Tactics or economics, what has changed in the Premier League?

The table never lies…

On December 19th, The Economist newspaper published a thought provoking blog Competitive balance in football: Why the English Premier League has been turned upside down, which argued that the unpredictable nature of this season’s games and the remarkable performance of Leicester City in particular was not as a result of either the financial success or business model of the competition, but rather due to a mix of luck, skill and tactical innovation.

The piece is a great read, using the disparity between the performance and expectations of Chelsea and Leicester City to highlight the issues, backing this up with interesting data sources and noting that the season up to the 19th December 2015, had:

  • the highest number of games won by underdogs, 26% according to bookmakers, compared to a previous high of 23%; and
  • the lowest ELO score, an accepted measure for predicting sports’ outcomes, since 2003-4, suggesting the gap between teams has fallen significantly.

…and it is not because of the money…

The writer argues that the usual suspect when we seek to understand outcomes in football, money, is not the factor driving the unexpected results in 2015. In particular:

  • The success of the Premier League in generating ever higher amounts of income for clubs, especially from broadcasting rights, cannot explain relative outcomes in the Premier League because the distribution formula between teams has not changed; and
  • Financial Fair Play has, according to the author, worked to cement the existing hierarchy by favouring clubs with the highest commercial revenue, typically the teams that have dominated the Premier League in recent seasons.

Having ruled out the impact of money, the author goes on to explore other factors, concluding some element of luck, together with a degree of tactical innovation, supported by good signings explains both Leicester City’s meteoric rise and the wider unpredictably of results..

…or is it?

Football lover that I am, the idea that tactical innovation is the major reason for the unexpected ranking in the table is very appealing and it does fit with my personal experience as a fan. Mark Hughes has improved Stoke City’s position in the last two seasons by changing the team’s style. While the excitement and atmosphere generated by Stoke City’s first season in the top division of English football was unforgettable, the current team is easier on the eye and so far, more successful.

But the economist in me has a nagging doubt – much of the research into success in the Premier League has concluded that wages are the single most important factor in explaining positions in the Premier League. Have things really changed that much so that money is now less important than tactics?

As discussed above, the reason pundits have been arguing that the Premier League has changed is the decline in the dominance of the “Big 6”. In each of the last 5 seasons, five of the top 6 slots in the final table were taken by a combination of Manchester United, Manchester City, Arsenal, Chelsea, Tottenham Hotspur and Liverpool. Viewed against this, the current season does seem unusual, but is it?

In fact, the current season is not the first season that has seen the table at the end of the calendar year, roughly halfway through the season, not being dominated by the big teams. Only last season at halfway, Southampton was 4th and West Ham United 6th, which is similar to the current season with Leicester City 2nd and Crystal Place 5th at the mid-point. However as BBC Sport noted, this season is interesting because:

  • Chelsea have made the worst start of any reigning champion;
  • In early December, the gap between top place and fifth was the joint closest in the last 10 years; and
  • Chelsea and Manchester City, last season’s top 2 lost 12 games in the first 15 rounds of the season, the highest for 10 years.

It does appear that there is something afoot, although it may reflect a trend that has been developing over a few years. Are tactics and luck really the drivers? Having recently been involved with producing EY’s analysis of the Economic and Social impact of the Premier League, I felt that more attention needed to be given to the economics of the competition. Our report was clear that the Premier League’s business model was very effective in ensuring a competitive league. Could it be that this effect is just getting stronger?

Does money matter?

I wanted to understand if the suggestions that the increase in Premier League revenues and FFP were not drivers of the 2015/16 classification were valid. Where I differ with the thoughts set out in the blog mentioned above are:

  • My first hypothesis is that the success of the Premier League in increasing the revenues of its clubs relative to the clubs in the other major leagues has had a positive impact on the ability of clubs, especially outside of the Big 6, to attract top quality players from other major leagues. It is always dangerous to extrapolate from personal experience but the fact Stoke City have been able to attract Bojan, Shaqiri and Arnautovic suggests something is going on.
  • Secondly,  I had a suspicion that the interaction between higher total revenues and FFP has had an impact on the relative strength of teams in the Premier League?

To explore the issue further, I have drawn on the recent history of the Premier League. The 2010/11 season was the first time that clubs were restricted to squads of 25 home-grown players aged over 21. Using a variety of sources, the Sky Sports Football Yearbook, www.footballsquads.co.uk and the FIFA website, I set out to analyse the number of elite players in each club’s squad at the start of every season from 2010/11 to the current one. (This approach can be seen to an extent as a proxy for wages as we don’t have access to published wage data for the current season. It may become more useful as a method if FFP limits wage variability between clubs over time, limiting our ability to model the impact of wage differences on performance).

