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The UK economy – or how to flog a dead horse

, June 8, 2017, 0 Comments

uk-economy-brexit-marketexpress-inIf there are two key measures of a nation’s financial health – the budget deficit and national debt – then the UK is flat on its proverbial back.

Seven years after this government came to power it faces similar problems.

Writing this on June 8, election day, most polls suggest a Conservative majority of some 50-100 seats. If this is the case one can expect more of the same from the new government: disclarity as to what Brexit means, combined with more austerity and rhetorical window-dressing on higher public investment. The Prime Minister Theresa May’s Strong and Stable leadership will take the UK into the choppy unchartered waters of Brexit.

The Tories (aka Conservative Party) say they want to balance the books by 2025, a full decade after its initial deadline to eliminate the deficit under May’s predecessor David Cameron.

This extension – some might say tacit admission of failure – would obviously allow for higher borrowing – and thus spending – levels to support the economy in the run-up to Brexit should – or rather when – they will be needed.

But whether one can have one’s austerity cake and eat it (well, spend it) – despite what the Foreign Minister Boris Johnson may think – remains a moot point.

Labour’s economic policies, meanwhile, would unambiguously boost growth in the short term with a spending spree, which would keep debt at high levels. To pay for it – at least partially – the party wants new tax rules and renationalization of the postal service and railways, plus higher taxes on businesses and the higher paid.

A hung parliament, meanwhile, that is one in which the Liberal Democrats would likely hold the balance of power, along with the Scottish Nationalists (SNP), would see some of the party’s plans enacted (although don’t hold your breath after its last coalition experience with the Tories from 2010 to 2015).

So, is Keynes making a comeback?

The US economist Joseph Stiglitz has been arguing for some time for a return to some form of Keynesian approach.

“The choice facing the voters in this election is clear – between more failed austerity or a Labour party advancing an economic agenda that is right for the UK,” he wrote this week.

“Austerity has not only damaged the European economies, including the UK, but actually threatens future growth,” he wrote.

The Observer newspaper on June 4, meanwhile, published an open letter signed by 130 economists calling for and end to austerity.

“Both the Conservative and Labour Parties have policies to promote growth which are based around investment, including borrowing to invest,” Linda Yueh, Adjunct Professor of Economics, London Business School, told DW.

“Like Continental Europe, there is an acceptance of the need to focus on growth. The challenge will be how much of the new government’s focus will be on it – versus the negotiations around Brexit, which will surely dominate the policy agenda for at least the next two years.”

The economist and academic Will Hutton agrees. “I think the chances of Keynesian policies are both quite high – and likely to be successful even under a minority Corbyn government,” he told DW.

“Keynesian policies – under either Corbyn or May – will be organized around borrowing for infrastructure investment and there is widespread recognition – even in the capital markets – that this makes economic sense,” he added.

“Both Labour and Conservative are influenced by the German model,” Hutton said. “May should be regarded as a right-of-center Christian Democrat pursuing light Mitbistimmung policies (consultation with labor forces), plus reinforcing a British variant of Fraunhofer Institutes. Labour is more overtly enthusiastic about developing regional banking structures to support the Mittelstand, along with giving unions a role and voice in enterprise along German lines.”

“The paradox is that as Britain moves to leave the EU, its main parties are moving more overtly to copy critical elements of the German social market economy – without acknowledging their debt,” he added.

The UK economy – from hero to zero

Before the Brexit vote last June, the UK economy was doing reasonable well, outgrowing Germany, Japan and the US and initially held up better than expected in the months after, as consumer spending – the perennial mainstay of the UK economy – kept chugging away, mainly financed – again as ever – on the “never never” (credit).

Many forecasts of immediate economic disaster if the UK voted to leave the EU were proved wrong, failing to take into account possible compensatory action by the Bank of England (BoF) after the vote.

The BoE in fact took steps to boost the economy, cutting interest rates from 0.5 percent to 0.25 percent in August – the first reduction in the cost of borrowing since 2009 – taking rates to a new record low.

But alas it was not to last. In the first three months of 2017, the UK’s was the co-worst-performing advanced economy, with growth of 0.2 percent and although economists offer competing data, there are signs of a deterioration in 2017, with inflation inching up thanks to the slump in the pound making imports more expensive. Price rises are now outpacing wages, according to the latest Office for National Statistics data and this could see consumers reining in spending.

In 2017, businesses will also hold back on investment decisions because of uncertainty about Brexit, according to the majority of economists in an annual Financial Times survey. The economists now expect growth to slow, from about 2.1 percent in 2016 to no more than 1.5 percent in 2017.

The PWC UK Economic Outlook report in March said UK growth is projected to slow to around 1.6 percent in 2017 and 1.4 percent in 2018 due to slower consumer spending growth and the drag on business investment from Brexit-related uncertainty.

