Rebalancing at last?

After the General Election and the Budget, what is the economic outlook for business? A business friendly government…

A decisive General Election victory for the Conservative Party should mean that the economic policy framework for the next five years is both clear and predictable. And based on the sentiment expressed pre-Election with the fiscal policy contained in the Conservative Party Manifesto, the mood amongst businesses should be positive: they have a predictable and desirable policy environment.

…and a solid economic backdrop…

The UK economic recovery is continuing. Consumer spending continues to drive the economy. A buoyant labour market and rock-bottom inflation have lead to growth in real incomes of 4.5% in the year to the first quarter of 2015 and consumption has risen by 3.4%. This solid base means that, despite the continuing slowing of the outlook for the world economy and the pound’s strength against the euro holding back demand for the UK’s exports, the EY ITEM Club UK Summer forecast predicts GDP growth of 2.7% for 2015 and 2016.

…but wait a minute.

So everything is looking rosy? Well…not quite. The recovery – while continuing – is increasingly domestic in nature The net result is that the relatively positive economic outlook is based upon an increasingly unbalanced recovery with neither exports nor business investment contributing to the extent that the Chancellor’s believes is necessary to propel the UK to the position of the world’s richest economy by 2030. The post-election Budget differed significantly from the one that was expected based on the Conservative manifesto. The Chancellor has decided to gamble on potentially disrupting the economy in order to shock into moving to a higher level of productivity and ultimately a higher income level. The Government’s spending squeeze is now slower than set out in the Spring Budget, although the public sector cutbacks remain dramatic, but the slower pace of expenditure reduction has been compensated for by and the introduction of tax rises that will be worth £6.5 billion annually by 2020. Revised policy it may be, but it will still have the effect of reducing growth. Consumers will also be squeezed by the Summer Budget through a combination of the tax rises, loss of welfare payments  and reduced housing benefits. There is some compensating adjustments in the income tax system but the impact on consumers, and businesses, hinges on the impact of the ‘national living wage’ on economic activity.The Chancellor expects the national living wage to cost business £4 billion and lead to a loss of 60,000 jobs. The reduced tax on businesses’ profit is expected to deliver £3 billion of benefit to businesses and increased investment allowances should boost business investment.

…how should I interpret the productivity plan?

The key driver of the UK economic outlook is now how businesses respond to the call implicit in the Budget for business to boost investment, skills and exports. This is very uncertain and makes forecasting especially difficult, certainly more so than we expected given such a decisive poll victory. The Chancellor’s ‘productivity plan’, includes new measures to boost apprenticeship numbers and a range of other initiatives. These measures are clearly at an early stage and the productivity plan is more a collection of themes rather than a detailed plan. But at the core is the proposal for the national living wage which will change the labour market environment. The UK recovery has been built on the flexible labour market and the remarkable rate of job creation alongside a fall in real wages. We are now moving into uncharted territory compared to recent economic history.

Time to test the 5 year plan.

The economic landscape has changed significantly since the General Election with the Budget containing a number of unexpected twists. The Chancellor is gambling on business responding to the productivity challenge his national living wage creates, so that exports and investment will compensate for the fiscal squeeze and consumer slowdown. Now is the time for all companies to reassess the outlook, and formulate a five-year plan to run alongside this majority Conservative administration. This plan should involve three elements:

– First, a strategy and financial plan. This should take account of likely changes in revenues, as growth in the UK and global macro-economies slows down, and the cost base shifts under the impact of factors such as the living wage and fluctuations in currency exchange rates.

– Second, an assessment of the scope to make investments to improve labour economics, given the new wage paradigm.The key question to address is whether now is the time to accelerate the deployment of technology to improve productivity, as the relative costs of human capital rise.

– Third, a review by sector of the opportunities and threats facing the company, given its areas of activity, customer mix and business model. Depending on the focus, the factors affecting the business might include government spending cuts, investments in infrastructure, and further devolution and decentralisation of decision-making and tax-raising.

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