To define “elite” players, I took the top 10 ranked countries in the world in September of each season and identified how many players from these countries were in each 25 man squad at the start of September each season. I had to fiddle a little because England was only in the top 10 in 4 years but clearly accounts for  a significant number of the elite players in the PL. I allowed for this effect, by analysing England (and Wales in 2015/160 separately and moving another country into the top 10 and then adding in England international players by club, assuming all England internationals are “elite” players. I also had to adjust the data to account for the effect of France on the numbers – there are a significant number of high quality French players in the Premier League but France only made the Top 10 once, potentially distorting the results. I therefore did my analysis for 2014/15 with France in and also with France out of the numbers – my conclusions hold for both versions of the analysis.

The analysis is inevitably judgmental to an extent and open therefore to potential error in the data as permanent transfers, loans and the timing of international appearances can be difficult to confirm exactly. The good news is that I believe the results are clear and would not be affected by a few errors in my data, but you can judge for yourselves.

Money does matter…

The table below shows the number of “Elite” players (ie from the Top 10 FIFA ranked countries and England) for each season in the Premier League between 2010/11 and 2015/16, broken down into:

  • “Big 4” : Arsenal, Chelsea, Manchester City and Manchester United;
  • “Big 6”: Big 4 plus Liverpool and Tottenham Hotspur, two teams that have not won the Premier League title but have been part of the group dominating Champions; League places in the period;
  • “Constant 4”: the 4 teams who have also been in the PL in each of the seasons analysed, Aston Villa, Everton, Stoke City and Sunderland.
  • “The Rest”: the 10 teams in each season not in the above categories with 3 changes per season among the cohort due to relegation and promotion.

Number of “Elite” players per squad

Season 2010/11 2011/12 2012/13 2013/14 2014/15 2015/216
Big 4 38 47 55 52 49 52
Big 6 57 72 85 74 71 81
Consistent 4 15 21          15          24 30 25
The Rest 24 24 34 37 46 54
Total 96 117 134 135 147 160

 

With France included in 2014/15, the numbers are: Big 4(60), Big 6 (86), Consistent 4 (30), The Rest (46), Total (165).

Between 2010/11 and 2015/16, the number of elite players in the Premier League increased from 96 to 160, a growth of 67%. English international players accounted for 63% of elite players in 2010/11 but account for only 39% in the current season. There seems little doubt therefore that the greater wealth of the Premier League relative to other European leagues has increased the ability of clubs in aggregate to attract elite foreign players, but can this help explain the current competitive position?

The findings on the share of elite players accounted for by the different groups of clubs identified above shed light on the issues. There has been a significant decline in the share of elite players accounted for by the Big 4 and Big 6 groups:

  • In 2010/11, the Big 6 accounted for 60% of elite players, this share rose slightly in 2011/12 and 2012/13, but has fallen consistently since and now stands at 51%;
  • We see a very similar trend with elite player shares for the Big 4 which have fallen from 40% in 2010/11 to 33% in the current season.
  • The consistent 4 have increased the number of elite players in their squad by 60% over the period but this not has allowed them to maintain their share of elite players. They have strengthened relative to the Big 6 in terms of share of elite players but have moved in the opposite direction relative to the Rest, the other 10 clubs in the division.
  • The Rest are the big winners, increasing their share of elite players from around a quarter to a third over the 6 seasons reviewed.

This simple analysis suggests that the competitive gap in the Premier League, measured in terms of share of elite players, has narrowed in the last 5 and a half seasons. More work is needed but it does seem as though this is a plausible explanation for the ranking of clubs as at December 31st 2015, roughly the mid-point of the season. A more balanced competition means the chances of shocks increases and helps to explain the tighter bunching of teams.

So what has caused the change?

In my opinion, three things have happened:

  • The increase in relative wealth of Premier League clubs relative to clubs in other major leagues has led to more elite players being attracted to play in the competition.
  • The greater ability of PL clubs to attract elite players together with limits on squad sizes and restrictions on wages through FFP, means that the clubs outside of the Big 6 are able to strengthen their playing rosters more than previously.
  • But FFP has also limited the ability of the Consistent 4 to mop up the elite players not taken by the Big 6. These clubs may have first pick of the remaining elite players but can’t sign them all due to wage constraints, hence the relative improvement of “The Rest” in my categorisation.

