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Saturday, July 07, 2018

Brexit, the lost empire, and dodgy modern UK economy

On December 5, 1962, Dean Acheson, former United States secretary of state (1949-1953), asserted that Britain's role as an independent power was "about played out."

Acheson said at a conference on American affairs at the West Point Military Academy that “Great Britain had lost an empire and had not yet found a role.” He added:

Britain's attempt to play a separate power role — that is, a role apart from Europe, a role based on a 'special relationship' with the United States, a role based on being the head of a Commonwealth which has no political structure or unity or strength and enjoys a fragile and precarious economic relationship — this role is about played out…Great Britain, attempting to work alone and to be a broker between the United States and Russia, has seemed to conduct a policy as weak as its military power."

The blunt comments from a key architect of the postwar Western Alliance triggered consternation in London.

Acheson was President Kennedy's special adviser on NATO affairs and in his speech he said that Britain's application for membership of the Common Market (the European Economic Community, which was later renamed the European Union) was a "decisive turning point." Should Britain join the Six (then six member countries), "another step forward of vast importance will have been taken."

Charles De Gaulle, the French president, first vetoed the British application for membership of the EEC in 1963, commenting "l'Angleterre, ce n'est plus grand chose" ("England is not much anymore") and again in 1967. Eventually on January 1, 1973, Britain, Denmark and Ireland, became members.  

Organisation of Economic Cooperation and Development (OECD) data for 1973 using constant 2010 dollars, adjusted for price differences (PPS), show that Denmark’s GDP per capita at $24,800 was on top in the EEC compared with Ireland’s $12,200 — the Republic was the poorest country in Western Europe.

West Germany and France were at $20,600 and $20,300, Italy had a level of $19,200 while the UK was at $18,800. Greece’s GDP per capita was $17,600 — compared with Japan’s $17,000.

The Conservative Party in power in 1970-1974 had negotiated entry to the EEC and the Labour Party which returned to government in two general elections in 1974, promised an internal vote on a referendum on membership of the EEC as the party was split with the significant Left, including Jeremy Corbyn, the current leader, in his mid-20s, viewing the Community as a capitalist conspiracy.

A one-day Labour conference in April 1975 voted by almost 2-1 to leave the European Economic Community. Most of the 3.7m votes came from the two biggest unions, the Transport Workers, and the Engineering Workers.

Margaret Thatcher, leader of the Conservative Party, told the House of Commons on April 8, 1975:

When we went in we knew exactly what we were going into. If we were now to withdraw, it would be a leap in the dark. We should not have any idea of the trading conditions into which we were coming out, or of the effect on sterling. It is not a genuine alternative. A genuine alternative would be to have two sets of negotiations and choose between them; but that would not be possible. We knew what we were going into because of the careful negotiations. If we withdraw we have no idea of what alternative trading arrangements we shall be able to secure…We are already a member of the free trade area by virtue of being a member of the Common Market; and if we were out every EFTA (European Free Trade Agreement) country would have to secure EEC permission because of the free trade agreements. Secondly, we would be a market of only 40m, which is hardly comparable to a market of 200m in the EEC. Thirdly, agreements on EFTA are particularly tough on rules of origin, and those in themselves, in the way they operate, could have an adverse effect on some of our trade, particularly in motorcar components. Having been through some 60 pages of the rules of origin one understands the difficulties associated with them. As honourable  Members will know, there are provisions covering certain sensitive products in EFTA agreements under which tariff barriers have gone down, particularly in textiles, with the EEC. Those barriers would be erected again. So even if we could get into EFTA, that would be no answer to our problems. A second alternative would be to have a free trade agreement with the Community. The first thing that occurs to one on this is that a time when one has just broken a treaty is not, frankly, the best time to ask for another, particularly when one is a country of a similar size to other countries in the Common Market and one's products are such that one competes with many of the others."

The national referendum was held on June 5, 1975, with more than 67% supporting continued membership. 47.5% of Labour supporters voted to leave the EEC; 85% of Conservative supporters voted to remain.

In the Brexit referendum of June 2016, according to YouGov, the polling firm, Conservatives voted to leave, 61% to 39%. Labour voters (65%) and Liberal Democrats (68%) largely voted for remain but significant minorities went for leave. Only UKIP, where 95% voted for leave, and the Greens, where 80% voted for remain, avoided significant internal divisions on the vote.  

The UK economy

The Financial Times has reported that Britain joined what was then the European Economic Community in 1973 as the sick man of Europe. By the late 1960s, France, West Germany and Italy — the three founder members closest in size to the UK — produced more per person than it did and the gap grew larger every year. Between 1958, when the EEC was set up, and Britain’s entry in 1973, gross domestic product per head rose 95% in these three countries compared with only 50% in Britain.

After becoming an EEC member, Britain slowly began to catch up. Gross domestic product per person has grown faster than Italy, Germany, and France in the years to 2016. By 2013, Britain became more prosperous than the average of the three other large European economies for the first time since 1965.

Britain today faces economic challenges after Brexit reflecting existing fragilities in the economy.

