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How Brexit has made Britain the new sick man of Europe

The UK is too unbalanced, too unproductive and too unequal. To this amalgam of woes, a new menace has been added: EU withdrawal. 

In the 1970s, Britain was often more pitied than envied or admired, its economy characterised by little or no growth, high inflation and rising unemployment. This was the era of “stagflation”.

Weary of being outpaced by its continental competitors, the UK belatedly joined the European Economic Community in 1973. In 1976, the plummeting value of the pound forced Jim Callaghan’s Labour government to humiliatingly accept a £2.3bn bailout from the International Monetary Fund, the largest in its three-decade history. Britain became known as “the sick man of Europe” – a label first applied by Russia’s Tsar Nicholas I to the Ottoman empire in 1853. “Britain is a tragedy,” observed the then US secretary of state, Henry Kissinger, in 1975. “It has sunk to begging, borrowing and stealing until North Sea oil comes in.”

Margaret Thatcher was elected in 1979, intent on breaking the postwar Keynesian consensus. Conflict and strikes followed: unemployment reached a postwar high of three million in 1982. Yet slowly and after much pain, Britain forged a new role for itself. The creation of the European single market – enabling the free movement of goods, capital, services and people between member states – bolstered an increasingly service-driven economy. London, whose population had declined from 8.2 million in 1951 to 6.8 million in 1981, became Europe’s financial powerhouse.

In 1997, the New Labour government made the Bank of England independent, ending the manipulation of interest rates for political purposes. Chancellor Gordon Brown judiciously chose to reject British membership of the euro, and foreign investors came to prize the UK as a haven of stability. Britain’s over-dependence on finance, however, was exposed during the 2008 banking crisis. In response, the Bank of England used its monetary freedom to cut interest rates to 0.5 per cent and to undertake quantitative easing (electronically created money used to buy government bonds and other assets).

For the first time since 1965, GDP per person in the UK outstripped the average of Germany, France and Italy in 2013. Britain was the fastest-growing G7 economy in 2014 and 2016 and the second-fastest in 2015 (behind the US). Though living standards fell for the longest period in 50 years after 2008, real average earnings grew by 1.9 per cent in 2015 (aided by 0 per cent inflation) and by 1.5 per cent in 2016.

For most of this decade, the sick men of Europe have been the austerity-stricken southern European countries: Portugal, Italy, Greece and Spain (the “Pigs” in the argot of financial traders). But following the Brexit vote, the British economy is ailing. Are we destined to become the sick man of Europe again?

The European referendum result did not precipitate the immediate recession that many Remainers (including the then chancellor, George Osborne, and the Treasury) had forecast. The Brexit vote is, however, causing unambiguous harm. Gus O’Donnell, the former head of the civil service (2005-11), who now chairs Frontier Economics, told me: “Economists warned that Brexit would create uncertainty, which reduces investment, and that a big fall in the exchange rate would lead to higher inflation. All of those things have come true.”

The UK is no longer the fastest-growing G7 economy but the slowest (GDP performance has been the worst since 2011). Britain has endured the lowest growth and the highest inflation (3 per cent in September 2017) of the ten major EU economies. The once-derided eurozone grew twice as fast as the UK in the first two quarters of this year (0.5 per cent and 0.6 per cent). The surge in UK inflation is directly attributable to the pound’s diminished value – a mark of investors’ pessimism. Owing to higher prices, real wages have fallen for the past six months. Though less severe, the combination of rising inflation and stagnant growth is reminiscent of the stagflation of the 1970s. The return of negative wage growth for the first time since 2014 could presage the worst decade for pay since the Napoleonic Wars.

“Those on the lowest incomes are being hardest hit again,” Yvette Cooper, the Labour MP and former chief secretary to the Treasury, told me. “And that’s why it’s so important to avoid tariffs with the EU, because that would push prices up and further reduce living standards.”

The government is unsurprisingly fond of citing the UK’s resilient labour market. Unemployment remains at a 42-year low of 4.3 per cent (1.44 million) and employment is at a 46-year high (75.3 per cent). The Conservatives have cut more than a million public-sector jobs since 2010 (reducing the total to 16.9 per cent of the UK’s workforce, the lowest since the Office for National Statistics’ current records began in 1999), yet the private sector has more than compensated.

