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UK Economic Outlook

March 2015

The impact of lower oil prices on the UK economy

New job creation in the UK: which regions will benefit most from the digital revolution?

2 UK Economic Outlook March 2015

Contents

Highlights and key messages 3

1. Summary 4

2. UK economic prospects 7

• 2.1 Recent developments and the present situation 8

• 2.2 Economic growth prospects: national, sectoral and regional 12

• 2.3Outlookforinflationandrealearningsgrowth 14

• 2.4Monetaryandfiscalpolicyoptions 16

• 2.5Summaryandconclusions 16

3. The impact of lower oil prices on the UK economy 17

• 3.1 Trends in oil prices and the UK’s position 18

• 3.2ModellingtheimpactofoilpriceshocksontheUKeconomy 19

• 3.3Resultsfromouranalysis 20


• TechnicalAppendix–Modellingoilpricechanges 30

4. NewjobcreationintheUK:whichregionswillbenefitmostfrom 31 the digital revolution?

• 4.1Introduction 31

• 4.2NewjobcreationintheUKeconomy 33

• 4.3Evidenceofregionalconvergence,2004-2014 35

• 4.4ProjectedemploymentgrowthacrossUKregions,2014-2024 36

• 4.5Fosteringnewjobcreation:Implicationsforpolicy 37


• TechnicalAppendices–DataandMethodologyandRegressionAnalysis 39

Appendices 41

AOutlookfortheglobaleconomy

BUKeconomictrends:1979–2014

Contacts and services 43

3UK Economic Outlook March 2015

Highlights and key messages for business and public policy

Key projections

2015 2016

Real GDP growth 2.5% 2.3%

Inflation (CPI) 0.3% 1.8%

Source: PwC main scenario projections

• TheUKeconomyhasbeenrecoveringatarelativelystrongratesinceearly2013,althoughtherewere signs of a slight slowdown in growthinlate2014duetoproblemsin the Eurozone and other geopolitical uncertainties.

• InourmainscenarioweexpectGDPgrowth to average around 2.5% in 2015,supportedbyrecentoilpricefalls,beforeeasingslightlytoaround2.3%in2016.

• WejudgethatriskstoUKgrowthare weighted somewhat to the downside in the short term due to internationalrisks,buttherearealsoupsidepossibilitiesinthemediumtermiftheglobaleconomicenvironment improves.

• We expect the services sector to remain the main engine of UK growth forbothoutputandemployment.Manufacturingandconstructiongrowthhaveslowedrecently,butshouldremainpositivecontributors tooverallUKgrowthin2015-16.

Lower oil prices are positive for the UK economy

• The sharp fall in oil prices since mid-2014shouldboostmostsectorsoftheeconomyexceptforthosedirectlyinvolvedinoilandgasproduction.

• Inourcentralscenario,whereoilpricesrisegraduallytoaround $73perbarrelin2020,totalUKemploymentcouldbearound37,000higherin2020thaninabaselinescenario where oil prices remained attheirmid-2014levelsofaround$108perbarrelthroughto2020.

• Loweroilpricesshouldalsobenefitconsumerssignificantlyintheshortterm,aswellasboostinggovernment revenues and narrowingthetradedeficitslightly.

Low inflation in the short term may not prevent interest rate rises from late 2015

• Consumerpriceinflationislikelytobeclosetozeroonaveragein2015duetolowerglobalenergyandfoodprices,butcouldreturntotargetbytheendof2016.

• WeexpecttheMPCtokeepinterestrates on hold in the short term, butthentoincreasethemgraduallyfromlate2015orearly2016onwards, returning to around 3.5-4%by2020.Businessesandhouseholds should start to prepare for this upward trend now.

London continues to lead the recovery, but growth has diffused to other regions

• London and the South East are continuingtoleadtherecovery, ashasbeenthepatternformanyyears,butotherUKregionsshouldalso register positive real growth ofaround1.7-2.5%in2015.

• DetailedanalysisinthisreportshowsthatLondonhasbeenakeysourceofnewjobcreationassociatedwith the digital revolution of the past 25years.Butthebenefitsofthishavestarted to diffuse to other regions overthepasttenyearsandwe expect this to continue.

• Wethinkgreaterregionalbalancewouldbegoodforthelong-termfutureoftheUKeconomy,butthisshouldnotbeattheexpenseofweakeningtheLondoneconomy.London needs increased investment inaffordablehousingandtransportinfrastructure to support potential continuedstrongjobsgrowthoverthe next decade.

• Thereshouldalsobeanemphasisonbuildingupsuccessfulmanufacturingand service sector clusters outside London and the South East, which requireslong-terminvestmentintransport infrastructure, skills and knowledgehubslinkedtotopregional universities.

3


1 – Summary

Recent developmentsTheUKeconomygrewby2.6%in2014as a whole, which was the fastest rate seensince2007andthestrongestgrowthrateintheG7.

However,UKquarter-on-quarterGDPgrowthslowedsomewhatto0.5%inthefourthquarterof2014,whichappearstoreflectthedragfromsluggishgrowthintheEurozoneaswellaswiderglobalgeopolitical risks related to the situation inRussia/UkraineandtheMiddleEastinparticular.Butlowerglobaloilpriceshavebeenapositivefactorfromtheperspective of UK consumers.

UKgrowthhasbeendrivenprimarilybyservicesoverthepastfiveyears,butmanufacturing and construction have also beenonanupwardtrendsinceearly2013despitesomeslowdowninlate2014.

TheslowdownintheEurozonehasbeenpartlyoffsetbystrongergrowthintheUSsincethesecondquarterof2014, butmoregenerallyinternationalriskshave increased over the past nine months. As such, UK growth remains heavilydependentondomesticdemand.

UKemploymenthascontinuedtorisestrongly,whichhassupportedconsumerspendinggrowthdespiterelativelysubduedratesofaveragerealearningsgrowth until recent months. Rising house prices have also supported consumerconfidenceandspending, buthavemoderatedsincemid-2014.

Businessinvestmenthadbeenshowingsignsofastrongerrecoveryinrecentyears,thoughthisfellbacksomewhatinlate2014accordingtothelatestpreliminaryofficialestimates.Publicspending cuts have slowed down over the pastyear,butwillremainadragongrowthformanyyearstocomeandcouldaccelerate again after the general election.

Therateofconsumerpriceinflation(CPI)hasfallensharplyoverthepastyeartorecordlowsasimportpriceinflationhasdroppedduetoglobalenergyandfoodpricedeclines.

Future prospectsAsshowninTable1.1,ourmainscenarioisforUKGDPgrowthtoaveragearound2.5%in2015andaround2.3%in2016.This is similar to the latest consensus and OBR forecasts.

ConsumerspendinggrowthisprojectedtobebroadlysimilartoGDPgrowth,withaboostfromloweroilpricesthisyearbutsomemoderationingrowthin2016.

We expect continued investment growth in2015,butataslowerratethanin2014asbusinessconfidencecouldbeaffectedbyincreasedinternationalrisksandpossiblyalsotemporaryuncertaintyaround the general election outcome.

Netexportshavebeenerratic,butwe donotexpectthemtomakeasignificantpositivecontributiontogrowthin2015and2016givenongoingproblemsintheEurozone in particular. UK growth will thereforeremainheavilydependentondomestic demand.

Asalwaystherearemanyuncertaintiessurroundingourgrowthprojections,asillustratedbythealternativescenariosinFigure1.1.Therearestillconsiderable

downside risks relating to trends in the Eurozone and emerging markets (includingUkraineandtheMiddleEast),andthesehaveincreasedsincemid-2014.Buttherearealsoupsidepossibilitiesiftheseproblemscanbeavoidedandavirtuouscircleofrisingconfidenceandspendingcanbeestablishedasinpasteconomic recoveries.

Inflationwillremainverylowthisyear,butcouldreboundtoclosetotargetin2016ifpastfallsinglobalenergyandfood prices do not continue. There could beupsideriskstothisinflationoutlookin the longer term if domestic wages start to recover without a corresponding riseinproductivity.

WedonotexpectanyimmediateriseinofficialUKinterestrates,butagradualupwardtrendseemslikelytobegininlate2015orearly2016.Inthelongterm,however,wewouldstillexpectofficialratestoreturnverygraduallytoamorenormallevelofaround3.5-4%by2020.

Higher interest rates will help savers andreducepensionfunddeficits,butborrowers(includingbusinessesandthegovernment)mightgainfromlocking in funding now for long term investments such as infrastructure and housing.Householdsneedtobearinmindlikelyfutureinterestraterisesinanydecisionsonmortgagesorotherlonger term loans.

Table 1.1 – Summary of UK economic growth prospects

Source: Office for Budget Responsibility (December 2014), HM Treasury survey of independent forecasts (average values in February 2015 survey) and latest PwC main scenario.

Indicator (% change on previous year)

OBR forecasts (December 2014)

Independent forecasts (February 2015)

PwC Main scenario (March 2015)

2015 2016 2015 2016 2015 2016

GDP 2.4 2.2 2.6 2.3 2.5 2.3

Consumer spending 2.8 2.2 2.9 2.4 2.6 2.3


Impact of lower oil prices on the UK economyAs discussed in detail in Section 3 of this report, we think that the fall in the oil pricesincemid-2014shouldhaveasignificantpositiveimpactontheUK byincreasingoveralleconomicactivityas the cost of production decreases for businesses,especiallyforthosethatareheavilydependentonoilinputs.

Although the oil and gas extraction sectorisnegativelyaffectedbythereduction in the oil price, sectors such agriculture, air transport, coke and refinedpetroleummanufacturing,andoil-intensivemanufacturingsectorswillbenefitasthepriceofakeyinputfalls.

Our modelling implies that water transport and other services sectors willenjoyasmallerpositiveimpact.However,oil-intensivesectorsarelikelytobenefitfromthereallocationofcapital and resources at the expense oflessoil-intensivesectors.

Futureoilpricetrendsremainhighlyuncertain, so we have looked at three alternativescenarios.Inacasewherethe reduction in the oil price is persistent,thesizeoftheUKeconomyincreasesbyaround1%onaveragerelativetothebaselinebetween2015and2020.Employmentalsoincreases byaround90,000by2020inthiscase(Scenario1inTable1.2).

Incontrast,theimpactsaremuchsmallerwherethefallintheoilpriceiswholly orpartiallytemporary:inthesescenariostheaverageimpactonthelevelofGDP is0.2-0.5%,withemploymenteffects in2020ofaround3,000to37,000depending on how far and fast oil prices rebound.Thecentralcase(Scenario2)whereoutputis0.5%higherandemploymentin2020around37,000higherwouldbemostconsistentwith ourmainscenariofortheUKeconomy, buttheotherscenariosshowninTable1.2arealsoquiteplausibleoutcomes.

Figure 1.1: Alternative UK GDP growth scenarios

Source: ONS, PwC scenarios

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Real household incomes also rise due to lower oil prices, which increases consumer spending. As a result of growing economic activity,weprojectthatgovernmenttaxrevenues should also rise as the tax take from corporate and personal income taxes increasesbymorethanthelossofNorthSea oil and gas revenues.

Insummary,loweroilpricesshould bepositiveformostsectorsoftheUKeconomy,householdsandthegovernment.Butthescaleofthesebenefitsremainshighlyuncertaindependingonhowoilprices evolve from here.

Table 1.2: Increase in total UK employment relative to baseline: 2016 and 2020

Source: PwC analysis (the effects shown are relative to employment levels in a baseline case where oil prices remained at their mid-2014 level of around $108 per barrel through to 2020).

Oil price scenarios ($ per barrel) 2016 2020

Scenario 1 (settling at $50) 121,000 91,000

Scenario 2 (rising to $73 by 2020) 53,000 37,000

Scenario 3 (rising back to $108 by 2020) 11,000 3,000


Which UK regions will benefitmostfromdigitaljob creation?Thedigitalrevolutionhasbothcreatedanddisplacedmanytypesofjobssince1990.InaspecialarticleinSection4 ofthisreportbyDrCarlBenediktFrey ofOxfordUniversityandJohnHawksworthofPwC,wefocusonthenewtypesofjobscreatedsince1990 and assess how this has affected total nationalandregionalemploymentintheUKsince2004.WehighlightthekeyroleofLondonasanincubatorforthedigitalrevolution,butalsofindsomesigns of catch up in other regions such as theNorth,WalesandNorthernIreland.

Weexaminednewjobtitlesthatemergedonlyafter1990andfoundthat5.5% of the UK workforce had shifted intothesenewtypesofjobsby2004. Butby2014thisproportionhadrisenonlyslightlyfurthertoaround6%. Eight of the ten occupational categories wherethesenewjobtitlesarosewererelatedtocomputers,sothiscanlargelybelinkedtothedigitalrevolution.

Londonhasbeenthegreatestmotorforthecreationofnewtypesofjobs,outperformingtherestoftheUKeconomy:forexample,newtypesofjobsinCentralLondonincreasedfrom8.6%to9.8%oftotalemploymentbetween2004and2014.

Butwealsofindsomeevidenceofregionalconvergence over the past decade. While London continues to lead in terms of the proportionofworkersinnewtypesofjobs,regionslikeYorkshire,Tyne&Wear,WalesandNorthernIrelandwithlowinitialemploymentsharesinnewtypes ofjobsin2004experiencedhighergrowthratesofthesenewjobtypesonaveragebetween2004and2014.

Ourfindingssuggestthatnewtypesofjobscreatedsince1990(linkedmainlybutnotonlytothedigitalrevolution)initiallyappearedinareaslikeLondonwhereentrepreneurs,innovativefirmsand skilled workers were concentrated andthengraduallydiffusedtootherregions. These other regions will continue to catch up unless London’s paceofnewjobcreationishigherthanthe rate of regional diffusion.

Projectingpatternsinregionalemploymentgrowthoverthenextdecade,wefindthattotalemploymentinCentralLondoncouldgrowbyaround25%between2014and2024,butthiswouldbedownfromaround35%totalemploymentgrowthoverthepasttenyears(seeFigure1.2).

Bycontrast,employmentgrowthratesover the next decade in regions like West Yorkshire,GreaterManchester,theWestMidlands,ScotlandandtherestoftheSouthEastareprojectedtoseesomeaccelerationinjobcreationrelativetothe past decade as the digital revolution continues to diffuse.

FutureUKandLondongovernmentsneedtomakesurethatthecity’sgrowthpotentialisnotconstrainedbythesupplyofhousingandtransportinfrastructure. But it also needs to supportthediffusionofdigitaljobcreationtootherUKregionsbyboostingtransport links outside London, supporting leading regional universities, andbuildingskills,whichwefindtobeakeydriverofeconomicsuccessforcities.

