Tag: confidence

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World Uncertainty Index

We continue to live through incredibly turbulent times. In the past decade or so we have experienced a global financial crisis, a global health emergency, seen the UK’s departure from the European Union, and witnessed increasing levels of geopolitical tension and conflict. Add to this the effects from the climate emergency and it easy to see why the issue of economic uncertainty is so important when thinking about a country’s economic prospects.

In this blog we consider how we can capture this uncertainty through a World Uncertainty Index and the ways by which economic uncertainty impacts on the macroeconomic environment.

World Uncertainty Index

Hites Ahir, Nicholas Bloom and Davide Furceri have constructed a measure of uncertainty known as the World Uncertainty Index (WUI). This tracks uncertainty around the world using the process of ‘text mining’ the country reports produced by the Economist Intelligence Unit. The words searched for are ‘uncertain’, ‘uncertainty’ and ‘uncertainties’ and a tally is recorded based on the number of times they occur per 1000 words of text. To produce the index this figure is then multiplied up by 100 000. A higher number therefore indicates a greater level of uncertainty. For more information on the construction of the index see the 2022 article by Ahir, Bloom and Furceri linked below.

Figure 1 (click here for a PowerPoint) shows the WUI both globally and in the UK quarterly since 1991. The global index covers 143 countries and is presented as both a simple average and a GDP weighted average. The UK WUI is also shown. This is a three-quarter weighted average, the authors’ preferred measure for individual countries, where increasing weights of 0.1, 0.3 and 0.6 are used for the three most recent quarters.

From Figure 1 we can see how the level of uncertainty has been particularly volatile over the past decade or more. Events such as the sovereign debt crisis in parts of Europe in the early 2010s, the Brexit referendum in 2016, the COVID-pandemic in 2020–21 and the invasion of Ukraine in 2022 all played their part in affecting uncertainty domestically and internationally.

Uncertainty, risk-aversion and aggregate demand

Now the question turns to how uncertainty affects economies. One way of addressing this is to think about ways in which uncertainty affects the choices that people and businesses make. In doing so, we could think about the impact of uncertainty on components of aggregate demand, such as household consumption and investment, or capital expenditures by firms.

As Figure 2 shows (click here for a PowerPoint), investment is particularly volatile, and much more so than household spending. Some of this can be attributed to the ‘lumpiness’ of investment decisions since these expenditures tend to be characterised by indivisibility and irreversibility. This means that they are often relatively costly to finance and are ‘all or nothing’ decisions. In the context of uncertainty, it can make sense therefore for firms to wait for news that makes the future clearer. In this sense, we can think of uncertainty rather like a fog that firms are peering through. The thicker the fog, the more uncertain the future and the more cautious firms are likely to be.

The greater caution that many firms are likely to adopt in more uncertain times is consistent with the property of risk-aversion that we often attribute to a range of economic agents. When applied to household spending decisions, risk-aversion is often used to explain why households are willing to hold a buffer stock of savings to self-insure against unforeseen events and their future financial outcomes being worse than expected. Hence, in more uncertain times households are likely to want to increase this buffer further.

The theory of buffer-stock saving was popularised by Christopher Carroll in 1992 (see link below). It implies that in the presence of uncertainty, people are prepared to consume less today in order to increase levels of saving, pay off existing debts, or borrow less relative to that in the absence of uncertainty. The extent of the buffer of financial wealth that people want to hold will depend on their own appetite for risk, the level of uncertainty, and the moderating effect from their own impatience and, hence, present bias for consuming today.

Risk aversion is consistent with the property of diminishing marginal utility of income or consumption. In other words, as people’s total spending volumes increase, their levels of utility or satisfaction increase but at an increasingly slower rate. It is this which explains why individuals are willing to engage with the financial system to reallocate their expected life-time earnings and have a smoother consumption profile than would otherwise be the case from their fluctuating incomes.

Yet diminishing marginal utility not only explains consumption smoothing, but also why people are willing to engage with the financial system to have financial buffers as self-insurance. It explains why people save more or borrow less today than suggested by our base-line consumption smoothing model. It is the result of people’s greater dislike (and loss of utility) from their financial affairs being worse than expected than their like (and additional utility) from them being better than expected. This tendency is only likely to increase the more uncertain times are. The result is that uncertainty tends to lower household consumption with perhaps ‘big-ticket items’, such as cars, furniture, and expensive electronic goods, being particularly sensitive to uncertainty.

Uncertainty and confidence

Uncertainty does not just affect risk; it also affects confidence. Risk and confidence are often considered together, not least because their effects in generating and transmitting shocks can be difficult to disentangle.

