How inflation, competition for talent and rising employment costs can affect family business

The final episode sees George Lagarias, our Chief Economist, join Natalie Wright to discuss the economic landscape and how it is affecting family businesses in the UK. We touch on various sectors including manufacturing, retail, and wholesale as well as property and construction. Although still in the midst of a global pandemic, we are moving away from lockdowns, resulting in more demand for products; the result being a demand for employees, rising business volumes, and a more optimistic future for businesses. However, against this backdrop, concerns around inflation, pivoting business models, rising employment costs, and the need for more rapid digital transformation are all things we need to contend with.

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Natalie Wright: You are listening to the Exploring Family Business Podcast brought to you by Mazars. I'm your host Natalie Wright, head a family business at Mazars UK. And having worked extensively with family businesses for a number of years and Kingsport is valuable sector of our society. At Mazars, we believe there is nothing more personal than a family business. Every family and every business are unique that we look forward to sharing [00:00:30] knowledge, insights, and practical tips for those navigating the unique issues that arise from being in business with family. Now on with this week show. Hello and welcome to the final episode of season two's Exploring Family Business Podcast. Today I'm joined by George Lagarias. George is our Chief Economist at Mazars in the UK, is a frequent media commentator in the Financial Times, and also an academic and thought leader who's passionate [00:01:00] about making the complex simple to empower individuals to make informed decisions for long-term prosperity. George, thank you for joining me today. Can you explain a bit more about you, your background and your role at Mazars?

George Lagarias: Thank you very much, Natalie. I am the Chief Economist at Mazars Wealth Management. Currently, our assets under management are a little bit over 1.5 billion. I've been with Mazars for about five years now. My background is [00:01:30] mostly from banks. I used to work as a fund manager or a strategic analyst in various wealth managers both in the United Kingdom and previously in Greece.

Natalie Wright: As you know, this season of the podcast is focused on succession. And I guess there may be questions around how is this top relevant, but given the impact that the global pandemic has had, not just in terms of the economic slowdown that we saw last year, but also with record levels of debt, which are still [00:02:00] rising, there will be implications depending on your business, your plans for the future, how you position now on the sector that you operate in. So, today I want to explore some of those points further. But before we get into anything sector specific, can you give us an overview of the current economic landscape?

George Lagarias: So, we are in the acute phase of the economic recovery. Lock downs are ending for all intents and purposes. People can again enjoy [00:02:30] a drink at the pub. They can go in stores and shop and with less and less limitations. As vaccination rates go up, people will be freer to resume all the previous activities. Now, when the pandemic started, we had no idea where we're going to end up. Maybe the scars of the pandemic, which change consumer behavior. And what we're finding is that this hasn't happened. People want [00:03:00] to get back to normal. That is why we have seen a lot of pent-up demand for goods and services being released. To make no mistake, it's wreaking havoc in global supply chain because spending a year and a half virtually in a coma, Western economies have just woken up and started ordering stuff. So, to meet that demand, supply chains are working overtime to the point of breaking down.

Now the US is leading the economic charge as would be expected. The UK is following suit as would also be expected and Europe has to shuffle through its own problems, which comes to probably no one surprise. But still, it is opening up albeit a bit slowly than the Anglo-Saxon economies. And this is very good for the UK because two thirds of trades still happen with Europe. Now within the UK, we see the global science of strength. We see them in the UK and we see them across the board. All regions, pretty much exhibit the same signs of strength. Interestingly enough, the charge this time is not led by London, but by the industrialized Northwest. Why? Because we see faster resumption in manufacturing activities and services are following. So, this is pretty much where we are. In 2021 is bound to be a bullish year, bound to be the year of the great recovery.

I'm sure some people will call it that once it's done. As with any good story, it's not so easy to kill the monster. And there are a few cabinets here. COVID-19 is not gone. In fact, now lately we've been talking about the Delta variance and how this might affect further lockdowns. Although we don't really anticipate global lock bounds anymore. Not with the levels of vaccination we have achieved, but we could see a few more localized versions and they could also hinder some economic activity, some economic bullishness. If you feel that you have a cafeteria and might close down again in September. At the very least, you might not be too keen to invest in new personnel and offer permanent contracts and all of that until you see how this plays out. So yes, we are in the acute recovery phase, but also COVID-19 is lurking.

