Residential development in Canary Wharf, London, UK: with more houses available, workers could follow work, making the UK economy more efficient (photo: iStockPhoto/VictorHuang)

UK Economy Must Get More Efficient

February 14, 2018

Brexit, as the UK’s decision to exit the European Union (EU) is commonly known, is weighing on the economy, even as growth is accelerating in the rest of the world. Higher prices, caused by a weaker pound, have limited increases in people’s spending, and uncertainty about the future relationship with the EU has kept some business investments on hold. In this situation, it will be even more important for the UK to raise productivity and balance its public finances, the IMF said in its latest annual assessment of the economy.

Economic growth in the UK has slowed, and Brexit is partly to blame. The sharp depreciation of the pound following the referendum in June 2016 led to higher prices, with a negative effect on household budgets. Firms also invest less than would be expected given strong global growth, as they await more details about the future relationship between the UK and the EU. 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, which partially offset weaker consumption and investment in the UK.

Brexit uncertainty 

The ultimate consequences of Brexit may take many years to fully materialize, and will depend on the nature of the final agreement with the EU. However, changes to regulations, trade, and firms’ ability to attract the workers they need will affect all sectors of the economy. The financial sector, for instance, may suffer if UK-based financial firms lose the right to sell services to EU clients. 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 marketManufacturing 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 makes clear 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.  

The way out: more efficiency in production 

In the long run, the country has to produce more efficiently for living standards to keep improving, and for economic growth to benefit all groups of society. 

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. This is because 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.

Here are some suggestions on how the UK could support productivity and reduce inequality: 

  • Build more homes, including by easing planning restrictions. 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. 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. 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. 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.    

Create a cushion 

The UK should continue to work to put its public finances in order, so as to enable it 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. To cushion the blow to public finances, the IMF recommends a reduction of generous guaranteed annual increases in state pensions (with targeted help for retirees who need it), as well as tax reforms—such as scaling back preferential value added tax rates, and harmonizing the tax treatment of the self-employed and regular employees.