It is “the economy, stupid”. James Carville coined this phrase in Bill Clinton’s campaign of 1992. 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 created by sustained growth. Political stability, too, depends on the positive-sum politics that economic growth creates. If, as now, in the UK and other high-income countries, the economy stagnates, politics becomes fraught, since one group cannot have more without others having less. The struggle becomes more bitter if the labour force shrinks relative to the population and so tax-funded transfers tend to rise as a share of national incomes.
Today, the focus is on a recent shock to aggregate real incomes — the so-called cost of living crisis. This crisis is portrayed as the consequence of a sudden rise in prices. But today’s realities reflect not one, but four developments: a lengthy period of stagnant real incomes; the pandemic; the post-pandemic deterioration in the country’s “terms of trade” (the relative prices of its imports against its exports), greatly exacerbated by the impact on energy prices of Russia’s war on Ukraine; and, finally, high inflation. One outcome of the latter is that it brings about large and unexpected reductions in the real incomes of workers whose pay is fixed by government, with the results we now see in its strife with its employees.
Consider each element in this story.
According to the IMF’s latest data, real gross domestic product per head in the UK rose by a mere 6 per cent between 2008 and 2022. This was the second worst performance in the G7, above Italy’s. To put this dire outcome in context, UK real GDP per head rose by an impressive 33 per cent in the 14 years to 2008. Such weak growth ensured austerity. But the decision to make almost all the post-financial crisis fiscal adjustment by cutting spending made this even worse.
In 2020, came the pandemic. Between 2019 and 2022, real GDP per head in the UK shrank by 1.9 per cent, the deepest fall in the G7. One explanation for this big hit to output was indeed the deterioration in the country’s terms of trade. As a net energy importer, this was sure to be large for the UK: according to Silvana Tenreyro, a member of the UK’s Monetary Policy Committee, the country’s terms of trade deteriorated by 9.5 per cent between February 2020 and September 2022. Partly as a result, real GDP and household consumption remain well below even their poor 2013-19 trends. The US, in contrast, enjoyed a gain in its terms of trade and, partly as a result, has already returned to pre-pandemic trends.
Finally, the overall price level has also soared, so bringing about large shifts in the distribution of real earnings. According to the IMF, consumer prices will jump by 21 per cent between the end of 2020 and 2023. Evidently, this is imposing a huge cut in real earnings upon those whose pay does not also rise substantially in nominal terms.
So, yes, the shocks of the past few years have been large and unexpected. But what has made them particularly difficult to cope with was the long period of stagnation and austerity that preceded them. Indeed, everything has become far harder to manage in this context.
Give credit where it is due. Former prime minister Liz Truss was right about one thing: economic growth matters. But she and her chancellor Kwasi Kwarteng had no intelligible view on how faster growth was to be achieved. Yes, incentives are important. But so are sound public finances, low interest rates, an open economy and a reputation for sound economic management. Much of this has been sacrificed to the totemic politics of Brexit. These are not yet even over: consider the nonsense of the “retained EU law bill”, which is a plan to “review or revoke” much of the EU-derived law that forms the basis for much of today’s national life.
All this is just dancing on the decks of the Titanic. It is hard to believe that the UK will thrive, perhaps even survive, as a peaceful and orderly democratic society without faster economic growth. To bring that about, the country will need to raise its dreadfully low national rates of savings and investment, build far more houses, and reform its pension system, in order to generate more risk-taking capital, create dynamic new businesses, discover a route towards better opportunities for trade in its European neighbourhood, offer high quality jobs to its people and fund the education and training they desire. Only if all this is done can it also afford the public services it needs and its public will certainly continue to demand.
The UK is not alone in hitting the economic buffers. But its plight is dire. Why are its politicians incapable of responding?
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