Flickr/The Prime Minister's Office, CC BY-NC-ND 2.0
The Bank of England, the Office for Budget Responsibility and many commentators all appear to be reasonably confident that the UK economy will grow at a little under 2.5% between now and the next general election in 2020, with consequent favourable impacts on incomes. Yet it is unlikely that this relatively benign outcome will be achieved for all the reasons set out below.
The economy is extremely unbalanced
The UK economy has at least six major imbalances. First, the proportion of our GDP which we invest rather than consume is so low – currently at 12.5% excluding intellectual property – that, allowing for depreciation and our rapidly growing population, there is no net investment in physical assets per head of the population now taking place at all. Second, we have allowed the economy to deindustrialise to a point which, with only about 10% of our GDP coming from manufacturing, means that we cannot pay our way in the world. Third, for this and other reasons, we have an increasingly unmanageable balance of payments problem.
Fourth, because the government deficit is now largely the mirror image of our foreign payments deficit, with sterling as strong as it now is, we currently have no chance of reducing the government deficit significantly from where it is at present. Fifth, because of both our government and foreign payments deficits, we are running up debt much faster than the economy is growing. Sixth, what growth we have seen recently has been achieved very largely as a result of ultra-low interest rates and consequent asset inflation, which have drawn more people into the labour force without increasing output per head – which again is unsustainable.
Because current government policies are not oriented towards dealing with any of these imbalances, the scene is set for a variety of adverse consequences which are very likely to undermine the forecasts on which it appears the authorities are currently relying.
Productivity will increase very little, if at all
It is only since the Industrial Revolution began that average living standards have risen significantly and virtually all the increases in real incomes which have resulted have come from the application of machinery and technology. Almost all the rest of the economy has simply adapted to the huge rises in output per head which mechanisation and technology have made possible. The problem in the UK is that we are now investing far too little in the future. While we invest barely 12.5% of our GDP each year, the world average is about 25% and in China the figure is around 46%. Of the total we do invest, barely a quarter – currently 28% – goes towards manufacturing and when depreciation is taken off this low figure, on average, nothing is left. This is why productivity is not increasing. Between 2008 and 2014, output per head in the UK rose by no more than 0.1% per annum, while physical investment as a percentage of GDP remained static.
The foreign payments balance will act as a constraint
The UK’s foreign payments balance has become a major problem, as can be seen from the table below:
UK Balance of Payments Breakdown – net figures, all in £m
CLICK TO ENLARGE
Source: ONS BNBP Balance of Payments Quarterly First Releases and 2015 Q2 Balance of Payments Report. London: ONS, 2015.
Between 2008 and 2011, the total balance of payments deficit sustained by the UK averaged about £40bn per annum. It is now averaging about £100bn a year and it is likely to be on a rising trend. The trade deficit is static at best but will probably increase if sterling retains its current value. Our net income from abroad is likely to become more and more strongly negative as a result of the continuing sell-off of UK assets which is keeping the value of sterling up. If the return on borrowing or the sale of assets is about 5% and we have a foreign payments deficit of £100bn per annum, our net income from abroad can be expected to go down by about £5bn every year. UK net transfers abroad are increasing both as a result of rising contributions to EU budgets and its other institutions and because of remittances increasing as the number of migrants settling in the UK goes up.
£100bn a year represents approaching 6% of the UK’s GDP. Is the rest of the world going to continue forever allowing us to live at a level of expenditure which is 6% higher than we are earning, while we run up more and more net liabilities to finance a level of spending which we have not earned?
Incomes may remain static even if GDP is increasing
From its peak during the first quarter of 2008, UK GDP had risen by the second quarter of 2015, net of inflation, by 5.6% - an increase in 2015 prices of £110bn. Over this same period the population increased by 4.0%. On this basis GDP per head rose by 1.6% or £31bn. Incomes, however, did not rise by this amount because significant proportions of the increase in GDP were not paid to UK residents but went abroad.
The sums involved can be seen from the UK’s balance of payments accounts. These show that between 2008 and 2015, the UK’s net income from abroad went from a positive £3bn in 2008 to a negative annualised rate of £30bn in 2015. Similarly, the UK’s net transfers abroad, in the form of payments to the European Union, migrants’ remittances and the UK’s aid programmes, rose over the same period from £14bn to £24bn. Adding the swing on these two figures together produces a total of £43bn. If this figure is subtracted from the £31bn calculated in the previous paragraph, less than nothing is left.
What has happened is that expenditure per head of the population has risen but not incomes. The gap has been filled by a combination of consumer borrowing and the government spending more than it has raised in taxes, fees and charges. If we carry on as we are with increases in GDP per head continuing to be diluted on the present scale by our rising population and leakages abroad, by 2020 we will have experienced more than a whole decade where average incomes have failed to grow. If, during this period, inequality in incomes increases, as may well happen, a substantial proportion of the population will still be worse off in 2020 than in 2008.
The government will fail to eliminate its deficit and may not be able to get it down at all
It is a central plank of government policy, supported by most of the Opposition, to reduce the government deficit to zero by the time of the next general election. The table below shows why this target is extremely unlikely to be met
UK Net Lending (+) and Net Borrowing (-) by Sector- all figures in £m
CLICK TO ENLARGESource: Table I. Net Lending by Sector in ONS Statistical Bulletin – Quarterly National Accounts 2015 Q2 and previous editions of the same table. Figures for 2014 and 2015 are still being reconciled by ONS and the net totals will also be very close to zero when this process is complete.
As a matter of accounting logic, all borrowing in the economy has to equal all lending, and all deficits have to be exactly matched by surpluses. As borrowing by households at present is fairly similar to lending by corporations, the foreign balance has to be close to the government deficit. On current trends, it seems likely that the total 2015 government deficit will be about £80bn and the foreign payments deficit about £90bn
The only way in which the government deficit could be reduced to zero by 2020 would be as a result of some combination of a huge reduction in the foreign payments deficit or much more borrowing by both corporations and households. On current trends, none of these developments looks remotely likely. It is therefore very probable that the government deficit will be similar in 2020 to what it is now or possibly even higher. Attempts by the government to reduce the deficit by cutting expenditure or increasing taxation will founder on the fallacy of composition entailed in assuming that what would work for an individual whose expenditure was greater than his or her income would work for the government as a whole. It will not do so. Government cuts, in these circumstances, will simply tend to tip the economy towards recession.
Because the UK economy is now so unbalanced and distorted, it is much more vulnerable than it should be to other events and developments which may well tend to derail the trajectory of the UK economy between now and 2020. These include the introduction of domestic policies which may cause major political problems, such as the implementation of the current tax credit policies which adversely affect millions of low-paid families. They also include external threats such as the current slowing down of world economic expansion; the travails in the Eurozone which looks likely to achieve, at best, very slow growth but with the possibility of the Single Currency breaking up threatening a much bigger negative impact at least in the short term; the possibility of a banking crisis probably caused by excessive public sector lending against weak or non-existent security; and the election of governments with incoherent policies in reaction to endless austerity and economic failure, leading to weakening world trade.
The UK badly needs to recognise how poorly positioned its economy is to provide satisfactorily for the future needs of the UK population on a sustainable basis. On present trends, on the contrary, by 2020 the UK economy may well be seen to be in deep trouble.
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John Mills is a donor to openDemocracy.