The poor state of the UK economy

The post-recession economic recovery in the UK has been far from great. The coronavirus outbreak hit the British economy harder than most, with GDP falling 12% in 2020 – the third largest contraction in the G20. GDP in six of the twenty G20 nations is now above pre-pandemic levels; at the same time, the UK experienced further declines in GDP in the first quarter of 2021. Poor economic growth is far from the only problem facing the UK economy today, with rising inflation and a housing crisis – factors that have culminated in the bleak state of the UK economy.

Sluggish GDP growth in the UK post-March 2020 is largely due to the imbalanced sector composition of the British economy. The UK is a largely service-based economy, with the service sector comprising 79% of GDP in 2017, as a posed to the 20% provided by the industrial sector. Whilst a service-based economy is a sign of economic progress, over-reliance on this sector makes an economy particularly susceptible to recessions. During economic hardship, consumers first cut back on services as they are seen as ‘extras,’ instead prioritising essentials. This phenomenon has been witnessed in the UK, which is still yet to see GDP rise above pre-pandemic levels. By comparison, both South Korea and China have achieved this, with the service sector comprising 58% and 52% of their GDP respectively; the industrial sector is responsible for 40% of GDP in each of the two nations. Therefore, a move to a more balanced GDP sector composition in the UK would likely have resulted in not only a smaller fall in GDP when the pandemic first arose, but also a more immediate economic recovery. This phenomenon was witnessed in both South Korea and China – countries that rely less heavily on the service sector.

Moreover, the rising inflation that has emerged in 2021 can be traced back to the actions of the Bank of England. In March 2020, the BoE cut the bank rate from 0.75% to 0.1%. This greatly encouraged consumer borrowing, as debt repayments became cheaper. As a result, the growing supply of goods and services couldn’t keep up with this growing demand from easier access to credit that comes with interest-rate cuts, resulting in demand-pull inflation. At the same time, excessive quantitative easing by the Bank of England has contributed to rising inflation. This policy involves the Bank of England purchasing various securities, such as government bonds and mortgage-backed securities. In November 2020, the BoE purchased £900 billion worth of bonds. These funds are credited to the investors’ accounts who held these securities, increasing the money supply. As there is more money in circulation due to these asset purchases, inflation soon follows, given that too much money ends up chasing too few goods. The CPI reached 3.2% in August, the highest since 2012 – a direct result of the expansionary monetary policies pursued by the Bank of England. Therefore, the recent hike in inflation is a result of the policies enacted by the BoE. The combination of interest-rate cuts fuelling consumer demand and the excessive QE increasing the money supply has resulted in rising inflation.

Finally, the ever-spiralling house prices in the UK are a major factor in the poor state of the British economy that we see today. Both the constraints on the supply of homes and the Bank of England’s monetary policies have created the growing house-price inflation over the past decade. Excessive housing planning laws and regulations have reduced investment into building new homes. This is because of the bureaucracy to obtain planning approval, with the excessive paperwork and red tape disincentivizing property developers and investors alike. As a result, the number of new homes built in the UK lags significantly behind comparable countries. In 2015, over 500,000 new homes were built in France, a country with far less cumbersome planning laws compared to the UK. By comparison, only 170,000 homes were built in the UK during the same period. Both nations have similar population sizes and GDP levels. Whilst France has a larger surface area, the percentage of land classified as farmland/nature is similar to that of the UK. Thus, it is clear to see that these planning laws have suppressed the supply of homes in the UK, thereby creating a shortage in the housing market, resulting in rising house prices. Additionally, the ultra-low bank rate has further contributed to housing price inflation. This is because of the subsequent low yields of newly issued government bonds that come with low-interest rates. Low yields have created a problem for mutual and pension funds, alongside other institutional investment groups, as one of their most sources of returns has been reduced. This has led to these institutional groups pursuing more riskier investments, including real estate. As a result, property prices have skyrocketed, with house prices having doubled in Wimbledon in the last ten years. Therefore, the current housing crisis is a result of both the cumbersome planning laws and the Bank of England’s monetary policies. The former has restricted the supply of housing, with the latter facilitating a sharp increase in real-estate investment by institutional investors due to the low bond yields that come with low-interest rates.

Ultimately, the current poor state of the UK economy is the result of recent sluggish GDP growth, rising inflation and a decade-long debacle of rising house prices. A more balanced sector composition to the UK economy, less stimulus by the Bank of England and reduced government bureaucracy are possible solutions to the aforementioned crises. However, rising interest rates, a potential solution to both the inflation and housing crises, comes at the cost of stifling business growth due to greater borrowing costs. Thus, as is the case with all economic decisions, compromises must be made elsewhere.