Source: ONS Labour Force Survey; calculations by Carl Frey

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Figure 1.2: Projected total employment growth in UK regions, 2014-2024, as compared to the past decade


2 – UK Economic prospects

Key points• TheUKeconomyexpandedby2.6%in2014,itsstrongestgrowthratesince2007.However,therewassomelossofmomentuminthefinalquarteroftheyear.

• Inourmainscenario,weexpecttheUKeconomytogrowbyaround2.5%thisyear,moderatingslightlytoaround2.3%in2016.

• The services sector remains the primarydriverofUKgrowthasoutputin manufacturing and construction are stillwellbelowtheirpre-crisisleveland lost some momentum in the secondhalfof2014.However,weexpectallmajorsectorstoshowreasonablegrowthin2015-16.

• London and the South East are expected to maintain their positions as the two fastest growing regions in theUKthisyear,butotherregionsshould also see positive growth.

• TheUKrecoveryisstillexposedtodownside risks emanating from the Eurozone and an escalation of geopolitical unrest in Russia/Ukraine and/ortheMiddleEast.However,therearealsoupsidepossibilitiesfromalargerthanexpectedboosttohousehold spending from lower oil prices,fasterfallsintheunemploymentrate and stronger real wage growth.

• The falling oil price has pushed inflationclosetozerorecently,butitislikelytoreboundtoclosetotargetbylate2016.Thepotentialmedium-termupwardpressuresoninflationthatcouldemergeastherecoverycontinuesmayleadtoagradualincreaseintheofficialinterestratefromlate2015onwards,althoughthetimingofthefirstUKrateriseremainshighlyuncertain.

• Publicborrowingnowlookslikelytocomeinataround£90billionthisfiscalyear,closetoOBRprojections.WeexpectabroadlyneutralBudgeton18thMarch,withany‘giveaways’largelymatchedby‘takeaways’.

IntroductionInthissectionofthereportwedescriberecentdevelopmentsintheUKeconomyand review future prospects. The discussion covers:

2.1 Recent developments and the present situation

2.2 Economic growth prospects: national, sectoral and regional

2.3 Outlookforinflationandrealearnings growth

2.4 Monetaryandfiscalpolicyoptions

2.5 Summaryandconclusions

Figure 2.1: GDP and key components of domestic demand

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Source: ONS


2.1 – Recent developments and the present situationUKGDPgrowthof2.6%in2014wasthefastestsince2007andthestrongestintheG7.Butthepaceofquarter-on-quartergrowtheasedto0.5%inthefinalquarterof2014,reflectingslowergrowthin the Eurozone and other geopolitical uncertainties.

AsshowninFigure2.1,thelevelofGDPhasbeenonanupwardtrajectoryforthelastfewyears,largelytrackingconsumerspending growth. Although still around 4%belowitspre-crisispeak,fixedinvestmenthasalsopickedupstrongly inrecentyearsaccordingtothelatestofficialestimates(thoughinvestmentdippedagaininQ42014relativetothepreviousquarter).Governmentspendingheldupbetterintherecession,buthasgrownmoreslowlyrecentlyastheTreasuryhassoughttobringthebudgetdeficitdown.

Services continue to lead the recovery

AsshowninFigure2.2,theservicessector continues to outperform manufacturing and construction, and remains the main driver of economic growth. Output levels in the manufacturing and construction sectorswerestillwellbelowtheirpre-crisispeaksbyaround5%and 8%respectivelyinQ42014.

Despite the upward trend in output levels intheconstructionsectorinthefirstthreequartersof2014,therewasasharpdownturninthelastquarteroftheyearowing in large part to a drop in repair and maintenance work, which experiencedthelargestquarter-on-quarterfallsinceQ42009.Fortheyearas a whole, however, the picture was more promising with an annual growth

Figure 2.2: Sectoral output and GDP trends

Source: ONS

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rateof7.3%in2014.Despitethedisappointing fourth quarter data, theJanuaryconstructionPMIof59.1indicatesthatgrowthmomentummayhavereturnedinearly2015,althoughthis is still lower than the average of 61.8seenin2014asawhole.

Manufacturingoutputgrewby2.7% onaveragein2014,whichwasthehighestpaceofgrowthsince2010.ManufacturingoutputgrowthalmoststalledinQ42014,however,dueinpartto the drag on exports from the weakness of demand from the Eurozone. Lower oil prices, feeding in through a decline in inputcosts,shouldboostmanufacturingthisyear,however,asdiscussedinmoredetailinSection3below.

ThemessagefromtheofficialdataislargelyconfirmedbythelatestMarkit/CIPSPurchasingManagers’Indices(PMIs)forservicesandmanufacturing(asshowninFigure2.3).TheservicessectorPMIinearly2015signalledthatthesectorwasstillgrowingrelativelystronglydespitesomeslowdownover

thepastyear.Therewasasharpfallinthe pace of growth in the manufacturing sectorinmid-2014,dueinparttoweakness in demand from the Eurozone. ThemanufacturingPMIhasbeenmorestableinrecentmonths,andremainedinpositiveterritoryataround54inFebruary2015.ButitisstilltheservicessectorthatisleadingtheUKrecoveryinearly2015accordingtothesePMIindices.

The services sector continues to outperform manufacturing and construction, and remains the main driver of economic growth.


Figure 2.4: Employment is rising strongly but productivity has been broadly flat

Source: ONS

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Figure 2.3: Purchasing Managers’ Indices of business activity

Source: Markit/CIPS

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Recovery still driven by jobs not productivity

AcontinuingnotabletrendintheUKeconomyistherobustincreaseinemployment,whichhassurpasseditspre-crisislevels,butproductivityremainssubduedasshowninFigure2.4.Employmentgrowthhasbeenparticularlystrongsinceearly2013 and continued its upward momentum throughout2014.Theunemploymentratereportedforthelastquarterof2014was5.7%,downfrom7.2%ayearearlier.

OneofthebiggestuncertaintiesforthefutureofUKrecoveryiswhetherandwhenproductivitywillpickup.Giventhatthereisnowlesssparecapacityintheeconomy(onlyaround0.5%ofGDPaccording to latest Bank of England estimates),strongerproductivitygrowthwillbecriticalinenablingwagestorecoverwithoutsparkinginflationarypressures in the medium term.

The‘productivitypuzzle’ofrecentyearshas persisted despite revised data publishedlastautumnshowingstrongerinvestmentgrowththanpreviouslythoughtduringtherecovery,soreducingthesignificanceofthisfactorinexplainingwhyUKproductivityhasremainedsolow.Itmaybe,however, that it will take time for this investment topushupproductivitygrowth,atleastasmeasuredbythenationalaccounts.

Therobustlabourmarketperformance inthelastquarterof2014isgoodnews,butsignsoflabourmarkettighteninghave started to emerge as vacancies haverisenabovetheir2008peakandbusinesssurveysareindicatingrisingskills shortages, for example in the constructionsector.Therehasbeensome

increase in average earnings growth with regularpaygrowingby1.7%inthelastquarterof2014comparedtoayearearlier,significantlyfasterthanthegrowthrateofconsumerpricesforthefirsttimeinmanyyears.Futureprospectsforrealearningsgrowth are considered further in Section 2.3below.


Housing market has cooled

Housepricesended2014around10%higherthanatthestartoftheyear,which was the strongest annual average performancesince2007.Buttherewereclear signs of the pace of house price increaseseasinglaterintheyear.

Figure2.5showsnominalhousepricesrisesovertheyeartoDecember2014byregionbasedonofficialONSdata.

Figure 2.5: House price rises by region

Source: ONS

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The London housing market experienced average price growth of 17.4%in2014,thefastestgrowthratesince2000,thoughthisrateofincreasehadmoderatedto13.3%bytheendof2014asFigure2.5shows.TheaverageLondon home now costs around £500,000accordingtotheONS,although this is down somewhat from its peakinmid-2014.ExcludingLondonand the South East, house prices

Consumer spending remains relatively buoyant

Figure2.6showstheevolutionofconsumerconfidenceandretailsales.Duringthefinancialcrisisandsubsequentdownturn,thetwodidnotreallymoveinasimilarpattern.Sinceearly2014,however,therehasbeenapick-upinbothmeasuresastherecoveryin the UK has strengthened and lower oilandfoodpriceshaveboostedrealhousehold spending power.

Figure 2.6: Consumer confidence and retail sales

Sources: PwC Consumer survey, ONS,

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We think average house prices across the whole of the UK will grow at an averagerateofaround6-8%thisyear,which would involve some further moderation in the pace of growth, particularlyinLondon1.

1 WeplantoanalysehousepriceprospectsinmoredetailintheJuly2015editionofthisreport.


Mixed trends in stock markets

EquitymarketindicesintheUS,UKandEurozone picked up towards the end of 2014andinearly2015afterfallingbackinSeptemberlastyear(seeFigure2.7).Despite their volatile nature in the short term,equitymarketsintheUSandEurozonehadareasonablystrongyearin2014aswhole,buttheUKmarketwasless strong2.ThiscouldreflecttheglobalcompositionoftheFTSE,whichmakes itrelativelyexposedtotheriseingeopolitical risks during seen during 2014.Nonetheless,equitymarketsremainbroadlysupportiveofinvestmentgrowth,particularlyintheUS.

2.2 Economic growth prospects: national, sectoral and regionalWeareprojectingGDPgrowthofaround2.5%in2015,verysimilarto2014,fallingslightlytoaround2.3% in2016(seeTable2.1).

OuroverallGDPgrowthprojectionsarelargelyunchangedfromthepreviouseditionofthisreportinNovember2014,withtheboostfromloweroilpricesoffsetbyincreasedrisksrelatingtotheEurozone and wider geopolitical risks. We have, however, revised our estimates for the different expenditure componentsandinflationinlinewithrecent data releases.

We expect consumer spending growth toremainrelativelyrobustataround2.6%in2015,butwithsomemoderationingrowthin2016asthehouseholdsavingsratestabilisesandspendinggrowthbecomesmoredependentonreal income growth.

Figure 2.7: Equity market indices

Source: Thomson Reuters Datastream

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Consumer spending 2.1% 2.6% 2.3%

Government consumption 1.5% 1.1% 0.6%

Fixed investment 6.8% 2.9% 4.8%

Domestic demand 2.9% 2.2% 2.4%

Net exports (% of GDP) -0.5% 0.2% -0.2%

CPI inflation (%: annual average) 1.5% 0.3% 1.8%

Table 2.1 – PwC main scenario for UK growth and inflation

Source: ONS for 2014, PwC main scenario projections for 2015-16

2 AlthoughtheFTSEperformedbetterinFebruary2015.


Weexpectreasonablyrobustgrowthinbusinessinvestmentthisyear3 and next owingtothebenefitsofloweroilpricesandsteadydomesticdemandgrowth,thoughtheelectionmayleadtoatemporaryperiodofuncertaintythatcould slow investment growth during thefirsthalfof2015.Totalinvestmentremainsbelowitspre-crisispeak,however, so there is still room to grow to make up for past relative weakness (seeFigure2.1).Withinterestratesstillatrecordlowlevels,businessesareexpected to continue to take advantage ofthistoboosttheirinvestmentlevels.

Governmentconsumptiongrowthisprojectedtoremainmodestasthenewgovernment, of whatever complexion, continuestobeardownonthebudgetdeficitin2015and2016.

NetexportsareexpectedtomakeabroadlyneutralcontributiontoGDPgrowthonaveragein2015and2016 astheEurozoneremainsrelativelyweakandglobalgrowthpicksuponlyslowlyin our main scenario (though the US shouldbeabrightspothere,whichshouldboostUKservicesexports inparticular).

AcomparisonofTables2.1and2.2showsthatourlatestGDPprojectionsareslightlymoreoptimisticthanthoseoftheOBRfromDecember,butsimilartothemoretimelyestimatesfromtheaverage of the independent forecasts surveyedbytheTreasuryinFebruary.

Table 2.2 – Official and independent forecasts

Source: ONS for 2014, OBR Economic and Fiscal Outlook (December 2014), HM Treasury Forecasts for the UK economy: a comparison of independent forecasts (February 2015)

(% real YoY growth unless stated otherwise)

Latest estimates

OBR forecasts (December 2014)

Average independent forecasts (February 2015)

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GDP 2.6% 2.4% 2.2% 2.6% 2.3%

Manufacturing output 2.7% N/A N/A 1.7% 1.8%

Consumer spending 2.1% 2.8% 2.2% 2.9% 2.4%

Fixed investment 6.8% 8.4% 5.9% 5.3% 5.0%

Government consumption 1.5% -0.4% -0.6% 0.8% -0.1%

Domestic demand 2.9% 2.9% 2.2% 2.7% 2.3%

Exports 0.4% 2.4% 4.7% 2.9% 4.3%

Imports 1.8% 3.9% 4.7% 3.0% 4.1%

Current account (£bn) -74 -64.6 -55.2 -82.5 -78.3

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Figure 2.8: Alternative UK GDP growth scenarios


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Main scenario Renewed slowdown Strong recovery

2007Q1

2008Q1

2009Q1

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2011Q1

2012Q1

2013Q1

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3 Theprojectedaverageannualgrowthrateofinvestmentin2015isdampenedbybaseeffectsfollowinganapparentfallinQ42014,althoughthiswasonly apreliminaryestimatethatcouldwellberevisedlater.


Alternative growth scenarios

Uncertaintyremainsakeythemewhenconsidering future prospects for the economyand,toaccountforthis,wehave considered two alternative UK growth scenarios in addition to our mainscenario,asshowninFigure2.8:

• Our ‘strong recovery’ scenario projectsgrowthacceleratingtoaround4%in2016.Thisrelativelyoptimistic scenario assumes a much quickerrecoveryintheEurozoneandglobaleconomiesthaninourmainscenario,boostingconsumerandbusinessconfidenceintheUK.This in turn would result in businessesundertakinggreaterinvestmentactivityandanincreasein consumer spending, as well as higherdemandforUKgoodsabroad.

• Our ‘renewed slowdown’ scenario, bycontrast,seesUKgrowthslowingdownsharplytoonlyaround0.5%in2016.Thisisbasedontheassumptionof adverse shocks emanating from a revived crisis in the Eurozone, such as thepossibilityofGreeceexitingtheeuro,asignificantlyweakereconomicoutlook in some Asian markets such as China, as well as further unrest in Russia/UkraineandtheMiddleEast.These events would have negative implicationsforUKbusiness,damagingconfidencewhichcouldleadtocutbacksininvestmentandemployment,therebyalso depressing consumer spending.

Wedonotbelievethatthesealternativescenariosarethemostlikelyoutcomes,buttheyarecertainlywellwithintheboundsofplausibility.Businesses

shouldensuretheyhavecontingencyplansinplacetodealwiththepossibilityof these kinds of events.

