Britain’s economic model must be entirely redrawn before it’s too late

Boris Johnson, escapologist and apologist for law-breaking lawmakers, is safe – for now at least. Unless new revelations emerge about his personal conduct of him, his MPs of him will not move against him.

Whether the electorate is so sanguine is a different matter. We will not know the voters’ definitive answer until the next election, but the limited time window between now and then raises a different question. What is it all for? As inflation spikes, recession looms, and trade unions threaten strikes, there is grim talk of a return to the 1970s: the decade of the three-day week, the winter of discontent, and a currency crisis that prompted a bailout from the International Monetary Fund (IMF ). If this seems pessimistic, some economists believe we are heading for something even worse.

Then as now Britain had uncertain governments. Ted Heath hoped to reform the economy and lost a battle of wills with the unions. Jim Callaghan ended up repudiating Keynesian economics before Margaret Thatcher adopted her monetarist alternative.

Yet our present discontents may be explained in the apparent success of economic policies since Thatcher. Many of the drivers of inflation and instability are global. China, factory of the world, is still in partial lockdown. Ukraine, breadbasket of Europe, is unable to export its corn and wheat. Russia, huge exporter of gas, is sanctioned. Western economies are still recovering their own lockdowns and contending with these inflationary forces.

But consider the following facts. Before the financial crash, British GDP per capita was just 75 per cent of that in America, and since the crash it has fallen further still.

This is partly because the American economy is simply more productive. According to the Office for National Statistics, its productivity is up to 28 per cent higher. And it is not only America against whom we compare poorly: our productivity is estimated to be 18 per cent lower than France. What British workers produce in five days, French workers produce in four.

Since the crash, Britain has kept unemployment down. But pay stagnated for more than a decade, and recent wage increases, driven by a tighter labor market, are now being wiped out by inflation, which, including housing costs, is running at almost eight per cent, the highest for three decades. Inflation, the thief in the night, is a correction that brutally tells us we are not as rich as we believed we were.

Britain is in a particularly difficult position. According to the IMF, our economy will grow less next year than that of any other G7 country. Personal debt stands at 133 per cent of household income. We have grown used to and dependent on ultra-loose monetary policy, with incredibly low interest rates and quantitative easing artificially propping up asset prices. Amid rows about whether the Bank of England should have increased rates earlier and more decisively, the elephant in the room was the effect even modest rises might have on families with big mortgages.

We can argue about tax rates and regulatory regimes, but the truth of our predicament is more fundamental. We have an economic model dependent on consumption, but too many people are on incomes too low to consume without credit. We have run down our manufacturing capacity and built a services economy that makes a small number of people very rich while creating many low-productivity, low-skill, low-paid jobs. We have world-class financial services, a brilliant creative sector, and some high-performing manufacturers. The issue is that we have far too little of the latter.

As a share of our total economic output, manufacturing fell from 27 per cent in 1970, and 17.4 per cent in 1990, to less than 10 per cent today. As production shifted to Asia, manufacturing declined across all Western economies, but nowhere as severely as in Britain. In America, Germany, Italy and France manufacturing plays a bigger role in the economy than here.

The result is fewer productive and well-paid jobs, and in particular fewer such jobs in the regions outside the south-east of England. But even more important than this, the change from a balanced to an unbalanced economy means fewer exports, and a significant trade deficit. That deficit, which stood at almost £ 60 billion last year even during the pandemic, creates a series of perverse outcomes.

To finance the deficit and protect the currency, Britain needs to attract foreign capital, and doing so entrenches the problem further. British companies and other assets like public utilities and housing stock are sold to foreign investors. This risks a vicious cycle that increases the deficit, increases the need for more and more foreign capital, and skews Government policies. Utility companies can profiteer without investing in infrastructure. High asset prices – too high for many struggling Brits – need to be maintained. Investment in technology and research and development is kept low. Young and successful companies are sold off before they can grow.

We need a truly radical change to this economic model. Without it, there can be no leveling up, no great improvements in productivity or pay, and we will not make the most of Brexit. Such change will require us to smash shibboleths. Ever freer trade with developing economies may not work as the conventional wisdom assumes. Aggregate demand matters. And Brexit – supposedly a danger to our wellbeing – may well help us. Already supply chains are reforming and European imports are down.

This is not about bringing back the industries of the past, but building the industries of the present and future. Neither is it about competing with lower-cost economies on price. With investment, the right tax regime, and giving our people the right skills and training, we can compete on quality.

The strategic objective must be to achieve economic growth through a rebalanced economy. And everything – from education policy to immigration, fiscal and monetary policy to energy policy, the regulation of labor markets and the supply of housing – needs to be directed at achieving that objective. Our economy has many great strengths, but we cannot keep going as we are.

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