been the productivity laggard in the G7, which some people still find surprising. Japan has an efficient manufacturing sector but a combination of lifetime employment (which results in over-employment) and a weak services sector gives it low overall productivity.

Of the rest, the UK’s output per hour worked is a little better than Italy and Canada, but quite a lot worse than France, Germany and America. On the output per hour measure highlighted by the ONS, French labour productivity is 18 per cent higher than the UK, Germany 19 per cent and America 25 per cent.

This is all quite concerning. You may recall that, before the pandemic, there was a suggestion that the UK might not be such a productivity laggard because hours of work in this country were being overestimated. The gap, however, remains.

It is also there when productivity is measured by output per worker. This time, the UK is behind every other G7 country except Japan, so including Canada and Italy. US productivity, on an output per worker basis, is almost 50 per cent higher than the UK.

“These figures confirm that the UK remains behind other leading nations in the productivity race. But, while we’ve trailed for over a decade, it’s not an intractable challenge,” said Anthony Impey, chief executive of Be the Business, an organisation which champions small business productivity, “We often refer to the UK’s lagging productivity figures as a ‘puzzle’ - but we can crack the code and close the gap by inspiring businesses to work more efficiently.”

What do these figures tell us about the effect of the pandemic on productivity, and the changes it brought about, including furlough schemes, working from home, and so on? Taking the annual figures for 2020 and 2021 together, something unusual happened as economies swung into recession and back out of it again. Hours worked dropped sharply, particularly in 2020, and output per hour showed a sharp rise in the UK, rising by an average of 5.1 per cent a year in 2020 and 2021, with even stronger rises in Canada, 6.1 per cent, and Italy, 5.9 per cent.

These figures, however, tell us very little about underlying productivity growth, which on an output per worker basis fell by an average of 1.2 per cent a year in the UK in 2020 and 2021. Other figures from the ONS, covering the UK only and taking us into 2022, published late last year, showed that productivity on an output per hour basis was in line with its weak pre-pandemic trend, while growth in output per worker was quite a bit below that trend.

The debate about the impact on productivity of working from home will continue. These are early days, and we are yet to see where it settles. So far, however, there is no evidence that it has moved the dial on productivity in either direction.

What can we do about the productivity problem? Quite a lot. Skills are a particular problem for the UK, with the Edge Foundation’s latest Skills’ Shortages Bulletin highlighting Open University research which shows that 78 per cent of organisations have suffered a decline in output, growth or profitability as a result of an inability to recruit suitably qualified people.

Sunday, January 08, 2023
The peak is in sight for UK interest rates
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt. Not to be reproduced without permission.

One of the big questions for this year is how much interest rates will go up. 2022 saw plenty of action on this front, with official interest rates in the UK rising from 0.25 per cent in January to a 14-year high of 3.5 per cent. The Bank of England, having been accused of being asleep at the wheel, was relentless in raising rates, doing so at every opportunity; all eight scheduled meetings of its monetary policy committee (MPC).

In Bank circles, the analogy of “boiling the frog” used to be employed to describe the impact of raising interest rates. At first the effect is quite pleasant, as the water gets gradually warmer. Then it starts to get a bit uncomfortable. Then, before you know where you are, you have killed the poor little fellow.

The Bank started gradually last year, with quarter-point rate hikes, which have been the norm since independence in 1997. Then it went into overdrive, partly influenced by what other central banks were doing, with three half-point hikes and one of three-quarters. That suggests a degree of urgency, even panic, as inflation raced into double figures.

What happens next? As I wrote last week consensus forecasts among economists are for a big fall in inflation this year, though not a return to the 2 per cent target. A degree of humility is appropriate – most did not see this inflation coming – and there are new debates about whether China’s abandonment of its zero Covid strategy could, by spurring stronger growth, add to inflation. There is also uncertainty about the course of the war in Ukraine and its impact.

But I am going to stick to my view that the peak in interest rates is in sight and that the peak should be about 4 per cent. That implies, either a final half-point rise on February 2, the next announcement, or a quarter then and another on March 23.

Why do I think this? There are a few reasons. If we look under the bonnet of the last of the MPC’s rate hikes in 2022, announced on December 15, it was rather interesting. Two members, Swati Dhingra and Silvana Tenreyro did not think any increase was needed and would have preferred to leave the rate at 3 per cent, arguing that the economy was already weak and, because of the lags involved in monetary policy, most of the effects of the rate rises already announced had yet to come through. They fear for the fate of the frog.

