Unlocking UK Growth: From Wages to Productivity with Simon Oates, Barret Kupelian & Andy Haldane

Transcript

Simon Oates: Hello and welcome to a new series of PwC economic podcasts. My name is Simon Oates. I'm a Strategy& partner and I lead the UK economics practise for the firm.

In this period of unpredictable and unreliable economic outlook, this pod is going to aim to isolate the signal from the noise and bring some clarity to the economic outlook that we all face.

To help me do that today, I'm joined by two special guests who are well placed to bring us some insight and clarity. First of all, Andy Haldane, hi, Andy.

Andy Haldane: Hi, Simon.

Simon: Andy is a senior economic advisor to the firm and former chief economist at the Bank of England, and I'm also joined by Barret Kupelian. Hi Barret.

Barret Kupelian: Hey.

Simon: So let's dive straight in. We are but a matter of days away from the end of the first year of this government's term of power, a government whose central manifesto pledge was all about bringing new emphasis to UK economic growth. So my first question and I'm going to turn to you Barret, is where are we on our growth prospects in the short term? Is it looking up? How are we stacking up against the ambition to be the fastest G7 economy?

Barret: That's a very good and big question to start off with, Simon, I think. The best way to answer that question is to focus on the trend rather than the month on month or the quarterly numbers, which is what's typically done in the media. And if you look at the the trend of recent short term growth and also the forward-looking forecasts, we sort of expected to grow at about 1% this year and maybe probably 1% next year as well, maybe slightly higher or lower. And if you start comparing us against our G7 peers. So I suspect Germany, France, and Italy are likely to grow slightly slower than us this year, at least, and probably Canada and the US will are likely to grow a bit faster. So no, with this definition, we're not the fastest growing G7 economy, but we're sort of middle of the G7.

And just to give you a bit of context of where 1% stacks up to history, now when I started my professional career in PwC, which was just before the global financial crisis that very year we were growing at 2.4%. So you know quite down shift from the pre GFC numbers.

But there are quite a few interesting themes as well appearing in the UK economy, and once you start peering through that, the headline GDP number, I think the first one for me is with respect to the sources of economic growth. So if you split the economy into two bits, so first the public sector, so that will be the Civil Service, education, defence and health and then the rest of the economies or the private sector dominated industries. What you'll find is that in the past 24 months public sector output has gone up by about 4%, so really driving economic activity reflecting quite a lot of the investment that's going into the health service. Whereas if you look at the rest of the economy in the private sector, let's call it like that, that's grown by about almost 1% in the past sort of 24 months, so in an ideal world you'd want both engines of the economy really streaming ahead, and we don't have that yet.

Simon: Interesting. Interesting. So middle of the pack. That’s quite an interesting split as you say, between the public and private sector growth dynamic, Andy, how do you see the kind of short term prospects well come on to look at the kind of longer term agenda but some of the short term?

Andy: Yeah, it's funny you mentioned this line that's been spaced out by politicians about us being the highest growing according the G7, the same words were being used by the previous government at exactly this point a year ago. So, sort of Groundhog Day.

As Barret said out very nicely, we are edging up in growth terms. We're probably crabbing sideways in growth per head terms and that's been the story actually the last three years, and there's nothing from this year's numbers that should lead us to alter our perception, if anything, over the last 12 months and the first year of this government, we've seen growth forecasts being revised downwards rather than upwards.

I think the only forecaster to have bucked that trend is the Office for Budget Responsibility which actually leaves in a bit of an outlier position in growth terms. It'll probably come back into the pack, which will be a further downgrade. I mean what Barret said about the split of the economy is really interesting. Sitting beneath that, of course, even for the public sector is a somewhat less benign picture, because if you looked at public sector productivity as distinct from public sector output, that has fallen over the course of this decade. And even by the end of this decade, we'll not have recovered this level at the start of this decade.

And ultimately, it's that that flatlining productivity, both public and to an extent private, that is laying low our growth prospects not just this year, but stretching out from now as well.

Simon: Interesting. Very interesting. And just pushing a little bit more on that public versus private. Is there anything around the kind of labour market that that we sort of want to just kind of air a little bit in this conversation? Is there anything around the kind of private sector and sort of where the labour market is in the UK that is that is sort of constraining or actually maybe even, you know, hold potential for returning back to a a more trend rate of growth?

Andy: I'll just make a start on that. I mean on the jobs market, which I would say you know is one of if not the bellwether of the economy generally. It's all about people.

Let's not forget that that's been loosening now for the better part of two years is the truth of it. We saw that initially in vacancies, published vacancies falling, they've been falling for getting on for two years now, which is basically businesses deciding.

