EEF blog

EEF have long said that tax reform needs to be central to rebalancing our economy.

But because of silly Whitehall turf wars, the good work coming from BIS on industrial activism and a manufacturing strategy has often existed apart from the realities of the tax system.

For example, the Strategic Investment Fund of £950m is being put to use to encourage investment in growing markets and supply chains.

But the capital allowance regime actively discourages manufacturing investment.

How? 

Manufacturers replace their equipment, on average, ever 7-8 years. With a capital allowance level of 20%, the tax system only recognises that investment over 28 years. That gap raises the cost of investing in modern machinery in the UK. Looking across the tax system, you get similar disincentives to invest in manufacturing.

But at a speech on Monday night at a Progress event, Pat Macfadden, the BIS Minister linked the two issues of tax and industrial activism.

It was a first for the government and an extremely welcome recognition that building a balanced economy requires strategy that is implemented across government, not just by a forward-looking BIS department.

Today’s data confirm that manufacturing is now out of recession.  But they also continue to raise questions over the health of the wider economy.

Previously, we've said that weaker growth in Q4 would be a good thing, because a strong q4 would most likely have come at the expense of a weak start to 2010.

But at 0.1% q-q, GDP growth was very weak in q4. Not even a strong boost from manufacturing of 0.4% q-q could boost growth in the wider economy. 

So while exports remain the best prospect for a turnaround, the next six months will be uncertain one for the recovery.

Read our reaction on the BBC website.

Back in December, the head of construction company told me the following:

"No one has got to grips with what's just happened to us. Which means the don't really understand what it takes to get us out of this. And that leaves us drifting."

His comment got to the heart of the matter - do we really know where we are , why we've gotten here and where we want to go as an economy?

A couple of recent reports on the state of government in the UK suggests why we haven't come to grips with our problems:

"a conspicuous lack of a single coherent strategy for government as a whole...inhibits the ability to set overall government priorities and translate them into action."

Another report by Whitehall Manderins comes to similar conclusions and makes the following recommendations:

• improve the quality of legislation by slowing down the legislative process and improving scrutiny;
• strengthening Commons Selet Committees; and
• stopping the frequent shifting of Ministers.

Although these criticisms are slightly sensational as they come just months before an election, they are all too familiar to businesses at the sharp end of frequent changes to the tax and skills systems, for example.

EEF raised these issues last year - first in our report on the competitiveness of the tax system, and then again in Manufacturing. Our Future. report which set out a government-wide strategy to rebuild our economy.

So what's the key challenge for the next parliament given these criticisms about the state of government?

Thinking and acting differently, because we can't afford to drift any longer.

We've argued that the key to UK's prospects in 2010 depend on how it fared at the end of 2009.

Did consumers spend more in the Christmas season? If so, did that shopping splurge come at the expense of spending in the New Year?

A stronger December 2009, therefore, could signal a weak start to 2010 and the recovery.

Well, the good profit results from the high street retailers was a strong sign of a healthy Chistmas.

Today, data on the public finances suggests the government got a big boost in VAT receipts - a sure sign that spending jumped in December 2009. As Barclays Capital write:

"On the revenue side, central government receipts were 1% y/y higher in December, well off the low of -22.3% y/y seen in March 2009 but still substantially below the growth of close to 4% that was typically seen prior to the financial crisis. Income tax receipts remain weak, down 8.4% y/y, but VAT receipts have recovered somewhat, rising by 4.4% y/y (the strongest growth since September 2008), giving further credence to the view that pre-Christmas spending was firm."

Next Tuesday we get the Q4 GDP numbers. My guess is that strong q4 growth (anything above 0.6% q-q) is likely to be a bad sign for the recovery. Weaker growth is likely to be a good thing.

Like any good economist, we're expecting 0.6% - so on the one hand...and on the other...

A jobless recovery...but a recovery nonetheless. 

The markets might be disappointed in today's jobs data from the US, but a look at the details and a little knowledge about previous recession suggests that the US recession ended in July or August of 2009 and that the labour market is on the mend.

