After a tumultuous year the UK finds itself facing a very different 2017. James Sproule looks back on last year forecasts and makes a 2017 forecast for UK business
Each December we cast our minds forward to see if we can identify some trends or events for the next year, as well as making a few predictions of events that we view as likely, if not in the coming year, at some point in the next few.
First things first: we did not forecast the event of the year, nay decade – Brexit – although we did have the sense to see that the vote was going to be sufficiently close that aligning ourselves with any particular camp during the campaign would be a mistake. Our view was that we were going to have to work with the results come what may. That said, clearly Brexit is a decision with considerable ramifications for our predictions for this coming year.
So how did we fare in 2016? Not quite as well as 2015, where we gave ourselves a score of 80 per cent. Conservatively, this year we think we were right in three of our five predictions, giving us a score of 60 per cent. Our longer-term forecasts are once again yet to come to pass, but we maintain that they remain valid concerns for the future, and we have added a couple of new ones to the list.
The predictions for our 2017 forecast have to meet what is known as the 40/70 rule. We had at least 40 per cent of the information necessary to make a forecast based on some objective information, but not more than 70 per cent, above which matters move from providing perceptive insight to something approaching a foregone conclusion.
In setting out our predictions, we kept a number of factors in mind:
• Predictions should range across a wide number of areas
• They should look to both the immediate future and longer term
• Wishful thinking should be avoided
• Reversion to mean is a strong driver of trends
• Consumers and businesses are ultimately self-interested
Moreover, we tried in every case to answer the alternate wording of the question as well. So if we predicted wages were set to rise, say, what did we think of the idea that wages would not rise? This is a useful check when making any sort of prediction and one we have employed for the 2017 forecast as well.
Our 2016 predictions
• UK interest rates will finally rise
Clearly we got this one wrong. Not only were rates not raised, they were cut from the already extraordinarily low rate of 0.5 per cent to 0.25 per cent following the Brexit vote. The IoD has maintained its advocacy of higher rates throughout the year, pausing briefly in the aftermath of the referendum.
The reduction in rates that followed the vote was not, in our view, necessary – although other Bank of England actions, such as standing by to supply emergency liquidity, were entirely correct – nor as some have claimed, was the quarter-point reduction the reason the economy has not fallen into recession.
Critically for businesses, the premium they pay above base rates (the spread) has continued to decline. This is undoubtedly due to commercial and competitive pressures among lenders, rather than a reflection of lower overall risk inherent in UK businesses.
Our contention a year ago was that there was a danger ultra-low rates were contributing to capital misallocation, something that, a year on, we believe has become steadily more apparent. Overall, we were wrong in our prediction, but we still wish, for the good of the UK economy, that it would come true.
• UK corporate profits are near their peak
A half tick on this one. Profits of UK corporates did indeed reach an all-time high of 13 per cent net rate of return on capital in Q3 of 2014, and they have declined slightly since then to around 12.2 per cent. We asked ourselves two questions: could recent trends be sustained? Are we likely to see a mean reversion?
We believed very low inflation has removed pricing power from companies while ultra-low interest rates have promoted misallocation of credit, as larger businesses which can borrow have levered themselves, while smaller businesses have not been able to gain a similar advantage.
We continue to stand by both of these assertions and we believe that any interest rate rise will make borrowing less attractive, and as a consequence corporate returns are likely to continue to drift down as the year progresses.
• UK productivity is set to improve
UK productivity has in fact improved in 2016, albeit slowly, so we give ourselves another half tick here. Whether these improvements are noise within an overall still stagnant trend, dragged down by a reluctance to invest, or signs of a revival, has yet to be determined.
At least a part of our forecast was due to reversion to trend including a revival of investment, but a bigger part was our belief that employment had peaked and rising unemployment often coincides with better productivity.
That productivity picked up as employment continued to grow is therefore particularly positive. We stand by our report of 2014 in which we concluded that business agility matters more than productivity, particularly in light of the rising number of opportunities in both the intellectual and information revolutions.
• Talent wars are going to intensify
Again, a tick on this one. To our surprise, UK employment prospects continued to improve through 2016. Digging into the figures, however, much of this increase was in lower-skilled occupations such as administration and construction.
More importantly we have seen inflation in professional services and highly skilled occupations running some two to three per cent above inflation, pointing to a reasonably tight war for talent. Looking to the coming few years, immigration is one of our key Brexit policy concerns.
The more there is a clampdown on immigration, the more that business will have difficulty finding the people it needs to expand and thrive. Even if the government proclaims that it is only going to restrict less skilled migration, the danger remains that potential immigrants hear a more negative message.
• The southern eurozone remains mired in recession
Regrettably, we were correct here, and for the reasons we stated. Access to credit remains a key component of any successful economy. The domestic deposit base that fled southern European banks in 2008, fearing withdrawal from the euro and a subsequent devaluation, shows no sign of returning.
Indeed years of slow, or no, growth in places such as Italy are steadily increasing the stock of non-performing loans, leaving the health of banks across Mediterranean Europe ever more in doubt. A short-term solution looks as difficult as ever, but there is the potential to make a bad situation much worse in the long term.
This would arise if, as a result of Brexit, corporates in the EU who were having difficulty accessing bank lending were also cut off from London capital markets funding.
Our 2017 forecast
• 2017 forecast: Theresa May will trigger article 50 in 2017
Despite the legal judgment that parliament gets its say on triggering article 50, we believe Brexit will still mean Brexit. The judges’ ruling does, however, add a note of uncertainty to the timetable. Before the court decision ministers themselves had rated the chances of a March 2017 triggering at 60 per cent.