And of course, we have to wait and see what happens after we spent a year and a half up in our homes. It's natural that we want to go out and spend. Savings rates are sky high, especially the higher incomes and the white-collar jobs continue to pay throughout the pandemic without the break. So, people and consumers have money to spend. The question is what happens after September, October, when we get back to let's say, modicum of normality in terms of income, will we be willing to spend as much then make the big investment decisions, buy a house, buy that car, take a holiday eventually when we're allowed again, that sort of decision-making. And we have yet, although there is a lot of bullishness now within consumers and businesses, I will be keen to wait a few months to see whether that is sustainable or not.

Natalie Wright: Thanks, George. I appreciate it. I asked you to summarize a huge subject there, and I think you've encapsulated the main points, which some of those we'll come onto shortly. I think it's fair to say that we often find headlines around economic activity in particular being confused with how investment markets are performing. So, is it worth also picking up on how the main investment markets have been affected and how this has correlated or perhaps not with economic activity?

George Lagarias: Yeah. So, investment markets have spent a lot of time decorrelating from economics. Investment markets in the past 12 years, they mostly followed central banks and mostly the US Federal Reserve. When the US Federal Reserve is feeling generous so do stocks and bonds. When the US Federal Reserve does not feel generous, stocks and bonds tend to tank. But real time economic activity and even when it impacts earnings has been less of a factor. Case in point, in April and May, we saw the best earning season in the US in many years, yet the S&P 500 just barely moved. And the picture is very similar in the UK, those equity indices, especially these times they tend to correlate. So, in investment land with the exception of one-month last year, last March through to April, COVID-19 never really happened. And the impact of the real economy just got quickly discounted and they fast forwarded to the end of 2021 when the pandemic is set to be behind us.

And they said, "Fine. We're going to start looking at the fundamentals from that point onwards." Now, the reason again, that we're able to do it is that they spent 12 years in the Fed bubble, which allows investors to remain optimistic. What can spoil that particular party inflation? And we have been seeing signs of inflation across the board. Now the fed and other central banks believe that they are transitory. We would tend to agree that this particular bout of inflation, the way it's caused a slack in the economy and demand from G7 economies. Also, a very big differential between the east and the west. So, there is no harmony in supply chains. All these are causing shortages are causing raw materials to go up and obviously inflation ensues. Now we think, and the federal reserve thinks that all these things are temporary, but we have also examined the number of scenarios to determine whether it will continue to be temporary, or maybe at some point, demand will pick up, or maybe at some point, those supply chain disruptions become slightly more permanent to push inflation upwards.

Why is this important for investment land? It's important for investment land because if there is a lot of inflation out there, then the federal reserve, which has virtually underwritten risk taking for investors in the past 12 years might not be able to do their job. And that would mean a very significant shift in the way we invest people's pensions, people's portfolios. So, we spent the last few months thinking what that environment might look like and we have taken steps to formulate a plan in case we see a paradigm shift.

Natalie Wright: Thanks, George. I promise I'm not going to ask you to get your crystal ball out or anything, but you clearly process and monitor and analyze a lot of information. And I know we don't have any slides for kind of visual material, but we will leave some main links in the show notes to a webinar that you did last week which highlights some of the points. So, we are going to need to keep it high level so listeners can absorb some of the main headlines. But let's talk about some specific sectors, particularly those in which we see many family business operating in. Could we start with manufacturing? And I know you touched on it before and in itself, it's a huge sector. So, it's going to be impossible to break it down to cover all areas. But can you talk us through the manufacturing sector in the UK and how it's been affected over the last year?

George Lagarias: So, obviously it has been affected. A lot of plants closed because of the pandemic. However, in the past two months activity has been rebounding. Currently, we're looking at the best manufacturing conditions in over 13 years. In fact, last month featured the highest production in the UK with the exception of August, 2013, the highest production since July, 1994. Now what is happening is there is a lot of demand again for goods. And work people previously manufacturers were not too keen to restock because they did not know how the pandemic would turn out. Now that consumers have come out on mass, they went back to their manufactures and they said, "Produce as much as you can." So, there is a lot of demand even for export orders. As a result, there is a lot of job growth, big backlogs, long delivery times, and the best sentiment in 20 years. Having said that, because of all that demand also we see inflation across the boards.

What is happening is that manufacturers are now competing with their suppliers over who gets the raw material first to manufacture something. And again, that is pushing inflation higher up, and it is already showing up in the prices of a lot of goods. It's not just the CPI that's up to 2.5%, that's nothing. We're talking about copper wires and tips and stuff like that, that have either jumped one or 200% or they are completely unavailable and if you want to order a new car, it could take months until it arrives.

