Tag: productivity

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Brexit 10 years on: the economic impacts

It is 10 years since the Brexit referendum. From an electorate of 46,501,251 people, 17,410,742 (37.4%) voted to leave, 16,141,241 (34.7%) voted to remain and 12,949,258 (27.8%) did not vote. The UK left the EU on 31 January 2020 at 11:00 pm, but remained in the single market and customs union during a transition period lasting for a further 11 months until December 31 2020.

To mark the 10th anniversary of the vote a number of articles have been written assessing the effects of Brexit. Here we look at the economic effects, as do the articles linked below. This blog updates the analysis of an earlier one, The costs of Brexit: a clearer picture.

Trade

After the referendum, extensive negotiations took place on the trading arrangements between the UK and EU that would exist once Brexit was finalised.

One possibility was ‘The Norwegian model’, which would have seen the UK join the European Economic Area (EEA), giving it access to the single market, but removing regulation in some key areas, such as fisheries and home affairs. This was ruled out in favour of a bilateral trade agreement. Three main types were available:

  • Swiss model, where the UK would negotiate a series of bilateral agreements with the EU, including selective or general access to the single market.
  • Canadian model, where the UK would form a comprehensive trade agreement with the EU to lower customs tariffs and other barriers to trade.
  • Turkish model, where the UK would form a customs union with the EU. In Turkey’s case the agreement relates principally to manufactured goods.

The agreement reached, the Trade and Cooperation Agreement (TCA) was a version of the Canadian model. The UK would leave the single market and customs union, but there would be tariff-free and quota-free trade in goods between the UK and the EU. However, to ensure that it was EU and UK business that would benefit from these ‘trade preferences’, businesses must show that their products fulfil ‘rules of origin’ requirements.

Rules of origin. Under rules of origin requirements, when a good is imported into the UK from outside the EU and then has value added to it by processing, packaging, cleaning, remixing, preserving, refashioning, etc., it can only count as a UK good if sufficient value or weight is added. The proportions vary by product, but generally goods must have approximately 50% UK content (or 80% of the weight of foodstuffs) to qualify for tariff-free access to the EU. For example, in the case of a petrol car, 55% of its value must have been created in either the EU or UK.

Meeting rules of origin has created a large amount of paperwork for businesses and this has created a significant barrier to trade. What is more, exporters are required to complete import/export declarations. Also, agri-food goods are subject to strict physical border controls. These barriers have increased the costs of trade and reduced its volume.

Services. Free trade in services is not provided by the TCA. Instead, services exporters face various barriers, such as certain professional qualifications no longer being recognised in EU countries and a loss of ‘passporting’ rights that previously allowed cross-border financial operations with minimal extra permissions.

Brexit impact. Despite new barriers to trade in services, they are generally less significant than the barriers for trade in goods, particularly in a digital age. Indeed, UK services exports have held up well. Although they fell in 2020, they have grown significantly since. According to House of Commons Library Statistics on UK-EU trade (see link below):

In 2025, UK exports of services to the EU were 28% above their 2019 level in real terms. Exports to non-EU countries were 26% above their 2019 level.

UK exports of goods to the EU, however, have fared less well. In 2025 they were 14% below their 2019 level in real terms. This is partly the effect of COVID and the Ukraine war, but exports to non-EU countries were only 8% lower than 2019. According to research by economists John Springford and Anton Spisak for the Centre for European Reform (see link below), Brexit has depressed UK goods exports to the EU by 16%. According to the Office for Budget Responsibility, (see link below) both exports and imports in the long run will be around 15% lower than they would have been if the UK had remained in the EU. What is more, the growth of goods trade (exports plus imports) has fallen well behind the average of the rest of the G7. And according to British Chambers of Commerce research (see link below), 54% of UK exporters think the TCA is making it harder to export and the need for change is urgent.

The new barriers reduce market access, while lower export volumes reduce competition and economies of scale. There is less competition too from imports, with many EU firms no longer exporting to the UK because of the costs. The barriers lead to a misallocation of resources, with highly productive UK firms exporting less, with less productive firms in the UK and EU focusing purely on their domestic markets. The barriers thus impose an impediment to the exploitation of comparative advantage

Investment

Both domestic and foreign direct investment (FDI) in the UK have been adversely affected by Brexit. Bloom et al., in their paper for the NBER (see link below), estimate that by 2025, investment was 12–18% lower than it would have been without Brexit.

In the early years after the referendum, lower capital investment was mainly the result of uncertainty and devoting significant resources to administrative Brexit preparations. Later it was largely the result of the trade barriers themselves. Not surprisingly, firms in the UK with high exposure to EU markets experienced a sharper decline in investment than less-exposed ones.