Oxford Economics economist, Martin Beck, has argued that there are signs the impact of the vote for Brexit may finally be starting to filter into the habits of British consumers. Many others think unemployment will rise as businesses try to restrain costs in the face of uncertainty about the UK’s future outside the EU, which is also expected to depress business investment. These pressures will in turn hold back consumer spending.

Structural problems

The plight of the UK economy has long been dominated by a central issue of under-production – the imaginatively named ‘production puzzle.’

Over the post-war period both Labour and Conservative governments have sought to increase it, and failed. Mass immigration, lower wages, supply side reforms, weakening trade union activity, privatization and changes in employment rights, a brief period of social-democratic Tripartism in the 1970s – all failed.

“The UK’s main long-term structural problem is also found in other major economies like the US and Germany, which is low wages,” Yueh said. “This has different causes in different countries, but is part of a general trend in developed nations. The UK has a particularly worrying case, which requires a much stronger focus on raising productivity and investing to grow the economy,” she said.

Several structural problems other than productivity also bedevil the UK economy – weak business investment perhaps the top of the list.

Capital spending as a share of GDP has fallen from 20 percent in 2007 to under 15 percent today. The commercial banking system is reluctant to finance expansion plans of many small and medium-sized businesses and this has a knock in terms of low Research and Development funding, which is at under 2 percent of GDP.

While there has been a fall in UK unemployment – currently 5.7 percent – structural problems remain, with over 30 percent of unemployed out of work for at least a year, high youth unemployment and very wide regional variations.

The UK economy has seen a structural decline in manufacturing and continues to reply on financial services.

In trade, Britain runs a consistent and structural trade deficit and export growth in the recovery has been disappointing despite the UK enjoying a more competitive exchange rate. The pound fell dramatically after the Brexit vote last year, and since then has been trading around 15 percent lower compared to the dollar and 12 percent lower compared to the euro than it was before the referendum.

There is also a structural fiscal deficit, with the cyclically-adjusted budget deficit above 5 percent of GDP.

Structural under-funding of public services, with some economists arguing the NHS needs a major injection of extra funding over the next 5-10 years.

As Larry Elliott in the Guardian argues, these longstanding problems – “a hollowing out of manufacturing, overreliance on the City, a large and growing trade deficit, big regional differentials in productivity” – have been given a political manifestation by Brexit. There was, he argues, a strong link between voting patterns and the health of the local economy.

Oh – and then there is Brexit  

“The World Bank believes that if Britain switches from single market membership to trading with the EU on World Trade Organisation terms – the ‘no deal’ option – then British trade in goods with the EU will halve and trade in services will fall by 60 percent as these effects work through,” Hutton wrote in the Guardian recently.

Britain will also have to renegotiate 759 agreements with 168 countries that are now held by the EU. “That is 759 opportunities for other countries, knowing our plight, to try to negotiate something better. Britain has to find solutions to all these issues in less than 12 months,” Hutton argues.

“The Conservative manifesto commitment to leave the single market and customs union and seek a trade relationship outside any of the EU’s frameworks – not the EEA or even Efta – is a declaration of economic war upon ourselves,” Hutton wrote.

“There is no corner of British economic life that does not face disruption bleeding into mayhem as a consequence of no deal. The politician who declares that no deal is better than a bad deal is either supremely ignorant – or lying.”

There are hints that Brexit uncertainty is already hitting business confidence.

The clearing of financial instruments is a key sector that could face obliteration. Clearing-houses – which are central to securities or derivatives transactions ensuring that deals are honored – could do a London post-Brexit exit.

In November a study commissioned by the London Stock Exchange (LSE) warned that if euro clearing was forced out of the City, 83,000 British jobs could be lost, and a further 232,000 affected.

On May 4th the European Commission said it was looking into new rules for euro-denominated clearing.

By 2016, 62 percent of the $544 trillion (about 490 trillion euros) global over-the-counter derivatives market was settled in this way and London handles 37 percent of foreign-exchange derivatives globally and 39 percent of interest-rate derivatives.

Elliott argued that one benefit of Brexit, meanwhile, is that it could allow the economy to be rebooted.

“The last time UK policymakers had the chance to implement root and branch cures to the economy’s structural weaknesses was during the financial and economic crisis of 2008-09. Instead they bottled it, relying almost wholly on the Bank of England to support activity through interest rate cuts and the money-creation program known as quantitative easing (QE),” he wrote.

“Real structural reform goes deeper and requires something that has typically been in short supply in Britain: patience,” Elliott argues.

A YouGov poll reports that 50 percent believe Britain should stay in the single market – only 29 percent do not and a narrow majority would even accept freedom of movement as the price of staying in.

The markets still assume that the Tories will win and that May will lead the UK into Brexit talks later this month. But with an ailing economy, weak support among her own party after a disastrous campaign and up to 800 separate trade chapter to wade through she may soon come to regret winning the election after all.