UK to perform worst of major economies in 2023, says IMF – here’s how to achieve long-term growth
- Written by Michael Kitson, Associate Professor in International Macroeconomics, Cambridge Judge Business School
The International Monetary Fund (IMF) has produced another dismal forecast for the UK economy[1]. The IMF expects it to contract by 0.6% in 2023, whereas all other major economies are expected to grow – including sanctions-hit Russia. Meanwhile the Bank of England expects[2] the UK economy will be no larger in 2026 than it was in 2019.
The growth of the economy is a key sign of prosperity, but the most important indicator is the growth of productivity, or output per worker.
“Productivity isn’t everything, but in the long run, it’s almost everything,” the Nobel prize-winning economist Paul Krugman observed[3] in his book The Age of Diminished Expectations. It is so important because it is the main driver of growth in real wages, corporate profits and tax revenues.
Productivity growth has been stagnant in the UK[4] since the 2008 global financial crisis. This has also been the case in other high-income countries, but UK productivity performance is near the bottom[5] of the league table of the G7 advanced economies. More importantly, the UK government does not have any coherent ideas about how to address the problem.
According to the IMF, the UK is the ninth biggest economy[6] in the world (according to purchasing power parity, which accounts for varying currency strengths). But the World Economic Forum ranks the UK 61st out of 141 countries[7] in terms of the government’s “long-term vision”. If this institutional myopia is not addressed, the UK will continue to drop down the productivity performance league.
Soundbites vs policy
In a recent speech, UK chancellor Jeremy Hunt outlined his “vision”[8] for the UK economy which consisted of “the four ‘Es’ of economic growth and prosperity”: enterprise, education, employment and everywhere. But behind the rhetoric and slogans, there was no strategy or policy that would actually increase productivity. Kitty Ussher, chief economist at the Institute of Directors, added a fifth item to the chancellor’s list – an E for “empty[9]”.
Of course, this is not the first time that politicians have resorted to slogans and banalities to mask a lack of economic content. Boris Johnson’s government used “build back better”. Even Johnson himself could not resist mocking[10] this slogan.
Gordon Brown, UK chancellor from 1997 to 2007, took his slogans far more seriously. In 1994, he said that New Labour’s economic policy[11] would be based on “post-neoclassical endogenous growth theory”. Aside from being unintelligible to most people, that phrase even befuddled economists who understood endogenous growth[12] but didn’t know what the “post” prefix meant. Showing his populist instincts, Tony Blair translated Brown’s slogan as “education, education, education[13]”.
UK problems – and solutions
Moving beyond slogans and soundbites, the conventional wisdom of modern economics[14] tells us that key drivers of productivity growth are:
- investment in physical capital (the machinery, equipment and structures that can produce goods and services);
- investment in human capital (education and training), innovation and technology;
- and institutions that foster growth and development.
The UK needs to address problems in all three areas.
1. Insufficient capital investment
Investment by both the private and public sectors will allow more goods and services to be produced in the future. But the UK has persistently low levels of capital investment[15] compared to other advanced economies.
In the private sector, this low level of investment reflects economic and policy instability. This instability has been reinforced by Brexit, COVID and the war in Ukraine, but it also reflects a lack of long-term industrial policy and a financial system that emphasises dividends and share buy-backs over patient long-term investment.
A lack of investment in infrastructure by both the public and private sectors has also hindered long-term growth. There are deficiencies in the transport, energy and sewage systems and a need to properly address climate change.
The UK has established a state-owned Infrastructure Investment Bank[16] to “finance a green industrial revolution and drive growth across the country”. But the bank is too small scale.
According to a January 2023 report from Westminster’s Public Accounts Committee[17], 18 months after its launch the bank had only deployed “£1 billion of its £22 billion capital to 10 deals”, and had employed just 16 permanent staff “against a target of 320”. The committee also said it was “not convinced the bank has a strategic view of where it best needs to target its investments”.
2. Weaknesses in the innovation system
Innovation policy in the UK focuses on how to generate new technologies including spending more on R&D. The government target for this is 2.4% of GDP (based on the OECD average in 2018). It continually failed to meet this until the way the data was collected was substantially revised[18].
A important inadequacy of UK innovation policy is the lack of focus on the diffusion[19] of new technologies. A new technology does not have the most economic impact when it is developed, but once it is widely used[20].
This diffusion of innovation can be difficult, costly and take time, however. And implementation in the UK has been hindered by a range of factors including deficiencies in company management[21], a lack of technical knowledge and risk aversion by companies.
3. Institutional deficiencies
Identifying the appropriate policies is necessary, but not sufficient, to address the productivity problem. An institutional framework is needed to see that policies are implemented effectively over time. The UK lacks such an effective and powerful institution that will focus on growth and productivity.
The Treasury is the dominant government department in this area but its focus is on short-term fiscal sustainability, what some call “government by accountants[22]”. In 1964, the Wilson government established the Department of Economic Affairs (DEA) to promote economic growth. This Department, with its long-run remit, lasted just five years[23]. The Treasury reasserted its monopoly power over economic policy in 1969.
In the political domain, many politicians are primarily preoccupied with being re-elected in the next few years and are less concerned with what the economy and society will look like in the more distant future.
The UK is blighted by systemic short-termism; it needs long-term vision and institutional stability to secure productivity growth.
References
- ^ dismal forecast for the UK economy (www.imf.org)
- ^ Bank of England expects (www.bankofengland.co.uk)
- ^ Paul Krugman observed (blogs.worldbank.org)
- ^ stagnant in the UK (twitter.com)
- ^ near the bottom (www.ons.gov.uk)
- ^ ninth biggest economy (www.imf.org)
- ^ ranks the UK 61st out of 141 countries (www3.weforum.org)
- ^ outlined his “vision” (www.gov.uk)
- ^ empty (www.ft.com)
- ^ mocking (www.independent.co.uk)
- ^ New Labour’s economic policy (academic.oup.com)
- ^ endogenous growth (corporatefinanceinstitute.com)
- ^ education, education, education (www.theguardian.com)
- ^ conventional wisdom of modern economics (www.sciencedirect.com)
- ^ low levels of capital investment (www.instituteforgovernment.org.uk)
- ^ Infrastructure Investment Bank (www.ukib.org.uk)
- ^ Public Accounts Committee (committees.parliament.uk)
- ^ substantially revised (www.nature.com)
- ^ lack of focus on the diffusion (academic.oup.com)
- ^ once it is widely used (www.technologyreview.com)
- ^ deficiencies in company management (assets.publishing.service.gov.uk)
- ^ government by accountants (www.theguardian.com)
- ^ lasted just five years (www.tandfonline.com)
