United Kingdom

   

Economic Policies

#15
Key Findings
With Brexit-driven concerns undermining economic stability, the United Kingdom falls into the upper-middle ranks (rank 15) in the area of economic policy. Its score on this measure has improved by 0.5 points relative to 2014.

The looming uncertainty of Brexit has overshadowed the country’s economy. While economic response to the referendum was delayed, GDP growth slowed substantially over the past several years, reaching 1.3% in 2018. The export sector remains weak, and the lack of clarity regarding future UK-EU relations, especially financial-sector access to the continent, has weighed on the economy.

The labor market has remained strong, with unemployment rates falling to 4%. However, this has come at the cost of weakness in real wages and weak productivity growth. Youth unemployment rates are considerably higher, but falling. Real wages only recently reached their pre-crisis levels. A new “digital tax” on technology companies with UK users has been imposed.

Debt has peaked at a relatively high 85.2% of GDP in 2018, and is forecast to decline in the future. Low interest rates have kept debt-service payments manageable. Financial regulation is expected to remain closely aligned with EU standards, but the European Banking Agency is moving to Paris. In general, forecasts for the near future are predicated on a Brexit deal that sustains the UK’s economic structures.

Economy

#23

How successful has economic policy been in providing a reliable economic framework and in fostering international competitiveness?

10
 9

Economic policy fully succeeds in providing a coherent set-up of different institutional spheres and regimes, thus stabilizing the economic environment. It largely contributes to the objectives of fostering a country’s competitive capabilities and attractiveness as an economic location.
 8
 7
 6


Economic policy largely provides a reliable economic environment and supports the objectives of fostering a country’s competitive capabilities and attractiveness as an economic location.
 5
 4
 3


Economic policy somewhat contributes to providing a reliable economic environment and helps to a certain degree in fostering a country’s competitive capabilities and attractiveness as an economic location.
 2
 1

Economic policy mainly acts in discretionary ways essentially destabilizing the economic environment. There is little coordination in the set-up of economic policy institutions. Economic policy generally fails in fostering a country’s competitive capabilities and attractiveness as an economic location.
Economic Policy
7
The UK economic framework was substantially reformed after 1979 in a market-friendly direction and most of these reforms were maintained after the election of the Labour government in 1997, albeit with some rebalancing toward labor interests – notably through the introduction of a minimum wage. The UK economy grew steadily from the early 1990s up to 2007, but then endured a deep recession during the financial crisis before recovering from 2013 onwards, despite weak demand from the euro zone, the United Kingdom’s largest export market. There are concerns that the economy is too reliant on consumers’ expenditure, fueled by overly high household debt and sustained by very loose monetary policy.

The change in government in 2010 led to the adoption of an economic policy framework ostensibly focused on budgetary consolidation, but there has been a substantial watering down of the fiscal rules put in place by previous governments; targets for returning to fiscal balance have repeatedly been pushed to later dates. This has meant the squeeze on public spending has been less than is often claimed because the government also chose to protect key areas of public services, such as health care spending. The corollary, especially as service charges on government debt increased, was that cuts in other areas of public spending had to be even deeper. Insufficient public investment is reflected in creaking infrastructure and skills shortages.

The economy initially appeared to shake off the political shock of the “leave” vote in the June 2016 EU referendum, with the fall in the exchange rate helping to absorb the shock. In 2017, however, economic growth slowed such that the United Kingdom shifted from being one of the most rapidly growing mature western economies to one of the slowest. The labor market has remained buoyant, with the number of people in work reaching another all-time high at 32.4 million toward the end of 2018. This labor-market performance partly reflects a job-friendly economic policy, but nominal wages have not kept pace with inflation, leading to falling real incomes until the last few quarters. Moreover, disappointing productivity figures have led the independent Office of Budget Responsibility to reduce its estimate for the long-term growth potential of the economy. The current account deficit exceeded 5% of GDP between 2013 and 2016, but decreased in 2017 and 2018, and is expected to be around 35% in 2018. This is indicative of the continuing export weakness of the UK economy. Uncertainty about future UK-EU relations and threats to the future access of UK financial services to the continental market are weighing on the economy.

Citations:
https://cdn.obr.uk/EFO_October-2018.pdf
https://www.bloomberg.com/news/articles/2018-09-28/u-k-current-account-deficit-widens-business- investment-falls

Labor Markets

#11

How effectively does labor market policy address unemployment?

10
 9

Successful strategies ensure unemployment is not a serious threat.
 8
 7
 6


Labor market policies have been more or less successful.
 5
 4
 3


Strategies against unemployment have shown little or no significant success.
 2
 1

Labor market policies have been unsuccessful and rather effected a rise in unemployment.
Labor Market Policy
8
After a period of remarkably good and stable labor-market performance in which the rate of unemployment was below that of the euro zone and the OECD average, conditions in the United Kingdom deteriorated in the wake of the 2008 crisis and the ensuing economic downturn. Underlying weaknesses (such as the comparatively high degree of working-age inactivity linked to the high number of claimants of disability-related benefits) came to the fore, and the unemployment rate rose to its highest rate since the mid-1990s. But after labor-market flexibility was increased through deregulation and the lowering of secondary-wage costs, the unemployment rate fell significantly from 8.3% at the end of 2012 to 4.0% in August 2018. In fact, recent labor-market performance has been so robust that the new government has declared full employment an official government objective. The UK labor market continues to attract substantial numbers of economic migrants.

