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Economic Review, July 2014

Released: 02 July 2014 Download PDF

Abstract

The key economic stories from National Statistics produced over the latest month, painting a coherent picture of the UK economic performance using recent economic data.

Key Points

  • The Quarterly National Accounts indicated that the UK economy grew at an unrevised rate of 0.8% in the first quarter of 2014. Gross Domestic Product (GDP) was around 3.0% higher in the first three months of 2014 than in the same period a year ago.

  • While household expenditure has supported the growth of GDP since the end of 2009, investment has made a more substantial contribution in recent quarters, largely as a consequence of stronger investment in dwellings and buildings & other structures.

  • Average UK house prices in April 2014 were around 6.5% above their pre-downturn peak, although much of this increase is concentrated in London. However, despite this recent rise, households continued to deleverage in Q1 2014. The stock of long term loans as a percentage of gross households’ disposable income has fallen from 133% in 2008 to 118% at the start of 2014.

  • The UK has run a persistent trade deficit with the European Union (EU) in recent years, offset by a small but increasing trade surplus with non-EU nations. This edition of the Review finds that trade in goods with the EU is more important for the production of pharmaceuticals, transport equipment and machinery & equipment than for other types of good.

  • New estimates of the capital stock provide some evidence that firms have been replacing capital with additional labour input, possibly helping to explain some of the recent weakness of UK labour productivity. In the decade prior to the economic downturn, output per hour growth was strongest in those industries that increased their capital stock per unit of labour input. Recent low investment appears to have contributed to lower net capital stocks per hour worked in a majority of industries.

  • A range of far reaching changes to methods and data sources will be introduced to the National Accounts in September. Articles which detail these changes and give some indication of their impact have been published to give users advance notice of likely revisions.

Introduction

The Quarterly National Accounts indicated that the UK economy grew by 0.8% in the first quarter of 2014, unrevised from the estimate published on 22 May 2014. Annual growth of Gross Domestic Product (GDP) (3.0%) was at its highest rate since the onset of the economic downturn, and was supported by a combination of stronger household expenditure and investment.

Against this backdrop, this edition of the ONS Economic Review addresses three issues at the centre of the economic debate in the UK. Firstly, following action by the Bank of England’s Financial Policy Committee to limit the supply of high loan-to-income ratio mortgages, the Review examines how the stock of long- and short-term household debt has evolved. Following a period of deleveraging, this edition of the Economic Review assesses the gearing of households, and finds that both the stock of loans and the cost of servicing that debt are substantially lower as a fraction of gross households’ disposable income than the pre-downturn peak.

Secondly, this edition of the Review examines the importance of the European Union (EU) to the UK’s current account position. This Review analyses the extent of UK trade with the EU and examines the composition of the UK’s trade in goods with the EU and the rest of the world. It assesses the importance of the EU for the UK’s balances on income and current transfers, and finds that the nature of UK trade with the EU varies substantially from its trade with other nations.

Finally, following debate over the nature and causes of the recent weakness in productivity, this edition of the Economic Review analyses the impact of recent changes in the capital stock on output per hour growth in the UK. In the decade prior to the economic downturn, output per hour growth was strongest in those industries that increased their capital stock per unit of labour input. However, recent low investment appears to have contributed to lower capital per hour worked in a majority of industries, possibly helping to explain the weakness of labour productivity over this period.

Quarterly National Accounts

The Quarterly National Accounts indicated that the UK economy grew by 0.8% in the first quarter of 2014, unrevised from the estimate published on 22 May 2014. Gross Domestic Product (GDP) was 3.0% higher than the same period a year ago in Q1 2014 – the highest annual rate of growth since 2007. The UK economy has now grown for five consecutive quarters: the longest run of sustained output growth since the onset of the economic downturn in 2008.

The sustained nature of the economic recovery since the end of 2012 means that GDP is now estimated to have recovered almost all of the output lost during the economic downturn. Figure 1 shows the path of UK GDP indexed to its pre-downturn peak. It shows that following a period of relatively erratic output growth between 2010 and 2012, UK GDP started to grow more consistently from the end of 2012. As a result, output in Q1 2014 was just 0.6% below the pre-downturn peak.

Figure 1: Gross Domestic Product (GDP) and GDP per head, Q1 2008=100, constant prices, seasonally adjusted

Figure 1: Gross Domestic Product (GDP) and GDP per head, Q1 2008=100, constant prices, seasonally adjusted
Source: Office for National Statistics

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However, Figure 1 also highlights the path of GDP per head – an indicator of output that controls for changes in the size of the population. On this measure, the UK economy has also grown more quickly in recent quarters, albeit from a lower starting point. GDP per head has recovered relatively slowly since 2009 and was 5.6% below its pre-downturn level in Q1 2014, at around the level first achieved in mid-2005.

