Don’t Bet on a British Revival

The United Kingdom is likely to hold a general election in the fall, and the outlook appears dire for Prime Minister Rishi Sunak and his Conservative Party. In December 2019, the Conservatives were reelected with an 80-seat majority in the House of Commons on the strength of campaign promises to “get Brexit done” and “level up” those parts of the country that had not broadly shared in the benefits of economic growth and investment. However, the illegal Downing Street parties during COVID-19 lockdowns, former Prime Minister Liz Truss’s fiscal meltdowns, and the creeping costs of Brexit have demolished what had seemed an unassailable lead. Since he became prime minister in October 2022, Sunak’s Tories have trailed the Labour Party in opinion polls by an average of 20 points.

When the election comes, the Labour opposition leader, Keir Starmer, is expected to cruise to an easy victory. Tory fatigue is widespread, which is perhaps unsurprising after 14 years of often chaotic Conservative rule in which five prime ministers—David Cameron, Theresa May, Boris Johnson, Truss, and Sunak—have served in quick succession. In Scotland, Labour’s prospects have been enhanced by the Scottish Nationalist Party’s fall from grace, caused in large part by its mishandling of transgender and free speech issues. Meanwhile, in England, the Conservatives are bleeding votes on their right flank to the Reform Party, the successor to Nigel Farage’s Brexit Party. All three factors have put the wind in Labour’s sails.

But what will ultimately put Labour in power is the dismal condition of the British economy. Voters reasonably blame the Tories, who have been in power for the last decade and a half, for this economic decline. Labour has yet to offer a credible economic plan, however. Unless Starmer is willing to commit to a more radical economic agenda, a Labour victory at the next election will just mean more trouble for the country—and could spell ruin for the party.

THE SICK MAN OF EUROPE IS ILL AGAIN

Britain’s economic picture is bleak. As the Financial Times columnist Martin Wolf recently observed, the United Kingdom’s real per capita gross domestic product at the end of 2023 was 28 percent below what it would have been if the average growth trend between 1955 and 2008 had been maintained. Over 14 years of Conservative governance, the country has been a growth laggard, consistently performing in the bottom third of economies in the Organization for Economic Cooperation and Development. Ironically, one of the main factors behind the growth that the United Kingdom has experienced since 2019 is a high level of immigration. The country saw an increase in net migration from 184,000 in 2019 to 745,000 in 2022, about twice the number who arrived in France and Italy. Although many perceive Johnson and Sunak as hostile to immigrants, the reality is that immigration from countries outside the EU has increased substantially since Brexit. One driver has been a rise in international students who are charged much higher tuition fees and thereby make up for the shortfall in universities’ public funding. Another has been the hiring of non-EU skilled health and care workers to address a chronic labor shortage in the country’s National Health Service (NHS) after many eastern and southern Europeans went back home.

The chief factor underlying the United Kingdom’s economic malaise is a complete collapse in productivity growth, caused by a dearth of both public and private investment. The collapse in public investment since 2010 was driven, first, by the 2008 global financial crisis, which was a shock to a British growth model that remains highly dependent upon financial and related services, and second, by biting austerity measures. Under Cameron and May, the government slashed public spending as a percentage of GDP from 46 percent in 2010 to 39 percent in 2019. Because certain areas of spending were protected, principally pensions and the NHS, the cuts fell heavily on local government services, infrastructure, the justice system, education, and transportation. The result has been a sharp decline in local consumption, and growth that is highly regionalized. Private investment has lagged because of the corporate sector’s reluctance to invest in an economy with such limited growth prospects, as well as the overall makeup of the British economy, with large numbers of smaller firms concentrated in services. This lack of private investment was compounded by the economic uncertainty that came with the Brexit referendum and its aftermath, as international investors began to think twice about investing in a country that was about to leave the European single market.

This economic situation poses a challenge for Labour. The party last won a general election in 2005—although its landslide victory in 1997, which ended 18 years of Conservative rule, is the kind of win that the party appears on track to replicate. In 1997, however, the leader of the Labour opposition, Tony Blair, and the shadow chancellor of the exchequer, Gordon Brown, inherited a strong economy with low levels of public debt and a benign international system. But that will not be Starmer’s inheritance. Instead, the fiscal challenge that Labour will face is daunting, with the world economy fractured and its outlook marred by geopolitical conflict. The task is clear: to reverse the downward trend in public investment and work with EU officials in Brussels to forge a long-term economic and strategic partnership that can spur private investment. Brexit may still be the official policy of both parties, but starved of growth, the United Kingdom needs better access to the EU’s single market. Although Starmer and his shadow chancellor of the exchequer, Rachel Reeves, are unlikely to make things worse, their current plans are much too timid to make a real difference, given the scale of the problems the country is facing.

