David Smith's EconomicsUK

My Sunday Times piece is available on www.thetimes.co.uk – this is an excerpt. Not to be reproduced without permission

In deciding on a topic for this week, I could have just written about rising Middle East tension which, in combination with the war in Ukraine, could derail the global economy and with it the UK.  It is a danger, and it adds to a troubling sense of uncertainty, but so far the economic damage appears to be limited.

It is more than two years since Russia illegally invaded Ukraine and, while that helped fuel uncomfortably high inflation, it did not stop the world economy from experiencing a reasonable post-pandemic recovery.

On International Monetary Fund (IMF) figures, world gross domestic product (GDP) grew by 3.5 per cent in 2022, the year of the Russian invasion, and by 3.2 per cent last year, a rate it is predicted to maintain this year and next. The UK economy had a good year in 2022, growing by 4.3 per cent, but managed a barely positive 0.1 per cent growth last year and is predicted by the IMF to grow by 0.5 per cent this year, only marginally better than flatlining.

Though they do not get much credit for it, and in the case of the Bank of England has been subject to some batty criticism recently, for the past two years central banks have been trying to get inflation down without driving their economies into recession. The soft-landing scenario, or what some call “immaculate disinflation”, has been the unofficial aim.

The Bank almost blotted its copybook on this when the UK went into “technical” recession in the second half of last year. But this not a useful way of looking at it, and the economy should have made up the small amount of ground it lost then by the end of the first quarter. The penalty for getting inflation down has, though, been an economy that has barely grown since early 2022 and has suffered a prolonged fall in GDP per head.

Now, however, the question is whether the road to a soft landing has become rather bumpier, and not just because of those international tensions. They have not been reflected yet in higher oil prices, the usual bellwether, with the price of Brent crude still stuck at about $90 a barrel. Gas prices, which we have learned to take more notice of, are however up over the past month, by a few per cent.

This is not a significant reason why the road has got bumpier. It is still likely that inflation figures for this month, to be published in May, will show a big fall to very close to the 2 per cent target because of the previously announced reduction in the energy price cap.

That will not remove some of the concerns, particularly for the Bank, about inflation. The devil is in the detail, and the detail of the latest inflation figures, published a few days ago, was that certain aspects of inflation remain too hot for comfort.

The headline figure for inflation, 3.2 per cent, was a touch lower last month than February’s 3.4 per cent and did not match the recent US consumer price index release in heading back higher (to 3.5 per cent). The UK annual rate fall was, though, smaller than expected and the monthly rise in prices, 0.6 per cent, was quite chunky. The hope is that some of this reflected the build-up to an early Easter, but that is not guaranteed.

Service-sector inflation, regarded by the Bank as the best measure of domestically generated inflation, stood at a high 6 per cent last month, boosted by a 15 per cent rise in insurance premia (and nearly 30 per cent for car insurance), as well as a 6 per cent annual rise in restaurant and café prices, and 7 per cent for accommodation.

These businesses would say they have no choice but to raise prices quite sharply when, for example, faced with a near 10 per cent rise this month in the national living wage, the old minimum wage.

“Underlying services inflation remains red hot even as goods has slowed sharply,” said Allan Monks, an economist with J.P Morgan. “Services inflation tends to be more persistent, and this is a warning sign that inflation may be set to stay high even after the dust settles on the recent swing lower in imported goods prices … it is hard to argue that the MPC (the Bank’s monetary policy committee) should feeling very confident at the moment about sustainably delivering inflation at 2 per cent.”

The inflation figures were not terrible but, as in America, they have punctured some of the euphoria about the consequences of an imminent drop in inflation to the target rate of 2 per cent. If that is seen to be purely an energy price effect, and possibly a temporary one, then the implications in terms of early interest rate cuts may be less than hoped.

In the labour market too, things remain bumpy. The latest figures suggested that the UK is, one hopes just for the moment, experiencing the worst of all worlds with strong wage growth alongside rising unemployment and higher economic inactivity and falling employment and job vacancies.

