The UK economy is now one of the sick men of Europe.
A survey by the European Commission last week found that economic sentiment in the eurozone is at a 10-year high. Ifo’s index of the German business climate is at its highest since the survey began in 1991. And purchasing managers say that growth in the eurozone is near a six-year high.
Meanwhile, the ONS reports that UK real GDP rose only 0.3 per cent in the second quarter – probably half the rate of eurozone growth – which implies that GDP per person has stagnated so far this year.
This poses the question: why is the UK not benefiting from the rapid expansion on our doorstep?
It’s not because exports aren’t growing. They are, despite the fact that exporters have raised prices in response to sterling’s fall last year. Export volumes in the three months to May were 6.4 per cent up from the second quarter of 2016.
Instead, there are three other reasons for our relative weakness.
One is that because supply chains are globalised, higher exports suck in more imports, which means that net output rises only slightly when exports grow. Simple statistics tell us this. Since 1997 the correlation between annual growth in export volumes and import volumes has been 0.89 – which is enormous considering how variable growth has been – and each percentage point rise in exports has been associated with a 0.7 per cent rise in imports. In this context, the 5.8 per cent growth in imports since the second quarter of 2016 is unsurprising.
I suspect that one reason why the ONS’s estimate of growth this year has been lower than some surveys (such as purchasing managers and the CBI) is that the ONS measures value-added rather than gross output, and the former has been weaker than the latter.
A second reason is that consumer spending has faltered: retail sales volumes in June were below the autumn’s levels. This is consistent with consumers pulling some spending forward from 2017 into 2016 because they anticipated that the weak pound would raise prices.
A third reason is that business investment has been weak. We don’t have the second-quarter data yet, but first-quarter data shows that this has fallen since 2015. Last week’s CBI survey points to little turnaround. Although this showed that investment intentions were above their long-term average, it also showed them to be lower than they were before the Brexit referendum.
This is especially strange because high capacity utilisation, good growth in export markets, and the boost to profit margins from sterling’s fall should have raised capital spending plans.
Why, then, are they weak? A big clue is that the CBI found that the proportion of companies citing “inadequate net return” as a factor limiting investment is at a 10-year high. You might think this is odd given that official figures show that profit rates are quite high. But I’m not sure it is. For one thing, the official figures are flattered because the capital stock is measured in today’s prices rather than at the (higher) ones that many companies actually paid. And for another, these numbers tell us about the profitability of past operations (if that) when what matters is that of future ones.
It would be tempting to blame such pessimism upon Brexit. This, though, might be only part of the story. The are other reasons for low profit expectations, among them: the scarring effect of the financial crisis upon animal spirits; the fear that profits will be competed away by future technical progress; the ongoing stagnation in productivity; a lack of current obvious innovative ideas; or a fear that continued austerity, among other things, will dampen domestic demand.
I agree with most economists that Brexit will hurt the economy. I fear, though, that it distracts us from the fact that we have many other problems.
