What now for the UK economy?
The UK economy is facing yet another crisis. After Covid, the 2022 gas crisis and the Liz Truss bond market fiasco, we now have to face the American tariff disaster.
This latest crisis is not self-inflicted, but the UK economy enters it in a parlous state. A mix of flatlining productivity, peaky inflation and stretched public finances would be problematic in a benign climate; in an era of global turmoil, it is potentially disastrous. Just as seriously, the UK’s politics has entrenched itself into a consensus that is deeply damaging to the economy: against migration, against closer links with our largest trade partner, against the broad-based tax rises required to pay for the public services we want, against almost any reform that might create winners and losers.
Given this unhappy mix – heading into an Atlantic storm with a listing ship and a mutinous crew – what should the UK government do next?
There are some basic things related to the tariffs to start with.
Don’t give in to protectionism or economic nationalism. There are plenty of other countries besides the USA to trade with, and we already trade much more with them. For a small, open economy like Britain’s, retreating from trade would be a fatal mistake. We need to reorient, not retreat.
That said, there may be a need for specific tariffs to respond to the change in global trading patterns. Responding to dumping of goods intended for the US, or protecting critical industries in the short term may be necessary and justified. There is a case for building a bit more autarky potential into the UK economy too, ensuring that key parts of the economy – defence, energy, food, key manufacturing inputs – are not too dependent on other countries.
You also have to ensure you have your fiscal and monetary policy levers ready to respond. The tariffs and their associated turmoil are likely to significantly reduce global demand. British companies will lose export sales, wealth is being destroyed by the stock market plunge, and it will likely get worse.
For now, there is precious little scope for loosening fiscal policy, but that could change quickly. The first step in a demand slump will be to loosen monetary policy and cut interest rates, but fiscal policy may also need to play its part in time.
This may sound mad with UK borrowing costs currently under such pressure. But that is as much a function of inflation as anything else. If demand slumps and interest rates fall, borrowing costs become much less of an issue. The UK’s biggest fiscal problem is not its debt or deficit, but its low GDP growth. Taking a moderate increase in government debt for a modest increase in GDP growth would very likely be a good trade for His Majesty’s Treasury.
These direct responses aside, the UK needs to move faster to do the thing it already needed to do: fix its economy.
The UK’s central economic problem is a supply-side one: we simply do not sell enough valuable stuff to the rest of the world. Or, to be more precise, we aren’tgrowing the high value, tradable parts of its economy quickly enough.
To grow your economy, you need to do two things. You need to raise productivity, through a mix of more capital, higher skills and better technology, all used more efficiently. And you need to sell enough stuff to everyone else to generate demand for your own economy. The two are related: those industries that export abroad tend to be the ones that see the fastest productivity gains, which then flow out to the rest of the economy via the magic of the Baumol effect.
The UK, to be blunt, no longer has enough new stuff to sell. In London and the South East, which specialises in finance and professional services, productivity growth stalled around 2016. In the rest of the UK, which is more oriented towards manufacturing, and whose major cities have not grown their high value service sectors as much as they should, stagnant productivity growth is a more longstanding trend. If we want to turn the UK economy around, we need to revitalise the industries that different places in the UK are actually good at. We need to grow new industries too, but those new industries will most likely cluster in the places with strong, similar existing industries. Economic geography is still sticky.
The US situation will make it harder for the UK to build on its strengths. The biggest problem may come on services. Britain exports a large amount of services to the USA – it is probably our most important trade surplus. While those services may not face tariffs – and weren’t included in the Trump tariff formula – the wider difficulties in doing business in the USA may threaten these exports. And the USA may prove a more difficult market to replace for services. We have never traded as deeply with the EU in services, and many of the US-UK business links may be hard to replicate elsewhere. Of course, we should still try.
There are, however, things we can do to build on our strengths. Some of these are picked up by John Kingman in his recent piece for Comment is Freed.
First, we need to turn around the crisis in our universities. British universities are one of our biggest economic strengths, as a major export industry, as a source of innovation and ideas, and as anchor institutions that play a crucial role in our cities. Finding a sustainable funding model and taking in far more overseas students are both essential. The UK simply cannot pretend it is striving for economic growth until it does this.
