Last updateFri, 24 Mar 2017 12pm


Budget 2017: why Brexit uncertainty will put bright economic outlook to the test

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By Costas Milas, Professor of Finance, and Mike Ellington, Research Associate in Finance, at the University of Liverpool

Philip Hammond has delivered his first budget since taking over the role of chancellor of the exchequer after the UK's Brexit vote put paid to his predecessor, George Osborne. He has unveiled a brighter outlook for economic growth, with an upgraded forecast for growth in 2017 from the Office for Budget Responsibility. He spoke of job creation and wage growth. And, with public finances in better shape than expected, he was also able to report lower borrowing forecasts than in his Autumn Statement.

But recent history shows us why we should not be so confident about all these healthy forecasts. A look at the recent history of economic forecasting makes the upgraded expectations of 2% growth in 2017 questionable. Then there's the fact that Brexit hasn't happened yet. With Article 50 soon to be triggered, the uncertainty that harms economies the most will only get worse in the months to come.

Deriving forecasts about the state of the UK economy and public finances is a huge challenge – in general – but especially now that we do not know how the UK's relationship with Europe will shape up following Brexit. Indeed, the ancient Greek scientist Thales of Miletus was one of the first experts to (implicitly) recognise the challenges of forecasting by noting that "the past is certain, the future obscure".

Reflecting the state of economic forecasting, the Bank of England's interest rate setter Jan Vlieghe recently informed MPs: "We are probably not going to forecast the next financial crisis, nor the next recession. Models are just not that good."

As astonishing as this statement might sound, Vlieghe knows exactly what he is talking about. Figure 1 (below) shows the inability of policymakers (the Bank of England's in this case) to forecast GDP growth two years into the future.


As the graph shows, policymakers' ability to predict UK GDP growth has been rather poor. This can be seen in the way the forecast moves in the opposite direction to the actual outcome.

Figure 1 makes two further worrying readings. First, UK policymakers have been overconfident in their predictions. The Bank of England has, on average, over-predicted annual GDP growth by a massive 1.52% over the past nine years. Second – and perhaps much more worryingly – the Bank's officials (and many other economists) completely missed the 2008-09 recession.

So what this tells us is that models are not good – at all – when they are needed the most. If this is indeed the case, what is the purpose of going through the somewhat futile exercise of presenting budget forecasts three to five (or even more) years into the future? Was this train of thought going through Phillip Hammond's mind when he announced that there will only be one, rather than two major budget statements a year?

Irrespective of what Hammond's thinking might have been, the health of the UK public finances critically depends on the country's economic performance. This is hard to pin down. Indeed, provisional (or real-time) published GDP data are often revised quite dramatically down the line. This is more the case in periods of increasing uncertainty – such as the recent financial crisis and (arguably) the present volatile economic climate following the recent Brexit vote.


Figure 2 (above) plots together provisional and revised estimates of annual GDP growth in the UK. The revised estimates reflect the latest belief of how the economy has performed based on the most recent information.

Although the correlation between provisional and revised GDP growth is quite high, a closer look at the data reveals the following:

1) During the 2008-2009 financial crisis, GDP fell earlier and more sharply than policymakers thought at the time.

2) Since 2015, provisional GDP growth data seems to be sending the rather misleading signal that the economy is doing better than it actually is.

This all has important implications for the UK's public finances. Policymakers use data available in real time to produce forecasts about GDP growth and public finances. These forecasts should always be taken with a pinch of salt because real-time data (which are subject to potentially large revisions) are used as inputs in any forecasting model. To make things worse, forecasts critically depend on the underlying forecasting model, which is unlikely to adequately capture all the time-varying, evolving features of what we want to forecast.

Even if we were to naively assume that provisional data remain unrevised and that we have an accurate forecasting model, economic uncertainty itself will challenge the economy. As Figure 3 shows, economic uncertainty takes its toll on annual investment growth, which in turn limits economic growth.

The inverse relationship between UK economic uncertainty and investment growth, 1950-2016. Estimates of the authors using ONS data. Economic uncertainty is measured by the 10-year rolling volatility of UK's long-term interest rate, CC BY-ND.