We can think of confidence as capturing our mood or sentiment, particularly with respect to future economic developments. Figure 3 plots the Uncertainty Index for the UK alongside the OECD’s composite consumer and business confidence indicators. Values above 100 for the confidence indicators indicate greater confidence about the future economic situation and near-term business environment, while values below 100 indicate pessimism towards the future economic and business environments.

Figure 3 suggests that the relationship between confidence and uncertainty is rather more complex than perhaps is generally understood (click here for a PowerPoint). Haddow, Hare, Hooley and Shakir (see link below) argue that the evidence tends to point to changes in uncertainty affecting confidence, but with less evidence that changes in confidence affect uncertainty.

To illustrate this, consider the global financial crisis of the late 2000s. The argument can be made that the heightened uncertainty about future prospects for households and businesses helped to erode their confidence in the future. The result was that people and businesses revised down their expectations of the future (pessimism). However, although people were more pessimistic about the future, this was more likely to have been the result of uncertainty rather than the cause of further uncertainty.

Conclusion

For economists and policymakers alike, indicators of uncertainty, such as the Ahir, Bloom and Furceri World Uncertainty Index, are invaluable tools in understanding and forecasting behaviour and the likely economic outcomes that follow. Some uncertainty is inevitable, but the persistence of greater uncertainty since the global financial crisis of the late 2000s compares quite starkly with the relatively lower and more stable levels of uncertainty seen from the mid-1990s up to the crisis. Hence the recent frequency and size of changes in uncertainty show how important it to understand how uncertainty effects transmit through economies.

Academic papers

Articles

Data

Questions

  1. (a) Explain what is meant by the concept of diminishing marginal utility of consumption.
    (b) Explain how this concept helps us to understand both consumption smoothing and the motivation to engage in buffer-stock saving.
  2. Explain the distinction between confidence and uncertainty when analysing macroeconomic shocks.
  3. Discuss which types of expenditures you think are likely to be most susceptible to uncertainty shocks.
  4. Discuss how economic uncertainty might affect productivity and the growth of potential output.
  5. How might the interconnectedness of economies affect the transmission of uncertainty effects through economies?
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Worries about the Chinese economy

According to the IMF, Chinese GDP grew by 5.2% in 2023 and is predicted to grow by 4.6% this year. Such growth rates would be extremely welcome to most developed countries. UK growth in 2023 was a mere 0.5% and is forecast to be only 0.6% in 2024. Advanced economies as a whole only grew by 1.6% in 2023 and are forecast to grow by only 1.5% this year. Also, with the exception of India, the Philippines and Indonesia, which grew by 6.7%, 5.3% and 5.0% respectively in 2023 and are forecast to grow by 6.5%, 6.0% and 5.0% this year, Chinese growth also compares very favourably with other developing countries, which as a weighted average grew by 4.1% last year and are forecast to grow at the same rate this year.

But in the past, Chinese growth was much higher and was a major driver of global growth. Over the period 1980 to 2018, Chinese economic growth averaged 9.5% – more than twice the average rate of developing countries (4.5%) and nearly four times the average rate of advanced countries (2.4%) (see chart – click here for a PowerPoint of the chart).

Not only is Chinese growth now much lower, but it is set to decline further. The IMF forecasts that in 2025, Chinese growth will have fallen to 4.1% – below the forecast developing-country average of 4.2% and well below that of India (6.5%).

Causes of slowing Chinese growth

There are a number of factors that have come together to contribute to falling economic growth rates – growth rates that otherwise would have been expected to be considerably higher as the Chinese economy reopened after severe Covid lockdowns.

Property market
China has experienced a property boom over the past 20 years years as the government has encouraged construction in residential blocks and in factories and offices. The sector has accounted for some 20% of economic activity. But for many years, demand outstripped supply as consumers chose to invest in property, partly because of a lack of attractive alternatives for their considerable savings and partly because property prices were expected to go on rising. This lead to speculation on the part of both buyers and property developers. Consumers rushed to buy property before prices rose further and property developers borrowed considerably to buy land, which local authorities encouraged, as it provided a valuable source of revenue.

But now there is considerable overcapacity in the sector and new building has declined over the past three years. According to the IMF:

Housing starts have fallen by more than 60 per cent relative to pre-pandemic levels, a historically rapid pace only seen in the largest housing busts in cross-country experience in the last three decades. Sales have fallen amid homebuyer concerns that developers lack sufficient financing to complete projects and that prices will decline in the future.