While much of the growth since the end of the economic downturn has been as a result of growing household expenditure, investment growth has made a more substantial contribution in recent quarters. Table 1 shows the contributions of households, government, investment and trade to the growth of total expenditure since 2012. Household expenditure – which added 0.9 and 1.3 percentage points to GDP growth in 2012 and 2013 respectively – added 1.4 percentage points to annual GDP growth in the first three months of 2014, continuing a run of consistently strong growth. By contrast, gross capital formation (GCF) reduced GDP growth by 0.1 percentage points in 2012 and added just 0.2 percentage points during 2013. However, gross capital formation appears to have started to recover during the second half of 2013. Following contributions to annual GDP growth of 1.0 and 0.9 percentage points in Q3 and Q4 2013 respectively, investment added 1.4 percentage points to annual growth in Q1 2014: a similar contribution to that of household expenditure over the same period.

Table 1: Contributions to annual growth in the expenditure measure of GDP, constant prices, seasonally adjusted

Percentage Points Contributions
2012 2013 2013 2013 2013 2013 2014
      Q1 Q2 Q3 Q4 Q1
Household Exp. 0.9 1.3 1.3 1.2 1.5 1.3 1.4
NPISH Exp. 0.0 0.1 0.1 0.1 0.1 0.1 0.0
General Gov. Exp. 0.4 0.2 -0.4 0.3 0.4 0.3 0.4
Gross Capital Form. -0.1 0.2 -0.2 -0.7 1.0 0.9 1.4
Exports 0.5 0.2 0.0 1.2 -0.6 0.0 0.2
Less Imports -1.1 -0.1 0.2 -0.2 -0.4 0.1 -0.3
Net Trade -0.5 0.1 0.3 1.1 -1.0 0.1 -0.1
GDP 0.3 1.7 0.7 1.8 1.8 2.7 3.0

Table source: Office for National Statistics

Table notes:

  1. Figures may not sum due to rounding. Note that because of the statistical discrepancy, which aligns the three measures of GDP, the growth of the expenditure components will not sum to GDP growth between 2012 and 2014.

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This recovery of investment – albeit from a low base – has been driven by a combination of stronger business investment and investment in dwellings. Business investment – comprising all non-government investment excluding dwellings and transfer costs – grew by 10.6% in the year to Q1 2014 and has now expanded for five consecutive quarters: the longest run of business investment growth since the onset of the economic downturn.

Figure 2 analyses this recent growth by decomposing the growth of investment into broad asset classes. While estimates of investment can be volatile, Figure 2 suggests that much of the recent recovery is due to stronger investment in both dwellings and buildings & other structures. Taken together, these two assets added around 1.5 and 5.1 percentage points to the annual growth of gross fixed capital formation (GFCF) in Q3 and Q4 2013, before adding 7.2 percentage points in Q1 2014. While both series remain well-below their pre-downturn levels, their contribution appears to have accelerated smoothly in recent quarters.

Figure 2: Contributions to the growth of Gross Fixed Capital Formation (GFCF) quarter on same quarter a year ago by asset, percentage points, constant prices, seasonally adjusted

Figure 2: Contributions to the growth of Gross Fixed Capital Formation (GFCF) quarter on same quarter a year ago by asset, percentage points, constant prices, seasonally adjusted
Source: Office for National Statistics

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House prices, household debt and interest payments

The recent growth of investment in dwellings is one feature of the recovery in the housing market that has accompanied the broader strengthening of economic conditions in recent quarters. Stronger investment in dwellings has come alongside growth in residential construction output and relatively large increases in house prices, raising questions about the extent to which the economic recovery is dependent on the UK property market. Figure 3 shows the recent evolution of UK house prices relative to their pre-downturn peak. It suggests that in April 2014, average UK house prices were 6.5% above their January 2008 level. However, Figure 3 also shows that the property market in London has had a significant effect on the UK average. In London, house prices in April were 31.6% above their pre-downturn level. In the rest of the UK, house prices were 0.2% below their January 2008 level.

Figure 3: House prices in the UK: January 2008=100

Figure 3: House prices in the UK: January 2008=100
Source: Office for National Statistics

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The recent growth of house prices – in London in particular – is one factor that has raised concerns about the possibility of a ‘bubble’ developing in the property market. Recent ONS analysis suggests that the ratio of house prices to the incomes of mortgage applicants is above the long term average and particularly high in London, the South East, South West and Eastern regions [Economic Review - June 2014], while the Bank of England has identified recent house price increases as a potential threat to the UK’s financial stability. Against this backdrop, the Financial Policy Committee of the Bank of England has recently announced measures to limit the availability of mortgages where the value of the loan represents a relatively large multiple of the applicant’s income, and parallel changes have been introduced to limit the availability of these types of loans through the Government’s ‘Help to Buy’ scheme.

