Why has UK growth fallen short?

The IMF downgrades the UK

The IMF, in its most recent forecasts, revised UK growth for this year down from 1.3% to 0.8%. It added that the UK is one of the most vulnerable economies to events in the Gulf, likely to suffer more from the disruption to trade and the sharp rise in oil and related prices from the US/Israel/Iran/Hezbollah war. The IMF have captured the market mood about the UK. 

The bond markets have pushed up the costs of UK state borrowing by more than other advanced countries. There are concerns about the size of the deficits in the years ahead that need financing and about the way the UK economy is prone to higher inflation. The underlying problem is the lack of growth. If the economy would grow faster, tax revenues would expand from the extra incomes and sales. The numbers unemployed and on benefits could contract, easing the pressures on public finances.  

The government swept into office saying they planned for the UK to be the fastest growing G7 economy. The UK, like the other major EU economies, had suffered a poor century prior to that date, falling way behind the USA which was achieving double the UK/EU growth rate. The Europeans were badly hit by the banking crash and great recession of 2007-10 and had struggled to grow pre COVID. The UK had gone from 90% of US GDP per head in 2000 to 60% now, whilst the EU average had fallen to just 50% of the US.  

There are two main reasons for superior US performance. The US tax, legal and regulatory system allowed the digital revolution to grow fastest, whilst the EU system was unhelpful to smaller challenger companies and hostile to innovation. The US built the seven corporate digital giants. The US went for an abundance of cheap domestic energy, whilst the Europeans, including the UK, embarked on a very expensive transition from oil and gas to renewable electricity.  

The new UK government decided not to follow the US model, but to double down on the EU view that the answer lay in green growth. A range of taxes, subsidies, price controls, state investment, regulations and bans were rolled out or reinforced to speed the transition to battery cars, heat pumps, renewable generation, electric factories and the full net zero strategy. All this replacement investment was designed to generate more jobs and profits whilst cutting CO2 emissions. Unfortunately, China was well advanced with the green technologies and soon proved capable of dominating the solar panel, large battery, electric car and wind turbine markets. The EU and UK struggled to get a foothold in these areas, whilst jobs and activity fell away in fossil fuel-based activities. 

The UK compounded the adverse impact on productivity and growth by accelerating the closure of its own domestic oil and gas industry. New exploration wells were banned and possible new field developments delayed or stopped. Oil and gas extraction are areas of high wages and high productivity, as the value of the output is high relative to the numbers employed directly in this activity.

Closure of a wide range of high energy using industries followed from UK electricity and gas prices rising far above US levels, where cheap domestic gas powers the country, and above China, where plenty of cheap coal and cheaper imported Russian and Middle Eastern oil and gas are used. In the last two years the UK has closed two of its six refineries, large chemical plants, plastics recycling factories, a large fibreglass plant, and several ceramics factories. The government points to new jobs in the construction of windfarms, in the installation of heat pumps and in maintaining battery cars as offsets to the losses.  

The UK government also decided on a boost to public sector capital investment. It set up the National Wealth Fund and Great British Energy. It has continued plans for a fully nationalised railway. It has not been able to find much extra money to boost public sector spend on projects. It will be looking to ensure better control of such spending with more positive results than recent large, nationalised schemes have delivered. The new capital is likely to go mainly to decarbonisation projects in the energy and transport sectors. 

The largest project underway is HS2, a new railway line with faster trains from London to Birmingham. The government has allocated an additional £25bn for current construction work following a trebling of the original forecast cost and big delays in completion. The project is unlikely to remunerate its capital once it is finished and trains run. The Post Office computerisation programme, under successive governments, was also unfortunate, leading to the wrongful imprisonment of staff over false allegations of fraud as the system was faulty. That was another big investment that produced none of the promised return and landed the government with a substantial compensation bill and a loss-making business.  

The government has now added to its two ambitious ideas for more growth the need to negotiate an EU reset. They believe that more integration with EU code law could help boost UK exports to the zone. The EU as a bloc is the UK’s largest trade partner, but during the UK's period in the EU, the EU share of UK trade fell whilst the UK ran a large deficit, struggling to export more. For more EU trade to boost our growth rate it will need the government to ensure our exports grow by more than our imports from the zone, given our comparative smaller export base. It will also require a reorientation of our exports. Past successes have been exporting oil, gas, refined oil products and diesel and petrol cars. As all these items are being managed down or being banned, so the UK will need to find replacements. 

It is difficult to conclude that current policies will lift the UK growth rate above the US anytime soon. The UK still lacks production capacity for the main goods of the green revolution, and public investment remains disappointing in its returns and achievement. It looks like the IMF was right to downgrade the outlook for this year, whilst the bond market poses questions over the longer-term finances.

About the author 

Lord Redwood has been a long-standing member of the EPIC Investment Partners Advisory Board. 

Lord Redwood is a well known commentator on governments and economies, with long experience of investment markets. Trained as an analyst at Robert Flemings, he moved to N.M. Rothschilds where he became a Manager and Director of pension and charitable funds and Head of Equity Research. He was seconded to become Head of the Downing Street Policy unit before chairing a large, quoted UK industrial business. He served as an MP and a government Minister.  

In 2007 he set up Pan Asset with a colleague, an investment management business that pioneered active/passive funds and models in the UK. Following the sale of the business to Charles Stanley, a quoted investment manager in the City, he became their Global Chief Strategist advising on non-UK markets and economies. He also ran a demonstration fund for the FT, writing articles about it and illustrating the use that can be made of ETFs in portfolios. 

He is now an adviser to EPIC, providing insights into the big investment issues of the day from the debt and spending problems of the major governments to the green and digital revolutions which have so much impact on equity markets. He is a Distinguished Fellow of All Souls College, Oxford, where he helps with their Endowment investments and gives occasional lectures on modern economics and politics.