But Leicester City’s success goes beyond economics…

The Premier League business model is based around a relatively equitable distribution of revenues to ensure a strong competition, certainly when compared to other European leagues. As the Premier League’s relative success has increased this has created opportunities for some of the supposed weaker teams to strengthen their playing squads. The indicative analysis presented above suggests this can explain some of the events of the current season.

However, Leicester City’s remarkable success goes beyond the level any economist would forecast. Yes the club has strengthened its playing squad but not to a level on paper that would be consistent with results this season. Football lovers everywhere should rejoice in the fact that we can’t quantitatively identify the mix of skill, luck, tactics and team spirit that is allowing the Foxes consistently to beat all predictions and confound the pundits.

UK profit warnings on the rise, are the markets right to be worried about the economic outlook?

Summer seems a long way away.
As I discussed last week, the start of the New Year has seen a flow of gloomy economic news with the Chancellor of the Exchequer and Governor of the Bank of England both raising concerns, especially about the state of the global economy. The EY ITEM Club struck a note of optimism, arguing that the latest falls in oil and commodity prices together with the delay to changes to tax credits announced in the Autumn Statement would boost consumer spending and hence growth.

EY’s latest Profit Warnings Report seems to be a blow to those of us clinging to the optimistic messages from EY ITEM Club. After a positive early summer with relatively low numbers of profit warnings, businesses found the going tougher as 2015 drew to a close. The EY report shows there were 100 announcements in the fourth quarter alone, the highest quarterly total since 2009, with the highest percentage of companies warning in one quarter since Q4 2001. In total UK profit warnings totaled 313 in 2015, up from 299 in the previous year and the highest annual amount since 2008.

Should we be more worried? What do profit warnings tell us about the state of the economy?

Is it the global slowdown that is causing the problems?
The decline in commodity prices including oil has been widely chronicled and this does go some way to explaining the high number of companies warning in 2015. Around one fifth of all warnings cited falling commodity prices, although these were mostly from companies outside the sector. In addition, around 50% of FTSE Oil Equipment, Services & Distribution companies issued a profit warning in 2015 as pressures passed down the supply chain.

It is becoming increasingly clear that the slowing of the global economy did not just affect companies exposed to commodities. Manufacturing companies featured highly in the profit warnings list, with falling capital budgets, volatile currencies and uncertain export demand all contributing to the sector’s difficulties. In 2015, 42% of FTSE Electronic & Electrical Equipment companies, and 40% of the FTSE Aerospace & Defence sector issued profit warnings.

Taken together the impact of falling commodity prices and a slowdown in manufacturing also hit Support Services (16 warnings). Almost 40% of the Industrial Supplier sub-sector warned in 2015. Clearly the global slowdown does have implications for the UK economy and we must not lose sight of this.

Profit warnings by sector (Q4 2015)

There are other factors at work.
We also saw relatively high numbers of warnings from General Retailers (7), Media (6) and Travel & Leisure (6) in the final quarter of 2015. While the global slowdown might impact these companies to an extent, the range of sectors hit by significant numbers of warnings illustrates once again how complex the economy is to call currently. There are domestic influences impacting individual sectors in different ways. We have left the days of predictable growth in which most businesses were able to do reasonably well behind us and now find ourselves in a more complex world.

With further fiscal austerity ahead, along with the introduction of the National Living Wage (NLW) and no let up on pricing pressures, we can expect to see more stress in a number of sectors in 2016, especially those with government, wage or contract-reliant profiles, such as:

 FTSE Software & Computer Services;
 Construction seems to be a very difficult sector to call with peaks and troughs more prevalent that we would expect even in this traditionally volatile sector; and
 Although healthcare spending is increasing, the care sector will be disproportionately affected by the NLW and the drive for greater fiscal balance.

Balance risk and ambition
The last time profit warnings rose to over 100 in a quarter in 2008-9, earnings forecasts reset and profit warnings fell away dramatically. Maybe there is nothing to worry about. But, of the 240 companies warning in 2015, 59 — just under a quarter — warned more than once. With each warning leading to a median share price fall of just under 14% in Q4 15, failure to forecast accurately can be very expensive.

The UK economy is challenging but as the EY ITEM Club forecast pointed out last week, there are also opportunities with for example, consumers and some export markets offering good growth prospects. The Profit warnings report serves to emphasise the key messages for businesses from EY ITEM Club. Companies should undertake a realistic assessment of their business and their markets, looking at their operational resilience and where and how they can create value, balancing risk management with focused expansionary strategies. Robust forecasting and scenario analysis should be at the core of planning in this challenging environment.

