JANUARY 2014
THE ECONOMY
WHAT’S AROUND THE CORNER IN 2014?
featured speakers Todd Buchholz Frances Cairncross Stephane Garelli Sir John Gieve Megan Greene Anthony Hilton Paul Johnson Lord NORMAN Lamont Doug McWilliams Pippa Malmgren David Smith Guy Verhofstadt Fabian Zuleeg
JANUARY 2014
THE ECONOMY: WHAT’S AROUND THE CORNER IN 2014?
Todd Buchholz Former White House Director for Economic Policy
What will 2014 bring for President Obama? President Obama would prefer to flip back the clock to 2012, when he still looked popular and youthful. The failure of Obamacare is staggering. In recent meetings with White House, Treasury and Federal Reserve Board officials, I found no advisor who could recall an example of such a widespread and instantaneous collapse in domestic policy. Sure, George W Bush’s Iraq incursion incited protests, and JFK’s botched liberation of Cuba sputtered in embarrassment back in 1961, but those examples did not directly impair the daily lives and wallets of a hundred million Americans. The problems run deeper than a temporary snag in a government website. The entire US economy is feeling pinched by the healthcare debacle - at a time when the consumer is already looking queasy. Kohl’s and Wal-Mart have shaved their profit outlooks, and chain restaurants like the Olive Garden and Red Lobster are finding fewer customers digging into over-sized bowls of pasta and cracking fat lobster claws. Those consumers with private health insurance are worried that the postman will hand them a thin envelope cancelling their coverage. Not long ago Obama had a secure grasp on the Democratic Party. But now he is quickly becoming a lame duck. Democrats are looking for a new savior, and we’ll soon hear a bell to mark the beginning of the 2016 Presidential race. Joe Biden will scuttle off with Hillary Clinton, who is now free to reveal her rifts with the White House. Her husband Bill recently kicked dirt in Obama’s face, declaring that he should keep his word and allow Americans to retain their old health care plans if they’re happy with them. Biden and Clinton will likely draw foes from the Left, too, led by freshman Senator Elizabeth Warren of Massachusetts, a firebrand who won her seat despite an embarrassing claim that she was 1/32nd Cherokee. More candidates will emerge, and each time they do it will seep more power and attention from the White House.
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JANUARY 2014
THE ECONOMY: WHAT’S AROUND THE CORNER IN 2014?
Frances Cairncross Chair, Executive Committee IFS
What do you see determining the pace of UK recovery? Three things matter. Firstly, the pace at which our main trading partners grow. The US recovery still looks fragile and subject to political uncertainty; the EU has simply shelved the euro problem and is moving into a deflationary cycle that could prove disastrous. Secondly, the pace at which the Bank of England puts the brakes on QE. Low interest rates and surging monetary growth are creating another asset bubble. It will spill over into the ‘real’ economy, but it’s unstable and unsustainable. Thirdly, the pace at which we reduce debt. Until this painful process makes real headway, no recovery will be sustainable. Is progress being made in rebalancing the economy? Not nearly enough. The main debt reduction has been by companies, which are swilling in cash and avoiding borrowing (or else they’re unable to borrow). The personal sector has made some progress, but the government has made too little. Invert this order and you might get real rebalancing. Do you see a change of direction from the BoE, ECB or Fed? It will be interesting to see what Janet Yellen does. (She was a contemporary at Brown University in the US, and did an excellent paper on optimal currency areas – so she’ll understand the issues in the EU.) In the UK, the innovation is that Carney wants to work with the banks, rather than against them. That said, his efforts at forward guidance have been unimpressive. A promise to hold down rates may be the wrong signal with asset inflation kicking off. How will the West perform against major emerging economies in 2014? It’s hard to be confident. India has an election; everything will turn on whether there’s a workable coalition. If Modi gets in, he might get the trains to run on time and achieve some liberalisation. If there’s a messy Congress solution, all bets are off. China has more problems than have so far been apparent - but even slow growth in China will be better than what we had 20 years ago.
JANUARY 2014
THE ECONOMY: WHAT’S AROUND THE CORNER IN 2014?