HEADS BELOW THE PARAPET

In a major speech to a London business audience in March, Reeves set out Labour’s future economic policy, focusing on her idea of “securonomics”—a kind of homeopathic Bidenomics without the fiscal largess and the continent-wide scale. Reeves’s basic ambition is to make work more secure and more remunerative for ordinary Britons. Given the collapse in wage growth in the United Kingdom over the past 15 years—according to Torsten Bell, the economist who heads the Resolution Foundation think tank, British workers would be some $13,000 a year better off “if real pay growth had continued to follow its pre-recession trend”—this is a laudable goal. Although regulation might be able to do something about employment insecurity, getting wages up means getting productivity up, and that means a large rise in investment. It is not clear where Reeves thinks that investment will come from.

In her speech, Reeves promised to maintain a stable macroeconomic framework featuring budget-balancing fiscal rules for day-to-day expenditures that will reduce the ratio of debt to GDP. This is very much in line with Sunak’s policies. Reeves also pledged to preserve the current corporate tax rate of 25 percent, which is low by international standards. She further declared that she would tackle the country’s chronic underinvestment through a close partnership with the private sector and argued for thorough reforms of the public sector. Labour will take on the overly rigid planning system governing the United Kingdom’s land use and public infrastructure, Reeves said, and work to decentralize the government. Although some of this is new and different from what the Conservatives have been offering, particularly in terms of planning and decentralization, some of it is very similar.

It is therefore unclear whether a Labour victory will lead to an increase in investment. For if new investment must come from domestic saving or international borrowing, the United Kingdom is constrained on both sides. Saving implies yet more austerity, and borrowing suggests yet more indebtedness. Prioritizing stability may sound good, but in a depressed economy it only means further stagnation. The country’s experience with letting the private sector run infrastructure has largely been a failure, as seen in the billions spent by the government on bailouts of water utilities after their privatization and on buybacks and dividends by the firms themselves. The idea of selling off more bits of the state to boost investment simply lacks credibility. Reforms in the planning process can help, for example, by addressing the country’s acute housing shortage, but the government will still need to invest in building up the actual housing stock.

There is a practical reason for Labour’s timidity. Starmer and Reeves have no doubt made the decision to allow the Conservatives to tear themselves to pieces as they resist the temptation to make bold promises that the country’s right-wing tabloid press could attack them for. They may also have made a decision to say as little as possible to maximize their room for maneuver when in office on the logic that if they do not rule out a policy, they can do it later. Although that may make strategic sense on one level, it hollows out any notion of democracy as being more than a cynical game. Regardless of strategic intent, if a Labour government ends up offering nothing more than Tory austerity with a human face, the party cannot expect to serve more than one term in office. If Labour is not seen as trying to make a real difference in the lives of ordinary Britons after a brutal decade and a half, it will rightly be turned out for being all strategy and no substance. The cost may be another long period on the opposition benches and internecine infighting over this lost opportunity.

IDEAS OF INTEREST

Although the United Kingdom’s economic situation is grim, there is much more that Labour can promise to do. First, it could massively increase its fiscal space by telling the country’s central bank, the Bank of England, to stop paying interest on the commercial bank reserves that it holds to influence short-term interest rates. With the United Kingdom’s high interest rates, banks prefer to hold onto money and not invest in the real economy. As a consequence, they are expected to make around $286 billion in interest by 2033 by simply parking reserves at the central bank. If one of the government’s major policy goals is to increase investment, this money could be better spent. Labour recently decided to shelve green investment plans that would cost around $35 billion a year, judging that they were too expensive. Yet that figure is far less than what the Bank of England is handing out as free money to the banks for simply showing up. This is nothing less than a fiscal embarrassment. Ending this practice would instantly reduce long-term debt projections and smooth the path for new investment at lower rates. The Bank of England’s routine monetary policy operations should not hurt national investment. Across the English Channel, the European Central Bank stopped paying interest on minimum reserves held by commercial banks at the beginning of September 2023. Its new rate is zero percent.