Continue reading “Achieving a soft landing looks harder than it did”

My Sunday Times piece is available on www.thetimes.co.uk – this is an excerpt. Not to be reproduced without permission

April is the cruellest month, at least according to T.S. Eliot’s The Waste Land, a challenging read. But this April, if you will forgive the clumsy lurch from high art to economics, itself something of an art as well as a social science, has been anything but cruel for many people.

This month has seen, for most workers, a second two percentage point in national insurance (NI). It has also seen a rise of 8.5 per cent in the state pension, which in the context of inflation of 3.4 per cent, represents a very substantial real increase.

That is not all. Though not welcomed by all employers, this April has also witnessed a 9.8 per cent increase in the national living wage, the old minimum wage, with increases ranging up to more than 21 per cent for younger workers.

The minimum wage, a Labour initiative originally opposed by the Conservatives, has become a source of Tory pride. It is up to two-thirds of median earnings, has risen by 70 per cent in real terms since its introduction in 1999 and will cover 6.7 per cent of all workers this year, including more than 16 per cent of 16–17-year-olds in work.

All these are what political pundits call “retail offers” to voters, and an advantage of incumbency – being in office – is that governments can implement such offers, while opposition parties can only promise them, and voters may take such promises with a pinch of salt. More on that in a moment.

I would be failing in my duty by not pointing out that the government is giving with one hand and taking away with another, by persisting with the long freeze on income tax and NI allowances and thresholds, a sustained stealth tax rise. Most people, though, will be net beneficiaries this year from the changes outlined above.

They are not expected to shift the political dial in time for next month’s local and mayoral elections, and senior figures in government caution against a sudden shift in the polls. Voters may have just decided that the Tories need to be booted out. A YouGov poll for The Times a few days ago suggested that even an improving economy and tax cuts will not be enough to prevent a very heavy Conservative defeat.

But some ministers are giving it a good go, particularly Jeremy Hunt, who has managed to construct a tax-cutting strategy out of the very difficult inheritance he was faced with when he succeeded Kwasi Kwarteng as chancellor in the autumn of 2022.

Treasury sources think a return to growth when GDP (gross domestic product) figures are published next month, in combination with a drop in inflation to the target rate of 2 per cent, will allow ministers to claim “the plan” is being delivered.

The NI cuts, meanwhile, are a useful signalling device for the Tories, contrasting their tax-cutting instincts, albeit alongside a rising tax burden, with Labour’s willingness to accept that higher tax burden.

Of the three retail offers, the state pension rise was forced on the government by the triple lock, which it would have been politically suicidal to abandon at this stage in the electoral cycle. The national living wage rise, similarly, arose straightforwardly out of an election pledge to lift it to two-thirds of earnings.

That makes the cuts in NI the most interesting. Two years ago, it was heading in the opposite direction, Rishi Sunak announcing in 2022 an increase of 1.25 percentage points on top of the then rate of 12 per cent to form the basis of a new health and social care levy.

That rise was scrapped during Liz Truss’s premiership, apparently never to return, so in the space of two years the employee rate has gone from 13.25 per cent to 8 per cent. How did this tax cut, which came out of the blue, occur?

Continue reading “Will Tory tax cuts ever start shifting the political dial?”

My Sunday Times piece is available on www.thetimes.co.uk – this is an excerpt. Not to be reproduced without permission.

This is an important moment for artificial intelligence (AI). Not only will we be on the lookout for AI-generated deep fakes in this year’s many elections, but somebody is bound to declare 2024 the “year of AI”, just as many did in 2022 and, even more so, in 2023.

They all have a point. AI became widely used in business and was starting to be used in government last year and that trend is continuing. “Generative” AI, deep-learning models that can produce high-quality text and images, is sweeping through many sectors of the economy.

The mention of AI, apart from the fears it raises about misuse, brings an age-old question back to the fore. Will this be a technology that not only renders many jobs obsolete, but also leads to a big and sustained rise in unemployment?

That may seem a distant fear when the labour market is tight and the unemployment rate below 4 per cent, admittedly on official figures that come with a health warning, but it is a question that needs to be asked.