The end of the single market and customs union reduced the attractiveness of the UK as a hub for FDI relative to competitor countries. And UK firms were encouraged to invest in the EU to create hubs for selling within the EU, thereby allowing them to avoid the trade barriers.

According to the Bloom et al. analysis, the effect of lower investment and less competition has been a fall in UK productivity of around 3% to 4% compared to remaining in the EU. The Office For Budget Responsibility argues that the post-Brexit trading relationship will reduce long-run productivity by 4% relative to remaining in the EU.

Growth in GDP

Lower investment, lower productivity and trade barriers have had a negative impact on economic growth. According to analysis by the National Institute of Economic and Social Research (NIESR) (see link below), by the end of 2023, UK real GDP was some 2–3% lower solely as a result of Brexit – in other words, after having taken into account the effects of COVID-19 and the Russia-Ukraine war. This corresponds to a per capita income loss of approximately £850. The NIESR analysis predicts that this will rise to some 5–6% of GDP, or about £2,300 per capita, by 2035.

Bank of England data, based on surveys of chief financial officers of over 2000 firms (small, medium and large), suggest that the UK economy is some 6% smaller than it would have been without Brexit. The Office for Budget Responsibility estimates that Brexit has caused a long-run reduction in GDP of 4% as a result of a similar percentage reduction in productivity.

The growth of small and medium-sized enterprises (SMEs) has been disproportionately dampened by the compliance costs of trade with the EU. Some SMEs, especially in the food and drink sector, have ceased exporting to the EU altogether.

Labour supply and migration

Halting the right of EU workers to move freely to the UK for work created acute labour shortages in specific sectors such as hospitality, health and social care, logistics, construction and agriculture. However, while immigration from the EU fell dramatically, this was more than offset by increased immigration from non-EU countries. But this was unable to fill shortfalls in some sectors.

The loss of free movement of labour means that UK workers now face restrictions on working in the EU. These include obtaining a work visa, which requires a formal job offer, sponsorship and meeting strict salary thresholds. While business trips for meetings, conferences, trade fairs, etc. are generally exempt, if the work involves remuneration, then normally a work visa will be required. The terms of work visas vary between member states. This has created a considerable barrier for touring bands and other artists. Short-term self-employed or freelance work is highly restricted, with virtually no work permit options available for visiting UK nationals.

Because employing UK nationals now imposes extra administrative and time-consuming burdens on local EU employers, many now prioritize applicants from EU nations who can start immediately.

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Questions

  1. Summarise the negative effects of Brexit on the UK economy.
  2. Why is it difficult to quantify these effects?
  3. How have UK firms attempted to reduce the costs of exporting to the EU?
  4. Why have goods exports been worse affected by Brexit than services exports?
  5. What difficulties would lie in the way of the UK negotiating a Turkish or Swiss model of trading relations with the EU?
  6. Have there been any economic benefits from Brexit and, if so, what?
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Will AI make the world less equal?

With businesses increasing their use of AI, this is likely to have significant effects on employment. But how will this affect the distribution of income, both within countries and between countries?

In some ways, AI is likely to increase inequality within countries as it displaces low-skilled workers and enhances the productivity of higher-skilled workers. In other ways, it could reduce inequality by allowing lower-skilled workers to increase their productivity, while displacing some higher-skilled workers and managers through the increased adoption of automated processes.

The effect of AI on the distribution of income between countries will depend crucially on its accessibility. If it is widely available to low-income countries, it could significantly enhance the productivity of small businesses and workers in such countries and help to reduce the income gap with the richer world. If the gains in such countries, however, are largely experienced by multinational companies, whether in mines and plantations, or in labour-intensive industries, such as garment production, few of the gains may accrue to workers and global inequality may increase.

Redistribution within a country

The deployment of AI may result in labour displacement. AI is likely to replace both manual and white-collar jobs that involve straightforward and repetitive tasks. These include: routine clerical work, such as data entry, filing and scheduling; paralegal work, contract drafting and legal research; consulting, business research and market analysis; accounting and bookkeeping; financial trading; proofreading, copy mark-up and translation; graphic design; machine operation; warehouse work, where AI-enabled warehouse robots do many receiving, sorting, stacking, retrieval, carrying and loading tasks (e.g. Amazon’s Sequoia robotic system); basic coding or document sifting; market research and advertising design; call-centre work, such as enquiry handling, sales, telemarketing and customer service; hospitality reception; sales cashiers in supermarkets and stores; analysis of health data and diagnosis. Such jobs can all be performed by AI assistants, AI assisted robots or chat bots.

Women are likely to be disproportionately affected because they perform a higher share of the administrative and service roles most exposed to AI.

Workers displaced by AI may find that they can find employment only in lower-paid jobs. Examples include direct customer-facing roles, such as bar staff, shop assistants, hairdressers and nail and beauty consultants.