Both of these measures are designed to make it more difficult for households to take on greater quantities of housing-related debt, and therefore make them less vulnerable to future increases in interest rates. Figure 4 shows how the outstanding stocks of short- and long-term loans taken out by households have changed as a proportion of gross households’ disposable income (GHDI) since the late 1980s. It shows that while households gradually reduced their exposure to both long-term (mainly mortgages) and short-term (mostly unsecured) loans during the 1990s (a process known as ‘deleveraging’), this process reversed during the 2000s, as households took on more mortgage related liabilities in particular. Between 1998 and mid-2008, long terms loans increased in value from around 78% of annual GHDI to around 133%.

Figure 4: Stocks of short- and long-term loans as a percentage of rolling four-quarter gross households’ disposable income, current prices

Figure 4: Stocks of short- and long-term loans as a percentage of rolling four-quarter gross households’ disposable income, current prices
Source: Office for National Statistics

Notes:

  1. The denominator – gross households’ disposable income – is calculated on a rolling four quarter average basis. For instance, the stock of loans in Q1 2014 is divided by the sum of gross households’ disposable income between Q2 2013 and Q1 2014.

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Figure 4 also highlights that households have taken measures to reduce their exposure to debt since the onset of the economic downturn in 2008, in a renewed period of deleveraging. Since 2008, the ratios of long- and short-term debt to GHDI have fallen from around 133% to 118% and from around 24% to just under 16% respectively. The reduction of short-term debt is marked – and is now close to its level in 1997. By contrast, households’ stock of long-term liabilities remains elevated, and the pace of deleveraging appears to have slowed marginally in recent quarters.

While the stock of debt offers a picture of the extent to which household balance sheets are stretched (‘leverage’), it is the level of interest payments each period that is a prime determinant of whether that debt is sustainable (‘gearing’). Households who find interest payments absorbing a greater share of their income are more vulnerable to income or expenditure shocks: the larger the fraction of households in this position, the more vulnerable the economy as a whole.

Figure 5 gives some indication of households’ gearing by expressing net interest payments (interest paid on loans less interest received on deposits) as a fraction of GHDI. It suggests that the cost of servicing household net debt increased sharply between 1997 and 2008, rising from 2.3% to 6.3% of GHDI, reflecting both the enlarged stock of debt and higher interest rates. Between 2008 and mid-2012, interest payments fell as a fraction of GHDI – reflecting both deleveraging in the household sector and the pass through of historically low interest rates.

Figure 5: Net (unadjusted) interest paid as a percentage of gross households' disposable income, current prices, seasonally adjusted

Figure 5: Net (unadjusted) interest paid as a percentage of gross households' disposable income, current prices, seasonally adjusted
Source: Office for National Statistics

Notes:

  1. The numerator in this calculation is net interest payments, not including the National Accounts adjustment for Financial Services Indirectly Measured (FISIM). The denominator is gross households’ disposable income. Both measures used to calculate net interest payments as a fraction of gross households’ disposable income are both published in the UK Economic Accounts. Shaded bars indicate recent economic downturns.

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In recent quarters, however, net interest payments have partially reversed this decline: rising by around 0.3 percentage points since late 2012 to 3.9% in Q1 2014. On closer examination, this recent rise is a result of broadly stable household payments of interest, and a fall in the value of interest receipts on households’ deposits. This reflects recent Bank of England data on the effective interest rates paid and received by households, shown in Figure 6. It suggests that while the interest rates both paid and received by households have fallen since mid-2012, deposit rates have fallen relatively more sharply, resulting in an increase in net interest payments.

Figure 6: Effective interest rates received and paid by households, % and index numbers, (2012=100)

Figure 6: Effective interest rates received and paid by households, % and index numbers, (2012=100)

Notes:

  1. Source: Bank of England

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Trade and the European Union

The recent strength of household spending and the growth of investment contrasts relatively sharply with the subdued and oscillating contribution that net trade has made to GDP growth in recent periods. In the year to Q1 2014, export volume growth of 0.5% was offset by import volume growth of 0.9%, resulting in net trade reducing annual GDP growth by 0.1 percentage points. While the recent appreciation of Sterling – which increased by around 10.9% on a trade-weighted basis between March 2013 and June 2014 – may have weighed on this contribution, net trade has been unusually weak in recent years, especially given the substantial depreciation of the exchange rate between 2007 and 2009 [Explanations beyond exchange rates - trends in the UK since 2007].

The importance of trade to the UK economy has come under greater scrutiny in recent times – both as a consequence of the UK’s substantial current account deficit and as a result of debate over the nature of the UK’s relationship with the European Union (EU). Figure 7 examines the relative importance of the EU for the UK’s international trade by summarising cross-border flows of goods and services between the UK and EU and non-EU nations as proportions of nominal GDP. Figure 7 indicates that the magnitude of UK trade in goods and services with the EU is broadly similar to its trade with the rest of the world, as indicated by the comparable height of the EU and non-EU bars. In Q1 2014, exports to the EU (non-EU) accounted for 12.7% (17.0%) of UK GDP, while imports from the EU (non-EU) accounted for 16.0% (14.9%) of UK GDP. These data indicate that the EU market is almost as important for UK exports as nations in the rest of the world, and accounts for a slightly larger fraction of imports than all other nations outside of the trading bloc.