For me and most economists who have examined this question in the past, the usual answer is: why should this time be different? Technological advances in the past have not prevented a steady rise in the number of people in work, over decades, even centuries. It will be the same, we tend to argue, with AI. Some jobs will disappear, as they always have, but many others will be created and the technology will not result in mass unemployment.

If there is a concern about this view, it is that the way this has worked in the past is that there has always been an expanding sector to create the jobs destroyed by technology. When mechanisation replaced most jobs in agriculture, there were opportunities in manufacturing and mining. When automation, structural change and lack of competitiveness wiped out employment in these sectors, a fast-expanding services sector was there to take up the slack.

What happens, though, when it is service sector jobs which are most exposed to this latest technological wave? This is one of the gauntlets thrown down by a good new report on AI from the Institute for Public Policy Research (IPPR). The others, in the report, ‘Transformed by AI: How Generative Artificial Intelligence Could Affect Work in the UK, and How to Manage it’, by Carsten Jung and colleagues, is the sheer speed with which AI is spreading, which they argue is significantly faster than other technologies.

“It can hardly be overstated what an astonishing achievement this is. It was until recently thought to be feasible only in the distant future. And given many knowledge work processes are already digitalised, in many cases it does not require huge process changes or capital investments to introduce AI to these processes. The speed of adoption is likely going to be faster than during past technological waves.”

“Our central take is that, with the advent of generative AI, the game has changed,” the report says. “Rather than having to reason about possible future technical capabilities, a technology now exists that has now been proven to produce high quality outputs that are often indistinguishable from human ones, in a fraction of the time that a human would take, across a wide range of applications.

There are some interesting numbers to back up the report’s arguments. After analysing 22,000 different job tasks in the UK, they find that 11 per cent of jobs would be immediately affected simply by plugging generative AI into existing processes, and that back office and administrative roles are most exposed, including personal assistants and secretaries, typists, data entry administrators, writers and translators and marketing associates. This is the “low hanging fruit” of AI but could nevertheless result in significant job displacement, particularly of low and medium-paid occupations, and those mainly done by women.

Much bigger effects – five times as many, 59 per cent – occur if generative AI is fully integrated into the economy, and in this case the impact is on higher-paid jobs, including finance officers, brokers, tax experts and IT managers.

My Sunday Times piece is available on www.the times.co.uk – this an excerpt. Not to be reproduced without permission

The two most important events of the past few days were the drop in inflation to a lower-than-expected 3.4 per cent and a long talk by the shadow chancellor, Rachel Reeves, setting out her economic approach. The government says the fall in inflation is all part of Rishi Sunak’s “plan” and the economy is now turning a corner.

There will be quite a lot more of this in coming weeks and months, as inflation falls further. I’m not sure how cunning a plan this is, however. Celebrating a fall in inflation partly has the effect of drawing attention to its earlier big rise. And people tend to think in terms of prices, which in most cases are still rising, rather than the inflation rate. Food prices are 5 per cent higher than a year ago, while service sector prices are up 6.1 per cent.

Still, the inflation nightmare is clearly subsiding, and Jeremy Hunt hopes that that will permit the Bank of England to cut interest rates significantly between now and an autumn election.

Getting invited to deliver the Mais lecture was something of a coup for Reeves. Many distinguished people have done so at the City University Business School (now called the Bayes Business School after the 18^th century mathematician and theologian Thomas Bayes, who is buried in nearby Bunhill Fields). It has played a significant part in modern UK economic history. The lecture, by the way, is named after Lord Mais, the 645^th Lord Mayor of London who had close connections with the university.

Sir Geoffrey Howe and Nigel Lawson, two of Margaret Thatcher’s three chancellors, delivered important Mais lectures, as did other chancellors, including Kenneth Clarke, Gordon Brown and, two years ago, Rishi Sunak. That was, in many ways, the high watermark of his period as chancellor, and perhaps his political career, and he hosted a celebratory dinner discussion at 11 Downing Street afterwards.

