New British government inherits worst economic plight since World War II

Britain’s new Labour Party government is betting that an economic plan modeled on “Bidenomics” will reverse more than a decade of economic drift and boost stagnant living standards without requiring budget-busting spending.

It won’t be easy.

Like President Biden, Prime Minister Keir Starmer promises a more active government than his Conservative Party predecessor, as well as investments in green energy and industrial policies that promote domestic manufacturing.

But Starmer - who is scheduled to meet Biden at the White House on Wednesday - inherited an economy showing the strains of more than a decade of political tumult, inadequate business investment and sclerotic government planning. He also lacks a ready source of cash.

The economic climate represents “the worst set of circumstances since the Second World War,” Rachel Reeves, the country’s first female chancellor of the exchequer, or finance minister, said Monday. Adjusted for inflation, wages are virtually unchanged since 2007, according to the Center for Economic Performance, a research institute. The average German is now 20 percent richer than the typical citizen of the United Kingdom.

“The U.K. is not in a quick-fix situation. Most people think it is going to take the best part of a decade to see material improvement come through,” said David Page, head of macroeconomic research at AXA Investment Managers in London. “But I think there’s also now a hope, and that’s different, that you might see that emerge in the next 10 years.”

Reeves moved quickly this week to underscore the urgency of the challenge, calling economic growth “our national mission” and saying that “there is no time to waste.” But she has vowed to obey informal fiscal rules that will limit Labour’s ability to spend freely, given the country’s debt load. Her aim is to use modest amounts of public money to attract private capital.

The roots of Britain’s economic woes lie in weak productivity growth, economists said. Equipping workers to produce more goods each hour is the key to expanding the economy and raising living standards. And it is what has been missing from Britain’s recent performance.

The typical American worker last year produced 23 percent more than their British counterpart. That gap had more than doubled since 2007. French and German workers also outperform the British.

British productivity rose steadily for nearly three decades but has flatlined since the 2008 financial crisis. The government austerity and recurring political crises that followed the Great Recession discouraged companies from investing to make workers more efficient, economists said.

In the United States, business investment has risen by more than one-third since 2016, almost seven times the increase in the United Kingdom, according to government statistics.

“What does it mean? It means you’re working with outdated equipment and less of it,” said Rob Wood, chief U.K. economist for Pantheon Macroeconomics in Newcastle upon Tyne.

The pandemic - and government budget cuts that left the National Health Service understaffed - also took a toll on productivity. There are 754,000 more working-age people inactive now compared to before the pandemic, according to a House of Commons analysis. Many are among the more than 6 million Britons who are waiting to see a doctor, according to the British Medical Association.

Britain’s problems are the legacy of years of interplay between public and private choices. The country’s overly large financial services industry shrank following the 2008 crisis, which made credit harder to get than elsewhere.

The government met the crisis with an “age of austerity,” which hurt public services and crimped economic growth.

“We’ve learned that public austerity destroyed the private sector as well. We need to invest,” said David Blanchflower, an economics professor at Dartmouth College, who served on the Bank of England’s monetary policy committee before the 2008 crisis.

Brexit - the 2016 decision to quit the European Union - and its implementation consumed three prime ministers over most of a decade and continues to shadow the economy.

Erecting commercial barriers against its largest trading partner will shrink the U.K. economy by 4 percent and will leave both exports and imports roughly 15 percent lower than if the country had remained in the E.U., according to the Office for Budget Responsibility, an official agency.

Government instability has been an impediment to growth. Since 2010, Britain has had five prime ministers, seven chancellors, nine cabinet ministers for business and countless long-term economic plans.

Last fall, Prime Minister Rishi Sunak canceled the second half of a high-speed rail line intended to link London with northern cities. First proposed in 2009, the line - billed as Europe’s largest infrastructure project - was to have connected the capital with Birmingham and Manchester, farther north.

But in October, Sunak eliminated the portion of the line from Birmingham to Manchester, leaving businesses that had planned on faster rail connections fuming.

“The sheer political and policy volatility [means] businesses don’t know whether they are coming or going,” Wood said.

Starmer’s scheduled meeting with Biden on the sidelines of a North Atlantic Treaty Organization summit is likely to underscore the “special relationship” between the allies.

In a Washington speech last year, Reeves sketched an economic formula that resembled Treasury Secretary Janet L. Yellen’s doctrine of “modern supply-side economics.” The two share an enthusiasm for spurring growth by expanding the labor force and investing in infrastructure and climate-friendly energy sources.

Relative to the size of its economy, the U.S. public debt is a bit larger than that of the United Kingdom. But the dollar’s status as the global reserve currency gives the U.S. government more latitude in dealing with its spending issues.

Labour has said it will abide by an informal fiscal rule developed by the previous U.K. government. That will require it within five years to start reducing debt as a percentage of gross domestic product, which is now set to reach 95 percent in 2026.

Labour also has ruled out increasing personal income taxes, the national insurance levy or the value-added tax.

Budgetary realities already have caused Labour to shrink its ambitions. In February, the party scrapped its pledge to spend 28 billion pounds, or roughly $36 billion, each year on green energy programs. Instead, officials said annual spending would hit 4.7 billion pounds, or $6 billion.

“Reality has kicked in,” said Paul Dales, chief U.K. economist for Capital Economics. “The new government has to focus on areas where actually they can make a difference without costing lots of money.”

One such priority will be overhauling the notoriously slow planning process that governs housing and infrastructure projects. Labor wants to speed planning approvals to build 1.5 million new homes over the next five years and to overhaul the energy grid.

The new government this week ended the Conservatives’ ban on onshore wind farms. Instituted in 2015, it allowed a single objection to block projects.

Labour faces a daunting to-do list. But it may enjoy a short-term tailwind. Inflation in May was running at an annual rate of 2.8 percent, down from its peak near 10 percent in 2022. After a brief recession last year, growth is beginning to stir. The International Monetary Fund expects the economy to expand at by 0.7 percent this year and accelerate to 1.5 percent in 2025.

With inflation falling, the Bank of England could soon cut its 5.25 percent benchmark lending rate for the first time in four years, which would give the economy a boost.

If the new government can improve the nation’s health service and return some inactive workers to the labor force, the economy would get a further lift.

Labour’s massive parliamentary majority, and the disarray in the ranks of the opposition Conservatives, mean that Starmer can expect to remain in office for at least a full five-year Parliament, if not two.

That relative stability comes as other major economies are preoccupied with domestic politics. In France, the left-wing coalition that triumphed in parliamentary voting this month has endorsed free-spending policies that could unsettle financial markets. And the United States is in the midst of a divisive presidential contest, which could return an unpredictable former president to the White House.

“In an uncertain world,” Reeves said on Monday, “Britain is a place to do business.”