One member, Catherine Mann, took the opposite view and voted for a rise of three quarters, while the majority favoured a half-point increase. That majority, it should be said, warned of further increases but the emergence of a “dovish” wing on the MPC, which thinks enough has already been done, should constrain the Bank from acting too aggressively.

The second central point is that the evidence of the impact of higher interest rates on the economy is already coming through. Though mortgage rates have become somewhat disconnected from Bank rate, and the effects of the Truss-Kwarteng mini budget are still casting a venomous spell, the slump in mortgage approvals announced by the Bank a few days ago, was striking. Mortgage approvals in November, 46,075, were 30 per cent down on the average of the previous six months and nearly 40 per cent lower than their level as recently as August.

The impact of the Bank’s monetary tightening can also be seen on the wider economy. Deloitte’s quarterly survey of CFOs (chief financial officers) showed that higher interest rates have reduced the appetite among firms for taking on more debt.

Sunday, January 01, 2023
Mild recession and falling inflation - barring accidents
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt. Not to be reproduced without permission.

Consensus is rarer these days than it used to be, now that we argue about everything, but it can be useful. Consensus forecasts for the economy enable us to see what the average expectation is for the year ahead, the wisdom of the economic crowd, if you like. They also allow us to look for areas where it might be useful to aim off that average expectation.

For some years the Treasury has performed the useful service of compiling a monthly set of tables of independent forecasters’ predictions. I think it arose from the time when it was responsible for the government’s official forecast and was criticised for ignoring what other forecasters were saying.

It is invaluable to me because I use it for compiling my annual forecasting league table, which I shall do in a couple of weeks. It also allows us to see what forecasters – and more than 30 are included in the survey - expect.

The latest compilation published a couple of weeks ago showed an average expectation for gross domestic product in 2023 for a fall of 0.7 per cent, a recession, but quite a mild one. Around that there is a range, with the gloomiest new forecast (made within the past three months) a fall of 2 per cent, and the most optimistic a rise of 0.7 per cent.

A year ago, nobody expected a recession in 2023 but a continued, if modest, post-Covid recovery of roughly 2 per cent growth. There is a similar pattern to inflation forecasts. Everybody is convinced that inflation, having topped 11 per cent recently, will fall. But the extent of that fall, to an average of 5 per cent by the final quarter of this year, with a new forecast range of 2.2 to 7.4 per cent, shows that uncertainty about the inflation outlook remains.

Early in 2022, the expectation was that there would be brief inflation peak last spring, after which it would fall rapidly. The cost-of-living crisis, which is the main factor driving the economy into recession, would have eased months ago, instead of which it intensified.

What else can I tell you about what forecasters are expecting? Government borrowing, the budget deficit, is expected to remain every high, with an average forecast of £166.9 billion for this year, 2022-23, followed by £133 billion in 2023-24. For comparison, the figure for 2021-22 was £125.4 billion. This was supposed to be a time of repair for the public finances, but they remain fragile.

The current account deficit, representing the UK’s external transactions, is put at £125 billion for this year, after £133 billion in 2022, so plenty or red ink there too. I should also mention the unemployment rate, which is a very low 3.7 per cent, having been down to 3.5 per cent, but is expected to rise to about 4.5 per cent by the end of the year.

These consensus forecasts, as I say, can be very useful and tell of a mild recession, a fall in inflation but to some way above the official 2 per cent target, big budget deficits and the UK’s external vulnerability because of a large current account deficit. I think you could describe the outlook as mixed; not terrible but not great either.

Sunday, December 25, 2022
Those who live by the markets can be undone by them
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt. Not to be reproduced without permission.

This is my last column of 2022, and this is not a normal Sunday, but I cannot let it go without reflecting on something than happened three months ago, before the memory begins to fade and it takes its place in history.

Just over three months ago, on about September 20, I was a long way from London – I won’t say where – when news reached me about Kwasi Kwarteng’s forthcoming mini budget on September 23, a rare important Friday economic statement; normally a very quiet day in Westminster.

Had that news reached me a few days earlier. I would have shared it with you, but it was too late for a Sunday journalist, or for that matter for my midweek column for The Times.

The news, of course, was that the then chancellor intended to throw the kitchen sink into his mini budget, not just reversing the increases in national insurance and corporation tax but bringing forward a penny off the basic rate of income tax, abolishing the 45 per cent additional rate of income tax – then the rate on incomes above £150,000 (now just over £125,000) – as well as scrapping the cap on bankers’ bonuses.