Second, we should become more open to high-skilled migration. Inward migration directly grows the economy by adding more people, but more importantly, high-skilled migration can raise productivity. At a time of such acute and tragic crisis for research in the USA, the UK could benefit by welcoming in those who want to come, even temporarily. Part of London’s economic success, sometimes a dubious part, is based on providing a safe haven for wealthy people from countries with political risks. Why not extend that service to people from the wealthiest country of them all?
Third, and this is really obvious, the UK needs to open up much closer trading relationships with more reliable partners. Canada and Mexico may be targets here, and our relationship with China may need some rethinking, but there is one bloc above all others that we need to get closer to in many different ways: the EU.
Fourth, we may need to help some critical UK industries. I hold the unfashionable opinion that manufacturing really matters to our economy, because it is so productive, so export-intensive, and because it is integral to so many towns and cities in the UK. Some industries may also become crucial to national security in this new era. Whether it is steel making in Scunthorpe or ammonia production in Teeside, the UK government should be a bit more open to helping – perhaps even nationalising some companies. In general, industrial strategy should try to focus on new, growing industries, and should only support existing ones with a view to turning them around. But there are some industries we need to keep alive no matter what, and we should be unashamed about doing that.
The UK government should also look at trying to lower the cost of finance for businesses, especially manufacturing businesses, outside the South East; one of the most deleterious consequences of the 2008 financial crisis has been to leave businesses outside London facing higher borrowing costs, which has held them back. A renewed funding for lending scheme targeted at key industries could be a key part of responding to this problem.
Fifth, the UK should launch a blitz of pro-consumer competition policy. One of our big, baked-in economic problems is that a lot of our consumer services – like broadband and telecoms, utilities, insurance and financial services – have higher inflation than the rest of the economy. A useful guideline in the UK economy is that, if you have to use a call centre to cancel something, it’s probably ripping you off. I would look at outlawing, for example, the RPI + x% contracts that hit so many people each April, not least because RPI is a defective measure of inflation. I would certainly legislate so that everything you can subscribe to online you can also cancel easily online. Regulation of utilities and natural monopolies needs to be both better resourced and smarter. Tackling economic rents and lock-in across consumer services could help fix part of the UK’s economic sclerosis.
There are also plenty of things the UK government is doing and needs to keep doing. Building more homes is still the right thing, especially if we are to welcome more migrants. Strengthening local government, especially at the strategic level around city regions, is still the right thing, and it may be starting to pay off as more mayors take control of bus services.
One of the longer term things the UK still desperately needs to do is to fix the fabric of its big city regions. Many of them lack the transport infrastructure and the dense urban cores to attract the kind of professional service and tech clusters they should have. This will require investment, though, and perhaps giving more control to local leaders. Building more and better transport infrastructure is one thing UK governments have talked about a lot and delivered on very little over recent decades. It remains an important part of any future UK growth strategy. It is unlikely to help us during the coming crisis, but it needs to e done nonetheless.
The UK also needs to stick with its energy policy. Many people have argued that the tariffs, or the need for increased defence spending, means we can no longer afford to prioritise clean energy. This is a bad misunderstanding of both what is wrong with our energy system and the role energy plays in national security. On both fronts, the UK’s aim should be very simple: reduce our reliance on imported gas as quickly as we can. The quickest way to do that is to build out renewable energy quickly and upgrade the electricity grid, while switching our transport and heating to electricity too. John Kingman’s argument that we should make more of our North Sea resources isn’t necessarily wrong by this measure, but it is largely irrelevant – there aren’t many cost-effective oil fields left in British waters, and they certainly aren’t going to reduce energy prices.
Ultimately, the UK’s answer to the Trump tariffs needs to be “more of what we already needed, more quickly”. What we need is to focus on the things we’re good at, and to find enough markets to sell those things in. That will require some decisions that sit outside our current political window – but unless we want to further deepen our economic problems, that window needs to move, and quickly.
