Economists like to use fancy words. Their tendency to obfuscate language by relying on incomprehensible jargon is nothing new but, with headline inflation sitting at 10.1 percent, strikes in every major sector, and en-masse company divestment away from Britain, the skill of disentangling and understanding the words of leading financiers is becoming increasingly essential. You would be forgiven for finding yourself completely bewildered trying to understand the ins and outs of the current economic disarray. In this article, we’ll set the record straight on what is really making the economy turn head over heels.
To start, Firstly, we must look to Brexit, where seven years on, the tremors of Britain’s divorce reverberate through the economy. Exit from the single market saw tariffs slapped on British goods and services, thereby decreasing our competitiveness. Following ‘Exit day’ in January 2020, exports fell dramatically. Data from the Office for National Statistics shows a 22.9 percent drop in exports to the EU in the 15 months following the implementation of the Brexit agreement. The promise that a revival in British industry could fill in the trade-gap and lead Britain to self-sufficiency was central to the arguments made by Brexiteers before the referendum. Unfortunately, this does not seem to have come to pass. Non-EU imports, a proxy measure of the ability of Britain to provide for itself, have risen by 10 percent. It is not surprising then, that Britain’s balance of trade has deteriorated to -£84 billion a year, this essentially translates into the fact that, in order to sustain our current standards of living, Britain is now borrowing more than 4 percent of its GDP from foreign creditors. This is unsustainable and, without government intervention, would translate into a mild recession for the British economy. The government would have its work cut out if it just had the seemingly intractable problem of Brexit to deal with, however the government has been firefighting on all fronts since 2020.
All of us will remember the long days of the Covid-19 lockdown. As we were all beholden to Government restrictions, the economy, too, was held hostage by the pandemic. In order to help the economy cope with the unprecedented closure of the country, the government stepped in by furloughing the majority of workers. Whilst this staved off the negative effects of a massive recession, by the end of the lockdown it was clear that the money pumped in the economy via quantitative easing programmes (the Bank of England injecting money into the open market) was going to impact price levels. There was now more money floating about the economy competing for the same value of goods. Accordingly, demand for goods, and hence their nominal value, had been artificially increased by pandemic era expansionary policies. This is the primary reason for the first bout of inflation experienced in late 2021.
Lockdown also affected the supply side. During the pandemic, supply chains were put under immense pressure. Most of us will recognise the spectre of product shortages in supermarkets, but the real economic problems came due to shortages of labour as workers stayed at home, the increased barriers to trade associated with countries locking down, and the inability of multinational corporations to rapidly offshore production due to the global nature of the virus. Coming out of lockdown, international companies sought to protect their supply chains by initiating a massive de-offshoring of production facilities, where companies sacrificed profitability for moving their factories back to their home nation. Given Britain’s newfound exclusion from the EU single market and its accompanying lacklustre status as an exporter, the acceleration of business activity seeking to transfer facilities from Britain to Europe and the US was not surprising. This squeeze on British industry was inevitable, but the unexpected rapid uptick in pace has put severe downward pressure on British investment, a trend that has continued into 2023. This divestment away from Britain has further increased the price of British imports and reduced the availability of domestic goods– this is known as a real depreciation of the British pound – and the short-term consequence of such a change is the reason why Britain experienced a second round of inflation in the first half of 2022.
The last important piece in the puzzle of Britain’s stalling economy is the Russian invasion of Ukraine. Whilst frontbench politicians parrot party lines that inflation is or isn’t the result of the spiralling cost of Russian energy, its impact is undeniably seismic. The direct effect of the price of gas on inflation has been long observed and, whilst Britain is not massively dependent on Russian gas, Europe is. The increase in global prices as Europe goes cold turkey and demand for non-Russian oil skyrockets has been astonishing. Spot prices – the level at which wholesalers can order an immediate shipment of gas on the European market - rose to eight times their usual levels. The increased costs facing businesses soon get passed on to consumers in the form of higher prices. This is the third and final cause of Britain’s price rising woes, a bout of inflationary pressure that continues to this date.
Taken individually, any one of these four factors - Brexit, the domestic response to Covid, the international response to Covid, and the war in Ukraine - would have been manageable. The first-round effects of natural inflation would not have had the opportunity to bake themselves into a wage-price spiral and there would be no artificial second-round effects. But, given that all three have occurred in quick succession, it is easy to see why Britain has fallen into disrepair with negative growth over the last quarter, why food inflation sits at 16 percent, and why resentment in every sector of the labour market has led to the largest set of strikes since the Winter of Discontent. Britain has experienced crisis after crisis, and now its economy is following suit.