The odd thing about this, and its most eye-catching element, getting rid of the 45 per cent rate, was that it was immediately clear to me, and to my informant, that this would go down like a lead balloon with voters and the financial markets.

Those who cheered it to the rafters, and quite a few did, did not understand markets, nor voters. Neither did the then prime minister, Liz Truss, nor her first chancellor, Kwarteng. I assume it may have been their naïve belief that a mini budget which abolished the cap on bankers’ bonuses and the 45 per cent rate would have gone down a storm in the City, an echo of Nigel Lawson’s historic 1988 budget. But there is a big difference between what is good for well-rewarded individuals and how they will respond as market players. Many of the hedge fund grandees who were significant personal gainers from the proposals profited by shorting the pound. As it is, the consequence of all this is that the 45 per cent rate now kicks in at a lower level of income than before, it abolition having been scrapped, and more. Quite funny really.

The Truss-Kwarteng period, brief though it was, was damaging. The former chancellor is gone, but so is the well-respected former top civil servant at the Treasury, Sir Tom Scholar, who Kwarteng sacked on arriving in the department. He, I think, would have advised against the mini budget but his sacking discouraged others in the Treasury from speaking out. You might have thought that Scholar could have been reinstated when Kwarteng went, but apparently that does not happen. Politicians come and go but professional civil servants, once sacked, stay sacked.

The reason that the Truss-Kwarteng episode also stood out was that it was the first time I can think of that a UK prime minister and chancellor have been brought down by the reaction of the financial markets. A badly received budget in the markets used to be the FTSE-100 falling by 40 or 50 points and sterling dropping a cent against the dollar. People used to say that a budget which went down badly on the day would look good six months later. The reaction to this one was thus off the scale and that rule would not have applied.

The mini budget, and some unwise comments from the then chancellor about even more tax cuts on the near horizon, not only sent the pound crashing to a record low but also, for a time, provoked the biggest crisis in the gilt (UK government bond) market in decades, perhaps ever.

The Bank of England, which was required to intervene in the gilt market in financial stability grounds, to prevent a so-called doom loop in which pension funds needing to meet their short-term obligations were forced sellers of gilts, should perhaps have been more aware of the risks. But it had no idea that the then prime minister and chancellor would do anything quite so stupid and was forced to mop up.

It is hard to argue, on this occasion, that what the markets did was wrong. Governments should not get away with a ridiculously cavalier approach, or with undermining the UK’s institutions, including the Bank and Office for Budget Responsibility (OBR). Truss and Kwarteng deserved what they got, though we as voters did not deserve them.

Kwarteng has since said, in effect, she made me do it, though I do not think he will ever lose his reputation as the chancellor who crashed the markets. Truss, by all accounts, is unrepentant. She promised to hit the ground, which she did, but appears to think that only by trying to do too much at too quickly did she fail to hit the ground running.

We can debate what might have happened had the contents of the mini budget been limited to merely reversing the hikes in national insurance and corporation tax, as Truss promised during the Tory leadership contest. They were anticipated and thus “in the market” so there would have been no logical reason for the kind of reaction that we saw, Who knows? Perhaps Truss would still be prime minister and Kwarteng chancellor, though as a team they were an accident waiting to happen.

Friday, December 16, 2022
A year of damaging inflation - and of a loss of credibility
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt. Not to be reproduced without permission.

When you look back on this year, one thing sticks out like the proverbial sore thumb. The return of inflation has been painful and all-encompassing. It has dominated economic and business decisions, given us the worst industrial relations climate in decades and led to more interest rate hikes in any year since 1988, of which the latest was the expected half-point rise on Thursday, taking Bank Rate to 3.5 per cent, its highest level since early November 2008.

Though the latest inflation figures a few days ago showed a fall in the annual rate, from 11.1 to 10.7 per cent, and may indicate that we are past the peak, we are ending the year with inflation in double figures, which not many expected. Retail price inflation, and you may wish to cover your eyes now, was 14 per cent last month, from 14.2 per cent in October.

This time last year, it was possible to report on an inflation rate which, while rising, was still only just over 4.5 per cent. Forecasters expected a peak in the spring and a fall in the second half of the year. In the Bank of England’s case, the spring peak was expected to be about 5 per cent, before a fall to roughly 3.5 per cent now.