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A rebalancing and divergent world is hard for business to call

It could go either way…

The EY ITEM Club Winter forecast is optimistic about the UK’s ability to withstand the problems in the global economy in 2016. The EY ITEM Club expects continued consumer spending, reasonable export performance in developed markets and business investment to offset any negative effects from the challenges for the world economy emanating from emerging markets.

Chart of UK: Contributions to GDP growth

UK: Contributions to GDP growth

…so it is important to balance ambition…

The reality is that the global economy remains dynamic and uncertain but most importantly there are likely to be a significant divergence in performance between countries and regions.

Divergence means that there will be both opportunities and risks. The start of a new year is the ideal time to review existing plans and business models to ensure that the appropriate level of ambition is in place. Based on the specifics of the EY ITEM Club assessment of both the UK and global economies, the key areas for focus are:

  • Geographic focus: with the outlook for emerging markets remaining challenging, UK corporates should review their portfolios to ensure they are giving adequate focus to the improving economic prospects in the developed world such as the US and the EU. By contrast, a blanket approach to emerging markets would be the wrong strategy. Attention should be given on selecting the specific opportunities in countries less exposed to exports to China and commodity sales. India certainly merits review in this context.
  • Understanding the changing consumer landscape: consumer spending is expected to remain strong but levels of income growth are likely to vary by segment. The national living wage will benefit lower earners in the main whereas mid-income employees may see technology eroding their bargaining power. Understanding the variations will be crucial in shaping corporate investment and resource allocation plans.
  • Margins are likely to come under increasing pressure with the introduction of the National Living Wage, increasing average earnings and an eventual rise in interest rates. Businesses should review their business models and ensure their investment plans incorporate sufficient resources to drive productivity enhancing change. This could be the year when technology delivers on its promise to transform business activity more widely than has been the case to date as the availability of cheap labour starts to decline and capital begins to look relatively more attractive.
  • UK regions: The UK Government has embarked on a programme to devolve economic decision-making power to the UK regions. This will create new opportunities and the recent EY report on the UK region and city economic forecast is a good starting point for identifying what these might be.

…with risk management.

While the EY ITEM Club believe the UK is well placed to ride out the global storm, there are obvious risks to this view and hence a clear risk management plan should be high on the corporate agenda. Key areas are:

  • China: the impact of a significant slowdown – which would impact both commodity and trade activity and hence businesses either directly or indirectly exposed to this activity. The slowdown in Brazil illustrates how sharp a slowdown could be.
  • Geo-political risk: if there was an unexpected spike in oil prices for example, this might well impact countries less exposed to China such as the US and the Eurozone. Companies should consider how their trade activity, both sales and supply chain might be exposed to sudden shifts.
  • Currencies are likely to remain hard to forecast in this complex global economy as monetary policy divergences play a major role in shaping relative currency strength. The future level of sterling in particular is especially hard to predict.
  • UK domestic activity could slow and Government could easily find its finances under strain if tax receipts fail to meet expectations. This will have obvious implications for businesses that deal with the public sector but all parts of the economy could feel the impact if taxes have to rise.
  • Brexit will loom ever larger in 2016 although the impact remains hard to assess, it is sensible to begin to think through what the options might mean.

Scenario planning could help shed some light on the right balance of activity.

Scenario planning was all the rage when I was a boy but it has fallen out of favour in recent times. Given the risks identified above, now might be the moment to revisit this technique. In particular, it offers the possibility to scale the potential impact of some of the risks relating these to the business plan and hence providing guidance on the scale and allocation of resources to risk management.

Can the UK consumer hold off the Chinese dragon?

Happy New Year

January started with a flow of bad news from the global economy and especially China. Executives reading the press on their return to work would have been rushing to downgrade their forecasts for the year. In fact the mood was so pessimistic that the positive news on US job growth was missed by many people, buried as it was in the inside columns.

Yet the latest EY ITEM Club forecast expects the UK economy to grow by 2.6% in 2016 and to continue with steady – albeit slightly slowing – economic growth for the next two years, This is a slightly more optimistic view than EY ITEM Club presented in their Autumn forecast, suggesting UK prospects are improving.

How can we reconcile these apparently contradictory views of the economic outlook?

