The cracks begin to show: a review of the UK economy in 2015 (part one)

On the first day of 2016 trading the FTSE 500 index nosedived. This surprised perennially optimistic business commentators, but will not surprise those who read the EREP review of the UK economy in 2015. Read part two here.

Jeremy Smith John Weeks Özlem Onaran Andrew Simms Ann Pettifor Richard Murphy
5 January 2016
The year 2015 has repeatedly disappointed those who had high expectations that the UK economy was back to “normal times” and destined to see significant continued economic “growth.”  At the start of the year, there was a general expectation that inflation would start to rise after the sudden fall in oil prices, and that the Bank of England’s Monetary Policy Committee would start, gently, the process of raising interest rates as “slack” in the economy disappeared.

In reality, and despite some positive results (the number of those in some form of employment, for example) those expectations have gently deflated as 2015 progressed.  Most economists had forecast annual GDP increase of over 2.5%. The most recent ONS estimates, up to Q3, show a continuing slide in the annual rate of change per quarter.  The annual rate of real GDP change in 2014 per Quarter was 2.8%, 3%, 2.8% and 2.8%.  But in 2015, a series of steps down:

Q1  2.5%

                Q2  2.3%

                                 Q3  2.1%

More worryingly still, the rate of change in nominal GDP (i.e. current prices) in Q3 was also 2.1% - it is exceptionally rare for nominal GDP not to be greater than real GDP, and besides being an indicator of deflation, has a negative impact on the government finances.  Indeed, we saw in the October and November public finance figures some evidence that tax receipts have slowed since the summer, with VAT in November being just 0.8% greater than in November 2014.  This may make achievement of the government’s borrowing target for 2015/16 (£73.5 billion) difficult to achieve. 

These recent GDP and public finance figures were published just before Christmas – and just a few weeks after the November Autumn Statement and Spending Review. The Office for Budget Responsibility had – thanks to some assumptions on GDP and tax receipts that were queried by many as being over-optimistic – helped the Chancellor to sidestep short-term political problems over working tax credit by allowing a slower path to his promised budget surplus.  Those OBR and government assumptions now suffer from considerable scepticism.

Not only has GDP decelerated, but its composition has continued to disappoint.  There is almost no sign of the promised “rebalancing” towards “the makers” and “the builders”.  While several service industries, including real estate and food and hotels, have fared relatively well, manufacturing has seen a decline, while overall industrial production has only marginally increased over the year:

Manufacturing annual change per quarter:

Q1 1.2% 

Q2 0.1% 

Q3 -0.9%

Industrial production, with help from a UK oil industry increasing output (but at far lower prices) has risen between 1% and 1.4% year on year, while construction – after a strong rate of annual increase in 2014, fell back from an annual rate of 6.4% in Q1 to a very modest 1% in Q3.

This imbalance is also to be seen in the UK trade and current account statistics, both of which continue to show major deficits. The current account deficit was £17.5 billion in Q3, the same as in Q2 – leaving a deficit of 3.7% of GDP.  The total trade deficit widened to £8.7 billion in Q3, from £4.7 billion in Q2, with our trade in goods worsening.

Inflation, if that is the right word, remains close to zero, with some months just above (0.1% in November), and some just below.  This is due not only to the continuing fall in oil prices, but to the steady fall in all commodity prices, which indicates a wider and deeper basis for sustained deflationary pressure (at least in all manufactured goods).

The economy is far short of reaching the 2% inflation target set for the Bank of England by the government, and in part explains why UK Bank-set interest rates  - unlike in the US – seem likely not to rise for some time yet.   But equally important, the rise in wages which earlier in the year looked as though it might top 3% per annum, meaning a real terms pay increase at last, has recently abated, with the last two months (September and October) only showing annual rises of around 2%.  The only main exception is pay in construction, which is over 6% up on the year.

Despite the increase in those in some form of employment (as employee or self-employed), the wage pressures are far from strong, and real wages remain far below their peak in 2008.  This trend to lower pay has weakened demand and productivity.  Whilst commodity and producer deflation have enabled shoppers to buy more goods for the same money, it is notable that people are not spending much more.  On the contrary, in recent months, we have seen unsecured private debt mounting, as people once again resort to borrowing to get by.

