Putting economic turning points in a historical context can be insightful. Rachel Reeves began her budget referencing 1945, 1964 and 1997, three years when Labour took power from the Conservatives in the postwar era.
Although she didn’t mention it, this also occurred in 1974 and that may be the more relevant comparison. Now, like then, the government has to wrestle with a host of domestic economic problems against a difficult global backdrop.
In the United States, the election has rekindled memories of the 1980 “Reagan Revolution” and its major realignment of American politics.
Subsequently, despite twin budget and current account deficits, the US economy outperformed, helped by a supply-side boom driven by tax cuts. Now, higher tariffs are part of its policy mandate, clouding the outlook.
The UK’s prospects will be impacted heavily by the global outlook. For a start, the focus of financial markets is shifting from concerns about inflation to a focus on growth. In a couple of years, attention will shift to debt. Given the UK’s borrowing needs, the government will need to remain alert to keeping domestic and international investors onside.
Inflation is low globally, but before the pandemic there was a secular rise in service sector inflation. This may be reasserting itself and will keep core inflation high. Meanwhile, another long-term trend of downward pressure on wages has reversed, suggesting persistent inflation. This will limit the extent to which central banks can lower rates. This may be a problem for global growth, as there is little room for fiscal manoeuvre either, as the world is sitting on a debt pile.
In October the IMF forecast global growth of 3.2 per cent both this year and next. Worryingly, and reflecting tough economic times, the IMF’s five-year-ahead projection for global growth has fallen consistently over the last two decades, from close to 5 per cent on the eve of the 2008 global financial crisis to 3.2 per cent now.
For the bulk of the period since 2008, western economies have relied upon cheap money and debt to boost growth. To rely on such policies in the future would risk repeating recent problems: with rising global public debt and more of it having to be bought by central banks, leading to asset price inflation, markets not pricing properly for risk, a misallocation of resources, cost of living pressures and an eventual repeat of the 2008 crisis.
In the UK, monetary policy became the economic shock absorber and Westminster did not pursue necessary structural reforms. A new approach is needed.
The government is right to focus on growth and investment, but we must be competitive and pro-business too, ideally with a supply-side agenda that raises productivity. We are some way from that.
Yet low productivity growth is not solely a UK phenomenon. The response globally has been a shift towards industrial policies and protectionist measures such as subsidies, regulatory barriers or tariffs. A national security lens, or focus on addressing the climate crisis, has reinforced this across many countries.
The UK therefore has to adapt to two global turning points: the shift in the balance of economic power, and rising protectionism. As an open economy, the UK is particularly impacted.
Economic power is shifting to the Indo Pacific, from India in the west, China in the middle and to the US and Pacific Rim in the east. Global policy forums are adapting to this. Witness this week’s Asia-Pacific Economic Cooperation leaders’ meeting in Lima and the G20 Summit in Rio, both attended by President Biden and President Xi. Sensibly, the prime minister, Sir Keir Starmer, is attending Rio, building G20 ties. Western Europe is already the slow-growth region of the world economy, and while Mario Draghi’s powerful report on competitiveness laid bare the EU’s challenges, ever closer union is not the answer.
Superimposed on these economic plate tectonics is a geopolitical shift towards national agendas. Globalisation has given way to fragmentation, and a rise in friends-shoring — sourcing from allies — or onshoring. Yet, many firms are still thinking globally, especially in services in which the UK excels, and even when barriers are erected against one country in goods, trade still occurs with production shifting to another location. So, if there were a widespread shift to protectionism it would be a sea-change from recent years and dampen trade and global growth.
President Trump’s domestically focused policies will boost the US. Financial markets are taking a rosy view, anticipating a stronger US outlook, driven by tax cuts and lighter regulation. They are also factoring in interest rates not falling as far as thought, because of a higher budget deficit and as tariffs push up the relative prices of goods affected, if not the overall price level.
What does this mean for the UK? Amid debates about our relationship with the EU, the opportunity that being outside of the customs union and single market presents shouldn’t be forgotten, particularly for a services sector-based economy. Many sectors that will drive future economic growth are ones where the UK can benefit from regulatory autonomy.
It is wise for the PM to build ties with China, with a UK-China Economic and Financial Dialogue back on the agenda. Before the pandemic China accounted for a third of global growth and now its economy is moving up the value curve, which will provide opportunities for the UK.
The US will remain the global economic superpower. Since 2010 the US has pulled ahead of Europe, with a cumulative annual growth rate of 2.3 per cent each year compared with the UK’s 1.5 per cent, Germany’s 1.3 per cent and France’s 1.2 per cent. Staying close to the US given our strength in services, which are not facing tariffs, may be necessary. Nonetheless we should not be complacent about contagion from the global fallout caused by US tariffs.
Finally, to prevent 2008 being embedded as the economy’s recent historic turning point, we need to address our sluggish growth in GDP per head. Key to the solution is positioning ourselves in this changing global landscape.
Please note, the value of your investments can go down as well as up.
