New Labour government experiences worst economic situation since World War II

But Starmer – who is due to meet Biden at the White House on Wednesday – — has inherited an economy that shows the strains of more than a decade of political turmoil, inadequate business investment and sclerotic government planning. It also lacks an immediate source of cash.

The economic climate is “the worst situation since World War II,” said Rachel Reeves, the country’s first female finance minister, on Monday. Adjusted for inflation, wages have remained virtually unchanged since 2007, according to the research institute Center for Economic Performance. The average German is now 20 percent richer than the average citizen of the United Kingdom.

“The UK is not in a situation where it needs to move quickly. Most people think it will take nearly a decade to see any significant improvement,” said David Page, head of macroeconomic research at AXA Investment Managers in London. “But I think there is also hope now, and that’s another thing, that this could play out in the next decade.”

Reeves was quick to underline the urgency of the challenge this week, calling economic growth “our national mission” and saying there is “no time to lose”. However, she has vowed to abide by informal fiscal rules that will limit Labour’s ability to spend freely given the country’s debt burden. Her aim is to use modest amounts of public money to attract private capital.

The roots of Britain’s economic problems, say economists, lie in weak productivity growth. The key to economic growth and raising living standards is equipping workers to produce more goods every hour. And that is precisely what Britain has been lacking in recent times.

The average American worker produced 23 percent more than his British counterpart last year. This gap has more than doubled since 2007. French and German workers also perform better than the British.

British productivity has risen steadily for nearly three decades but has stagnated since the 2008 financial crisis. Government austerity and recurring political crises after the Great Recession discouraged companies from investing in improving labour efficiency, economists said.

In the US, business investment has increased by more than a third since 2016, almost seven times as much as in the UK, government statistics show.

“What does that mean? It means you’re working with outdated equipment and using it less and less,” says Rob Wood, chief UK economist at Pantheon Macroeconomics in Newcastle upon Tyne.

The pandemic – and government budget cuts that led to staff shortages in the National Health Service – have also had a negative impact on productivity. A House of Commons analysis found that 754,000 more people of working age are inactive today than before the pandemic. Many of them are among the more than six million Britons waiting for a doctor’s appointment, according to the British Medical Association.

Britain’s problems are the legacy of years of mismatches between public and private decisions. The country’s overly large financial services sector shrank after the 2008 crisis, making it harder to get credit than elsewhere.

The government responded to the crisis with an “era of austerity” that damaged public services and slowed economic growth.

“We have learned that public austerity has also destroyed the private sector. We need to invest,” says David Blanchflower, an economics professor at Dartmouth College who was a member of the Bank of England’s monetary policy committee before the 2008 crisis.

Brexit – the decision to leave the European Union in 2016 – and its implementation have occupied three prime ministers for almost a decade and still cast a shadow over the economy.

The construction of trade barriers against the country’s largest trading partner will cause the British economy to shrink by four percent and both exports and imports will be around 15 percent lower than if the country had remained in the EU, according to the official agency Office for Budget Responsibility.

Government instability is a hindrance to growth. Since 2010, Britain has had five prime ministers, seven chancellors of the exchequer, nine business secretaries and countless long-term economic plans.

Last autumn, Prime Minister Rishi Sunak cancelled the construction of the second part of a high-speed rail line linking London with cities in the north. First proposed in 2009, the line – considered Europe’s biggest infrastructure project – was supposed to link the capital with Birmingham and Manchester further north.

But in October, Sunak cancelled the Birmingham-Manchester section of the route, angering companies that had planned faster rail connections.

“The enormous political and legal volatility means companies don’t know whether they are coming or going,” Wood said.

Starmer’s planned meeting with Biden on the sidelines of a NATO summit is likely to underline the “special relationship” between the allies.

In a speech in Washington last year, Reeves outlined an economic formula similar to Treasury Secretary Janet L. Yellen’s “modern supply-side” doctrine. Both are enthusiastic about boosting growth by expanding the workforce and investing in infrastructure and climate-friendly energy sources.

Relative to the size of the US economy, the national debt is slightly higher than that of the UK, but the dollar’s status as a global reserve currency gives the US government more flexibility in dealing with its spending problems.

Labour has said it will stick to an informal fiscal rule developed by the previous British government that would require the party to begin reducing debt as a percentage of gross domestic product within five years. The current target is to reach 95 percent of debt by 2026.

Labour has also ruled out increases in income tax, national insurance contributions and VAT.

The fiscal situation has already caused Labour to scale back its ambitions. In February, the party walked back a pledge to spend £28 billion (about $36 billion) each year on green energy programs. Instead, officials said annual spending would be £4.7 billion ($6 billion).

“Reality has set in,” said Paul Dales, chief UK economist at Capital Economics. “The new government needs to focus on areas where it can actually make a difference without spending a lot of money.”

One of these priorities will be overhauling the notoriously slow planning process for housing and infrastructure projects. Labour wants to speed up approval processes for the construction of 1.5 million new homes over the next five years and overhaul the energy network.

The new government this week lifted the Conservatives’ ban on onshore wind farms. The ban came into force in 2015 and allowed projects to be blocked with a single objection.

Labour faces a huge task list. But it could get a tailwind in the short term. Inflation was 2.8 percent in May, below its peak of almost 10 percent in 2022. After a brief recession last year, growth is slowly picking up again. The International Monetary Fund expects the economy to grow by 0.7 percent this year and accelerate to 1.5 percent in 2025.

With inflation falling, the Bank of England may soon cut its base interest rate from 5.25 percent for the first time in four years, giving the economy a boost.

If the new government succeeds in improving the country’s health care system and reintegrating some inactive workers into the labor market, this would give the economy a further boost.

Given Labour’s massive parliamentary majority and the disarray within the ranks of the opposition Conservatives, Starmer can expect to remain in office for at least the full five-year term, if not two.

This relative stability comes at a time when other major economies are preoccupied with domestic politics. In France, the left-wing coalition that won this month’s parliamentary election has endorsed policies of profligacy that could unsettle financial markets. And the United States is in the midst of a contentious presidential campaign that could return an unpredictable former president to the White House.

“In an uncertain world,” Reeves said on Monday, “Britain is a place to do business.”