I have previously written about the potential for a post-Brexit boom. I think Brexit will be what we make of it; it will come with some costs, but also present opportunities for growth and to rebalance out of existing problems.
The case for an economic boom in the intermediate term is primarily driven by a rebound in capex, which has flat lined since the 2015 EU referendum law:
Source: BoE Inflation Report
The longer term opportunity to make Brexit a success is more complicated and it seems the Conservatives are planning a major overhaul of regional and sectoral industrial policy and government support for more investment. You could call it a subtle approach of supporting more private sector investment and innovation, while Corbyn is more at home with the public sector driving it.
It looks this week Boris will either get a small majority or a working minority.
Source: Guardian poll of polls
If you look through the numbers, it is unlikely Labour will get enough seats with the SNP to have an absolute majority of 322; net of 44 SNP seats, Labour would need 278 MPs vs winning 262 last time.
If the Conservatives get 310, SNP 44, Lib Dems 14, NI 17, Green 1, Plaid 4, Speaker 1, only leaves Labour with 259. A Labour/ SNP coalition would then only be 303.
Corbyn has closed some gap but is too far behind the Tories, even if you allowed as much as a 1.2m vote swing from newly registered voters, who perhaps aren't showing in the polls properly. Cobyn is polling around 34% presently. He could pick up say 2% more from the Liberal Democrats, but many Lib Dem voters seem reluctant to tactically back Labour/ Corbyn and if you allow another 2% for newly registered voters not being polled accurately, that still leaves him on 38%, he got 40% last time and lost. The Tories got 42.4%, pretty much the same as now and won 317 seats. The Brexit Party has pretty much blown up last week, so there may be a small amount more leaver swing to the Tories by the end of this week. So overall it seems the main change in this election is the SNP and perhaps the Lib Dems picking up a few more seats at Labour's expense, having won 35 and 12 respectively in 2017.
However, the wild card remains tactical voting in marginal constituencies, it doesn't take a lot of tactical voting to put the Tories in to a working minority, say 305-320 vs 317 last time.
A hung Parliament with Boris leading 305-320 MPs would give him enough leave Labour MPs to push through the Withdrawal Agreement. Corbyn would then have achieved his two main aims, which have been speculated to be splitting the Thatcher Conservative Party and getting out of the EU. He would also be fairly likely to step down after losing two elections. His replacement is likely to be a more pragmatic centrist like Keir Starmer or someone similar.
Post-election industrial policies
So a Tory Party having pushed the Withdrawal Agreement through Parliament by the end of Jan will still be weak by historical standards and if they are a minority government they will have to focus on shared, nationally popular, middle of the road policies.
Their main manifesto policies related broadly to the industrial areas are summarised below:
- 2.4% of GDP target for R&D with government funding for higher risk/ higher reward projects and tax credits for R&D spending
- A £3bn skills fund including 3.8m apprenticeships
- £2bn for colleges including 20 new technology institutes
- 40GW of wind power capacity by 2030, vs 30-40GW of typical demand
- 29% increase in NHS spending, including 40 new hospitals and preferential visa treatment for experienced health care professionals, thousands more nurse and doctor training places
- Continued funding for the Catapult Centres that try and primary academic and applied industrial research
- Devolved decision making for FDI incentive packages
- Open ten freeports around the UK
- Exiting the Common Agricultural and Fisheries Policies and supporting domestic production
- Push up affordable home building numbers, including a £10bn fund for infrastructure linked to housing like schools and roads.
- £9bn on home insulation and energy efficiency
- £100bn (5% of GDP) on transport
- Rail links upgraded in the North and Midlands
- £29bn for roads
- £1bn for fast charging networks
- Look to end the sale of ICE combustion engines at the right time
- £5bn for full national fibre/ gigabit Internet by 2025
Overall they seem like sensible policies compared to Corbyn's five year plan Marxist lunacy. But in totality they still represent quite significant changes.
The Northern Powerhouse
One of the most important overall policies is reinvigorating the industrial belt from South Wales to Newcastle in the North West. Most of England and Wales' traditional industries are concentrated in the area shown below, with the areas around London, Cambridge, Oxford and the South in general being more IT and high-tech focused.
Dominic Cummings led the leave campaign for Brexit and is now senior adviser to Boris Johnson. On his blog he recently referenced a paper by Sheffield academic Richard Jones, which discusses how to make the Northern Powerhouse work.
As an economy develops into a service economy, factor productivity declines. After all, how do you make a teacher, or cop more productive? As health care complexity goes up, you could argue that the number of hours worked per treatment goes up, so in a way the health care system becomes more labour intensive, albeit with better health care outcomes and people living longer retirements. Classrooms now have 2 or 3 staff for 30 students, vs 1 when I was at school in the 1980's and 90's.