A rebalancing world is a divergent one…

The global outlook in recent times has been driven by China and the US. We now also have to take into account the role being played by Saudi Arabia in oil markets – the oil price is effectively being set by political not economic factors. Global economic conditions remain challenging in aggregate but there are stark differences between countries/regions:

  • The US recovery is strengthening although the rise in wages is weaker than the rate of job growth, suggesting the Fed may have gone slightly early on interest rates. A growing USA economy adds demand to the world economy but the rise in interest rates is squeezing financial flows to emerging markets, contributing to a slowdown in their growth.
  • China is growing more slowly than at any time in the last decade. The exact rate of growth is open to debate but the consequences of China’s slowdown can be seen in the fall of prices in non-oil commodity markets and the decline in world trade growth. Both of these developments impact the emerging markets and are more significant drivers of a slowdown than US interest rate rises.
  • Saudi Arabia’s recent policy announcements on fiscal and public sector reform confirm its intention to remain on its current strategy in respect of oil production. This means oil is now likely to stay below $60 a barrel for an extended period. Overall a lower oil price is usually marginally positive for global growth but the key point is that growth is redistributed from oil producing to oil consuming countries. Europe, the US and India are all winners from this shift.

…that plays to the UK strengths…

The key UK export markets such as the US and Europe have been growing and are forecast to continue to do so. According to the EY ITEM Club, the result has been improved export performance to these two markets, with the value of exports to the US up 34.7% in the three months to November 2015, compared to a year earlier, and while export values to the EU fell, volumes were up 6%. This trend is expected to continue and offset the challenging conditions in other markets to an extent. The UK is in effect now benefiting from its failure to penetrate the emerging markets more deeply in recent years.

…and allows UK consumers to continue to spend.

The UK consumer seems unconcerned by the global outlook and consumer spending has been the largest component of UK economic growth over the last two years. The EY ITEM Club expects this to be the case in 2016.

Chart Contributions to GDP growth

The recent falls in oil and other commodity prices will ensure inflation remains low for even longer than previously forecast and with labour markets still strong, wage growth increasing, the abandonment of the tax credit reforms in the Autumn Statement and interest rates remaining at low levels, The EY ITEM Club expects consumer spending to grow at 2.8% in 2016, very similar to the likely out-turn for 2015.

However, 2016 is likely to be as good as it gets for consumer spending in this decade as increasing inflation, interest rate rises and welfare reform start to bite in later years. The EY ITEM Club expect a significant impact with consumer spending growth decelerating to an average rate of around 2% annually from 2017 to 2020.

The response of UK business is the big unknown.

The UK consumer is likely to continue to spend and help offset the impact of any slowdown in emerging markets. However beyond the short-term, the strategies adopted by UK businesses will be the primary driver of UK economic growth.

Businesses have already begun to react to higher demand with business investment reaching 10% of GDP in Q3 2015 for the first time since 2001 (allowing for changes in data classification). With favourable financial conditions (profitability, availability of funding and the cost of capital), continuing steady domestic growth and expansion in selected export markets, EY ITEM Club expects this trend to continue.

Chart Business investment & GDP

In addition, the introduction of the National Living Wage and accelerating wage growth in several sectors together with falling energy prices will increase the relative attractiveness of capital compared to employing people. This combination of higher demand and changing supply economics, points towards an increase in capital investment which will play a greater role in driving growth from 2016. If this investment drives productivity improvement then the UK economy will be in a good place to continue to grow strongly.

But we have seen before that confidence can be fragile and the coverage of global developments is unlikely to be helpful in encouraging risk-taking. There is also the Brexit issue and the resulting uncertainty could begin to impact confidence and hence investment decisions.

The need is for a balanced approach.

The EY ITEM Club forecast assumes the UK consumer continues to push ahead, UK businesses exploit the growth in the US and Europe and that businesses invest in response to increased demand. A growth rate of 2.6% in 2016 requires all of this to come together and it is clear that the risks are certainly more towards the downside especially on exports and business investment. Businesses need to balance risk and ambition and I will turn to the details of what this means in practice in my next post.

 

The Eurozone is rebalancing, is your business?

The recovery continues…

EY’s end of year Eurozone forecast confirms that the economic recovery remains on track and is indeed strengthening. The first half of the year was very strong in terms of GDP growth and while there was some easing in the third quarter as a result of uncertainty from the Greek crisis and the challenge of migration over the summer, recent indicators are more positive and we expect growth in GDP of 1.5% for 2015, accelerating to 1.8% in the next two years. While this remains below the pre-crisis trend, in a slowing global economy this is a significant step forward for the currency zone given the challenges of the last few years.