Intheshortterm,riskstogrowthremain somewhat tilted to the downside giveninternationaluncertainties,buttheyappearmorebalancedinthemedium term if these short term risks donotmaterialise,particularlyifoilpricesremainrelativelylow(asdiscussedfurtherinSection3below).

Sectoral prospects

ThesectordashboardinTable2.3showstheactualgrowthratesfor2014,alongsideourprojectedgrowthratesfor2015and20164,forfiveofthemainsectorswithintheUKeconomy. Thetablealsoincludesasummaryofthekeyissuesaffectingeachsector.

Growth

Sector and GVA share 2014 2015p 2016p Key issues/trends

Manufacturing (10%) 2.7% 2.5% 2.9% The manufacturing sector started the year on a reasonably high note with a PMI of 53 in January. Oil price falls should provide a boost for the sector in 2015.

The ongoing uncertainty around Greece and the possibility of a further slowdown in the Eurozone could be a negative influence on UK goods exports. As such, domestic demand will remain a key driver of growth.

Construction (6%) 7.3% 1.1% 2.0% The construction PMI picked up in January after disappointing official data for Q4 2014.

Residential house building is expected to remain reasonably buoyant in 2015.

Distribution, hotels & restaurants (14%)

4.7% 3.3% 2.4% Retail sales volumes have generally been on an upward trajectory since 2013, with growth picking up in Q4 2014 following the slowdown seen in Q3.

Falling unemployment and improving real wage growth caused by low inflation rates will lift consumer purchasing power and keep strong growth going at least in 2015.

Business services and finance (31%) 3.7% 3.5% 3.1% The UK’s large and relatively strong business services sector continues to experience strong growth.

The financial sector remains exposed to the risks stemming from the Eurozone, regulatory changes and global financial market volatility.

Government and other services (23%) 1.1% 1.0% 1.2% Government spending should continue rising at only a relatively modest pace given continuing efforts to control the budget deficit.

Total GDP 2.6 % 2.5% 2.3%

Table 2.3 – UK sector dashboard

Sources: ONS for 2014, PwC for 2015 and 2016 main scenario projections and key issues. These are only five of the most important sectors of the economy, so their GVA shares only add up to around 84% rather than 100%.

4 Thoughwewouldstressthatsectoralprojectionsfor2016remainhighlyprovisionalatthisearlystage,withwidemarginsofuncertaintysurroundingtheillustrativeprojectionsinTable2.3fornextyear.


Regional prospects

Figure2.9showsourprojectionsforgrowthinthemainUKregionsfor2014and2015.LondonandtheSouthEast5 are expected to retain their positions as the two fastest growing regions this yearwithagrowthratesimilartothepreviousyear.MostotherregionsareexpectedtoexpandataslightlyslowerratethantheUKaveragethisyear, butallshouldseepositivegrowthofmorethan1.5%in2015.

Figure 2.9: PwC main scenario for output growth by region

Source: PwC analysis

0.0

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% g

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2014 2015

3.0% 3.0% 2.9% 2.9%

2.6% 2.5% 2.5% 2.4%2.6%

2.4% 2.5% 2.4% 2.5% 2.4% 2.4% 2.3%

2.7%

2.3% 2.2% 2.1% 2.0% 1.9% 1.8% 1.7%

2.6% 2.5%

Itisimportanttonotethatregionaldataaremuchlesstimelythannationaldata–thelatestavailableregionalGVAdataarefor20136. As a result, the margins of erroraroundtheseregionalprojectionsare even larger than for the national growthprojectionsandsotheycan onlybetakenasillustrativeofbroaddirectional trends. Small differences in projectedgrowthratesbetweenregionsarenotofanypracticalsignificance.

2.3Outlookforinflationand real earnings growth TheheadlineCPIinflationratewaswellbelowtheMonetaryPolicyCommittee’stargetof2%in2014anddippedfurthertoarecordlowof0.3%inJanuary2015.

The lagged effects of past reductions inglobalenergyandfoodpriceswerethemaincontributorstothissharplydecliningheadlineinflationrate,althoughcoreinflation(excludingfood,drink,tobaccoandenergycosts)remainedhigherat1.4%inJanuary

2015,andhasactuallyrisenslightlyfrom1.2%inNovember.Itseemstherefore that, as the Bank of England has said, around two thirds of the slowdownininflationrelativetothe2%targetisattributabletotheeffectoffactorsthataretemporaryinnature andwhoseimpactwouldbeexpected todissipatetowardtheendoftheyear,barringfurtherfallsinglobalcommodityprices.

ThereisnosignyetintheUKofthesystemicdeflationexperiencedinJapaninthe1990sandtheEurozonemorerecently.

Inourmainscenario,weexpecttheannualrateofinflationontheConsumerPricesIndex(CPI)measuretoaverage0.3%thisyear.Thisissignificantlybelowtheaverageof1.5%reportedin2014.Weexpectinflationtoregainmomentumin2016,bringingtherateclosertoitstargetlevelof2%bythe endofnextyear(seeFigure2.10).

AswithourGDPscenarios,wehavealsoconsidered two alternative scenarios for UKinflation:

London and the South East are expected to retain their positions as the two fastest growing regions this year with a growth rate similar to the previous year.

5 AsdiscussedindetailinSection4,thisisalongtermtrendlinkedinparttotheprominentpositionofLondoninnewcomputer-relatedareasofwork, with positive spillovers to other parts of the South East.

6 Thissignificantregionaldatalagexplainswhywedonotattempttomakeregionalgrowthprojectionsfor2016atthistime.


• Inour‘high inflation’ scenario, we assumethatacombinationofstrongerglobalgrowth,amarkedreboundinoil prices and resilient developments in domestic cost growth will push headlineCPIinflationbackuptoaround3%onaveragein2016.

• Inour‘low inflation’ scenario,bycontrast, we assume that UK domestic demandgrowthwillbeslower,globalGDPgrowthratesdeteriorateandcommoditypricesremainweak. As a result, the average annual inflationrateinthisscenariowouldremainverysubdued,averagingonlyjustabovezeroin2016.Inthisscenario,weexpectnegativeinflationratesforseveralquartersin2015 (ascomparedtoonlyforamonth ortwoinourmainscenario).

AswithGDPgrowth,thesealternativescenariosarenotaslikelyasourmainscenario,butbusinessesshouldplanforsuch contingencies.

Outlook for real earnings growth

AsshowninFigure2.11,realaverageearnings growth was pushed into negative territoryfor6yearsupto2014,withrealgrowthratesaveraging-1.2%perannumduring that period. However, the real earningssqueezeexperiencedin2014wasverymodestcomparedtoearlieryears.The largest real earnings squeeze was experiencedin2011withafallof2.5%.

In2015,ourmainscenarioisthatthesqueeze will end and real earnings will exhibitpositivegrowth.Thisisdueprimarilytotheverylowconsumer priceinflationrateexpectedin2015, asdiscussedabove.Thispositivegrowthin real earnings is expected to continue inthefollowingfewyears,asFigure2.11shows,butthelevelofrealearningswouldnotbeexpectedtoregainpre-crisispeaksuntillateinthisdecade.

Figure 2.10: Alternative UK inflation (CPI) scenarios


Projections

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% c

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Main scenario Low inflation High inflation

2010Q1

2011Q1

2012Q1

2013Q1

2014Q1

2016Q1

Inflation target = 2%

2015Q1

Inflation target

Figure 2.11: CPI inflation vs nominal earnings growth

Source: ONS, PwC analysis

Projections

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20172016201520142013201220112010200920082007200620052004200320022001

CPI

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Real Squeeze

% c

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CPI Average weekly earnings (excl bonus)


2.4Monetaryandfiscalpolicy optionsTheMonetaryPolicyCommittee(MPC)again agreed to maintain the Bank Rate at0.5%andthestockofpurchasedassetsfinancedbythecentralbankreservesat£375billionatitsFebruarymeeting.However,fortwomembers,thedecisionwas“finelybalanced”asthecase for increasing the Bank Rate later thisyearisstrengthenedbytheoutlookofdomesticinflationarypressuresinthemedium term. Against this, for one memberoftheMPC,thelikelihoodof amonetarypolicytighteningwasthesame as loosening.

Itseemsunlikelythattherewillbeanearlyraterise(certainlynotbeforethegeneralelectioninMay),butwewouldexpectthedebateontheMPCtopickupagainaslongastherecoverycontinuesthroughtheyearandtherearenomajoradverseglobalshocks.Inthiscase, wemightexpectthefirstrateriseinlate2015orpossiblyearly2016,thoughanysuchincreasesarelikelytoproceedat averygradualpace.

Therefore we might expect interest rates toincreasetoaround2%bytheendof2017andtoaround3.5-4%by2020.Business and individuals should consider suchrisesinthecostofborrowingmoving forward, as well as stress testing against rate rises where these would have majoreffectsontheirfinances.

Thelatestpublicsectorfinancesdata sawastrongbudgetsurplusinJanuary. Itnowseemslikelythatthebudgetdeficitwillcomeinataround£90billionin2014/15asawhole,similartotheOBR’sforecastinDecemberbutsomewhathigher than the implied forecast at the timeoftheMarch2014Budget(althoughdefinitionalchangessincethenmakeaprecisecomparisondifficult).

Fiscalpolicyplansfor2015/16andbeyondwillbereviewedintheBudget,which the Chancellor will deliver on 18 March.Wewouldnotexpectanymajorchangeintheoverallfiscalstance,withany‘giveaways’beingbroadlybalancedby‘takeaways’.However,whateverthecomposition of the next government, furtherfiscaltighteningislikelyforatleastthenext2-3years,thoughthetaxand spending plans of the different parties diverge more after that period.

2.5 Summary and conclusionsThepaceoftheUKeconomicrecoveryeasedslightlyinthefourthquarterof2014,butremainsrelativelystrongcompared to the rest of Europe. Consumerspendinghasbeenakeydriver of this growth and the upward trendininvestmentinrecentyearshasalso helped to support growth (despite adipininvestmentinQ42014). The services sector remains the main engineofgrowthasithasconsistentlyoutperformed the manufacturing and constructionsectors,butbothofthesealsoshowedsomerecoveryin2014.

Inourmainscenario,weexpecttheUKeconomytogrowbyaround2.5%in2015,helpedbytheboosttohouseholdspending power from lower oil prices, beforeslowingslightlytoaround2.3%in2016.WeexpectLondonandtheSouthEasttocontinuetobethefastestgrowingpartsoftheUKin2015,butallregionsshould show positive growth of more than1.5%thisyearinourmainscenario.

OurmainscenarioprojectionisforinflationtoremainalongwaybelowtheMonetaryPolicyCommittee’s(MPC)inflationtargetof2%thisyear,butthenpickuptowardstargetin2016,ontheassumptionthatoilpricesrisegraduallyover this period. We would not dismiss thepossibilityofaninterestrateriselaterthisyeariftheMPCseesdomesticinflationarypressuresmountinginthemedium term.

SignificantuncertaintiescontinuetosurroundtheUKrecovery,withrisksstemmingfromtherecentproblemsinGreeceandelsewhereintheEurozone,and continued geopolitical tension in Russia/UkraineandtheMiddleEast.However, there are also upside possibilitiesduetothecontinued robustgrowthininvestmentandconsumerspending,particularlyifoilprices remain low (as discussed in more detailinthenextsectionofthisreport).

Insummary,theUK’srecoveryremainsrelativelyrobust,buttheinternationalenvironmentcontinuestobeasource of downside risks.


3 – The impact of lower oil prices on the UK economy

Key points• Thesignificantfallinoilprices sincemid-2014shouldincreaseoverallUKeconomicactivityas the cost of production decreases for businesses,especiallyforthosethatareheavilydependentonoilinputs.Thiswillboostbothinvestment andemployment.

• Although the oil and gas extraction sectorisnegativelyaffectedbythereduction in the oil price, sectors such as agriculture, air transport, cokeandrefinedpetroleummanufacturingandoil-intensivemanufacturingsectorswillbenefit asthepriceoftheirkeyinputfalls.

• Water transport and other services sectorswillenjoyasmallpositiveimpact.However,oil-intensivesectorsarelikelytobenefitfrom the reallocation of capital and resources at the expense of less oil-intensivesectors.

• WeuseamodeloftheUKeconomytoquantifytheseeffectsinthreealternativescenarios.Inacasewherethe reduction in the oil price is permanent, settling at around $50perbarrel,thesizeoftheUKeconomy(GDP)increasesbyaround1% on average relative to the baselinebetween2015and2020.Employmentalsoincreasesbyaround90,000by2020,withapeakboosttoemploymentofaround120,000in2016.

• Incontrast,theimpactsaresmallerwhere the fall in the oil price is temporary:dependingonhow farandfastoilpricesrebound, theboosttoGDPcouldvary from0.2-0.5%andtheincrease inemploymentby2020could varyfrom3,000to37,000.

• Real household incomes also rise as oil prices fall, which increases consumer spending. This is due to two factors: overall consumer prices fall as cost savings are passed on to households and real wages increase asdemandforlabourrisesinfast-expandingsectors.

• As a result of growing economic activity,governmenttaxrevenuesalso rise as the tax take from corporate and personal income taxes increase, more than offsetting declining revenues from the oil and gas sector. The fall in the oil price should also have a small impact in narrowingtheUKtradedeficit.

IntroductionThe dramatic decline in oil prices since mid-2014ishavingasignificantimpactontheworldeconomy.Howdoessuch a large and unexpected decline in oil pricesaffecttheUKeconomyspecifically,andwhichindustrysectorsarelikelytoemergeaswinnersorlosers? How does a change in the oil price affect UK government revenues andthetradebalance?

Inordertoanswerthesequestions, weusedourdynamiccomputablegeneralequilibrium(CGE)modeltoassess the impact of future changes intheoilpriceontheUKeconomy. Weusedthreeprojectedoilpricescenarios that differ in the magnitude and persistence of the oil price shock, againstabaselinewhereoilpricesremainatmid-2014peaklevels.

The rest of the article is structured as follows:

• Section 3.1 discusses past trends in oil prices and the UK’s trade position in crude oil and oil products.

• Section 3.2 sets out our oil price scenarios and modelling approach.

• Section 3.3 discusses the results fromtheanalysis.

• Section3.4summarisesanddrawsconclusionsfromtheanalysis.

The significant fall in oil prices since mid-2014 should increase UK economic activity.


3.1 Trends in oil prices and the UK’s positionTrends in oil prices

OilpricesmostlytradedabovetheUS$100/barrelmarkoverthefouryearstomid-2014.However,bymid-January2015,oilpriceshadfallendramaticallyto around a third of their peak level in June2014and,despitesomerecoverysincemid-January,remainwellbelowthose levels. The recent fall in oil prices wasoneofthebiggestinhistory,withtheonlycomparabledeclinesinrecentdecadesbeingtheoilpricecollapseinthe1980sandinthe2008-9globalfinancialcrisis.Thelatterwasreversedrelativelyquickly,buttheformerprovedtobelong-lasting,soweneedtoexplorehow different scenarios for future oil pricemovementswillinfluencetheeconomic impact of the recent decline.