This now looks optimistic. There are still hold-outs who predict (or pray) that Brexit will never come to pass, but that is not our expectation. We have three central scenarios as to what form it might take: ‘quick’ (revert to WTO rules), ‘easy’ (accepting an EEA-type agreement); or ‘effective’ (a bespoke free-trade agreement between the UK and EU).
How any of these scenarios will play out in light of parliamentary legislation and amendments, not all of which will be designed to be helpful, is an open question.
• 2017 forecast: UK tax revenues will continue to disappoint
The Treasury view is that a given amount of economic activity will usually generate a predictable amount of tax revenue. However, for the past few years, the tax yield has been falling short of expectations.
In 2015–16, Inland Revenue raised an all-time high of £682bn, and the budget forecast was for revenue to rise by 4.6 per cent per annum over the next five years.
Essentially for tax yields over time to revert to mean. Our view is that this remains highly unlikely and that while tax collected may well rise as part of general economic expansion, individuals and businesses have adjusted their behaviour permanently to avoid tax. Our forecast is for yields, on steady tax rates, to lag overall economic growth.
• 2017 forecast: populist revolts are far from over
Since the credit crisis of 2008 there has been a growing political unease. At first there was simply the rise of alternative political parties, often as not with strong anti-business agendas.
More recently voters have been responding to anti-establishment movements, from Greece’s Syriza to the No vote in Italy to the UK’s European referendum to Donald Trump’s US presidential victory.
The next 12 months are going to see a presidential election in France and general elections in the Netherlands and Germany.Our 2017 forecast is that the likelihood of at least one of these throwing up a significant surprise is, we believe, high.
For business the challenge is going to be that many of the politicians behind this trend are at best ambivalent about the value of businesses, and think they can regulate and direct desirable outcomes.
We at the IoD have long campaigned and lobbied for the belief that business is a force for good in society and that, in today’s ever-more complex world, regulation will be less effective than hoped, while the unintended consequences are likely to be greater than expected.
• 2017 forecast: significant cyber-attack will bring down a company
Our Policy Voice survey last year revealed that most businesses that have fallen victim to cyber attack do not report it to any authority. Little information is generally published about any attack and so far those companies that have suffered have generally managed to quietly contain the damage.
Such a tactic may be a tempting course for an individual company, but the 2017 forecast is that the pace of increase in cyber attacks means more such attacks will become apparent.
These will range from the state-sponsored – Sony was seemingly punished for offending the leadership of North Korea – through to the rogue – TalkTalk was hacked in a straightforward case of blackmail that earned the blackmailers nothing but cost the company an estimated £60m.
Meanwhile, marital infidelity facilitator, Ashley Madison, a company which should have had client discretion at the heart of its business plan, simply folded following security failings.
For the broader business community, there is a new risk to assess: your business should ask itself not only if its own cyber-security systems are sufficiently robust, but also whether those of its clients and suppliers can be trusted.
• 2017 forecast: European banks are in serious trouble
Much of our prediction that southern Europe would remain mired in recession was based on the ongoing difficulties faced by their banks: local capital flight has left southern EU banks unable to lend.
Given local businesses’ dependence on bank loans, this situation makes any kind of economic growth very difficult. Adding to these woes has been the broader desire across the eurozone for banks to deleverage, ie to shrink their balance sheets and diminish the risk of their being too big to fail.
Banks have achieved much of this deleveraging by curtailing cross-border lending, a development which means that paradoxically deleveraging has geographically concentrated, and thus raised, remaining risks.
Combine this with bank lending against financial models that will have assumed modest macro-economic growth and you have the makings of a fresh financial crisis. Our only question for the 2017 forecast is how much of this will become apparent this year.
Beyond the 2017 forecast
Last year we made these long-term predictions: social media will drive public sector reform, as people make more informed choices; fiscal consolidation will raise questions over priorities, as slow growth in government spending leads to doubts about budget ringfencing, particularly pensions; a failed developed nation, an Argentina for the 21st century, will emerge – Greece is not the only one in peril; government debt ceases to be risk free, as many European states are now so over-extended some form of debt repudiation will be attractive to populists. We stand by these and add the following:
• London will remain Europe’s financial centre
Other cities and countries may think they desperately want to become a rival financial centre because of the potential tax revenues, but when it comes to the crunch are they willing to pay the wider political price?
It is not just the advantage of the English language, although that is important. Contracts are written in English law as it is seen as being particularly amenable to commerce (necessitating a pool of English lawyers). UK employment law is undoubtedly more amenable to the rapid hiring and shedding of labour, an approach that banks have traditionally taken.
More generally there is widespread appreciation that corporation tax rates need to be competitive, but so too do marginal rates of personal tax. Lowering these to attract bankers would, for many countries, be controversial to say the least. Finally, accountancy rules need to be drafted to inform outside investors; progress is being made, but more is needed.
It may be that certain bank operations grow more rapidly in the eurozone in the coming years, particularly where the issuer wishes to see eurozone financial centres favoured (sovereign bond issuance for example). But London and the EU need each other. Hopefully political leaders will realise this in the coming years.
• There is a risk of hyper-migration
The refugee crisis has died down this year with numbers running at one-third of the million-plus level seen in 2015. The 2017 forecast from military intelligence, however, suggests that there is still a large body of people who could easily be tempted to migrate across the Mediterranean to Europe.
For business the implications are fourfold. The cost of effectively handling this mass movement is likely to overwhelm existing arrangements. Many governments will be tempted to bring in more restrictions on non-EU migrants, to the detriment of business.
Mishandling a future migration crisis could yet see a government fall. Finally, countering refugees can easily disrupt the free flow of goods as immigration officials battle people smuggling.