Such job displacement by AI is likely to redistribute income from relatively low-skilled labour to capital: a redistribution from wages to profits. This will tend to lead to greater inequality.

AI is also likely to lead to a redistribution of income towards certain types of high-skilled labour that are difficult to replace with AI but which could be enhanced by it. Take the case of skilled traders, such as plumbers, electricians and carpenters. They might be able to use AI in their work to enhance their productivity, through diagnosis, planning, problem-solving, measurement, etc. but the AI would not displace them. Instead, it could increase their incomes by allowing them to do their work more efficiently or effectively and thus increase their output per hour and enhance their hourly reward. Another example is architecture, where AI can automate repetitive tasks and open up new design possibilities, allowing architects to focus on creativity, flexibility, aesthetics, empathy with clients and ethical decision-making.

An important distinction is between disembodied and embodied AI investment. Disembodied AI investment could include AI ‘assistants’, such as ChatGPT and other software that can be used in existing jobs to enhance productivity. Such investment can usually be rolled out relatively quickly. Although the extra productivity may allow some reduction in the number of workers, disembodied AI investment is likely to be less disruptive than embodied AI investment. The latter includes robotics and automation, where workers are replaced by machines. This would require more investment and may be slower to be adopted.

Then there are jobs that will be created by AI. These include prompt engineers, who develop questions and prompt techniques to optimise AI output; health tech experts, who help organisations implement new medical AI products; AI educators, who train people in the uses of AI in the workplace; ethics advisors, who help companies ensure that their uses of AI are aligned with their values, responsibilities and goals; and cybersecurity experts who put systems in place to prevent AI stealing sensitive information. Such jobs may be relatively highly paid.

In other cases, the gains from AI in employment are likely to accrue mainly to the consumer, with probably little change in the incomes of the workers themselves. This is particularly the case in parts of the public sector where wages/salaries are only very loosely related to productivity and where a large part of the work involves providing a personal service. For example, health professionals’ productivity could be enhanced by AI, which could allow faster and more accurate diagnosis, more efficient monitoring and greater accuracy in surgery. The main gainers would be the patients, with probably little change in the incomes of the health professionals themselves. Teachers’ productivity could be improved by allowing more rapid and efficient marking, preparation of materials and record keeping, allowing more time to be spent with students. Again, the main gainers would be the students, with little change in teachers’ incomes. Other jobs in this category include social workers, therapists, solicitors and barristers, HR specialists, senior managers and musicians.

Thus there is likely to be a distribution away from lower-skilled workers to both capital and higher-skilled workers who can use AI, to people who work in new jobs created by AI and to the consumers of certain services.

AI will accelerate productivity growth and, with it, GDP growth, but will probably displace workers faster than new roles emerge. This is likely to increase inequality and be a major challenge for society. Can the labour market adapt? Could the effects be modified if people moved to a four- or three-day week? Will governments introduce statutory limits to weekly working hours? Will training and education adapt to the new demands of employers?

Redistribution between countries

AI threatens to widen the global rich–poor divide. It will give wealthier nations a productivity and innovation edge, which could displace low-skilled jobs in low-income nations. Labour-intensive production could be replaced by automated production, with the capital owned by the multinational companies of just a few countries, such as the USA and China, which between them account for 40% of global corporate AI R&D spending. For some companies, it would make sense to relocate production to rich countries, or certain wealthier developing countries, with better digital infrastructure, advanced data systems and more reliable power supply.

For other companies, however, production might still be based in low-income countries to take advantage of low-cost local materials. But there would still be a redistribution from wages in such countries to the profits of multinationals.

But it is not just in manufacturing where low-income countries are vulnerable to the integration of AI. Several countries, such as India, the Philippines, Mexico and Egypt have seen considerable investment in call centres and IT services for business process outsourcing and customer services. AI now poses a threat to employment in this industry as it has the potential to replace large numbers of workers.

AI-related job losses could exacerbate unemployment and deepen poverty in poorer countries, which, with limited resources, limited training and underdeveloped social protection systems, are less equipped to absorb economic and social shocks. This will further widen the global divide. In the case of embodied AI investment, it may only be possible in low-income countries through multinational investment and could displace many traditional jobs, with much of the benefit going in additional multinational profit.

But it is not all bad news for low-income countries. AI-driven innovations in healthcare, education, and agriculture, if adopted in poor countries, can make a significant contribution to raising living standards and can slow, or even reverse, the widening gap between rich and poor nations. Some of the greatest potential is in small-scale agriculture. Smallholders can boost crop yields though precision farming powered by AI; AI tools can help farmers buy seeds, fertilisers and animals and sell their produce at optimum times and prices; AI-enabled education tools can help farmers learn new techniques.