Acombinationofsupply-anddemand-side factors led to this sharp decline. Onthesupply-side,stronggrowthinproductionbynon-OPECproducers and growing US shale oil production havecontributedtoanoverallincreasein output. Added to this is the apparent strategyofOPECproducersledbySaudiArabia(whohavelowerproduction

costs)tomaintainproductionlevels in order to defend and grow market sharebyforcingmoreexpensiveunconventional sources out of the market.Onthedemand-side,thedecelerating pace of growth in China andthesloweconomicrecoveryin theEUhavecontributedtoweakeningdemand for oil.

Thesefactorscombinedhaveexerteddownwardpressureonprices.Inaddition,oil consumers are taking advantage of theopportunitytostockpilecheapoil,which could further dampen demand foroilintheshort-term.

Inthelongerterm,technologicaladvancements will continue to drive down the costs of extracting unconventional shale gas and tight oilreserves(includinghydraulicfracturingor“fracking”methods),whichwillbolsternon-OPECoilsupply.Furthermore,therebalancingoftheChineseeconomyawayfrommanufacturing to services could have a negative impact on oil consumption.1 Growthinotherdevelopingcountries,increasingenergyefficiencyandtheshifttowardsrenewableenergyindeveloped countries could mean that

Figure 3.1: UK net exports of crude oil and oil products2

Source: DECC

-30,000

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-10,000

0

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20132012201120102009200820072006200520042003200220012000

'000

tonn

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Crude oil Oil products

demandforoilisincreasinglydriven bydevelopingcountriesratherthandeveloped countries.

The net impact of these factors is unclear, butcouldimplyareturninthelongerterm to a level of oil prices in line with marginalsupplycosts,whichatcurrentandprojectedlevelsofglobaldemandmightbearound$70-100perbarrel. Thepathbywhichpricesreturntothiskindoflevelis,however,highlyuncertain,asisthepaceofanysuchadjustment.

The UK’s position

The UK is the largest producer of oil andsecond-largestproducerofnaturalgasintheEuropeanUnion.ProductionfromUKoilandnaturalgasfieldsintheNorthSeapeakedaroundthelate1990sandhasdeclinedsteadilysinceasthediscoveryofnewreservesandnewproduction has failed to keep up with thematurityofexistingsites.Figure3.1shows the UK’s position in terms of net exports of crude oil and oil products. Followingyearsofbeinganetexporterof petroleum and natural gas, the UK becameanetimporterofcrudeoilfrom2005,andoilproductsfrom2013.

1 IMF(2013)“CommodityMarketReview”,October2013.2 Crudeoilincludestheproductionofcrudeoilandnaturalgasliquids,petroleumproductsarerefinedcrudeoil.Anegativevaluesignifiesthatinthatparticularyear

imports were greater than exports.


Figure3.2comparesthehistoricrealgrowthinGVAfortheUKoilandgassectorandfortherestoftheeconomy.Theoilandgas sector – which consists of the extraction of crude petroleum and natural gas and the manufactureofrefinedpetroleumproducts– has shrunk to around a third of its size sinceitspeakinthelate1990s.Thesectornow accounts for less than 2% of total UK GVA,ascomparedto6%in1999.

3.2 Modelling the impact of oil price shocks on the UK economyOur modelling approach

Weusedacomputablegeneralequilibrium(CGE)modeltoassesstheimpactoffuturechangesintheoilpriceontheUKeconomyin three alternative scenarios. The model estimateshowtheUKeconomywouldreacttochangesinpolicy,technologyandotherexternalfactorsbylookingattheinteractionsbetweendifferentindustrialsectors, households, the government and the rest of the world. These models are a standard tool of empirical economic analysis,andarewidelyrecognisedandusedbyinternationalorganisationssuchastheIMF,OECDandtheWorldBank,as well as the European Commission, nationalgovernmentsandcentralbanks.

We simulate an oil price shock in this modelbyreducingtheoutputpriceoftheoil and gas extraction sector and the input priceofothersectorsintheeconomy,which takes into account the relative oil intensityofthedifferentsectors.

Oil price scenarios

We assess the following three scenariosfortheperiodto2020(showninFigure3.3):

Figure 3.2: Real GVA growth for oil and gas sector vs rest of UK economy

Source: ONS

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-10

-5

0

5

10

20142013201220112010200920082007200620052004200320022001200019991998

% p

.a. g

row

th

Oil and gas sector GVA excl oil and gas

Rest of economy

Oil and gas

Figure 3.3: Alternative oil price scenarios

Source: PwC analysis, IMF

Baseline

0

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Scenario 3

Scenario 2

Scenario 1US$/

barr

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Baseline

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2011Q1

2013Q1

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2020Q1

2012Q1

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Scenario 1 Scenario 2 Scenario 3

• Scenario 1: Oil price remains atalowlevelofUS$50/barrel.

• Scenario 2:OilpricegraduallyincreasestoUS$73/barrelin2020.3

• Scenario 3:OilpricegraduallyreturnstoUS$108/barrelin2020.

TheCGEmodelmeasurestheimpactofeachscenariorelativetoabaseline

3 TheforecastsforScenario2weredrawnfromtheIMF’sprojectionspublishedinJanuary2015.ThisscenarioisalsobroadlyconsistentwithourmainscenariofortheUKeconomyinSection2above.


Figure 3.4: Impact on the level of real GDP, 2015-2020


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where the oil price remains at its mid-2014peakofaround$108perbarrel.ThisbaselineisalsoconsistentwithourgrowthprojectionsfortheUKeconomypublishedintheJuly2014issue of the UK Economic Outlook. Themodelalsoassumeslonger-term UKeconomicgrowthtobeinlinewithhistorical trend growth rates.

3.3 Results from our analysisThe results from the modelling show thattheUKeconomywillbesignificantlyaffectedbyareduction inoilprices.AlthoughNorthSeaoilproducersandrefinerswillexperience areductioninoutput,theUKeconomybenefitsasawhole.Generally,thefall in oil prices increases overall economic activityasthecostofproductiondecreases and investment increases. Consumersalsobenefitfromlowerenergycostsandcheapergoodsandservices,whichboostsrealincomes and translates into an increase in consumption. Below we present and discuss these results in more detail.

Impact on overall UK GDP

Figure3.4showstheimpactofthechange in oil price on the level of UK realGDP.4AsshowninFigure3.4, in Scenario 1, where the oil price remainspersistentlylowatUS$50 perbarrelbetween2015and2020, the initial impact will raise the level of realUKGDPbyaround1.2%inthefirstyearrelativetothebaselinewhereoilpricesremainedat$108perbarrel. Theeffectpeaksin2016whenthelevelofGDPincreasesbyaround1.4%ofthebaselinelevelasthefullimpactoftheoilpriceshockfiltersthroughtheeconomy.Theimpactthentailsofftoaround0.6%ofthebaselineastheUKisexposedtostrongercompetitionbycheaperimports

fromothercountriesthatalsobenefitfrom the oil price shocks, thus diminishingthebenefittotheUK.

InScenario2wheretheoilpricerecoversgraduallyto$73by2020inlinewithlatestIMFprojections,UKGDPisestimatedtobearound0.5%higheronaverageoverthe2015-20periodrelativetothebaseline.

InScenario3,wheretheoilpricerecoverstomid-2014levelsby2020, theimpactontheeconomyismuchsmallerat0.2%onaverageoverthe2015-20period,withminimaleffectsonthelevelofGDPby2020giventhisisapurelytemporaryshockinthisscenario.

The model assumes adaptive expectations, which means that economic agents revise their expectations of future oil prices during eachperiodbasedoncurrentoilprices.The implication of this assumption is thatthereisalagbetweentheinitial oilpriceshockandthesubsequenteconomic impact. The stickiness of downwardpriceadjustmentsalsomeans

that the impact of the oil price shock takestimetofilterthroughtheeconomy.

Inthefollowingsub-sections,wesetouttherestofthefindingsfromouranalysis,particularlywithregardtosectoralGVAandemployment,inflation,householdconsumption, UK government revenues andthetradebalance.

Impact on output by industry sector

Figure3.5mapsthetransmissionofafallintheoilpriceattheindustrysectorlevel.Wedistinguishbetweentheoil and gas extraction sector, sectors with oil-intensiveproductionprocesses, and sectors that use oil and gas less intensivelyintheirproductionprocesses.Ouranalysisfocusesontheimpactofthefall in the oil price on the UK as a whole, ratherthanfocusingonspecificregionswithintheUK.However,therearelikelytoberegionaldifferences,dependingonthedistributionofoil-intensiveindustriesacross the regions.5

TheCGEmodeltakesintoaccountthe“reorganisationeffect”,wherefirmsautomaticallyadjusttheirproduction

4 Seethetechnicalappendixforcomparisonsoftheresultsofourstudywithexistingacademicliterature.5 Inparticular,theareaaroundAberdeenmaybealosergiventheconcentrationofonshoreoilandgasactivitythere.SomepartsoftheNorthandMidlandsmayalsobenefitmorefromimpactsonoil-intensiveheavyindustry,butourmodeldoesnotallowquantificationoftheseregionalvariations.


Figure 3.6: Oil intensity by sector, 2014

Source: ONS

0 5 10 15 20 25 30 35

Proportion of intermediate consumption accounted for by petroleum (%)

Electricity, gas, steam and air conditioning supply

Air transport

Land transport

Agriculture, forestry and fishing

Oil-intensive manufacturing

Water transport

Wholesale and retail trade

Other industry

Other service activities

Construction

Non-oil intensive manufacturing

Financial services and insurance

Figure 3.5: Transmission mechanism of a fall in the oil price

processes in response to changes in input prices, such as wage costs and the cost of intermediate inputs. As the prices of intermediate inputs, such as oil, fall, firmsreorganisetheiractivitiestomakeefficientuseofcheaperinputs,enablingthemtoincreaseoutput.Oil-intensivesectors such as the utilities, transportation,agricultureandoil-intensive manufacturing sectors (seeFigure3.6)arelikelytobenefitmost.Withintheoil-intensivemanufacturing sector, oil and gas-relatedinputsandenergyconsumptionaccountforatleast10% of total intermediate consumption for the following sectors: the manufacture ofrefinedpetroleum,industrialgasesand chemicals, cement and metals.

Oil and Gas SectorSectors with oil intensive

production processes

Sectors that use oil and gasless intensively in their production processes

These sectors experience smaller economic impacts as their oil related cost base falls by less. This means that they have less scope to reduce

prices. They may also experience more competition for scarce resources e.g. skilled

labour or investment so may find it harder to compete with oil intensive industries.

There is generally an increase in aggregate demand in the economy and

these sectors will benefit. They will increase their downstream purchases.

Oil becomes cheaper as an input. Able to reduce prices to increase the demand for their products. If benefits

are not passed on (this happens in some sectors), their profits increase.

Leads to increased investment and greater downstream demand.

Market prices fall and this knocks through to revenues and profits.

Leads to reduced investment and less exploration in the North Sea.

Also purchase less from the downstream supply chain.

Sector Impact Sector Impact Sector Impact

Supply Chain Impact Supply Chain Impact Supply Chain Impact


The model also assumes that workers canmovebetweensectorsastheseexpandorcontract.Ifwagesriseinasectorthatbenefitsfromthefallintheoil price, then we can expect workers to move into this sector to gain from the wage rise. The model also assumes atemporarylossinproductivitytotakeinto account the fact that people need toberetrainedwhenmovingbetweensectors,andconsequently,theirwagesfall during this period.

Table3.1showstheaverageestimatedimpact of the fall in the oil price on the levelofrealGVAbysectorbetweentheyears2015and2020.Averageimpactsare smaller in Scenarios 2 and 3 than in Scenario 1 as in these scenarios the scaleoftheoilpricedeclineisdefined tobesmaller.

As we might expect, the modelling resultssuggestthatsectorswithoil- andenergy-intensiveproductionbenefitmost from a reduction in the oil price. Thesesectorswillbenefitfromlowerproduction costs, and these cost reductionsareassumedtobelargelypassed through to consumers over time which in turn creates increased demand for their products. Higher levels of demand lead to increased investment andimprovedproductivity.Therewillalsobegreaterdemandforexportsandincreased import competition. The increase in overall output also generates more demand for supplier inputs, whichpositivelyaffectsthedownstreamsupplychainviathemultipliereffect.6 Thisiscombinedwithafurtherknock-on impact on aggregate demand as workersemployedwillspendmoreongoodsandservicesintheUKeconomy.

In Scenario 1withpersistentlylowoilprices, the agriculture, air transport,

Table 3.1: Impact on level of real GVA by sector, average for the years 2015-2020


Average % difference from baseline Scenario 1 Scenario 2 Scenario 3

Agriculture, forestry and fishing 2.3% 1.1% 0.3%

Air transport 2.1% 1.0% 0.3%

Manufacture of coke and refined petroleum products

1.6% 0.7% 0.6%

Oil-intensive manufacturing 1.4% 0.6% 0.4%

Other industry 1.4% 0.6% 0.3%

Construction 1.2% 0.6% 0.1%

Non-oil intensive manufacturing 0.9% 0.5% 0.4%

Financial services and insurance 0.7% 0.3% 0.2%


0.7% 0.3% 0.1%

Wholesale and retail trade 0.3% 0.1% 0.0%

Water transport 0.3% 0.1% 0.0%

Land transport 0.2% 0.1% 0.0%

Other service activities 0.0% 0.0% -0.1%

Government -0.1% -0.1% 0.0%

Extraction of crude petroleum and natural gas

-7.9% -4.0% -2.2%

oil-intensivemanufacturingandconstruction sectors all experience an expansioninoutputofaround1-2%ofsectorGVA.Thecokeandrefinedpetroleum manufacturing sector also expandsbyaround1.6%inScenario1.Althoughtheoilintensityofthissectorisrelativelyhigh,theimpactoftheoilprice fall is dampened due to its close linkages with the oil and gas extraction sector,whichisnegativelyaffected.Manufacturingsectorsthatarerelativelyoil-intensiveandenergy-intensive, such as the manufacturing of cement, industrial gases and chemical

products,metals,machineryandequipment and wood products, also experience an increase in output due to the fall in the oil price.

Thebenefitstomanufacturerswouldnotbeuniformlypositiveandareductioninoil prices could generate winners and losers.Forinstance,sectorsthatuselarge volumes of imported materials couldbenefitastransportationcosts fall and overseas suppliers pass on thebenefitstheyobtainfromloweroilprices. However, sectors that operate inexportmarketsmayexperience

6 Theincreaseindemandforsupplierinputsalsoleadstoanincreaseininputprices.


increasedcompetitionfrombusinesseswho can now compete on price in these markets due to lower production and transportation costs.