Natalie Wright: Thanks, George. I think some of the stats might surprise people, but depending on which specific sector you're operating in, it probably resonates. And imagine inflation is going to raise its head frequently throughout this discussion. But if we move on to property and construction, because I think this is been a really interesting one, particularly when we saw headlines last summer about property market collapse. And there's clearly a difference in terms of residential and commercial property when it comes to supply and demand and valuations. But can you explain what you've seen in the property in construction sector?

George Lagarias: First of all, let's talk about construction itself. There is a very rapid rise in new business volumes, despite inflation to the point where supply chains are struggling to deliver struggling to deliver a house, it's not just the walls, it is to construct it you need again, copper wiring or other sorts of wiring. Except for the electrics, you need the plumbing parts. You need many, many different vendors go in, in constructing a house. So, supply chains are struggling to deliver right now and delays are inevitable. But and the good news is that demand is there. Household optimism is at the five-year high and people are very, very optimistic about their finances. So, now they want to buy the house especially as long as the government continues to subsidize it with the COVID-19 emergency measures. Now this is for the housing market and housing prices which should continue to go up for this year at least maybe until pent up demand slows down and stamp duty is back.

Now the darker side of this is office space. We are all working from home more and more. Those business leaders who are putting in the money to maintain an office need to decide between continuing to do so and trying to lure workers back in or going with the flow and letting people work from home and skip the commute at least two or three days a week. So, as we understand, this is causing distress in the office space market in terms of commercial real estate. Having said that, things are always looking more positive in the last few years if you own some sort of property that's related to logistics, so warehouses and stuff like that. Because the more we move off the main street shops and we order more Amazon stuff from home or other mail-order ways of shopping, then it stands to reason that you own a warehouse the price for that will go up. But if you own office space in Central London right now, you must be thinking of what to do with it in the next two or three years.

Natalie Wright: I think optimism is something that a lot of people wouldn't have anticipated if we'd have been discussing this this time last year, but it's nice to hear that there's some optimism out there and more positivity, particularly when we're used to kind of being forced to see so much negativity in the press. But interesting, also what you picked on there with the likes of Amazon and changing habits. So, if we finally move on to sector specific points, particularly around retail and wholesale, and this has taken a huge hit as a direct result of the lockdown. And we've seen well-known high street names, close the doors. The reason now a lot of talk about changing habits when it comes to retail, but is that what you see in, and does this tie in with the Amazon effect?

George Lagarias: It's not just that people didn't want to shop because they were too afraid to go to a store and mingle with others. I think we, as a society have reached that level of misanthropy just yet. What I think is that it's simply easier to find stuff that you want with the click of a button rather than go out and search in stores and look at all the other wonderful products they have. So, the idea of decades was that somebody opens a corner shop and you don't just go into buy the one thing. There's other merchandise that features prominently. Now with the ascent of more buying from online, you get much, much less of that. People go for targeted purchases. So, A, this means that a lot of high street names are being forced to reconsider the business models. B, some of them are having to consider their existence in this environment.

The world changes. It was once supermarkets and superstores that put the smaller stores out of commissions, now they're being put out of commission by online retail and that is that. It is a world that has much savvier than myself. Shopkeepers will tell me; you need to keep adjusting. I don't think there are going to be legislative solutions out of that. Natalie, I don't know if you want to talk a little bit about also the services sector, i-Hospitality and the such in terms of retail, because they also have a problem to fix. And the problem is not that we're going to order our beer online, that will never happen. But the problem is they don't have people to go and work for them. So, basically, we are seeing the quickest pace of permanent hires in the last 23 years and the sharpest rise in permanent salaries that we have seen in a very long time.

Now, somebody who used to work for your local pub as a temporary hire can now go to the city or better yet a new firm in the Northwest and get a much better permanent salary and finally do that white collar job, they always dreamed about doing. This is the perfect storm for companies that rely on temporary hires and temporary contracts, because A, they've lost, they're losing out a lot of people to competition from those who for more permanent contracts and higher end jobs. They have lost a lot of people to VU as the pandemic has seen a lot of VU people repatriate. So, there is a massive skill gap now in the UK. And people are calling on the government to fix the skill gap, but you can't really re-skill on a government mandate or you can't really re-skill as quickly as it's needed to get everything back on track.

So, apart from your traditional retailers have a problem with online, there are also some services companies, again like your local pubs and maybe your present and all of these who are having time finding the staff to service people. And this might not go away for some time until they rehired, re-skilled, retrained. It could take months in which time those business models are going to be disrupted and the patience of the owners is going to be tested, especially after government stimulus is eventually withdrawn.

Natalie Wright: Thanks, George. I guess the old adage, nothing is permanent has never been more relevant and with change does bring opportunity. So, looking ahead and specifically in the context of the economic environment that we're facing, are there any key opportunities that you can see for any of the sectors that we focused on there?

