When all things are taken into account, the UK is in effect investing nothing in its future economy. The coalition may have conjured some temporary growth, but we need serious change if we wish to avoid long term decline.
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All those who believe that the current growth in the UK’s economy – 1.9% in total in 2013 – is sustainable need to ponder two figures, both of which can easily be verified from Office for National Statistics (ONS) publications.
Gross and Net Investment
The first is the proportion of our national income which we devote to investment. ONS figures for the first three quarters of 2013 show that this ratio – which was 16.7% in 2008 - had dropped by 2013 to 13.5%. This is one of the lowest percentages in the entire world. The CIA estimated that in 2012 the ratio was 14.2% - slightly higher than it is now. Comparing other countries across the world in 2012 showed that of a total of 154 countries surveyed, the UK ranked number 142 equal - with El Salvador. This compares dismally badly with the performance almost everywhere else. The world average for gross investment as a percentage of Gross Domestic Product (GDP) in 2012 was 23.8%. The percentage for China was 46.1%.
While the gross figure is bad enough, the net position is far worse. ONS figures show that Capital Consumption – i.e. the depreciation of existing assets in the UK is running at just over 11% of GDP. If, therefore, we subtract from the gross investment percentage a provision for existing capital assets becoming worn out and needing to be replaced, we are left no more than about 2.3% of our GDP as net investment. This is also far lower than almost anywhere else.
Worse, however, is to come. Unlike in many other countries, especially in the developed world, the UK’s population is growing relatively fast - by around 350,000 a year on average - about 0.6% as a percentage of the total number of people living in the UK. The average value of all the capital assets in the country divided by the current population gives a figure of around £120k. We are therefore now in a position where our current net investment of about £37bn (2.3% of £1,620bn) is less than the £42bn (350k x £120k) which needs to be spent every year just to stop the capital assets of the country being diluted down by our rising population.
The result of these easy-to-check calculations is that our net investment per head of the population is as close to zero as makes no difference. No doubt this has a lot to do with the collapse in the rise in productivity, which has been such an apparently puzzling recent development for many people. With no net investment per head of the population this is bound to happen. The Industrial Revolution was built on investment in stocks of more and more capital goods of all sorts, but particularly those used in manufacturing operations. If this accumulation stops – which is what has occurred to the UK economy – productivity increases will stop with it. This is exactly what has happened.
Manufacturing
The second figure which ought to be of concern to anyone who thinks that the UK is now on a viable course to sustained growth is the percentage of our GDP which currently comes from manufacturing. It is now about 10.7%. As recently as 1970 it was 32%. Even in 1980 it was 24%. It haemorrhaged during two decades. One was during the heyday of monetarism in the 1980s. The second was during the gross over-valuation of sterling during most of the 2000s.
Manufacturing is of key importance to the viability of any economy such as ours for three main reasons. One is that it is far easier to achieve productivity increases in manufacturing industry than it is in the service sector, as all the statistics continually show. The second is that manufacturing produces much more high quality and high income skilled blue collar jobs than is the case in the rest of the economy. It also produces them with a far better geographical spread than is the case, for example, in financial services which are heavily concentrated in the South East of the UK. Most important of all, however, is the role that manufactured goods play in enabling us to be able to pay our way in the world – or to fail to do so as has been our lot now for many decades. The last time the UK had a foreign payment balance was in 1983 – now over 30 years ago.
ONS figures for 2012 – the most recent which are available in detail – show the UK having a total balance of payments deficit on current account that year of £59bn. Largely as a result of the huge sell-off of UK assets which took place in the 2000s, we no longer had any net income from abroad. In 2008 this was still £33.2bn but by 2012 it was minus £2.1bn. Transfers abroad are another negative item – rising from £13.7bn in 2008 to £23.1bn in 2012, mainly as a result of the increasing cost to the UK of our EU membership. With negative net income and transfers, we therefore needed to have a sufficiently positive net trade performance – a surplus of exports over imports - to offset these burdens. Exports of services in 2012 did do well, with a surplus of £74bn, of which almost half - £36bn – came from financial services. Unfortunately, however, the deficit on goods – at £108bn - was much larger than the surplus on services. Of this £108bn, about £84bn was a deficit on manufactured goods.
The problem the UK has as a relatively compact and densely populated country with comparatively few major natural resources is that the only way we can pay our way in the world is by selling other countries sufficient quantities of manufactured goods. Exports of services are too small to bridge the gap and nearly all the rest of our foreign trade is in commodities such as oil and coal, where supplies are limited. We are never going to be able to do this with only just over 10% of our GDP coming from manufactures. This ratio needs to be around 15% for viability. Unless this gap can be closed, the balance of payments will act as a perennial deadweight constraint on us and we will face year after year of stagnation.
Current Prospects
Against the background of no net investment per head of the population and too small a manufacturing base to enable us to close an already very large payments deficit, what are the prospects for the UK economy over the next few years? The Coalition government has achieved 1.9% growth in 2013 and expects about 2.4% in 2014. Looking further ahead, the Office for Budget Responsibility paints a relatively optimistic picture in their forecasts for 2015 and 2017, with growth rates per year averaging about 2.5% annum. Are these forecasts likely to be correct? Looking ahead to 2014/15, running up to the general election, they may be right but those further ahead look wildly optimistic.
Current growth is not based on any improvement on our trade performance which can reasonably be expected. It is based on the feel good factor generated by very loose money and the consequent rise in asset prices, including both housing and stocks and shares on the Stock Exchange. Growth is therefore being driven very largely by more consumer expenditure and not by investment and improved trade performance. At least three consequences, however, are likely to flow from this background:
The balance of payments will deteriorate with a deficit, which is already about 4% - and one of the highest in the world - widening to increasingly unmanageable proportions.
As there is a very strong link between the government deficit and the foreign payments balance, if the latter deteriorates, the former is very likely to do so too. Government borrowing, therefore, far from falling will almost certainly get larger, rising to well over 100% of GDP.
- Against this background the authorities are all too likely to believe that interest rises are need both to damp down the economy and to avoid sterling sliding in value. If this sequence of events materialises, growth will grind to a halt.
What is therefore in prospect for us at the moment is a mini-boom which no doubt the Coalition government knows will help them during the election but which brings dismally poor prospects ahead once the brief period of growth which we can now expect grinds to a halt.
What can be done?
The root problem facing UK economic policy makers is that there is no solution to us achieving a sustainable rate of reasonably strong economic growth unless we can get both our investment rate and our manufacturing capacity up substantially, and one depends to a significant extent on the other. The figures, however, look daunting. The same output cannot be used both for consumption on the one hand and for investment and closing the payments gap on the other. If we were to get our rate of investment up to the world average of 23%, we would need to shift about 10% of our GDP out of consumption into investment to do so. To close the current foreign payments gap we would need another 4% - making 14% in total. Even half of these percentages, which might get us back to slow growth rather than stagnation, would need a shift of around 7% - triggering a reduction in consumer expenditure of about 10%.
Who believes that it would be possible to persuade consumers to reduce their living standards by a further 10%? If this is not done, however, it is very hard to see how we are not in for decade after decade of stagnation.
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