The role of the transport sector, whether itbebyland,seaorair,willbecriticalindeterminingthescaleofanyeconomicimpacts from oil price reductions. Transport services are critical in facilitating trade within the UK and internationally.Morespecifically,althoughlandtransportisfairlyoil-intensive,itisalsoahighlycompetitivesector. This means that although overall output volumes have increased, the reduction in oil prices could increase the numberofnewentrantstothesector,orforceincumbentstoexpandtheservicestheyoffer,therebysqueezingoverallindustrymargins.

Our modelling also suggests that the construction sector could also gain significantlyfromareductioninthe oilprice.Asbusinessinvestmentrisesfollowing the rise in intermediate demand and consumer spending, we would expect the construction sector tobethekeybeneficiary.Inordertoexpand,businesseswillneedtomovetonew premises, enlarge existing premises orengageinrefurbishment,andtheconstructionsectorwillbetheprimaryprovider of these services.

Thefinancialservicessectorwillexperience a small positive impact on output as it facilitates the reallocation of capital and other resources to the sectors that want to invest in response torisinglevelsofdemand.Ingeneral,oil-intensivesectorsarelikelytobenefitfrom the reallocation of capital and resourcesattheexpenseoflessoil-intensivesectorsthatdeliverrelativelylower returns to investors.

Moregenerallytheimpactonthe“otherservices”sectorwillbelargelyneutral.Thesesectorswillbenefitthroughincreased demand for their products fromothersectorsoftheeconomythatare expanding as well as increased consumer spending. However, the businessesinthissectormayfindincreased competition for scarce resources,e.g.skilledlabourandinvestment,whichmaylimittheircapacitytorespondtothisincreaseddemand. A similar effect occurs in the publicsector–growthinthesectorisconstrainedbygovernmentspendingplans,andthesectorfindsitdifficult to retain skilled workers who leave for higher wages in the expanding sectors.

Although the fall in the oil price is associated with an increase in household spending, the wholesale and retailtradesectordoesnotreflectallofthe increase in spending as this sector onlycapturesthevalueassociatedwithactivitiesrelatedtothedistribution,notthe production, of manufactured goods.

Therefore, most of the value generated from increased household spending is reflectedinthemanufacturingandagriculturesectors.Theprimaryproductproducedbytheagriculturesector is food and raw material for clothing, so agriculture is therefore expected to experience a rise in demand associated with increased consumer spending.Similarlythemanufacturingsectorbenefitsbecauseitproducesconsumerdurablesandclothing.

However,whilethesesectorsmaybenefitfromlowerfuelcosts,wehavenottakenintoaccountanyadversecorresponding economic effects that might dampen economic performance inthesesectorsandreducetheirabilityto pass on lower oil prices to their customers, e.g. a weaker outlook in theEurozonemayrestricttheirability to invest.

The oil and gas extraction sector is most heavilyimpactedbythefallinoilprices(seeFigure3.7)andistheonesector

Figure 3.7: Oil and gas extraction sector - impact on level of real GVA, 2015-2020


-14

-12

-10

-8

-6

-4

-2

0202020192018201720162015


% d

iffer

ence

from

bas

elin

e


thatlosesoutsignificantlyintermsofGVA.Theindustryislikelytofacefurthercost pressures as highlighted in the recent ActivitySurveypublishedbyOil&GasUK, which shows the costs of operating intheUKContinentalShelfrisingby8%in2014,andproductioncostsincreasingfrom£17/barrelto£18.50/barrel.7

InScenario1,theoilandgasextractionsector suffers a severe contraction in outputandemploymentduringthefirsttwoyearsfollowingareductionintheoilprice, with higher cost producers exiting theindustryorscalingbacktheiroperations. A permanent reduction in the oilpricecouldreducethelevelofGVAinthissectorbyaround8%onaveragebetween2015and2020,withapeakoutputlossofaround12%in2016.

InScenarios2and3,wheretheoilpricereturns to a higher level, the oil and gas extraction sector could suffer a smaller contraction in output, which might moderate over time. The oil price will also have a negative effect on investment and explorationactivitybythesector.Thereissomeriskthatasignificantdownturncouldaffecttheabilityoftheindustrytoinvestinmajorinfrastructure(suchashubplatformsandpipelines),causingtheexplorationofsmallerandmoretechnicallydifficultfieldstobecomeuneconomic.

Although the fall in the oil price is permanent, it triggers an increase in demand for oil as it is now a cheaper input. The fall in the oil price also narrowsthegrowingspreadbetween oil and gas prices, which slows the rate of switchingfromoiltogas,ortorenewablesourcesofenergyinthelonger-termas

Table 3.2: Increase in total UK employment relative to baseline, 2016 vs 2020


Oil price scenario 2016 2020

Scenario 1 (staying at $50) 121,000 91,000



Table 3.3: Impact on level of employment by sector, 2020, in thousands of full time equivalents


In thousands Scenario 1 Scenario 2 Scenario 3

Construction 20.2 8.0 0.7

Wholesale and retail trade 18.9 7.8 0.7

Agriculture, forestry and fishing 13.4 5.3 0.5

Oil-intensive manufacturing 12.8 5.0 0.5

Land transport 10.9 4.5 0.4

Financial services and insurance 6.9 2.7 0.3

Non-oil intensive manufacturing 5.9 2.4 0.2

Other industry 4.4 1.8 0.2

Other service activities 2.1 0.9 0.1

Air transport 1.8 0.8 0.1


1.2 0.5 0.0


0.2 0.0 0.0

Water transport 0.0 0.0 0.0

Government -4.2 -1.8 -0.1


-2.9 -1.2 -0.1

7 Oil&GasUK“ActivitySurvey2015”

the cost saving incentives to do so are lessened. The increase in economic activityinothersectorsalsoleadstoasubsequentincreaseinthedemandforoil.Thisreboundeffectmeansthatthecontractioninoutputexperiencedby the oil and gas sector slows over time.


Impact on employment

The fall in the oil price will have a positiveimpactonemployment, which is associated with increased levels ofeconomicactivity.Theincreasedproductivityandprofitabilityamong UKbusinessesthatbenefitfromthefallin the oil price will increase demand for labourandcapital,which,inturnincreases wages and investment returns. Higher wages attract more workers into employmentinthesesectors,andunemploymentfalls.

Table3.2showstheincreaseinemploymentrelativetothebaselinefortheUKeconomyinourthreescenarios.Theemploymentimpactspeakin2016and moderate over time as the effects of loweroilpricesfilterthroughtheeconomy.Ifthereisapermanentreductionintheoilprice,theeconomywillseeanincreaseinemploymentofaround90,000by2020.Theemploymenteffects are smaller where the fall in the oilpriceistemporary:inScenarios2and3,thetotalnumberofjobsincreasesbyaround37,000and3,000respectivelyby2020.

Table3.3showstheemploymentimpactsbysectorinthousandsofjobs.The construction sector will see the largestincreaseinemploymentinabsoluteterms,followedbythewholesale and retail trade sector, andagriculture.Theoil-intensivemanufacturing sectors will also see an additional13,000jobsifthefallintheoilpriceispermanent.Inpercentagetermshowever(seeTable3.4),theagriculture, air and land transport sectors will experience the largest percentageincreasesinemployment. Asoutlinedabovethesesectorsbenefitfrom a rise in consumer spending. Both the agriculture and retail sectors

Table 3.4: Impact on level of employment by sector, 2020, in % difference from 2013


% difference from 2013 Scenario 1 Scenario 2 Scenario 3

Agriculture, forestry and fishing 2.9% 1.2% 0.1%

Air transport 2.6% 1.1% 0.1%

Land transport 2.3% 0.9% 0.1%


1.6% 0.6% 0.1%

Construction 1.6% 0.6% 0.1%

Other industry 1.5% 0.5% 0.1%

Oil-intensive manufacturing 1.4% 0.5% 0.0%


0.8% 0.3% 0.0%

Financial services and insurance 0.7% 0.3% 0.0%

Non-oil intensive manufacturing 0.5% 0.2% 0.0%

Wholesale and retail trade 0.4% 0.2% 0.0%

Other service activities 0.0% 0.1% 0.0%

Government -0.1% 0.0% 0.0%

Water transport -0.1% 0.0% 0.0%


-7.9% -3.1% -0.3%

provideanentrypointintothelabourmarketforpart-timeorlowerskilledworkers,whichmakeitrelativelyeasierfor these sectors to attract new workers and meet the predicted demand increase. The lower input costs for themanufactureofcokeandrefinedpetroleum also means that the sector willseeanincreaseinemploymentofaround1.6%wherethefallintheoilpriceispermanent.Asdescribedin theprecedingsection,thepublicsectorexperiencesafallinemploymentaspublicsectoremployeesmovetothefaster-growingprivatesectorswherewages are now higher.

The fall in the oil price will have a positive impact on employment.


Impact on inflation

The lower cost of production from the fallinoilpriceacrossarangeofenergy-intensivegoodswillbepassedontoconsumerstovaryingdegrees,andsoreduceinflationdirectlyasisalreadyapparentinthelatestCPIfigures.AlthoughtheincreaseinrealGDPandaggregate demand will exert upward pressureonprices,thisisoffsetbythecost savings that translate into lower consumerprices.Figure3.8showsthemodelled impact of negative oil price shocksonconsumerpriceinflationinour three scenarios, relative to a baselinewhereinflationremainedontargetat2%.Notethatthisignoresotherfactorsthatmayaffectinflation,soit is illustrative of how oil price changes aloneaffectinflation,ratherthanbeingforecastsofwhatwethinkinflationwillactuallybe(forwhichreadersshouldrefertoSection2above).

Figure 3.8: Impact on CPI inflation relative to baseline target level, 2015-2020


1.0

1.2

1.4

1.6

1.8

2.0

2.2

202020192018201720162015


Inflation target: 2%

CPI,

annu

al %

cha

nge

Figure 3.9: Household expenditure, average per week, 2013

Source: ONS

0

10

20

30

40

50

60

70

80

HealthEducationCommunicationClothingand

footwear

Householdgoods

and services

Miscellaneousgoods

and services

Restaurantsand

hotels

TransportHousingHousehold fuel(incl for personal

vehicles)and power

Recreationand

culture

Foodand

beverages

£/w

eek

Impact on household spending

Figure3.9showsaveragehouseholdexpenditure per week on various goods and services. Expenditure on power and fuel(includingforpersonalvehicles)accountforaround11%oftotalweeklyspend,or£50perweek.

Our modelling suggests that consumers benefitoverallfromthereductioninoilpricesasbusinessespassoncostsavingsto consumers in the form of cheaper goods and services. However, less than 1%ofelectricityintheUKisgeneratedfrom petroleum, so the fall in the oil


pricewillonlyhaveaminimalimpact onthehouseholdelectricitybills.Householdsshouldalsobenefitastheincreaseindemandforlabourinfast-expanding sectors should increase the overalllevelofwagesintheeconomy,thus increasing their spending power. Thisisoffsetslightlybythesubsequentincrease in prices due to the increase in demand for consumer goods and services,buttheoverallnetimpactis an increase in real household spending.

Figure3.10showstheimpactonhouseholdspending in real terms as a result of the fallintheoilprice.InScenario1, thepersistentlylowoilpricewillenablehouseholdconsumptiontorisebyanadditional£372ayearinrealtermsonaveragebetween2015and2020. Wherethefallintheoilpriceistemporary,the impact on real household spending issmaller,increasingby£195andjustover£100ayearonaverageinScenarios2and3respectively.

Impact on the trade deficit

Figure3.11showstheimpactonUKexportsasapercentageofGDP,asaresult of the fall in oil prices. As a net importer of crude oil and oil products, the fall in the oil price will provide a smallbenefittotheUKbynarrowing thetradedeficit.InScenario1,theexpansion in other sectors also leads to an increase in exports. However, the value of exports decreases in the short-runasthewealtheffectfromthefall in the oil price means that more goodsandservicesarebeingconsumeddomestically.ThiseffectalsoexplainswhytheimpactonUKexportsislessapparent in Scenario 1 in comparison to Scenarios 2 and 3.

Figure 3.10: Impact on real household spending average over 2015-2020

0

50

100

150

200

250

300

350

400


372

195

104

Aver

age

£ pe

r hou

seho

ld/y

ear

(real

term

s at

con

stan

t 201

3 va

lues

)


Figure 3.11: UK exports in different oil price scenarios, 2015-2020


29.2

29.3

29.4

29.5

29.6

29.7

29.8

29.9

202020192018201720162015


% o

f GDP


Figure3.12showstheimpactonUKimports.Importsdeclineinitiallyasthecostofoilimportsfall.Inthelonger-term,althoughUKfirmsexperienceanimprovement in international competitiveness and exports increase, this also generates wealth, part of which willbespentbyhouseholdsonincreasing their consumption, including imported goods. This means that the impact on net exports is dampened as overall economic growth in the UK also drivesupimports.Onbalance,ourresultssuggestthattheUKwillenjoy asmallnarrowingofthetradedeficit as a result of the fall in the oil price.

Impact on UK government revenues

TheUKoilandgasfiscalregimeappliesto exploration for, and production of, oil in the UK and on the UK Continental Shelf.Thiscurrentlyconsistsofcorporationtax,thesupplementarycharge and the petroleum revenue tax. Figure3.13showsthetrendsingovernment tax receipts from the oil and gas sector compared to trends in oil prices.Upuntilfiscalyear2011-12, the share of government revenues from theUKoilandgassectorbroadlyfollowed trends in oil prices. However, thisrelationshipbegantodecoupleinrecentyearsassignificantdeclinesinoilproduction and increasing costs led to a reduction in tax revenues from the sector. In2012-13,taxrevenuesfellbyaround45%to£6.1billion,andthenfellagaininthefollowingyearbyaround25%to £4.7billionduetolowerproductionlevels and higher expenditure. These trends are linked to the increasing maturityoftheNorthSeafieldsasoil andgasfrommarginalsitesbecomemoreexpensiveanddifficulttoextract.