As a result, many property developers have become unviable. At the end of January, the Chinese property giant, Evergrande, was ordered to liquidate by a Hong Kong court, after the judge ruled that the company did not have a workable plan to restructure around $300bn of debt. Over 50 Chinese property developers have defaulted or missed payments since 2020. The liquidation of Evergrande and worries about the viability of other Chinese property developers is likely to send shockwaves around the Chinese property market and more widely around Chinese investment markets.

Overcapacity
Rapid investment over many years has led to a large rise in industrial capacity. This has outstripped demand. The problem could get worse as investment, including state investment, is diverted from the property sector to manufacturing, especially electric vehicles. But with domestic demand dampened, this could lead to increased dumping on international markets – something that could spark trade wars with the USA and other trading partners (see below). Worries about this in China are increasing as the possibility of a second Trump presidency looks more possible. The Chinese authorities are keen to expand aggregate demand to tackle this overcapacity.

Uncertainty
Consumer and investor confidence are low. This is leading to severe deflationary pressures. If consumers face a decline in the value of their property, this wealth effect could further constrain their spending. This will, in turn, dampen industrial investment.

Uncertainty is beginning to affect foreign companies based in China. Many foreign companies are now making a loss in China or are at best breaking even. This could lead to disinvestment and add to deflationary pressures.

The Chinese stock market and policy responses
Lack of confidence in the Chinese economy is reflected in falling share prices. The Shanghai SSE Composite Index (an index of all stocks traded on the Shanghai Stock Exchange) has fallen dramatically in recent months. From a high of 3703 in September 2021, it had fallen to 2702 on 5 Feb 2024 – a fall of 27%. It is now below the level at the beginning of 2010 (see chart: click here for a PowerPoint). On 5 February alone, some 1800 stocks fell by over 10% in Shanghai and Shenzhen. People were sensing a rout and investors expressed their frustration and anger on social media, including the social media account of the US Embassy. The next day, the authorities intervened and bought large quantities of key stocks. China’s sovereign wealth fund announced that it would increase its purchase of shares to support the country’s stock markets. The SSE Composite rose 4.1% on 6 February and the Shenzhen Component Index rose 6.2%.

However, the rally eased as investors waited to see what more fundamental measures the authorities would take to support the stock markets and the economy more generally. Policies are needed to boost the wider economy and encourage a growth in consumer and business confidence.

Interest rates have been cut four times since the beginning of 2022, when the prime loan rate was cut from 3.85% to 3.7%. The last cut was from 3.55% to 3.45% in August 2023. But this has been insufficient to provide the necessary boost to aggregate demand. Further cuts in interest rates are possible and the government has said that it will use proactive fiscal and effective monetary policy in response to the languishing economy. However, government debt is already high, which limits the room for expansionary fiscal policy, and consumers are highly risk averse and have a high propensity to save.

Graduate unemployment
China has seen investment in education as an important means of increasing human capital and growth. But with a slowing economy, there are are more young people graduating each year than there are graduate jobs available. Official data show that for the group aged 16–24, the unemployment rate was 14.9% in December. This compares with an overall urban unemployment rate of 5.1%. Many graduates are forced to take non-graduate jobs and graduate jobs are being offered at reduced salaries. This will have a further dampening effect on aggregate demand.

Demographics
China’s one-child policy, which it pursued from 1980 to 2016, plus improved health and social care leading to greater longevity, has led to an ageing population and a shrinking workforce. This is despite recent increases in unemployment in the 16–24 age group. The greater the ratio of dependants to workers, the greater the brake on growth as taxes and savings are increasingly used to provide various forms of support.

Effects on the rest of the world

China has been a major driver of world economic growth. With a slowing Chinese economy, this will provide less stimulus to growth in other countries. Many multinational companies, including chip makers, cosmetics companies and chemical companies, earn considerable revenue from China. For example, the USA exports over $190 billion of goods and services to China and these support over 1 million jobs in the USA. A slowdown in China will have repercussions for many companies around the world.

There is also the concern that Chinese manufacturers may dump products on world markets at less than average (total) cost to shift stock and keep production up. This could undermine industry in many countries and could initiate a protectionist response. Already Donald Trump is talking about imposing a 10% tariff on most imported goods if he is elected again in November. Such tariffs could be considerably higher on imports from China. If Joe Biden is re-elected, he too may impose tariffs on Chinese goods if they are thought to be unfairly subsidised. US (and possibly EU) tariffs on Chinese goods could lead to a similar response from China, resulting in a trade war – a negative sum game.

