In this article I look mainly at the UK’s GDP position. While the ONS first estimate for Q1 2022 shows that it is now 0.6% higher than the pre-pandemic peak in Q3 of 2019, this is entirely down to increased government consumption and investment, mainly health-related. But for this real-terms increase, the economy (measured in GDP) would be some 2% smaller now, even before the cost-of-living crisis hits us fully, and before government and Bank of England tighten fiscal and monetary policy simultaneously. In a second article, I will seek to analyse this week’s labour market statistics and their significance for policy.
We’ve now had the UK’s GDP and labour market estimates from the Office for National Statistics for the first quarter (Q1) of 2022, plus the April stats for inflation, so we can start to analyse how the economy has been going. If – a rather gigantic ‘if’ – one ignores inflation (April CPI 7%, RPI 11.2%) and war for the moment, then (on the surface) the picture painted by some was one of a ‘return to pre-pandemic normal’.
In his anodyne twitter-language, the Chancellor Mr Sunak told us (May 12):
Growing the economy is one of the best ways to help with the cost of living and that’s why I’m pleased today’s figures show the UK economy is continuing to grow. The economy is now bigger than it was before Covid hit, and growing faster than the US, Germany, France, and Italy.
But now the future looks a little, well, ‘apocalyptic’, to adopt the Bank of England Governor’s favoured adjective. But first, let’s dig a little deeper into what the GDP numbers actually tell us.
Real GDP – level pegging with Euro Area…
Real GDP was up by 0.8% on the previous quarter (due wholly to a strong-ish January) and for the first time since the Covid pandemic began, GDP surpassed its late 2019 levels. The pre pandemic ‘peak’ was Q3 2019, and Q1 this year was just 0.6% greater than back then. I have been comparing the two quarters across a range of indicators, to see what is broadly now the same, and what has changed.
But first, let’s look at how the UK economy compares – in terms of GDP – to European and US comparators. Here, I’ve taken the OECD indexed GDP statistics by quarter, in which the year 2015 is the base year (=100). Chart 1 shows the evolution of GDP for each country/bloc over the last 7 years, from Q1 2015 to Q2 2022. I’ve ignored the bottom of the 2020 dip, which has more to do with health policies and different ways of measuring GDP than useful economic information at this stage.
In a nutshell, in Q1 2022, the UK and the Euro Area indices were almost identical, with France within a whisker. The front-runner by far is the USA, and the EU as a whole has also pushed ahead. The laggard, which also pulls down the EA and EU figures, is Germany, whose economy has been spluttering since 2018.
…but UK has slipped a little relatively since Brexit Referendum
I have also analysed the GDP index data for changes in the period since the Brexit referendum in June 2016. Comparing the last pre-Referendum quarter, Q2 2016, with Q1 2022, we find that the UK’s GDP is now up by 7.1%, compared to the Euro Area’s 7.3%, and France’s 7.4%. The EU as a whole has gained more (GDP up by 8.8%), while the USA has sailed away on 12%. The worst performing economy by some margin is Germany, whose Q1 GDP is only 4.4% above its level of Q2 2016.
In summary, before Brexit, the UK economy was ‘growing’ a little faster than that of the Euro Area, which had suffered from the perverse “debt brake” ideology of Ms Merkel and the European Commission; following the Referendum, the UK started to slow a little relative to its comparators, due largely (it would appear) to the insipid ensuing level of business investment. But if the headline figures seem to show the UK economy faring little worse than its main comparators, and indeed better than Germany, there are some interesting factors to note.
Public spending to the rescue (for the moment)
I’ve mentioned above that Q1 real GDP was 0.6% greater than Q3 2019, the previous peak. We should note that there are significant uncertainties in the Q1 figures, with large “statistical discrepancies” and “alignments” to help towards equalising the three approaches to GDP. (I look here at the output and expenditure approaches, the third is the income approach). In comparing two single quarters, there is of course also a margin of error or volatility to allow for, but overall I am confident that what follows gives a true if broad picture of what has now changed, and what has not.