Figure 3.13: Revenues from the UK oil and gas sector

Source: ONS, Thomson Reuters

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

2013-2014

2012-2013

2011-2012

2010-2011

2009-2010

2008-2009

2007-2008

2006-2007

2005-2006

2004-2005

2003-2004

2002-2003

2001-2002

2000-2001

1999-2000

0

20

40

60

80

100

120

% o

f gov

ernm

ent r

even

ues

Oil price, US$/barrel

Share of government revenues Oil price

Figure 3.12: UK imports in different oil price scenarios, 2015-2020


29.5

29.6

29.7

29.8

29.9

30.030.1

30.2

30.3

30.4

30.5

202020192018201720162015


% o

f GDP


Figure 3.14: Net impact on government tax revenues per annum, average over 2015-20


0

1

2

3

4

5

6

7

8

Scenario 3Scenario 2Scenario 10.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

£ bi

llion

s/ye

ar(re

al te

rms

at c

onst

ant 2

013

valu

es)

Net impact on tax revenues (£bn)

% of governm

ent revenues

% of government revenues

Ouranalysissuggeststhatthereductionin oil price will have a small positive impact on overall government tax revenues(seeFigure3.14).Althoughtaxrevenues from the oil and gas sector are likelytodecline,risingtaxcontributionsfromothersectorsoftheeconomywillmorethanoffsetthislossastheyexpand.InScenario1,theUKgovernmentreceives£6.7billiononaverage in additional tax revenues between2015and2020,whichisaround1.4%oftotaltaxrevenues. The additional tax impacts from a temporaryfallintheoilpricearesmaller–ataround£3.2billionand£1.3billioninScenarios2and3respectively.

Inourmodelweassumethattheoverallincrease in government tax receipts is transferredbacktoconsumersvialump-sumtransfers,whichprovide afurtherboosttoconsumerspendingand economic output.

3.4 – Summary and conclusionsThe fall in the oil price should have asignificantpositiveimpactontheUKeconomybyincreasingoveralleconomicactivityasthecostofproductiondecreasesforbusinesses,especiallyforthose that are dependent on oil inputs. Although the oil and gas extraction sectorisnegativelyaffectedbythereduction in the oil price, sectors such as agriculture, air transport, coke and refinedpetroleummanufacturingandoil-intensivemanufacturingsectorswillbenefitasthepriceofakeyinputfalls.

Water transport and other services sectorswillenjoyasmallpositiveimpact.However,oil-intensivesectorsarelikelytobenefitfromthereallocation of capital and resources at theexpenseoflessoil-intensivesectors.

Futureoilpricetrendsremainhighlyuncertain, so we have looked at three alternativescenarios.Inacasewherethe reduction in the oil price is persistent,thesizeoftheUKeconomyincreasesbyaround1%onaveragerelativetothebaselinebetween2015and2020.Employmentalsoincreases byaround90,000by2020.

Incontrast,theimpactsaremuchsmaller where the fall in the oil price iswhollyorpartiallytemporary: in these scenarios the average impact onthelevelofGDPis0.2-0.5%, withemploymenteffectsin2020ofbetween3,000and37,000dependingonhowfarandfastoilpricesrebound.

Real household incomes also rise, which increases consumer spending. Asaresultofgrowingeconomicactivity,government tax revenues increase as the tax take from corporate and personal incometaxesincreasebymorethanthelossofNorthSeaoilandgasrevenues.

Insummary,loweroilpricesshould bepositiveformostsectorsofthe UKeconomy,householdsandthegovernment. But the scale of these benefitsremainshighlyuncertaindepending on how oil prices evolve from here.


Technical Appendix: Modellingoilpricechanges

Table3.5setsouttheoilpriceprojectionsforeachscenarioinouranalysis.

As part of our modelling exercise, we also undertook a literature review of studies on the impact of an oil price shock on oil importing countries. Cournede(2010)foundthatanincreaseintherealoilpriceof65%reducesUSpotentialoutputby1.3%,implyinganelasticityofoutputtotheoilpriceofaround-0.02.TheauthorfoundsimilarestimatesfortheEUwherea59%increase in the real oil price reduces EU potentialoutputby0.7%,whichimpliesanelasticityofaround-0.01.AmorerecentstudybytheBankofEngland(2013)showsthatanincreaseinoilpriceofaround10%leadstoareductioninoutputofaround0.2%inUK.

Theseestimatesvarywidely,dependingontheoilintensityoftheeconomy,dependenceonenergyimportsandmethodology.Wecomparedtheestimates of elasticities from the academicliteraturewithouranalysis,and found that our results were in line with most other estimates. These are summarisedinTable3.6.

8 Millard,S.andShakir,T.(2013)“OilshocksandtheUKeconomy:thechangingnatureofshocksandimpactovertime”,BankofEnglandWorkingPaperNo.476,August2013.

9 Peersman,G.andVanRobays,I.(2012)“Cross-countrydifferencesintheeffectsofoilshocks”,EnergyEconomics,Volume34,Issue5,September2012,Pages1532-154710 Cournede,B.(2010)“Gaugingtheimpactofhighercapitalandoilcostsonpotentialoutput”,OECDEconomicsDepartmentWorkingPapersNo.789,July2010.11 Duval,R.andVogel,L.(2008)“Oilpriceshocks,rigiditiesandtheconductofmonetarypolicy”,OECDEconomicsDepartmentWorkingPapersNo.603,April2008.12 Barrell,R.andKirby,S.(2008)“Thebudgetaryimplicationsofglobalshockstocyclesandtrendsinoutput:impactsofhousing,financialandoilshocks”,October2008.13 Blanchard,O.andGali,J.“Themacroeconomiceffectsofoilpriceshocks:whyarethe2000ssodifferentfromthe1970s?”,NBERworkingpapersNo.13368,2007.

Table 3.5: Oil price scenarios, US$/barrel

Scenario 2015 2016 2017 2018 2019 2020

Baseline 108 108 108 108 108 108

Scenario 1 50 50 50 50 50 50

Scenario 2 57 64 68 71 72 73

Scenario 3 60 68 76 85 96 108

Note: Oil prices calculated as an average of Brent crude, WTI and Dubai.

Table 3.6: Estimates from academic literature compared to PwC estimates

Reference Impact of a 1% increase in oil prices on GDP, %

Time period

PwC study Scenario 1: -0.024%

Scenario 2: -0.015%

Scenario 3: -0.010%

5 years (projected)

Bank of England (2013)8 UK: -0.02 36 years (1975-2011)

Peersman and Van Robays (2012)9 US: -0.04

Euro area: -0.04

22 years (1986-2008)

Cournede (2010)10 US: -0.02%

EU: -0.01%

3 years (2007-2009)

Duval and Vogel (2008)11 OECD: -0.03% 10 years (projected)

Barrell and Kirby (2008)12 UK: -0.04% 2 years (2008-2009)

Blanchard and Gali (2007)13 UK (1970-1983): -0.1%

UK (1984-2007): -0.02%

37 years (1970-2007)


4 – New job creation in the UK: whichregionswillbenefitmostfrom the digital revolution?1

Key points• Thedigitalrevolutionhasbothcreatedanddisplacedmanytypesofjobssince1990.Inthisarticle,wefocusonthenewtypesofjobscreatedandassesshow this has affected total national and regionalemploymentintheUKsince2004.WehighlightthekeyroleofLondonasanincubatorforthedigitalrevolution,butalsofindsomesignsofcatch up in other regions such as the North,WalesandNorthernIreland.

• Weexaminednewjobtitlesthatemergedonlyafter1990andfoundthat 5.5% of the UK workforce had shiftedintothesenewtypesofjobs by2004.Butby2014theproportionofworkersinthesenewtypesofjobshadrisenonlyslightlyfurthertoaround6%.Eightofthetenoccupational categories in which thesenewjobtitlesarosewererelatedtocomputers,sothiscanlargelybelinked to the digital revolution.

• Londonhasbeenthegreatestmotor ofthecreationofnewtypesofjobs,outperforming the rest of the UK economy:forexample,theproportionoftotalemploymentinnewtypesofjobsinCentralLondonwas8.6%in2004,increasingto9.8%in2014.

• Butwealsofindsomeevidenceofregional convergence over the past decade. While London continues to lead in terms of the proportion of workersinnewtypesofjobs,regionslikeYorkshire,Tyne&Wear,WalesandNorthernIrelandwithlowinitialemploymentsharesinnewtypesofjobsin2004experiencedhighergrowthratesofthesenewjobtypesonaveragebetween2004and2014.

• Ourfindingssuggestthatnewtypesofjobs(linkedmainlybutnotonly tothedigitalrevolution)initiallyappeared in areas like London where entrepreneurs,innovativefirmsandskilled workers were concentrated andthengraduallydiffusedtootherregions. These other regions will continue to catch up unless London’s paceofnewjobcreationishigherthan the rate of regional diffusion.

• Projectingpatternsintotalregionalemploymentgrowthoverthenextdecade,wefindthattotalemploymentinCentralLondoncouldgrowbyaround25%between2014and2024,butthiswouldbedownfromaround35%totalemploymentgrowthoverthepasttenyears.

• Bycontrast,employmentgrowthrates over the next decade in regions likeWestYorkshire,GreaterManchester,theWestMidlands,Scotland and the rest of the South Eastareprojectedtoseesomeaccelerationinjobcreationrelativeto the past decade as the digital revolution continues to diffuse.

• FutureUKandLondongovernmentsneedtomakesurethatthecity’sgrowth potential is not constrained bythesupplyofhousingandtransport infrastructure. But it also needs to support the diffusion of digitaljobcreationtootherUKregionsbyboostingtransportlinksoutside London, supporting leading regionaluniversities,andbuildingskills,whichwefindtobeakeydriver of economic success for cities.

1 ThisarticlewaswrittenbyDrCarlBenediktFrey,OxfordMartinProgrammeonTechnologyandEmployment, UniversityofOxford,andJohnHawksworth,chiefeconomistatPwC.

2 Formoreinsightsonthisgeneralphenomenon,pleaseseePwC’smegatrendsandWorldinBetawebsitesat: http://www.pwc.co.uk/issues/megatrends/index.jhtmlandhttp://www.worldinbeta.com/

3 AutorandDorn(2013).

4.1 IntroductionOverthelasthundredyears,technological change2 has fundamentallytransformedlabourmarkets in most industrial nations. Inrecentdecades,thearrivalofnewdigital technologies has displaced a wide range of routine work, including thejobsofbookkeepers,assemblyworkers, cashiers and telephone operators.3 At the same time, theappearanceofmorethan1,500 newoccupationaltitlesinofficialclassificationssincethecomputerrevolutionofthe1980s,suggeststhatahost of new occupations have emerged.4 IntheUnitedStates,around4.4%oftotalemploymentin2000wasintypesofjobsthatdidnotexistin1990.5

Manynewoccupationsaredirectlyrelated to the arrival of the personal computer(PC)inthe1980sandthesubsequentinternet(or‘digital’)revolution that has rolled out since the early1990s.Table4.1showsthedetailedoccupational categories with the highest proportionsofnewtypesofjobsbetween1990and2010.8ofthe10occupational categories with the highest fractionsofnewjobtitlessince1990weredirectlyrelatedtocomputertechnologies.6 This also explains the highproportionsofnewjobtypesinprofessional and technical occupations asshowninFigure4.1.


As computer technologies disrupt the world of work, making some occupations redundant in the process7, thekeychallengeforgovernmentsis to help support the shift of workers intonewandemergingemploymentopportunities. A concern is therefore that the companies leading the digital agehavecreatedrelativelyfewnewjobscomparedtothegiantsoftheearlycomputerrevolution:whileIBMandDellstillemployedaround430,000 andaround110,000workersrespectivelyin2013,Facebook’sglobalheadcountreachedonly7,185inthatyear. We turn next to examining the broaderimplicationsofthistrend fortheUKeconomy.

Figure 4.1: Proportion of new job types by broad occupational category in 2010

Source: Calculations by Carl Frey based on methodology in technical appendix

0%

2%

4%

6%

8%

10%

12%

14%

Elementaryoccupations

Process,plant

and machineoperators

Administrativeand

secretarialoccupations

Skilledtrades

occupations

Managers,directors

and seniorofficials

Sales andcustomerservice

occupations

Caring, leisureand otherservice

occupations

Associateprofessional and technicaloccupations

Professionaloccupations

% E

mpl

oyed

in n

ew ty

pes

of jo

bs

4 BergerandFrey(2014a);Lin(2011).5 Lin(2011).6 Interestinglytheotheroccupationswithahighproportionofnewtypesofworkwereinthepersonalcarearea(i.e.physicaltherapistsandbeauticians),whichisonewherecomputerscannoteasilyreplacehumans.Thisgeneralareaalsoseesrelativelyhighlevelsofnewworkatthebroadoccupationallevel,asshowninFigure4.1.

7 Thiswillalsochangethenatureofworkforothers,asdiscussed,forexample,inPwC’sreportontheFutureofWork(2014b): http://www.pwc.com/gx/en/managing-tomorrows-people/future-of-work/journey-to-2022.jhtml

Table 4.1: Top 10 occupational categories in 2010 with the highest proportions of new job types that did not exist in 1990

Source: Lin (2011); calculations by Carl Frey using methodology described in the technical appendix. These proportions are derived from US data, but should be broadly similar for the UK in the same occupational categories, which is what we assume in the rest of this analysis.

Category New job types (%)

Computer Software Engineers 80.0

Database Administrators 78.6

Network and Computer Systems Administrators 78.1

Computer and Information Systems Managers 76.5

Computer Support Specialists 71.4

Computer Programmers 59.1

Miscellaneous Personal Appearance Workers 50.0

Logisticians 50.0

Computer Hardware Engineers 50.0

Physical Therapists 50.0


4.2 New job creation in the UK economyTheUKlabourmarkethaswitnessed a structural transformation since the early1990s.In2004,5.5%oftheUKworkforcewasalreadyemployedinoccupationsthatdidnotexistin1990(see Technical Appendix A for details ofthemethodologyanddatausedtoproduce this and other estimates in this sectionofthearticle).By2014theshareofUKworkersemployedinthesenewtypesofoccupationshadgrownfurther,butonlyrelativelyslowly,toaround6%(Figure4.2).

Whileweareunabletomakecross-countrycomparisonsduetolackoffullyconsistentdata,ourfindingsfortheUKseemtolargelyreflectpreviousfindingsfor the US. According to an earlier estimatearound4.4%oftheUSworkforcein2000wasemployedinoccupationsthatdidnotexistin1990.8 ThisimpliesabroadlysimilarrateofincreaseovertenyearsintheUStotherise from zero9to5.5%overthe14yearsto2004intheUK.

Furthermore,justasmorerecentrates ofnewjobtypecreationintheUKhavebeenrelativelymodestasshowninFigure4.2,theUSeconomyhaswitnessed a decline in some indicators oftechnologicaldynamism. Inparticular,thefallingpaceofjobreallocation—theprocessbywhichworkers move from contracting companies to expanding ones— hasinducedconcernaboutthefuture ofjobs.10 The slowdown in the rate of creationofnewtypesofjobsintheUKover the last decade thus seems to reflectabroadertendencyofdigitaltechnologiestocreatefewerjobs than the technologies of earlier computer revolutions.

