New Labour government sees worst economic situation since World War II

The new Labour government in the UK is betting that an economic plan modelled on “Bidenomics” will reverse more than a decade of economic stagnation and improve stagnant living standards without spending too much.

Like President Biden, Prime Minister Keir Starmer is promising a more active government than his Conservative predecessor, as well as investment in green energy and an industrial policy that promotes domestic manufacturing.

But Starmer, who is due to meet Biden at the White House on Wednesday It inherited an economy that is strained by decades of political turmoil, inadequate business investment and sclerotic government planning. It also lacks a ready source of cash.

The economic climate represents “the worst set of circumstances since World War II,” Rachel Reeves, the first female chancellor of the exchequer, or finance minister, said on Monday. After taking inflation into account, wages have remained virtually unchanged since 2007, according to the Center for Economic Performance, a research institute. The average German is now 20 percent richer than the average U.K. citizen.

“The UK is not in a situation where there is a quick fix. Most people think it will take almost a decade to see a significant improvement,” said David Page, head of macroeconomic research at AXA Investment Managers in London. “But I think there is also hope now, and it is something different, that you could see it in the next 10 years.”


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Reeves acted swiftly this week to underscore the urgency of the challenge, calling economic growth “our national mission” and saying there was “no time to waste.” But she promised to stick to informal fiscal rules that would limit Labor’s ability to spend freely, given the country’s debt burden. Her aim is to use modest amounts of public money to attract private capital.

Economists say the roots of Britain’s economic problems lie in weak productivity growth. Equipping workers with the ability to produce more goods per hour is key to growing the economy and raising living standards. And that’s what’s been missing from Britain’s recent performance.

The typical American worker produced 23 percent more than his British counterpart last year. That gap has more than doubled since 2007. The French and Germans also outperform the British.

British productivity rose steadily for almost three decades but has fallen since the 2008 financial crisis. Government austerity and repeated political crises that followed the Great Recession have discouraged companies from investing in workers to boost their productivity, economists say.

In the US, business investment has increased by more than a third since 2016, almost seven times the growth in the UK, according to government statistics.

“What does that mean? It means you’re working with older equipment and in smaller numbers,” said Rob Wood, chief UK economist at Pantheon Macroeconomics in Newcastle upon Tyne.

The pandemic – and government budget cuts that have led to staff shortages in the National Health Service – have also hit productivity. A House of Commons analysis found that there are now 754,000 more working-age people inactive than before the pandemic. Many of them are among the more than 6 million Britons waiting to see a doctor, according to the British Medical Association.

Britain’s problems are the legacy of years of interplay between public and private choices. The country’s oversized financial services sector shrank after the 2008 crisis, making credit harder to get than elsewhere.

The government responded to the crisis with an “austerity drive” that negatively impacted public services and hampered economic growth.

“We learned that public austerity has also destroyed the private sector. We need to invest,” said David Blanchflower, an economics professor at Dartmouth College who sat on the Bank of England’s monetary policy committee before the 2008 crisis.

Brexit — the 2016 decision to leave the European Union — and its implementation consumed the work of three prime ministers over almost a decade and continues to cast a shadow over the economy.

According to the Office for Budget Responsibility, an official agency, erecting trade barriers with its largest trading partner would shrink the UK economy by 4 per cent and its exports and imports would be around 15 per cent lower than if the country had remained in the EU.

Government instability has been a drag on growth. Since 2010, Britain has had five prime ministers, seven chancellors, nine business ministers and countless long-term economic plans.

Last autumn, Prime Minister Rishi Sunak cancelled the second half of a high-speed rail line that would have linked London to northern cities. First proposed in 2009, the line – billed as Europe’s biggest infrastructure project – would have linked the capital to Birmingham and Manchester, further north.

But in October, Sunak scrapped part of the line from Birmingham to Manchester, sparking outrage among businesses that had been planning faster rail links.

“The huge volatility in the political situation and strategy means companies don’t know whether they’re in or out,” Wood said.

Starmer’s planned meeting with Biden on the sidelines of the North Atlantic Treaty Organisation summit is likely to underline the “special relationship” between the allies.

In a speech in Washington last year, Reeves outlined an economic formula that resembled Treasury Secretary Janet L. Yellen’s “modern supply-side economics” doctrine. Both share an enthusiasm for boosting growth by expanding the workforce and investing in infrastructure and climate-friendly energy sources.

Relative to the size of the economy, the U.S. national debt is slightly larger than that of the U.K. However, the dollar’s status as a global reserve currency gives the U.S. government more leeway in dealing with spending problems.

Labour has said it will stick to an informal fiscal rule devised by the previous UK government that will require it to start reducing debt as a percentage of gross domestic product over five years, currently set to reach 95 per cent by 2026.

Labour has also ruled out increasing personal income tax, national insurance contributions and value added tax.

Budget realities have already forced Labour to scale back its ambitions. In February, the party backed away from a pledge to spend £28 billion, or about $36 billion, a year on green energy programs. Instead, officials said annual spending would reach £4.7 billion, or $6 billion.

“Reality has sunk in,” said Paul Dales, chief UK economist at Capital Economics. “The new government needs to focus on areas where it can make a real difference without spending a lot of money.”

One such priority will be a major overhaul of the notoriously slow planning process that governs housing and infrastructure projects. Labour wants to speed up approvals for 1.5 million homes over the next five years and rebuild the electricity grid.

The new government this week ended a Conservative ban on onshore wind farms. First introduced in 2015, it allowed a single opposition to block projects.

Labour faces a daunting to-do list. But it can enjoy a short-term tailwind. Inflation was 2.8 per cent a year in May, down from a peak of nearly 10 per cent in 2022. After a brief recession last year, growth is starting to pick up. The International Monetary Fund expects the economy to expand by 0.7 per cent this year, and accelerate to 1.5 per cent in 2025.

With inflation falling, the Bank of England may soon cut its benchmark interest rate of 5.25 percent for the first time in four years, which would stimulate the economy.

If the new government manages to improve healthcare and bring some of the inactive workers back into the job market, the economy will gain even more momentum.

Labour’s huge majority in Parliament and chaos within the ranks of the opposition Conservative Party mean Starmer can expect to remain in office for at least five years, if not two.

This relative stability comes as other major economies are preoccupied with domestic politics. In France, the leftist coalition that won a parliamentary vote this month has backed free-spending policies that could rattle financial markets. And the United States is in the midst of a controversial presidential contest that could return an unpredictable former president to the White House.

“In an uncertain world,” Reeves said on Monday, “Britain is the place to do business.”