Without productivity growth, real wages cannot recover the ground lost since 2008 without hurting corporate earnings. The Bank will have much less room for manouevre in setting interest rates, and George Osborne will have that much more need for austerity to balance the books. There was far too little debate on the problem in the electoral campaign, but boosting productivity growth should now be front and centre of the Chancellor’s first truly Conservative Budget in July.
A third concern is Britain’s external accounts. Not only is the current account deficit, at 5.5 per cent of GDP, the largest in the post-war era, but we are more reliant on volatile portfolio flows to fund it rather than ‘stickier’ sources such as foreign direct investment, which takes longer to go into reverse.
So far, policymakers – including senior figures at the Bank of England – have been less concerned about this vast gap between Britain’s global spending and its global earnings than the numbers would have led you to expect. That is because the gap has been driven not by a deterioration in the trade balance but by a 4 per cent of GDP swing in the investment account.
After decades of making more money on our investments abroad than foreigners made on their UK assets, this part of the balance of payments has swung sharply in the other direction, leading to a net outflow of investment earnings from the UK. Officials believe this is likely to be largely temporary, but the longer the problem persists the more worried we should be.
Whatever the reason, no country can afford to borrow 5 to 6 per cent of its GDP from the rest of the world indefinitely. And anyone unconcerned with relying on those short-term flows to fill the gap should remind themselves of the fickleness of financial markets, which has once again been demonstrated by the brutal recent sell-off in core eurozone government bonds. Investors who bought those bonds at their peak have in some cases lost double digits in only a few days.
Finally, there is Britain’s future role in the European Union, which is now to be decided in a referendum held in 2016 or 2017. Financial markets consider this the big negative to emerge from this surprising result. But in reality, the choice between the two parties on the referendum really came down to timing, not outcome.
In the past five years, the likely future shape of Europe has changed dramatically, and so have UK popular attitudes towards it. Both these developments will make it much more difficult for us to remain in the EU on the same terms as before. Sooner or later, we will have to choose what we want to have instead.
