Brexit latest and thoughts on a slower growth world
* With Brexit uncertainty undimmed we start this week’s Briefing with a short recap on the economics of leaving the EU.
* The consensus among economists is that the UK will grow by 1.3% this year and 1.5% next. With activity slowing across the world, particularly in the euro area, and the UK scheduled to leave the EU, growth at these rates looks pretty respectable. Given the uncertainties facing the UK it’s perhaps surprising that its economy is expected to outpace Italy or Germany’s this year.
* This fairly cheery outlook for the UK comes with a major caveat. Most forecasts are predicated on the UK leaving the EU in an orderly, managed fashion. In the event of an abrupt departure without a deal UK growth forecasts would almost certainly plummet. Leaving the EU without a deal would, according to the OECD and the National Institute of Economic and Social Research, leave the UK growing by around 0.4% this year and next.
* Such forecasts are speculative, but reflect concerns that disruption to trade and supply chains, along with sterling weakness, rising import costs and uncertainty, would dampen growth.
* Betting odds offer one way of thinking about the probability of different Brexit options. At the time of writing, the odds from bookmaker Paddy Power imply a 36% chance of Mrs May’s deal being passed by the House of Commons at the third attempt, a 17% chance of the UK exiting without a deal before 1st April and a 29% chance of another referendum happening before the end of this year.
* We now turn to the main subject of this week’s briefing, the way in which deep recessions can depress growth for years to come.
* In the ten years since the financial crisis Western growth has run at much lower rates than in the two decades before the crisis. In the G7 group of major industrialised nations the growth rate has fallen by a quarter since 2008-09. For G7 nations it means a cumulative loss of 6% of GDP over ten years.
* There are lots of theories as to what has gone wrong, but no consensus. One factor which gets little attention is how deep recessions can have lasting effects on an individual’s behaviour and prospects.
* There is a large body of literature showing that trauma can led to a sustained decline in the risk tolerance of individuals. US research shows numerous examples of such so-called scarring effects.
* Researchers in California examined the business strategies of US CEOs who grew up during the Great Depression of the 1920s and 1930s. As CEOs these individuals displayed greater caution than peers who had not experienced the Great Depression, relying more heavily on internal financing and making less use of debt.
* In a similar vein, researchers at MIT and Cornell looked at individuals who started their careers during a recession and served as CEOs in the 1990s and 2000s. Again, recession-generation CEOs exhibited greater caution than their peers. Cost control was ranked as a higher priority for this group while investment, R&D and taking on debt were less important.
* The tendency in recent years for corporates to run high cash balances may well reflect a similar post-crisis mood of caution.
* The labour market provides another example of scarring effects. For young people a spell of unemployment, or even entering work in a recession, can have lasting effects on pay.
* Researchers in North Carolina found that being unemployed at the age of 21 depressed wages for at least ten years relative to those who not been unemployed at this age. According to a Yale study those entering the labour force at a time of recession, even if they find employment, are also likely to see enduring depressed earnings.
* This seems to have been the case in the UK since the financial crisis. For younger workers the upward trajectory of earnings, from one generation to the next, has ground to a halt. Data from the Resolution Foundation show that median real pay for 30 years olds was lower in 2017 than it was 15 years earlier.
* Recessions raise risk aversion and people tend to stick with their current job. As a result they miss out on the step changes in pay that tend to accompany job changes. (Resolution Foundation data for the UK show that moving jobs is associated with a pay rise of 7.3% compared to a 2.5% increase for those staying put). This is a particular issue for younger workers; most of the increase in a person’s salary occur in the first 15 years of work. Less job-switching at this stage of a career can have a significant impact on subsequent earnings.
* The lesson from history is that recessions, especially deep ones, cast long shadows.
PS: Following our briefing on Germany last week, more worrying data has emerged for Germany. The influential Ifo institute cut its forecast for German growth in 2019 from 1.1% to 0.6%. This would be the lowest growth since 2013.