Figure 7: UK exports, imports and trade balance to EU & Non-EU countries as a percentage of nominal GDP

Figure 7: UK exports, imports and trade balance to EU & Non-EU countries as a percentage of nominal GDP
Source: Office for National Statistics

Notes:

  1. The left hand panel shows exports (imports) to (from) the European Union as a fraction of nominal GDP. The right hand panel shows exports (imports) to (from) non-EU nations as a fraction of nominal GDP. Imports are shown as negatives. Balances from both are calculated as exports less imports.

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Secondly, while the UK has run a persistent trade deficit with the EU of an average 2.4% of GDP between 2007 and 2014, it has run a small, but rising balance of trade surplus with the rest of the world, of around 0.4% of GDP on average over the same period. The UK’s trade deficit with the EU reflects a small surplus on trade in services (the UK exports more services to the EU than it imports from the EU), and a deficit on trade in goods (the UK exports fewer goods to the EU than it imports from the EU). By contrast, the UK’s trading relationship with the rest of the world is more balanced: reflecting both stronger goods and services balances. 

While the EU is clearly important as a market for UK exports and as a source of imports, this importance is amplified for particular types of production. Figure 8 examines which goods are particularly dependent on international trade and on trade with the EU in particular. Panel 8A begins this analysis by showing how the production of different types of goods is affected by total trade. To the right of the vertical axis, the bars indicate the fraction of UK production that is exported. Production that is more export orientated – including pharmaceuticals, machinery & equipment and transport equipment – have larger bars, as a higher proportion of UK production is exported. To the left of the axis, the bars indicate the fraction of UK supply that is imported. Goods that have a higher degree of import penetration – including machinery & equipment, mining & quarrying and computer & electronic products – have larger bars, as imports account for a higher fraction of total supply. Finally, the points indicate the total trade balance as a fraction of the total supply of each product.

Taken together, the series in Panel 8A suggest that the importance of trade varies widely across different types of UK production. Export demand accounts for a much larger proportion of machinery & equipment (47%), pharmaceuticals (47%) and transport equipment production (36%) than for wood & paper (6%), agricultural (7%) and food products (9%). Equally, Panel 8A suggests that import penetration is much larger for mining (52%) and computer & electronic products (49%) than for wood & paper (21%) and food products (16%). Panel 8A clearly indicates that the importance of trade differs for different types of UK production, and that the UK has a trade surplus in comparatively few products, mainly focussed in chemicals and machinery & equipment.

Figure 8: Panel A: UK export demand and import penetration by product in 2011

Figure 8: Panel A: UK export demand and import penetration by product in 2011
Source: Office for National Statistics

Notes:

  1. Figure 8 shows product exports as a fraction of total product demand to the right of the axis, and product imports as a proportion of total product supply to the left of the axis. The balance reflects the difference between export demand and import penetration. Note that this chart excludes any exports or imports of services that fall into these product categories.

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Figure 8: Panel B: UK export demand and import penetration from the EU & Non-EU by product, % of final demand, 2011

Figure 8: Panel B: UK export demand and import penetration from the EU & Non-EU by product, % of final demand, 2011
Source: Office for National Statistics

Notes:

  1. Figure shows product exports as a fraction of total product demand to the right of the axis, and product imports as a proportion of total product supply to the left of the axis. Total supply and demand are taken from the Supply & Use Tables of balanced GDP estimates published by ONS. The EU and non-EU shares are calculated using the quarterly trade in goods release which details trade by product. Note that this chart excludes any exports or imports of services that fall into these product categories.

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To explore the importance of the EU to this pattern of trade in goods, Panel B of Figure 8 divides aggregate import penetration and export demand into the relative contributions of the trading bloc and the rest of the world. It suggests that different types of production activity vary in their exposure to the European market. While some production is quite strongly orientated towards non-EU trade in goods – such as mining & quarrying and computer, electronic & optical products – the production of other goods is comparatively more dependent on trade flows between the UK and EU. The production of machinery & equipment, pharmaceuticals and chemicals products in particular appear to be more exposed to the European market, as a relatively large fraction of the production of these goods is exported to the EU and the trading bloc accounts for a large fraction of total imports of these products.