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Questions

  1. What types of job are most vulnerable to AI?
  2. How will AI change the comparative advantage of low-income countries and what effect will it be likely to have on the pattern of global trade?
  3. Assess alternative policies that governments in high-income countries can adopt to offset the growth in inequality caused by the increasing use of AI.
  4. What policies can governments in low-income countries or aid agencies adopt to offset the growth in inequality within low-income countries and between high- and low-income countries?
  5. How might the growth of AI affect your own approach to career development?
  6. Is AI likely to increase or decrease economic power? Explain.
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ISA Reform: Will it boost the London Stock Exchange (LSE)?

For a while now, debate has raged over how to revive the fortunes of the London Stock Exchange (LSE). Since the 2008 financial crisis, the market has suffered a lack of investment, poor liquidity and low performance. This has produced a moribund financial market which has become unattractive to both investors and companies. Returns from the UK market lag international competitors, particularly the USA (see the chart).


Investment in the S&P 500 Index over the period would have produced annualised rates of return of 14.35%, more than double that from the FTSE 100 Index. Part of this underperformance is due to the industrial mix of the listed companies: low-growth energy and mining compared to the high-growth technology sectors in the USA. This has led to the perception that London is not a place for firms to list, particularly those in high-growth sectors.

In 2024, 88 companies choose to delist or transfer their primary listing elsewhere. Only 18 took their place. Several big companies from a range of industries, including Ashtead, Flutter and CRH have transferred their primary listing to New York or have plans to do so.

The new Labour government views stimulating higher levels of investment though the London market as an important element in its drive to boost productivity and growth in the UK. Recently, it has been reported that investment institutions have been lobbying the UK government to reduce significantly the tax-free allowance for Cash Individual Savings Accounts (ISAs) as a way to encourage more of UK households’ savings to be channelled through the UK stock market.

Currently, UK savers can save up to £20 000 annually into ISAs without paying tax on the interest earned. This can be held solely in Cash ISAs, or in a combination of Cash plus Stocks and Shares ISAs. The tax-free instruments which were introduced by a Labour government in 1999 to encourage higher savings have proved immensely popular. Data from Paragon Bank indicate that over £350 billion are held in these accounts. However, under the new proposals, the amount which would be allowed to be saved as cash has been rumoured to be cut to £4000 per year, with the hope that some of it will be invested in the UK stock market.

The proposals have proved controversial, with high-profile figures voicing opposition. In this blog, we’ll analyse the reasons behind the proposal and discuss whether it will have the desired effect of stimulating higher levels of investment. We’ll also discuss other proposed policies for making the LSE a more effective channel for investment flows to boost economic growth.

Stock markets and the saving and investment channel

The main reason for the proposed ISA change is to encourage more investment in the UK stock market. By reducing the amount which can be saved in Cash ISAs, the government hopes to encourage savers to invest in Stocks and Shares ISAs instead, particularly ones linked to the UK market. This would increase the amount of finance capital in the market, thereby boosting its liquidity. This would then make it an attractive place for young, vibrant UK and foreign companies to list.

An active, liquid secondary market in shares is important to attract firms to list on stock exchanges by issuing shares to outside investors. Traditionally, this channel has been important to the growth and development of firms.

Existing savings in Cash ISAs are deposited with financial institutions such as banks and building societies. Through the credit-creation process such funds can be used to finance productive investment. In countries like the UK, lending by financial institutions is an important way that investment is financed, particularly for small and medium-sized enterprises. However, scale limits, regulatory restrictions and the need to diversify lending properly means that there are limits to the financing available for company investment through these institutions.

Capital markets like the LSE are intended to meet these larger-scale requirements. Financial claims, such as debt and equity, are divided into atomised instruments and sold to outside investors to fund investment and business growth.

Further, the desire for a capital injection to finance growth is not the only reason that firms seek stock market listings. Founders of companies may have a lot of wealth invested in the equity of their firms. Selling some of their equity to outside investors through a stock market listing is a way of diversifying their wealth. However, if they are to maximise the potential sale price, there must be an active, liquid secondary market to encourage investors to buy shares in the primary market.

Proponents of reform want to encourage a greater appetite for risk among UK investors, which will produce more savings being channelled through the LSE.

One issue is whether savers will respond in the way anticipated and channel more funds through the UK stock market. Many savers like the security of Cash ISAs. Such vehicles offer a low-risk/low-return combination, which savers like because the tax benefits boost returns. A survey by the Nottingham Building Society found that a substantial number of Cash ISA savers are concerned that the proposed changes could affect their ability to save for important financial goals, such as buying a house or building an emergency fund. Higher-risk Stocks and Shares ISAs are not suitable for such savings because of the potential to lose the initial amount invested. Many may not be prepared to do so and one-third suggested they would save less overall.