They did not factor in or expect the Russian invasion of Ukraine, though it is likely that their forecasts would have provide optimistic even in the absence of it. Measures of “core” inflation, excluding food and energy, are indirectly affected by higher energy prices, but have averaged close to 6.5 per cent in the second half of the year. Core inflation is currently 6.3 per cent.

Businesses, which a year ago were looking forward to a strong post-Covid recovery, had every incentive to invest this year, it seemed, given the corporation tax “super deduction” announced by Rishi Sunak when he was chancellor. But managing their way through rising costs and high inflation took priority and business investment was down marginally in the latest quarter, and 8.4 per cent below pre-pandemic levels.

High inflation, meanwhile, fundamentally changed the labour market and wage calculations. Regular pay growth in real terms turned negative in November last year and has remained sharply negative since. Real wages have been falling, and particularly sharply for some groups of workers. Inflation gave us the biggest drop in household real incomes since records began in the mid-1980s.

Inflation’s return, in the form of a powerful economic shock, has also shaken us out of the complacency of recent decades. In that respect it is a bit like the as yet elusive quest for a return to normal rate of productivity growth. Before the financial crisis, it was a given that, no matter what you did to the economy, productivity growth would still trundle along at 2 per cent a year. Then the spell was broken, and a return to that 2 per cent would be regarded as a triumph.

Sunday, December 11, 2022
How to fix a labour market that has stopped working
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt. Not to be reproduced without permission.

It has been a momentous year in many respects, some good, plenty bad. For Britain’s labour market, it has been mostly bad. For years, a flexible labour market had been one of this country’s great advantages. It delivered a rise in the number of people in employment of four million, or 14 per cent, between the start of 2010 and the end of 2019.

A year ago, there was relief that the end of the furlough scheme was not followed by a significant rise in unemployment. Strikes were such a rarity that the Office for National Statistics had suspended publication of the monthly figures for industrial disputes in the pandemic. Labour shortages were starting to emerge in some sectors, but they appeared to be a temporary, post-pandemic phenomenon and not particularly out of the ordinary.

Today, things look different. Strikes, concentrated in the unionised public sector and former nationalised industries, have begun to do serious damage and tell of a country that does not seem to work anymore. We have not seen a concentration of strikes like this since the winter of discontent of 1978-9, which helped bring down the government of the day.

Labour shortages are rife, preventing businesses that want to expand from doing so and forcing plenty of others to limit hours of operation. According to the latest Recruitment and Employment Confederation/KPMG report on jobs, permanent job placements have fallen for the second month in a row, as candidate availability continues to fall because of “tight labour market conditions, fewer foreign workers and a greater hesitancy among people to take up new roles due to increased economic uncertainty”.

The number of working age people (officially measured as those aged 16-64) who are economically inactive is up by more than 600,000 since early 2020. Michael Saunders, a former member of the Bank of England’s monetary policy committee, now with Oxford Economics, estimated in a recent commentary for Oxford that the workforce is a million smaller than pre-pandemic trends would have suggested.

In sharp contrast to the strong employment growth of the 2010s, the UK now has the weakest record in the G7 and as the Institute of Employment Studies (IES) points out, has tumbled from sixth to 12th place for employment rates (the proportion in work) among OECD countries.

If the pre-pandemic trend had persisted, the total number of people employed might have been expected to rise by about a million over the past three years. As it is, the actual figure shows a drop of 300,000. Even allowing for the damage from the pandemic recession, this is a very weak performance.

We will get new figures from the Office for National Statistics on Tuesday, though employment has been flat at best since the spring. UK employment is down by about 1 per cent since before the pandemic, compared with a rise of 2.1 per cent for the EU, 1.6 per cent for Germany and 1.5 per cent for France. If employment is now turning down, we may not get back to that pre-pandemic employment level for some time.

What can be done about our dysfunctional labour market? Starting with strikes, each differs in the detail, but the root cause is similar. For public sector workers, and for those where the government stands behind employers, such as the railways, the biggest falls in real wages are happening.

A situation in which private sector pay is rising by rising by nearly 7 per cent a year against public sector pay of 2 per cent would not be sustainable in any circumstances, let alone when inflation is in double figures.

A government that, admittedly under a different prime minister, was willing to announce big unfunded tax cuts will have to find more money for public sector pay settlements. A 19 per cent pay increase, demanded by England’s nurses, is impossible to justify. A 7.5 per cent increase, which the Scottish government has offered to its nurses, avoiding strike action, is not.