The balance on trade is just one element of the UK’s broader current account position. The current account – which summarises the UK’s international transactions – is composed of the balance on trade, the income balance (the value of UK earnings on investments abroad less the value of overseas earnings on investments in the UK) and the balance on current transfers (payments received by institutions in the UK, less payments to overseas institutions and governments). The balance on the current account, which was examined in the June edition of the Economic Review [Economic Review - June 2014] and in the Bank of England’s recent Inflation Report [Bank of England - Inflation Report May 2014], improved to a deficit of 4.4% of GDP in Q1 2014, lower than the record deficits of 5.9% and 5.7% of GDP in Q3 and Q4 2013 respectively. The improvement came both as a result of a rise in the balance on trade and a stronger income balance, although lower current transfers also played a part.

Figure 9 completes the previous analysis of the balance on trade by showing the UK’s balances on income and current transfers with EU and non-EU nations. It suggests that the UK’s current transfers – both to EU and non-EU nations – act to reduce the UK’s current account balance. Together, these accounted for around 1.4% of GDP in Q1 2014. However, much of the recent deterioration in the current account has arisen as a consequence of a fall in the balance on income with non-EU countries. While the income balance with EU countries has been relatively weak – in particular since the renewed economic downturn in Europe – the balance with non-EU countries has been positive until recent quarters.

Figure 9: UK balance on income and current transfers with EU & Non-EU as a percentage of nominal GDP

Figure 9: UK balance on income and current transfers with EU & Non-EU as a percentage of nominal GDP
Source: Office for National Statistics

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Changes to the National Accounts

The June edition of the Quarterly National Accounts (QNA) comes just three months before the Blue Book 2014 consistent QNA release on 30 September 2014. The Blue Book and Pink Book are annual publications which show the development of the UK economy and of the UK’s overseas transactions, introducing revisions to the statistical record that reflect both new data and methodological improvements.

In September, the scope of these changes will be unusually broad, arising from changes of three sorts: Firstly, the UK is moving to new, internationally agreed standards set out in the European System of Accounts (ESA2010) and Balance of Payments Manual (BPM6).  This is part of the regular international process of revising statistical methods and sources in order to keep pace with the changing nature of the economy.

ESA2010 will introduce a number of new concepts, including the new treatment of research & development expenditure and spending on military weapon systems as investment, as well as changes to the way pension entitlements are recorded. Estimates of the impact of changes to investment data have been published here [National Accounts articles - Gross Fixed Capital Formation and Business Investment – Impact of ESA2010 changes on Volume Measures]. The new BPM6 standard will include new measurement methods for foreign direct investment, gambling, and the processing of intermediate outputs abroad.

Secondly, changes will also arise as a result of improvements in the way Gross National Income (GNI) is measured – one of the key statistics used in the calculation of Member States’ contributions to the EU budget. One such change is the inclusion of illegal activities in GNI, which in the case of the UK means that activities such as drug dealing and prostitution will be included in the national accounts from September. An indication of the impact of these changes is given here [ Inclusion of Illegal Drugs and Prostitution in the UK National Accounts (251.9 Kb Pdf) ].

Finally, revisions arising from these new international standards will be accompanied by changes to the way inventories and fixed investment are measured.  In addition, there will be the usual annual updating of the base and reference years, in this case from 2010 to 2011; data for 2012 will undergo the supply and use balancing process for the first time; and the weights used in calculating producer price indices will see their five-yearly updating to 2010 values. Estimates of the impact of changes to the treatment of inventories have been published here [National Accounts articles - Changes in Inventories – Impact of Blue Book 2014 changes on Volume Measures], while estimates of the impact of Producer Price Index rebasing have been published here [National Accounts articles - Impact on National Accounts of Producer Price Index Rebasing].

ONS has provided a provisional assessment of the impact of these changes on the annual growth rate of real GDP between 1998 and 2009 in this recent article [National Accounts articles - Impact of National Accounts improvements on headline GDP growth (chained volume measure)]. While average annual GDP growth over this period is unchanged at 2.2% per year, there are some large revisions to individual years, as shown in Figure 10. Growth in 1999 and 2001 is estimated to have been 0.5 percentage points higher, while growth in 2000 and 2004 has been revised down by 0.6 and 0.7 percentage points respectively. Revisions to growth during 2008 and 2009 have also impacted on the profile of the economic downturn. While GDP growth in 2008 is now estimated to have been 0.3 percentage points weaker than previously thought, growth in 2009 is now thought to be 1.1 percentage points stronger than previously estimated – reducing the depth of the downturn over this period.

Figure 10: Impact of Blue Book 2014 changes on annual growth rates of GDP, constant prices

Figure 10: Impact of Blue Book 2014 changes on annual growth rates of GDP, constant prices
Source: Office for National Statistics

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Labour market

The recent strength of the UK economy continues to be reflected in developments in the UK’s labour market (Table 2). The unemployment rate among those aged 16 and above, which fell just 0.4 percentage points in the year to April 2013, has fallen a further 1.2 percentage points over the last year to 6.6% in the three months ending in April 2014. The inactivity rate – the proportion of the population aged from 16 to 64 who are neither in work nor looking for work – has fallen by 0.5 percentage points over the same period, while the employment rate has risen by 1.4 percentage points over the last year: reflecting an increase in employment of 780,000. Taken together, these movements point to a broad intensification of the use of available labour and have raised questions about the degree of spare capacity in the UK labour market [Economic Review - June 2014].