The other side of the coin is asset inflation.  The reluctance of the private sector to invest in non-speculative assets, combined with QE providing liquidity for the wealthy, together help propel a property price boom which the government has done much to promote with state-aided Help to Buy and similar schemes to increase property prices. 

So indeed, as the year has progressed, the economy has slowed and regressed. The public finances are built on hopes and assumptions that appear to be fragile indeed, and economic activity in many key areas has decelerated whilst the property boom helps the asset-rich.  The weaknesses in the UK economy are more and more apparent, like a building with a flashy design but poor construction.  The cracks begin to show.  Let’s hope there’s no earthquake coming…

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In this review of the UK economy in 2015, we have contributions on a range of themes from members of Economists for Rational Economic Policies (EREP).

John Weeks argues that the UK economy remains demand-constrained, and the government’s fiscal policy has made that straitjacket ever tighter. The depressing effect of that fiscal policy shows in GDP growth itself, which declined in current prices by 2.4 percentage points during the 12 months through 2015 Q3 compared to the previous 12 months (2013 Q3 – 2014 Q3).  While noting that the Chancellor is now years behind his original ‘plan’ to cut the deficit, John argues that “to have done so would have made a bad performance worse.” 

Ann Pettifor sees a discord between (radical) monetary policy and (tight) fiscal policy, with the major beneficiaries of the government’s “lop-sided approach” being big corporations and the rich - owners of assets whose value are inflated by QE.  Yet due to the failure of its fiscal policy, the government has borrowed 7.5 percentage points of GDP more than expected since 2010/11.  This is despite the large windfall gain to government from QE and monetary policy, with the government (through assistance from the Bank of England’s Asset Purchase Fund) having access to a pool of virtually debt-free borrowing. 

Richard Murphy sees the concentration of power in the hands of the Conservative Party in 2015 as accelerating the process of change in tax policy seen over the previous five years.  The post-election 2015 strategy made three things clear. First, tax is at the core of whatever might be called the UK’s industrial strategy, which – based on ever lower taxation of corporate profits and international tax competition - comes down in effect to making the UK a tax haven. Second, tax is apparently to now be used to exacerbate economic inequality, with the burden of taxation being steadily transferred from business to citizens. Third, by starving HMRC of the necessary resources, the tax system reinforces the government’s strategy of shrinking the state. 

Özlem Onaran argues that in 2015, the growth in GDP is based on shaky foundations. The rise in inequality and pay stagnation are among the fundamental flaws in our economic model, which were at the root of the Great Recession, and we are far from correcting this imbalance. Real pay is still 9% lower compared to its peak month in early 2008. After the longest and most dramatic period of decline in real wages since the Victorian times, wage and salary earners seem likely to have to wait till at least 2017 for a recovery in their incomes. “Financialization” is another major brake on investment and growth, with companies’ surging financial activities serving to crowd out private investment in physical assets.

Jeremy Smith looks at the development of labour productivity. Unlike the dominant supply-side approach to productivity (which remain important for the long term), data show that it is demand and economic activity that drive shorter term changes in productivity.  The government is caught on the horns of a dilemma.  Should it celebrate the (real but skimpily-remunerated) increase in employment over the last 3 years?  Or see this as the result of a dysfunctional low productivity economy, increasingly of its own shaping?  With large cuts in real wages, the ultra-flexible UK labour market has caused productivity to fall.  A large, sustained, government-driven programme of investment is the best way to combine economic activity (GDP), higher pay, and higher productivity.

Andrew Simms argues that while the politics and economics of energy and climate change dominated the year, nowhere are the full implications for economies being appreciated. Indeed, cuts to clean energy incentives were justified by the government, in a year when the Chancellor announced new fossil fuel subsidies, and a new legal obligation for the maximum use of North Sea oil and gas. As 2016 looks set to be hotter still than 2015, our greatest challenge will be to learn how to flourish within planetary boundaries. In rich countries like the UK we need to replace consumption-led growth with a new kind of materialism that respects and cares for the material world, with better distribution and a more creative approach to the art of living.