So you have these people-delivered service drags on productivity, but what you can do is increase industrial productivity, but the US and UK have both lost out in industrial sectors in the last 30 years, which in part has given room for the likes of Trump and Farage to rise to prominence.
So what does Richard Jones' paper say about supporting the industrial sectors? Two of his key observations are shown below.
"There has been a general collapse in total factor productivitygrowth – the economy is less able to create higher value products and services from the same inputs than in previous decades. This is a problem of declining innovation in its broadest sense...
...Despite these successes, the UK’s wider research and development base suffers from three faults:
- It is too small for the size of our economy, as measured by R&D intensity
- It is particularly weak in translational research and industrial R&D
- It is too geographically concentrated in the already prosperous parts of the country."
Specifically he finds that there has been a lack of coordination between universities and existing companies to take primary scientific discoveries and translate them into improved high value products. Apple's iPhone is famously based, in part, on primary scientific breakthroughs that were Federally funded.
Additionally, Jones finds that where there have been high value technology based industries, these have been too concentrated around the South East and this has left the traditional industrial areas behind in high value industry, while also losing low end jobs to China. The hub effect has benefited the South East but discouraged investment in the regions and has caused regional economic stagnation.
This stagnation has led to low productivity, underemployment and high government transfer spending in most of these regions, while London and the South and East are the net government contributors.
Large regional towns and cities like Birmingham, Manchester, Liverpool lost industry in the 1980's and 1990's and never found replacement industries.
Regions like Cornwall and Devon have been hampered by the Common Agriculture and Fisheries Policies. The CAP subsidises sub-scale inefficient farms, while the CFP gives UK boats 25% of the EU catch, despite UK waters holding half of the stocks.
Rebalancing the trade deficit via goods imports and exports
I have pasted a few tables and charts below summarising the trade position. Essentially we run a small surplus with the world ex-EU, ex-China. With China and the EU we run a large goods trade deficit that is not offset by a services surplus.
It is about a £100bn a year goods deficit with the EU. We do run a £25bn surplus in services with the EU, but that surplus is in the South East and the goods deficit in the rest of the country, so the services surplus does not really help offset the goods deficit from a regional perspective.
Put simply at say £100k of sales per worker, there are a million high quality, goods producing jobs in the EU that should be in the UK. That statistic alone can explain many of the regional problems. The UK private sector workforce is 27m, so that 1m of directly lost jobs is 3.7% of the total and as it is regionally focused, the impact is greater locally.
With China we import £45bn and export £23bn in goods and services. China, as a large, faster growing economy, which has problems with the US, we should focus on promoting more exports to, to rebalance overall, instead of trying to bring back manufacturing of simple, low value items.
Reducing the goods trade deficit by £100bn would create perhaps 1 million jobs directly and possibly 1m more indirectly. At a 34% tax base it would raise £34bn in taxes directly, plus more indirectly and reduce government transfer spending on the unemployed and underemployed. It would easily be enough to put the government budget into a surplus.
UK total trade in 2018 amounted to £1.32Tn, about 65% of GDP. Taken as a whole, the EU accounted for 49.0% of total UK trade in 2018, with the largest trading partners being Germany (10.2%), the Netherlands (7.2%) and France (6.5%).
In 2018 the UK trade deficit was £37.7billion. In 2018, the UK had a global trade in goods deficit of £142.4billion and a trade in services surplus of £104.7billion. Of the £142bn in goods deficit £96bn was with the EU.
Germany is by far the biggest culprit and with them most of the deficit is accounted for by the machinery, electrical items and transportation segments. Basically the sectors that fell behind in the UK in the 70s and 80s.
Source: ONS data
Put simply the £100bn a year EU goods deficit (5% of GDP), the lost jobs and then the government transfer spending are tied together and account for the root cause of most of the regional problems.
So how do we rebalance with the EU when we have now and will probably agree after Brexit transition a free-trade agreement with no tariffs or quotas? i.e. we can't pursue industrial rebalancing via the way Trump has chosen to with tariffs.
Fishing and Farming
Immediately on Brexit we can get £6-8bn via taking back our fish stocks. At the moment we supply half of the EU's stocks but only get 25% of the quota in the CFP, but with onshore processing this 25% is worth £6-8bn and that revenue would be concentrated in some of the poorest regions. We can also reduce food imports by reforming farming and farm subsidies to encourage, small and inefficient farms to be consolidated and taken over by more productive managers.
Our overall food deficit is ~£24bn. While are arent going to start to grow much citrus fruit here, we can make agriculture more efficient, use technology like LEDs and hydroponics to grow some salads and soft fruits and try and export more. Halving the deficit would be worth £12bn for the rural economy.
By removing EU tariffs of up to 40% on foods, we can source cheaper non-EU suppliers, and in turn do more overall trade with those countries in other areas. If we want to sell high end goods and services to emerging markets, pretty much the only thing they have to sell to us is commodities with which to pay for their own imports.
