UK: New Labour Goverment Faces Economic Challenges

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There remains a large gap between the current productivity rate and pre-pandemic levels.

The ascension of the Labour government injected rare impetus into Britain’s capital market, accompanied by many positive economic signs. On Friday, the first day of the newly-elected Labour government, the domestically-focused FTSE 250 index rose by 0.86 percent and the country’s 10-year bond yield dipped by 0.8 percentage points.

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The GDP for the first quarter this year increased by 0.6 percent, and the annual Consumer Prices Index rose by 2 percent in May, aligning with the anticipated interest rate cut by the Bank of England.

The Labour government inherited a comparatively strong economy. However, it also faced an economy with significant inertia. There remains a large gap between the current productivity rate and pre-pandemic levels, and investment rates are low compared to other developed countries. The Labour government faces substantial challenges in revitalizing the economy.

LOW INVESTMENT

Data from the Economics Observatory showed that the overall investment rate in Britain fell from a high of around 23 percent of the GDP in the late 1980s, to around 17 percent from 2000 onwards. In contrast, investment rates among its peers in G7 countries remained largely between 20 and 25 percent.

The primary focus for the new Labour government should be on investment, said Tim Besley, school professor of economics at the London School of Economics and Political Science (LSE).

“When you talk with economic heavyweights or entrepreneurs, they will tell you that it’s very hard to see the strategic direction of the UK economy and the institutional framework that will deliver economic targets,” he said. However, it may take time for Labour to form a coherent industrial strategy and plan.

Steve Nolan, senior lecturer in economics at Liverpool John Moores University, said that the Labour Party fought a cautious campaign and their future economic plans are fairly slim.

Infrastructure could be a key area for attracting investments. The Labour government is set to establish a National Infrastructure and Service Transformation Authority, which will focus on infrastructure delivery and play a critical role in setting the path for development. “If it’s structured right, there is potential for the UK to address the low level of investment,” said Besley.

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TAX RATE

Tax policy has been a contentious issue during Britain’s general election campaign, with former Prime Minister Rishi Sunak repeatedly pressing then-Labour leader Keir Starmer to clarify his stance. In response, the Labour Party pledged not to increase income tax, national insurance, and value-added taxes.

Labour has “tied their own hands by restraining from raising taxes. If you don’t raise taxes, then the debt level will become a constraint,” Iain Begg, a professorial research fellow at the LSE, said, noting that the public debt level in Britain is nearly 100 percent of the GDP, in addition to a significant fiscal deficit.

The Labour government should be very careful with public finances to avoid the pitfalls of former Prime Minister Liz Truss, whose policies, including substantial borrowing while maintaining low tax rates, rattled the financial markets.

“The Labour solution is to try to raise growth. Higher growth means the same level of debt comes out as a lower ratio of debt to GDP, and the Labour is hoping that they can achieve this through regulatory interventions rather than public spending,” said Begg.

Britain’s Securonomics, blog by Michael Roberts

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— Neil Parsons ????️‍???? (@parsons_ne29217) July 8, 2024

INTERNATIONAL TRADE

The Financial Times reported last year that the Department for Business and Trade revealed a 27-percent decrease in foreign direct investment projects in Britain for the year ending in March 2023, compared to the period from 2016 to 2017.

Besley believes it is important to provide a framework and conditions that carefully choreograph plans and strategic government support for investors.

John Bryson, chair in Enterprise and Economic Geography at the University of Birmingham, said that “what the Labour government needs to do over the next five years is to ensure that relations with China, the United States, and the EU are appropriate, positive, and constructive. “These relationships must be constructive if the UK economy is to grow,” he stated.

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