Prof. Stephane Garelli Director, World Competitiveness Centre
Where are we on the road to recovery? We are moving in the right direction, but serious questions remain. Would a few percentage points growth be sufficient to solve budget and debt problems in advanced economies? Probably not. And what will happen when the Fed stops flooding the market with $75bn every month? What impact will it have on interest rates, consumption and business confidence? Nobody knows. How will the US itself perform in 2014? They should lead world economic recovery. Again. The energy renaissance will cut company costs, boost demand for infrastructure spending and bring in additional export revenues (or energy substitution). Meanwhile the new head of the Fed will be sensitive to unemployment targets. All this will increase American confidence. How do you see the competitive challenge for Europe? Europe has a problem of government efficiency and governance. Of course in Germany it will be ‘business as usual’: Chancellor Merkel was not re-elected for her bold experiments! And interestingly, most European companies are doing relatively well – outside the Eurozone. What of the emerging nations? Some emerging economies have become addicted to inflows of cheap money (especially those with a current account deficit). Can they absorb the shock when America turns off the tap completely? How much more reform is needed? Will we see a reverse outcome: advanced economies recovering while emerging ones are slowing down?
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JANUARY 2014
THE GLOBAL RACE 2014
JANUARY 2014
THE ECONOMY: WHAT’S AROUND THE CORNER IN 2014?
Sir John Gieve Former Deputy Governor, Bank of England
Do you expect the Bank of England to stick to its current line? Yes, for at least a year. The Bank has made a major shift in policy under Mark Carney in issuing forward guidance, and that can only work if it is credible. It can’t chop and change to respond to short-term shifts in sentiment. Like Janet Yellen in the US and Haruhiko Kuroda in Japan, Carney has been appointed on a growth ticket; his diagnosis is that we have fallen behind the sustainable growth path, so we need a period of catching up. We’ve gone from targeting inflation to growth and reducing unemployment, subject to a broad inflation constraint. It looks unlikely that the ‘inflation knock out’ will be triggered and very unlikely that unemployment will come down so fast as to trigger a policy rethink this year. The importance of the shift has been disguised by central bank rhetoric. (While governments present every slight shift as a radical change, central bankers present fundamental changes as entirely consistent with past policy.) The Bank currently expects growth to strengthen but to remain modest by historic standards. If that happens and inflation remains below 3.5%, interest rates and QE will remain unchanged well into 2015-2016. The main action will be on regulation to continue to build banks’ capital defences, and possibly to dampen asset prices if they grow too quickly. Politically that would be acutely difficult; the Chancellor launched his scheme to boost the housing market and won’t want to see it closed or offset in the run up to the 2015 election. What could derail this? Crises in the Euro or the Middle East, or budgetary impasse in the US, could pitch us back into recession and require resumption of QE. Or more welcome, we could see a real bounce in activity (as after most recessions) and a pick-up in inflation. In that case the Bank could have to step back from its guidance and bring forward unwinding of QE – embarrassing for Mark Carney, but a problem of success.
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JANUARY 2014
THE ECONOMY: WHAT’S AROUND THE CORNER IN 2014?
Megan Greene Chief Economist, Maverick Intelligence
What do you see determining the pace of recovery across Europe? Firstly, the speed at which European banks clean up their balance sheets. The upcoming stress tests are crucial; if they’re not stringent, banks will not write down non-performing loans and we’ll continue to have a creditless recovery. Secondly, while unemployment remains particularly high in the periphery and among youth, it will be difficult to have any kind of domestic demand. Thirdly, symmetry. So long as the weaker Eurozone countries have to make all the adjustment and the stronger ones (especially Germany) are not forced to adjust at all, the weakest will provide a continued drag on economic recovery. What should we expect from Merkel’s new coalition? Nothing we haven’t seen before. There will be some differences in domestic policy (ie minimum wage, Financial Transaction Tax), but as far as Europe is concerned the approach won’t change. What action would you welcome from the Commission or ECB? The European Commission should demand more of an economic adjustment from Germany, which has seen its current account surplus soar without being punished as part of the Annual Growth Survey (Nov 2013). The ECB should purchase SME loans from banks to reduce financial fragmentation. This would reduce borrowing costs among peripheral SMEs, which form the backbone of their economies.