Videos

Articles

Questions

  1. Why is China experiencing slowing growth and is growth likely to pick up over the next five years?
  2. How does the situation in China today compare with that in Japan 30 years ago?
  3. What policies could the Chinese government pursue to stimulate economic growth?
  4. What policies were enacted towards China during the Trump presidency from 2017 to 2020?
  5. Would you advise the Chinese central bank to cut interest rates further? Explain.
  6. Should China introduce generous child support for families, no matter the number of children?
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Nominal and real retail sales figures: interpreting the data

The distinction between nominal and real values in one of the ‘threshold concepts’ in economics. These are concepts that are fundamental to a discipline and which occur again and again. The distinction between nominal and real values is particularly important when interpreting and analysing data. We show its importance here when analysing the latest retail sales data from the Office for National Statistics.

Retail sales relate to spending on items such as food, clothing, footwear, and household goods (see). They involve sales by retailers directly to end consumers whether in store or online. The retail sales index for Great Britain is based on a monthly survey of around 5000 retailers across England, Scotland and Wales and is thought to capture around 75 per cent of turnover in the sector.

Estimates of retail sales are published in index form. There are two indices published by the ONS: a value and volume measure. The value index reflects the total turnover of business, while the volume index adjusts the value index for price changes. Hence, the value estimates are nominal, while the volume estimates are real. The key point here is that the nominal estimates reflect both price and volume changes, whereas the real estimates adjust for price movements to capture only volume changes.

The headline ONS figures for September 2023 showed a 0.9 per cent volume fall in the volume of retail sales, following a 0.4 per cent rise in August. In value terms, September saw a 0.2 per cent fall in retail sales following a 0.9 per cent rise in August. Monthly changes can be quite volatile, even after seasonal adjustment, and sensitive to peculiar factors. For example, the unusually warm weather this September helped to depress expenditure on clothes. It is, therefore, sensible to take a longer-term view when looking for clearer patterns in spending behaviour.

Chart 1 plots the value and volume of retail sales in Great Britain since 1996. (Click here for a PowerPoint of this and the other two charts). In value terms, retail sales spending increased by 165 per cent, whereas in volume terms, spending increased by 73 per cent. This difference is expected in the presence of rising prices, since nominal growth, as we have just noted, reflects both price and volume changes. The chart is notable for capturing two periods where the volume of retail spending ceased to grow. The first of these is following the global financial crisis of the late 2000s. The period from 2008 to 2013 saw the volume of retail sales stagnate and flatline with a recovery in volumes only really starting to take hold in 2014. Yet in nominal terms retail sales grew by around 16 per cent.

The second of the two periods is the decline in the volume of retail sales from 2021. To help illustrate this more clearly, Chart 2 zooms in on retail sales over the past five years or so. We can see a significant divergence between the volume and value of retail sales. Between April 2021 and September 2023, the volume of retail sales fell by 11%. In contrast, the value of retail sales increased by 8.4%. The impact of the inflationary shock and the consequent cost-of-living crisis that emerged from 2021 is therefore demonstrated starkly by the chart, not least the severe drag that it has had on the volume of retail spending. This has meant that the aggregate volume of retail sales in September 2023 was only back to the levels of mid-2018.

Finally, Chart 3 shows the patterns in the volumes of retailing by four categories since 2018: specifically, food stores, predominantly non-food stores, non-store retail, and automotive fuel. The largest fall in the volume of retail sales has been experienced by non-store retailing – largely online retailing. From its peak in December 2020, non-store retail sales decreased by almost 20 per cent up to September 2023. While this needs to be set in the context of the volume of non-store retail purchases being 14% higher than in February 2020 before the pandemic lockdowns were introduced, it is nonetheless indicative of the pressures facing online retailers.

Importantly, the final chart shows that the pressures in retailing are widespread. Spending volumes on automotive fuels, and in food and non-food stores are all below 2019 levels. The likelihood is that these pressures will persist for some time to come. This inevitably has potential implications for retailers and, of course, for those that work in the sector.

Articles

Statistical bulletin

Data

Questions

  1. Why does an increase in the value of retail sales not necessarily mean that their volume has increased?
  2. In the presence of deflation, which will be higher: nominal or real growth rates?
  3. Discuss the factors that could explain the patterns in the volume of spending observed in the different categories of retail sales in Chart 3.
  4. Discuss what types of retail products might be more or less sensitive to the macroeconomic environment.
  5. Conduct a survey of recent media reports to prepare a briefing discussing examples of retailers who have struggled or thrived in the recent economic environment.
  6. What do you understand by the concepts of ‘consumer confidence’ and ‘economic uncertainty’? How might these affect the volume of retail spending?
  7. Discuss the proposition that the retail sales data cast doubt on whether people are ‘forward-looking consumption smoothers’.
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End of the line

HS2 has been cancelled north of Birmingham. The prime minister, Rishi Sunak, announced this at the Conservative Party conference on 4 October, some 13 years after the plan was adopted by the Labour government to build a new high-speed railway from London to Birmingham, which then would branch into two legs – one to Manchester and one to Leeds. The initial budget for this was £15.8bn to £17.4bn. When it came to power, the Conservative-Liberal coalition government ordered a review of the plan. In light of this, the government gave the green light in January 2012 for the full Y-shaped project to go ahead. The London–Birmingham leg was planned to open in 2026 and the two northern legs from 2033.

