Why isn’t Britain getting richer anymore?

Originally published in Economic Review magazine which provides articles which make recent academic research accessible for A-level students, apply economic theory to real-world situations and sharpen students’ skills.

Until the Great Recession in 2008, the British economy was growing. The Gross Domestic Product per capita – an estimate of the total value of everything made in the UK each year, divided by the number of people – was getting larger at a rate of almost 2% per year. If that had carried on, we would have produced an average of £47,000 for every person in the country last year. If we had grown a bit slower than that, and only grown as fast as the USA has since 2008, we would have produced an average of £41,000 per person. Instead, we produced an average of £37,000. This has big knock on effects for everyday life: once you adjust for inflation, the average working person in Britain earned a lower wage in 2022 than the average working person in 2008.

The Productivity Puzzle

Britain’s relative lack of growth in the last fifteen years can be explained by a decline in productivity. Productivity is defined as the average output produced for each hour of work done in the country. Much like GDP, productivity in the UK has stagnated in an unprecedented way: in the 35 years before 2008, productivity doubled. In the 15 years since, it has gone up by 5%. This stagnation became known as the productivity puzzle, and has prompted a lot of debate amongst economists.

There have been two phases to the UK’s low productivity. From 2008 until 2019, British productivity stagnated relative to pre-Recession trends, but this was also true for many developed nations. Since 2019, however, it has stalled further, and other countries have begun to leave the UK behind. So, what could explain each of these periods of stagnation?

Investment

One key driver of economic growth is investment. Investment can take a lot of forms: it could be a car factory buying a new machine, or it could be the government spending money to build a new high-speed train, but at its core it involves spending money on things so that you can make more money in future. In classical economic theories of growth, investment can boost productivity: the new machine the car factory buys might mean that the same group of workers can make more cars in the same amount of time, and the new train the government builds might help businesses across the country work together, increasing their ability to make and sell more goods in the same amount of time.

Since before the Great Recession, the UK has had lower levels of investment than many similar countries, such as France and Germany. After the Great Recession, investment fell heavily in the UK, as businesses couldn’t afford to invest as much, and the government chose not to due to the growing deficit. Similar falls happened in many countries, so it is difficult to compare the effect of it relative to other countries. This may explain the slow productivity growth across developed nations in the 2010s.

Unemployment

Another possible explanation is that the number of people working changed. Normally, after a recession, more people become unemployed, as firms lay off workers and are reluctant to hire new

ones. This happened after the Great Recession, but much less so than economists expected. Since 2008, the unemployment rate has been relatively low, and now more people are working in Britain than ever. This might have brought down productivity, as it is likely that those who would otherwise have been unemployed are less productive, bringing down the average. If this is the cause of poor productivity, is not necessarily a bad thing: even if the average worker is producing less, the benefits of that production (in the form of wages) are being spread out to more people.

Brexit

The unexpected Brexit vote is likely to have had negative impacts on growth in several ways. One component of the Gross Domestic Product is exports, which are the goods made in Britain and sold to other countries. By increasing the barriers to trade between Britain and the EU, Brexit increased the cost of selling goods to the EU, which is the UK’s largest trading partner. This has, in turn, reduced Britain’s exports, and meant we produced less than we would have had we not left the EU.

It is likely that Brexit also had its own effect on reducing investment in the UK. In 2016, business investment was recovering from the Great Recession and beginning to increase again. Upon the UK’s unexpected vote to leave the European Union, business investment stagnated again. There are several ways in which Brexit might have caused this decline in investment. One is those same barriers to trade: companies knew that if they invested more in Britain, the goods they produced would be harder to sell to the EU than they were before. Another is the reduction in immigration from the EU: industries may well have feared that they would not have been able to hire the best workers from around Europe if they invested in the UK. In combination, it seems likely that some of the poor growth performance in the UK since 2019 can be attributed to Brexit.

A Couple of Other Things

You may have noticed that a few other big things have happened since 2019. Covid-19 hit all economies hard, as many people were unable to do their jobs, and lots of economic activity stopped. In every country, you can see a big drop in GDP in 2020. What varies more across countries, however, is how they recovered. Relative to the pre-pandemic era, the British economy is performing the worst of the Group of 7 wealthiest democracies. Whilst this could be because of Brexit – the UK left the EU two days after the first positive Covid test in the Britain – some have suggested that the furlough scheme may have been the wrong way to preserve productivity through the pandemic.

In order to protect workers who would lose their jobs in the pandemic, some countries, including the US, greatly increased the generosity of their unemployment insurance, instead of paying businesses to keep workers in their jobs, as the furlough scheme did. Some economists believe this helped their economy recover quickly, as workers could look for a new job in the post-Covid economy, which had different priorities, whereas the furlough scheme kept workers in jobs where they might no longer be as productive.

Another big shock since 2019 was been the war in Ukraine, and its impact on energy prices. The increased cost of importing natural gas stemming from the cutting off of Russian supply has hit the UK economy hard, prompting inflation, which has forced the Bank of England to try and keep wages lower to slow down inflation. Countries not exposed to this shock, such as the US (which has its own

gas supply) and France (which has extensive nuclear power), have rebounded much faster from the pandemic. Economists face a near impossible task disentangling the effect of Brexit, Covid and energy prices on Britain’s recent stagnation, but there is a good argument to be made for each of them.

What might we have done differently?

There are a few things the government could have done differently, which might have helped reduce the effect. They could have invested more, or encouraged more business investment, with either subsidies, tax changes, or changes in regulations. Brexit in itself was a self-inflicted hit to growth, but attempting to reduce the frictions between the UK and the EU would likely have limited the damage. While the shocks of the last few years have been difficult to predict, an increase in our energy production through solar, wind and nuclear power would help insulate us from future international energy shocks. Going forward, we can only hope something happens that turns Britain’s troubling growth around.