Itisimportanttonotethatthiscannotbeexplainedjustasacyclicalphenomenon given that the period from 2004to2014thatisshowninFigure4.2probablycoversclosetoafulleconomiccycle,witharelativestrongperiodin2004-7,thenadeeprecessionin2008-9andagradualrecoverythereafter,pickinguppacein2013-14.Instead,thereseemtobeamorestructuralfactoratworkinthedigitalrevolutiondirectlycreatingasmallernumberofjobsthanearlier technological revolutions.

However,theremaystillbelargeindirectjobcreationeffectsasthe extrawealthgeneratedbythedigitalrevolutionfiltersdownthroughtheeconomyandthenewtechnologyincreasestheproductivityofmanyexisting occupations.

Figure 4.2: Proportion of employment in new types of jobs in the UK economy, 2004-2014

Source: ONS Labour Force Survey; calculations by Carl Frey using methodology described in the technical appendix

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8 Lin(2011).9 Bydefinition,theproportionofworkersintypesofjobsthatdidnotexistin1990wouldbezerointhatyear.10 Deckeretal.(2014).


The regional perspective

NearlyallUKregionshaveincreasedtheiremploymentinnewtypesofjobsoverthepastdecade.Nevertheless,London stands out relative to other regions,mainlyduetoitsrelativelyhighinitialshareofnewwork.In2004,theshareofemploymentinnewworkvariedbetween4.1%inRestofNorthernRegionto8.2%inCentralLondon(Figure4.3).OutsideCentralLondon,thecreationofnewtypesofjobsissomewhatmoreconcentratedinsurroundingareas,includingInnerandOuter London as well as the South East, although other regional rates do not varythatmuchasFigure4.3shows.

Figure 4.3: Proportion of workers in new types of jobs in UK regions, 2004 and 2014

Source: ONS Labour Force Survey; calculations by Carl Frey using methodology described in technical appendix

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Thepatternsobservedin2004havelargelyremainedinplacesincethen.Central London has seen a further rise intheshareofworkersinnewtypes ofjobsoverthepastdecade,reaching9.8%in2014.InnerLondonandtheSouth East also experienced increases innewtypesofjobs,butwefindthatOuterLondonisfallingslightlybehind.By2014,allregionshadseentheirshareofnewtypesofjobsincrease,withtheexceptionofRestofYorkshire&Humberside,whichwitnessedasmalldeclinefrom4.8%to4.6%.Incontrast,SouthYorkshiresubstantiallyincreasedtheshareofitsworkersinnewjobtypesbetween2004and2014,growingfrom4.5%to5.5%,suggestingsomepossibledisplacementofnewjobsacross the region.


4.3 Evidence of regional convergence, 2004-2014Despite the fact that Central London and surrounding regions still had higher proportionsofworkersinnewtypesofjobsin2014,theshareofnewjobsacross UK regions converged over the pastdecade.AsshowninFigure4.4,regionswiththelowestemploymentsharesinnewtypesofjobsin2004sawthese shares increase the fastest over the nexttenyears,especiallyifoneexcludesCentralLondon.TheRestofNorthernregion, with the lowest initial share of new work, experienced the fastest growth in new work over the past decade: the region increased its employmentinnewtypesofjobsbyaround24%,closelyfollowedbySouthYorkshire(23%)andTyne&Wear(21%).

Thesefindingsresonatewithpreviousresearch showing that since the advent ofthecomputerrevolutionnewtypesofworkhaveemergedmorestronglyinthemost skilled cities.11Gradually,however,asthenewworkbecomes“old”work, it diffuses to other cities and regions. Thus,newjobcreationinthedigital areatendstobeconcentratedincitieslikeLondon,OxfordandCambridgewitha large pool of skilled workers, where entrepreneurs,innovatorsandearlyadopters experiment with new technologies.12Onlyafterproductionprocesseshavebecomemorestandardizeddoesittendtobewidelyadopted elsewhere.13

Figure 4.4: Regional convergence across UK, 2004-14

Source: ONS Labour Force Survey; calculations by Carl Frey using methodology in technical appendix

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New job types increased faster on average in 2004-2014 in regionswith lower proportions of new job types in 2004

Inotherwords,convergenceoccursif thediffusionof“old”worktakesplace atafasterpacethannewjobcreation. Inlinewiththegeneraltrendofaslowdown in the creation of new work between2004and2014,ourfindingssuggest that the diffusion process took placeatarelativelyfastrate.Accordingly,regionalconvergenceisnotnecessarilygoodnews.AsLondonremainstheearlyadopteroftheUKeconomy,theapparentslowdowninnewdigitaljobcreation inLondonmayimplyasubsequentslowdown across other regions over the next decade.

Thesefindingsareinterestingandsurprising, given that the perception wouldbethatinotherhighvalueaddedservicese.g.financialandbusinessservices, the agglomeration economies pushing towards existing clusters would stillbepredominant.Thisseems,however,tobelesstrueindigitalsectorswhere economies of scale (and indeed physicallocation)maybelessimportantandsoactivitycandiffusemorewidelyacrossthecountry.

11 BergerandFrey(2014a).12 Lin(2011);BerryandGlaeser(2005);Glaeseretal.(2012).13 DurantonandPuga(2001).


4.4 Projected employment growth across UK regions, 2014-2024Usingdataonemploymentgrowthbyregionbetween2004and2014from theONSandtheshareofnewtypesofjobsineachregionin2004,weestimateasimpleordinaryleastsquares(OLS)regression where we examine the statisticalrelationshipbetweennewworkcreationandemploymentgrowth.Details are provided in Technical Appendix4B,butwefocushereon thekeyconclusions.

Themainfindingsarethattheshare ofnewtypesofjobsin2004isastatisticallysignificantpredictorofsubsequenttotalemploymentgrowthinaregion.Infact,wefindthatdifferencesintheshareofnewtypesofjobscan

explainabout50percentofthevariationinemploymentgrowthacrossUKregions over the last decade. Using this estimated relationship, we can also makeillustrativeprojectionsofemploymentgrowthoverthenext10years,basedoneachregion’sshareofworkersinnewtypesofjobsin2014.14

Accordingtoourillustrativeprojections(Figure4.5),CentralLondonseemslikelytoexperiencethefastestemploymentgrowth(ofaround25%)over the next decade, though this would bemarkedlylessthanthe35%totalgrowth rate over the past decade. This is followedbyInnerLondon(around12.5%butalsodecreasingrelativetothepastdecade),theRestoftheSouthEast(10%andrising)andOuterLondon (9%andrising).Ourestimatesalsoshow, however, that some regions

outside London and the South East show acceleratingemploymentgrowthoverthe next decade as compared to the previous decade. These include West Yorkshire(perhapsreflectingtheinfluenceofLeeds),GreaterManchester,theWestMidlandsandMerseyside.NorthernIreland,bycontrast,seessome‘reversiontothemean’initsprojectedemploymentgrowth.

Ourprojectionsaresubjecttomanyuncertainties,buttheygenerallysupport the view that skilled cities like London,Oxford,Cambridge,Leeds,ManchesterandEdinburghwillcontinuetobekeymotorsofjobsgrowth,bothindigitalareasandmoregenerallyacrosstheeconomy. Thisisconsistentwiththefindings ofotherpreviousPwCresearch.15

Figure 4.5: Projected employment growth across UK regions, 2014-24, as compared to past decade


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14 Theseprojectionsarecalibratedbasedonthetop-downassumptionthattotalUKemploymentwillgrowatanannualrateof0.7%overthenextdecade, basedontrendsinworkingagepopulationgrowthandemploymentrates.Theprojectiondoesnottakeexplicitaccountofthepotentiallyexpandingscope ofjobautomation(FreyandOsborne,2013)orotherfactors,whichiswhywedescribethemasonlybeingillustrative.

15 PwCGoodGrowthforCities(2014).


4.5 Fostering new job creation: Implications for policyIntermsofnewjobcreation,LondonhasbeenthelargestsingleregionalmotoroftheUKeconomy.Whileotherregionsarecatching-up,asnewworkdiffusesfromLondonacrosstheUK,ourfindingsimplythatnewworkinitiallyclusterstotakeadvantageofknowledgeflowsacrosscompaniesandindustries.Ourfindingsspeaktoagrowingbodyofresearchshowing that new occupations and industries emerge in skilled cities.16 Larger pools of skilled workers attract start-upsandknowledgeableworkersaremoreadaptabletotechnologicalchange.

ThisisalsoconfirmedbynewPwCresearch for this report. As shown in Figure4.6,highskillcities(asmeasuredbytheproportionofthoseaged25-64witheducationlevelsofNVQ3orabove)intheUKhavesystematicallyoutperformed other cities in terms of newbusinesscreationsince2005.

Furthermore,UKcitieswithahighfractionofskilledworkersin2005experienced much lower levels of unemploymentincreaseduringtherecessionandsubsequentlyupto2013(Figure4.7)accordingtootherrecentPwCresearchforthisreport.Skilledworkersseemtobemoreabletoshiftintonewtypesofwork,thoughtheeducationalmeasureusedheremaynotpickupallofthiseffect,whichcouldbemorespecificallyrelatedtolevelsofcognitiveskillsthatareparticularlyimportant in digital sectors and other professional and technical occupations.

Takentogether,thesefindingshaveimportantimplicationsfornewjobcreation in the UK. As the largest

Figure 4.6: New business creation according to average education levels in UK cities

Source: PwC analysis of ONS data

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Source: PwC analysis of ONS data

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proportionofnewworkisinitiallycreated in London, and then diffuses throughouttheUKeconomy,policies to support further growth of London are important. At the same time, there is a need to support further other clusters of skilled occupations and industries

elsewhereintheUK,asmanyLEPsandtheCityregiondevolutionprogrammehavesoughttodoinrecentyears.17

Insteadtheroleofpolicyshouldbetocreate and maintain the soft and hard infrastructurethatfacilitatesjob

16 BergerandFrey(2014a;2014b);DurantonandPuga(2001);Lin(2011).17 ThegainsfromcreatingstrongindustryclustersoutsideLondonarediscussedfurtherinMcKinseyandCentreforCities(July2014)

Industrial RevolutionsandalsobySentance(2014).


creation and regional diffusion. Universitiescanplayavitalroleinfosteringnewjobcreation.SinceFredrickTerman, the dean of Stanford’s Engineering School, encouraged two of his students, William Hewlett and David Packard,tofoundHewlett-Packard(HP)in1938,Stanfordalumnialonehavecreated39,900companiesandabout5.4millionjobs.18 London’s leading position innewworkissimilarlylikelytobeassociated with its universities. AccordingtoQSWorldUniversityRanking,4ofthetop10universities for computer science and information systemsintheUKarelocatedinLondon.Theothertop10rankeduniversitiesoutsideLondonincludetheUniversity ofSouthampton,Cambridge,Oxford,Birmingham,ManchesterandEdinburgh.The latter three are outside the South East andcouldprovideusefulhubsforfuturedevelopmentofdigitalhubsintheMidlands,theNorthWestandScotland.19

As the dissemination of knowledge and skills provides the most important force of convergence, investing in education is therefore crucial for regions to catch up and remain resilient to technological change.20Policyfocused on promoting further investment in educationandcollaborationbetweenuniversitiesanddigitalbusinessesacross regions would help to make regionsmoreadaptableandreceptive to the arrival of new technologies.

Second, there is a need to provide the hard infrastructure to facilitate the diffusion of new work across regions, while making sure that the growth of London is not constrainedbythesupplyofhousingandtransport. According to our estimates, employmentinCentralLondoncouldgrowbyafurther25%overthenextdecade.Crucially,asskilledcitiesarebecoming

more attractive, rising house prices makes themlessaffordableplacestolive21. Thishasimplicationsparticularlyforlow-incomeworkers,whocanoftennotafford to move or travel to places where newemploymentopportunitiesarebeingcreated.22Furthermore,housingconstraintsin London can also provide constraints on growthfortheUKeconomyasawhole.Forexample,arecentstudyestimatesoutputintheUnitedStateswas13percentbelowitspotential over recent decades as a result of insufficienthousinginskilledcities.23

To avoid such an outcome, investment inimprovingtheconnectivitybetweenplaceswillbeessentialtomakesurethatnewjobcreationcontinuestothriveinLondon, while diffusing faster to other regions.Inparticular,thereshouldbeincreasedattentiontobuildingaffordablehousingoutsidethecity, with faster, less congested commuting linkstocentralLondon.Doingsowillbevitaltoavoidholdingbackthegrowthprospectsofthecity.Inaddition,otherkeycitiessuchasManchester,LeedsandLiverpool also need improved transport links to support their growth and deliver the government’s vision of a new ‘Northernpowerhouse’.

4.6 Summary and conclusionsBetween2004and2014,UKregionsshowed some convergence in terms of the pacewithwhichtheywerecreatingnewtypesofjobsthatdidnotexistin1990,notablybutnotonlyinthedigitalarea.Thisconvergence,however,reflectsageneral slowdown in the creation of newtypesofjobsoverthepastdecade: atendencythatisnotparticulartothe UKeconomy.IntheUnitedStates,forexample,ratesoftechnology-relatednewjobcreationhavedeclinedoverthepast

decade, speaking to a growing concern thatthedigitalageofthe21stcentury hascreatedrelativelyfewemploymentopportunities compared to earlier waves ofnewtechnology,includingthepersonalcomputerrevolutionofthe1980s.

Central London continues to lead other UKregionswithashareofalmost10%ofitsworkforcein2014innewtypesofjobsthatdidnotexistbackin1990,relative to a UK average rate of around 6%.Ourfindingssupportthegeneraltrendofnewtypesofjobsclusteringinskilledcities,includingnotjustLondonbutalsoplaceslikeOxford,Cambridge,ManchesterandEdinburgh.

OurillustrativemodelprojectionssuggestthattotalemploymentinCentralLondoncouldgrowbyaroundaquarter over the next decade, although thiswouldbeslowerthanthe35%growth rate seen over the past decade. AkeytaskforfutureUKandLondongovernmentswillbetomakesurethatthecity’sgrowthpotentialisnotconstrainedbylagginghousingandtransport infrastructure.

Atsametime,ourprojectionsdosuggestanaccelerationofemploymentgrowthinsome regions outside London, including GreaterManchester,WestYorkshire,theWestMidlandsandMerseyside.Thisisencouraging,andreflectsourexpectationthattherewillbeacontinueddiffusion of the digital revolution (and other technologicaladvances)acrosstheUKover the next decade. However, this does require increased investment in transportconnectivityintheseregions,as well as the development of regional clustersaroundhighqualityregionaluniversities.Onlyinthiswaywillthefullpotentialbenefitsofdigitalbefeltacrossthecountry.