According to the survey, only 38% of Cash ISA holders said they would consider investing in Stocks and Shares ISAs if the Cash ISA allowance were reduced. It may be difficult to alter such risk-averse preferences given the average amount saved through ISAs and demographics. In 2022/23, the average amount subscribed to ISAs was £5000. This does not suggest that average households have a significant surplus of cash that they may want to investment at a high risk through the stock market. Indeed, many may want to have access to the cash at short notice and so are not prepared to forgo liquidity for the time needed to accrue the benefits of compounding which stock market investing produces.

Demographics may also play a role in this. Many of those who save more are now retired, or near retirement. They are less likely to see the appeal of compounding returns over long periods through investment in shares. Instead, with shorter investment horizons, they may only see the potential for losses associated with Stocks and Shares ISAs. Indeed, they will be starting to liquidate their long-term positions to draw income in retirement. Therefore, they may save less.

For others, who may be prepared to accept the additional risk, with the prospect of higher returns in the way that advocates of the reform hope for, the reduction in the Cash ISA allowance does not necessarily mean that they will invest in Stocks and Shares ISAs linked to the UK market. Since returns from the UK market have lagged international competitors, it may be that savers will channel their savings to those international markets, particularly in the USA, where the risk–return relationship has been more rewarding. Doing so has been made much easier and cheaper through a combination of economic forces including technological advances, regulatory changes and increased competition. This makes it much easier for UK savers to channel investment funds to wherever potential return is highest. At the moment, this is unlikely to be the UK, meaning that the anticipated boost to investment funds may not be as much as anticipated.

Critics of the proposal also question the motives of investment fund managers who have been lobbying government. They argue that the reforms will mean that many people who do now choose to save in Stocks and Shares ISAs will buy funds managed by fund managers who will receive fees for doing so. Critics argue that it is the prospect of higher fees which is the real motive behind the lobbying, not any desire to boost investment and growth.

What alternatives are available to boost the London Stock Exchange

The low valuations of LSE-listed companies compared to their international counterparts, particularly those in the USA, has discouraged growing firms from listing in London. To address this, there have been calls to enhance corporate governance standards and reduce regulatory burdens for listed companies.

This has already been recognised by the authorities. In 2024, UK regulators approved the biggest overhaul of rules regulating London-listed companies. The new listing rules will hand more power to company bosses to make decisions without shareholder votes. They will give companies more flexibility to adopt dual-class share structures used by founders and venture capital firms to give themselves stronger voting rights than other investors. This is particularly popular for founders who want to diversify their wealth without sacrificing control and is used frequently by tech companies and venture capitalists when listing in the USA. Such reforms may attract more companies in high-growth sectors to list in London.

Tax policies which provide the right incentives to buy and sell shares could also encourage more investment in the LSE. For instance, the repeal in the mid-1990s of the preferential tax treatment of dividend income for UK pension funds and insurance companies is seen as a major factor in discouraging those institutions from investing more funds in the London market. Since tax on capital gains is only liable when they are realised, this reduces their present value versus the equivalent amount on dividends.

As the following table illustrates, given the significantly higher percentage of total returns derived from dividends in the LSE compared to other exchanges, the equal tax treatment of dividend and capital gains provides an incentive to seek jurisdictions where capital gains predominate. This is what UK pension funds have done. Data from the Office of National Statistics show that in 2024, 77% of UK occupational pensions equity investments were overseas.

Reinstating this tax benefit could stimulate greater demand for UK equity from this significant sector, boosting liquidity in the London market. Allied to this are proposals from the UK government to consolidate the fragmented UK pension industry to achieve greater scale economies in that channel for investment. This can reduce financing costs, boosting the marginal return from UK investments for these funds, encouraging greater investment in the UK market (ceteris paribus).

Further, the 2.5% stamp duty on share purchases has been viewed as another disincentive for both retail and institutional investors to engage in security trading on the London Stock Exchange. The duty, which is much higher than in peer economies, effectively raises the expected rate of return on UK equites which depresses perceptions of their values and prices. Its removal may raise trading volumes, improving the liquidity of the market and be offset by increased tax revenues in the future. However, the Treasury suggests that the removal of stamp duty is doubtful, since it would create a significant hole in the UK government’s budget.

Ultimately, many of these reforms may have limited impact on investment. Efforts to boost confidence in the stock market will depend on improving the overall economic environment in the UK. Therefore, it will be the wider policies promoting growth in general which will increase the rates of return offered by London-listed firms and be more significant to attracting capital to London.

However, many of these are controversial themselves, such as relaxing laws around planning permissions and addressing business uncertainties around post-Brexit trading arrangements with the European Union. These broader economic measures could help make the UK generally, and the LSE specifically, more appealing to both domestic and international investors.

