In the UK, uncertainty remains prevalent following the Brexit vote. However, the national accounts data for the second quarter of 2016 were stronger than expected. In light of this, we have revised up our main scenario projections for UK GDP growth to 1.8% in 2016 (from 1.6%) and to 0.7% in 2017 (from 0.6%). These projections also reflect that fact that the early official data for July have held up reasonably well, notably for retail sales, but it is still too early to make a judgement on the impact of the referendum on the economy in Q3. We will update our projections in more detail in the November edition of our UK Economic Outlook report.
One consequence of the UK’s vote to leave the EU is that global trade has found itself under the spotlight. It is likely to be some years before we get clarity around the trade terms that will exist between the UK and the EU. However, following Brexit, we expect the UK government to pursue trade deals with leading EU and non-EU economies. Given the UK’s relative strength in services, policymakers are likely to place a particular emphasis on liberalising services trade. Over the last ten years, global services exports grew at an annual average rate of around 6.5% and now stand at about $5 trillion.
If the UK is able to secure trade deals with the US and fast growing emerging economies like China and India that make it easier to export and import services, and if an agreement can be reached on the Trade in Services Agreement (TiSA - a global agreement involving 23 WTO members including the EU), then there could be even faster global and UK services export growth still to come.
Focusing on the EU, if the Brexit vote results in the UK losing some of its access to the Single Market, then there may be opportunities for the Central and Eastern European (CEE) economies to attract foreign direct investment (FDI) from the UK. On average, the CEE economies have outperformed the wider EU at attracting foreign investment due, in part, to their low labour costs and relatively fast labour productivity growth. The challenge for policymakers in these economies now is to improve their business environment. If they can do this, then the CEE economies could continue to be among the EU’s star performers in the years to come.
Turning to the US, average monthly job creation to date in 2016 (186,000) has been slightly below our prediction from the start of the year of around 200,000, but the job creation data for June and July were more impressive. If this continues, we would expect the Fed to raise interest rates before the end of the year.
Average US jobs growth slightly below our projection so far in 2016
In the January 2016 edition of Global Economy Watch, we estimated that the US would continue to create an average of around 200,000 jobs per month in 2016. So far in 2016, the US economy has added an average of around 186,000 jobs each month (see Figure 2), slightly below our projection but not too bad.
Reducing labour market slack could bring big benefits
However, despite continued job creation, spare capacity still exists in the US labour market. The civilian labour force participation rate has averaged around 62.8% this year, considerably lower than a decade ago when the average participation rate was 66.2%. Involuntary part-time employment also remains high at close to 6 million, though this is now on a downward trajectory.
Eliminating this labour market slack would reap considerable benefits. For example, if the participation rate were to return to around 66%, and assuming the unemployment rate remained at current levels (4.9%), then US employment could increase by around 8 million. But achieving this would take time and specific policy measures to tempt people back into the labour force.
For policymakers, this slack is a signal that the labour market is still in recovery mode. But it is going in the right direction. Job creation in June and July was impressive and continued tightening of the labour market should begin to push up real wages, and eventually tempt people back into the labour force. It would probably also prompt the Fed to raise rates before the end of the year.
CEE economies outperforming the wider EU
Last year, the Central and Eastern European (CEE) EU economies – the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovakia and Slovenia – grew at a GDP-weighted average rate of 3.5%. This was faster than most other EU economies including Germany, France, Italy and the UK.
This strong growth is a continuation of historical trends. Since joining the EU in 2004, the CEE economies have grown at a GDP-weighted annual average rate of 3.2%, compared to average growth of just 1.2% per annum across the EU-28.
What makes the CEE economies an attractive destination for FDI?
The CEE economies have also succeeded in attracting foreign investors. On average, the stock of foreign direct investment (FDI) in these eight economies in 2014 was around 120% higher than in 2004. Over the same period, the stock of FDI across the EU increased by 95% (see Figure 3). Manufacturing businesses in particular have been attracted to the CEE region with several large automotive and electronic companies investing and expanding in these economies.
A number of economic conditions have made the CEE economies attractive for investors:
Looking forward, however, will these CEE economies continue to be a relatively attractive destination for FDI?
Opportunities for further FDI exist…
Economic growth is expected to remain relatively strong in the CEE region. For example in Poland, the largest CEE economy, we are projecting that real GDP will grow by around 3.5% on average in the short and medium-term.
Continued economic growth would be expected to drive up labour costs, and this could have an adverse impact on the region’s FDI attractiveness. However, it would take years for this to really have an impact. If labour costs were to continue to grow at their 2004-2015 compound annual growth rate in every CEE economy, it would be 2027 before labour costs in even one of these economies (Estonia) reached the current level for the EU as a whole. And EU average labour costs will also have risen over this period, even if not so fast, so the CEE’s cost advantage is likely to have narrowed but not disappeared by 2030.