OUR REVIEW OF LAST WEEK’S NEWS
The UK FTSE 100 equity index ended the week up 0.6% at 7,228
Economics and business
* British GDP grew by 0.5% in January, with three-month growth unchanged from the fourth quarter at 0.2%. Growth in the services sector masked falls in production and construction over the last three months
* US Inflation in the year to February was at its lowest level in two years at 1.5%. This supports the Fed’s current dovish stance on future rate increases
* British chancellor Philip Hammond delivered his spring update on the public finances. Against the backdrop of Brexit, forecasts for the public finances improved even as the short-term economic outlook deteriorated. No significant new spending or taxation was announced
* As part of his spring statement, chancellor Philip Hammond announced the Competition and Markets Authority will undertake a review into the digital advertising market
* Christine Lagarde, chair of the International Monetary Fund, has argued for global reform of corporate taxation to combat tax avoidance and profit shifting. Minimum tax rates, charges on cross border payments and splitting global profits according to ratios were all discussed
* The alternative credit provider Lendy, which specialises in property development peer-to-peer lending, has been placed under increased scrutiny by the Financial Conduct Authority. According to reports in the FT, 55% of outstanding loans are considered non-performing
* US-China trade talks continue. Chinese state media reported “substantive progress” on Friday although earlier in the week the US trade representative warned a deal should not be taken for granted
* US President Donald Trump has submitted a new budget to Congress requesting new funding for a border wall and the military with large cuts to education and healthcare. The likely clash with Congress risks another government shutdown
* The race for the 2020 US Democratic nomination is well underway with a crowded field. Kamala Harris, Bernie Sanders, Beto O’Rourke and currently unannounced Joe Biden are well fancied by betting markets
* The International Energy Agency warned that the political crisis in Venezuela threatens approximately 1% of the global oil output
* Investments in US passive funds are expected to overtake active funds by 2021
* The Turkish economy contracted again in the fourth quarter of 2018, shrinking by 2.4% and entering recession
* The accounting regulator, The Financial Reporting Council, is to be disbanded and replaced with the Audit, Reporting and Governance Authority. The new regulator is to be given enhanced powers. A consultation on whether to implement enhanced ‘Sarbanes-Oxley’ type reporting requirements was also announced
* The Boeing 737 Max has been grounded worldwide following two fatal crashes
* Interserve, a major UK government contractor, is set to enter administration following shareholders’ rejection of a debt-for-equity deal
Brexit and European politics
* EU chief Brexit negotiator Jean-Claude Junker said the risk of a no-deal Brexit has never been higher
* UK chancellor Philip Hammond said he would increase spending if a Brexit deal was agreed in the coming weeks
* The Bank of England told some UK banks to triple their holdings of liquid assets in the run up to Brexit to cope with increased market volatility
* The British Chambers of Commerce said anxiety among businesses is rising and customers are being lost as uncertainty around Brexit continues
* US President Donald Trump said that Theresa May had ignored his advice on how to negotiate Brexit and now “it’s tearing a country apart”
* The UK has announced the tariff regime that would apply under a no-deal Brexit. Most tariffs would be eliminated with exceptions for cars and certain agricultural goods. No tariffs would be applied at the Irish border. Europe’s agricultural commissioner suggested these were incompatible with World Trade Organisation rules and were a ‘stunt’
* US President Donald Trump threatened again to impose tariffs on EU exports as the European parliament voted against further trade negotiations
* Germany’s apparent leader in waiting, Annegret Kramp-Karrenbauer, seemed to pour cold water on president Macron’s vision for Europe, preferring something closer to the status quo
* The EU added ten countries, including the United Arab Emirates, to its tax haven blacklist
* The EU competition commissioner, Margrethe Vestager, announced new fines for Google last week following a trend of European regulators scrutinising large tech firms
* Nissan cancelled the production of two Infiniti models at its Sunderland factory as it withdraws the brand from western Europe
And finally… A fox was killed by a group of chickens on a farm in France last week. The fox is believed to have been overwhelmed after being trapped by an automatic door – Coop d’état