The project was divided into two phases: Phase 1 to Birmingham and Phase 2 to Manchester and Leeds. The Phase 1 parliamentary bill became law in February 2017 and soon after that, various construction contracts were signed. After some delays, preparation for construction work began in June 2019. There was growing doubt, however, about the viability of the northern legs.

On becoming prime minister in 2019, Boris Johnson ordered an independent review of the project after estimates that the costs of the full project would be some £88bn. The review, chaired by Douglas Oakervee, was published in December 2019 (for a link, see list of reports below). It found that costs (in 2015 prices) were likely to be between £62bn and £69bn. Nevertheless, it concluded that the project should proceed: that the original rationale for HS2 still held; that there were:

no shovel-ready alternative investments in the existing network that were available: if HS2 were to be cancelled, many years of planning work would be required to identify, design and develop new proposals; that the upgrading of existing lines would also come at a high passenger cost with significant disruption; that there would be serious consequences for the supply chain, the fragile UK construction industry and confidence in UK infrastructure planning if HS2 were to be cancelled at this late stage.

In February 2020, the prime minister announced that HS2 would go ahead, including the legs to Manchester and Leeds. The Department for Transport published a document (see source line to the following table) giving the full business case for Phase 1 and the outline case for Phase 2. The document itemised the costs and benefits as estimated at the time.

Source: Full Business Case: High Speed Two, Table 2.9, Department for Transport (April 2020)

Box 12.6 in Economics (eleventh edition) and Case study 8.16 on the Essentials of Economics (ninth edition) student website looks at these costs and benefits. The above table is taken from the box/case study. Net transport benefits (present value at 2015 prices) were estimated to be £74.2bn. These include benefits to passengers from shorter journey times, greater reliability, greater connectivity and less crowding, and reduced congestion on roads. They also include other benefits, such as a reduction in carbon emissions and a reduction in road accidents. Net benefits also include the wider benefits from greater connectivity between firms (resulting in increased specialism, trade and investment), greater competition and greater labour mobility. These wider benefits were estimated to be £20.5bn, giving total net benefits of £94.7bn.

Total costs to the government were estimated to be £108.9bn and revenues from fares to be £45.4bn, giving total net costs of £63.5bn. This gave a benefit/cost ratio of 1.5 (£94.7bn/£63.5bn). In the light of these findings, the government announced in September 2020 that the main work on the London to Birmingham leg would begin, despite the Public Accounts Committee’s finding that the project was badly off course and lacking in transparency.

Concern was expressed over whether the Leeds leg would go ahead, but in May 2021, the transport secretary, Grant Shapps, confirmed that it would be completed. However, with the publication of the Integrated Rail Plan in November 2021 (for a link, see list of reports below), the government decided that the eastern leg of HS2 would no longer reach Leeds but instead end in the East Midlands. Then in June 2022, the link between the HS2 line near Manchester and the West Coast Main Line was scrapped. This would have allowed HS2 trains to reach Scotland.

In early 2023, it was announced that the building of the terminus at Euston was being put on hold. Many interpreted this as meaning that it was being scrapped, with trains terminating at Old Oak Common, some six miles from Central London.

Finally, as we have seen, HS2 north of Birmingham has now been scrapped and the government is seeking private-sector funding to build the terminus at Euston and complete the line from Old Oak Common.

Arguments for scrapping the northern legs

The main argument given by the government was that projected costs have risen substantially above original estimates and that by cancelling the Manchester and east Midlands legs, the money saved could be better used elsewhere. The argument is one of opportunity cost. The cost of going ahead would mean not going ahead with better-value alternatives.

The government claims that £36bn will be saved and that this will be diverted to rail, road and other transport projects, primarily (although not exclusively) in the north of England. The money would be spent between 2029 and 2040. Projects include spending additional money on the planned upgrading of the rail link between Manchester and Liverpool, Sheffield, Leeds and Hull; building a new station at Bradford; developing a mass transit system for Leeds and its surroundings; a £2.5bn fund for improved transport for smaller cities, towns and the countryside in the north of England; extra funding for transport in the east and west Midlands, including funding a Midlands Rail Hub. Out of the £36bn, £6.5bn would be for projects elsewhere, including road improvement.

