Thursday, 14 November 2013

Who's Been Eating My Porridge

Even the Bank of England has now confirmed that the green shoots of recovery are growing strongly and that we have reached escape velocity.  Even inflation is falling towards the Government’s target range of 2%.   Some might describe this as the perfect Goldilocks scenario for our economy– not too hot not to cold! However there is one angry bear that might ruin the breakfast – poor productivity and falling living standards.

After years of steady growth (we were the fastest growing and most productive economy in the G7 between ‘95-‘08) we have had to deal with a massive retrenchment.  In the five years since the shock of the financial crisis our output (GDP) is now 18 per cent below the previous trend and still 3% below actual levels achieved in 2008.  The strange thing is that this has been realised with relatively low levels of unemployment, which points to a decline in output per head (productivity). The mystery of Britain’s failing productivity has been baffling policy makers and economists alike.  Why should the one of most productive economies of the ‘Noughties’ suddenly slip to the bottom of the league table? Is it more part time unskilled work replacing skilled positions (Bankers), is it zombie companies or a growth in the black economy?  Either way its unlikely to improve anytime soon!

 This chart is becoming the main political focus, if we are unable to turn the recent up-tick in economic activity into rising living standards then the good work done by the coalition in reining back government will be thrown away when Labour return to power in 2015.   For economists this means that attention has to shifted to productivity and inflation as living standards can’t rise unless the economy is more productive or price rise more slowly that wages.  The problem with productivity is also stalking Europe as well, where the combination of low productivity and demand is pushing the Eurozone close to a deflationary bust.

It’s probable that there are macro factors that are driving the poor productivity performance in the UK and globally, these will be linked to the lack of capital for investments (the banks aren’t lending), an imbalance in the economic share that labour take compared to the “owners of capital” (due to the rise of private equity and the internet perhaps) and other big ticket items.  The government is not going to be able to fix these in the next 15 months so any improvement in living standards will have to come from lower inflation. The good news is that the UK’s inflation rate has collapsed from over 5% three years ago to 2.2% but in Europe it’s about 0.7%.  For most of the period since 1997, inflation tended to be lower in the UK than in the eurozone; but ever since the pound devalued in late 2007, the BoE has struggled to keep inflation under control.  A closer inspection shows that inflation in Services, energy and food is much higher in the UK than Europe, although our manufacturing sector is still working hard to keep competitive, forced to do so by global pressures.  As Sterling has been broadly flat against the Euro over the last 12 months this discrepancy in inflation rates is likely to be a function of market inefficiencies for energy, utilities and retailing.  It is a scandal that the government has shown little appetite to deal with these market inefficiencies

Thanks to the FT
The chart above shows why Labour’s focus of the energy market is so compelling for hard pressed UK consumers, there must be a systemic problem with this market as we source the same energy supplies as main land Europe.  The problem for the UK is that many important markets were deregulated years ago, the utilities (water, energy, transport and communication) were privatised 20 or 30 years ago and the competitive and regulation regimes have not moved with the times.  There is a similar story in the grocery business where the large supermarket chains act as a huge break on the market – hampering the on-line market and keeping prices unnecessarily high through waste and the cosy cartel, which keeps up a pretense of competition.
Ed Miliband has given due notice that this is the new battle ground and the coalition need to get on the front foot.  Without some improvement in living standards labour are sure to win the election in 2015 and we will then face the dismantling of our free market economy. The Tories will only have themselves to blame if labour 'eat their porridge' they must make a start on 'consumerising' these critical markets now.

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