First, the output approach.
Total production in Q1 2022 was 1.9% down on Q3 of 2019, though within this, manufacturing output was almost unchanged. Construction was also unchanged. The ‘services’ sector as a whole was higher in Q1 by 1.5%. But there have some significant changes between the ‘shares’ of service sectors. The main ‘losers’ in comparing the two quarters were Wholesale & Retail, the FIRE (finance & real estate) sectors, and Education, all down by 1.5 to 2%, plus the smaller sector ‘other services’ (down over 6%). The main winners to date include ‘Transport Storage & Communications’ (+3.5%), ‘Professional Scientific Admin & Support’ (+2.5%), and ‘Public admin, Defence & Social Security’ (+2.8%) and – far and away the biggest percentage increase – ‘Health & Social Work’, which was over 15% higher in Q1. Though this sector accounts for just under 10% of total services output in ONS’s methodology, such an increase accounts for almost all of the service sector’s gain in Q1 this year over Q3 2019.
Second, the expenditure approach.
The main contributors to ‘final consumption expenditure’ are households; general government; and investment (GFCF – gross fixed capital formation). From the total consumption expenditure, the trade balance (usually negative in the case of the UK) is then subtracted (or added if positive) to give the GDP figure.
Comparing Q1 2022 once more with Q3 2019, we find the following main changes:
Household consumption: down 1.1% in Q1 (£345 bn, compared to £349 bn)
GFCF: up 1.9% in Q1 (£102 bn, compared to £100 bn)
General government consumption: up 9.5% (£115 bn, compared to £105 bn)
Trade: the figures here are volatile and come with a health warning – exports down 14.9%; imports up 1.2%)
We should also note that government capital expenditure is included in the GFCF total. Within overall GFCF, business investment (which comprises over half of the total GFCF) was down 9% in Q1 compared to Q3, private investment in ‘dwellings’ was up 7.1%, while ‘general government’ capital expenditure was up 33% (from £16 bn to £21 bn) in Q1.
What if government had not stepped up its consumption and investment?
If we take the increase in government spending as a whole, (consumption + investment), the increase in Q1 over Q3 2019 was around £15 bn (or £60 bn annualised).
In Q3 2019, general government consumption and investment constituted 21% of the GDP total.
In Q1 2022, general government consumption plus investment formed 23.9% of the GDP total.
If government consumption and investment had remained the same, in volume terms, in Q1 2022, and nothing else changed, GDP would be £554 bn, or 2% lower than the first estimate.
And on our chart comparing us with other ‘developed economies’, the UK would be nestled in at the foot just above Germany.
The surge in health-related expenditure
The main increase in government consumption relates, of course, to health services. In its summary of the previous quarter’s GDP, the ONS said:
In output terms, the largest contributors to the Quarter 4 increase were from human health and social work activities, driven by increased GP visits at the start of the quarter, and a large increase in coronavirus testing and tracing activities, and the extension of the vaccination programme.
This indicates that, while spending in the ‘ordinary’ NHS has increased, much of the pandemic surge is temporary, and indeed the Q1 figure already showed a slight reduction compared to Q4 2021.
The bad-worst is yet to come
The UK economy is about to hit a triple whammy, maybe even a higher multiple of whammy… The Bank of England signals that it will tighten monetary policy significantly, and the UK government announces its intention to tighten fiscal policy. We wait to see whether it can truly afford to do so; ‘afford’ in political terms, that is, scrunched as it is between the ‘rock’ of the cost-of-living crisis and the ‘hard place’ of the hard men of money calling for lower public spending and lower taxes. With both monetary and fiscal policy set to be tightened by the powers-that-be, and with real-terms pay falling now, there looks to be no positive way ahead for the UK economy, for many a month. Household savings rates are falling rapidly, and while the better-off may still have savings from the ‘pandemic era’ which they are willing and able to draw from for a period, we can already hear the click and clack of belts being tightened.
My next article will look at developments in the labour market – and how they may relate to inflation and inflation policy.