In order to judge whether the diversion of funds represents a better use of money, a full analysis of costs and benefits of the various projects would need to be conducted and compared with an updated cost–benefit analysis of continuing with the legs to Manchester and the east Midlands and possibly reinstating the Leeds leg too.

One possible benefit for the government is a political one. It hopes that promising more local projects rather than HS2 will appeal to the electorate in large parts of the north of England who are suffering from poor and unreliable transport links. However, most of these projects will be started well beyond the next election and this political gain may turn out to be small. Indeed, cancelling HS2 may breed cynicism, with people wondering whether any promised new projects will actually be delivered.

Arguments against scrapping the northern leg(s)

The benefits originally identified from HS2 will now be lost. It is not just that the northern legs of HS2 would have provided faster travel to Manchester and Leeds, but the new lines would have reduced congestion for slower trains and freight on existing lines. This has been the experience in countries such as Japan and Spain, which have invested heavily in new, separate high-speed lines.

When the line is completed to Birmingham, the HS2 trains will be able to continue north of Birmingham on existing lines. But these lines are heavily congested, which will limit the number of HS2 trains that can use them. Also they will be restricted to 110 mph on these lines as they have no tilting mechanism. Also they will have a maximum capacity of only 550 seats (a single train set) as the platforms at Manchester Piccadilly cannot accommodate double-set trains. The existing Pendalino trains on the West Coast mainline can travel at 125 mph as they do have the tilting mechanism and they have a higher capacity of 607 seats.

Then there are the signals that cancellation sends to industry about whether governments can be trusted to follow through on public-sector projects. Many business had expanded or relocated to places near the HS2 routes. Many others will wonder whether the promised new projects will go ahead. Indeed, shortly after giving a list of the projects (some of which had already been built or were being built), the list was removed from the government website. There is already a mood of scepticism amongst the electorate. Polling following the initial announcement showed that a majority believed that it was unlikely that the Conservatives would deliver the other projects if they won the next election.

The opportunity cost argument that the money would be better spent on alternative transport projects is predicated on various assumptions. One is that the money will actually be spent, which, as we have seen, people consider doubtful. Another is that the only choice is either spending a fixed pot of money on the northern leg(s) of HS2 or spending it on the alternative projects announced by the prime minister. It could be argued that the government should proceed with both the full HS2 and these other projects, and fund it by extra taxation. Investment as a percentage of GDP is low in the UK compared with other countries. Over the past 10 years, it has averaged 17.8% in the UK. This compares with 21.0% in the USA, 21.5% in Germany, 23.7% in France and 25.4% in Japan. Also, public-sector investment is low in the UK compared with that in other countries.

Assessing the arguments

Many of the costs and benefits of long-term projects, such as HS2, occur many years hence. There is, therefore, a great deal of uncertainty over their magnitude. This makes it extremely difficult to reach a clear conclusion over the desirability of cancelling HS2 north of Birmingham or continuing with it. Under such circumstances, politics tends to dominate decision making.

Articles

Government Press Release

Reports

Questions

  1. Why have the costs of HS2 (in real terms) risen substantially since the first estimates in 2012?
  2. Identify the types of environmental costs and benefits of the full Y-shaped HS2 project. Why might such costs and benefits be difficult to measure?
  3. Is the opportunity of cost of proceeding with the full Y-shaped HS2 a range of other transport projects? Explain.
  4. Find out the level of public-sector investment expenditure as a percentage of (a) total government expenditure and (b) GDP in some other developed countries and compare them with the UK. Comment on your findings.
  5. Should the decision whether or not to go ahead with the Manchester and east Midlands legs have been delayed until a new updated cost–benefit analysis had been conducted?
  6. If most of the benefits from the originally planned HS2 will be now be lost with the line ending at Birmingham, should this leg to Birmingham also be cancelled, even though many of the costs have already been incurred? Explain your reasoning.
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The UK Autumn Statement 2022

The Autumn Statement was announced by Jeremy Hunt in Parliament on Thursday 17th November. This was Hunt’s first big speech since becoming Chancellor or the Exchequer a few weeks ago. He revealed to the House of Commons that there will be tax rises and spending cuts worth billions of pounds, aimed at mending the nation’s finances. It is hoped that the new plans will restore market confidence shaken by his predecessor’s mini-Budget. He claimed that the mixture of tax rises and spending cuts would be distributed fairly.

What is the Autumn statement?

