Following the 1977 election, the incoming Irish government tried an experiment that ignored “orthodox” economics. There was a splurge of public expenditure funded by borrowing, which the then government argued would result in a large and permanent increase in growth. Ministerial speeches assured that growth would be helped by dramatically reduced purchases of imported goods by Irish households, without any evidence they would actually do so.
They didn’t.
The short-term fiscal stimulus brought temporary growth, but also a surge of imports into our open economy, eventually leading to a balance of payments crisis. Unfortunately, this ill-fated experiment continued for a number of years and it took some time to clean up the legacy of borrowing and debt. The outcome was the depressed decade of the 1980s.
The short-lived Truss government got one thing right – it identified UK economic growth as exceptionally slow. However, the diagnosis of why there was this disease was completely wrong, and the prescribed treatment was potentially fatal. The UK is fortunate that the recent excursion into unorthodox economics lasted only days, not a few years. As a result, while it has inflicted significant economic damage, the ill effects will eventually wear off.
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Magic economics won’t solve the low growth, low productivity problem of the UK economy. The real, underlying causes need to be identified and understood before the right treatment can be administered.
ESRI research published on Wednesday shows that Brexit reduced UK trade with the EU by between 15 and 20 per cent. This was predictable, and it is a major factor in the UK’s current poor economic prospects. However, the deed is done, and it is time to address the other obstacles to UK growth.
Historically, the UK had a comparative advantage in mechanical engineering industries such as car and aircraft manufacturing. This is a sector that has changed dramatically across Europe over the past 30 years. It has moved from huge factories in western economies covering every aspect of car production, to one where cars are assembled from parts made in many different countries. Germany has exploited this diversification of the supply chain 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 such as Poland and Hungary.
The UK also embarked on diversifying where different car and aircraft components were made. However, the costs and bureaucracy following from a hard Brexit have seriously affected this diversified supply chain. The logic of leaving the EU means the UK needs to move into sectors where disruption of supply chains as a result of Brexit poses fewer difficulties.
Regional inequality
Historically, the mechanical engineering industry was located in the midlands and the north of England, providing some counterpoint to London’s economic dominance. The sector’s problems today aggravate regional inequality.
While the economy of the southeast of England, which revolves around London, remains vibrant despite Brexit, the rest of the country languishes with low-productivity growth and lower living standards. One of the key factors affecting productivity is the educational attainment of the population in each region. Scotland, after London, has the highest share of graduates in its labour force, and it’s no surprise that its pre-Brexit growth rate was second highest of the regions after London.
ESRI research has shown that a highly educated labour force is crucial in attracting valuable foreign direct investment. Figures published by the UK statistical office this week showed that London and the southeast attracted 62 per cent of inward foreign investment, while the northeast, Wales and Northern Ireland combined accounted for less than 4 per cent. This reflects the regional differences in educational attainment. Regions such as northeast England, Wales and Northern Ireland are characterised by low average education attainment and low productivity; hence their low growth.
Boosting education performance in lagging regions will take time to bring about results. As well as building up human capital through investment in education and training, the UK also needs to invest in improving its physical infrastructure.
In European terms, the UK remains overall a low-tax economy, with scope to expand the tax take to undertake the necessary public investment in physical and human capital to achieve better productivity.
The elephant in the room remains Brexit. While it’s unlikely there is any going back, more constructive trading relationships with its nearest and biggest trading partner could ease some of the present frictions and undo some of the economic damage. Global Britain might do well to start with rebuilding relationships with the big economy on its doorstep.