George Lagarias: I think we have to also take this in context with Brexit. The whole point of Brexit was to reduce reliance in one city, London, which features 10 times more population to the second city in the UK. I think that will be Birmingham with population of 1 million. Also, to reduce reliance on the financial sector, because you have a small number of people getting very rich, and then you have the rest of the country in general malaise. So, the bird's eye view to answer your question is that the confluence of a post pandemic environment and post Brexit environment, are very quickly changing Britain. Now, if I'm honest, I think all the cards are up in the air. I have no idea where they're going to land. I have no idea how consumers are going to behave in a year's time. Yesterday, they're optimistic, but once those savings start to dwindle, I'm not really sure if they will continue to be optimistic.

In fact, what we have determined from our research this quarter, is that for optimism to be sustained, we need more expansive credit creation. And that means what might sound politically unpalatable move of removing some regulation from the banking system, because then you get credit. Credit is the lifeblood of the economy. That means that somebody can go out and finance their cafe because they really did not want a high growth tech business for which you can get easy money for, but actually they wanted to just build a cafe around the corner and live off of that. You need credit to finance that. That's why you need banks to be a lot more relaxed about giving out credit. So, there're still so many things at play. It is natural and understandable for a lot of business owners to wait and see where the dominoes land. I would pay very close attention to whatever trade deals the UK does because it is those sectors that will be the first out of the gateway.

So, say for example, they made a trade deal with Norway to supply steel or other materials manufacturing in the UK. Then you would focus on that. You need to be very targeted. You need to watch those trade deals and you need to watch where the government is spending money, because these are the sectors that are going to see the most opportunity in the next five years. This isn't any more about being very selective and looking for the one opportunity. This is a whirlwind that a scam, it has taken all the dominoes down and now we're trying to figure out what this new future looks like.

Natalie Wright: Thanks, George. I did say that I wouldn't ask you to get your crystal ball outside. I appreciate you sharing your thoughts and actually some practical points as well. Looking at, and we've spoken about inflation and there's clearly to be huge inflation rate, pressure's moving forward. I think most people have probably seen that now when it comes to any major expenditure, whether it's on a personal or business basis. But where do you see inflation going in both the short and medium term, and are there any major risks on the horizon that we need to be cognizant of?

George Lagarias: So, there are two types of inflation. There's supply side inflation and there is the demand inflation. Demand inflation will probably quiet down unless we somehow deregulate banks and give more credit to the people. But let's talk about supply side inflation. Now, theory has it and it stands to reason, I think we're talking about supply side inflation. We're talking about temporary disruptions in supply chains. Eventually in a year when the pandemic will be behind us and there's again harmony in the global supply chain, things are going to materially improve. Now we see however, a few sources of longer-term supply inflation. And although we cannot quite put our finger on the probabilities, it is at the very least worth discussing. The only possible for banks demand side inflation that we might see is fiscal stimulus sending up in people's pockets in the form of cheque. We think this can happen, but obviously the government can't keep doing that forever so even this has limits.

Now an interesting forum of inflation and one people might not be too keen to acknowledge is the green inflation. We loved fossil fuels as a species because they were cheap. We now began to hate it because of them, our children won't be able to breathe. Natalie, you are a mother as I'm a father and I care much less about what I'm paying in the pump now, if that means my little Lily will be able to breathe in a year to 2070. Having said that not everybody sees it like that. Currently we stimulate the global fossil fuel industry by over 5 trillion per annum. This is 6% of global GDP to subsidize the use of fossil fuels. The more we turn to green energy, the more those subsidies are withdrawn, that means higher oil prices, and they're going to permeate everything.

Now, there is also the possibility that those supply chain problems might become chronic. One, because we need to reinsure some strategic materials and assets. Europe already put out a paper saying it tends to do that for some parts of its supply chain. We're also seeing de-globalization. In the last 20 years, China was manufacturing cheap stuff. Again, you're a mom, Natalie. You know that you can afford a lot of toys for your kid that when you and I were growing up, there was no way would come anywhere near them. And that happened because they were manufactured in Eastern countries for a fraction of the cost that it would take to manufacture them here. As we deglobalize and reinsure businesses, that means at the very least in the beginning, it means inflation.