                                                          *   *   *

John Weeks is co-convenor of Economists for Rational Economic Policies, EREP, and Professor Emeritus of Development Economics at SOAS.

Ann Pettifor is director of Policy Research in Macroeconomics, and author of Just Money.

Richard Murphy is an economist and Professor of Practice in International Political Economy at City University London.

Özlem Onaran is Professor of Economics and Director of Greenwich Political Economy Research Centre, University of Greenwich.

Jeremy Smith is co-director of Policy Research in Macroeconomics, and a co-convener of EREP.

Andrew Simms is an author, analyst and campaigner. He co-founded the New Weather Institute, and is a fellow of the New Economics Foundation.

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2015: A failing fiscal policy

John Weeks

When he became chancellor in May 2010 George Osborne pledged to eliminate the fiscal deficit, to “balance the books”.  In his first budget statement that summer he set a specific target, to borrow no more than £37 billion during fiscal year 2014/2015.  That fiscal year ended on 31 March 2015, and borrowing for the fiscal year weighed in at a tidy £90 billion, which by simple subtraction yields an over-run of £53 billion.

The table below shows the major UK fiscal indicators for the latest available statistics, the 12 months ending 30 October 2015.  Despite not meeting the target he set for himself, the chancellor has boasted of success because the overall fiscal balance (i.e. government revenues less spending) is now just over minus £50 billion compared to over £100 billion when he took over Britain’s public finances (borrowing and fiscal balance numbers in the table differ due to asset sales, almost all from bailed out banks).

UK Fiscal Indicators, 12 months through October 2015 (click to enlarge)

(£billions, current prices & percentages)


Note: YT is income tax.

*In June 2010 Osborne announced an annual borrowing target of £37 billion for fiscal year 2014/15.

This heart-felt self-congratulation inspires scepticism for three reasons.  First, the cost in human suffering of the fiscal “savings” has been enormous, felt most acutely through the devastation of local government services.  Over the 12 months covered in the table, local government funding fell by over £4 billion or 3.5 percent of total spending by councils. 

Though central government spending on social “benefits” (aka what we pay taxes for) increased slightly, adjustment for inflation and population increase renders the change close to zero.

Second, the reduction in the fiscal deficit and borrowing resulted from tax revenue increases not from cuts in spending.  Total spending actually rose by £4.6 billion, outweighed by a revenue increase of £25 billion (almost all coming from household income taxes and VAT). 

The implication of the second source of scepticism yields a third, that the budget cuts prevented a balancing of the books. A look at the chart below tells the tale.  The fall in the deficit has been strongly linked with falls in the GDP growth rate (across the ten quarters a decline in the fiscal deficit of one percentage point was associated with a fall in GDP growth of 0.6 percentage points).

The causality is obvious. Tax revenues increase when GDP increases (and people’s income increases); cutting public spending reduces overall demand, depressing GDP growth.  During the 12 months covered in the table the net overall effect of the chancellor’s fiscal policy was a negative 1.1% of GDP. 

The depressing effect of fiscal policy shows in GDP growth itself, which declined in current prices by 2.4 percentage points during the 12 months through 2015Q3 compared to the previous 12 (2013Q3 - 2014Q3).  The larger fall in GDP growth than the fiscal drag results from a slightly negative trade effect, slowdown in private investment, and the expenditure multiplier magnifying all three.

Changes in Treasury Net Borrowing (12 months)

and Nominal GDP Growth Rate 2013Q1-2015Q3 (Source: ONS)


A review of fiscal policy for 2015 shows what we should expect.  The UK economy remains demand-constrained, and the Chancellor’s policies made that straitjacket ever tighter.  We should compliment the chancellor for not achieving his £37 billion borrowing target for fiscal year 2014/2015.  To have done so would have made a bad performance worse.

2015: Monetary and fiscal policy discord

Ann Pettifor

The British Prime Minister declared at Davos in 2012 that he (and his Chancellor) were “fiscal conservatives but monetary radicals injecting cash into the banking system and introducing credit easing measures to make it easier for small businesses to access finance.”