Table 2: Headline labour market statistics

        %
  Employment Rate All aged 16 to 64 Unemployment Rate All aged 16 and over Inactivity Rate All aged 16 to 64 Average Weekly Earnings % changes year on year (3 month average)
Feb-Apr 2013 70.7 8.1 22.9 1.8
Feb-Apr 2013 71.5 7.8 22.4 1.0
Sep-Nov 2013 72.1 7.1 22.2 0.9
Oct-Dec 2013 72.1 7.2 22.1 1.0
Nov-Jan 2014 72.3 7.2 22.1 1.2
Dec-Feb 2014 72.6 6.9 21.9 1.4
Jan-Mar 2014 72.7 6.8 21.9 1.3
Feb-Apr 2014 72.9 6.6 21.8 0.9

Table source: Office for National Statistics

Table notes:

  1. The headline employment rate is the number of people aged 16 to 64 in employment divided by the population aged 16 to 64.
  2. The headline unemployment rate is the number of unemployed people (aged 16+) divided by the economically active population (aged 16+). The economically active population is defined as those in employment plus those who are unemployed.
  3. The headline inactivity rate is the number of economically inactive people aged 16 to 64 divided by the population aged 16 to 64.
  4. The Average Weekly Earnings series used relates to regular pay (excluding bonus pay). The three month average figures are the changes in the average seasonally adjusted values for the three months compared with the same period a year earlier.

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However, although the growth of employment has been particularly marked in recent periods, wage growth has remained relatively weak. While measures of total pay in April – including both regular and bonus pay – were affected by changes in the timing of remuneration associated with the reduction of the top rate of tax a year ago, regular pay growth remained weak. Regular earnings were just 0.9% higher in the three months ending in April 2014 than in the same period a year earlier, with weak growth in the services (0.8%) and construction (-0.7%) industries in particular. Figure 11 plots the growth of average regular pay for rolling three month periods alongside the rate of inflation from the Consumer Prices Index (CPI) calculated on a comparable basis. It shows that on this measure, real wages have been falling continuously since late 2009. ONS will publish a report examining real wages over the past 40 years on 3 July 2014, considering in particular how the real wages of cohorts who started work in the 1970s have fared compared with those who started in the 1990s.

Figure 11: Contributions to the growth of real regular pay: Consumer Prices Index (CPI) inflation and the growth of average regular weekly earnings, three-month on three-months a year ago

Figure 11: Contributions to the growth of real regular pay: Consumer Prices Index (CPI) inflation and the growth of average regular weekly earnings, three-month on three-months a year ago
Source: Office for National Statistics

Notes:

  1. The Average Weekly Earnings series used relates to regular pay (excluding bonus pay). The three month average figures are the changes in the average seasonally adjusted values for the three months ending with the relevant month compared with the same period a year earlier.
  2. The Consumer Prices Index (CPI) inflation rate is the annual percentage change in the three-month average CPI index compared with the average in the same three-month period a year ago. This will be negative when inflation is eroding the real value of nominal earnings.
  3. Real regular pay growth is calculated as the growth of nominal regular pay less the rate of inflation.

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Capital stocks and productivity

While the weakness of real wage growth contrasts sharply with the relative strength of employment growth and the pace of the economic recovery as a whole, it is consistent with the weakness of productivity growth since 2008. As recent ONS analysis has shown, output per hour worked in the UK fell relatively sharply during the economic downturn and has remained weak since the start of the recovery [Economic Review - April 2014]. Some of this weakness can be accounted for by a few specific industries, including mining & quarrying and financial services [Labour Productivity - Q1 2014].

A wide range of explanations have been suggested for the evolution of productivity growth in recent years. One such explanation involves a shift in the relative prices of labour and capital: this hypothesis argues that while real wages have fallen since 2008, the global financial market shocks increased the effective cost of capital, giving firms an incentive to replace more expensive equipment with more affordable labour. Applying additional labour to a constant (or shrinking) quantity of machinery or equipment is thought to lower the amount of output that each unit of labour can produce, leading to lower productivity. Empirically, this mechanism is consistent with two of the defining characteristics of the recent downturn: a sharp reduction in levels of investment (as firms cut back on expensive capital spending) and a sharp rise in the level of employment (as firms increased their use of labour input).

