The recent upgrade to UK GDP for the fourth quarter of 2015 from 1.9 per cent to 2.1 per cent was widely perceived as positive news, and a sign of the growing strength of the UK economy. But do people really understand what GDP means?
GDP is a widely quoted but often misunderstood metric. As measured by expenditure, it represents the value of goods and services purchased in the period. It is calculated by adding consumption, investment, government spending and net exports.
In the UK, as is the case with all developed economies, consumption is the largest component. No surprises so far, but while a boost to consumption or government spending can increase GDP in the short term, it says little about the long-term prospects of the country.
GDP provides a good starting point to measure a country’s economic performance, but it is just one factor and cannot be relied upon exclusively. To really understand the UK economy and see how sustainable its performance is, other measures in conjunction need to be examined to see how they link together as a whole. In other words, we have to join up the dots.
The current account – which measures the balance of trade and net cash transfers – rose to a deficit of 7 per cent of GDP in the fourth quarter of 2015, the highest since quarterly records began in 1955. The large deficit is a cause for concern because it indicates that the economy is unbalanced; much of domestic consumption has been driven by imports from overseas, which have significantly exceeded the UK’s level of exports.
When consumers become more cautious, the ratio starts to rise again, generally leading to a decline in consumption and equities John Goodall, WH IrelandGood news for the UK economy we would think, but value, which represents the growth in spending on a pound-for-pound basis, revealed a gain of just 1.4 per cent for the same period, due to falling prices. While readings can be volatile from month to month, the overall trend represents a slowing in growth and an uninspiring future for the UK’s economy.
People with money spend money and the two go hand in hand, so clearly employment levels will always be a major contributory factor in retail sales. With more than 31m people in employment, there have never been more people working in the UK. Again, good news for the growth of the UK economy. However, the positive impact of rising employment levels has been tempered by the fact wage growth has been weak. Adjusting for inflation, average earnings are more than 4 per cent lower than they were in 2007.
The saving ratio is an overlooked metric that tracks what proportion of their total disposable income households have available to save. It fell to 3.8 per cent in the fourth quarter of 2015, the lowest since records began in 1963, against the long-term average of 10 per cent.
The ratio is inversely correlated with both GDP and the stockmarket. In other words, consumption is boosted by a falling saving ratio. When consumers become more cautious, the ratio starts to rise again, generally leading to a decline in consumption and equities.
Unsecured lending has been rising fast, exceeding growth of mortgages and business loans. The pace of growth has moderated, although it still rose 5.6 per cent on the year to February to £180.7bn, the highest level since 2010. It is clearly not a sustainable way of generating long-term growth. With average interest rates on credit card debt of around 18 per cent and overdraft rates near 20 per cent, according to Bank of England data, this type of behaviour is only storing up problems for the future.
Meanwhile, the housing market is one area that has been performing well in the UK, although arguably house price appreciation has been driven more by scarcity of supply and availability of cheap credit than underlying strength in the economy. Despite rising prices, homeowners have become more cautious and this will undoubtedly have had a negative impact on consumption.
By joining these dots together we can see there are many influences on GDP.
Some of these are positive and some are negative on a short-term basis. With retail sales struggling to make headway, dependent on an all-time low saving rate and a rise in unsecured lending, consumption is unlikely to grow strongly despite record employment.
Looking into the medium to long term, it is difficult to see how GDP growth can be sustained, even at the current level. The future of the UK economy therefore remains uncertain.
John Goodall is head of private client research at WH Ireland
