You can’t buck the market, Margaret Thatcher liked to say, and she was right. You can’t buck the market, you can’t buck reality, and you can’t sustain prosperity by consuming and importing more than you produce and export.
Britain, like many European countries, is in a bad way. Growth is sluggish, and wages no higher than before the Great Financial Crash. Our birth rate is declining, and immigration has soared. Productivity is poor. We have a persistent trade deficit, a budget deficit and a large stock of debt. Our very viability depends on the kindness of strangers.
Globalisation, in the form we have known it, is dead. China’s rise always meant international free trade, such as it ever really existed, had a short life expectancy. Prompted by Donald Trump and hastened by Covid, the US has shifted its strategic focus to the threat from Beijing and the security of the Pacific. Geopolitical competition has prompted national and regional protectionism and a new wave of industrial strategies.
Britain is over-exposed and under-prepared for the new world. Many of the theories, assumptions and policies that underpin our economy are bankrupt. Writing for the IMF recently, Sir Angus Deaton, professor of economics at Princeton, reassessed his own beliefs. Business has too much power over workers, he said, free trade had damaged the Western working and middle classes, and immigration does more harm than good.
Few of Sir Angus’s colleagues would be so honest, but we should not stop there. Classical economic theory holds that it does not matter who owns what, nor what is made where. Comparative advantage means countries do what they are good at, and buy what other countries provide. Thus, trade makes us all richer.
But this is not the case. First, governments get in the way. Countries like Russia and Iraq – controlled by Iran – can sell us hydrocarbons, but we should not fund our enemies. China was good at manufacturing protective equipment, but blocked its export when Covid first struck. The European Union sought to confiscate vaccines bought by Britain.
Neither does comparative advantage make everyone better off. If Britain only does the things it is best at – like financial services – and stops doing the things it does less well, the people and places reliant on those abandoned industries suffer. We end up, as economic geography shows us now, with one prosperous but overcrowded corner of the country, with the remainder reliant on fiscal transfers to sustain an acceptable quality of life.
Economic theory, and generations of politicians, told us not to worry about leaving manufacturing behind. But the balance of the economy matters. Goods can indeed be exported around the world, but services are protected by governments through hidden protectionism, and language barriers apply more to services than to goods.
Being a services superpower is good for Britain, but it is not enough. With artificial intelligence coming, many service industries face enormous disruption. Regardless, with important exceptions such as life sciences and aviation, our manufacturing sector is too small. The result is a bifurcated labour market, poor productivity and a deep trade deficit.
Since we moved to a floating exchange rate, economists and politicians have claimed this does not matter. But the trade deficit is both a product of our problems and a cause. It is a product because we do not make, do or sell enough to the rest of the world. It is a cause because the arising current account deficit leads us to sell assets to foreign investors and build up external debt, which leaves us with less control over our economy, and more exposed to investors’ interests and increases in international interest rates.
It also compounds the regional imbalances of our economy. London is a net exporter, creating wealth in the capital, but the regions consume more than they produce and export. The foreign investment we seek to compensate for the trade deficit is sucked mostly into London and the South East – making the imbalance worse and overheating asset prices further where they are already high.
Then there is the budget deficit and stock of debt. The state spends more than it raises, but not to fund investment that might increase productivity and growth but to meet demand for welfare, services and debt interest. We have an ageing population, but too many working-age people are inactive and the state is too inefficient. The huge interventions following the Great Financial Crash, Covid and the energy crunch mean there is little fiscal firepower left.
In 2024-25 Britain plans to issue a record £271 billion in new gilts, and the strangers upon whom we depend will demand higher yields. They will wonder about inflation – higher in services than goods – and the value of Sterling, and price British debt accordingly. Some in the City foresee a gilts crisis, especially if a future government shows signs of fiscal irresponsibility.
There are no shortcuts, then, on the journey to rebalancing our economy. We cannot borrow to fund a spending splurge. We cannot slash taxes without slashing the services the country needs. And in the years ahead, spending on defence, pensions, health and social care will increase.
But we can be honest. Our economic model is bust. The theories that underpin it have failed. We need fiscal rectitude to survive our dangerous exposure to the bond markets. And we need brutal honesty about what we can and cannot afford. The state and public services must be made efficient. The welfare system must be reformed. Absurdities such as the unilateralist climate change policies that further undermine domestic production need to be rethought.
And we need a serious strategy to reindustrialise, increase private and public investment, improve manufacturing output, narrow the trade deficit and rebalance the economy. With increased global transport costs, technology that brings production closer to customers, and Brexit – which challenges the logic of comparative advantage – the objective is feasible. But the task of achieving it is enormous. Time is limited and the danger very grave. It will take intellectual honesty, leadership and unstinting resolve. We cannot buck the market – and we cannot buck reality any longer.