The CEE economies could also stand to benefit from the UK’s vote to leave the EU. If the UK loses its access to the Single Market, then some UK businesses may decide to establish a presence in the EU to serve the European market, and it is likely that they would consider investing in the CEE economies for the reasons outlined above.
…but becoming more business friendly would make the CEE economies even more attractive
For all the CEE economies’ benefits, they do still face some challenges, particularly related to their business environment. Excessive bureaucracy and red tape may discourage some foreign companies from investing, despite the attractive investment proposition on offer. In the World Bank’s 2016 ‘Ease of Doing Business’ Index, the CEE economies rank between 16th and 42nd out of 189 countries. While relatively high in global terms, these economies still lag behind many other European economies such as Denmark, which ranks 3rd and the UK, which ranks 6th.
The CEE economies have been among the EU’s star performers over the past decade. If their policymakers engage with businesses, foreign and domestic, and make the necessary improvements to their business environment, then this could continue in the years to come.
Brexit vote puts trade back on the agenda
Global trade has been under the spotlight over the past few months. In particular, the Brexit vote has prompted uncertainty around the future trade terms between the UK and the EU, which will have an impact on businesses throughout the UK, Europe and perhaps further afield. The UK has a particular strength in services, and it is widely expected that UK policymakers would seek to put services at the heart of future trade deals, but how have global services exports been performing in recent years?
Over the last decade, global services exports grew at an annual average rate of around 6.5%. This was higher than the growth rate of nominal global GDP and global goods exports and has pushed the value of services exports around the world up to around $5 trillion.
So, which economies are the top performers in services? To answer this question, we looked at the value of services exports across the G7 and E7 economies since 2010. Our analysis was conducted in nominal terms and in national currencies to exclude the impact of the strong US dollar skewing the 2014 and 2015 estimates.
Japan experienced the highest growth in services exports in the G7…
The G7 economies contribute just under 40% of global services exports (see Figure 4), with the US ranking as the world’s largest exporter. But between 2010 and 2015, Japan was the G7 country that enjoyed the highest growth in services exports (10.4%), ahead of France (7.7%) and Germany (6.0%). However, the value of services exports in Japan remains some way behind that in the US and the UK in particular.
Japan has also enjoyed relatively strong growth in the value of financial services (FS) exports, which averaged around 23% per annum. Low domestic yields have encouraged banks in Japan to offer loans abroad at competitive rates, whereas in Western economies, the low growth environment and risk aversion by banks has constrained lending activity. As a result, Japan overtook the UK as the largest provider of cross-border loans in 2015 (see Figure 5). Loose monetary policy in Japan, coupled with a likely US interest rate increase later this year and continued uncertainty regarding Brexit in the UK, mean that Japan’s recent success in exporting financial services looks set to continue.
…but it’s in the E7 that the fastest growth has occurred
Since 2010, the average annual growth rate of services exports has been above 10% in every E7 economy. China is unsurprisingly the largest services exporter in the E7 and has enjoyed average annual services exports growth of 14.3% since 2010, but India (15.2%) and Turkey (15.2%) have been the top performers among the E7. Focusing on the two largest emerging economies – China and India – some interesting sector stories begin to emerge (see Figure 1).
In China, financial services has been the strongest performing services exports category when measured in annual average growth terms. While FS exports only comprise 1% of total service exports, the contribution of the FS sector to the Chinese economy is increasing. In 2010, the financial intermediation industry made up around 6.2% of Chinese GDP, but this rose to around 9.2% in the first half of 2016. The increasing prominence of the Chinese renminbi in global markets (as symbolised by its inclusion in the IMF’s Special Drawing Rights basket), coupled with a growing FS sector, suggest that financial services will have an important part to play as the Chinese economy continues to rebalance.
In India, travel exports (or tourism spending) grew at a faster rate than overall services exports. Figure 6 shows that India does not currently attract as many visitors as some of its E7 peers, but it does occupy a sweet spot with relatively fast growth in both the number of international arrivals and tourism spending. The government has also taken steps to support the tourism sector, for example by introducing and expanding the e-tourist visa scheme to cover 150 countries. As this sector develops, there will be opportunities for both domestic and international businesses, with 100% FDI permitted in the tourism sector and several large travel-related companies already having a presence in India.
So, what next for global services trade?
Talks are ongoing on the Trade in Services Agreement (TiSA), a global agreement involving 23 World Trade Organisation (WTO) members, including the EU. Striking a deal around these negotiations would provide a spur to global services exports.
For the UK, the government will almost certainly seek to agree trade deals with fast growing emerging markets, and these will likely place a particular emphasis on services. Global services trade has been growing strongly, but there could be even faster growth still to come.