To keep buying UK debt, international investors will require a higher yield on UK bonds. This yield will also experience further ups and some downs as the UK goes through a potentially messy Brexit divorce. With economic uncertainty on the rise, UK investment will slow down. This will bring with it job losses and a reduction in public finances because of lower tax receipts and rising unemployment benefits.

The chancellor will no doubt be hoping that his plans to lower the UK's corporate tax rate to 19% in 2017 and 17% in 2020 will keep businesses happy. But the UK's existing corporate tax rate of 20% was already much lower than the 24% average for 34 OECD countries. It might be helpful for existing businesses and may even attract additional ones. But it will not be enough to counteract Brexit uncertainty. Business would definitely prefer assurances about a smooth divorce today rather than lower taxes in the future.

This article first appeared on The Conversation


What's new in the spring Budget?

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By Ben Barlow

Chancellor Philip Hammond has delivered his first Budget for 2017, saying his aim is to provide a stable platform for future Brexit negotiations, help young people gain the skills they need and improve education in the UK. Economic forecasts are for higher growth but Hammond told MPs that the Budget deficit was still too high and productivity lower than he wanted.

In his opening statement, Hammond began with some positive news that the UK economy was continuing to thrive, despite dismal forecasts last year. The Office for Budget Responsibility has predicted a 2% growth in 2017, which is 0.6% higher than its original forecast. The OBR also predicts borrowing will be £16.8 billion lower.


The Chancellor has made an extra £500 million available for technical and vocational education, which should go some way to closing the skills gap in the construction sector. Funding has been confirmed for 1,000 new PhD places and more free schools will be created, despite heavy criticism from the education sector on the benefits of investing in free schools. However, an announcement that the government will be committing money to the technical education sector has been welcomed.

Social Care Funding

The biggest announcement was the news that the Chancellor has earmarked an extra £2 billion to help alleviate the growing social care crisis in the UK. £2 billion will be made available over the next three years, with a further £1 billion in the kitty for the coming year.

Bad News for the Self-Employed

Self-employed people have a small tax increase to look forward to. Despite the Tory manifesto forbidding any Class 1 National Insurance increases, the Chancellor has managed to find a workaround by increasing Class 4 National Insurance rates instead. In a move that will upset self-employed voters, the Chancellor is increasing Class 4 NI from 9% to 10%, to close the gap between contributions made by employees and the self-employed. There will be an additional 1% rise in April 2019.

Business Rates Relief

Business rates have been in the news of late, so the Chancellor has included three measures in his Budget to cut business rates by £435 million, but only in certain sectors.

A £300 million discretionary fund will be given to councils to distribute to local businesses that are suffering from increase in business rates. Small businesses losing their small business rate relief will have their rates capped and pay no more than £50 extra per month. There is also extra help for pubs – 90% of pubs will receive a £1,000 business rates discount. However, this discount may not apply to companies that own several pubs.


Companies are also being targeted by the Chancellor, with tax-free dividends slashed from £5,000 to £2,000 from April next year.

Personal Tax Allowances

On a good note, the personal tax allowance will rise to £11,500 per year. Higher rate taxpayers will also enjoy a small increase in their personal allowances. The National Living Wage is also rising to £7.50/hour.

Reactions to Hammond's Budget have been mixed, ranging from "cautious" to "callous", depending on which media outlet you look at. How the electorate react remains to be seen, but no doubt they will make their feelings crystal clear when polling day comes back around.

Hammond bullish but OBR hints at stormier waters ahead

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Edward Hardy, economist at World First,  on today's budget

Today's budget certainly towed the line; Chancellor Philip Hammond's reforms were predictable – just as he intended. However, the announcements were less gimmicky than previous budgets and tied to the prime minister's agenda of social inclusion, pragmatism and future proofing of the economy.

This year's growth forecast has been upgraded but, crucially, longer-term growth expectations have either remained unchanged or been revised lower, suggesting the OBR believes recent economic strength is a front-loaded outlier, not a new normal. Other tax tweaks are to be net neutral in fiscal terms, despite Hammond quietly conceding that public spending will still be running £100bn higher as a direct result of the EU referendum result last year.