Doubt can be cast over the “fiscal conservatives” claim, as well as the claim that small businesses would benefit from greater access to finance. The major beneficiaries of the government’s lop-sided approach to monetary and fiscal policy are big corporations and the rich - owners of assets whose value are inflated by QE. But the biggest victim of the ‘fiscal conservative’ approach is the government itself. For as we argued in a paper written in 2010 – The Economic Consequences of Mr Osborne – “fiscal consolidation does not ‘slash’ the debt, but contributes to it, as the extent of economic recovery becomes increasingly uncertain.”

In cumulative terms the government has borrowed 7.5 percentage points of GDP more than they expected since 2010-11[1]. And in this year it borrowed more in the first quarter than was originally (2010) planned to borrow in the year as a whole.

This is particularly disappointing given the extremely loose monetary policies adopted by the Bank of England since the onset of the crisis in 2007-9. Lower interest rates combined with the Bank of England’s Asset Purchase Facility (APF) operations have radically reduced the cost of government borrowing – and helped to reduce the need to borrow more, now and in the future.

Thanks to what has come to be known as Quantitative Easing, the Bank of England (BoE) has become directly involved in government debt on a much larger scale and over a longer time period than before. According to the NIESR in their May 2015 Economic Review[2], since the Bank of England began purchasing government securities in March 2009, the government’s Debt Management Office (DMO) has raised more than £1,037 billion in cash by issuing debt “with a nominal value of £994 billion to the market.” If we assume that interest rates would have been at least 50 basis points higher, argue the NIESR authors, the DMO would have had to issue £70bn more in gilts to raise the same amount of cash.

Furthermore, the “forgone coupon payments on this unissued debt would have stood at £33bn over the life of the bonds” – a direct and additional saving to the fiscal authority. But these are underestimates as there are second-round effects. Thanks to QE the government has saved on further principal and coupon payments into the future – “because the principal and coupon payments on the (£70bn) unissued bonds would have been financed, for a given level of tax income, with new borrowing.” (My emphasis)

When the BoE began purchasing government securities from private debt markets in 2009, the government was obliged to pay interest on those securities to the Bank – just as it would have done to any private bondholder.

However in November, 2012 – worried about his failure to constrain public borrowing and debt – the Chancellor decided that the sums paid over to the BoE would be recycled back to the Treasury, on a regular basis. This was a handy windfall to cut the government’s Central Government Net Cash Requirement (CGNR). As a result, the government needs to borrow less. Fewer bond issues imply lower debt service payments for future generations.

While “radical” monetary policy has proved extraordinarily helpful to the Chancellor, it has done little to help him achieve his own public debt and borrowing reduction goals.

And it should come as no surprise that this one-sided monetary policy approach has failed to increase domestic demand, and with it wages and incomes. To do so would have required greater coordination of monetary and fiscal policy, and in particular the monetary authority’s support for increased public investment.

The Chancellor’s failure to use fiscal policy in tandem with monetary policy means that the timid and short-sighted private sector has lacked confidence to ratchet up investment in productive, income-generating activity – as opposed to speculative activity. This low private and public investment is causal of lower productivity levels, as Geoff Tily has argued.  Wage levels in real terms are still over 7% below levels in 2007, and this has led to rises in individual and household borrowing to compensate. The result is the slowest economic recovery in this nation’s history.

Low public borrowing costs provided the ideal environment for increased public investment in, for example, the transformation of the economy away from fossil fuels, and towards more sustainable energy sources. This could be achieved through a programme of activity to increase the energy efficiency of Britain’s leaky housing stock. Such a programme would provide a stimulus to private investment in higher skills, innovation, productivity and job-creation. Such job creation would in turn generate tax income (via the multiplier) to finance the government’s very low debt service costs, and reduce public borrowing and debt.

And such a programme could easily have been financed if only fiscal policy had moved in tandem with monetary policy.

