Who wants to be shackled to a static economy?
That was the question asked early last year by Britain's pro-Brexit crowd. The European Union was trapped in a seemingly bottomless pit of low growth, high unemployment and crushing debt. Let's free ourselves of the EU and thrive!
The argument helped secure Brexit in last year's referendum. Oh, sweet irony, look how the tables have turned. The economy of the EU, in particular that of the 19 euro zone countries, is now surging ahead, and it is the British economy that is suddenly looking weak.
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Growth in the first quarter was only 0.2 per cent, and the British consumer is showing signs of fatigue. A post-election recession is not out of the question.
Whoever wins the June 8 election – the Conservatives' Theresa May or Labour's Jeremy Corbyn – may have to deal with an economic fix-it job on top of the already messy Brexit negotiations, an unpredictable and isolationist U.S. President and the biggest domestic terrorism threat since the Irish Republican Army era. "My sense is that the U.K. is slowly drifting forward, but with increasingly troublesome headwinds," says George Magnus, an independent economist in London who was formerly chief economist of UBS.
The British election was never supposed to be about the economy and has not been. The economy was doing just fine, thank you very much, and the Brexiteers delighted in reminding pro-EU Britons, who had voted 48 per cent in favour of sticking with the EU, that Brexit would not translate into economic calamity. They have been right, so far.
Last year, British gross domestic product expanded by a healthy 1.8 per cent, second only to Germany's 1.9 per cent among the Group of Seven countries and ahead of the U.S. pace of 1.6 per cent. So there. Britain had a currency that it could devalue, acting as a shock absorber, and British industries, from auto-making to banking, showed little sign of preparing to decamp to the other other side of the English Channel.
Since it's accepted political wisdom that rising economies tend to favour incumbent parties – stick with what works – Ms. May, the Prime Minister, duly called an election, even though she had vowed not to several times since she replaced David Cameron. When she hit the poll button in mid-April, Labour was trailing the ruling Conservatives by as much as 20 percentage points. Ms. May's apparently cynical move would pay off and the last thing she had to worry about was a deteriorating economy.
The election did include a debate on economic policies – both parties' platforms received mediocre grades from economists – then, overnight, after the May 22 terrorist attack in Manchester, turned into a security election. Saturday night's London Bridge attack ensured that security would dominate the campaign to the very end.
While most Britons, possibly even the campaigning politicians themselves, weren't looking, the economy was taking a turn for the worse even though unemployment, at 4.5 per cent, had dropped to its lowest level since 1975 and employment rates had crept up to their highest levels since records began almost five decades ago. So far this year, GDP growth has been weak, and Britain is likely to lose its status as one of the strongest Western economies.
Where did the economic cracks appear?
The biggie was rising prices, the result of higher energy prices and the sinking pound, which fell 20 per cent against the U.S. dollar after the Brexit vote and is now down 10 per cent over the year. Inflation was measured in May at 2.7 per cent, well above the Bank of England's 2 per cent target rate.
Grocery inflation, at 2.9 per cent, is hitting consumers hard (though boosting sales at discount supermarkets such as Aldi and Lidl as shoppers seek bargains). "The consumer is under pressure because prices are rising faster than wages," says Sam Hill, senior U.K. economist for RBC Capital Markets. "We are seeing a consumer-led slowdown."
As rising inflation eats away at real incomes, consumer spending could stall, all the more so since consumption growth has been driven by what Mr. Hill calls an "unsustainable" drop in the savings rate. In effect, consumers have been borrowing more and saving less to maintain their lifestyles. The upshot? Consumers probably cannot be counted on to save the economy should it run into trouble.
The fall-off in the savings rate has been dramatic. The household savings rate was 6.5 per cent of income at the end of 2015. At the end of 2016, it had fallen to 3.3 per cent, the lowest on record (at the end of 2010, when Britain was still mired in postcrisis recession, the savings rate was 10.7 per cent). "The lower savings rate leaves the consumer open to a negative hit to confidence," Mr. Hill says. "If so, the consumer sector could pull back abruptly."
Already, new car registrations are plummeting.
The dire savings rate is probably the biggest potential threat to the British economy. The lesser ones would be the failure of the weaker pound to stimulate exports and business investment rates that haven't improved in almost two years, damaging productivity growth (productivity actually fell in the first quarter, by 0.5 per cent, over the last quarter in 2016).
RBC expects second-quarter growth to land at 0.4 per cent then fall to 0.2 per cent in each of the last two quarters of this year.
The wild cards are the election result and the outcome of the Brexit negotiations. A victory by the Conservatives will probably result in higher taxes – Ms. May has ruled out tax increases only for the rich – coupled with spending restraint. Labour, whose victory is not out of the question after Ms. May's uninspiring campaign performance, will raise taxes and boost spending. The victory of either party could put downward pressure on the economy.
Brexit is the great unknown, to the point that economists are unsure how to factor it into their economic forecasts. A smooth "soft" Brexit would help confidence and possibly restore investment spending. A chaotic "hard" Brexit, one that would leave Britain without a trade deal with the EU, would result in a 40 per cent drop in exports to the EU over 10 years and a 3 per cent drop in per capita GDP, according to economists Swati Dhingra and Thomas Sampson of the Centre for Economic Performance at the London School of Economics.
Britain has at least one good thing going for it. Almost half of its exports go the EU, and the EU and the euro zone economies are performing well after years in the tank; even Italy, the perennial laggard, is growing faster than expected. The EU is no longer lifeless. It just might be able to help Britain regain its economic form.