In inviting Reeves, the organisers were following the precedent set in 2010, when George Osborne delivered the lecture a few months before coming chancellor. In 1995 Tony Blair did the lecture a couple of years ahead of Labour’s landslide victory in 1997. Most recent Tory chancellors have not been around long enough to be invited. Hunt has, but I fear that he may have missed out.

Bank of England governors have also graced the Mais stage, including Gordon Richardson, Robin Leigh-Pemberton, Eddie George, Mervyn King and Mark Carney. I’m not looking for a gig, but it was once delivered by a journalist, the late Sam Brittan, doyen of economic journalism.

Reeves, who knows her economics and her UK economic history – everybody in the country will surely be aware soon that she once worked at the Bank of England, though as a graduate fresh out of university – delivered a lecture that was partly a long essay littered with references, and partly a critique of most chancellors who have gone before her in recent years. Even New Labour did not escape criticism.

It is easy to criticise, as people are always telling me, and partly because of this I do not think Reeves’s lecture contained as much useful and usable content as Sunak’s two years ago. His dissection of the UK’s problems of under-investment and low levels of skills and training was clinical.

Nor did it come anywhere near Lawson’s 1984 Mais lecture, which changed the way that politicians and economics thought about economic policy, and which I think Reeves got wrong. Lawson rightly buried the idea that you could control inflation with wage and price controls, then fresh in the memory from the 1970s. He also completed the task of burying post-war Keynesian demand management, a task begun by the Labour prime minister James Callaghan in 1976.

Beyond that, do we now have a coherent Labour economic policy? The Tories will keep saying Labour does not have a plan, unlike them, but that is an odd way of looking at it. We do not live in a planned economy, and there is a limit to the difference that chancellors can make. This idea of a plan is mainly the prime minister’s response to the fact that he took over after the most chaotic period of government in modern history, albeit presided over by his Tory colleagues.

Growth is driven by the private sector, and the question is whether government enables and encourages businesses and entrepreneurs or gets in the way. Political instability and crass policy errors during this parliament have undoubtedly held back growth and made many in business yearn for a change of government.

Those who warn that firms should be careful what they wish for tend to focus on Labour’s plans to boost the minimum wage/national living wage, which is already causing headaches in some sectors, and to strengthen workers’ rights. There may be some wiggle room on this. In her lecture, the shadow chancellor pledged a ban on “exploitative” zero hours contracts, giving workers the right to a contract which reflects the hours they generally work. That may fall short of an outright ban.

Continue reading “Reeves sets out her stall – but it’s not yet enough”

My Sunday Times piece is available on www.thetimes.co.uk – this is an excerpt. Not to be reproduced without permission.

I know what you are thinking. I hope he does not bang on about the budget today. We had enough of that last Wednesday, after weeks of speculation, and surely there is nothing new to say. I feel your pain but stay with me. Budgets are important milestones along the economic road, an opportunity to take stock. There are also loose ends I need to tie up.

I first need to check on how Jeremy Hunt did against the three tests I set last week. Then I should point to a minor victory for the chancellor. The third aim is to provide a slightly different take on the economic inheritance Rachel Reeves may be faced with should she become chancellor.

The tests, to remind you, were: was the budget based on a realistic fiscal outlook, will it do anything to boost growth, and was it nakedly political, cutting the legs from under the opposition? On test one, the budget was no more unrealistic than the chancellor’s autumn statement. There was widespread speculation that he would further reduce planned spending to make room for tax cuts but he did not, and he set out much-needed ways to boost public sector productivity.

On the second, there is a growth boost, from extra labour supply but also by putting more money into people’s pockets, from cutting national insurance. It wasn’t the elixir of growth, but it was a spoonful of sugar.

It was not, and this was my third test, a scorched earth budget. Hunt littered his speech with jibes at Labour and stole a couple of the opposition’s policies but stayed on the right side of responsibility. He did not pass the tests with flying colours but did better than you might have expected. Whether he can do as well if there is pre-election autumn statement in September, we shall see.

What about that small victory? The tax burden is going up, but by less than expected in the recent past. A year ago, in Hunt’s first budget, the Office for Budget Responsibility (OBR) said the tax burden would eventually rise to 37.7 per cent of gross domestic product (GDP), higher than in any year including 1948 (when the records start), probably the highest ever in peacetime.