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But the grim corollary of Britain’s jobs success is its productivity failure. The average French, German or US worker produces more in four days than a UK equivalent in five. In the most recent quarter, British output per hour was a mere 0.9 percentage points higher than it was a decade ago – the worst growth for 200 years. Here lies the root of the UK’s living standards crisis. In the absence of higher productivity, there is no sustainable means of increasing pay without stoking inflation.

Britain’s problem is not, as in France (where unemployment is 9.8 per cent), a lack of jobs but a lack of good and well-paid jobs. There are more overqualified employees in the UK than anywhere else in the EU; 1.4 million workers are on zero-hours contracts, some through choice. Britain neither invests nor exports enough. Its economy is dependent on rising property prices, consumer spending and financial services. Debt has been the engine of growth.

The UK is too unbalanced, too unproductive and too unequal. To this amalgam of woes, a new menace has been added: Brexit.

No country has left the European Union before. The UK, previously renowned for its stability and moderation, has chosen rupture. Rather than merely leaving the EU’s political institutions, the government has confirmed its intention to withdraw Britain from the single market and the European customs union (which enables tariff-free trade within the EU and imposes a common external tariff).


Picture: Ben Jennings

International businesses, which have valued the UK as a “gateway” to Europe, are confronted by what the Chancellor, Philip Hammond, has described as a “cloud of uncertainty”. Nicky Morgan, the former Conservative cabinet minister and the chair of the Treasury select committee, is pessimistic about the British economy. “Businesses are avoiding making big investments, and that includes making future employment decisions,” she told me.

Though Theresa May has proposed a transition period of two years, during which the UK would remain in the single market and the customs union, this risks merely delaying, rather than avoiding, the “cliff-edge” Brexit that business fears.

The government’s refusal to rule out leaving the EU on 29 March 2019 with no deal in place has heightened the uncertainty. If this should happen, companies and consumers would face costly tariffs, businesses would lose passporting rights (which enable them to operate and sell their services across the EU) and air flights to Europe could be grounded.

Brexit is deterring people as well as capital from Britain. In recent decades, the UK’s openness to EU migrants – it did not impose transitional controls on new eastern European member states in 2004 – has helped mitigate its economic shortcomings, though at the cost of fuelling the social discontent that enabled Ukip’s rise and the Leave vote. Immigrants filled vacancies in sectors such as retail, social care and agriculture and contributed more in taxes than they claimed in welfare benefits (though the Cameron government never made the case for immigration until it was too late).

In the year to March 2017, however, net migration fell by 81,000 to 246,000, the lowest recorded level for three years. The pound’s depreciation (which has made British wages less competitive), the spectre of Brexit (the government has refused to guarantee EU citizens the right to remain) and a rise in xenophobia are among the deterrents. Brexit, which the electorate narrowly voted for by 52 to 48 per cent in June 2016, ever more resembles an act of self-harm.

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The fall in the pound, which has been one of the world’s worst-performing currencies since the referendum, was hailed by Leavers as a boon for exporters. In August, Liam Fox, the International Trade Secretary, boasted of “increasing demand” for “UK holiday exports” such as ice cream and swimwear. Yet in the same month, Britain’s trade deficit widened to £5.6bn, its highest level for 12 months. Its goods deficit has never been greater: Britain imported £22bn from the EU but exported just £14bn.

Dani Rodrik, the Harvard economist and author of Straight Talk on Trade: Ideas for a Sane World Economy, told me that in a context of economic uncertainty and dismal productivity, the weaker pound would not deliver a surge in exports. He added that “the one possible silver lining of Brexit” would be that it moves “Britain away from its financial specialisation to production of real goods and services”.

In her early speeches as Prime Minister, Theresa May appeared to share this ambition. She spoke of the virtues of active government and promised a new industrial strategy. Yet since the general election, the government has struggled to translate rhetoric into policy (May’s allies partly blame what they regard as the inertia of Hammond and the Business Secretary, Greg Clark).

Brexit has crowded out the space for transformative economic policy. “Wouldn’t it be wonderful if our government, our civil service, our businesses and our trade unions were striving to solve the productivity problem?” Gus O’Donnell said. “Instead, all of the attention, all the legislation, all the government and civil service time, is being devoted to Brexit – because it has to be.” (Hammond’s allies, however, say that no issue absorbs him more than productivity.)