While new estimates of the capital stock – the stock of accumulated machinery, buildings, dwellings, transport equipment and intangible assets such as software – offer little evidence on the relative costs of labour and capital, they do appear to provide some support for this hypothesis. Conceptually, weaker investment by firms will lead to a smaller capital stock over time, as firms choose either not to replace retiring assets or ‘make do’ with older assets that are depreciating through ‘wear and tear’. Equally, taking on additional workers will reduce the capital stock to labour ratio over time – reducing the quantity of capital available per unit of labour input (‘capital shallowing’).

Figures 12, 13 and 14 make use of new estimates of the capital stock [Capital Stock, Capital Consumption - Capital stocks and consumption of fixed capital, 2013] published alongside this edition of the Economic Review to examine this hypothesis. Figure 12 plots the level of the net capital stock per unit of labour input in 2012 against the level of output per hour in 2012 in a range of industries. It confirms that industries with a larger stock of capital per worker tend to have higher levels of productivity. This effect is particularly marked in mining & quarrying, real estate, electricity, gas, steam & air conditioning and water supply industries: all of which have relatively large capital stocks and relatively high levels of productivity. By contrast, the accommodation & food services and professional, scientific & technical activities industries both have relatively small capital stocks and correspondingly low levels of labour productivity.

Figure 12: Net capital stock per hour worked and output per hour, by industry, 2012, current prices

Figure 12: Net capital stock per hour worked and output per hour, by industry, 2012, current prices
Source: Office for National Statistics

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While Figure 12 establishes that there does appear to be an association between the net capital stock and the level of productivity, Figure 13 examines how the average annual growth rate of the net capital stock per hour worked has varied by industry over two periods: the decade prior to the economic downturn and over the last two years for which data are available1. It suggests that the growth of the capital stock has slowed in all but six industries, and capital shallowing has been observed in all but nine industries. The capital stock per unit of labour input has fallen particularly sharply in information & communications, textiles and computer & electronic products, while growth has been relatively robust in transport equipment, agriculture and electricity, gas, steam & air conditioning.

Figure 13: Growth of the net captial stock per hour worked by industry

Figure 13: Growth of the net captial stock per hour worked by industry
Source: Office for National Statistics

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Do these patterns of capital stock growth help to explain the differing productivity performances of industries in recent periods? Figure 14 relates the capital stock growth rates in Figure 13 to the growth rates of productivity over the same two periods. It plots the average compound annual growth of the net capital stock per hour worked against the average compound annual growth rate of output per hour by industry. While far from scientific, Figure 14 is suggestive. Firstly, taking both periods together, it indicates that industries that have increased the quantity of capital per unit of labour input at a faster rate have seen stronger productivity growth than industries that have increased the effective supply of capital per unit of labour at slower (or negative) rates.

Figure 14: Average annual compound growth rates of the net capital stock per hour worked and output per hour, by industry, current price, seasonally adjusted

Figure 14: Average annual compound growth rates of the net capital stock per hour worked and output per hour, by industry, current price, seasonally adjusted
Source: Office for National Statistics

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Secondly, Figure 14 suggests that the average growth rate of the capital stock to labour ratio between 2010 and 2012 was slower than the long term average, and negative in a large number of industries. This finding is consistent with weak productivity growth in a number of industries arising from a change in the mix of factor inputs over this period, privileging the use of labour over the use of capital. However, to establish this descriptive association more rigorously, estimates of multi-factor productivity are required – which provide estimates of the contributions of labour, capital services and total factor productivity within a single framework. Current estimates of multi-factor productivity are available here, [Multi-factor Productivity (experimental) - Indicative estimates to 2012]: these will be updated following Blue Book 2014.

Notes for Capital stocks and productivity

  1. Growth of the capital stock per hour worked in 2008 and 2009 is affected by substantial changes in the number of hours worked associated with the economic downturn, making trends established in these periods difficult to interpret.

Reference Tables

Table 3: UK demand side indicators

  2012 2013 2013 2013 2014 2014 2014 2014 2014
      Q3 Q4 Q1 Feb Mar Apr May
GDP1 0.3 1.7 0.8 0.7 0.8 : : : :
Index of Services          
All Services1 1.3 1.9 0.7 0.7 0.8 0.2 0.5 0.3 :
Business Services & Finance1 2.1 2.1 1.0 1.0 0.9 0.4 0.7 0.3 :
Government & Other1 1.1 0.6 0.4 0.7 0.2 0.0 -0.1 0.1 :
Distribution, Hotels & Rest. 1 0.9 3.5 1.2 0.5 1.7 0.9 1.1 0.0 :
Transport, Stor. & Comms. 1  0.0 1.6 0.0 0.3 0.6 -0.8 0.2 0.8 :
           
Index of Production      
All Production1 -2.4 -0.4 0.7 0.4 0.7 0.9 0.1 0.4 :
Manufacturing1 -1.7 -0.8 0.9 0.6 1.5 1.1 0.5 0.4 :
Mining & Quarrying1 -8.7 -2.5 0.5 -1.2 0.8 4.8 -0.9 -1.1 :
       
