Britain's economic prosperity built on a mountain of debt

An interesting new paper  from Policy Exchange argues that Britain's strong economic growth over the past 15 years is not as positive as it seems. It has, instead, been built on the back of a surge in house prices, leading to a lower savings ratio and a huge increase in private debt, which has been mirrored by a relentless increase in public debt. In addition, a rising population has meant that while GDP has grown by 49.3 per cent in real terms, GDP per capita only increased by 41.9 per cent. The authors continue:

"The expansion of the public sector artificially inflates the GDP growth data. And it cannot continue much longer. Judging by the fiscal deficit trend, the UK is now in worse fiscal shape than almost any other major Western country."

So what to do? It's worth reproducing the authors' conclusions in full:

"As we have seen, the UK’s economic performance over the past 15 years was boosted artificially by some exceptional circumstances. How long these conditions will last is difficult to tell. But it would be unwise to rely on them any further. House prices cannot increase in double figures for much longer. Without a buoyant real estate market, households will need to borrow more carefully again. The recent jitters in financial markets, culminating in the first run on a UK bank since Victorian times, and the strained state of public finances suggest that growth could slow down soon...

"When the World Bank analysed the conditions of doing business in countries around the globe, the UK came out as the best place to do business in only one respect: the ease of getting credit. In other respects the UK fared less well. For example, the UK came only 54th in the category of dealing with licences, a clear indicator that there is room for improvement. According to the British Chambers of Commerce, the cost of regulation to business for the past decade has been above £50bn.

"Earlier we saw that other Anglosphere economies in the OECD had a better growth record than the UK. It is worth noting that in these economies the ratio of public expenditure to GDP was significantly lower than in the UK. In 2005, 45.1 per cent of the UK’s GDP was spent by government. This compares unfavourably with state spending in Ireland (34.6%), Australia (34.9%), the US (36.6%), Canada (39.3%) and New Zealand (40.6%). Although unsurprising, it is also worrying that the UK’s high public expenditure has coincided with a rising tax burden. It has already gone up from 34.8 to 37.3% of GDP in the last decade. UK business leaders frequently point to the level (and complexity) of taxation as one of their top concerns.

"Although the UK government has increased its overall spending substantially, our infrastructure still lags far behind our competitors. In terms of the public capital stock per person, the UK had only accumulated about half the OECD average in 2006. Consequently, in the competitiveness report published by the World Economic Forum the overall quality of the UK’s infrastructure ranked far behind countries like the US, Germany and Japan as well as the OECD average.

"All this presents UK economic policy with a challenge: to improve our infrastructure while reducing tax and regulatory burdens. This would increase the UK’s still disappointing productivity. In the long run, this is the key to economic growth. An economy built on lower taxes, lighter regulation and better infrastructure will be more sustainable than one built partly on rising house prices and extra debt."

The paper briefly mentions increasing future liabilities such as public sector pensions. This is crucial. If Britain is already swimming on a sea of debt, think how much worse will it get when the baby boomers retire. There are currently no sensible proposals to deal with the unsustainable burden of unfunded public sector pension liabilities from any of the main parties. Those not lucky enough to work in the public sector will see their retirement age rise over the next few decades, but affordability issues still remain. In addition, Lord Turner's plans for semi-compulsory retirement accounts represent a new burden on top of, rather than replacing, existing provision.


So it is refreshing to see another country embrace a better way. The Southeast European Times reports that Romania is gradually replacing its state pension scheme with a system of competing private retirement accounts:

"Under a new system launched last month, more than 3 million Romanian workers under 35-years-old must opt for one of 14 competing private pension funds before January 17th, 2008. Those ages 35 to 45 can also decide to join one of the private funds.

"Starting in 2008, 2% of every worker's general income will be redirected from the state budget to the chosen private fund. This contribution will gradually increase to 6% by 2015, and the current 9.5% social security contribution to the state system will diminish accordingly.

"Several million Romanians will become investors, and the private pension system will educate them in the spirit of a free market economy," says Romanian President Traian Basescu...

"A Commission for the Surveillance of Private Pensions System has been set up, and 17 companies have been licensed to administer the private funds. "The system is safe," insists Commission President Mircea Oancea. "A company not able to reach the minimum efficiency needed for a pension fund would be placed under a special supervision. If it continues to fail, the Commission would designate another company to take over the fund."

Similar boldness would be welcome in Britain. Indeed, it is crucial if we are to get to grips with looming challenges.

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