The biggest UK goods exporters are foreign-controlled car firms while the biggest services exporters are American-controlled financial services firms. 

This is a perilous situation for a country leaving its biggest market, for a dubious hope that the rest of the world will embrace it.

Trade and deficits

In 2017, the UK’s exports of goods and services amounted to £616bn and imports were valued at £642n. The EU accounted for 44% of UK exports of goods and services (£274bn) and 53% of imports in 2017.  Services accounted for 32% of the UK’s exports to the EU in 2017. 

The current account of the Balance of Payments, which comprises investment income and transfers as well as trade, was in a deficit of £79bn in 2017, compared with £103bn in 2016. The current account deficit was 3.9% of GDP in 2017 compared with 5.2% in 2016.

A deficit of £137bn on trade in goods was partially offset by a surplus of £112bn on trade in services in 2017. The overall trade deficit was £26bn in 2017.

The UK had a trade deficit with the EU of -£67bn in 2017 and a trade surplus of £41bn with non-EU countries. The overall trade deficit with the EU was made up of a surplus of £28bn on trade in services which was outweighed by a deficit of £95bn on trade in goods.

UK data show that the share of UK exports accounted for by the EU has dropped from 55% in 2006 to 43% in 2016, increasing moderately to 45% in 2017. 

The UK reported a trade deficit with 18 of the 27 other EU member states in 2016, a surplus with 4 others and was broadly in balance with the remaining. The UK’s largest EU trade surplus was with Ireland (£6bn) while its largest deficit was with Germany (£26bn).

The UK has had a trade deficit in its combined trade in goods and services every year since 1998. Since 1948, the UK has had a trade surplus i.e. the value of exports exceeding the value of imports — 18 times. There was a period of trade surpluses for the 9 years 1977-1985; the remaining 9 were recorded between 1956-58, 1969-71 and 1995-97.

Britain has had a Balance of Payments current account deficit every year since 1984.

PwC, the Big 4 accountancy firm, has said that in the 8 years from 2009 to 2016, the sterling Effective Exchange Rate was about 17% below its value in the decade before the Global Financial Crisis (1998-2007). However, UK export volume growth — both goods and services — has been the lowest of the G7 industrialised economies on average since 2010. 

Discussion of trade performance tends to focus on exports and imports of goods – especially manufactures. But if we are looking for the reasons for relatively poor UK export performance over the recovery period since the crisis, we need to focus more on the services side of the account. Services exports are particularly important for the UK economy: in 2016, services exports were 45% of total overseas sales and accounted for 12.5% of UK GDP. This is a much bigger contribution to national output than for other G7 economies – the equivalent figures for Germany and France are around 8% and for the US only 4%

PwC adds that UK services exports have increased by just 2.7% per annum in volume terms compared with 4.3% annual growth in goods exports. The equivalent figures for the long expansion that started in the early 1990s and came to an end in 2008, were 7.4% and 4.5% respectively, as Figure 4.6 shows. The rate of growth of UK goods exports in this recovery has been very similar to that seen in the economic upswing before the Global Financial Crisis, but services exports have grown at only just over a third of their pre-crisis rate. It is, therefore, the relatively disappointing performance of services exports that explains most of the UK’s lacklustre trade performance over this recovery period.

Bruegel, the Brussels think-tank suggests that there is no services exports bonanza for Britain in Asia. It says net services exports to China account for only 2.5% of the UK’s total services trade surplus while in Europe, Denmark and Germany have the closest services trade relationships with China, but the size of this trade is in general very limited: only about 3% of Danish and German services exports are sold to China.

The UK Institute of Fiscal Studies says that international supply chains play a particularly important role in UK-EU trade. Not only is the EU the UK’s largest source of imports (accounting for 54% of the total in 2016), but a majority of these imports now take the form of intermediate goods and services. These are goods or services that add to the value of a product which firms then sell either for further processing or for final consumption. Tin used to produce a can is an intermediate good. A tin of beans sold to a supermarket for sale to consumers is not.

Supply chains rely on having materials transported with ease across borders.

Nearly 70% of the UK’s exports to the EU take the form of intermediate inputs to the production of other goods and services. The relative importance of the EU in the UK’s trade thus largely reflects the role UK industries play in EU-wide supply chains."

According to the UK government in 2016, an estimates 8% of UK SMEs (small and medium-sized firms) export to the EU and a further 15% are in the supply chains of other businesses that export to the EU.

Annual budget outturns and public debt

Annual budget surpluses have been achieved in only 12 years since 1948 and only five years since 1971-72.

In April it was reported that the UK’s public finances have registered their first current budget surplus in 16 years (reflecting the difference between current spending and tax receipts), showing the progress made by the government on this measure of deficit repair since the last recession.

The Office for National Statistics (ONS) reported that public sector borrowing was just £1.35bn in March, the final month of the 2017-18 fiscal year. Public sector net borrowing (excluding public sector banks) over the 12 months was £42.6bn; that was, £3.5bn less than in the previous financial year (April 2016 to March 2017) 

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The overall annual budget including net investment will continue in deficit through the next decade.