Conclusion

The UK government’s proposal to reduce the Cash ISA allowance is part of a broader strategy to boost investment in the stock market and stimulate economic growth. While this change could lead to more capital being directed towards productive investments, it also poses challenges for savers who like the security and simplicity of Cash ISAs.

The ultimate impact will depend on how savers respond to these changes. The potential reduction in overall savings rates could counteract some of the intended benefits. Further, the extent to which they are prepared to channel their savings into UK-listed companies will be important. If many seek higher returns elsewhere, the impact on the UK stock market may be limited. In any case, policies to address the problems of the UK stock market will only work if the wider issues associated with UK productivity and growth are addressed.

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Questions

  1. Explain how banks use cash ISAs to finance investment through credit creation.
  2. What do stock markets offer which may boost investment and economic growth?
  3. What are the issues with the London Stock Exchange which is making it unattractive for raising finance?
  4. How is the rumoured ISA reform intended to help address these issues?
  5. Analyse the extent to which it will do so.
  6. How might some of the broader reforms proposed by the UK government influence rate of return on UK equities and attract capital?
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UK enters recession: what does this mean for living standards?

Latest figures from the Office for National Statistics show that the UK was in recession at the end of 2023. The normal definition of recession is two quarters of falling real GDP. This is what happened to the UK in the last two quarters of 2023, with GDP falling by 0.1% in Q3 and 0.3% in Q4. In Q4, output of the service industries fell by 0.2%, production industries by 1.0% and construction by 1.3%.

But how bad is this? What are the implications for living standards? In some respects, the news is not as bad as the term ‘recession’ might suggest. In other respects, it’s worse than the headline figures might imply.

The good news (or not such bad news)

The first thing to note is that other countries too experienced a recession or slowdown in the second half of 2023. So, relative to these countries, the UK is not performing that badly. Japan, for example, also experienced a mild recession; Germany just missed one. These poor economic growth rates were caused largely by higher global energy and food prices and by higher central bank interest rates in response. The good news is that such cost pressures are already easing.

The second piece of good news is that GDP is expected to start growing again (modestly) in 2024. This will be helped by the Bank of England cutting interest rates. The Monetary Policy Committee is expected to do this at its May, June or August meetings provided that inflation falls. Annual CPI inflation was 4% in January – the same as in December. But it is expected to fall quite rapidly over the coming months provided that there are no serious supply-side shocks (e.g. from world political factors).

The third is that the recession is relatively modest compared with ones in the past. In the recession following the financial crisis, real GDP fell by 5.3% in 2009; during the pandemic, GDP fell by 10.7% in 2020. For this reason, some commentators have said that the last two quarters of 2023 represent a mere ‘technical recession’, with the economy expected to grow again in 2024.

Why things may be worse than the headline figures suggest

Real GDP per head
So far we have considered real GDP (i.e. GDP adjusted for inflation). But if changes in GDP are to reflect changes in living standards, we need to consider real GDP per head. Population is rising. This means that the rate of growth in real GDP per head is lower than the rate of growth in real GDP

For 2023 as a whole, while real GDP rose by 0.20%, real GDP per head fell by 0.67%. In the last two quarters of 2023, while real GDP fell by 0.1% and 0.3% respectively, real GDP per head fell by 0.4% and 0.6%, respectively, having already fallen in each of the previous five quarters. Chart 1 shows real GDP growth and real GDP growth per head from 2007 to 2023 (click here for a PowerPoint). As you can see, given population growth, real GDP per head has consistently grown slower than real GDP.

Long-term trends.
If we are assessing the UK’s potential for growth in GDP, rather than the immediate past, it is useful to look at GDP growth over a longer period. Looking at past trend growth rates and explaining them can give us an indication of the likely future path of the growth in GDP – at least in the absence of a significant change in underlying economic factors. Since 2007, the average annual rate of growth of real GDP has been only 1.1% and that of real GDP per head a mere 0.4%.

This compares unfavourably with the period from 1994 to 2007, when the average annual rate of growth of real GDP was 3.0% and that of real GDP per head was 2.5%.

This is illustrated in Chart 2 (click here for a PowerPoint). The chart also projects the growth rate in GDP per head of 2.5% forward from 2007 to 2023. Had this growth rate been achieved since 2007, GDP per head in 2023 would have been 41.4% higher than it actually was.

It is not only the UK that has seen low growth over the past 15 years compared to previous years. It has achieved a similar average annual growth rate over the period to Germany (1.1%), lower rates than the USA (1.8%) and Canada (1.6%), but higher than France (0.9%) and Japan (0.4%).