The March Budget is the government’s main financial plan, where it decides how much money people will be taxed and where that money will be spent. The Autumn Statement is like a second Budget. This is an update half a year later on how things are going. However, that doesn’t mean it is not as important. This year’s Autumn Statement is especially important given the number of changes in government in recent months. The Statement unfortunately comes at a time when the cost of living is rising at its fastest rate for 41 years, meaning that it is going to be a tough winter for many people.

Statement overview

It was expected that the Statement was not going to be one to celebrate, given that the UK is now believed to be in a recession. The Office for Budget Responsibility (OBR) forecasts that the UK economy will shrink by 1.4% next year. However, Hunt said that his focus was on stability and ensuring a shallower downturn. The Chancellor outlined his ‘plan for stability’ by announcing deep spending cuts and tax rises in the autumn statement. He said that half of his £55bn plan would come from tax rises, and the rest from spending cuts.

The Chancellor plans to tackle rising prices and restore the UK’s credibility with international markets. He said that it will be a balanced path to stability, with the need to tackle inflation to bring down the cost of living while also supporting the economy on a path to sustainable growth. It will mean further concerns for many, but the Chancellor argued that the most vulnerable in society are being protected. He stated that despite difficult decisions being made, the plan was fair.

What was announced?

The government’s overall strategy appears to assume that, by tightening fiscal policy, monetary policy will not have to tighten as much. The hopeful consequence of which is that interest rates will be lower than they otherwise would have been. This means interest-rate sensitive parts of the economy, the housing sector in particular, are more protected than it would have been.

The following are some of the key measures announced:

  • Tax thresholds will be frozen until April 2028, meaning millions will pay more tax as their nominal incomes rise.
  • Spending on public services in England will rise more slowly than planned – with some departments facing cuts after the next election.
  • The state pensions triple lock will be kept, meaning pensioners will see a 10.1% rise in weekly payments.
  • The household energy price cap per unit of gas and electricity has been extended for one year beyond April but made less generous, with typical bills then being £3000 a year instead of £2500.
  • There will be additional cost-of-living payments for the ‘most vulnerable’, with £900 for those on benefits, and £300 for pensioners.
  • The top 45% additional rate of income tax will be paid on earnings over £125 140 instead of £150 000.
  • The UK minimum wage (or ‘National Living Wage’ as the government calls it) for people over 23 will increase from £9.50 to £10.42 per hour.
  • The windfall tax on oil and gas firms will increase from 25% to 35%, raising £55bn over the period from now until 2028.

The public finances

A key feature of the Autumn Statement was the Chancellor’s attempt to tackle the deteriorating public finances and to reduce the public-sector deficit and debt. The following three charts are based on data from the OBR (see data links below). They all show data for financial years beginning in the year shown. They all include OBR forecasts up to 2025/26, with the forecasts being based on the measures announced in the Autumn Statement.

Figure 1 shows public-sector current expenditure and receipts and the balance between them, giving the current deficit (or surplus), shown by the green bars. Current expenditure excludes capital expenditure on things such as hospitals, schools and roads. Since 1973, there has been a current deficit in most years. However, the deficit of 11.5% of GDP in 2020/21 was exceptional given government support measures for households and business during the pandemic. The deficit fell to 3.3% in 2021/22, but is forecast to grow to 4.6% in 2022/23 thanks to government subsidies to energy suppliers to allow energy prices to be capped. (Click here for a PowerPoint of this chart.)

Figure 2 shows public-sector expenditure (current plus capital) from 1950. You can see the spike after the financial crisis of 2007–8 when the government introduced various measures to support the banking system. You can also see the bigger spike in 2020/21 when pandemic support measures saw government expenditure rise to a record 53.0% of GDP. It has risen again this financial year to a predicted to 47.3% of GDP from 44.7% last financial year. It is forecast to fall only slightly, to 47.2%, in 2023/24, before then falling more substantially as the tax rises and spending cuts announced in the Autumn Statement start to take effect. (Click here for a PowerPoint of this chart.)

Figure 3 shows public-sector debt since 1975. COVID support measures, capping energy prices and a slow growing or falling GDP have contributed to a rise in debt as a proportion of GDP since 2020/21. Debt is forecast to peak in 2023/24 at a record 106.7% of GDP. During the 20 years from 1988/89 to 2007/8 it averaged just 30.9% of GDP. After the financial crisis of 2007–8 it rose to 81.6% by 2014/15 and then averaged 82.2% between 2014/15 and 2019/20. (Click here for a PowerPoint of this chart.)

