As Sterling hits further new lows against the Euro, the economic outlook for the UK seems more unstable than for some time.
Currency traders seem to be latching on to the structural problems of the British economy as a reason for selling. In short these problems come under four general headings.
Firstly, the UK has seen the largest increase in residential property prices over the course of the past 15 years. Average prices have more than doubled, but wages have not kept pace. The ratio of average house price to average earnings has gone from three times to more than six times. This is historically well out of line, and as inflation in food and energy prices nibbles away at spending power, the pressure on British consumers is intensifying.
Meanwhile, one major strength of the UK, which has been its ability to attract labour from such countries as Poland, is now also weakening. The weakness of Sterling has meant a stronger Zloty, and as wage rates have increased in Poland, the relative wage gap has fallen to the point where many Poles are now returning home- this a significant source of cheaper labour has now reduced. This may also have a marginal effect on house prices, as those who have bought to let find that rental demand has fallen.
At the top end, the cack-handed attempt by the government to tax non-doms is causing many to reappraise their commitment to the UK. Several investment firms are now considering relocation away from London. Although the income tax take may be small, the VAT and other taxes ARE paid by non-doms, whenever they spend money here, so should they move away, then economic activity will be slower and the tax take will be lower.
The fiscal burden in the UK is now quite high. The closing of various tax loopholes, especially on CGT, and a steady increase in the overall level of general taxation- although not the nominal rate of income tax- has increased the overall fiscal burden substantially. Although Gordon Brown was able, with some twisting of the figures, to stay within his pre set limits, it is practically impossible for his successor in the Finance ministry to do so. Government expenditure is high, and set to increase further. Yet the public sector continues to deliver poor quality services, even despite the substantial expenditure that has been laid out. Admittedly there has been a substantial waste in many projects. The NHS IT system has turned into a GBP 13 billion white elephant. The repeated crises in Agriculture have resulted in further lost billions, the PFI projects are also set to be far more expensive than was first mooted. The latest fiasco, that of Northern Rock is also set to cost the Treasury about GBP 7 billion, based on the fact that Northern Rock paper is being bid at 93 Pence on the Pound. All of this extra expenditure has brought little tangible benefit.
The NR affair has also brought home two further points of weakness- our dependency on financial services, including our regulators and our currency. The City has, in recent years, been challenging to be the leading Financial Services centre on the World. The relatively light regulatory burden was touted as a competitive advantage. However the failure of Northern Rock was massively amplified by the failure of the regulators to get to grips with the business until it was too late. The relatively smaller liquidity of the Sterling market has limited the options available, so that while there have been problems with both German and Spanish banks especially, these have been handled more effectively. The implosion of the global credit market will have a disproportionate impact on the UK, as jobs are lost from the City. It is now inevitable that Sterling will weaken still further, and one hedge fund manager said to me smilingly that he could see the real chance of Pound:Euro parity. "At that point", he said "Prime Minister David Cameron would be pleading with the ECB to let the UK into the Eurozone".
The situation in the British economy is complicated, with many pieces in play. However, the position is difficult, but not hopeless. It is essential that the state reduces dramatically it direct involvement in the economy. The burden of taxation must be reduced, and it is essential that the extraordinarily over-complex tax code is simplified drastically. I also believe that since the Poles are leaving, that we will need to find an alternative, and i suspect Ukraine or even Russia could be a good source of the kind of workers who have helped to maintain our economic momentum- at the moment this is down tacitly, but I believe that visa free travel from Russia and Ukraine might help the British gain a stronger economic foothold in these important countries, as it dis with the Baltic countries before.
Free trade, less regulation and a more open economy are all strongly liberal positions, and in the face of a protectionist clangour that is emerging in the US, we should not be afraid to speak out for these effective and important principles. I also believe that, although we should retain and develop our relationship with the US and with Canada, we need to engage further with the European Union. However, as with Britain, so with Brussels: we should explicitly state what the limits of European level decision making actually are. We should not be signing a blank cheque for ever closer Union. In that sense both the failed Constitution and the reform treaty that replaced it were significant improvements on the current position. In fact, since even David Cameron insists that he would not leave the EU, there is some general acceptance that the EU serves a positive purpose. It would not do our position in the EU any harm if this was publicly acknowledged by our political leadership.
The UK is headed for a period of economic weakness, which could be quite prolonged. The political fall out will be significant- to the point that the next election could well be the one to lose, rather than to win such is the scale of the poisoned chalice that the winners will inherit. However the crisis could become a catastrophe unless a disciplined economic policy, based on economic liberalism is adopted soon. This is the challenge for all political parties to rise to- I wish I had the confidence to believe that they will.