The Observer view on Britain’s economy: it is very sick, but there are remedies

<span>Photograph: Chip Somodevilla/Getty Images</span>
Photograph: Chip Somodevilla/Getty Images

It has been a week of bad economic news. The latest data from the Office for National Statistics confirmed that inflation has fallen in the UK, but to 8.7%, slightly higher than had been predicted. This triggered a strong reaction in the bond markets, pushing up the cost of government borrowing to almost the same as it was in the wake of Kwasi Kwarteng’s mini-budget that tanked the markets last September.

It is a sobering reminder of the lasting legacy of Liz Truss’s brief premiership. In just 49 days, she and her chancellor undermined long-term investor confidence to the extent that the UK government, once able to borrow at interest rates of almost zero, now faces some of the highest borrowing costs of developed nations, with these costs liable to rise even further as a result of only moderately bad economic news. It means that for the first time in decades, the UK is subject to the same sorts of external market pressures on its investment, tax and spending decisions as much less affluent economies.

The British economy has been subject to the same shocks as others around the world such as the pandemic and the impact of the Ukraine war on energy and food prices. But the UK has fared far worse than its competitors as a result of long-term structural weaknesses and terrible political choices.

The UK was too reliant on financial services to drive its buoyant growth in the 2000s, creating significant regional inequality between London and the south-east, and the rest of the country. This growth masked low productivity in other sectors and an economy too dependent on consumer spending, fuelled by personal debt secured against a housing price bubble, with not enough business investment and spending on skills. These weaknesses were exposed by the world financial crisis of 2008, but instead of trying to redress these imbalances the Conservatives have made the UK’s structural issues even worse.

By sharply increasing barriers to trade, Brexit has made it more difficult for British companies to grow through exports

This is the product of their austerity policies – deep cuts to the welfare safety net, public services and national infrastructure that have not only caused immense hardship in the here and now, but have damaged the long-term productive capacity of the economy. This is evident, for example, in the skills shortages, and in the fact that the pandemic appears to have had a much bigger impact on labour participation rates as a result of people leaving employment due to long-term sickness than in other countries. The UK’s participation rate in the workforce is below where it was before the pandemic, adding to inflationary pressures.

Austerity has been made worse by the hard Brexit pursued by Boris Johnson and other Tory Eurosceptics. By sharply increasing barriers to trade, Brexit has made it more difficult for British companies to grow through exporting and has had a significant depressive effect on growth. It, too, has added to inflation, one study by the London School of Economics suggests that as a direct result of Brexit, British households have collectively spent £7bn more on their food bills than they would have otherwise done since December 2019. All this means that Britain is suffering from the second worst productivity growth in the G7. The impact of these appalling economic decisions will not dissipate when the Conservatives leave office. They will continue to affect the British economy in the long term and will take a new government years to address.

Should Labour win the next election, its shadow chancellor Rachel Reeves will face an unenviable economic inheritance. Unlike in 1997, when the economy and tax receipts were booming, Labour’s overriding focus will have to be how to restore the economy to a healthier growth trajectory in order to fund the expansion of public services and the welfare state the country so desperately needs. That will be a huge task, requiring an ambitious industrial and skills policy. Reeves set out the emerging detail of her approach in a speech in Washington last week. She was reassuringly sober about the scale of the challenge. Labour would pursue an active industrial policy, centred on a £28bn-a-year capital investment programme in greening the economy, and expanding affordable childcare and skills provision to get more people into work.

Improving the productive capacity of the economy from the laggard starting point left by a combination of austerity, Brexit and Truss’s abandoned tax cuts will not be easy. Much will depend on the detail of policy:, on exactly how capital investment and extra money for skills will be spent; it is easier to spend money badly than well, and its impact on growth will be a matter of robust policy design. But Reeves is showing how much more she has to offer than the slash-and-burn approach of Truss and Kwarteng, or the acceptance of painfully high interest rates in the absence of any other plan we have seen from Rishi Sunak and Jeremy Hunt.

Britain urgently needs a period of economic renewal, and only a Labour government can deliver that.