If you look at previous US recessions, two sure signs that a recession is 'officially' over are the ISM new orders index above 55 for three consecutive months and the number of temporary workers on the rise. (Official dating of recessions is done by a group of academics months, sometimes years after the fact, so economists look for clues in current data.)

So the key stat in today's numbers are the temporary employee figures. They've been on the rise since July...the same time that manufacturing new orders started rose above 55 (on the ISM index) since late 2007.

That's not to say that the economy is going to bounce back strongly in 2010 or that the labour market in the States is going to add jobs at a steady clip. But it does suggest that companies are seeing a pick up in activity and are taking on temporary workers because they're uncertain if the orders will last.

The real question is when will businesses be confident enought to start taking on permanent staff rather than temps, how many permanent workers do they take on and how quickly?

That will determine the strength of the recovery.

The electoral cycle is complicating the economic cycle.

Markets, worried just as much as we are about how the UK economy will fare in what's set to be a stormy 2010, are also worried about the prospect of a hung parliament or a minority government.

Any new government will need to set a credible plan to address the perilous state of public finances. But a hung parliament or a minority government will find it very difficult to push through the necessary tough reforms.

If that happens, we're worried that businesses and consumers will become extremely cautious about investment and spending, weakening economy. And the markets are worried that a weak government and economy will mean the tough choices are pushed back, worsening an already decaying fiscal position.

That means that sterling is being buffeted about by investors second guessing the outcome of the election and the growing tension between the renminbi and the dollar. And a volatile exchange rate prevents manufacturers from taking advantage of export opportunities in growing markets, reinforcing business caution and the weak economy.

Consequently, bond holders are starting to shy away from UK government bonds...what happens when the Monetary Policy Committee decides to unwind its quantitative easing programme, but can't find any buyers for UK gilts? Prices will fall and interest rates will rise...undermining the economy.

The market's belief that the UK economy is risky is self-reinforcing, helping the UK economy get off to a rocky start to 2010.

So, yes, the election is about the economy, stupid. But the economy is very much about the election as well.

ps In case you were wondering, there's absolutely no snow in Westminster. Must be all the hot air.

Back at work and the newspapers are full of prognostications about 2010. What are we worried about?

• Monetary policy being tightened too quickly or too slowly.
• Public finance problems being tackled too quickly and the rising risk of sovereign default.
• Slow domestic growth and unsustainable global growth.
• The need to deleverage and the lack of adequate lending.
• Fixed exchange rates and volatile exchange rates.
• Labour market flexibility and a jobless recovery.

Throw in an uncertain election and 2010 should be just as maddening as 2009.

While 2009 might be behind us, the pain of the recession is likely to linger.

As 2009 ended, the UK was emerging from one of the longest and deepest recessions in post-war history.  In the six consecutive quarters of falling output since the early months of 2008, UK GDP had contracted by a total of nearly 6%.  And the downturn was synchronised across the world, knocking around 5% off GDP across the G7 and eurozone economies.

Financial markets, however pose the most significant risk.  The initial response to the crisis may have been a collaborative one, but the recovery will pull economies in different directions which could leave the global economy vulnerable to further shocks.  The timing and pace of tighter monetary policy and fiscal consolidation will also be central to global economic prospects.

Consumers were the driving force behind the UK economy for much of the past decade. A strong holiday shopping season could give way to austerity...but it all depends on whether consumers go back to business as usual or pay down debt and rebuild savings.  Credit constraints and a slow recovery in profitability are also likely to hold back business investment. 

The best prospects for growth look set to come from exports – supported by an upturn in world trade flows and a weak Sterling exchange rate.  That said, the global economic recovery has not fully taken root with the most acute risks remaining in the financial sector. 

An export-led upturn is, therefore, not assured.  Companies will therefore need to be agile in responding to what is likely to be a bumpy road out of recession over the next twelve months. 

It's a gloomy outlook for the start of the year, but hopefully the spring will bring warmer weather and a thaw in the economy.