Public sector net debt (excluding public sector banks) was £1,798.0bn at the end of March 2018, equivalent to 86.3% of gross domestic product (GDP), an increase of £71.2 billion (or 1.0 percentage point as a ratio of GDP) on March 2017.

The Office for Budget Responsibility (OBR) in a January 2017 report said that to return the debt-to-GDP ratio to its pre-crisis level of around 40% of GDP in 2066-67, would require a permanent increase in taxes and/or cut in spending of 4.3% of GDP (£84bn in 2017 terms) in 2022-23. The OBR acknowledged that such fiscal moves are unrealistic.

Stagnant wages

The UK had the biggest fall in real wages (inflation-adjusted) of any other advanced country apart from Greece, since the financial crisis began in 2007, 2016 research showed. Germany had the biggest rise of the advanced countries

A report by the UK’s Trades Union Congress, showed that real earnings had dipped more than 10% in the period 2007-2015, leaving the UK equal bottom of the wage growth league table with Greece, while the UK, Greece, and Portugal were the only three OECD countries that saw real wages fall over the eight-year period.

By contrast, over the same period, real wages grew in Poland by 23%, in Germany by 14%, and in France by 11%. Across the OECD, real wages increased by an average of 6.7%. Ireland had a rise of 1.6%.

After a brief recovery, real wages have been below the nominal Office for National Statistics (ONS) index in the period Jan 2016-2018.

In effect average real earnings in the UK in April 2018 were at 101.4 compared with the ONS index of 100 for 2005.  

Employment and output per British worker

In March 2018 the UK's employment rate — the percentage of the population of 15-64-year-olds working — was 74.7% compared with Germany's 75.6% and Ireland's 68.1% (Dec 2017).

In May 2018, the UK's headline unemployment rate was 4.1% compared with Germany's 3.4%.

According to Eurostat in 2016, every three people in employment in Greece was self-employed in 2016 (29%), and around one in five in Italy (21%) and Poland (18%). At the opposite end of the scale, the self- employed accounted for less than 10% of total employment in Denmark (8%), Germany, Estonia, Luxembourg and Sweden (all 9%).

The UK was at the EU average of 14% and Ireland was at 15%. During the recession in the UK, there was a jump in self-employment without employees and 83% of the British employed are employees compared with 89% in Germany according to the OECD.

According to the ONS, in 2011 output per worker in the UK trailed 21% behind the rest of the G7. In effect what this means is that a British worker must work for 21% as much time in order to produce exactly the same amount of goods as his or her equivalent in France or Germany.

Last April the ONS reported that the UK's long-running nominal productivity gap with the other six G7 economies (US, Germany, Japan, France, Italy and Canada) was broadly unchanged in 2016: falling from 16.4% in 2015 to 16.3% in 2016 in output per hour worked terms.

McKinsey, the consultancy, says:

For every hour worked by a British worker, a German worker produces 36% more. Much of this gap is due to the drag created by Britain’s large cohort of low-performing companies. Two-thirds of UK employees work for companies whose productivity is below average, adjusted for industry and size of company. The productivity challenge is also a geographic one. There is a wide variation in productivity among different regions in the United Kingdom, and also within them." 

McKinsey: Solving the Productivity Puzzle

The Financial Times writes:

Most people believe they are more effective than they really are. In research, 87% of MBA students at Stanford University rated their academic performance as better than the median. More than nine out of 10 American drivers think they drive better than average. And 95% of employees in the UK think they are at least as productive as their colleagues." 

Britain leads in business dynamism

One area in which Britain leads is in employer firm business startup rates while 2017 was a record year for UK foreign investment outflows, with a 35% increase in UK businesses investing into Europe "When 450 global investors were asked ‘where is the most attractive place to invest in the future’, they favoured Germany (1st), with France (2nd) overtaking the UK placed 3rd. France has seen a surge in FDI projects by 31% in 2017, supported by the so-called 'Macron effect'."

Although reliable cross-country data is scarce, and Softbank of Japan acquired the UK's top homegrown tech firm ARM Holdings — the chip designer — in 2016, the UK is viewed as the Digital Capital of Europe. Enda Kenny, then taoiseach, made that an aspiration for Ireland in 2011 but with about half the Irish ICT sector comprising admin staff, coupled with a low level of national innovation (despite international metrics polluted by tax avoidance distortions), the goal was as credible as the 2006 target for Ireland to be a world-class knowledge economy by 2013.

The Institute for Policy Research says that a total of £6.7bn was invested in UK tech firms in 2016 — more than any other European country.

See Economist Intelligence Unity survey on the digital environments in 45 global cites here: London and Madrid lead Europe while Berlin was last of the 45 cities.

The UK's overall startup rate is the best among the advanced countries:

Finfacts 2018: Ireland has very low employer firm startup rate- the UK is 4 times bigger

The Economist 2018: American tech giants are making life tough for startups

Harvard Business Review 2014With Fewer New Firms, the High-Tech Sector is Losing its Dynamism