Low investment
A key determinant of economic growth is investment. Since 2008, the UK has invested an average of 17.3% of GDP. This is the lowest of the G7 countries and compares with 24.9% in Japan, 23.7% in Canada, 23.5% in France, 21.3% in Germany, 20.4% in the USA and 19.1% in Italy. If UK growth is to recover strongly over the longer term, the rate of investment needs to increase, both private and public. Of course, investment has to be productive, as the key underlying determinant of economic growth is the growth in productivity.

Low productivity growth
This is a key issue for the government – how to encourage a growth in productivity. The UK’s record of productivity growth has been poor since 2008. The period from 1996 to 2006 saw an average annual growth in labour productivity of 6.4%. Since then, however, labour productivity has grown by an average annual rate of only 0.3%. This is illustrated in Chart 3 (click here for a PowerPoint). If the pre-2007 rate had continued to the end of 2023, labour productivity would be 189% higher. This would have made GDP per head today substantially higher. If GDP per head is to grow faster, then the underlying issue of a poor growth in labour productivity will need to be addressed.

Inequality and poverty
Then there is the issue of the distribution of national income. The UK has a high level of income inequality. In 2022 (the latest data available), the disposable income of the poorest 20% of households was £13 218; that for the richest 20% was £83 687. The top 1% of income earners’ share of disposable income is just under 9.0%. (Note that disposable income is after income taxes have been deducted and includes cash benefits and is thus more equally distributed than original income.)

The poorest 20% have been hit badly by the cost-of-living crisis, with many having to turn to food banks and not being able to afford to heat their homes adequately. They are also particularly badly affected by the housing crisis, with soaring and increasingly unaffordable rents. Many are facing eviction and others live in poor quality accommodation. Simple growth rates in real GDP do not capture such issues.

Limited scope for growth policies
Fiscal policy has an important role in stimulating growth. Conservatives stress tax cuts as a means of incentivising entrepreneurs and workers. Labour stresses the importance of public investment in infrastructure, health, education and training. Either way, such stimulus policy requires financing.

But, public finances have been under pressure in recent years, especially from COVID support measures. General government gross debt has risen from 27.7% of GDP in 1990/91 to 99.4% in 2022/23. This is illustrated in Chart 4 (click here for a PowerPoint). Although it has fallen from the peak of 107.6% of GDP in 2020/21 (during the COVID pandemic), according to the Office for Budget Responsibility it is set to rise again, peaking at 103.8% in 2026/27. There is thus pressure on the government to reduce public-sector borrowing, not increase it. This makes it difficult to finance public investment or tax cuts.

Measuring living standards

Questions about real GDP have huge political significance. Is the economy in recession? What will happen to growth in GDP over the coming months. Why has growth been sluggish in recent years? The implication is that if GDP rises, living standards will rise; if GDP falls, living standards will fall. But changes in GDP, even if expressed in terms of real GDP and even if the distribution of GDP is taken into account, are only a proxy for living standards. GDP measures the market value of the output of goods and services and, as such, may not necessarily be a good indicator of living standards, let alone well-being.

Produced goods and services that are not part of GDP
The output of some goods and services goes unrecorded. As we note in Economics, 11e (section 15.2), “If you employ a decorator to paint your living room, this will be recorded in the GDP statistics. If, however, you paint the room yourself, it will not. Similarly, if a childminder is employed by parents to look after their children, this childcare will form part of GDP. If, however, a parent stays at home to look after the children, it will not.

The exclusion of these ‘do-it-yourself’ and other home-based activities means that the GDP statistics understate the true level of production in the economy. If over time there is an increase in the amount of do-it-yourself activities that people perform, the figures will also understate the rate of growth of national output.” With many people struggling with the cost of living, such a scenario is quite likely.

There are also activities that go unrecorded in the ‘underground’ or ‘shadow’ economy: unemployed people doing casual jobs for cash in hand that they do not declare to avoid losing benefits; people doing extra work outside their normal job and not declaring the income to evade taxes; builders doing work for cash to save the customer paying VAT.

Externalities
Large amounts of production and consumption involve external costs to the environment and to other people. These externalities are not included in the calculation of GDP.

If external costs increase faster than GDP, then GDP growth will overstate the rise in living standards. If external costs rise more slowly than GDP (or even fall), then GDP growth will understate the rise in living standards. We assume here that living standards include social and environmental benefits and are reduced by social and environmental costs.

Human costs of production
If production increases as a result of people having to work harder or longer hours, its net benefit will be less. Leisure is a desirable good, and so too are pleasant working conditions, but these items are not included in the GDP figures.

The production of certain ‘bads’ leads to an increase in GDP
Some of the undesirable effects of growth may in fact increase GDP! Take the examples of crime, stress-related illness and environmental damage. Faster growth may lead to more of all three. But increased crime leads to more expenditure on security; increased stress leads to more expenditure on health care; and increased environmental damage leads to more expenditure on environmental clean-up. These expenditures add to GDP. Thus, rather than reducing GDP, crime, stress and environmental damage actually increase it.