The new official projection is for the burden to reach 37.1 per cent, a tad lower than 1948’s 37.2 per cent so no longer a record. He has clawed back a little of the tax rises announced in 2021 and 2022. 37 per cent may be about the maximum tax burden the UK economy can bear.

How about that economic inheritance? I don’t blame Reeves for describing it as the worst any chancellor has ever faced. No opposition chancellor says it will be a breeze.

It is, though, wide of the mark. Yes, Hunt stole some of Labour’s clothing, stealing its policy on non-doms which he previously said would be harmful. And yes, one of the ways that Reeves must lower expectations is on public spending. Sticking to the 1 per cent a year real-terms target for public spending in future years will be tough, even with efficiency savings, particularly with the NHS as the cuckoo in the spending nest, claiming an ever-growing share.

Continue reading “Hunt leaves things better – but Labour may reap the benefits”

My Sunday Times piece is available on www.thetimes.co.uk – this is an excerpt.

The table to accompany this piece is also available on www.thetimes.co.uk

The moment has arrived, the equivalent of the BAFTAs, the Oscars, or even the chartered accountant or heating engineer of the year awards. Yes, now that we have a better idea from the data of what happened to the economy last year, I can unveil my annual forecasting league table, run on these pages for something like the past quarter of a century.

I do it because learning about the past can tell us quite a lot about the future, and because it is a useful check on forecasters. At the start of last year, according to the Treasury’s monthly compilation of independent forecasts (from where all but one of my predictions are taken), the average expectation was for the economy to shrink by 0.8 per cent last year and for inflation to end 2023 (the fourth quarter figure) at 5 per cent.

Thus, even though the UK had a weak performance last year, it beat the average, with growth of 0.1 per cent, while inflation was 4.2 per cent in the fourth quarter, lower than predicted by the consensus.

Before congratulating the winners, a word in defence of the forecasters. Most of the forecasts included in the Treasury’s January compilation a year ago were prepared at the end of 2022. This was a period in which the economy had just suffered the worst period of economic management and most chaotic premiership, probably ever, under Liz Truss. I notice she is still trying to blame everybody else for her errors and ineptitude.

Not only was the chaos fresh in the memory, but the latest GDP (gross domestic product) figures then available showed a small fall in the third quarter of 2022, suggesting that the economy was already heading into recession. As it turned out, 2023 was rescued by a small rise in GDP in the final quarter of 2002, 0.1 per cent, and a slightly bigger one in the first quarter of 2023, 0.2 per cent. Jeremy Hunt and Rishi Sunak steadied the ship, though could not prevent the economy slipping into “technical” recession at the end of last year.

This caveat should be applied to quite a few of the forecasts, including those of the Office for Budget Responsibility, the official forecaster. The OBR was too gloomy about growth, predicting a 1.4 per cent decline in GDP, though was good on inflation. But its forecast was put together in the run-up to the November 17 autumn statement, when the money markets were still feverish and the gloom was all-pervasive.

You will want to know how the Bank of England did. It, for reasons that are not entirely clear, is not included in the monthly Treasury comparison. At the start of last year, its latest forecast was published in November 2022, and it was not a great one, predicting a 1.5 per cent drop in GDP in 2023, 5.25 per cent inflation by the end of the year and a 5 per cent unemployment rate. Its Bank rate assumption, based on money market expectations, was however spot on at 5.2 per cent. But the Bank’s excuse is even stronger than that of the OBR. Its forecast was published on November 2. By February last year, the Bank’s forecast was better. It still predicted a drop in GDP, though only of 0.5 per cent, and its end-year inflation forecast, 4 per cent, was very good.

The OBR next had a go in March. Its growth forecast was close, predicting a 0.2 per cent GDP decline, though it went too far on inflation, suggesting that it would end the year at just under 3 per cent.