In today's Budget, the Chancellor was quick to provide relief for SME brick and mortar businesses from rising business rates but, in upcoming tax reforms, announced he is to begin targeting the online economy for the first time. The details of these policy changes will be released in due course, but a stiff increase in the tax burden on those selling online could be a major hindrance to the UK's booming ecommerce community. This is likely to be felt in the north of England in particular, which accounts for over 30% of the UK's online exports.

On the other hand, the budget clearly sees any digital taxation as justified given the investment this government will be making in technical skills, the domestic workforce and a revitalised and regenerated training system for all young adults. It therefore suggests that a tax loss now will result in a productivity gain in the future.

UK budget 2017: the experts respond


Philip Hammond has delivered his first budget as Britain's chancellor of the exchequer. Here panellists from The Conversation give their take on what it means for the UK economy.


Michael Kitson, University Senior Lecturer in International Macroeconomics, Cambridge Judge Business School

The chancellor delivered an upbeat assessment of the economy – upbeat but rose-tinted. The economy is currently being sustained by debt-driven consumption and a low exchange rate, and Hammond has done little to address the long-term challenges.

We were given another glimpse of the chancellor's actuarial tendencies as he repeated the favoured mantra of his predecessor that he will "not saddle our children with ever-increasing debts". However, what the country needs is an entrepreneurial chancellor who will invest to ensure our children inherit a prosperous economy.

On the plus side, Hammond has announced some modest investment in technical and vocational training with the introduction of T levels, combined with a hotchpotch of piecemeal initiatives to conceal the lack of a strategy. But there are important areas that were largely ignored. First, how is the economy going to develop robust trade links outside of the single market? Things may look rosy at the moment because of low exchange rate, but this is not sustainable.

Second, the British economy's long-term record on investment has been poor and is likely to deteriorate if overseas companies decide that the UK is a less attractive option outside the EU. Offering subsidies and other sweeteners is not a coherent industrial policy. Innovation is one of the key mainsprings for long-term growth, but this requires companies to invest in the UK and for the economy to be open to talent from all countries.

The rhetoric was strong and the jokes were feeble. What was required – and what was lacking – was a long-term plan on how to deal with the challenges ahead.

Simon Wren-Lewis, Professor of Economic Policy at the Blavatnik School of Government, Oxford University

What any macroeconomist should ask of this budget is: has the chancellor done enough to get UK interest rates off near-zero (known as the zero lower bound); to get us out of what economists call a liquidity trap? When interest rates have gone as low as the Bank of England feels able to take them, then it has lost control of the economy. That is the situation right now.

The only duty of the chancellor in that situation is to give the Bank of England back control through a fiscal stimulus – something he has not done. If he did do this, however, the short-term deficit and borrowing numbers that go with the stimulus would be completely irrelevant. Seeing as he hasn't done this, his budget has failed.

The performance of the economy since 2010 has been terrible. There has been no recovery, using the proper meaning of the word, from the Great Recession. All this time the Bank of England has been forced to keep interest rates at or near their floor, and use incredibly inefficient instruments like quantitative easing, because the government has kept on cutting spending. This is not normal and austerity is no longer even the international consensus.


Kevin Farnsworth, Reader in International Social Policy, University of York

The biggest surprise of this budget is that the most significant factor that affected it wasn't mentioned at all. Not only did the chancellor not mention Brexit, it is not immediately obvious how any of his announcements connect directly to it either.

I would have expected a boost to regional development or support for new businesses along the lines being called for by the car industry. Usually, an unexpected boost to the finances – borrowing is set to be £26 billion lower than previously predicted by the end of this parliament as a result of stronger than expected growth – would provide some scope for new policies. But it gave the chancellor little wriggle room today. This is in part because he wants to reduce borrowing in future. But it is probably more to do with the fact that he wants to give himself more flexibility as the government prepares for Brexit.

