UK Economy Must Get More Efficient

IMF News, February 14, 2018

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Publication date: February 14, 2018
Main theme: Brexit is weighing on the economy of the United Kingdom (UK) even as growth is accelerating in the rest of the world; the IMF’s latest annual assessment emphasizes the need to raise productivity and balance public finances.

The sharp depreciation of the pound following the referendum in June 2016 led to higher prices, with a negative effect on household budgets.
Higher prices, caused by a weaker pound, have limited increases in people’s spending.
Uncertainty about the future relationship with the EU has kept some business investments on hold.
On the brighter side, higher growth in the country’s trading partners and a cheaper pound have led to more demand for UK products abroad, partially offsetting weaker consumption and investment in the UK.
The ultimate consequences of Brexit will depend on the nature of the final agreement with the EU and may take many years to fully materialize.
The IMF baseline projection assumes a 40 percent reduction in net exports of financial services to the EU as a consequence of the UK leaving the single market.
Manufacturing firms that rely on foreign suppliers, such as automobile companies, could be hit if trade with EU partners becomes more expensive or is complicated by new rules and requirements.
The IMF report states that early agreement on a transition period for new arrangements would reduce the uncertainty facing firms and workers, and give them more time to adjust.

Since the global financial crisis, employment in the UK has been increasing steadily, but productivity growth—the increase in average output per worker—has almost stalled.
With record-low unemployment and fewer EU workers coming to the UK, future economic growth will depend on increasing the amount that each employee can produce.
Brexit will not help resolve the problem of lackluster productivity: the more difficult it is to conduct cross-border trade, and to employ foreign workers, the more negative will be the impact to the economy.
Rationale: international competition usually encourages firms to boost their efficiency and invest more, while immigration helps to provide them with employees with the skills they need.

Build more homes, including by easing planning restrictions.
- Rationale: Housing is very expensive in the UK. With more houses available, they would become more affordable and it would be less costly for workers to move between regions to take better-paying jobs. That would improve living standards and reduce inequality.
Improve the quality of infrastructure.
- Rationale: Transportation bottlenecks and other infrastructure problems hold back development in regions with lower productivity. Better connectivity would help reduce regional inequalities and support growth.
Reform the education system.
- Rationale: UK students rank low on tests of basic skills, while UK firms continue reporting shortages of skilled workers, including those with technical education. Better schooling would help young people find jobs, especially once they have obtained a degree. Unemployment rates are the lowest among those with the highest levels of education.
Invest in research.
- Rationale: Public and private spending on research and development in the UK is relatively low. Increasing such investments would make local companies better able to compete internationally.

The UK should continue to work to put its public finances in order to better respond to future shocks.
While the country reduced its budget deficit, public debt—at 87 percent of GDP—remains high by international standards.
In a future clouded by weaker growth prospects and higher public spending in response to population aging, the budget will come under additional strain.
IMF recommends:
- Reduction of generous guaranteed annual increases in state pensions (with targeted help for retirees who need it).
- Tax reforms—such as scaling back preferential value added tax rates, and harmonizing the tax treatment of the self-employed and regular employees.

International Monetary Fund — February 14, 2018