Sustainable Growth and Employment: What needs to be done?

Published in eGov Monitor, 24 September 2007

By Dr Oliver Marc Hartwich, Chief Economist, Policy Exchange

The Chief Economist at the Policy Exchange analyses the British economy’s performance over the past decade and argues that all is not well for the UK economy. He argues we are heading in the wrong direction and urges for reform in key areas.

For the past fifteen years Britain seemed to be a solid rock of growth and prosperity in a turbulent world economy. Since Britain’s exit from the European Exchange Rate Mechanism and the ensuing economic turbulences of 1992, the country has enjoyed more than 60 consecutive quarters of economic growth. While other parts of the world suffered the consequences of the Asia Crisis in 1997, the Russia Crisis in 1998, the end of the dot-com bubble and the fallout from the 9/11 terror attacks in the early years of this century, the British economy seemed to remain unshaken and continued to grow.

The headline figures that this British economic miracle has produced are impressive at first sight. Between 1992 and 2006 the UK’s economy grew by 49 per cent in real terms. The Euro area, by comparison, only managed to achieve 33 per cent growth over the same period. No wonder, then, that the UK overtook Germany in GDP per capita in 2001. On employment, too, the UK seems to compare favourably with its continental European neighbours. The current UK unemployment rate of 5.4 per cent is significantly lower than German, French or Italian unemployment rates.

All in all the British economy of the past one and a half decades seems to have been a success story. But unfortunately, things are not all as positive as they appear at first sight. The remarkable figures conceal some less pleasant facts and problems.

First, the growth record may not be that spectacular after all. When the late comedian Henny Youngman was asked “How is your wife?” he always responded “Compared to what?” This applies to the UK growth figures as well. Instead of comparing them to the more sluggish economies of the Eurozone, perhaps one should put them against the growth records of major Anglosphere economies. And then the UK’s growth record is less impressive. Whereas the UK grew by 49 per cent, Canada achieved 59, the United States 60, New Zealand 62, Australia 73 and the Republic of Ireland a stunning 167 per cent real GDP growth between 1992 and 2006. Obviously, all other English-speaking OECD countries have done better than the UK over this period.

Second, the growth of GDP is not the only important economic indicator. One also has to look behind this figure and ask how it has been achieved. It is impossible to overestimate the importance of four factors in this: immigration, house prices, private debt and the public deficit. Strong immigration into the UK has pushed up GDP, but consequently the per-capita growth rate of GDP has been well below the overall growth figure. House price inflation has been strong with annual rates well in the double digits. House prices boosted private debt, both because higher mortgages were needed to get a foot onto the property ladder and also as people took out mortgages against the increase value of their houses to finance their consumption. Finally, despite overall economic growth, government spending accelerated and led to high public deficits.

To sum it up, the growth that the British economy experienced in the past 15 years was not as remarkable as is often believed and, crucially, it was to a large degree dependent on the coming together of a number of influences which are not sustainable in the long run. Immigration at the levels experienced since the mid-1990s may not continue for much longer. House prices cannot go up by more than ten per cent every year indefinitely, nor would this be desirable. Private indebtedness is also increasingly regarded as a social problem, and with interest rates rising private debt will slow down. Finally, the Government is expected to announce a curb on public spending in the forthcoming comprehensive spending review.

In other words, the pillars on which the UK’s economic growth has rested in the past are breaking away simultaneously. Our temporarily supercharged economy will enter dangerous waters, and it is unclear how it will deal with these radically changed circumstances. And of course, the question then becomes what the government needs to do.

It is worth noting that the Eurozone countries, those economies that the UK outperformed in the past, have for some time embarked on a policy of economic reform. Slowly but steadily they have modernised their labour markets, consolidated their budgets and lowered their corporate and personal taxes. The UK, on the other hand, has gone in the opposite direction. Taxation increased under Gordon Brown’s chancellorship as did the state’s share of the economy. Earlier this year, the UK even overtook Germany in this respect. This should have been a warning.

If we want our economy to grow in the future, it would be wrong to focus exclusively on the competitive threat that comes from emerging economies like India and China. Rather we have to look across the channel to see that our European competitors have used their past economic crises as opportunities to reform themselves. We, on the other hand, have simply relied on debt, immigration and rising house prices, while our economic competitiveness with regards to taxes, regulation and public spending has deteriorated.

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