It’s Westminster that has killed the UK’s economic growth

As recently as the two decades between 1990 and 2010, the UK economy - on a US-dollar, per capita basis - grew in near perfect synchrony with the pre-eminent US economy. Both economies delivered an increase in living standards of a third over a two-decade period. Annual per capita income stood at $40,000 a year in the UK. The equivalent data was $48,000 in the US. Fifteen years on this has risen to just $44,000 in the UK, but has raced ahead to $62,000 in the US. The constant-currency gap in individual incomes has more than doubled.

Understanding what broke over that period is crucial in understanding whether the UK can recapture, or at least arrest that widening gap in living standards. There is a rump of UK politics, and certainly a large constituency of the governing Labour Party, that lay the blame at what they see as public sector austerity. For a UK economy that has seen public spending rise to its highest share of the economy since the mid-1970s - more than 44p in the £1 - and the tax burden to a eighty-year high, it as an odd belief.

My reading of the latest UK economic data is that all roads for the recent underperformance  lead back to inflation. Indeed, the decoupling of US and UK living standards have not coincided with a relative slowdown of nominal GDP growth in the UK. In the last fifteen years UK growth has averaged a very spritely 4.5% a year by that, inflation-unadjusted, measure. That is precisely the same rate of growth as the 1990-2010 period. It is when the impact of inflation is added back in that the picture deteriorates. Up to 2010, UK inflation averaged 2 percent a year. Since then it has averaged 3 percent a year. In short, conducting economic activity in the UK has become more costly, and firms have passed these higher operating costs on to households. This process has diluted the spending power of households, and the level of growth that UK businesses can achieve.

Normally questions of inflation would place the central bank, the Bank of England (BoE), firmly in the dock. But a review of the stance of interest rates, the Bank’s balance sheet, and monetary aggregate growth since 2010 does not suggest the BoE have been any more stimulative than its near peers in either the US, or in Europe. Demand-pull inflation over the last fifteen years - where interest rates are too low for the domestic economy - has been notable by its general absence. By contrast cost-push inflation is everywhere you look. The loss of control of UK inflation has been triggered by decisions taken by lawmakers in Westminster.

One policy area stands out more than most. In the mid-2000s the UK had the same industrial electricity costs as the United States. At 3.8p/kWh the UK’s electricity costs were the same as the average of all the countries that are members of the International Energy Agency (IEA). Two decades on, and this price is up six-fold. UK electricity prices are now the highest in the IEA, and two-and-half times higher than electricity prices facing US industry. This permeates all parts of the economy from the hairdresser heating their salon, to the pub warming their bar area, to the manufacturer power its machines. Hyperscalers are not going to bring their AI-fuelled activity to the UK given their huge appetite for energy. Almost every domestic price, at some stage in the production process, comes into contact with energy costs.   

Whilst some of this higher energy price - particularly since 2022 - has been the result of volatile gas prices associated with the Ukraine war, that commodity price has now reverted close to its pre-war level. Yet the prices facing business remain penally high.  Last month, NESO - the National Energy System Operator – released a discouraging report into the outlook for UK Gas Supply Security. The UK is on track to supply just 3% of its own peak gas demand by the winter of 2035, having supplied an average of 36% over the last decade. More maddening still is the shortfall is being delivered by the Norwegian supply from the same geological area as the UK, or more polluting, and less secure, imported Liquified National Gas (LNG) from countries like the US and Qatar. It is hard to think of a more damaging policy for living standards, for inflation, for tax revenue, and for growth than the UK’s approach to securing a stable supply of natural gas. This failure also enables alternative suppliers of energy to the UK to keep their prices elevated, rather than face the scrutiny of competition.  

The inflationary energy picture has been amplified by repeated failures surrounding nuclear power. The Nuclear Regulatory Taskforce recently identified that the cost of building UK nuclear capacity is now the highest in the world. A culture of risk aversion, perverse incentives, and a focus on process over outcomes is identified as a key driver.

The real killer for UK economic growth however is that this abject failure in one sector - energy - has permeated through the entire economy as lawmakers have chosen to embed energy-driven price increases in regulated prices for labour, for pension payments, and in the tariffs of key goods and services. The National Living Wage, the Triple Lock, and the prices for water, transport, telecoms, and electricity all take some form of the previous year’s inflation rate - and apply it to future prices. Prices in an efficient economy respond to supply and demand conditions to send important signals to suppliers and consumers. The UK has in taken large parts of the UK economy and removed this price signal, and diluted the message that prices should send on where to allocate investment, and where to consume.

For example, the National Living Wage has moved from 48% of average earnings in 2015, to now sit at 66% of average earnings. This change has happened independently of any increases to productivity – fuelling inflation for labour intensive businesses like hospitality. And the triple lock indexation of the state pension has embedded indexed prices into transfer payments to almost a fifth of the UK population. This has created a feedback loop of requiring higher taxes on workers and businesses, who in turn seek to raise their prices. In the UK in the 1970s was characterised by a wage-price spiral, the 2020s looks on course to be a regulated price spiral.  Breaking free of this dynamic - rather than doubling down on  it - will be essential if the UK is to recapture her economic lustre.