Growth is back – but here are five challenges still facing the UK

 
Allister Heath

THERE can be no doubt that the UK’s economic picture has improved dramatically. Growth is back, employment is buoyant and optimism is returning. But the economy remains horribly scarred by the downturn, with many issues still needing to be tackled. Here are five especially pressing challenges.

1) Median incomes remain six per cent lower in 2013-14 than they were in 2007–08, according to the Institute for Fiscal Studies. This is a major problem. The top 10 per cent of earners have suffered the biggest drop in real terms – their income has crashed nine per cent since the recession – while those in the lowest tenth are down 2.4 per cent, helped by the fact that benefits went up faster than wages. But these real-terms figures assume that everybody faces the same, average rate of inflation. Digging down behind the numbers, the IFS has discovered that inflation at the top was lower (partly because of falling mortgage interest) than inflation at the bottom (driven up by rocketing food and energy prices). The end result is that the impoverishment was broadly spread.

But the IFS predicts that the fall in median income has probably come to a halt – great news politically for the coalition and bad news for Labour.

2) While the Bank of England will do all it can to keep interest rates on hold for the time being, the market is already pushing up the cost of money. The five-year swap rate, used to calculate fixed rate mortgages, hit 1.7 per cent this month, up from below one per cent last spring, according to the Legal and General Mortgage Club. The day of reckoning is nearing for those with large debts and for zombie firms.

3) Whereas the cost of borrowing is going up, the returns to saving are still going down. This is primarily the result of the interaction of all of the new capital and liquidity rules affecting the financial system. The average new time deposit paid just 1.58 per cent last month, down from around two per cent a year earlier and three per cent in late 2011. Savers are still being hammered.

4) Britain has just been dethroned as the world’s largest exporter of financial services by the US: it’s a case of New York, 1, London, 0. Figures from the United Nations Conference on Trade and Development (UNCTAD) reveal that the UK’s financial services exports have fallen a disastrous 20 per cent since their pre-crisis peak – by contrast, America’s have risen steadily, as noted by Anthony Browne of the British Bankers’ Association. We need to export more invisibles to pay for our imports of goods. Part of the decline may be due to reduced demand in the Eurozone – but the banker-bashing has clearly also backfired. We need a stable, well-managed financial system – but that doesn’t mean killing the geese that will export the golden eggs.

5) The budget deficit remains huge, as does public spending as a share of GDP. Tackling this is key. But we are starting to get a better idea of the difference between the Tories and Labour on fiscal policy. The Tories believe the deficit – defined by public sector net borrowing – will have fallen to 0.1 per cent of GDP by 2018-19, which for all intents and purposes is a balanced budget. Labour has pledged to balance the current budget – excluding capital expenditure – by the end of the Parliament. But the coalition says this measure will be in surplus by 1.4 per cent of GDP by 2018-19, which means that Labour could therefore spend all of this and possibly more and still hit its own, looser target. Labour also wants to hike taxes, which could yield another 0.2 per cent or so of GDP. We can therefore expect a difference of 1.6 per cent between Labour’s and the coalition’s spending plans. With Labour ahead in the polls, this is bad news for Britain’s fiscal prospects.

allister.heath@cityam.com
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