Sunday, June 11, 2023
What will the economy look like at the next election?
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt. Not to be reproduced without permission.

A lot of people ask me about the next election, which must happen before the end of January 2025, or more realistically, in the spring, summer or autumn of next year. Some of the questions about it are better answered elsewhere, notably whether the prime minister can recover from the events of Friday evening, and the daggers thrown at him and his leadership by a departing Boris Johnson, how firm is Labour’s significant opinion poll lead, whether the opposition needs to come forward with many more policies - and not change existing ones too much - or how relevant is it that Rishi Sunak is more popular than his party (spoiler alert, the same was said to be true of Theresa May before she lost her Commons majority).

What I can try to do is set out what looks likely to be the economic backdrop to the election, and a new report from Capital Economics, ‘Why is the UK economy lagging behind?’ provides a useful way of looking at it.

The report splits recent history into two phases. Phase 1, the pandemic period, covers the time between the first quarter of 2020 and two years’ later. Phase 2 is the post-pandemic period, from the first quarter of 2022 until a year later.

In both phases there is UK underperformance compared with America and the eurozone, In phase 1, UK growth of 2 per cent compares with 4.6 per cent in the eurozone (or 4 per cent excluding Ireland, whose gross domestic product figures are distorted) and 4.9 per cent in America. In phase 2, negligible growth in the UK, 0.2 per cent, compares with 1 per cent in the eurozone (including and excluding Ireland) and 1.6 per cent in America. Revised figures a few days ago showed that eurozone gross domestic product (GDP)dipped by 0.1 per cent in the first quarter, on this occasion dragged down by Ireland, after a similar small fall in the final quarter of last year, thus meeting the daft definition of a “technical” recession. But that does not change the big picture. EU GDP rose by 0.1 per cent in the first quarter.

Some readers will already have drawn their conclusions about why the UK has underperformed but wait a moment. The first explanation for the UK’s weakness, according to Ruth Gregory, the report’s author is, unusually for the UK, feeble consumer spending.

During the pandemic, lockdowns, other restrictions and behavioural changes limited consumer spending to a greater extent than elsewhere. In the post-pandemic phased, consumers were hit by a bigger and longer-lasting cost-of-living squeeze. Indeed, spending on consumer-facing services is almost 10 per cent below pre-pandemic levels.

The second reason, perhaps surprisingly, is that government spending, having substantially supported during the economy during the pandemic, has subtracted from economic growth during the post-Covid period.

Then there is the third reason, which is the one you might have been expecting. As Capital’s report puts it: “The third factor is Brexit, which in both phases has undoubtedly contributed to the slower growth in UK exports relative to elsewhere.” Comparing export volumes for goods and services for the rest of the G7 in the first quarter of this year with the 2018 average, before Brexit-related distortions kicked in, they are up by 3.3 per cent, while the UK is 5.9 per cent down.

There are other effects, the UK has suffered a combination of a European-style cost-of-living crisis and a US-style rise in economic inactivity and labour shortages, but in each case somewhat worse.

All this adds up to a gloomy picture. It was a different era, but the Tories fell to a landslide defeat in 1997 against Tony Blair’s Labour party. Despite four years of strong growth in the economy and living standards. The next election will be fought against a backdrop in which GDP will have barely grown over the parliament and could have shrunk if some current warnings over the dangers of recession prove correct.

The Office for Budget Responsibility, the official forecaster, predicts that real household incomes per head will still be slightly below pre-pandemic levels, and thus levels at the time of the last election, in 2027-28. Never have we seen a squeeze like this since records began in the mid-1950s. Real household income per head in 1997 was nearly 9 per cent higher than at the time of the previous election in 1992. Even with the impact of the financial crisis, Labour lost in 2010, despite per capita real incomes being 4 per cent up compared with the previous election in 2005.

It sounds from all this as if the prime minister might as well book the removal vans for Downing Street now. There are some alternative possibilities. One is that voters do not decide solely on economic issues, on what Americans sometimes call “pocketbook” issues. On this basis, if the choice at the next election was between two unexciting, technocratic candidates, why not the devil you know, rather than the risk?

There is another possibility, which may offer a better hope for a beleaguered prime minister, and which may explain the emphasis placed upon it by he and his chancellor. This is that, while the economy’s dismal performance during this parliament is more or less baked in, there could yet be a temporary boost to real incomes, a “feelgood factor” which would persuade people that a corner has been turned.

The Organisation for Economic Co-operation and Development (OECD), while revising up its growth forecast to an anaemic 0.3 per cent this year, 1 per cent next, warned of the danger that inflation could be more enduring than feared. The UK has the highest proportion of its consumer prices index in which price rises have exceeded 5 per cent for 12 consecutive months of any major economy, and the highest inflation this year of any advanced economy except Turkey.

But the OECD predicts a big fall in inflation next year, partly because some recent big increases will drop out of the annual comparison. In what will be music to the ears of the Bank of England, it expects inflation to be closing in fast on the 2 per cent official inflation target, as does Capital Economics. The Bank itself, and the International Monetary Fund, think it will take longer, into 2025, which is also the consensus among independent forecasts. Inflation forecasters, it should be said, have not covered themselves in glory over the past couple of years.

For the government, the ideal combination would be one which combines a big pre-election fall in inflation with reductions in interest rates. That has to be its main hope but there is a better chance of inflation falling that rates being cut in response. The Bank, having marched interest rates up to the top of the hill, is unlikely to be in a hurry to march them down again. As for inflation, it remains to be seen how grateful people will be for its return to where, according to the official target, is should have been all the time.