They'll not go out in quite the same energetic way they were when, when backfilling roles. That was the story of that's been story the last two years and over the course of this year.

We've seen, you know, not backfilling old roles give way to cutting existing ones. In other words, we've seen unemployment going up alongside vacancies coming down, which suggests a second phase of the labour market loosening that commenced 2 years ago.

And looking ahead from now, I mean I think the big question or among the big questions for our economic fortunes would be how dramatic will that cutting of employment be genuinely open question. And secondly, what will be the knock on consequences of that rise in unemployment? Both for those that are made unemployed or indeed more importantly for the fears of unemployment among the wider consumer sector. On that I would say, hinges the fortunes for UK growth over the second-half of this year.

Simon: Interesting. We've done some recent work as a firm in terms of how AI is disrupting the jobs market, which again is sort of another ingredient to sort of play into the mix, what could be going on there?

Barret: I can supplement that with a couple of points. So I think the big picture story for me is that the labour market is cooling, but real wages are still growing relatively strong, which you know if you think of it from an economist point of view, it's probably a bit counterintuitive. Now if you dig into the labour market I see sort of three stories appearing depending on which sector you're in.

So there are sectors where vacancies are contracting and you see that being reflected in pay, which is sort of growing slower than the national average. And that sectors like our own, so business services, it's education, it's the real estate elements which is all about marketing property and so on and so forth.

Then there's sectors where vacancies are contracting, but pay is growing faster than the average. And that sectors like hotels, catering, the health sector and I suppose the question is why is that happening? It's a bit counterintuitive. So there's less demand for labour, but pay is still relatively strong, or growing relatively stronger. And I suspect the reason there is about skills mismatch. So we've got demand that's relatively strong in some parts of the economy, but we don't have the people to fill it in. So they're able to command a higher salary. And then there's one sector in the economy where vacancies are growing and pay is growing, and that sector is construction, which is an anticipate then of what is likely to happen with the infrastructure bill coming through and capital spending ramping up from government?

I agree with Andy that you know the real big question is about how as consumers and households we react because we're seeing real pay growth. But we're not seeing the same sort of virility in consumer spending, which is the biggest driver of economic activity. In fact, we're seeing savings go up so you really need to understand what's happening there to figure out the fortunes in the short term for the UK economy.

Simon: Super observations and at that point about consumer confidence and consumer savings, I think again your team have done some work recently looking at where that sits versus trend and identifying that there's about £40 billion of additional savings in the economy. Look, I'm going to move us on a little bit from the UK context as we can't talk about the economic outlook at the moment without reflecting on the impact of U.S. trade policy that is just ricocheting throughout the global trading system. So, Andy, I'm going to give you give you again a big expansive question, partly because it's so unpredictable. But how do you see that continuing to play out?

Andy: I think it's quite important to distinguish a couple of things here in terms of their growth implications globally and indeed domestically as well. And the first is the rewiring if that's what's going on to the world trading system, I mean some rewiring is definitely underway pretty quickly as best we can tell. Anecdotally, it's happening pretty quickly so people are looking again at their supply chains and doing some redirection.

That will doubtless because any change comes with a cost is just a rewiring rather than a retraction in World Trade, that will come at some short run cost and that's already been seen in GDP numbers over the course of this year. My personal view, which may be fanciful and over optimistic, is that things ultimately will rewire and we won't see a structural, long lasting, significant retreat of World Trade. We'll see a redirection or rewiring, but not a retreat. There'll be some short-run costs, but the long run costs will be relatively modest and manageable. But of course, that's just one of the things that's underway. Because the second thing, and this worries me more as I think it’s set to be more persistent which is the huge fog of uncertainty that's being kicked up and not just by the US, not just by Trump. We've gone 10 minutes not mentioning Donald Trump, and there we go, I just broke our duck.

But of course, just by geopolitical events generally all around the world, we have a contagious set of conflicts around the world right now, and they too are adding to uncertainties about World Trade, about energy. And it's really that uncertainty that I think could longer term be the more significant tax on global growth. We know that uncertainties are tax on business. It's a tax on investment and therefore it's a tax on growth and multitude of sources from which that uncertainty is emanating currently.

And I can't see that dying down very quickly. We may even be talking about a different sort of epoch or era for uncertainty, structurally higher than in the past and that will mean a different sort of approach to planning and resilience among businesses among governments than has been the case in the past and that will carry a growth cost.

Simon: I really like that framing of uncertainty being that kind of tax on our economic system, I think it's really eloquently put. Barret, any observations or builds from you?

