But the real issue is tackling productivity, says David Absolon, investment director at Heartwood Investment Management
The UK’s general election campaign officially kicked off last week and it is no surprise that markets woke up to the ensuing political discourse: the UK equity market underperformed the major markets, losing 0.7%. The decline came in spite of relatively sanguine economic reports, including a modest upward revision to fourth quarter GDP, consumer confidence reaching its highest level for almost 13 years and solid manufacturing data.
Last week’s wobble is likely to be a foretaste of what’s to come over the next few weeks, given that we are heading into one of the most uncertain elections of modern times. With everything to play for, the political party rhetoric will get louder, more promises will be made and scare tactics will be deployed – all of which are likely to have a de-stabilising impact on market sentiment.
Needless to say, the economy is likely to override most other issues in this campaign, including the NHS and Europe. Both of the main parties agree to eliminate the structural budget deficit by 2017/18, but the routes to achieving this aim differ. The Conservatives aim to eliminate the deficit through 100% spending cuts, while Labour are looking towards a 50/50 mix of tax and spending cuts.
Whichever party wins in May, more austerity is coming in one shape or another. But what will be incumbent on any new ruling government is raising productivity growth. This is needed to lift wages and increase tax revenues in helping to reduce the budget deficit. The London School of Economics Centre for Economic Performance identified productivity growth as “probably the greatest challenge facing the UK economy”.
Indeed, last week it was announced that productivity growth fell by 0.2% in the fourth quarter of 2014 (quarter-on-quarter). Furthermore, it was little changed from year ago levels and slightly lower than in 2007. According to the Office of National Statistics, this seven-year absence of productivity growth “is unprecedented in the post-war period”. Meanwhile, labour unit labour costs (wages, pension contributions, bonuses and other benefits) increased by only 1% per annum over the last five years.
The Office of Budget Responsibility’s forecasts of productivity growth over the next five years at 1.8% appear overly-optimistic , considering that actual productivity has grown by a mere 0.5% a year since 2008. Increasing productivity requires higher investment across infra-structure, research and development and education. It also requires business-friendly taxation policies to encourage competition and innovation. Neither of the main parties fulfils all of these criteria, as the Conservatives fiscal plans leave less scope for public investment, while Labour errs on the side of interventionist policies.
Overcoming the productivity puzzle will require an ambitious governmental response; a difficult feat to achieve without a clear electoral outcome. Historically, UK markets have been pretty apathetic toward elections, but the distinct nature of this election could produce more jitters than we have become accustomed to. UK investors are preparing for uncertain times ahead.