… With the consumer leading the way…

Boosted by lower commodity and energy prices, Eurozone consumers have found themselves with higher spending power and have been quick to utilise this with all forms of spending including discretionary picking up. An improving labour market with unemployment falling in 7 of the last 10 months is now driving consumer confidence higher and boosting the amount of disposable income in the economy. We expect consumer spending to continue to play its part in driving growth as healthy levels of consumer confidence, largely as a result of the improving labour market conditions, encourage households to keep spending. Growth will slow slightly from a 1.8% increase this year to 1.6% next as the boost from lower energy prices fades. But for consumer facing businesses this is a much more positive outlook than they could have imagined only a year or so ago.

CHART1

Source: Oxford Economics/Haver Analytics

…but rebalancing is now starting…

The consumer has been the driving force behind the recovery so far but there are clear signs that the other key components of the economy, government, business and trade will all contribute to growth going forward. This gives us more confidence that this is a sustainable recovery.

The really good news, especially for the medium-term health of the economy, is that business investment is picking up. Increased business confidence, higher consumer spending and access to credit on favourable terms are all supporting positive decision-making by corporates. We expect fixed investment to grow by 2.5% in 2016, the fastest rate since 2007, and then increase further by 3% in 2017 and continue at around 2.6% per annum for the rest of the decade.

The IMF and other forecasters have downgraded their outlook for the global economy in recent months, primarily because of the slowdown in emerging markets. In part, Eurozone consumers have benefitted from lower input prices, but exporters have found demand slowing. This slowing demand effect has been offset by increased competitiveness in countries such as Spain that have implemented reforms, by a weaker currency as a result of quantitative easing by the ECB, and by faster growth for some products and services as a result of the recovery in developed markets such as the USA and UK. We project export growth of over 3.5% in 2016 and 2017.

…and even the public sector will contribute to growth.

Emergency austerity is now in the past and the pressure on fiscal reform appears to have eased. We expect public investment to grow for the first time in seven years in 2016, increasing by 1.2% on the way to the heady heights of 3% growth by 2018. Current government spending will also recover although not to the levels of growth we saw pre-crisis.

CHART2

Source: Oxford Economics/Haver Analytics

There is more for governments to do…

The Eurozone is not at the level of competitiveness necessary to achieve a long-term rate of growth that will support the debt deleveraging and increase in employment that are still required to return the economy to good health. Countries such as Spain and Ireland show what can be achieved but more work is required at both the individual country level and at the Eurozone level to continue to drive structural reform. The world economy is rebalancing and this is creating opportunities across all sectors for the Eurozone but policy-makers must continue with the reform agenda that has been already developed.

…but businesses need to act now.

It is not just fixed investment that is increasing in the region. In the year to September, around a third of global M&A by both value and volume was directed at targets in the Eurozone. A competitive currency and signs of a revival have attracted the interest of capital from outside of the currency union. This activity will start to improve the competitive landscape and businesses within the Eurozone should consider how to respond. There is now a platform of reasonable growth against which to consider investment options and with a slowing in the emerging markets, the Eurozone now offers relatively low risk access to a significant number of higher value consumers. On a risk adjusted basis the Eurozone is more attractive than for some time and corporates should ensure they have the right level of presence in the region.

There will still be differences by country as the analysis of labour markets highlights. Germany and Austria have very tight labour markets currently which contrasts with many of the countries in the south of the area which continue to have high levels of unemployment. There is high structural employment in France and Italy that will only be reduced by structural reform. Plans must be tailored to individual country circumstances and in the tight labour markets, unless migration feeds through into increased labour supply, it may be time to consider accelerating investment in labour saving technology.

CHART3

Source: Oxford Economics/Haver Analytics

Is devolution enough to rebalance the UK? national and regional policy must work in tandem.

Rebalancing, what rebalancing?

Given the projection in EY UK region and city economic forecast that the regions closest to London will tend to grow faster than the rest of the UK through to 2018, it’s hardly surprising that we expect that Luton and especially Reading will all do well in terms of GVA growth, with Bristol, Exeter and Cambridge close behind. Indeed our forecast indicates that Reading will marginally outperform London to record the highest GVA growth of any UK city through to 2018, at 3.1%.

Chart3.

 

 

 

 

 

 

 

 

 

 

 

At first sight, this projection might appear to confirm that the UK’s cities are set to fit in with a general widening of the ‘North-South divide’. Newcastle, Hull and Liverpool all face a challenging outlook, Belfast is set to grow relatively slowly and even Leeds, generally seen as a city on the up, will only grow at the national average rate according to our forecasts. Birmingham is also expected to lag the country as a whole as Manufacturing slows.

However, the reality is more complex. For example, we expect that Southampton will slightly underperform the UK average in terms of GVA growth – and will lag even further behind the performance of Manchester and Leeds for example.