Barret: For me, it's all about the mega trends you know about the mega trends came around, at least the PwC mega trends that came around 10/11 years ago when a few of us in the team went in a room and sort of asked the question what do we think are the few big tides that will affect and impact every single economy of the world and every single sector within those economies, and then we came up with this PwC megatrends framework, which was climate change, technological disruption, social instability, demographic change and a fracturing world. And the last one fracturing world is the latest sort of installment of what we we've been seeing with tariffs and I think it's also being amplified a bit with social instability and social media.

So if we just focus on the on the trading environment? Where are we heading toward?

You know, the honest answer is I don't know. I think we are moving from a predictable rules based WTO-driven trading system to a new equilibrium. I think if you if you highlight the markers of what that new sort of era looks like, it's probably going to be less multilateral, more bilateral. Something that is much more based on economic clout and size and not rules, and also driven by the type of stuff that countries produce. So you know EVA's or rare earth metals, so it's not just about size, but we are sort of going towards a new direction and that comes with uncertainty now.

We did do 3 scenarios in in PwC which we've got on our website which sort of highlights the different possibilities around the future. I won't bore you with the details with that but I will tell you about some of the common elements within those 3 scenarios, which is I think the more insightful point, which is the first point is that irrespective of the scenarios that you look at, the US is becoming more protectionist.

I think that's almost certain. Now the second point is that we are within the advanced economies seeing some of them cozying up together even more aggressively. So, you're seeing that within the European Union and you might see some more aggressive movements, for example, in the European Union, in the next few years on capital markets union. So you are seeing much more activity there. You might also see Canada for example, being a bit closer to the European Union in the future.

Then the third point, which is the big question mark in my head is you might also see this fragmentation spill into other areas. So right now it's focused on goods and it's quite clear what the main tool is, which is tariffs. But you are seeing some creeks appear in services, for example, or in the transfer of ideas across borders or in the transfer of people across borders, and potentially even in the transfer of capital across borders, particularly given that we've got these big long term public infrastructure projects that are in the pipeline with respect to technological change or climate change, so you might be seeing changes there as well in the way that businesses and people at large are not used to because they might not have seen this in in their life.

So I think if you're a business and you're thinking about the medium to long term future, agility is the is the name of the game. You know being able to plan for what were perceived as tail scenarios. I think becoming a bit more likely now and I would also say thinking outside the box is becoming something that I think most business leaders need to think more and more about.

Simon: Look, I'm going to move us on again. Partly, I think it's a bit unfair to push you too hard on where this unpredictable policy stance will lead us, but I'm going to pick up on that word, that phrase, Andy, that that that you coined, which is this sort of fog of uncertainty that is being driven by the U.S. policy stance. Turning back to the UK we started this pod with this framing of a government end of their first year and we've had the Spring Statement, now we’ve had the spending review. We're going to have the infrastructure strategy, and the industrial strategy is coming out. How do you see that UK policy environment setting us up to help navigate this fog of uncertainty over the medium to longer term? Are we setting ourselves up to move from middle of the pack to genuinely challenging as the fastest growing G7 economy by the end of this Parliament?

Andy: It is true that for what's felt like quite a long wait for the better part of a year waiting for some growth-friendly announcements they can be like buses. We've got three alone in three weeks with the spending review last week, this week's infrastructure review and next week's industrial strategy and what we know of the first of those is spending review in some ways that was spending of the fiscal envelope that was sat set in last year’s Budget. It was how those monies were to be allocated.

From a growth perspective, the most important of which, without any question or shadow of a doubt, was the extra more than 100 billion public investment we mentioned. With uncertainty acting as a tax on investment, one way of bucking that trend of course is by government showing the way and it's investing publicly hoping that it will crowd in private investment.

And you know £100 billion in 4 years. It's a decent chunk of change, just shy of 1% of annual GDP. And now we know a bit more about how it's going to be allocated. It sounds like pretty sensible stuff, right. So yes, energy, yes, R&D, yes, transport, yes, houses. Everyone would think that those are the seed of growth and will have some impact on growth and lifting up fortunes.

For someone like me who takes an interest in what's happening right across the UK as of course you two do as well. That spending was pretty well spread geographically. All four corners of the UK, so good sectorally and good spatially.