Alternative approaches to measuring production and income

There have been various attempts to adjust GDP (actual or potential) to make it a better indicator of total production or income or, more generally, of living standards.

Index of Sustainable Economic Welfare (ISEW)
As Case Study 9.20 in the Essentials of Economics (9e) website explains, ISEW starts with consumption, as measured in GDP, and then makes various adjustments to account for factors that GDP ignores. These include:

  • Inequality: the greater the inequality, the more the figure for consumption is reduced. This is based on the assumption of a diminishing marginal utility of income, such that an additional pound is worth less to a rich person than to a poor person.
  • Household production (such as childcare, care for the elderly or infirm, housework and various do-it-yourself activities). These ‘services of household labour’ add to welfare and are thus entered as a positive figure.
  • Defensive expenditures. This is spending to offset the adverse environmental effects of economic growth (e.g. asthma treatment for sufferers whose condition arises from air pollution). Such expenditures are taken out of the calculations.
  • ‘Bads’ (such as commuting costs). The monetary expense entailed is entered as a negative figure (to cancel out its measurement in GDP as a positive figure) and then an additional negative element is included for the stress incurred.
  • Environmental costs. Pollution is entered as a negative figure.
  • Resource depletion and damage. This too is given a negative figure, in just the same way that depreciation of capital is given a negative figure when working out net national income.

Productive Capacities Index (PCI)
In 2023, the United Nations Conference on Trade and Development (UNCTAD) launched a new index to provide a better measure of countries’ economic potential. What the index focuses on is not actual GDP but potential output: in other words, ‘countries’ abilities to produce goods and deliver services’.

The PCI comprises 42 indicators under eight headings: human capital, natural capital, information and communication technology (ICT), structural change (the movement of labour and other productive resources from low-productivity to high-productivity economic activities), transport infrastructure, institutions (political, legal and financial) and the private sector (ease of starting businesses, availability of credit, ease of cross-border trade, etc.). It covers 194 economies since 2000 (currently to 2022). As UNCTAD states, ‘The PCI can help diagnose the areas where countries may be leading or falling behind, spotlighting where policies are working and where corrective efforts are needed.’ Chart 5 shows the PCI for various economies from 2000 to 2022 (click here for a PowerPoint).

The UK, with a PCI of 65.8 in 2022, compares relatively favourably with other developed countries. The USA’s PCI is somewhat higher (69.2), as is The Netherlands’ (69.8); Germany’s is the same (65.8); France’s is somewhat lower (62.8). The world average is 46.8. For developing countries, China is relatively high (60.7); India’s (45.3) is close to the developing country average of 43.4.

Looked at over a longer time period, the UK’s performance is relatively weak. The PCI in 2022 (65.8) was below that in 2006 (66.9) and below the peak of 67.6 in 2018.

GDP and well-being

GDP is often used as a proxy for well-being. If real GDP per head increases, then it is assumed that well-being will increase. In practice, people’s well-being depends on many factors, not just their income, although income is one important element.

The UK Measuring National Well-being (MNW) programme
The MNW programme was established in 2010. This has resulted in Office for National Statistics developing new measures of national well-being. The ONS produces statistical bulletins and datasets with its latest results.

The aim of the programme is to provide a ‘fuller picture’ of how society is doing beyond traditional economic indicators. There are currently 44 indicators. These are designed to describe ‘how we are doing as individuals, as communities and as a nation, and how sustainable this is for the future’. The measures fall within a number of categories, including: personal well-being, relationships, health, what we do, where we live, personal finance, the economy, education and skills, governance and the natural environment.

Conclusions

In the light of the limitations of GDP as a measure of living standards, what can we make of the news that the UK entered recession in the last half of 2023? It does show that the economy is sluggish and that the production of goods and services that are included in the GDP measure declined.

But to get a fuller assessment of the economy, it is important to take a number of other factors into account. If we are to go further and ask what has happened to living standards or to well-being, then we have to look at a range of other factors. If we are to ask what the latest figures tell us about what is likely to happen in the future to production, living standards and well-being, then we will need to look further still.

Articles

Data and Analysis

Questions

  1. Using GDP and other data, summarise the outlook for the UK economy.
  2. Why is GDP so widely used as an indicator of living standards?
  3. Explain the three methods of measuring GDP?
  4. What key contributors to living standards are omitted from GDP?
  5. What are the ONS Satellite Accounts? Are they useful for measuring living standards?
  6. Assess the UK’s economic potential against each of the eight category indices in the Productive Capacities Index.
  7. What is the difference between ‘living standards’ and ‘well-being’?