Confronted by the UK’s faltering economy, Leave supporters have accused individuals and institutions – the Bank of England governor, Mark Carney; Philip Hammond; the BBC; the civil service – of undermining and even “sabotaging” Brexit. I asked Gus O’Donnell (whose initials and work rate earned him the nickname “God” among colleagues) for his assessment. “The civil service are there to deliver the programme of the democratically elected government,” he said. “Where they find it difficult is when the government’s not clear about what its position is. I would say the problem has been, ‘What is our position on Brexit?’”

EU member states have expressed similar bemusement. In the period since the government invoked Article 50 on 29 March, ministers have spent more time negotiating with one another than with Europe.

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The Brexiteers are increasingly unable to disguise the short-term costs of EU withdrawal. Yet they maintain that there will be long-term benefits. Liberated from the shackles of Brussels, they say, the UK will be able to strike trade deals with non-European countries, reappropriate its EU budget contributions and discard costly regulations. Yet in not one of these areas are the gains obvious or easy. As O’Donnell noted, the potential benefits of free trade deals with the US, India and China “are tiny compared to the potential losses outside of the EU” (other countries in Europe account for 44 per cent of British exports).

New agreements would be painful to negotiate (the recent EU-Canada deal took seven years) and would be far from universally favourable to the UK. Britain’s inexperience of trade negotiations – the preserve of Europe for 44 years – and its desperate need for deals weaken its position. President Donald Trump has demanded an “all-in” trade deal, including agriculture and services (the prospect of chlorinated chicken imports was enough to divide the cabinet).

The Leave campaign’s promise was that Brexit would benefit the UK by ending its EU budget contributions. In his recent Daily Telegraph article, which undermined Theresa May on the eve of the Tory party conference, Boris Johnson resurrected the claim that Britain would “take back control of roughly £350m per week” (to be largely devoted to the NHS).

When I asked Paul Johnson, the director of the Institute for Fiscal Studies, whether the UK would reap a fiscal bounty, the usually mild-mannered economist grew indignant. “It’s nonsense! It’s always been nonsense. There may be a case for Brexit for reasons of sovereignty, or immigration, or a particular view of democracy – all of that is absolutely honourable. But to pretend that, at least in the short to medium run, it will have anything other than a negative effect on the economy and the public finances is just untrue.”

The UK’s gross contribution to the EU is £350m a week (£18.2bn a year). However, this discounts our budget rebate, which reduced our 2016 contribution to £252m a week, and the £5.6bn that we receive in EU subsidies. Rather than recouping the remainder, the UK is forecast to pay a Brexit penalty. The Office for Budget Responsibility anticipates a £15.4bn hit to the public finances by 2018-19: as much as £300m a week.

Other Brexiteers advocate radical action in pursuit of prosperity. Leavers such as Liam Fox, Margaret Thatcher’s former chancellor Nigel Lawson and John Redwood aspire to reduce taxes and regulation. This vision is often erroneously described as the “Singapore model”. As the IFS’s Paul Johnson said: “Singapore has incredibly high regulation and public involvement. The state plays a much bigger role in Singaporean society than it does in British society.”

Were the UK significantly to cut taxes, Johnson warned, the government would have to spend less on public services or borrow more. Pragmatic Tories recognise that there is no majority for small-state libertarianism in either parliament or the country. “I’m with John Major on this,” Nicky Morgan told me. “He said this is not a model that the British public would welcome or endorse.”

Britain’s vote against EU membership was partly a symptom of deeper economic and social discontent: stagnant living standards, an unbalanced economy, inequality and feelings of alienation.

“I’m a great believer in the resilience of the British people,” Morgan said. “We will get through this, because that’s the British way. But I’m crestfallen at the time, the money, the opportunity cost of Brexit, when there are so many other challenges that people want us to solve and that Brexit will not solve.”

If the present trends continue, the United Kingdom will be a poorer country in every respect: diplomatically, socially and economically. 

George Eaton is political editor of the New Statesman.

This article first appeared in the 26 October 2017 issue of the New Statesman, Poor Britannia