And I know that £100 billion sounds like a lot but when you see the starting point for UK PLC. Alas, we're filling in a big gap when it comes to capital. Let me throw out a number to bring that to light. If you compare on a sort of per head basis, the stock of physical assets that we have as a country are about third less than our competitors and that ends up being a decent chunk of change, like a £2 trillion chunk of change. You know it's 2/3 of GDP, relative to the 1% of GDP I mentioned per year in investment spend, so without being too discouraging, that suggests that while directionally right, the scale of effort, at least so far, will only get us so far when it comes to lifting our growth fortunes in an absolute sense. But of course, you mentioned that the growth mission is cast in relative sense. It will be outpacing our G7 colleagues and partners well, the truth is, even with the top up in public investment, we'll still be investing less than those countries, which means that our capital stock will still be getting relatively smaller than theirs over the remainder of this decade, which means just to complete the loop, other things equal, our relative growth fortunes will not be rising, they will be falling relative to our competitor countries. So all in, although directionally, right, there's little if anything I think in the spending announcements so far that should give us confidence that that mission could be met this decade.

Simon: Yeah, brilliant and I must say I had my heart in my mouth for a minute when you said you were giving us a figure in the £2 trillion because we've done some analysis internally as well but actually we're kind of spot on where you are and Barrett and his team led that work. And post global financial, we estimate about £100 to £130 billion a year of investment that we're down versus our G7 peers, which gets to really you know, between friends, the £2 trillion gap by today. And to your point, it's a big hole despite the step up in spending. So Barret, the governments turned up the dial on public spending and the spending review has positively set out both sectorally and then geographically are kind of pretty positive use for those funds, but clearly to fill this gap, it's gonna be about attracting private capital. The nature is we're really reliant on international private capital. I wonder how you think policy needs to embrace that?

Barret: Well, it's all about setting the foundations for foreign capital to come in. But when Andy was saying or his views on the budget. You know, if I cast my mind sort of 10 years ago about what policy was all about back then, it was quite clearly about export led growth. You know, we had a one trillion target of exports from the UK economy. I I remember it was all about export.

And now the arguments shift towards much more around building domestic growth, domestic resilience and also quite interestingly, it's about the supply side of the economy. It's no longer about demand management, it's about supply side and you'll see this story actually repeat in some shape or form in other advanced economies as well including the US. Quite interestingly, if you look at the capital spending increases quite a lot of it will go to defence for obvious reasons, which then means that you know the stuff that We feel on a day-to-day basis - roads, rails, bridges - there's probably less of that than it would have actually been had we not had the international situation that that we're in right now, which is an interesting point for me.

And then the second one is with respect to the day-to-day spending, which the overwhelming majority of that will go to the health service and of course that is the right thing to do, particularly in view of the fact that we've got higher levels of economic inactivity compared to pre pandemic levels, you know that's a that's a scar from the pandemic that is very apparent in the UK economy in a way that is not apparent in our in the other G7 economies.

And again, I think the hope there is that if you manage to tackle the backlog in the National Health Service, you will actually indirectly be able to tackle the problem of economic inactivity we've had ever since the pandemic at least which is again a supply Side Story, right? We've lost the elasticity of labour supply from the European Union. I talked about the skills mismatches that we have in some sectors of the economy. So you would have hoped that some of those people that are currently inactive will gradually be encouraged to re-enter the workforce and hopefully alleviate some of those pressures and lead to economic growth. But there's a lot to do, I think in the next few quarters, let alone years. So the mountain to climb is quite high.

Simon: Just bringing to life of where that public spending will go and really nice to draw out how it should hopefully address that workforce and activity problem that as you say is really stark for the UK, but I'm going to push you again because you didn't pick up my thread which you know is a little personal hobby horse about investment flowing international capital flowing into our economy and it just seems very clear to me that if you're reliant on international capital in relative terms, you can't be as attractive and be satisfied with being as attractive as other homes for that internationally mobile capital because you're not going to radically increase your share of it. And given we need to radically increase our share of it to £2 trillion over whatever period of time we think is appropriate to try and fill that hole, I think we need to be doing something in our policy landscape to make the UK look relatively more attractive than it has done over that period. Otherwise, common sense would tell me that we're not going to start filling that hole, closing the gap and therefore having the real foundations to catch up on our G7 peers.

So to kind of put it back to both, is there anything that you are seeing in the policy landscape that gives you hope that that that shift is happening and that we're sort of addressing that internal comparative position, that international attractiveness, or is that still the kind of big missing piece of this policy jigsaw for the current government?

Andy: I think charitably speaking, its still a work in progress. I think there is an opportunity here. I mean the flip of the world being upside down is that we look like a relative bastion of calm, certainly in political terms. That's against a backcloth of UK assets still appearing pretty cheap. Hopefully through our industrial strategy we'll have a better sense of what do best as a country and can therefore back it with money, but partly through enabling measures of various types, whether they tax or regulatory. That would give me hope, actually, that if we did a somewhat better job than we have historically in red carpeting, what's best about Britain in business terms, that would bring in the people, the money, the ideas and for us to be seen as a magnet, a hub certainly for some sectors and that all strikes me as eminently doable now right now, well, perhaps not as wholehearted or as full throated as we might be. Let's take people. Let's take people. Yeah, we know people are on the move. Barrett mentioned that earlier on and are looking for homes that are stable and attractive to build businesses or to build academic careers or to study.

