Economy & Pensions Update With James Sproule and Malcolm Small

1. Economy & Pensions UpdateWith James Sproule and Malcolm Small Institute of Directors Wednesday 10th September

2. Macro Economic Outlook GDP – Interest Rates - Thresholds of Demand September 2014James Sproule, Chief Economist Institute of Directors James.sproule@iod.com@jamesrsproule

3. Contents • Economic forecasts • Interest Rates • Thresholds of Demand

4. Addicted to debt – Hampered by bureaucracy

5. UK economic forecasts remain too calm • Economic forecasts have a strong tendency to underestimate volatility • Consensus estimate real trend rate of UK growth to be ~2.0% • Disaggregating consensus does not significantly raise forecast volatility • Conclusions • Look to economists for a trend • Any trend forecast has to stack up with expected changes that can be observed (demographics etc.) UK GDP (HM Treasury consensus survey forecast) Forecast Source: ONS, HM Treasury Consensus

6. UK CPI Source: ONS, IoD Policy Unit

7. UK economic forecasts • GDP growth looking set to rise modestly above trend (2.5%-3.0%) for next two years • Debt consolidation continuing, corporates and banks doing well, consumers and government debt consolidation continues • Exporters used weak sterling to increase margins rather than expand market share, this contributed to rapid corporate debt consolidation • UK Directors are expecting to increase staff pay modestly underpinning consumer confidence • Inflation remains subdued. • Pay remains very tied to firm performance • Housing inflation is not uniform and can be addressed by other means • UK productivity remains middling • UK productivity in line with Italy and Canada, below Germany and the US • Service sector has in recent years seen substantial rises in productivity, although public sector continues to lag • UK workforce participation rates remain high (73%), this has the effect of lowering aggregate UK productivity measures • IoD has called for rise in UK interest rates in autumn/winter 2014/2015 • BoE has called present situation “Extraordinary Monetary Policy”, economy can now sustain normal rate environment • Rise in rates from 0.5% necessary to allow monetary policy lever to function properly

8. UK Interest rates • Bank of England base rates are at 0.5%, the lowest in history • Monetary policy remains ineffective as rates are too low to allow for stimulus UK Bank of England Base Rates Source: BoE

9. UK Interest rates – cont UK 10 Y Gilt Curve • Long term time value of money varies with inflationary expectations • Bank of England sets overnight rate, markets determine shape of the curve from that point US Credit Spreads • Corporate borrowing is at a (highly variable) premium above base rates. • Spreads move in response to market sentiment and investors outlook Source: BoE, St Louis Fed Reserve, IoD Policy Unit

10. UK Interest outlook • Bank of England determines base rates - a single point in a highly complex picture. • Inflationary expectations can be shaped by a responsible governments and can destroy irresponsible governments. • Investor confidence – reflecting broad risk assessments – is the key to interest rate spreads. Spreads matter more to businesses, particularly SME businesses than base rates.

11. Global opportunities abound – But many will never see them

12. Stages of Economic Development • Low Cost Labour • Business friendly government encourages Multi National Corp (MNC) investment • MNC’s seeks to lower costs of commoditised products and services • Intellectual capital transfer is low • MNC’s can cope with uncertainty/SME can not • Secure Property Rights • Politicians are brought fully under the law • Secure property rights allow for development of domestic business base • Basic components& services supplied locally GDP/Head of ~$2500 • Intellectual Development • Local value added goods and services are brought to market • Tech development in domestic market • Fading dependence on FDI, domestic demand is increasingly sophisticated GDP/Head of ~$7500

13. Time to Increase GDP

14. Thresholds of Demand Source: IMF, ITU, CIA, IoD Policy Unit

15. Development and Thresholds of Demand Source: IMF, IoD Policy Unit

16. Development and Thresholds of Demand • A degree of reality is necessary in making assumptions about future growth. • The world is rarely so predictable that straight line growth forecasts are a reliable guide to much of anything. • Sustainable economic growth naturally takes economies and societies through a number of significant changes. • Many vested interests will find these transitions difficult; it should not be assumed that what is best for an economy overall will prevail. • What economic growth means to individual businesses and industries varies, and there are clear points of increasing demand. • These thresholds are dynamic, but they do offer clear guidelines as to where potential business opportunities are likely to arise. • Over the next decade a number of significant markets, Nigeria and India to name but two, are going to be seeing strong growth in communications and media, while demand for air travel in China is (hopefully) set to explode.

17. Pensions “Why Pensions Matter and the Policy Agenda” September 2014Malcolm Small Senior Adviser, Financial Services Policy Institute of Directors malcolm.small@iod.com

18. What We’ll Be Looking At: • Why Pensions Are Important • What IoD Has Argued For In Pensions • What We Will Be Arguing For In Future • Some Thoughts On Longevity

19. But First, A Story About Steam Engines And A Watch…

21. WHY PENSIONS ARE IMPORTANT TO BUSINESS • £2.4 Trillion Asset Pool • Pension Funds Are Major Shareholders • Employees Need To Retire • Employers Need Them To Do So • Role Of The State Must Shrink • Elder Care Cannot Fall On Business

22. What We Have Argued For • Raise State Pension Age Towards 70 And Beyond. Sorry. • Provide A Decent, Flat Rate, Basic State Pension • Reform The Structure Of A “Pension” To Make It Attractive Again • Support Older People To Work Longer

23. What We Will Be Arguing For • Abolish The Lifetime Allowance • Keep Higher Rate Tax Relief On Contributions • Keep Supporting Older Workers/Entrepreneurs • Views Please – Compulsory Saving? • Views Please – Tax Relief?

24. Longevity 1 • Average Male Life Expectancy Now 80 – Was 66 In 1948 • Male Age 65 = 17 Years Life Expectancy • Female Age 65 = 20 Year Life Expectancy • But Healthy Life Expectancy Just 13 Years And 15 Years Respectively

25. Longevity 2 • Male 65 Cohort Life Expectancy Forecast To Be 25 Years By 2051 • Females 28 Years • Population Aged 80(+) To Grow From 2.8 Million In 2008 * To 5.8 Million In 2033 * To 10.6 Million In 2083 • Number Of People Over S.P.A. Will Increase 32% By 2033 • But Number Of Under 16s Will Only Increase By 10% • Who Is Going To Pay?

26. Longevity 3 • And It Could Get Even More Interesting • Who Would Want To Take A Bet?

27. Conclusions • Pensions Are Important To Business • They Will Become More Important • IoD Is Having Impacts On Policy, And Will Have More • Longevity Is The “Elephant In The Room”

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