Economy
15 June
2022
Why Britain is once again the sick man of Europe
The UK is predicted to record the worst economic
growth of any major country except Russia next year. What has gone wrong?
By Duncan
Weldon
Illustration
by Anthony Gerace
Until very
recently, Boris Johnson liked to boast that Britain was “the fastest-growing
economy in the G7”. This was never worth taking especially seriously. If you
torture numbers enough they will tell you anything. In this case the method
used was to focus on the limited time period after the first national lockdown
in 2020. Britain’s economic growth fell further in the first wave of the
pandemic than that of many international peers and so bounced back quicker.
Nowadays, not even our boosterish Prime Minister can find much to shout about.
Britain’s
economy is shrinking. In April, GDP fell 0.3 per cent, following a 0.1 per cent
contraction in March. For the first time since the national lockdown of January
2021, all three of the UK’s main sectors – services, industrial production and
construction – registered falls in the latest data. The consensus view of
economists is that 2022 will be a tough year for the British economy but that
it should just about avoid a recession. Sadly, the track record of economists
when it comes to spotting British downturns is terrible. In the case of both
the 2008 crash and the early-1990s recession, forecasters failed to predict the
falls in output, only spotting the downward trends months after they started.
Measures of consumer confidence have proved a more reliable guide to the
outlook over the last few decades. The longest-running survey, from the public
research firm GfK, in May recorded the lowest reading since the series began in
the mid-1970s.
Whether the
UK falls into an outright recession or not, 2022 is likely to see the biggest
drop in living standards on record and a tough trading environment for firms.
But beyond the immediate outlook, even the bigger picture is failing to provide
much cause for cheer. The OECD expects Britain’s economy to perform worse next
year (zero per cent GDP growth) than that of any other developed country except
for sanctions-hit Russia. In its view, high inflation will continue to squeeze
household incomes while the government raises taxes and the Bank of England
hikes interest rates. The result is a dismal economic climate. Domestic
spending is weighed down by falling real incomes, the export environment is
tough and business investment is drying up as firms are ever more cautious
about the outlook.
The
lingering impact of the Covid-19 pandemic, disrupted global supply chains and
the commodity price shock emanating from the war in Ukraine are causing
problems for economies around the world. Global factors are the primary
determinants of the high inflation that is driving the cost-of-living crisis.
But the UK is being hit harder than many of its peers.
As the
2020s progress, Britain increasingly appears an outlier. Inflation is forecast
to be higher in the UK than in much of Europe, and growth weaker. It has been a
long time since Britain was last dubbed “the sick man of Europe” (a label first
applied by Russia’s Tsar Nicholas I to the Ottoman empire in 1853). In the
1970s the UK was western Europe’s laggard. It was a country beset by toxic
industrial relations, stubbornly high inflation and a volatile business cycle
that veered between periods of overheating and contraction. “Britain is a
tragedy,” observed the then US secretary of state, Henry Kissinger, in 1975.
“It has sunk to begging, borrowing and stealing until North Sea oil comes in.”
The reason
the sick man label is recurring is that the UK’s troubled start to the 2020s
followed a poor previous decade. Real wages, adjusted to take account of
inflation, are expected to be no higher in 2025 than they were in 2008. Workers
are facing almost two lost decades of growth.
In the
decade before the 2007-09 financial crisis, the British economy grew at an
average annual rate of 2.7 per cent. In the following decade – before the
pandemic – it grew by just 1.7 per cent. The financial crisis was a jarring
experience for many countries. Few emerged unscathed. But almost no major
country suffered as great a blow as the UK. Before 2007, Britain enjoyed the
second fastest growth rate among the G7 group of countries, behind only the US.
Since then, it has recorded the second lowest, ahead of only Italy.
Italy is
the cautionary tale for students of economic decline. As recently as the early
1990s it was as rich as Germany when measured by GDP, or national income, per
head. A decade later in the early 2000s, it had fallen behind Germany but was
still ahead of Britain. Nowadays Italy’s income per head is closer to that of
Spain. The fear is that Britain is embarking on a similar path. Not a sudden
economic shock that grabs the attention of the public and politicians but a
slow process that plays out over years and decades; relative economic decline
with a whimper rather than a bang.
Most
economists would agree that the long-term driver of economic growth and higher
living standards is productivity growth, the ability to get more output from
any given level of inputs. While global productivity growth slowed sharply
after 2008, Britain’s crashed. Output per hour worked in the UK economy grew at
1.9 per cent a year between 1997 and 2007 but only 0.7 per cent between 2009
and 2019. It is that slower productivity that has led the economy as a whole to
fall further behind the US and Germany over the last 15 years.
The causes
of this sharp slowdown in productivity growth are not straightforward; they are
many and varied. Nor are they universally agreed upon: for much of the decade
economists spoke of a “productivity puzzle”. Weak business investment, a
damaged banking system after 2008, poor quality-management, skills gaps and a
host of idiosyncratic problems in different sectors all contributed. Weak
economic demand, as David Cameron’s government pressed ahead with austerity and
prioritised deficit reduction over economic growth, played a role. Whatever the
ultimate causes, there is little doubt the financial crisis acted as a catalyst.
Britain’s old growth model was damaged, perhaps fatally, by the events of
2007-09.
