Professor Nigel Jump writes the latest in his series of blog focussing on the state of the economy in Dorset.
Inflation is a big problem for the UK economy this Winter. Its path from here (CPI +11.1% year to October) depends on the ongoing scale of shocks to world supply chains from the Ukrainian war, the pandemic and monetary policy matters. Outcomes will be driven by the reactions of local businesses and households to such unfolding events.
The path of inflation has five critical routes:
- Direct inflation through consumption - final demand exceeds supply for foods and fuels etc, reflecting substitution and diversion effects from luxuries to essentials under the so-called cost of living crisis
- Indirect inflation through firms’ supply chains from energy, components and other trade costs pushing down on investment, hiring and heightening cost control decisions by companies
- Secondary inflation through union and employer attempts to defend real wages, prices and profit margins, including earnings distribution effects
- Medium-term inflation through lower real incomes and higher unemployment, reflecting fiscal drag and other recession response factors
- The inflation hangover from belated money supply growth and interest rate adjustment, specifically whether higher inflation expectations do or do not become embedded and whether the Bank of England can get ahead of the markets
As a net importer, with deteriorating terms of trade driven by Brexit barriers, bond risk premiums and the volatile currency, the UK economy faces a difficult alignment of demand and supply as consumption and savings, interest rates, and asset prices (housing, shares etc) all adjust. With inflation (11%) well above target (2%) and base interest rates (3%), more monetary policy tightening is required before, as the Bank predicts, the squeezes on demand overtake the cost pressures on supply in the bullet points above. Interest rates can move lower again but only when the ‘hit’ has worked through all our budgets.
The governments’ “fiscal plan” (November) adds to the demand squeeze through £55bn of tax increases and spending austerity over the years to come (mostly after the next election (2025+). The Office of Budget Responsibility (OBR) said the UK is probably already in recession. OBR forecasts a fall in real GDP in 2023 and into 2024. It expects a rise in unemployment from 3.5% to 4.9% by 2024 and a 7% drop in real incomes over the next two years: a scale of decrease not experienced since the 1950s. Some economists even suggest this demand squeeze could see a drop into deflation in the medium term - that current inflation is a blip, albeit a significant and damaging one. Reactions to this blip determine how high it goes and how long it lasts. Ideally, we would all agree to take the prices hit and ensure it is spread fairly.
Against this macroeconomic background, regional development remains much about the importance of place to local businesses and households. It suggests a growing desire not to allow ‘specialisation’ and ‘efficiency’ to compromise ‘capacity’ and ‘inequality’.
The “levelling up” agenda is just the latest label in a long history of UK attempts to transform productivity and performance outside the London-centred ‘hothouse’. Frankly, over the years, British success in positive regional adjustment has been meagre, largely because we (private and public economic actors alike) have failed to put enough finance and momentum behind policies and investments that build local resilience and wider competitiveness. Such initiatives have tended to be promulgated at the worst time: when the economy is macro-weak. Moreover, we have tended not to stick with it until we can see real impact and measure the net positive returns.
Now is the time to plan incentives and actions needed for the eventual recovery, and beyond.
- The authorities are right to emphasise the immediate need for supporting the hope of stable public finances in the medium term, but they need also to prepare for a rebound and more regional growth and development.
- Firms are keen to safeguard their enterprises against the immediate shocks, but they need also to plan for more and better local innovation and entrepreneurship, driving future market competitiveness.
- Workers are trying to limit the damage to living standards and well-being from short-term inflation, but there is also a need for them to address skills deficits and mismatches for the jobs of the late 2020s – to earn higher wages etc through higher productivity.
UK post-war history suggests we don’t invest enough and, therefore, our productivity is low and sluggish. Our future requires more productivity enhancing measures to get sustainable and sustained real growth rates up to where we can build living standards whilst addressing environmental concerns.
Stopping inflation is difficult once it is allowed to gain a foothold. The Russian war is destroying capital, the pandemic has reduced labour participation and recent higher trade barriers are circumscribing world trade. If the mood has shifted from globalisation to relative autarky (“friend reliance”), how are local buyers and sellers going to make the necessary adjustments?
Economists are always talking about the differences between short-term and long-term plans and policies. Clarity of thought on these distinctions is of paramount importance as we approach a cyclical and structural nadir.
Tomorrow’s winners are already with us.
- Who and where are they in Dorset/southern England - can we identify, promote and protect potential winners (without centralised ‘picking’) by sector, place and aspiration?
- What do winners need and how will they to succeed in the new environmental century, especially within the market changes of a seemingly disunited Kingdom?
- Is there scope for the benefits of relative “collectivisation” - cooperating to compete with neighbours by industry and community - to replace the lost advantages of “globalisation”?
Decades of experience makes one sceptical for changing UK relative regional performance in the years ahead, but it is to be hoped that scepticism is wrong. If there is to be a “new modus operandi” in a post-global world, local talented and brave people will have to prepare to be ready for, and good at, the new realities of 21st scarcity and exchange sooner rather than later.