Help is provided for larger businesses – perhaps those most able to leave the UK if they don't get a good Brexit deal – by way of the further reduction in corporation tax (down to 17% by 2020). In ordinary times, this would be headline-grabbing – the UK already has one of the lowest rates of its competitors. But larger businesses may be disappointed that Hammond didn't go further. His predecessor, George Osborne, promised to bring corporation tax down to 15% in his budget following the Brexit vote.

So it's surprising that Brexit didn't really feature. We might have expected much more in the way of help, support and compensation for businesses considering their own futures once article 50 is triggered. My guess is that the chancellor is playing a waiting game, with one eye on the potential for greater borrowing to ease Brexit going forward. And such is the level of uncertainty in the future that what he did today amounts to the calm before the storm.


Geraint Johnes, Professor of Economics, Lancaster University

Productivity is very much at the heart of the budget, with specific projects being allocated funding from the £23 billion fund previously announced in the 2016 Autumn Statement. These include investment in STEM research, support for disruptive technologies, help with the high-speed broadband roll out and further transport projects to relieve local congestion.

But the main announcements made today concern the country's education and skills infrastructure. New funding will be made available to support the creation of 110 free schools. These will, controversially, include new selective schools and specialist maths schools. While it is widely recognised that students attending selective schools can benefit from the experience, average performance across all students in areas served by such schools is not enhanced.

The chancellor also announced a long overdue and welcome tidying up of vocational and technical qualifications, replacing more than 13,000 qualifications by some 15 new T levels. Here the devil will be in the detail – we know that the job market has been polarising and that routine jobs will face challenge from continued advances in automation. To prevent a situation where we train people to do jobs that robots will soon do, technical education will need to emphasise adaptability, a high level of creativity, and the ability to learn how to learn. Finally, a relatively small investment – but an important one – addresses the issue of lifelong learning. Hammond has announced £40m to be spent on pilot projects in this area.

Industrial strategy

Ian Greenwood, Associate Professor in Industrial Relations and Human Resource Management, University of Leeds

The government's plan for a "modern industrial strategy" requires clarity of vision, strong leadership and of course substantial investment. In his budget speech today, Hammond offered additional investment in intermediate skills, but – worryingly for UK industry – the extent that the government is ideologically committed to management of the economy is unclear.

Hammond adopted a schizophrenic attitude to state intervention – a corollary of any industry strategy. He attacked the Labour Party for its past intervention in the economy while seeming to accept that the market does not always work as a remedy to all ills.

The immediate and critical needs of the UK aerospace and automotive sectors, and the downstream foundation industries – such as steel – that support these sectors are manifest. They will drive innovation, R&D and good jobs, especially in the context of Brexit. It would not have been difficult to develop a narrative in today's announcement that the government understands this.

Is it significant that this was absent? The acquisition of Vauxhall by France's PSA Group has raised again the prospect of the auto industry exiting the UK. The upstream devastation that this would cause to the wider economy surely warranted a mention?

Pensions and savings

Jonquil Lowe, Senior Lecturer in Economics and Personal Finance, The Open University

The budget confirmed that reform of national insurance for the self-employed will go ahead from 2018. Class 4 national insurance contributions will be increased in stages over two years, taking the standard rate to 11% from its current level of 9% (compared with the 12% paid by employees). The original rationale for the lower rate for the self-employed was mainly that they were not entitled to the old additional state pension. With the introduction of the flat-rate state pension since April 2016, the self-employed now build up the state pension at the same rate as employees. The remaining 1% point gap compared with employees reflects the self-employed's lack of sick pay and contributory unemployment benefits, although the government has said it will consult on parental benefits for the self-employed.

There will also be measures to reduce the tax advantage for working through an owner-managed company, starting with a reduction in the Dividend Tax Allowance (only introduced in April 2016) from £5,000 to £2,000 from April 2018. This will also affect investors with large shareholdings (around £50,000 or more).

A new National Savings & Investments 3-year bond will be introduced from April. Offering 2.2% a year (taxable); it is among the best rates currently available. But, with inflation forecast to rise to 2.4% this year, competing returns may prove better.

