Economic performance is lagging
The Ernst & Young ITEM Club Summer forecast released on Monday reveals that the apparent strong export performance of the UK is largely the result of VAT fraud.
In reality, the poor performance of British manufacturers is preventing the national economy from rebalancing and is piling pressure on the already overextended consumer and government sectors.
The ITEM Club is predicting that export growth for 2006 will be more than 15%. However, once you allow for Missing Trader VAT fraud (MTIC) the headline figures look much more modest and stand closer to 9 per cent.
MTIC is a problem throughout the EU. Fraudsters register for VAT in order to obtain EU goods or services from other EU member states free of VAT. They then sell the goods with VAT included but do not pass the VAT onto the authorities.
By the time the authorities catch up with them, they have disappeared.
Sometimes the goods are then exported, and the exporter claims back VAT which has in fact never been paid.
In the UK, the fraud is estimated to cost the government GBP 10 bln in revenue each year.
Labour costs a problem
The overall forecast by ITEM Club Summer shows that over the last decade there has been a considerable improvement in UK manufacturing productivity growth – beyond that of the UK’s largest European competitors.
However, simultaneously there has been an even larger increase in domestic labour costs, leading to the UK persistently losing export market share in Europe and elsewhere.
Professor Peter Spencer, chief economic advisor to the Ernst & Young ITEM Club says, “Although France and Germany have made only modest productivity gains since 1997 labour costs in both countries have remained virtually static because of relatively high unemployment. As a result, they are doing much better in export markets than we are.”
The United States has also faced ballooning labour costs in the last ten years, mainly because of increases in the cost of health and social insurance schemes, but because of the massive gains in productivity, driven principally by innovative technological change, the effects are felt less acutely than in the UK.
ITEM says that the UK has just had ‘seven years of plenty’, based on heavy spending by the consumer and the government. Now these sectors are over-borrowed and can no longer take the lead in driving the economy forward. This leaves medium term GDP growth critically dependent upon exports, investment and ultimately the strength of the world economy.
The forecast export growth of 9% excluding Missing Trader VAT fraud (MTIC) still shows a significant improvement over the last two years.
However, Spencer comments, “It appears that the recent revival in UK exports largely reflects the activities of fraudsters rather than genuine business. When seen against the background of the boom in world markets, it’s actually very disappointing.”
Until UK manufacturers manage to break out of the vicious circle of low profitability, low investment and a lack of cost control the medium term prospects for exports remain poor.”
On a slow boat to China
The UK’s relatively poor export performance is revealed most clearly in an analysis of its trade with China. The UK began slowly in its attempts to break into the mainland Chinese market and is still lagging behind its competitors. By comparison French exports to the People’s Republic of China (PRC) in the first half of 2006 were up by 60 per cent.
A key reason for the UK’s limited impact on the Chinese market is that the UK is a big exporter of financial services, which the PRC does not yet import to any great extent.
However nearly two thirds of the UK’s exports still come from the manufacturing sector and whilst the UK does export machinery, as well as intermediate and finished goods, which the Chinese do import heavily, the UK continues to punch below its weight.
Spencer explains, “The fact is that German and Japanese capital goods manufacturers have been much more successful in selling into the Chinese investment boom than we have. Although our exports to the PRC have been growing, we still only exported $5.5 billion worth of goods and services in 2005, about a fifth as much as Germany.”
Although ITEM does not mention it in the press release, one has to question whether the UK’s use of a marginal currency in global terms is a negative factor which raises transaction and currency hedging costs for traders.
ITEM is forecasting UK output should grow by 2.5% this year with growth next year edging down from 2.6% to 2.5%, while that for 2008 is down from 3.0% to 2.8%. The base rate will remain at 4.5% as CPI inflation eases back from June’s 2.5% to 1.8% by the end of next year.
ITEM concurs with this relatively benign economic outlook but warns of a number of scenarios that could expose some of the inherent weaknesses at the heart of the economy.
Peter Spencer concludes, “The UK economy is failing to exploit the current excellent global economic conditions and remains overexposed to any fault line that could develop. With Brent Crude closing on $80 a barrel, the hurricane season beginning shortly in the Caribbean, the US housing market looking ready for a crash and the recent decline in Japanese consumer confidence, the Chancellor can’t pack his bucket and spade and head to the beach quite yet.”