It is not a simple story…

These findings clearly highlight that the deeper the geographic level we analyse economic performance at, the more insight we develop into how policy and different industrial structures influence economic performance. A comparison of some of the fastest growing cities in the South East and East regions really brings this point home.

There are specific reasons for the relatively poor outlook for Southampton. The city and its hinterland have suffered not only from the loss of  manufacturing capacity generally, but also from pressure on defence spending – which has had a dramatic impact on the Portsmouth Dockyards, and in turn on many contractors in the supply chain within the conurbation. Public Administration and Health account for 14% of GVA in the area compared to 10% for the South East as a whole in 2015, so as public expenditure is squeezed the impact will fall disproportionately on Southampton and the South Coast.

…and sectors are at the core of it… 

The performance of Reading, Cambridge and Luton illustrates the importance of sectors in determining performance. We forecast that the UK GVA of Information & Communications and Professional Services will grow by 13% over the next three years. By contrast, Manufacturing will grow by 3% and Public Administration will shrink by 1% over the period. This translates into strong performance for Reading where the Information & Communications sector accounts for more than twice as large a share of GVA as the national average. Professional Services account for twice as much of Cambridge’s GVA as the national average underpinning the city’s strong performance.

…pointing towards the opportunity…

But it is Luton which offers the most interesting perspective. Luton’s GVA is forecast to grow at 2.8% over the next three years significantly above the national average of 2.3%. While it has a reasonably strong Professional Services sector, it is also the case that Manufacturing accounts for 16% of GVA and Administrative Services of 10%. These sectors are not amongst the fastest growing but contribute to a diversified local economy which also includes a strong contribution relative to the national average from Transport and Logistics.

In similar vein, the strong GVA performance both historic and projected for Manchester reflects a number of factors including the substantial investments made over more than a decade in revitalising the city centre – Real Estate accounts for 18% of the city’s GVA, the highest shares in the UK; the commercial opportunities offered by Manchester Airport and its surrounding business infrastructure; the city’s strong surface transport links; and a clear positive reputational effect.  Manchester also gains from being particular strong in Professional Services and Financial Services but the real story is how targeted initiatives can drive superior growth. Manchester’s projected growth of 2.5% in GVA puts it in the group of top performing cities and shows geography is no barrier to progress if the right initiatives are put in place. The challenge is to develop and implement the right mix of policies.

Rebalancing will be good for all…

As EY ITEM’s most recent UK forecast makes clear, the UK economy is recovering but moving to a faster level of growth is challenging. The aim of rebalancing growth to maximise the potential of all the UK’s regions and cities is therefore essential if the UK is to move to a higher sustainable rate of economic growth. In this context, we believe our economic forecasts for the UK’s regions and cities provide a lot of food for thought – not least for government policymakers seeking to stimulate a faster and more balanced pattern of growth across the UK, and for local, regional and city authorities seeking to claim their fair share of that growth.

…but it will take time…

Our projection is that with some notable exceptions, primarily among the major northern cities, the North-South divide is set to widen still further over the next three years. The potential of targeted initiatives such as the Northern Powerhouse is clear but these efforts will take years to have a noticeable impact. And in the meantime, other policy initiatives such as ongoing austerity and welfare cuts will drive the economy in the other way direction.

…and more national support is required…especially for sectors 

The three clear messages to emerge from our analysis are:

  • Firstly, national and regional policies have to be co-ordinated. Top down policies such as welfare reform can cut across efforts to boost local growth.
  • Secondly, relative sector performance is a critical driver of relative geographic performance. Rebalancing the economy is not just about adjusting for geographic differences, the interaction with sector must also be considered.
  • Finally, the city and region landscape is becoming more competitive. Successful local development strategies around the world tend to be based upon specialisation in a small number of sectors with policy integrated to support this focus.

This leads us to three areas for national and region/city level policy-makers to work together on.

  • Manufacturing remains important to many regions and cities of the UK, especially outside of the South and East. The resurgence in the Midlands shows what is possible and as our recent report Reshoring manufacturing — time to seize the opportunity demonstrated, the UK has a once in a generation to capture share in selected industries as the world economy changes. Co-ordination will be key in identifying appropriate sector opportunities by region/city and funding over and above that generated regionally will be required to support the transformation of UK capability to a competitive global level.
  • Trade generally will be another important component of region and city growth strategies. UK Trade & Investment in particular has a key role to play once again ensuring the appropriate levels of support and co-ordination across the UK, such as helping individual areas develop realistic plans for sectors which offer the opportunity to build a local base for successful trade.
  • It is clear that technology will be a key component of UK growth both within the Information & Communication sectors but also more broadly across other sectors of the economy. London, the South and East are clearly winning the battle for skilled resources in these areas and benefitting from superior growth as a result. Policies must be designed to facilitate both the development of greater number of skilled STEM resources outside of the current hot markets and the retention of those skills once training is complete.