Dividend tax

Michael Devereux, Professor of Business Taxation, University of Oxford

The "dividend tax exemption" of £5,000 was introduced only in the summer budget of 2015 and came into effect in April 2016. Now it has been reduced by to £2,000. It is hard to see much consistency there.

It seems that Hammond is concerned about the tax incentives for individuals and partnerships to incorporate – when they would be liable to corporation tax and income taxes on dividends – instead of income tax on the whole income.

The corporation tax rate is falling to 19% in 2017/8, which is much lower than income tax rates. Plus there is no national insurance on corporate profit. Taxes on dividends do generally remove the tax advantage to incorporation – and more so now. But that is only when profits are distributed; if you keep the profit in the company then you pay only corporation tax.

So why was the dividend tax exemption ever introduced? And why not just get rid of it entirely? Maybe that is for next year.

This is an edited article which first appeared on The Conversation.


Pension flexibilities: opportunities for final salary pension schemes

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Liam Mayne, Associate, corporate consulting at Barnett Waddingham

The decision to relax rules relating to the purchase of an annuity at retirement has revolutionised the defined contribution (DC) landscape. The measure has been popular with members – HMRC has estimated that since April 2015, around £9 billion of retirement savings has been accessed by over 500,000 members.

The measures do not extend directly to defined benefit (DB) members – however, it is now apparent that the second-order impact of these changes on DB schemes could be substantial indeed.

Previously, not much attention was typically paid to a member's statutory option to transfer their benefits to an alternative arrangement. Now, many non-pensioner members are exploring opportunities to transfer their final-salary benefits and avail of the flexibilities in a DC scheme.

Opportunities for sponsors – de-risking and cost reduction.

Around 60% of DB members in the UK are not yet retired – covering assets of approximately £800 billion; this highlights the potential for large transfers to occur from DB to DC in the future. 

This presents opportunities for sponsors to manage the financing of DB schemes. For each member transferring, the financial obligation and associated risk is removed. This will be expected to reduce cash funding, in effect, the prudent reserve which schemes must fund for is released. In addition, it will be cheaper than securing benefits with an insurance company, which is the end game for many schemes.

For those sponsors approaching this in a pro-active manner, liability management exercises are likely to include actions such as subsidising the cost of members' financial advice. However, the upshot for these companies would be a plausible scenario of 20% to 30% of non-pensioner members aged 55 and over transferring out.

Incentive exercises – potential pitfalls

In addition to technical matters such as the relationship between the scheme's funding and transfer bases, a key component of a successful strategy includes adequate member protection. A minority of historic cases have led to some reputational damage for incentive exercises – however, such projects are now subject to a voluntary but universally-adopted code of practice supported by the industry.
It is also necessary for companies to involvei independent financial advisers (IFAs) to represent members' interests – indeed, new legislation compels companies to pay the cost of financial advice if the company is incentivising members to take a transfer.

Maximising the opportunities

Taking advantage of the pension flexibilities regime represents one of a number of tools available to companies. Ideally, it will form part of a wider strategic framework that is scheme-specific - for example, a transfer incentive exercise is unlikely to be optimal for a mature scheme with a small proportion of non-pensioners. We recommend a collaborative approach with scheme trustees. This will facilitate better understanding of any potential roadblocks e.g. quality issues with member data.

The appropriate use of IFAs presents an important line of defence for members – we recommend adequate due diligence is performed to understand processes, capacity and preferences. We believe in keeping the big picture in mind at all times - if done in a sensible way, companies can reduce costs and better control their risks.

Meeting members' needs in the longer term

The long-term success of incentive exercises will depend on protecting members from poor decision-making. The prevalence of pension scams and the tendency for individuals to underestimate their own life expectancy means there are significant risks to negotiate.
Here employers can play a leading role in providing access to financial education programmes. It is crucial this is done before individuals leave the workforce – it is much more difficult to engage after this point.

Good outcomes will require good quality advice – in a positive step, the government has recently announced an increase in the tax relief available for employer-led advice whilst also setting out plans for members to be able to fund advice from their pension pots on a tax-free basis.



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