JANUARY 2014
THE ECONOMY: WHAT’S AROUND THE CORNER IN 2014?
anthony hilton Senior Commentator, The Independent & Standard
How strong is the UK recovery? Consumers start spending, even if they can’t really afford to, because they’ve got used to tougher times, adjust to them and gradually become confident enough to assume something will turn up. It is the same with companies, but though most have plenty of money they are not spending it on expansion. This is the big issue. Traditionalists say businesses are not quite confident enough to commit, but give them time. Others say there’s a more fundamental problem: corporate bonuses have changed management behaviour. What about the challenges facing Europe? The best measure of economic efficiency is value added per hour worked. On this basis France and the US are almost identical, but the American consumer spends nearly 50% more than their counterpart. The explanation for this paradox is the French spend their wealth on different things: long lunches, long holidays, early retirement and much higher levels of social spending. Add in the fact that Germany is the world’s second largest exporter after China (and the leading exporter of high value goods by a long way) and it becomes obvious that the Eurozone’s problem is less the need to become more efficient, and more a question of deciding priorities. Do they continue with the social model or abandon it? And how can they spread the wealth more evenly throughout the different countries? These are political, not economic challenges. And the wider challenges for the UK and global economy? There are four. Firstly, China’s growth can’t be sustained because it lacks the collaborative institutions common to all wealthy economies. Their export-led model has run its course and an internally driven alternative means wrenching change. Secondly, while technology is a significant source of growth, networks are prone to catastrophic failure. We must expect more frequent catastrophic shocks – every 10 years rather than every century. Thirdly, we are in for a period of regulatory austerity. The reaction to the crash is to pile regulation on regulation to prevent it from happening again. This will gradually choke the system, stifle innovation and result in a huge waste of resources. Finally, finance has reached a point of diminishing returns, where it transfers wealth rather than creates it. This means that the bigger the financial sector, the lower the overall growth rate. It will cause increasing problems in the UK’s North / South divide and rising inequality in the coming decade.
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JANUARY 2014
THE ECONOMY: WHAT’S AROUND THE CORNER IN 2014?
Paul Johnson Director, Institute for Fiscal Studies
What’s the outlook for the public finances? Good economic news is not going to change plans for spending cuts; the long-term outlook for public finances remains grim. This recession has been different. We are left with high employment but lower incomes and a huge drop in productivity, which has big policy consequences. There’s been a real squeeze on living standards, but up to now we have ‘all been in it together’: rich and poor have both lost out significantly. Welfare cuts will change that. And have we seen a significant generational divide? Our older people have fared well and younger generations very badly over the past decade, and potentially in the future. Auto enrolment and the single tier pension are radical and welcome reforms, but do they address the right problems? How should we respond to the fact that pensioners are now less likely to be poor than anyone else? What does the future hold with the demise of occupational schemes except in the public sector – where lots of scope for reform remains? What about tax reforms? There’s little sign of a sensible tax strategy from either side. We’ve incurred huge expense through higher personal allowances, lower fuel duties and corporation tax. Current energy policy is similarly incoherent, but not in the way the public debate suggests: business is over taxed relative to households, and is effectively subsidising gas use. If political parties of all stripes sign up to ambitious climate change targets, then someone has to pay. I see a high probability of tax increases post election.
JANUARY 2014
THE ECONOMY: WHAT’S AROUND THE CORNER IN 2014?
Lord Norman Lamont Former Chancellor of the Exchequer
What do you see determining the pace of UK recovery? Growth looks like being faster than in many countries, but it’s based mainly on consumption and an improving housing market. We have not yet seen rebalancing into greater investment or exports. What do you make of Labour’s economic policy? They are still in denial about the financial crisis, which won’t do them any good. They’ve tried to change the terms of the debate and it is true that living standards have not improved – but that’s because the Government has had to clear up the fiscal mess. Only after the public finances have been put in order will we see a rise in living standards. Do you expect the Eurozone to be more or less stable in 2014? I expect it to muddle through – with Germany doing exactly what it has been doing hitherto: the minimum at the last possible moment. The Euro is a religion or political ideology, not an economic idea. I have never predicted its early breakup and have always said it would survive its first crisis, but perhaps not its second. Surviving isn’t the same as being successful. I would anticipate modest Eurozone growth this year, but a grim long-term outlook. Do you expect a change of direction from the ECB or Federal Reserve? Money supply is growing very slowly in the Eurozone, and bank lending is likely to be constrained. Some argue this should lead to European QE, but ECB statutes prohibit it. I believe rates will remain unchanged. As regards the Federal Reserve, I think they were wrong to blink and hold off reducing the amount of QE until now. How will the West perform against major emerging economies? China and others have slowed markedly, and the West has picked up speed. For the first time since 2007, most growth will come from developed countries. While Chinese slowdown to 7.5% was intended, there will be knock-on effects in South East Asia. I wouldn’t expect another Asian crisis, but those like India and Indonesia with large current account deficits and foreign borrowings are vulnerable.