If something is manufactured in Manchester, instead of Manchuria, it is possible that it's much better in terms of quality, but it will also most likely be more expensive. And then there's of course, extending that scenario to the full trade war between the east and the west. And here I'd like to remind a lot of people that China holds about 90 to 95% of rare-earth materials. Rare-earth materials are used for anything to microchips. A lot of the green technologies, including wind turbines and hybrid cars, surprisingly x-ray machines, MRI systems, engines, and visual displays. So, 85 to 95 of these originate in China. If we push China to heart, we could see a repetition of what happened in the '70s when the Arab states decided to shut off oil for the west and we saw the biggest spike in inflation in recent recorded history.

So, all of these scenarios that could happen, I will profess being agnostic to the wills of politicians, because sometimes those things are not rational. They have an electorate to please, or they're pleasing it in the way they think they should, which could be shorter term over the longer term. So, I will not go into this discussion about what politicians should do, but I would say that if things quickly devolve from where they are right now in terms of the trade disputes between the East and the West, expect to see more of that inflation that we've been seeing recently to last. If that doesn't happen, supply chains eventually get back to normal. If we don't deregulate banks, we do not get that either growth or inflation bump and we're back to the sluggish growth we have seen over the past years.

Natalie Wright: Thanks, George. I think you raise some really powerful issues actually there in particularly on the point of sustainability and ultimately the trade-off that that might bring. If we turn now to personal planning, because this season, the podcast has focused on succession planning in particular. And for some that will mean exiting a business, potentially turning shares into cash. And you've already explained the current low interest rates environment, inflation rates. And so, that means holding cash over the longer term. We'll see the real value of capital eroding, which effectively means your future purchasing power is reduced. So, what other options are there, especially for those who may consider themselves risk averse, and is there another option?

George Lagarias: In an inflationary world and pardon the expression, cash is trash. You do not want to have a large portion of your finances in cash. Cash is useful as a buffer in case things go wrong, but it should not constitute a very big portion of your wealth. Good news is that the pandemic hasn't swayed people from wanting to continue on with their investments. So, one in seven people, according to a recent survey, are expected to increase their pension contributions next year. More than two thirds expect to stay on track with retirement plans despite the pandemic. So, people will continue investing in investment portfolios because that is at least a proven way or a very likely way to beat inflation. If there is an inflationary environment and if we're talking about good inflation, a demand driven inflation as opposed to bad inflation, which is raw materials going up, then people could also consider investing their money in real businesses in some way, shape or form either as partners owning them, running them however it would work.

If you see more sustained levels of demand, then it makes sense that a lot of those businesses are going to do much better than they did in the past 10 years. Now, if you get bad inflation, the supply side, raw materials, trade war with China kind of, of inflation, then I think people would be better off in the more financial economy rather than the real economy because with the real economy, you get the danger of not being able to deliver or going bust at any case. Now, what happens if we do not get inflation? And I have to say, in fact, around 50% of our scenarios see an eventual return to secular stagnation in the next two or three years, what we have before the pandemic.

So, in case you don't have inflation, does it still make sense to hold cash? No, because even in that case, you did get a modicum of inflation. Things were not deflationary. You still got one, 1.5% per annum. And in that scenario, it's a scenario we know very well, that's where financial markets thrive, because you would still have central banks underwriting risk. So, you could put your money in the financial economy, in a portfolio and have much better return than just keeping it in the bank and losing one, 1.5% per annum. In most of these scenarios, it still makes sense to hold an investment and retirement portfolio. If we get that massive economic boom, because let's say we do have a lot of fiscal stimuluses, and then we have banking, deregulation, a lot of credit and a lot of demand and suddenly you can go out with your credit card and buy stuff you couldn't afford just like you did in the '90s, which was a very cold period to live in.

Jet skis were invented and the other very, very cool stuff, including probably the best music in the, I'd say in the past 40 years, that's the environment you might have. And in that environment, you might be wanting to focus a little bit more on the real economy. That takes advantage of the demand because returns there could be great. If you do not get that environment and the investment portfolio, the stable and safe investment portfolio, if you're risk averse or the more slightly aggressive, if you're a risk taker are probably your best bets.

Natalie Wright: Thanks for sharing that with this George. And I concur on the '90s music point. I'm not sure about the jet skis, but as I mentioned at the outset, you've got a real knack of making the complex simple, so really appreciate everything you've covered off today. And I know that we have gone into lots of different areas. So, in the show notes, I will leave a link to the webinar that I mentioned that you hosted last week along with your contact details, actually so people can connect with you on LinkedIn or on Twitter. And that brings the Exploring Family Business Podcast season 2 to a close. If you enjoy today's show, please subscribe to the series and leave a review on iTunes. It will help us to extend our reach to the Family Business community. We look forward to sharing more with you in the next season of the podcast, but for now, thank you for listening.

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