Britain needs a way out of economic stagnation

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The UK began the 20th century as Rome and the 21st as Italy. The latter comparison should not be taken very far: any fool can see that there are many differences between the UK and Italy. But one similarity cannot be ignored: productivity, which is the chief determinant of standards of living, is stagnant in both countries. This has been true in Italy since the late 20th century. It has been true in the UK since the financial crisis. The principal economic challenge for the UK is ending this stagnation. Without that, it will be impossible to solve its other social and political problems.

An important new book, Ending Stagnation, from the Resolution Foundation, addresses this failure head on. But its attention is not just focused on ending stagnant productivity, vital though that is, but also on other weaknesses. Indeed, the charge sheet turns out to be depressingly long. Among the most striking conclusions from this long list of failures is how much Brexit was a costly diversion from the challenges the country must tackle if it is to remain a prosperous high-income democracy.

Let us start with the stagnation. Between 2007 and 2021, UK output per hour rose by 7 per cent. Between 1993 and 2007, in contrast, it rose by 33 per cent. Median real hourly wages rose by 8 per cent between 2007 and 2021. Between 1993 and 2007, in contrast, they rose by 28 per cent. Again, according to the OECD, real gross domestic product per head in the UK rose 6 per cent between 2007 and 2022. This was better than in Italy, where GDP per head actually fell 2 per cent over this period. But between 1992 and 1997, real GDP per head rose by 46 per cent in the UK. The UK’s economic dynamism has evaporated.

As a result, incomes have fallen well behind those in peer countries: by 2018, median household incomes were 48 per cent higher in Canada, 37 per cent higher in Australia and 20 per cent higher in Germany. Low-income households were some 27 per cent poorer than in France or Germany. (See charts.)

Inequality surged in the 1980s and has remained high ever since. It is higher as a result than in any other large European country. The higher minimum wage has not changed this significantly, because wages do not translate directly into relative household incomes. What Resolution calls “the stubborn grip” of inequality retains its hold because the top of the income distribution has pulled away from the middle. It is also due to substantial benefit cuts, the fact that lower earners work shorter hours, and an enormous rise in housing costs for poorer households.

Bar chart of Median household net income relative to UK, selected OECD countries, 2018 (% above/below UK level) showing UK median income has fallen well below levels in most peer countries

This high inequality is not just among households. It is also among places. These regional inequalities, too, are longstanding. Thus, according to Resolution, “80 per cent of the income variation between areas we see today is explained by the differences back in 1997”. The gap between London and other cities is dramatic. The capital is 41 per cent more productive than Manchester. Paris, in contrast, is only 26 per cent more productive than Lyon.

A standard defence of high inequality is that it creates incentives for innovation and growth. In the UK, this has been strikingly untrue. The resulting combination of low growth with high inequality is toxic. The young have never experienced the progress in pay that their parents did. Partly because of low interest rates and partly because of the failure to build, those born in the early 1980s were almost half as likely as their parents to own their own home at 30.

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An important proximate cause of these failures is low investment. In the 40 years to 2022, the UK’s fixed investment rate was the lowest among G7 member countries. In the average member of the OECD, public investment is also nearly 50 per cent higher than in the UK. This lack of investment, and so the shortages of beds and equipment, is one of the reasons why the NHS is always on the brink of collapse. Time spent commuting is also relatively high. As bad as the low level is the volatility of public investment, as spending is turned off and on in response to short-term fiscal exigencies.

Line chart of Housing cost to income ratio* for working-age family units, by income quintile showing Rising housing costs have hit poorer families’ living standards

At least as important are the low levels of private investment. Expensing of investment spending, announced by Jeremy Hunt in his Autumn Statement, should help, provided this policy lasts. Given past chopping and changing of corporate taxation, that hardly seems likely. An important challenge is constraints on building just about anything, which affects both residential and commercial construction. But to invest more, it is necessary also to save more: the UK is an extremely low saving country relative to other high-income countries.

Bar chart of Square metres of built-up land per capita showing Britain hasn’t been building

Unfortunately, these difficulties are set to get worse. The combination of ageing, geopolitical tensions, Brexit, higher interest rates and the energy transition will raise pressures on the economy and public spending at a time when the tax burden is already at historically high levels and public debt is already close to 100 per cent of GDP. The Autumn Statement resorted to substantial chicanery to forecast a manageable medium-term fiscal position.

Line chart of Proportion of adults polled (%) showing The British public is disenchanted with the state of the nation

So, what is to be done? In addressing this fundamental question, three points need to be borne in mind. First, these are strategic, not tactical, problems. The economy is not delivering the prosperity the great majority desires. As the country falls behind, unhappiness will grow. Second, Thatcherism did not, alas, cause an enduring revival of the UK economy. Indeed, the growth prior to 2007 was itself in part an illusion. This must be admitted, at last. Finally, strategic problems need strategic solutions. British governance does muddling through, instead. But that just will not work. I plan to discuss what must be done and how in a subsequent column.

martin.wolf@ft.com

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