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JANUARY 2014
THE ECONOMY: WHAT’S AROUND THE CORNER IN 2014?
Prof. Doug McWilliams Executive Chairman, CEBR
How do you see the economy performing in 2014? We continue to live in uncertain times. The growth momentum could gain pace, but there are risks: US budget difficulties, Euro fragility and increasing dangers in the Middle East (which will remain the major source of marketable energy for the next 10 years). The UK could have a relatively comfortable 2014 as the Coalition pumps up the economy in the run-up to the General Election, but afterwards there will be a requirement to tighten budgets again. What’s your view of the Scottish economy, as referendum approaches? Outside the oil sector, Scotland has lagged behind the UK economy for most of the past 30 years. But since the start of recession its relative performance has caught up. This might seem surprising, given the damage to the Scottish banking sector, but it partly reflects the fact that Scots got less indebted than others in the UK. Meanwhile consistently high oil prices (though production is now declining) have meant that the oil sector continues to boom. And because extraction is increasingly in more complicated fields, the knock-on effect from oil remains strong. As for the referendum, what the business community fears most is an inconclusive result – particularly a ‘no’ vote with a small majority that would keep the issue in play almost continuously. What else do you expect to be addressing in speeches this year? One of my themes will be the likely shift in the shape of the UK economy from consumption to exports as we respond to globalisation. Consumer spending currently amounts to roughly 70% of GDP, while exports are about 30%. (The other components like government spending, investment and stock-building are almost equal in value to imports, and so net out.) We predict that exports and consumer spending will be equally important within about 30 years – a dramatic change. This has huge implications for our economic structure.
JANUARY 2014
THE ECONOMY: WHAT’S AROUND THE CORNER IN 2014?
Dr. Pippa Malmgren WEF Global Leader for Tomorrow
What can we expect of the US authorities in 2014? The new head of the Federal Reserve is Obama’s third choice candidate, so the White House will want to load the board with close allies. This means the dissenters are bound to get louder. For Janet Yellen, 6.5% unemployment is not enough to reverse policy. She will wait until wages are rising. Meanwhile she’s likely to have even less sway over Congress and their excessive spending than Bernanke. Is recovery set to continue? The West is in a structural upswing. Emerging markets have become far less competitive as a result of food and energy inflation and rising wage demands. The industrialised West will be a huge beneficiary as manufacturing, mining, agribusiness, property investment and financial services all return to the US, Mexico, UK, Germany and Eastern Europe. So what will be the effect on emerging markets? Yellen will enrage central bankers in emerging markets, who will face even more inflation given her dovish stance. They are bound to see more conflict and social unrest given the loss of their income and business model. This in turn will make strategic security issues important for markets in 2014. And how do you see the current outlook for Europe? I think the Eurozone is more stable AND will see some members leave. The Germans now have no problem with some countries leaving (Greece and Cyprus) and some joining (Latvia) – so long as it can be done without creating turmoil. They continue to work for that outcome. You can have a more elastic, more flexible Euro without destroying stability.
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JANUARY 2014
THE ECONOMY: WHAT’S AROUND THE CORNER IN 2014?