Within traditional manufacturing and heavy industries, reclaiming market share in mature, margin sensitive industries, when the UK companies are not scaled EU/ global leaders, is difficult. So the focus has to be on building up existing industries via innovation and being targeted leaders in new, high value industries.
Richard Jones and Dominic Cummings solution is to make Britain a leading country for university education and science and then spinning the primary research out into commercially successful products and new industries.
Creating hubs for new technologies
Based around the idea of clustering and local eco-systems of similar firms, Jones argues that universities and government funded institutes should be supported regionally in order to create a commercial eco-system of innovation smaller companies, commercialisation of primary research and the ability to diffuse new technology and processes into the wider network of businesses, the latter of which is where the real productivity gains would come from.
Increasing R&D spending
The UK has fallen back in terms of R&D spending as a percent of GDP, with most of the fall happening in the 80's and 90's as heavy industry was lost. The government plans a 2.4% target and Labour more. On a 1:2 public:private spending ratio, the government needs to support primary research and then the private sector needs to take that and commercialise it. The R&D also needs to be more spread out geographically.
To support this regional drive the Conservatives are committing to £2bn investment in colleges including 20 technology institutes to supply skilled staff to these sectors, a £3bn skills fund and 3.8m apprenticeships, a £1bn clean energy fund, reforming and increasing spending on university research with a focus on life sciences, clean energy, space, design, computing, robotics and artificial intelligence, a full fibre broadband network, leading NHS take up of new technologies and treatments, easing visas for STEM workers etc. They will also change the procurement process to support new companies and technologies - the government is a huge buyer of goods in the economy, over £250bn per year.
To support regional clusters of new technologies the UK is supporting Catapult Centres that are modelled on Germany's Fraunhofer Society. Fraunhofer gets EUR700m of public funding and EUR1.5bn in competitive research contracts. The UK's Catapult Centres have received £237m of core funding, which is expected to be matched with the same amount of collaborative R&D projects and direct industrial contracts. There are 11 Catapult Centres covering segments ranging from health care, to clean energy, to modern, connected cities. The two most successful Catapult Centres, so far, are in Warwick and Sheffield and are tied into the auto and aerospace industries and work with firms like Jaguar Land Rover, McLaren, BAE and Boeing. So they build on and support the existing large businesses and supply chains behind them.
Becoming energy independent
40 GW of wind power alone would turn the UK into a wind super power. Peak loading is only 50GW and most of the time demand is in the 30-40GW range depending on seasonal temperatures. Most production currently is renewables (~40%) and gas turbine (30-35%):
Offshore wind with some marine wave, solar, hydro, nuclear and gas turbines from North Sea gas as the peak loading buffer would make the UK more or less energy independent.
Per a 2018 Parliamentary briefing paper, we currently import 36% of energy. Gross imports are worth £45bn, about 2.5% of GDP, net imports about £20bn, 1% of GDP. Gas for electricity is one of the main deficit areas.
Source: UK parliamentary papers
Making Brexit a success
Michael Gove during the Brexit campaign remarked that “people in this country have had enough of experts”, by which he referred to supposed experts, working in think tanks and similar, that make a career out of telling other people what to do, while being consistently wrong in their predictions and often not living their own lives consistent to their high handed preachings.
These so-called experts have predicted Brexit will be a failure, will lead to lower GDP, and generally rail against any pro-UK independence, self-determination or smaller, more accountable government policies, without themselves being held publicly to account.
Cummings and Boris have run on a fairly slim manifesto and have focused on a few simple messages on Brexit, policing, the NHS in order to win the election and not confuse the message with complicated issues, as discussed above.
Overall I think Brexit is a success which is ours to make and we will have to wait and see what their real plans are for after the election.
Contrasting Trump's approach
The UK economic problems are fairly similar to the US. Trump got elected on the simple MAGA message of bringing industrial jobs back. His approach is the opposite of the subtle, competitive, investment-led approach described above. He is spending big up-front (fiscal stimulus), putting up trade barriers that disrupt supply chains (tariffs), cutting interest rates (pressuring the Fed) and so far, while the US economy has grown, the trade war has back fired.
High value supply chains can take years to relocate, while there is no coordinated strategy to translate general fiscal deficit spending into targeted new investment. So applying tariffs overnight is simply recessionary, but is offset by fiscal deficits and low Fed fund rates. The most likely outcome when the current slowdown ends and economy starts to bounce is a wage/ inflation cycle starting to take hold, while the Fed keeps rates low and bonds/ the US Dollar gets sold.
Trump is following his tried and tested approach: spend bigly upfront, go large, with the gut, and little analysis or forethought, then if the revenues don't show up, strategically default. This time round though he has learnt to keep rates low and will default through inflation not not a pre-pack.
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