Main Problems of UK Economy

Readers Question: What are the main problems of the current UK economic situation?

  1. Low economic growth and in particular stagnant real wage growth
  2. Poor productivity growth
  3. Inflation which is contributing to fall in disposable income.
  4. State of the housing market – expensive prices and rents are contributing to intergenerational inequality.
  5. Uncertainty from Brexit transition.
  6. Relative poverty and inequality

One of the main problem facing the UK economy at the present time is weak economic growth, with output below its previous trend rate of growth.

real-gdp-trend-actual

The lost output is due to low productivity growth and relatively weak demand

Low economic growth adversely affects many different economic problems:

  • Fall in real wages. Relatively weak economic growth has contributed to a fall in real wages and lower living standards.
  • Increased ratio of government debt / GDP. With weak economic growth in GDP, it becomes much more difficult for the government to reduce the burden of government debt to GDP. Despite austerity measures, the debt to GDP ratio is forecast to keep rising.

Productivity puzzle

labour-productivity-index-since-63

In the post-war period, we have become accustomed to rising productivity – and this is a key factor behind rising real GDP and rising living standards. However, since 2007, productivity has fallen dramatically behind the post-war trend and is struggling to catch up. Part of the low productivity growth may be explained by growth in low-wage jobs – which on the positive side is causing a faster than expected fall in employment. But, 10 years after the crisis, it is concerning UK productivity growth is slipping behind our major competitors. If this trend continues it will have adverse consequences for living standards and tax receipts. This, in turn, will limit government spending on public services, such as healthcare.

More on productivity puzzle

Government Debt

UK national-debt-since 1975
UK national-debt-since 1975

Since the credit crisis of 2008/09, UK debt levels have increased from under 40% of GDP to over 82% of GDP. Reducing debt levels have proved more difficult than government forecast. In many areas, tax revenues have been falling and political reasons make it difficult to raise tax rates. Whilst tax revenues have been weak, demand for government spending is rising from areas such as pensions (ageing population) and health care (greater demand from ageing population and more technology)

Concerns over government debt are often exaggerated. For example, the rise in debt has not caused rising bond yields (as some predicted) in fact bond yields have fallen – showing there is a surplus of saving and high demand to buy government bonds. However, the rise in debt has a political impact and may limit the willingness of future governments to invest in UK’s infrastructure. (which has considerable needs for investment, especially transport)

More on UK debt

Inflation

cpi-inflation-latest
From one perspective Inflation is relatively low by historical standards (currently just above government’s inflation target of 3%) But, with weak nominal wage growth, this moderate inflation is actually causing a fall in real wages and a fall in living standards. Some of the cost-push inflation may prove temporary (due to effects of devaluation). However, the prolonged stagnation in living standards is unprecedented in post-war Britain.

uk-real-wages-01-17

This fall in living standards is exacerbated by rising housing costs. Young people experiencing a squeeze on living standards are seeing the cost of renting (or buying) rise above inflation. For those who do not own a house, there are greater economic costs.

Real disposable income per head

real-disposable-income-per-head

Another way of seeing this issue is real disposable income per head. It shows that rising real GDP – is not translating into rising disposable income. Part of this is due to a rising population, but also it shows higher GDP is not leading to higher incomes (e.g. company profit rising)

UK inflation

Housing market

House prices have increased faster than inflation, decreasing affordability. This is particularly affecting young people who are not on the property ladder.

england-renting

Cost of renting is increasing faster than inflation.

FTB-earnings-house-prices

The ratio of house prices to incomes is rising to historical highs.

mortgage-payments-as-percent

If interest rates increase from the current lows, it could adversely affect homeowners with large mortgages. Consumers have become accustomed to historical lows – if interest rates rise it will cause a rise in loan defaults.

More on UK housing market

Current account deficit

UK-current-account-2001-15

The deterioration in the UK current account is a cause for some concern because it is occurring – despite weak economic growth. Usually, low growth leads to lower imports and an improvement in the current account. This deterioration in the current account suggests the UK could have declining international competitiveness. More on current account deficit

Brexit uncertainty

Since the 2016 vote, consumer spending has held up. Though with rising prices from the effects of Brexit devaluation, households are increasingly squeezed and consumer confidence is dropping to levels not seen since 2009. Firms are also experiencing concerns about uncertainty over future trading relations and the impact of a ‘no deal’ solution on trade and exports. Given climate of weak consumer demand and uncertainty  – firms are holding back from investment.

Poverty and inequality

Some progress in poverty reduction was made in the 1990s and early 2000s, but there are still concerns of levels of poverty – especially after housing costs are included.

relatively-low-income

In particular, it is people of working age and children who are experiencing higher levels of poverty in UK

relative poverty

Source: HM Government – Child Poverty Evidence Review (2014)

Related

2 thoughts on “Main Problems of UK Economy

  1. Hello Pettinger,

    I would to ask you about bank regulation. Nawadays many people are talking about

    the bank system need more regulation . My question is what is advantage and disadvantage of more regulation after financial crisis in 2007-2008?

  2. Usually, low growth leads to lower imports and an improvement in the current account , don’t you think this phrase is wrong .

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