However, the increase in employment has come at the cost of weakness in real wages and weak productivity growth. Real wages only recently returned to their pre-crisis levels, partly because of a moderating effect of immigration. An increase in the national minimum wage to the level of the so-called living wage was announced (£7.20 since 1 April 2016 for people over 25 and scheduled to rise more rapidly than average wages over the coming years). This is expected to reduce sharply the de facto subsidy to employers provided by tax credits. There has also been criticism of other facets of labor-market flexibility. For example, the topic of zero-hour contracts gained substantial attention during the general election of 2015 but has not been effectively addressed yet, as Brexit continues to dominate the political agenda. The youth unemployment rate fell to 10.8% compared to 12% a year before. This is the lowest youth unemployment rate since comparable records for unemployment by age group began in 1992, still significantly higher than the overall unemployment rate of 4.0%, but comparatively low in relation to other major European economies (20.4% in France, 31.6% in Italy, 31.6% in Spain and 14.9% across the European Union).

Citations:
Brinkley, I. (2013) “Flexibility or insecurity? Exploring the rise of zero-hours contracts” London: The Work Foundation

https://www.theguardian.com/uk-news/zero-hours-contracts

Taxes

#13

To what extent does taxation policy realize goals of equity, competitiveness and the generation of sufficient public revenues?

10
 9

Taxation policy fully achieves the objectives.
 8
 7
 6


Taxation policy largely achieves the objectives.
 5
 4
 3


Taxation policy partially achieves the objectives.
 2
 1

Taxation policy does not achieve the objectives at all.
Tax Policy
7
The United Kingdom has a progressive income-tax system. The balance between direct and indirect taxes is reasonably fair, as measured in terms of horizontal equity. The system is, however, very complex. In relation to vertical equity, there are too many opportunities for tax avoidance, with the results bordering on evasion for the rich. Property taxes are high and have been increased for purchases of high value houses, but labor taxes are low compared with many other EU member states. The financial crisis and the ensuing economic downturn sharply reduced tax revenue with the squeeze on wages contributing to a lower yield from income tax. However, overall tax revenue has risen in the past years and is projected to be sufficient to continue to narrow the public deficit over the course of the current parliament. A risk factor is, though, that the potential costs of leaving the European Union are still unclear and therefore not calculable yet.

The Autumn Budget 2018 included the introduction of a so-called digital tax, a form of taxation that has been discussed in many countries but has so far hardly been implemented. The United Kingdom will tax tech companies 2% of the revenue they make from UK users. The Treasury expects the tax to raise around £400 million per year. Further, the government will impose a new tax on the production and import of plastic packaging containing less than 30% recycled plastic to set an incentive for the reduction of plastic waste.

Citations:
World Economic Forum 2017: The Global Competitiveness Report 2017-2018.

Budgets

#30

To what extent does budgetary policy realize the goal of fiscal sustainability?

10
 9

Budgetary policy is fiscally sustainable.
 8
 7
 6


Budgetary policy achieves most standards of fiscal sustainability.
 5
 4
 3


Budgetary policy achieves some standards of fiscal sustainability.
 2
 1

Budgetary policy is fiscally unsustainable.
Budgetary Policy
7
The United Kingdom is fiscally a highly centralized state. As such, central government has considerable control over budgetary policy. Most public spending is directly or indirectly controlled by the central government, with few other influences compared to, for example, federal countries. This also means, however, that the central government has to shoulder the blame if things go wrong.

Under previous Labour governments, the “golden rule” of UK fiscal policy was to limit deficit spending to investment over the business cycle. However, public spending as a proportion of GDP increased during the 2000s and, in hindsight, was too pro-cyclical. In 2009, adherence to fiscal rules was abandoned to cope with the consequences of the crisis. There is now a fiscal council, the Office for Budget Responsibility, and fiscal rules, including provision for surpluses in “good times,” are being in a new Charter for Budget Responsibility.

With reasonably good economic growth – especially in comparison to some other European economies – estimated at 1.3% of GDP in 2018, government debt peaked at 85.2% of GDP in 2018 and is forecast to fall to 83.7% of GDP in 2019/20 with an ongoing declining trend. Nevertheless, this is still less than previously expected, borrowing is now expected to be £11.6 billion lower in 2018/19 than was forecast in the 2018 spring statement. That is equivalent to 1.2% of GDP. Chancellor Hammond explained that the government will meet its long-term financial targets three years early, as the current deficit will fall to 1.3% of GDP in 2021. Low interest rates and the extensive purchases of public debt by the Bank of England through its quantitative easing program enable the United Kingdom to avoid paying a high price for the period of high debt, with debt service payments only marginally higher than during the 2000s.

