It’s “the economy, fool”. James Carville coined this phrase during Bill Clinton’s 1992 campaign. He was right. The economy is not everything. But it is almost everything.
Modern democracy itself would not have been born if it were not for the opportunities that sustained growth creates. Political stability also depends on the positive-sum policies that create economic growth. When the economy stagnates, as it is now in Britain and other high-income countries, politics becomes strained as one group cannot have more without others having less. The struggle becomes even more bitter as the labor force-to-population ratio shrinks and the share of tax-financed transfers in national income tends to increase.
Today the focus is on a recent shock to aggregate real incomes – the so-called cost-of-living crisis. This crisis is presented as a result of a sudden price increase. But today’s reality reflects not one but four developments: a long period of stagnant real incomes; the pandemic; the post-pandemic deterioration in the country’s terms of trade (the relative prices of its imports versus its exports), greatly exacerbated by the impact on energy prices of Russia’s war against Ukraine; and finally high inflation. A consequence of the latter is that it leads to large and unexpected reductions in the real wages of workers whose wages are set by the government, with the results we now see in his dispute with his employees.
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Consider each element in this story.
According to the latest data from the IMF, real gross domestic product per capita in the UK increased by just 6 percent between 2008 and 2022. This was the second worst performance in the G7, ahead of Italy. To put this dire result in context, the UK’s real GDP per capita grew by an impressive 33 per cent in the 14 years to 2008. Such weak growth prompted austerity measures. But the decision to make almost all post-financial crisis fiscal adjustments through spending cuts made it worse.
In 2020 came the pandemic. Between 2019 and 2022, real GDP per capita in the UK contracted by 1.9 percent, the sharpest decline in the G7. Indeed, one explanation for this large drop in output was the country’s deteriorating terms of trade. As a net energy importer, this was certainly big for the UK: According to Silvana Tenreyro, a member of the UK Monetary Policy Committee, the country’s terms of trade deteriorated by 9.5 per cent between February 2020 and September 2022. As a result, real GDP and consumption remain households lagged far behind even under their weak trends of 2013-19. The US, on the other hand, enjoyed a gain in its terms of trade and, partly as a result, has already returned to pre-pandemic trends.
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Finally, the general price level has also shot up, leading to large shifts in the distribution of real incomes. According to the IMF, consumer prices will increase by 21 percent between the end of 2020 and 2023. Obviously, for those whose wages do not rise in nominal terms, this means a huge drop in real earnings.
So, yes, the shocks of the last few years have been big and unexpected. What made them particularly difficult to manage, however, was the long period of stagnation and austerity that preceded them. In fact, everything has become much more difficult to handle in this context.
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Give credit where it’s due. Former Prime Minister Liz Truss was right about one thing: economic growth matters. But she and her chancellor, Kwasi Kwarteng, had no clear idea of how to achieve faster growth. Yes, incentives are important. But also solid public finances, low interest rates, an open economy and a reputation for sound economic governance. Much of this was sacrificed to totemic Brexit policies. These aren’t even over: consider the nonsense of the ‘retained EU draft law’, which is a plan to ‘review or revise much of the EU-derived law that forms the basis of much of national life today withdraw”.
All this just dances on the decks of the Titanic. It is hard to believe that without faster economic growth the UK will thrive, perhaps even survive, as a peaceful and orderly democratic society. To do that, the country must raise its appallingly low national savings and investment rates, build far more homes and reform its pension system to generate more risk-taking capital, create vibrant new businesses, and find a path to greater commerce in its economy European neighbourhood, offers its people quality jobs and finances the education and training they want. Only if all this is done can it also afford the public services it needs and which its citizens will certainly continue to ask for.
The UK is not alone when it comes to economic buffers. But his plight is dire. Why are its politicians unable to react?
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