Second, Labour should pursue growth in productivity by encouraging greater labor mobility and the development of job skills. One way to do this is to invest in housing. The United Kingdom effectively stopped building affordable housing at scale in the 1980s, and it now needs to build 4.3 million homes to keep up with population growth and overall demand. This shortfall has created an affordability crisis centered around London, where almost one-third of GDP is generated, further impeding growth. Labour should therefore commit not only to building housing but also to owning the housing stock. By creating assets that produce income and holding them on the state’s balance sheet, income will be generated over time that reduces overall debt as assets and liabilities are matched. Alternatively, Labour can leverage this future revenue to invest in training the skilled high-wage workers the country needs to build housing and decarbonize the economy, such as plumbers, electricians, and heating, ventilation, and air-conditioning engineers.

Third, Labour should change the way the state’s accounting treats such long-term investments, by taking them out of current spending and matching assets and liabilities by building assets. This is not accounting chicanery; it is good business practice in the private sector. Such assets could be held in an independent Citizens’ Wealth Fund that takes advantage of countercyclical dynamics in the cost of capital to make investments when bond prices rise and yields fall. Rather than playing it safe, there is much that Labour can do to break out of its self-imposed fiscal straitjacket. Politicians are put in charge to rule, not to enforce fiscal rules that hurt investment in the real economy.

BRUSSELS A LA CARTE

Labour must also recalibrate its relationship with the European Union. Although Starmer is worried about being accused of betraying Brexit—as was shown once again in his recent rejection of the EU’s “youth mobility scheme,” which would enable young Britons to work in other countries and vice versa—he must change course and begin to repair ties with Brussels. It makes no sense to perpetuate the Tories’ hostile relationship with the EU, the United Kingdom’s most important trading partner, while the United States and China are turning mercantilist and Russia is waging war on Europe’s borders. Although Labour has decided to stick to its Brexit red lines for now—which rule out pursuing open borders for EU citizens or seeking membership in the single market or customs union—the party can afford to be bolder. Starmer can start by seeking small agreements to help facilitate trade, make it easier for British companies to provide services in the EU, and enhance mobility for workers with critical skills. If the United Kingdom is going to turn around its economy, it will need the size and scale of the EU’s single market.

The challenge will be getting the EU to sign on to such agreements. But perhaps this will be less difficult than many imagine. As the war in Ukraine rages on, Brussels is finally getting serious about providing for its own security and defense. To do so in a credible manner, it will need London’s help. Not only does the United Kingdom have nuclear weapons and a permanent seat on the UN Security Council, it is also the only European military power other than France with a global reach and footprint—though it is much diminished from its heyday. The EU and its institutions have no military capacity of their own but can play a useful role in coordinating procurement and organizing an industrial defense strategy that would better pool resources and coordinate national weapons production. The United Kingdom will need to offer the EU something that goes well beyond a series of small agreements to make its exit less painful.

There is an opportunity for a political grand bargain here. The United Kingdom could agree to play a leading role in developing and coordinating Europe’s security, and the EU could offer the United Kingdom a relationship close to single-market membership that reduces nontariff barriers to trade to the bare minimum and makes doing business much easier than it is now, while stopping short of complete freedom of movement. Although purists in Brussels may protest that such a bargain amounts to letting the United Kingdom cherry-pick which EU benefits it receives, a longstanding complaint, it is worth pointing out that the situation in Europe has fundamentally changed since Russia’s invasion of Ukraine. From the perspective of eastern Europe and the Baltic countries especially, the EU needs the United Kingdom’s military heft if it wants to make significant and timely progress towards a more stable and secure continent.

NO TIME TO BE NERVOUS

Despite its commanding lead in the polls, Labour has been fearful that proactive spending plans would undermine its ability to commit to balanced budgets and worried about being seen to betray the Brexit vote. Either it has been browbeaten or gaslighted by the Tories into a pro-austerity default mode, or it genuinely sees an electoral danger in promoting pro-investment policies. Although such a prudent stance might make electoral sense in an overheating economy, that is not the world the United Kingdom currently inhabits.

According to the polling organization Ipsos, 40 percent of the British electorate thinks that Labour has the best policies for working people, compared with 15 percent who believe the Conservatives do. Fourteen years of austerity have already broken Britain. Doing more damage in the name of fiscal rectitude will derail Labour’s positive agenda and, with it, possibly the party itself. The British economy is in dire straits, and voters expect Labour to fix it. Continuing the Tory medicine, with a spoonful of sugar, will only spur voters to turn their backs on Labour in the next election. On the issue of Brexit, 56 percent of British citizens now think it was wrong to leave the EU, while 33 percent think it was right. Forging closer ties with the bloc is long overdue. Meanwhile, the EU must realize that Labour’s success is in its own economic and security interests. A grand bargain gaining London’s defense clout in return for granting more generous access to its single-market could inaugurate a strategic partnership in which both sides are better off and more secure.

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