In an unpredictable and increasingly competitive global economy, guiding the UK towards more balanced growth will not be easy. Devolution is a clear step in the right direction but enabling the regions alone will not be sufficient. National policy must be designed to complement regional policy.

Northern Powerhouse or powder puff? How to build on Manchester’s success and rebalance the UK economy.

A more unbalanced economy?

The UK economy is becoming more geographically unbalanced according to EY’s first UK region and city economic forecast. This shows that London has been the fastest-growing component of the UK economy since 2012 and that the East and South West have both grown in excess of the average rate since 2012.

Clear evidence of the potential for change elsewhere…

Historic analysis does however also serve to illustrate the potential benefits that devolution can bring. Both the North West and West Midlands have posted growth in excess of the national average since 2012. In the former, this growth in part reflects the successful initiatives undertaken in Manchester that are now being used to create the foundations of the Northern Powerhouse. In the latter, the resurgence in manufacturing, especially automotive has contributed to strong relative performance.

…but  a lot to do…

It is good news that targeted strategies by geography and sector can generate improved economic performance. The challenge is to sustain and build on these examples because there is much to do. Consider for example, the North East which will record GVA growth of only 0.9% in 2015. This performance partly reflects the region’s relative reliance on public expenditure within the UK, and partly its heavy reliance on manufacturing – a sector that faces particular problems given the current strength of the pound against the euro. Boosting this and other challenged regions will require strong, concerted and co-ordinated policy, supported by significant resources.

…and this is a long game…

Looking forward, our forecasts largely point to more of the same. We project that London will continue to outperform all other UK regions through to 2018 with average annual GVA growth of 3.0%. Its neighbouring regions, the East of England and South East, will also out-perform the UK average, with the South West just below the UK average.

Chart2

 

 

 

 

 

 

 

 

 

We expect that the weakest parts of the UK in terms of GVA growth will be the economies on the country’s geographical periphery: the three devolved nations of Scotland, Wales and Northern Ireland and the North East. The traditional English industrial heartlands such as the North West, West Midlands and Yorkshire & Humber will occupy an intermediate position between the two extremes.

…even for the ‘Northern Powerhouse’…

From our projections, it’s clear that we don’t expect the Government’s ‘Northern Powerhouse’ ambitions to have a radical economic impact during our forecast period through to 2018. Manchester will outperform other northern cities growing at rates more akin to cities in the south, but the spill-over will take longer to come through.

At best the economic boost will be felt more in the next decade than this one, given that major infrastructure schemes such as HS2 will not come into operation for another ten years. As work starts so the benefits will start to flow but these will be concentrated initially in the areas where work is taking place. Similarly, the impact of the devolution of powers to cities such as Birmingham and Liverpool will become effective only when budgets can be aligned and funds used more efficiently.

…because the present influences the future.

London’s growth is the result of a number of factors but its existing economic structure is clearly a very important influence on performance. London’s economy looks very different to the rest of the UK. In 2015, we expect that 16% of London’s GVA will be accounted for by Financial Services & Insurance, 13% by Professional Services and Information & Communications will contribute 11%. For the UK as a whole, the respective shares are 7%, 8% and 6%. As these are expected to be three of the fastest growing sectors over the next three years, London’s existing strength provides the basis for stronger future performance.

The rest of the South also tends to have more exposure to the fastest growing sectors and this will drive faster growth relative to the North as a whole. There are variations between the southern regions in terms of sector mix but the overall impact is still positive.

London and the South are much less exposed to the plan to reduce the national debt, and turn deficit into surplus than other regions. Public spending and health account for 9% of London’s GVA compared to 12% nationally.  Plans to reduce public expenditure will affect regions with lower wages and higher unemployment harder, resulting in the North-South divide tending to widen rather than narrow.

…but it will take time

Our projection is that with some notable exceptions, primarily among the major northern cities, the North-South divide is set to widen still further over the next three years. The potential of targeted initiatives such as the Northern Powerhouse is clear but these efforts will take years to have a noticeable impact. And in the meantime, other policy initiatives such as on-going austerity and welfare cuts will drive the economy in the other way direction.

In my next blog I will analyse the forecasts for UK city performance and identify what this tells us about the policy mix required to drive successful rebalancing.