UK Economoy 2006 - Economics Help

Introduction – Recent UK economic performance

The UK economy is currently growing at an annual rate of 1.6%, it has low inflation close to the governments target of 2.%. Unemployment has risen in the last 8 months but it is still low at 1.4 million (ILO Survey) compared to the last recession of 1992. The UK manufacturing sector is weak with very fragile growth since 2000. The UK also has a current account deficit of 3.2% of GDP and government borrowing is also 3% (See Notes 1)

Strengths and Weakness of the UK Economy

In 2006 the UK economy is still experiencing positive economic growth, this economic growth has been positive since 1992. This makes it the longest period of uninterrupted economic growth since records began
In 2004 economic growth was 3.2 %, Last year growth was lower than predicted at only 1.6%. However in 2006 growth is expected to pick up again to 1.8% and then 2.4% in 2007. (2)

Graph showing economic growth since 2000.

Source: (2) National Office of Statistics

An important feature of UK economic growth is that we appear to have avoided the boom and bust economic cycles which was common in the post war period. Since 1992 economic growth has usually been relatively close to the long run trend rate of 2.5%. This has meant the UK has avoided any recessions (period of negative economic growth) This has led to increased stability which is very important for the long term benefit of an economy.

However one drawback to the economic growth is that many economists argue that it is unbalanced. The manufacturing sector has continued to underperform with the main cause of growth coming from consumer spending. Looking at statistics we can see that Manufacturing output is not increased very much in the period of economic growth. The graph below suggests manufacturing output has barely risen since 1999

Graph showing manufacturing output since 1999

Source (3) http://www.statistics.gov.uk/CCI/nugget.asp?ID=198&Pos=1&ColRank=2&Rank=896

Also business investment is quite low and fell in the last quarter.

Consumer Spending

With the manufacturing sector doing badly, the strength of the UK economy has been through consumer spending. This has been the main reason behind economic growth. High consumer spending has been caused by rising house prices and relatively low interest rates (they are currently 4.5% in 1992 interest rates reached 15%) .

Problems of consumer spending

However although consumer spending has been strong, it has partly been financed by record levels of consumer borrowing. The total stock of outstanding debt owed by UK consumers to £1.168 trillion. http://news.bbc.co.uk/1/hi/business/4761854.stm (83% which is in the form of mortgages)

This means that many consumers have high levels of debt and therefore would be badly affected if interest rates needed to rise. Even a small rise in interest rates would increase their costs of borrowing and therefore could cause a downturn in spending in the future. If Oil prices continue to rise this may cause cost-push inflation and therefore the bank of England may have to raise interest rates. Therefore the high levels of consumer debt are a potential problem. Also high levels of consumer spending have led to a deterioration in the current account deficit. (Imports have increased at a greater rate than exports therefore causing a bigger deficit. See later)

Unemployment

Unemployment is another success story for the UK economy. Since 1993 when over 3 million people were unemployed there has been a significant fall in unemployment to 1.4 million on the labour force survey.

However after reaching an all time low in 2004 unemployment is now starting to gradually increase. The Office for National Statistics (ONS) said that the number of people out of work rose WAS 5.1% in Dec up from 4.7% in October. Using the governments less reliable measure of unemployment (those claiming benefits – JSA) unemployment stands at 902,000 in November, the tenth month in a row that it has risen. More worryingly is the fact that the number of economically inactive people has risen to an all time high. Inactive workers include those on sickness benefits and early retirement. In July to September 2004, just under 8 million people of working age in the United Kingdom who were classified as being economically inactive.(4)

This puts pressure on government finances (Pay more benefits and receive less tax). The future prospects for unemployment remain uncertain. If growth continues to be below trend further jobs may be lost, particularly in the manufacturing sector. However if growth does pick up this upward trend may come to an end. The unemployment rate in the UK still compares favourably to EU economies like Germany and France where unemployment is close to double figures.

Inflation

(Source 6)

Inflation in the UK continues to be close to the government’s target, despite the continued high prices of oil. In December the CPI fell to 2.% down from over 3% at the end of 2004. This is a strength of the economy because it could lead to the prospect of future interest rate cuts. Inflation has fallen particularly in items such as electrical goods. Low inflation also appears to be a global phenomenon due to the increased competitiveness of the world economy. However inflationary pressures could return especially if the price of oil continues to rise.

Government finances

Despite 15 years of economic growth the government has been forced to borrow more than anticipated. The Pre-Budget Report forecast for 2005/6 is net borrowing of £37.0 billion. (The deficit on current budget showed a deficit of £4.0 billion, for December 2005 )

This indicates the government is close to breaking its golden rule for borrowing and the chancellor may be forced to raise taxes or cut spending if the finances don’t improve. As a % of GDP public sector debt has risen from 30% in 2001 to 37% in 2005. However, this is significantly lower than other OECD countries such as

Germany: 4.2% of GDP
France: 4.2% of GDP
USA: 4.9% of GDP
Japan: 7.4% of GDP (2003 financial years )
(Source 8)

Current account deficit

Current account deficit widens in the last quarter of 2005 to 3.5% of GDP, This is the largest deficit for a long time. The current account deficit is a reflection of the strong consumer spending on imports and the weak manufacturing sector which is, therefore, reducing exports. In the long term, a rising deficit could cause problems. It may put upward pressure on interest rates and reduce growth rates. constraints on lower interest rates and growth, although like the US the UK has been able to shrug off current account deficits without any ill effects. (Source 10)

Conclusion

Despite moderate rises in the unemployment rates the general prospects for the UK economy remain positive. With a backdrop of low inflation and steady economic growth it is quite likely economic growth will pick up creating more jobs by 2007. If inflation continues to be close to the government’s target it is also quite likely interest rates will be able to come down a fraction. The main cause for concern with the UK economy is the relative weakness of the manufacturing sector and industry in general. This makes it difficult to reduce the current account deficit and may cause more job losses in certain sectors of the economy.

Policy Choices Facing the Economy

Interest Rates

Can interest rates be cut to stimulate growth? Currently, economic growth is below trend. Inflation is on target of 2%. Statistics suggest consumer spending growth has fallen in recent months. Therefore there is an option for cutting interest rates. This may help stop the rise in unemployment. It will also help the manufacturing sector. Lower interest rates reduce their borrowing costs and also reduce the value of the pound. This makes their exports more competitive. However, others argue against a rate cut arguing this can lead to inflation and a further boom in the housing market. Also, they say a cut in interest rates will only give a short term boost to manufacturing. It will not help competitiveness in the long run.

Changes to Government Spending.

A problem facing the govt is the high levels of government borrowing. This problem may get worse in the future due to the increase in the number of old people past working age. Therefore the government may wish to introduce policies which reduce government spending on pensions. For example, raising the retirement age. This would help boost productivity for the economy and also reduce govt spending. However it would be very unpopular to introduce.

Join The Euro

Some people argue that joining the Euro would give many benefits to Britain and help to boost trade. By joining the Euro there would be lower transaction costs and also greater exchange rate certainty. This would enable increased trade and encourage more inward investment. This may help the manufacturing sector. However the problem of joining the Euro is that it may not be a good benefit for the UK economy to have a common monetary policy. UK would lose its ability to set interest rates. The ECB would set interest rates in the benefit of the whole economy. Therefore interest rates may be too high or too low. If they are too high they would cause a fall in economic growth. If they were too low they may cause inflation.