The real
danger with anaemic productivity growth is that it is not the kind of indicator
that grabs attention. High inflation and rising unemployment are the sort of
economic problems that bother voters and hence politicians. A slow-burning
crisis of weak productivity growth is much tougher to mobilise a political
coalition around.
Indeed,
weak productivity growth is an economic cloud, but one that comes with a
short-term silver lining. If productivity is the ability to get more output
from any given level of inputs and it is growing slowly, then more inputs are
required. To put it in straightforward terms, poor productivity growth means
that even a relatively weak economy can generate a lot of jobs.
That is the
story of Britain’s 2010s. Economic growth, by any objective measure, was low in
both absolute and relative terms. And yet, despite weak economic growth,
unemployment continued to fall and employment to rise. Unemployment declined
from almost 8.5 per cent in 2011 to just 3.9 per cent on the eve of the
pandemic in 2020. Cameron’s government used to boast of its “jobs miracle” as
joblessness fell far faster than most analysts expected. This fast jobs growth
was the flipside of weaker-than-expected productivity. In the short term, as
long as there were idle economic resources that could be put to use, poor
productivity growth was almost a nice problem to have, or at least a
politically convenient one. But as time moved on, the silver lining became
smaller and the cloud more apparent. By the end of the 2010s, Britain was
running out of spare economic resources to put to work in driving growth.
The
productivity and growth problem of the 2010s has been compounded by Brexit.
Indeed, for half of the first lost decade, political attention was more focused
on the fallout from the Leave vote than the underlying growth problem. If the
financial crash left Britain’s growth model in crisis, Brexit may have killed
it.
Membership
of the European Economic Community, and then the European Union, was a core
component of the British economic model that developed over the 1980s and
1990s. Access to a larger market helped exporters to grow, and even domestic
firms were subject to greater competitive pressure as imports from Europe
flowed easily into Britain. Firms could harness wider supply chains and hire
across the continent. London, whose population had declined from 8.2 million in
1951 to 6.8 million in 1981, became Europe’s financial powerhouse. All of this
was a factor in the UK’s relatively fast growth during the 1990s.
But EU
membership meant more to Britain’s growth model than simply increased dynamism
and productivity growth. Membership of the EU’s customs union and single market
served as an anchor for the policymaking elite across the major political
parties and the civil service. It deterred some of the economic interventions
previously favoured by the left (through strict rules on state aid and
procurement) and much of the deregulatory agenda of the right (through social
and environmental legislation).
Dismantling
a major pillar of Britain’s growth model was always going to cause problems.
The standard workhorse model of international trade, the so-called gravity
model, predicts that trade volumes will usually be determined by the size of
the economies involved and their physical distance from each other. Countries
tend to trade with their neighbours. Defying gravity, by making trade with
Britain’s largest and closest peers more difficult, was always going to create
an economic gap that had to be filled.
Many Brexiteers
thought they had an answer. Freed from the shackles of EU membership, “Global
Britain” would be a buccaneering, free-trading nation. Yes, trade with the EU
would be harder, but Britain would sign up to free-trade agreements with
faster-growing emerging economies. There would be deregulation too, as European
rules were scaled back, unleashing the dynamism of British firms. There was
even talk of “Singapore-on-Thames”.
[See also:
What is the Northern Ireland protocol?]
Six years
on from the Brexit vote, that agenda has foundered. Rather than Brexit
generating a new economic model, the government has been left scrabbling to
find “Brexit dividends” to show that the economic pain has been worth it.
Daniel Hannan, one of the godfathers of Brexit, recently conceded it might have
been better if Britain had stayed in the European single market for longer.
The plan
failed on two grounds, one economic and one in the realms of political economy.
In straightforward economic terms, the plan to revive British capitalism with a
dose of Thatcherite deregulation failed to engage with just how “British”
contemporary British capitalism actually is. The muscle memory of the 1980s
might be strong in the Conservative Party, but British business has changed. It
is more globalised, more integrated into international supply chains and much
less nationally focused. To the chagrin of Brexiteer ministers, many larger
British firms – from car-making to finance – are not especially keen on
diverging from European standards. They would rather cling on to whatever
market access they can retain than enjoy the fruits of deregulation.
Then there
is the politics. If Brexit was, as many of its advocates proclaim, a revolt of
“left-behind” areas against an out-of-touch policy elite, then it is difficult
to believe that what they were calling for was more deregulation and exposure
to competition with emerging economies.
With
neither the voting public nor the business elite keen on the wholesale
regulatory change that “Global Britain” promised, the country finds itself
stuck. It has incurred the upfront costs of Brexit in terms of postponed and
cancelled business investment, a fall in the value of the pound and new trade
barriers with the EU, but it is unable to even attempt to take advantage of the
supposed economic benefits.
The old
British growth model was damaged by the financial crisis and then wrecked by
Brexit. The result is an economy stumbling forward from crisis to crisis, and
economic shock to economic shock, with the government lacking any coherent idea
of how to respond. The pandemic and the inflationary surge following Russia’s
invasion of Ukraine are simply the latest episodes. The productivity crisis of
the 2010s was allowed to fester. Whatever the short-term upsides, it was always
going to be a problem in the long run. The long run is now our present, and,
despite John Maynard Keynes’s famous dictum, we are not dead. But Britain is
sick. And we have to live with the consequences: a persistent and slow period
of relative economic decline. Without a new growth model, the UK’s future looks
distinctly Italian – but without the pleasant weather.
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