All these figures are, however, based on the expectation of some sort of Brexit deal that will safeguard the economic structures on which the United Kingdom’s economic success relies. In his budget speech, Chancellor Hammond announced his readiness to boost the spring statement to a “full fiscal event” if necessary, a phrase that can easily be read as the announcement of an emergency budget in case of a hard Brexit.

Citations:
Autumn Statement 2018: https://www.gov.uk/government/publications/budget-2018-documents
https://www.gov.uk/government/speeches/budget-2018-philip-hammonds-speech

Research, Innovation and Infrastructure

#13

To what extent does research and innovation policy support technological innovations that foster the creation and introduction of new products?

10
 9

Research and innovation policy effectively supports innovations that foster the creation of new products and enhance productivity.
 8
 7
 6


Research and innovation policy largely supports innovations that foster the creation of new products and enhance productivity.
 5
 4
 3


Research and innovation policy partly supports innovations that foster the creation of new products and enhance productivity.
 2
 1

Research and innovation policy has largely failed to support innovations that foster the creation of new products and enhance productivity.
R&I Policy
7
The United Kingdom’s tradition of being an active player in research and innovation dates back to the Industrial Revolution. The country’s clusters of pre-eminent universities have for a long time played an important role in linking cutting-edge academic research with industries such as biotechnology or information and communications technology (ICT). Performance has been weaker in terms of overall R&D spending, which continues to fall well short of EU targets, as well as in the conversion of innovation into sustainable, large-scale production, which holds the potential for long-term profitability. However, it is important to emphasize that the UK economy does not have the industrial base to support a large-scale R&D effort, so it is necessary to look at other indicators, such as ICT spending (which matters more for service industries), to better understand trends in innovation in the United Kingdom.

Over the decades, attempts have been made by successive governments to improve this situation, for example, by targeting weaknesses in technical education on various levels. Recent government initiatives have focused on extending tax credits for R&D, setting up regional Technology and Innovation Centers, investing in digital infrastructure and new university research facilities, as well as establishing Innovate UK to promote economic growth through science and technology.

Despite tentative agreement that the United Kingdom will remain involved in EU research programs, there is still uncertainty about how this will evolve after Brexit and the status of researchers who are EU nationals working in the United Kingdom. This could have an adverse effect on UK universities, although they are lobbying intensively to prevent a negative outcome. While the potential loss of EU funds is not huge, and it has to be recalled that the United Kingdom has always been a net contributor to the EU budget, researchers are more apprehensive about barriers to collaboration with counterparts in the European Union. This all comes despite a year-long debate about how best to attract highly skilled immigrants to the UK science sector. Yet, the number of EU students applying to UK universities increased by 3% in 2018. University officials interpret the upturn either as a last-minute rush before Brexit or as a sign that the attractiveness of UK universities simply outshines the grim political prospects.

The challenge facing the UK government will be how to maintain its research and innovation effort if obstacles arise to collaboration with other EU member states. This could affect not only the university sector, but also the corporate sector – for example in areas like life sciences and pharmaceuticals where the United Kingdom maintains a prominent research role – if the supply networks of UK research facilities are disrupted.

Citations:
https://www.theguardian.com/education/2018/feb/05/uk-universities-rise-in-applications-eu-students (31.10.18)

Global Financial System

#10

To what extent does the government actively contribute to the effective regulation and supervision of the international financial architecture?

10
 9

The government (pro-)actively promotes the regulation and supervision of financial markets. It demonstrates initiative and responsibility in such endeavors and often acts as an international agenda-setter.
 8
 7
 6


The government contributes to improving the regulation and supervision of financial markets. In some cases, it demonstrates initiative and responsibility in such endeavors.
 5
 4
 3


The government rarely contributes to improving the regulation and supervision of financial markets. It seldom demonstrates initiative or responsibility in such endeavors.
 2
 1

The government does not contribute to improving the regulation and supervision of financial markets.
Stabilizing Global Financial System
7
The City of London is home to one of the world’s main financial hubs. Consequently, governments in the United Kingdom have traditionally tried to protect the interests of the City of London against more intrusive regulation whether national, European or global. Governments have often argued that the special characteristics of London as a financial center are not given sufficient attention by Brussels in particular. The Libor scandal of 2012 over the fixing of market interest rates, as well as other instances of market abuse, contributed to a reduction in public support for the financial sector and increased public pressure for tighter financial regulation.

At the international level, successive governments have taken a prominent role in attempts to improve the international regulatory framework through international bodies, such as the Financial Stability Board (chaired by the governor of the Bank of England) and the Bank for International Settlements, as well as through the prominent role of the Bank Governor in the European Systemic Risk Board. The United Kingdom has had substantial influence on EU financial reforms, both through government action and in the form of initiatives from the City of London.

Continued uncertainty regarding future relations between the United Kingdom and the European Union could affect the United Kingdom’s stance on global financial regulation. Though the expectation is that UK financial regulation will remain closely aligned with EU and international standards.

The European Banking Agency will move from London to Paris which will have ramifications on the United Kingdom’s proximity to centers of decision-making.
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