Is the IMF right about the UK economy?

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The IMF consigned Britain to the economic doghouse on Tuesday. As the only leading economy likely to contract this year, the UK’s growth forecasts were revised down by the fund at the same time as it boosted those of most other countries.

Even Russia is expected to grow more than the UK in 2023, in the fund’s outlook.

Britain’s politicians agree that the country has a problem. Jeremy Hunt, the chancellor, has blamed “uneven and lower growth” on poor productivity, skills gaps, low business investment and regional disparities in wealth. Rachel Reeves, his counterpart in the Labour party, simply blamed “13 years of Tory failure” in the House of Commons.

Is the IMF right about Britain’s economy?

The fund’s forecasts will never be entirely correct about the global economy or any one country. They are best thought of as a continuous process of updating expectations in line with the most recent economic developments.

The forecast for the UK reflects the country’s disastrous autumn of Trussonomics, which came too late for the IMF’s October forecasts, so it is not surprising the fund has taken a dimmer view of Britain’s prospects. Despite the downgrade, Pierre-Olivier Gourinchas, the fund’s chief economist, said the government’s economic policy was now “on the right track”.

In a parallel move, the fund took better-than-expected economic data from the eurozone in the face of energy price rises and China’s opening up to upgrade global growth prospects.

The UK forecast is not far out of line with other recent forecasts from the OECD and the private sector. But some economists queried the fund’s combination of optimism on the world and pessimism on the UK.

Ben May, director of global macro research at consultancy Oxford Economics, said he thought the IMF had become too sanguine about Chinese and US economic problems on the back of better recent data.

“Rather than economies simply shrugging off the slew of shocks of the past year or so, we think these knocks are taking [more] time to seep through to real activity than we had envisaged previously,” he said.

Why is the UK economy growing so slowly?

There are two problems, one temporary and one persistent.

The temporary problem is that Britain’s recovery from the coronavirus pandemic was too strong to keep inflation down and the Bank of England thinks the country needs a period of economic retrenchment to return to price stability.

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This transitory issue is not as acute as it appeared in the autumn because wholesale gas prices have fallen sharply. The BoE is still expected to raise interest rates to 4 per cent on Thursday, signalling that it does not think the problem has been solved.

The longer-term problem reflects Hunt’s concerns about capital expenditure, skills, employment and productivity growth. Although the workforce has higher levels of education than ever, productivity growth rates dropped more than in other countries after the 2008-09 financial crisis, and business investment has not grown since the 2016 Brexit referendum.

On the third anniversary of Brexit on Tuesday, Jonathan Portes, professor at King’s College London, said there was scope to disagree about the effect of leaving the EU on the UK economy, but there was no doubt that “Brexit has, as economists predicted, reduced UK trade and investment”.

Line chart of Real business investment (Q2 2016=100) showing UK investment stagnated after the Brexit vote and hasn't recovered since the pandemic

What is the government’s plan for increasing growth?

In a speech on the economy last week, Hunt said the government’s “plan for growth” would centre on “four Es”: enterprise, education, employment and everywhere — a reference to reducing regional inequalities.

But there were few details, leading business groups to describe the speech as “empty”. Jagjit Chadha, director of the National Institute of Economic and Social Research, who was in the audience, said the “overall theme is encouraging but the specifics are light, particularly on education and everywhere”.

Just as noteworthy as the speech was the discarding of the government’s previous growth-enhancing policies. Unlike in Kwasi Kwarteng’s 2022 “growth plan” last September, there was no 2.5 per cent annual target for GDP increases, business and personal tax cuts or planning reform to accelerate infrastructure.

Compared with Boris Johnson’s 2021 “plan for growth”, there was much less emphasis on active government “investing massively in science and technology” and focusing on “levelling up”.

How can the UK improve economic growth?

Most outside observers have little problem with the government’s “four Es”, but find its regularly announced new growth plans a distraction.

The CBI employers organisation, for example, wants greater support for business investment to go alongside higher corporate taxes and a longer-term focus on skills and barriers to work, such as affordable childcare.

Rain Newton-Smith, CBI chief economist, said: “We need a plan to lift UK growth and productivity. That’s about ensuring the UK’s got the right competitive landscape to drive investment, improve participation in the labour market, enhance skills and acts to improve energy efficiency and lead the green transition.”

In terms of focus, a medium-sized economy such as the UK cannot do everything and should concentrate on success in a few key sectors, said Erik Britton, managing director of Fathom Consulting.

“These should be sectors we know are highly productive and where there are [positive] spillovers from R&D into other sectors. Those are the sectors the UK needs to be in and [government] needs to support,” Britton said.

In the short term, the easiest way to raise the growth rate and help reduce inflation, however, will be to increase the number of people seeking work, which has fallen since the pandemic started.

Line chart of UK economic activity rate, % of all aged 16+ showing Labour force participation has fallen since the pandemic

This is not easy. Allan Monks, UK economist at JPMorgan, said the UK had lost almost 1mn people — nearly 4 per cent of the labour force — compared with the pre-pandemic trend, a problem that is almost unique internationally.

He added that the quickest solution would be to increase immigration but acknowledged that this was likely to be rejected by politicians. But he said that other policies to encourage more workers were likely to be “costly, too slow acting or still not politically viable”, limiting the chances of success, especially because the big decline in people seeking work had come from those classed as long-term sick and the over-50s who are able to retire early.

Source: Financial Times

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