2015: A year in taxation

Richard Murphy

Taxation naturally lends itself to annual review: much of it is assessed on the basis of annual income. Tax policy is not so neatly delineated: when it comes to policy the issue is usually one of trajectories and their convergence and divergence, plus the odd significant sea-change that indicates major changes in direction. The Coalition government established a new direction for UK tax on its election in 2010. The concentration of power in the hands of the Conservative Party in 2015 has accelerated the process of change that was seen over the previous five years.

The post-election 2015 strategy made three things clear. The first is that tax is at the core of whatever might be called the UK’s industrial strategy. In 2010 the government declared that ‘the UK was open for business’ by starting to cut the UK’s large company corporation tax rate. In 2015 this downward trajectory continued with announcement of plans for the rate to be cut to 18% - which is less than the basic rate of income tax. Coupled with changes made over the last five years to reduce the scope of UK tax to ensure that no profits arising outside this country need be taxed here, this reinforces what many have felt for a long time, which is that it is the government’s plan to turn the UK into a tax haven.

It is doing that by cutting the tax rate. It is also doing that by encouraging international tax competition. This represents the second clear strategy that emerged this year: tax is apparently to now be used to exacerbate economic inequality. In the process the UK government has become deeply antagonistic towards the international process run by the Organisation for Economic Cooperation and Development to tackle what is called ‘Base Erosion and Profits Shifting’. Nowhere was this clearer than when in March 2015 the UK created the Diverted Profits Tax (or ‘Google Tax’) that directly undermines internationally agreed measures. It is also widely thought that the UK is a major opponent to EU plans to create tax harmony. That is unsurprising when it continues to support a range of captive tax havens in the Channel Islands and elsewhere.

This policy of tax competition has, however, taken on a new guise domestically. The granting of corporation tax setting powers to Northern Ireland and Scotland opens the possibility of a domestic race to the bottom in profits taxation, and the extension of this policy to business rates, that will now be set by local councils with (in most cases) downward-only adjustments allowed, does much the same thing. The intended impact is obvious in all of these policies. The aim is to reduce the tax paid by business and capital and to shift it on to working people. Office for Budget Responsibility forecasts issued in July and November confirm this plan.

Starving HMRC of resources reinforces the likelihood of this outcome, and represents the third clear strategy, which in this case is designed to reinforce the shrinking of the state. First, a shrunken HMRC will not have the resources to challenge businesses on their tax affairs.

Second, a tax authority that cannot be accessed because people cannot, quite literally, get through to it is one that has a licence to make mistakes.

Thirdly, newly announced plans to ‘digitise’ personal and small business taxation undermine the personal relationships needed to make tax work and clearly signal an era when small business will be expected to pay its tax bills much sooner, which will suck them of much needed capital whilst also, perversely, encouraging more activity in the shadow economy and so an increasing tax gap that denies the state the resources needed to fund its social programmes. At a time when large companies have personal relationships with HMRC officers a clearer indication of the existence of a tax system in which everyone is very clearly ‘not all in it together’ could not be given.

Tax, then, has come to the forefront of politics. Jeremy Corbyn made my work on the tax gap part of Corbynomics for that reason, using it to indicate that other options are available in this area. Demands in the EU Parliament for action on tax abuse in December 2015 are a direct challenge to the Commission that seems likely, along with the UK government, to implement as few as possible of the OECD’s recommended measures to tackle international tax abuse.

It is said that tax need not be taxing but the reality is that tax does, in very many ways, provide any government with the best opportunity to shape the society for which it is responsible and to which it is accountable. If that is true, then I believe that this government is saying it is on the side of the wealthiest and big business and it has little care for the rest. It’s a tough message, and one that has to be challenged before the change it is promoting becomes deeply embedded in an even more divided society in 2016 and beyond.

Read part one here. 

[1]   Source: OBR and Geoff Tily, TUC: Borrowing’s in line with latest forecast, but over four times higher than originally planned

[2] The Impacts of the Bank of England’s Asset Purchases on the Public Finances by Simon Kirby and Jack Meaning. NIESR National Institute Economic Review, No. 232 May 2015, p. F73. 

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