18 EasleyandMiller(2012).19 AsdiscussedalsoinSentance(2014)20 Piketty(2014).21 See,forexample,thediscussioninPwC’slastGoodGrowthforCitiesreport(2014a).22 Andersonetal.(2014).23 MorettiandChang-TaiHsieh(2014).


Technical Appendix A DataandMethodology

Toidentifytheappearanceofnewtypesofjobs,weusedrevisionsoftheAlphabeticalIndexofOccupations,maintainedbytheUSCensusBureau.Eachindex(1990,2000,and2010)reportsapproximately30,000occupational titles that are used to identifyUScensusrespondents’occupation.Importantly,theseindexesareperiodicallyupdatedtoreflecttheappearanceofnewtypesofjobsinthelabourmarket.Newjobtitlesreflect, for example, the appearance of new technologies(e.g.solarPVinstaller) or shifts in consumer demand (e.g. sommelier),capturinghowthelabourmarket is restructured over time.

We created an algorithm that isolates jobtitlesinthe2010editionforwhichthereisnomatchinthe2000edition.Manually,wethencomparedeachnewjobtitletoexcludetitlesthataresimplyrelabelled,reclassified,separatedintomultiplecategories(e.g.bankcashierswithandwithoutanassociatedegree) or residual titles (e.g. life scientists\not specified).Wemappedeachtitlethatappearedforthefirsttimebetween2000and2010totheircorrespondingUSdetailedoccupationalcategoryusingcrosswalks from the US Census Bureau. Tothisweaddthenumberofnewjobtitlesthatappearedbetween1990and2000,takenfromearlierresearchbyJeffreyLin(PhiladelphiaFederalReserve,2011).

Foreachoccupationalcategory, wecalculatedthenumberofnewjobtitlesthatappearedbetween1990and2010.Overthisperiod,948newoccupational titles appeared (relative to atotalnumberof30,800titlesin2010).Wethennormalisedthenumberofnewtitlesbythenumberoftotaltitlesperoccupationin2010,sothatweobtainthefractionofnewtitlesfor469USdetailed occupations (that is, the probabilitythataworkerisemployed innewtypesofjobs).Forexample, indetailedoccupation104(ComputerSupportSpecialists),71%oftheoccupationaltitlesin2010appeared forthefirsttimeovertheperiodbetween1990and201024.

To map US occupations to their UK counterparts,webeganbymappingUSoccupations to their corresponding ISCO88codes,againrelyingoncrosswalks from the US Census Bureau. WethenusedcrosswalksprovidedbytheONSthatmapsUKSOC2000codestoISCO88codes.IncaseswhereUKSOC2000occupationsconsistofseveralISCO88codes,wetookasimplearithmeticaverage.From2011andonwards, the U.K. occupational data is reportedusingUK2010SOCcodes. We therefore used crosswalks to map ISCO88codestoISCO08codesfromtheILOthatinturnaremappedtoUK2010SOC occupations using a crosswalk from theONSthatmatchesISCO08codestotheirUK2010SOCcounterparts.

Usingdataonemployedpersonsagedabove16byregionofworkfromtheONS,wemergedthefractionofnewtypesofjobsperUKoccupationtoeachregion, for all occupations for which theONSprovideemploymentfigures.NotethatbecausetheONSreportsemploymentfiguresusingSOC2000codesfortheperiod2004-2010andSOC2010codesfor2011-2014,levelsofnewjobtypesperregionarenotstrictlycomparablebetweentheseperiods,butwe have spliced the data together in a waythatminimisesinconsistenciesovertime(ascanbeseenfromtherelativelysmoothtimeseriesbetween2010and2011inFigure4.2).

24 Whenconsideringdatafor2014intheUK,wearethereforeignoringnewjobtitlesthatappearedafter2010,sincethereisnodetaileddataavailableonthesemorerecentnewjobtypesemergingbetween2010and2014.


Technical Appendix B RegressionAnalysis

Weestimatedasimpleordinaryleastsquares(OLS)regressionwheretotalregionalemploymentgrowthbetween2004and2014wastheoutcome(dependentvariable)andthefractionofnewtypesofjobsin2004ineachregionwastheexplanatoryvariable(Table4.2andFigure4.8).

We found that the proportion of new typesofjobsisahighlystatisticallysignificantpredictorofsubsequentemploymentgrowth(p-value=0.00)byregion.TheR-squaredoftheregressionis52%,meaningthatabouthalfofthevariationintotalemploymentgrowthacrossUKregionsin2004-14canbeaccountedforbydifferencesintheinitiallevelofnewtypesofjobsintheworkforcein2004.

We then fed into this estimated model our data on the proportion of workers in eachregioninnewtypesofjobsin2014andusedthistoprojecthowtotalregionalemploymentgrowthmight varyoverthecomingtenyears.However, since these estimates are basedonasmallsampleofregionstheseresultsshouldbeinterpretedwithcare.Theycanonlybeconsideredillustrativeofpotentialbroadtrendsratherthanbeingregardedaspreciseforecasts.

Table 4.2: New Work and Employment Growth in UK Regions, 2014-2024


Outcome: Empl. Growth 2004-2014 (%)

Coef. Std. Err. P>t [95% Conf. Interval]

New Work 2004 (%) 6.10 1.35 0.00 3.28 8.92

Constant -25.28 7.20 0.00 -40.36 -10.21

Number of observations 21

R-squared 0.52

Figure 4.8: Relationship between proportion of workers in new types of jobs in 2004 and subsequent total regional employment growth in 2004-14

Source: ONS Labour Force Survey; analysis by Carl Frey

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ReferencesAndersson,F.,Haltiwanger,J.C.Kutzbach,M.J,Pollakowski,H.O.,andWeinberg,D.H.(2014).JobDisplacementandtheDurationofJoblessness: TheRoleofSpatialMismatch,NBERWorkingPapers20066,NationalBureauofEconomicResearch,Inc.

Autor,D.H.andDorn,D.(2013).TheGrowthofLow-SkillServiceJobsandthePolarizationoftheUSLaborMarket.AmericanEconomicReview,103(5),1553–97.

Berger,T.andFrey,C.B.(2014a).TechnologyShocksandUrbanEvolutions:DidtheComputerRevolutionShifttheFortunesofU.S.Cities? OxfordMartinSchoolWorkingPaper.

Berger,T.andFrey,C.B.(2014b).IndustrialRenewalinthe21stCentury:EvidencefromUSCities.OxfordMartinSchoolWorkingPaper.

Berry,C.R.andGlaeser,E.L.(2005).Thedivergenceofhumancapitallevelsacrosscities.Papersinregionalscience,84(3),407–444.

Decker,R.,Haltiwanger,J.,Jarmin,R.,andMiranda,J.(2014).TheRoleofEntrepreneurshipinUSJobCreationandEconomicDynamism. TheJournalofEconomicPerspectives,28(3),3–24.

Duranton,G.andPuga,D.(2001).Nurserycities:Urbandiversity,processinnovation,andthelifecycleofproducts.AmericanEconomicReview,91(5),1454–1477.

Frey,C.B.andOsborne,M.(2013).TheFutureofEmployment:HowSusceptibleAreJobstoComputerisation?,OxfordMartinSchoolWorkingPaper.

Glaeser,E.L.,Ponzetto,G.A.,andTobio,K.(2012).Cities,skillsandregionalchange.RegionalStudies,(ahead-of-print),1–37.

Glaeser,E.L.andSaiz,A.(2004).Theriseoftheskilledcity.Brookings-WhartonPapersonUrbanAffairs,2004(1),47–105.

Hsieh,C.T.andMoretti,E(2014).GrowthinCitiesandCountries.Workingpaper.

Lin,J.(2011).TechnologicalAdaptation,Cities,andNewWork.ReviewofEconomicsandStatistics,93(2),554–574.

Piketty,T.(2014).CapitalintheTwenty-FirstCentury.HarvardUniversityPress.

PwC(2014a),GoodGrowthforCities.Availablefrom:http://www.pwc.co.uk/government-public-sector/good-growth/index.jhtml

PwC(2014b),TheFutureofWork.Availablefrom:http://www.pwc.com/gx/en/managing-tomorrows-people/future-of-work/journey-to-2022.jhtml

Sentance,A(2014),GettingthebalancerightintheUKregions,UKEconomicOutlook,PwC,November2014. Availablefrom:http://www.pwc.co.uk/the-economy/publications/uk-economic-outlook/ukeo-nov2014-getting-the-balance-right-in-the-uk-regions.jhtml


Appendix A Outlookfortheglobaleconomy

TableA.1presentsourlatestmainscenarioprojectionsforaselection of economies across the world.

WeexpecttheUSeconomytoachieverelativelystronggrowthin2015and2016.TheoutlookfortheEurozoneeconomies remains weak in comparison toboththeUSandtheUK,althoughlower oil prices will help to give the Eurozone some modest upward momentumin2015-16.Intheemergingmarkets, China’s economic growth is slowingdown,butremainshighinabsoluteterms.Bycontrast,theRussianeconomyisexpectedtoexperienceasevereeconomiccontractionthisyearduetoacombinationofloweroilrevenuesandsanctions.Significantuncertainties continue to surround globaleconomicprospectswithparticular risks stemming from the recentproblemsinGreeceandelsewhereintheEurozoneandpossibleescalation of geopolitical tensions in Russia/UkraineandtheMiddleEast.

Theseprojections(includingthose fortheUK)areupdatedmonthlyin ourGlobalEconomyWatchpublication,whichcanbefoundatwww.pwc.com/gew

Table A.1: Global economic prospects

Share of world GDP

Real GDP growth (%) Inflation (%)

2013 at MERs 2015p 2016p 2015p 2016p

United States 22.4% 3.2 3.1 0.3 1.8

China 12.7% 7.1 7.2 2.2 1.8

Japan 6.6% 1.1 1.4 1.4 2.3

UK 3.4% 2.5 2.3 0.3 1.8

France 3.8% 0.9 1.4 0.1 1.1

Germany 4.9% 1.5 1.9 0.1 1.8

Greece 0.3% 0.7 1.5 0.2 0.3

Ireland 0.3% 3.3 3.2 -1.3 1.0

Italy 2.8% 0.4 1.1 0.4 1.8

Netherlands 1.1% 1.4 1.6 -0.1 1.1

Portugal 0.3% 1.7 1.8 1.2 0.8

Spain 1.8% 2.2 2.2 0.1 0.7

Poland 0.7% 3.3 3.5 -0.3 1.7

Russia 2.8% -5.0 -0.5 0.1 8.0

Turkey 1.1% 3.5 3.8 15.0 6.5

Australia 2.0% 2.6 3.1 6.7 2.6

India 2.5% 7.0 6.9 2.5 5.2

Indonesia 1.2% 5.8 5.7 4.2 6.7

South Korea 1.7% 3.5 3.7 6.5 2.2

Argentina 0.8% 0.1 3.1 1.5 -

Brazil 3.0% 1.0 2.9 25.0 4.5

Canada 2.4% 2.3 2.2 5.5 1.9

Mexico 1.7% 3.2 3.5 0.9 3.5

South Africa 0.5% 2.0 2.3 3.2 5.6

Nigeria 0.7% 4.2 4.9 5.1 9.9

Saudi Arabia 1.0% 3.2 3.0 11.7 3.0

World (PPP) 3.5 3.9

World (Market Exchange Rates) 100% 3.0 3.3 2.2 2.4

Eurozone 17.1% 1.2 1.7 0.1 1.4

Source: PwC main scenario for 2015 and 2016; IMF for GDP shares in 2013 at market exchange rates (MERs).


Appendix B UKeconomictrends:1979–2014

Annual averages GDP growth Household expenditure growth

Manufacturing output growth*

Inflation (CPI**)

3 month interest rate (% annual average)

Current account balance (% of GDP)

PSNB*** (% of GDP)

1980 -2.2 0.1 16.6 0.7 4.1

1981 -0.8 0.3 13.9 1.8 3.3

1982 2.1 1.2 12.2 0.7 2.5

1983 4.2 4.4 10.1 0.3 3.3

1984 2.3 2.5 10.0 -0.5 3.6

1985 3.5 4.1 12.2 -0.3 2.8

1986 3.2 6.5 10.9 -1 2.2

1987 5.5 5.3 9.7 -1.6 1.4

1988 5.9 7.8 10.4 -3.8 -0.7

1989 2.5 4.0 5.2 13.9 -4.3 -0.7

1990 0.5 0.7 7.0 14.8 -3.3 0.7

1991 -1.2 -0.7 7.5 11.5 -1.4 2.8

1992 0.4 1.2 4.3 9.6 -1.6 6.0

1993 2.6 3.1 2.5 5.9 -1.4 7.3

1994 4.0 3.3 2.0 5.5 -0.5 6.2

1995 2.5 2.1 2.6 6.7 -0.7 5.0

1996 2.7 4.2 2.5 6.0 -0.6 3.6

1997 2.6 4.6 1.8 6.8 -0.1 1.7

1998 3.5 4.4 0.4 1.6 7.3 -0.4 -0.1

1999 3.2 5.0 0.5 1.3 5.4 -2.6 -1.2

2000 3.8 5.3 2.3 0.8 6.1 -2.4 -1.5

2001 2.7 3.7 -1.6 1.2 5.0 -2.1 -0.7

2002 2.5 4.0 -2.6 1.3 4.0 -2 1.8

2003 4.3 4.0 -0.6 1.4 3.7 -1.6 2.8

2004 2.5 3.6 2.0 1.3 4.6 -2 3.1

2005 2.8 3.0 -0.1 2.1 4.7 -1.3 3.5

2006 3.0 2.2 2.2 2.3 4.8 -2.2 2.5

2007 2.6 2.8 0.7 2.3 6.0 -2.7 2.7

2008 -0.3 -0.5 -2.9 3.6 5.5 -3.7 4.8

2009 -4.3 -3.3 -9.4 2.2 1.2 -2.8 10.2

2010 1.9 0.5 4.7 3.3 0.7 -2.6 9.1

2011 1.6 -0.1 1.8 4.5 0.9 -1.7 7.0

2012 0.7 1.5 -1.3 2.8 0.8 -3.7 7.6

2013 1.7 1.7 -0.7 2.6 0.5 -4.5 5.9

2014 2.6 2.1 2.7 1.5 0.5 n/a 5.2

Average over economic cycles****

1979 - 1989 2.7 3.7 7.9 12.2 -0.8 2.4

1989 - 2000 2.3 3.1 3.3 8.3 -1.6 2.5

2000 - 2007 3.0 3.6 0.3 1.6 4.8 -2.0 1.8

* After the revisions to the national accounts data, pre-1998 data is not currently available ** Pre-1997 data estimated *** Public Sector Net Borrowing (calendar years excluding public sector banks) **** Peak-to-peak for GDP relative to trend Sources: ONS, Bank of England


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