Despite the political rhetoric, if current economic policies continue broadly as they are, the UK economy does not have a bright future. In my view, and that of many others, our economy has at least five big problems. These major challenges will end the current upturn probably shortly after the 2015 general election, no matter who wins.
Let's look at these five problems in detail:
In the UK, we effectively have no net new investment per head of the population at all. How can this be? Well, in 2013, gross investment as a percentage of GDP came to barely 14%. The world average is 24% and the figure for China is 46%. As depreciation of existing UK assets comes to about 11.5% of GDP per annum, this leaves only 2.5% left over. Our population is rising at around 400,000 per annum, which means all of this 2.5% and more is required just to stop our existing social capital - schools, roads, housing, factories, etc - from disintegrating. This is the main reason why productivity increases in the UK economy have ground to a halt, and since we are not investing in labour-saving machinery, the key to increasing output per head, on the basis of current policies we cannot expect any significant increases in productivity in the foreseeable future.
Manufacturing is vitally important. It is crucial to our ability to pay our way in the world. It is far easier to achieve productivity improvements in manufacturing than it is in services. And we desperately need our manufacturing sector to grow if the UK is to build a sustainable economy. While services tend to cluster towards the South of England, manufacturing creates high-quality blue-collar jobs and distributes them around the country. As a percentage of GDP, manufacturing slipped from 10.7% in 2012 to 10.4% in 2013. With the exchange rate where it is at the moment, there is no prospect of this ratio improving - and it may get worse. Unless we can increase the proportion of GDP in the UK coming from manufacturing to about 15% we will never be able to avoid continuing large-scale trade deficits. It is mainly because we have a huge deficit every year on our foreign trade in manufactured goods - currently running at just short of £100bn per annum - that we have not had a trade surplus (including both goods and services) since 1982 or an overall balance of payments surplus since 1983 - over 30 years ago.
Balance of Payments
In 2013 our trade deficit was £32bn and it is trending towards an even higher figure in 2014. On its own, this might still seem a containable problem. But our total balance of payments deficit is much higher than just our trade deficit. This is because there are two other major components to our balance of payments. One is our net income from abroad and the other is net transfers to other countries. Until recently, we had a substantial net income from overseas each year, averaging £17bn per annum between 2000 and 2010. Now, this has turned negative. In 2013 the figure was minus £13bn and it may well be minus as much as £30bn in 2014, a massive swing of at least £40bn. At the same time there has been a very large increase in UK net transfers to other countries, mainly made up of net payments to the European Union, which have doubled since 2010, remittances abroad by people who have migrated to the UK and by our foreign aid programmes. In 2003 net UK transfers abroad totalled £10bn, by 2008 they were £14bn. In 2013 they were £27bn and still on a rising trend. As a result, our total 2014 balance of payments deficit is trending towards about £90bn - almost £20bn more than £72bn in 2013 - and this figure is likely to be higher still in 2015 and beyond.
The UK is getting deeper and deeper in debt. This is a direct result of our need to finance our foreign payments deficit with either greater and greater borrowing from abroad or more and more net sales of UK assets. This is the major underlying reason why our net income from abroad is now negative and why this figures is likely to get worse. The other problem is that the government annual deficit is more or less a mirror image of the trade deficit. It is impossible to cut one while the other remains in place. It may seem obvious that the way to cut the government deficit is to reduce expenditure and to increase taxation. This is not, however, the way the economy works. In fact, as long as the foreign deficit stays as high as it is, and household and corporate borrowing and lending more or less balance each other out, cuts in government expenditure will not decrease the deficit. Instead, they will just reduce the government's revenues from taxation, fees and charges while increasing its expenditure on unemployment and associated benefits. The result will be to make the economy contract while leaving the deficit as large - or potentially even larger - than it was before - yet another reason for believing that the current policy stance adopted by all our major political parties is unworkable.
The main driver for our current economic growth is increasing asset values, which are making those who own shares or their own house feel richer. This is why total output - although not living standards, because of our rapidly growing population - has recently just got back to the level achieved in 2008. The reason why property values have risen so steeply is a combination of extremely lax monetary conditions and ultra-low interest rates - at least for those in a position to take advantage of them. The housing market, in particular, has seen rises of some 20% within the last 12 months in London and about 10% nationally. It is impossible to believe that increases in value of this size will continue at a time when inflation is well below its target rate of 2%. As property values stabilise - or perhaps even fall back - the current growth in the economy will fizzle out.
At present, close to 45% of GDP is government expenditure, while taxation - fees and charges - brings in about 39%. The gap between these two figures is the government deficit, which is currently running at 6% of GDP. Coalition efforts to decrease government expenditure as a percentage of GDP have largely failed. From a peak of 50% in 2009, the reduction has been only 5%, while government expenditure in money terms has risen significantly every year. It is extremely difficult to see how promises to protect the NHS, aid programmes and various other priorities can be maintained if government expenditure as a percentage of GDP falls, even if drastic cuts are imposed elsewhere. It is also doubtful whether there are any achievable ways of getting government revenues up from where they are at the moment as a percentage of GDP, because higher rates of tax are unlikely to produce significant increases in revenue. This is another way of looking at the impossibility of reducing the government deficit in the absence of policies designed fundamentally to rebalance the UK economy towards manufacturing, and export and import substitution-led growth.
Gross government debt was reported by the ONS to have been 91% of UK GDP at the end of 2013. It seems likely that the trend rate of increase of total government debt as a percentage of GDP will be of the order of 3% per annum for the foreseeable future on current policy projections. This will be made up of the deficit running at about 6% of GDP, less around 1% growth and 2% inflation. If this is correct, within a decade, total government debt will be about 125% of GDP. This will strain the UK's creditworthiness, very probably leading to interest rate rises and acting as yet another depressing influence on our growth prospects. With this level of debt, interest payments - already totalling more than the schools budget for the whole country - may well be approaching half the cost of the NHS. By contrast, if the policies advocated by the Pound Campaign were implemented, total government debt would be projected to fall by about 4% of GDP per annum, made up of 4% growth, plus inflation running at 3% less the government deficit at 3%, with government revenues at 37% of GDP and government expenditure at 40%.
If we carry on our current economic policies the outcome will be very slow growth, if any takes place at all, static or perhaps declining living standards for most people, high levels of unemployment and mounting inequality.
The key to what needs to be done is really relatively simple. Combined with appropriate supply side reforms, we must use a much lower exchange rate to change economic incentives, so that we can rebalance our economy towards those activities most clearly orientated to both enabling us to pay our way in the world and to increase the productivity of our work force and thus living standards. There is no way of making everyone better off other than getting the economy to grow faster and there is no reason - other than failure to see what the opportunities are - why this should not be made to happen.Suggest a correction