Construction 1 -8.2 1.6 2.8 0.5 1.5 -3.3 -0.2 1.2 :
           
Retail Sales Index      
All Retailing1 1.0 1.7 1.4 0.8 0.6 1.5 0.6 1.0 -0.5
All Retailing, excl.Fuel1 1.4 2.1 1.6 1.2 0.5 1.6 0.1 1.7 -0.5
Predom. Food Stores1 0.0 0.1 1.7 0.4 -1.6 2.1 -1.5 3.9 -2.4
Predom. Non-Food Stores1 1.7 1.9 0.9 1.6 2.2 0.0 1.8 -0.8 0.8
Non-Store Retailing1 9.8 18.4 5.1 3.6 1.8 8.9 -1.9 5.1 1.5
           
Trade      
Balance 2, 3  -33.4 -26.6 -10.0 -5.7 -5.2 -2.2 -1.7 -1.3 :
Exports4 0.5 2.3 -2.2 0.4 -2.3 -3.4 -1.1 2.8 :
Imports4 2.4 0.8 1.3 -2.8 -2.6 0.6 -2.2 1.6 :
           
Public Sector Finances      
PNSB-ex 5 -25.2 -1.7 0.0 -2.8 3.3 3.8 -4.0 1.0 4.6
PNSB-ex, ex RM & APF 6, 2.8 -11.1 0.5 -2.8 -3.1 1.1 -4.0 1.2 0.7
PNSD-ex as a % GDP 74.8 75.8 74.6 75.8 76.1 74.8 76.1 75.7 76.1

Table source: Office for National Statistics

Table notes:

  1. Percentage change on previous period, seasonally adjusted, CVM
  2. Levels, seasonally adjusted, CP
  3. Expressed in £ billion
  4. Percentage change on previous period, seasonally adjusted, CP
  5. Public Sector net borrowing, excluding the impact of financial interventions. Level change on previous period a year ago, not seasonally adjusted
  6. Public Sector net borrowing, excluding the impact of financial interventions, the Royal Mail Pension Plan and transfers from the Bank of England Asset Purchase Facility. Level change on previous period a year ago, not seasonally adjusted

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Table 4: UK supply side indicators

  2012 2013 2013 2013 2014 2014 2014 2014 2014
      Q3 Q4 Q1 Feb Mar Apr May
Labour Market        
Employment Rate1, 2 71.1 71.7 71.8 72.1 72.7 72.6 72.7 72.9 :
Unemployment Rate1, 3 7.9 7.6 7.6 7.2 6.8 6.9 6.8 6.6 :
Inactivity Rate1, 4 22.6 22.2 22.2 22.1 21.9 21.9 21.9 21.8 :
Claimant Count Rate7 4.7 4.2 4.1 3.8 3.5 3.5 3.4 3.3 3.2
Total Weekly Earnings6 £469 £475 £475 £477 £477 £478 £476 £478 :
         
CPI        
All-item CPI5 2.8 2.6 2.7 2.1 1.7 1.7 1.6 1.8 1.5
Transport5 2.3 1.0 1.3 0.1 -0.3 -0.4 -1.0 1.6 0.4
Recreation & Culture5 0.2 1.1 0.8 0.9 0.6 0.7 0.6 0.5 1.1
Utilities5 5.0 4.1 4.3 3.7 3.3 3.2 3.1 3.0 3.2
Food & Non-alcoh. Bev. 5 3.2 3.8 4.1 2.8 1.8 1.8 1.7 0.5 -0.6
         
PPI        
Input8 1.3 1.2 2.4 -0.6 -5.0 -5.8 -6.3 -5.3 -5.0
Output8 2.1 1.3 1.5 0.9 0.6 0.6 0.4 0.6 0.5
         
HPI 8 1.6 3.5 3.6 5.5 8.0 9.2 8.0 9.9 :

Table source: Office for National Statistics

Table notes:

  1. Monthly data shows a three month rolling average (e.g. The figure for March is for the three months ending in March)
  2. Headline employment figure is the number of people aged 16-64 in employment divided by the total population 16-64
  3. Headline unemployment figure is  the number of unemployed people (aged 16+) divided by the economically active population (aged 16+)
  4. Headline inactivity figure is the number of economically active people aged 16 to 64 divided by the 16-64 population
  5. Percentage change on previous period a year ago, seasonally adjusted
  6. Estimates of total pay include bonuses but exclude arrears of pay (£)
  7. Calculated by JSA claimants divided by claimant count plus workforce jobs
  8. Percentage change on previous period a year ago, non-seasonally adjusted

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Background notes

  1. Details of the policy governing the release of new data are available by visiting www.statisticsauthority.gov.uk/assessment/code-of-practice/index.html or from the Media Relations Office email: media.relations@ons.gsi.gov.uk

Content from the Office for National Statistics.
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