Threats to UK economy

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Since the credit crisis of 2008, the UK economy has experienced structural weakness of Low economic growth Very poor productivity growth Weak demand Unbalanced economy geared towards consumption and low levels of investment. In addition to these structural weaknesses, the UK economy in 2020 now faces real threats from A hard Brexit Risk of slowdown …

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Economic Growth UK

Economic growth measures the change in real GDP (national income adjusted for inflation; ONS call it chained volume measure of GDP) Since the end of the great recession (2008 – 2009) the UK economy has grown in fits and starts. It has been a relatively weak economic recovery compared to previous recessions. 2019 has seen …

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Impact of rising population in the UK

The UK population is projected to increase by 9.7 million over the next 25 years from an estimated 64.6 million in mid-2014 to 74.3 million in mid-2039. (ONS). Approx. 50% of the population increase is expected due to net migration.

This is a look at the economic and social impact of a rise in the population.

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The UK is bucking the trend of many Western economies, such as Italy, France and Japan – who are seeing low birth rates, an ageing population and declining populations.

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UK population projections at BBC

The growth of the UK population raises many issues, some positive and some negative. From an economic perspective, the population growth is generally good news. The growing population will increase the productive capacity of the economy, and help the UK avoid a demographic time bomb through improving tax revenues. However, a growing population will exacerbate existing problems, such as the long-standing housing crisis and a shortage of supply. It will also put pressure on existing infrastructure and the transport network. To deal with the rising population and congestion, we are likely to see increased building on greenbelt land and a change in the UK’s landscape.

On the one hand, population growth will help the UK economy become one of the largest in the EU, but as a consequence, we will have to deal with increased congestion and increased demand on local infrastructure.

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Housing

The UK is already struggling to meet existing demand for housing. A rising population will put even more pressure on housing; also, the rise in the number of households is greater than the rise in the population due to the growth of single occupancy households.

As mentioned in ‘housing crisis’, the UK already has a persistent shortage of housing. Demand is rising faster than our willingness to build. This shortfall is causing an increase in long-term house prices, reducing affordability. If the UK population continues to grow to 71 million plus it will, ceteris paribus put upward pressure on house prices. It will require a dramatic change in housing policy and could require large-scale new towns to catch up with the shortage.

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House price to earnings for first time buyers likely to keep rising.

If the supply of housing fails to meet the growth in the number of households, it will increase the cost of living. House prices will rise and the cost of renting will also continue to rise. This is likely to exacerbate the growth in wealth inequality we have seen in the past few years.

Arguably we could deal with the housing shortage if the political will is there. In the 1950s, we built 400,000 new homes a year. But, given the current resistance to even moderate new home building programmes, 300-400,000 new homes a year will be very difficult.

Limiting the impact of an ageing population

Many countries with declining populations are seeing a rise in the percentage of people over retirement age. This puts pressure on government spending (health and pensions) and leads to lower tax revenues (See: impact of an ageing population). The UK population is rising due to net migration and higher birth rates. This means the UK has a higher % of people of working age, who are net contributors to the exchequer (paying income tax, not receiving pensions)

Therefore the growth in the population improves the long-term UK budgetary position, reducing the need for spending cuts and/or tax increases.

The growth in the working age population also increases the size of the UK labour force, enabling higher productive capacity. This will help increase UK real GDP compared to other countries. (note, GDP per capita – GDP per head may not be affected by a growing population.)

However, by mid-2039, more than 1 in 12 of the population is projected to be aged 80 or over. (ONS)

Increased efficiency of greater population density

Increased population density is more efficient from both an environmental and economic perspective. The highest carbon per capita consumption comes from rural/low population density areas. There are economies of scale in providing transport and infrastructure which helps reduce the per capita impact on both government spending and the environment.

(Report: increased efficiency of higher urban density) (Study: efficiency of public services from higher density)

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Effects of a budget surplus

A budget surplus occurs when government tax receipts are greater than government spending. It means the government can either save money or pay off existing national debt. It is worth noting, that budget surpluses are quite rare in the past 120 years. Politicians have sometimes attempted to enshrine budget surplus into law but what are …

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Does a devaluation help the economy?

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A devaluation (depreciation) occurs when the exchange rate falls in value. This causes exports to be cheaper and imports to be more expensive. In theory, it can help increase economic growth, though it may cause inflation.

In theory, a devaluation will cause the following to happen:

  • The price of UK exports will be lower in foreign currencies. This will increase the competitiveness of UK exports and should cause an increase in demand for UK exports.
  • The price of imported goods into the UK will increase. This will reduce our spending on imports and instead we will be more likely to buy domestic goods.
  • The increase in (X-M) should cause an increase in Aggregate Demand (AD), economic growth and cause a reduction in unemployment.
  • The increased competitiveness should cause an improvement in the current account on the balance of payments.

Evaluation

The impact of a devaluation depends on economic circumstances.

  • If a country is suffering from being uncompetitive with high unemployment and low inflation – a devaluation may help considerably.
  • However, in a severely depressed global economy (e.g. 2008-13), a devaluation may be insufficient to restore economic growth.
  • The fall in the value of the Pound (2016) is partly due to concerns over Brexit (British exit from EU). This is causing uncertainty and will likely to reduce investment from export firms. In this situation, the devaluation will probably do little to boost economic growth. However, with inflation near zero, the usual inflationary pressure of devaluation will not be a problem.