Criticism

The government has been keen to stress that Mr Hunt’s statement does not amount to a return to the austerity policies of the Conservative-Liberal Democrat coalition government, in office between 2010 and 2015. However, Labour Shadow Chancellor, Rachel Reeves, said Mr Hunt’s Autumn Statement was an ‘invoice for the economic carnage’ the Conservative government had created. There have also been some comments raised by economists questioning the need for spending cuts and tax rises on this scale, with some saying that the decisions being made are political.

Paul Johnson, the director of the Institute for Fiscal Studies has commented on the plans, stating that the British people ‘just got a lot poorer’ after a series of ‘economic own goals’ that have made a recovery much harder than it might have been. He went on to say that the government was ‘reaping the costs of a long-term failure to grow the economy’, along with an ageing population and high levels of historic borrowing.

Disapproval also came from Conservative MP, Jacob Rees-Mogg, who criticised the government’s tax increases. He raised concerns about the government’s plans to increase taxation when the economy is entering a recession. He said, ’You would normally expect there to be some fiscal support for an economy in recession.’

Economic Outlook

High inflation and rising interest rates will lead to consumers spending less, tipping the UK’s economy into a recession, which the OBR expects to last for just over a year. Its forecasts show that the economy will grow by 4.2% this year but will shrink by 1.4% in 2023, before growth slowly picks up again. GDP should then rise by 1.3% in 2024, 2.6% in 2025 and 2.7% in 2026.

The OBR predicts that there will be 3.2 million more people paying income tax between 2021/22 and 2027/28 as a result of the new tax policy and many more paying higher taxes as a proportion of their income. This is because they will be dragged into higher tax bands as thresholds and allowances on income tax, national insurance and inheritance tax have been frozen until 2028. Government documents said these decisions on personal taxes would raise an additional £3.5bn by 2028 – the consequence of ‘fiscal drag’ pulling more Britons into higher tax brackets. The OBR expects that there will be an extra 2.6 million paying tax at the higher, 40% rate. This is going to put more pressure on households who are already feeling the impact of inflation on their disposable income.

However, this pressure on incomes is set to continue, with real incomes falling by the largest amount since records began in 1956. Real household incomes are forecast to fall by 7% in the next few years, which even after the support from the government, is the equivalent of £1700 per year on average. And the number unemployed is expected to rise by more than 500 000. Senior research economist at the IFS, Xiaowei Xu, described the UK as heading for another lost decade of income growth.

There may be some good news for inflation, with suggestions that it has now peaked. The OBR forecasts that the inflation rate will drop to 7.4% next year. This is still a concern, however, given that the target set for inflation is 2%. Despite the inflation rate potentially peaking, the impact on households has not. The fall in the inflation rate does not mean that prices in the shops will be going down. It just means that they will be going up more slowly than now. The OBR expects that prices will not start to fall (inflation becoming negative) until late 2024.

Conclusion

The overall tone of the government’s announcements was no surprise and policies were largely expected by the markets, hence their muted response. However, this did not make them any less economically painful. There are major concerns for households over what they now face over the next few years, something that the government has not denied.

It has been suggested that this situation, however, has been made worse by historic choices, including cutting state capital spending, cuts in the budget for vocational education, Brexit and Kwasi Kwarteng’s mini-Budget. It is evident that Britons have a tough time ahead in the next year or so. The UK has already had one lost decade of flatlining living standards since the global financial crisis and is now heading for another one with the cost of living crisis.

Articles

Videos

Analysis

  • Autumn Statement 2022 response

    • Institute for Fiscal Studies, Stuart Adam, Carl Emmerson, Paul Johnson, Robert Joyce, Heidi Karjalainen, Peter Levell, Isabel Stockton, Tom Waters, Thomas Wernham, Xiaowei Xu and Ben Zaranko (17/11/22)

  • Help today, squeeze tomorrow: Putting the 2022 Autumn Statement in context

    • Resolution Foundation, Torsten Bell, Mike Brewer, Molly Broome, Nye Cominetti, Adam Corlett, Emily Fry, Sophie Hale, Karl Handscomb, Jack Leslie, Jonathan Marshall, Charlie McCurdy, Krishan Shah, James Smith,
    Gregory Thwaites & Lalitha Try (18/11/22)

Government documentation

Data

Questions

  1. What do you understand by the term ‘fiscal drag’?
  2. Provide a critique of the Autumn Statement from the left.
  3. Provide a critique of the Autumn Statement from the right.
  4. What are the concerns about raising taxation during a recession?
  5. Define the term ‘windfall tax’. What are the advantages and disadvantages of imposing/increasing windfall taxes on energy producers in the current situation?