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 destabilising 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 per cent 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 per cent 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 one per cent 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 per cent appear overly-optimistic , considering that actual productivity has grown by a mere 0.5 per cent 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.
David Absolon, investment director at Heartwood Investment Management.