AFH Wealth Management comments on economic growth

The new Labour government has returned to sit in Parliament. After election promises that there will be growth in the economy, concerns over the budget suggests that things will get worse before they get better. What long term shocks for the economy lie ahead?

Chief Economist, Colin Warren, from AFH Wealth Management looked at some of the factors behind the UK economy’s poor performance in recent years this summer and the prospects for a pick-up in growth after the forthcoming election. Here is what he had to say:

'Opinion polls indicate that the Labour Party, led by Keir Starmer, is on course to win the election on 4th July, ending 14 years of Conservative rule. However, Starmer will face a far more challenging economic legacy than the one Tony Blair inherited in 1997. Economic growth is sluggish, public debt is close to 100% of GDP1, the tax burden is at a 70-year high2, and voter satisfaction with the quality of public services is low3.

'In this month’s commentary we look at the performance of the economy under 14 years of Conservative government and consider whether, given the considerable challenges the economy faces, growth is likely to pick up under Labour in the next parliament.

'Economic growth is key for the nation’s material wellbeing. Growth enables the living standards of individuals to improve over time, and rising GDP helps generate the taxation revenues on which good quality public services depend.

'The problem is that the UK has experienced a marked deterioration in trend economic growth in recent years. Annual average growth from 1997 to 2010, when Labour was last in power, was just over 2%. However, during the period 2010 to 2023, the pace has slowed to 1.5%. Moreover, this growth has been flattered by an increase in population, that has primarily come about because of immigration. Real GDP per person only rose by 0.9% per year on average from 2010 to 20236.

'Of course, this period includes the pandemic and the energy shock resulting from the war in Ukraine, factors which dragged on activity and raised inflation, prompting the Bank of England to sharply raise interest rates.

'However, there is little doubt that policy decisions under the Conservatives have also contributed to weak economic growth. Despite record low borrowing costs in the wake of the Great Financial Crisis (GFC), the Conservatives, under the leadership of David Cameron, drastically cut public investment during 2010-16 as part of their deficit reduction programme. Moreover, the aftermath of the Brexit vote in 2016, and the chaos of the Liz Truss mini-budget, created a climate of uncertainty, which has depressed private sector capital expenditure.

'In turn, low levels of public and private investment have weighed on productivity growth. During the period 2010 to 2023 average annual labour productivity growth in the UK was 0.6%, below the 0.8% average of the UK’s G7 peers7. 

'Although it is difficult to disentangle the impact of policies, there is little doubt that Brexit has had a negative impact on UK growth and productivity. The Office for Budget Responsibility (OBR, the independent budget watchdog) estimates that Brexit will reduce long-run productivity by 4% relative to remaining in the EU8. 

'The policy response to the pandemic has also probably been a contributing factor. Although Prime Minister Rishi Sunak has been keen to remind voters of the generous furlough scheme he introduced during the Covid crisis, there is some evidence to suggest that the policy, while protecting jobs, may have slowed productivity by keeping workers in less productive roles9. In contrast, countries like the US that allowed greater labour market flexibility saw quicker rebounds in activity and productivity in the wake of the pandemic.

'Going forward, the question is whether growth will improve under a future Labour government.

Prospective policy changes aside, there are some reasons for optimism. The drags on activity from the external shocks of Covid and the war in Ukraine are abating. With inflation dropping from over 10% in 2022 to nearly 2% currently, real (after inflation) earnings growth has turned positive following recent declines, reaching 2.3% in April, the strongest level since August 202110.