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UK Devaluation between 2008 and 2013

Between 2008 and 2013, the Pound experienced a 25-30% devaluation in Sterling, but the UK had only a weak recovery, some cost push inflation and a surprisingly large current account deficit. It seems the depreciation in the pound did little to help the UK economy. This was due to several factors

  • Demand for exports and imports relatively inelastic. UK continued to import more expensive German cars, but export demand also inelastic.
  • Weak Eurozone growth. 2008-13 was a period of low EU growth, therefore more competitive UK exports were insufficient to boost export demand.
  • Fiscal austerity and fall in bank lending were major factors depressing the economy. Therefore, the devaluation was insufficient to compensate for the fall in other components of AD.

Pound Sterling Index

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Pound Sterling index. The Index measures the value of the Pound Sterling against a basket of major trading countries.

 

Impact of devaluation on economic growth

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1. Economic growth. In terms of economic growth, the five years after 2007/08 devaluation were relatively low. The devaluation was insufficient to stop the deepest recession for a long time, and the recovery was weak – compared to other recoveries. (see: Comparison of different recessions)

2. Current account deficit. The current account deficit actually got bigger from 2010.

UK-current-account-from-2001

In 2008, the current account deficit was less than 2% of GDP. At the end of 2013, this current account deficit fell to more than 5% of GDP – a very high deficit (more at current account balance of payments) This seems to contradict economic theory – as you would expect a devaluation to improve the current account – not worsen it.

How do we explain the relative failure of devaluation to rebalance the economy in UK 2007-13?

1. Inelastic demand for exports and imports Evidence suggests that demand for UK exports is relatively inelastic. UK exports have become less price competitive as we’ve moved away from low-cost manufacturers to a variety of services and high-tech manufacturing; these goods tend to have relatively few close substitutes. Therefore, even if the price falls, the increase in demand is relatively low. Similarly, demand for imports is relatively inelastic meaning we continue to pay the higher price. (The Marshall-Lerner condition states a devaluation will worsen the current account if PEDx + PEDm >1)

Read moreDoes a devaluation help the economy?

Buy British campaigns

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At different times there have been campaigns to ‘Buy British’ – patriotic efforts to support the economy. The campaigns seem quite popular, but usually fade out, having made little difference to major macro-economic variables. It is a form of economic nationalism and similar campaigns can be seen in many different countries. Buy British campaigns can …

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UK Economy 2016

The UK economy in 2016 is emerging from a long period of economic stagnation and the recession of 2008-12, and has some positive signals of growth, low inflation and falling unemployment.

However, the UK chancellor has been giving mixed signals. On the one hand he has pointed out that UK has one of the strongest rates of economic growth in the developed world. On the other hand, he is also keen to lower expectations pointing to the many potential pitfalls to future economic growth.

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Summary of UK economy in 2016

  • Positive economic growth for past couple of years, with low inflation (0.1%) and falling unemployment (5.3%)
  • However, economic recovery is still fragile, with growth helped by low interest rates of 0.5%, and a fall in the savings ratio.
  • UK economy has outperformed (marginally) some of our European neighbours, but this has contributed to current account deficit and fears weak growth in Europe may curtail the UK economic recovery.
  • Although the budget deficit has fallen from crisis peak of 10% of GDP, the chancellor has indicated he still wishes to reduce deficit further. This will entail continued strictness in government spending.
  • There are signs the UK economy is unbalanced with rapid rises in house prices increasing wealth inequality and creating problems for those who cannot afford to buy.

Problems facing UK economy in 2016

  • Weak growth in major trading partners – Europe and Asia, could lead to lower exports.
  • Years of negative real wage growth have led to higher personal debt levels and lower saving ratios.
  • Continued squeeze in government spending as government seeks to reduce budget deficit.
  • Fall in oil prices could cause problems for oil industry and banks who have lent credit for investment
  • Headline inflation close to actual deflation, which could cause low growth.
  • UK is still reliant on services and consumer spending. Growth in manufacturing, construction and export sector much weaker.
  • Interest rate dilemma. Some would like to see interest rates rise, but it will have big impact on discretionary income of many homeowners and consumers.

UK economic growth

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Economic growth in 2015 Q3, 0.5%

  • In recent quarters, economic growth has been fairly consistent at around 0.5-0.7%; this is close to the UK’s long run trend rate of economic growth, and usually would be a very good sign. However, the economy is still trying to catch up from the lost output during the great recession.
  • The concern with economic growth is how sustainable it will be in 2016 and 2017? A slowdown in Europe and Asia could easily reduce confidence. Also, a rise in interest rates would hit consumers who have relatively high levels of debt and have become accustomed to low rates.
  • Economic growth has been boosted by population growth; economic growth per capita is less impressive.
  • Economic growth stats

Inflation

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A difficulty during the early parts of the great recession was that inflation well above the governments target of 2%. However, since 2014, headline CPI inflation has fallen below the government’s target and in recent months has been close to zero. This has been helped by falling oil prices and other commodities, but also is a reflection of the relatively weak demand and downward pressure on wages.

The recent rise in real wages may enable inflation to creep back towards the target. But, with inflation still perilously close to deflation, the Bank of England will be reluctant to raise interest rates – indicating how far from normality the UK economy still is.

Read moreUK Economy 2016

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