We absolutely should be red carpeting them into the country to support, but that that may jar with some things. But then we're in a land of trade-offs. If we're serious about growth, we absolutely should be seeking the brightest and the best people to come to our country to study or to work or to build businesses or to invest. And we're doing that a bit, but probably not enough to bring in to close that gap, that big gap, which will not be closed by the public sector, by the way, anytime soon it will require a private sector lift, not just of monies, but of people and ideas. We started kind of gloomy, I'm trying to pull it back now.

We could steal a bit of a march on that and if we don't others will because the truth is if you are Portugal right now, if you are Spain right now, if you are Italy right now, if you are France right now, you are red carpeting businesses, people and capital into your country and we should be doing at least as much energetically as they are.

Simon: Yeah, brilliant. Barret any final comments from you?

Barret: If you go to some of the smaller economies in Europe, what you see is that they're nimble, adaptable, flexible, just because of their economic size and they respond to events quite fast and on a rapid pace. We almost need to rediscover our spirit to deliver big projects relatively fast and with certainty, respond to events that are changing around us, being adaptable on a much more flexible and speedier basis, and rediscover that spirit because once you get in that mind frame, I think it's quite easy to change your economic fortunes and change impression impressions around you. Once you get that momentum, I think it's quite hard to stop. We're not there yet, but we are seeing, I think, pieces of the puzzle being put through by the government with respect to some of its plans. The fact that it we've got much more certainty about policy, but right now, I think it's more about delivery and adapting. If the facts change in a way that we can, we can sort of accelerate the pace of change.

Simon: Brilliant, right? Look, I'm conscious of time and bringing this this conversation to a close. But I do want to put to both of you just a closing question as I want to bring it back to business leaders. So if there was sort of one thing, or two things maximum that you would say to kind of the CEOs boards about what they should be focusing on given this economic set of circumstances, what would your words of wisdom be for them? I'm going to go to you Barret first.

Barret: We talked about growth quite a lot, I would say resilience is the name of the game. Typically, businesses, you know focus on revenue growth, which is sort of demand driven. I'd focus much more on your supply like your people, or if you're in the manufacturing sort of goods business, you know where you supply and source different materials. If you're reliant on one supplier or more than that, you know whether you need to hold more stock locally and so on and so forth. We're not in a just in time world anymore, we're in a just in case world.

And then the second point I would say is peer through. Think about what the next events in the next 2-3 years could be. No scenario is implausible. I think what we what we've seen throughout history, in the past five years you know we've gone through the Ukraine war, we've gone through a pandemic, we've gone through a high inflation period, we've gone through a rupture of a political union with our largest trading partner.

We've been having quite a lot of one-offs. So that doesn't mean that we won't have any more one-offs in the future. I suspect that will be more the norm, so plan for those events in the best way that you can.

Andy: This builds on the conversation we've been having and you can see why, for all the reasons we've been saying for the last few minutes, while now feels like a time to be leaning back rather than forward, protecting your balance sheet rather than putting it to work and that feels instinctively, right?

But it's almost certainly wrong from a commercial perspective as well as from an economic growth perspective, it is the point of peak uncertainty where the need for business bravery is greatest because not making a decision to make that investment, whether it's in physical stuff or in people stuff, will put you at a commercial disadvantage. Those that step up and are brave and do make those choices will ride the rapids much more successfully than those that don't.

That can be helped, I hope would be helped if some of that risk, because it is risk, can be shared with government and I think working in partnership with government through the industrial strategy is a way of stepping up and being brave, but being with the copilot in this case, the government and that would be a way of you know defraying the risk without shying away from the risk. And that will be key because the technological world is still spinning as fast as ever. Taking your foot off the investment accelerator in that will come at a long term commercial cost, so now is the time to be brave. Press the accelerator, put the balance sheet to work. I think those that do will be those that triumph.

Simon: Thank you very much. Thanks very much for listening. I hope you found today useful and insightful. There are a number of links for reports that the firm has produced that supports some of the conversation that you've heard today that you can access. And we're also very keen to get your feedback, want to make sure this is relevant for you and your clients.

So, if there's any topics that you'd like us to cover in future podcasts, any guests that you would like to hear from their perspectives on the challenges facing our economy or particular sectors and our economy, then please do feed it in. We'd love to hear from you and it'd be great to get them on the podcast. Thank you very much.