After the 1977 elections, the new Irish government attempted an experiment that ignored ‘orthodox’ economics. There was a spate of public spending funded by borrowing, which the government at the time believed would result in a large and lasting surge in growth. Ministerial speeches have been reassured that growth would be supported by sharply reduced purchases of imported goods by Irish households, with no evidence that this is actually the case.
The short-term fiscal stimulus brought temporary growth but also increased imports into our open economy, eventually leading to a balance of payments crisis. Unfortunately, this ill-fated experiment continued for a few more years, and it took some time to clean up the legacy of borrowing and debt. The result was the depressed decade of the 1980s.
The short-lived Truss government got one thing right – it identified Britain’s economic growth as extraordinarily slow. However, the diagnosis as to why this disease existed was completely wrong, and the treatment prescribed was potentially fatal. The UK is fortunate that its recent foray into unorthodox economics lasted only days, not a few years. As a result, although the negative impacts have caused significant economic damage, they will eventually wear off.
Magic economy will not solve the problem of low growth and low productivity in the UK economy. The true, underlying causes must be identified and understood before proper treatment can be administered.
An ESRI research released on Wednesday shows that Brexit has reduced Britain’s trade with the EU by 15 to 20 percent. This was predictable and is a major factor in the UK’s current poor economic outlook. However, the deed is done and it is time to tackle the other obstacles to UK growth.
Historically, the UK has had a comparative advantage in engineering industries such as car and aircraft manufacturing. This sector has changed dramatically across Europe over the past 30 years. It has evolved from huge factories in western economies covering every aspect of car production to a factory where cars are assembled from parts made in many different countries. Germany has used this supply chain diversification to improve its productivity and competitiveness. The really valuable parts of the production process are located in Germany, while less valuable processes, including final assembly, are outsourced to countries like Poland and Hungary.
The UK also began to diversify, where various car and aircraft components were manufactured. However, the costs and bureaucracy following a hard Brexit have seriously affected this diversified supply chain. The logic of leaving the EU means that the UK must move into sectors where the disruption to supply chains as a result of Brexit is less of a problem.
Historically, the engineering industry was based in the Midlands and North of England, which was somewhat of a counterpoint to London’s economic dominance. The sector’s problems today exacerbate regional inequalities.
While the South East economy, centered around London, remains buoyant despite Brexit, the rest of the country suffers from low productivity growth and lower living standards. One of the key factors affecting productivity is the level of education of the population in each region. Scotland has the highest proportion of graduates in its labor force after London, and it is no surprise that its pre-Brexit growth rate was the second highest of the regions after London.
ESRI research has shown that a highly skilled workforce is critical to attracting valuable foreign direct investment. Figures released this week by the UK Bureau of Statistics showed that London and the South East attracted 62 per cent of foreign investment, while the North East, Wales and Northern Ireland together accounted for less than 4 per cent. This reflects regional differences in educational attainment. Regions such as North East England, Wales and Northern Ireland are characterized by low average levels of education and low productivity; hence their low growth.
Increasing educational performance in lagging regions will take time to produce results. As well as building human capital through investment in education and training, the UK also needs to invest in improving its physical infrastructure.
From a European perspective, the UK as a whole remains a low-tax economy with scope for expanding tax revenues to attract the necessary public investment in physical and human capital to achieve higher productivity.
The elephant in the room is Brexit. While unlikely to turn back, more constructive trade relations with its closest and largest trading partner could ease some of the current tensions and reverse some of the economic damage. Global Britain could do well to start rebuilding ties with the big economy on its doorstep.