Now for the winners. This year’s league table is headed by Goldman Sachs, the investment bank. It also had a negative growth forecast, of 0.4 per cent, though that was closer than most to the outcome. Like the OBR, it went a bit too far on inflation, though the direction was right. Inflation, remember, was in double figures and set to remain there for some time when these forecasts were made. Goldman also got very close in its interest rate prediction, which is probably what matters most for financial markets.

Continue reading “How Truss’s chaos made forecasting even trickier than usual”

My Sunday Times piece is available on www.thetimes.co.uk – this is an excerpt, not to be reproduced without permission.

It has been a busy week, with lots of economic data. I shall leave it until a little later today to say something about the statistics, including those worse-than-expected GDP (gross domestic product) figures and whether we really are in recession. But first, if not for something completely different, perhaps a companion piece to last Sunday’s column on debt, which drew a large response.

One of the factors driving debt higher over the long-term is the ageing population, or what some describe as the demographic timebomb. We are living longer, and over the next 20 years, according to official projections, the number of people in the UK aged 65 and over will rise from less than 13 million now to more than 17 million, from less than 19 per cent to 23 per cent of the population.

A timebomb does not sound good, and it is customary to regard an ageing population as bad news, certainly for the economy. Indeed, a recent book by the economists Charles Goodhart and Manoj Pradhan, described “a great demographic reversal” which will result in lower growth and higher inflation. But, according to another new book out next month, The Longevity Imperative, by the economist Andrew Scott, published by Basic Books, we are looking at this from the wrong end of the telescope. Greater longevity is something to celebrate and, properly managed, it can be an economic benefit, not a problem.

The “ageing society” narrative “encourages seeing longer lives as a problem, not an opportunity,” writes Scott. “Instead of celebrating the reduction of grief over lost children, of fewer parents snatched away in midlife and more grandparents and even great-grandparents meeting their grandchildren, it sees greater longevity as a burden. Not only is that a perverse way of seeing a triumph of human development it darkens unnecessarily our view of our future lives.”

Scott, an economics professor at London Business School, has thrown himself into this subject, as co-founder of the Longevity Forum, a consulting scholar at Stanford’s longevity centre and joint author of an earlier book, The 100-year Life. 100 years is worth thinking about. Girls born in the UK now have a 20 per cent chance of living to that age, according to the Office for National Statistics’ life expectancy calculator. For boys it is nearly 15 per cent.

This is part of a rising trend for life expectancy over decades. Since the 1880s, life expectancy at birth in the West has increased by an average of 2-3 years every decade. Some of this is due to a huge reduction in infant and child mortality, but more people are also living longer, despite a wobble recently on some measures.

Scott has some other killer facts to demonstrate the importance of older people in the economy, and their potential. Across all G7 economies this century well over half of all growth in jobs has been in the over-50s age segment. There is a cohort effect, as a population bulge, some of it represented by baby boomers, moved into this age bracket. There is also, in the UK, an effect from equalising the state pension age for women with that of men. It is nevertheless a striking statistic. In the case of the UK, 75 per cent of employment growth this century – 4.4 million out of 5.9 million – has been among the 50-plus.

Meanwhile, there is a mixed picture when governments seek to raise state pension ages. Emmanuel Macron, the French president, suffered a fierce backlash when pushing through an increase in it from 62 to 64 for those born after 1968, but people in their early 20s in Denmark can expect to be working until 74. Only this month, a report from the International Longevity Centre suggested the UK state pension age will have to rise to 71 by 2050 to maintain the ratio of workers to retired people.

Raising the state pension age is unpopular, as Macron discovered, and is a crude instrument. Some people will want to work longer, and be able to do so, while for others it will amount to an unacceptable burden.

Instead, there should be a three-pronged approach. It will start with ensuring that more people have healthier lives as they get older, a challenge when 2.8 million people in the UK are economically inactive because of long-term sickness.

Related to this, as Scott points out, we must prevent a tailing off in employment among the over-50s who, once lost to the workforce, often never come back. Even though the over-50s have accounted for the lion’s share of employment growth, the employment rate in this age group is lower than for younger segments.

Continue reading “How to start defusing the demographic timebomb”