David Smith Economics Editor, The Sunday Times
How do you see the pace of UK recovery? I expect growth to persist in 2014. The end-of-year figure will be healthy by recent standards: 2.5-3%. The key to stronger growth is a recovery in real incomes and the beginning of the long-awaited upturn in business investment, which I expect to happen. The headwinds holding back recovery are gradually easing. Do you expect the BoE to stick to its current line if growth picks up? Mark Carney’s forward guidance is often misunderstood. It is not a policy to keep interest rates down come what may, but a pledge to do so until recovery is properly established. If it happens earlier than they said, and unemployment races down to 7%, the Bank won’t regard that as a defeat. I do not expect to see rates rise over the next two years, given the ground we have to make up. Do you see signs of coherent economic policy from Labour? For me, Ed Miliband and Ed Balls have to overcome a fundamental problem: every criticism they make of the Coalition comes with the enormous baggage of their own role in the country’s economic problems – whether on the budget deficit or energy prices. They are a long way from a coherent policy, but they have been reasonably successful irritants and get under David Cameron’s skin. Watch out for Miliband pledging a return to a 50% top rate if Labour is elected. Would a Scottish ‘Yes’ vote make any difference to the UK economy? Yes, in both the short and long-term. The challenges for Scotland are greater, but the end of the UK as we know it would reduce our international clout – and complicate monetary and fiscal policy at a time when we do not need it. How will the West perform against the major emerging economies? Last year the advanced economies briefly made a greater contribution to global growth than the emerging world. India in particular is encountering real difficulties. The challenge for emerging economies will be how they cope with the US Federal Reserve ‘tapering’ its quantitative easing asset purchases. However I still believe the West, with our twin banking and fiscal hangovers, will take second place to emerging economies over the medium and long-term. They will be the drivers of the global economy.
JANUARY 2014
THE ECONOMY: WHAT’S AROUND THE CORNER IN 2014?
Guy Verhofstadt Leader, Alliance of Liberals & Democrats for Europe, and Former Belgian PM
How would you characterise the challenge for Europe? Europe is stuck at zero growth while the world recovers. It’s more than 1.5% in the US, 2.5% in Australia, 4% on the African continent and 5% in Asia. But the economic struggle is also political. The only solution is a federal Europe, united in managing its public debt and pumping money into the economy. A common currency demands a unified political strategy, a Treasury, a real Government and a Parliament with full powers. Should we expect a change of direction from the ECB? When we created the Euro we opted for a central bank organised the German way, with strong focus on inflation management rather than broader economic targets. This is a good thing when you have other strong institutions that aim for economic growth, but this is not the case. The ECB helps where it can, but it’s very limited in its mandate and competencies. What do you expect in Angela Merkel’s third term? I hope we get to see a more relaxed Germany. I hope it will be less afraid of playing the European card and choosing solutions that are supranational instead of endless consultations between member states. What arguments will come to the fore in the European elections? Everybody agrees the EU is not working. If something is broken, you should fix it – but how? This is what’s at stake in the elections. Eurosceptic parties all over Europe argue that we should break up the union, retreat behind national borders and only keep a free trade area. The pro-Europe answer is for member states to integrate further and play a political and economic role on the word stage. This debate is at the core of the European elections. Can the EU continue without closer integration? Imagine the United States cleaning up the banking sector, or taking action against Chinese dumping activities, by assembling 50 Governors every time they need to make a decision. Imagine the dollar being endangered, without a President or Congress to support it. Everybody would consider it extremely inefficient and downright dangerous. Yet, this is the reality in Europe today.
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JANUARY 2014
THE ECONOMY: WHAT’S AROUND THE CORNER IN 2014?
Fabian Zuleeg Chief Economist, European Policy Centre
How do you see the Eurozone performing in 2014? There will be weak recovery, with significant downside risks due to continuing problems in the banking sector and potential political upheaval in places like Italy. The crisis countries will continue to struggle to emerge from recession and unemployment figures will not be improving. Do you expect a change of direction from the ECB? The central bank will continue its loose monetary policy, implicitly recognising that growth should take precedence over inflation. They will also continue to buy bonds from crisis countries on secondary markets – debt mutualisation is not on the cards in the foreseeable future. What might we expect from Angela Merkel’s third term? Merkel will be exactly where she wants to be: in the centre of German politics. The Grand Coalition will enable her to make compromises that will result in broadly unchanged European policy, but at least it will remove the blockage on decisions like Banking Union. There will also be greater emphasis on growth enhancing measures to complement austerity. What about the European Parliament elections? There will be a low turnout and far more seats for Eurosceptic and extremist parties. The Front National will do well in France, as will the AfD in Germany – although at a lower level of 8-9%. In the UK, UKIP will become the biggest party (certainly in England), accelerating the alienation with the rest of the EU and bringing us closer to Brexit. How do you characterise the challenge for Europe? Challenges include demographics, resource competition and rising inequalities within and between countries. Europe will struggle to maintain its economic and social model without significant reform. The Eurocrisis is far from over.
JANUARY 2014
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