Our memories have a well-documented recency bias. We put greater weight on contemporary developments, risking the conclusion that they have always been thus. While this permeates all parts of our lives, this is a column about economics. So, in the aftermath of a UK budget where economic growth is forecast to remain painfully anaemic, is this something the UK is doomed to in perpetuity? History suggests not.<\/p>\n
As recently as the two decades between 1990 and 2010, the UK economy \u2014 on a US dollar, per capita basis \u2014 grew in near perfect synchrony with the pre-eminent US economy. Both economies delivered an increase in living standards of a third over a two-decade period. Annual per capita income stood at $40,000 a year in the UK. The equivalent was $48,000 in the US. Fifteen years on this has risen to just $44,000 in the UK, but has raced ahead to $62,000 in the US. The constant-currency gap in individual incomes has more than doubled.<\/p>\n
Understanding what broke over that period is crucial in understanding whether the UK can narrow, or at least arrest, that widening gap in living standards. There is a rump of UK politics, and certainly a large constituency of the governing Labour Party, that lays the blame at the foot of what they see as public sector austerity. For a UK economy that has seen public spending rise to its highest share of the economy since the mid-1970s \u2014 more than 44p in the \u00a31 \u2014 and the tax burden to an 80-year high, it is an odd belief.<\/p>\n
My reading of the latest UK economic data is that all roads lead back to inflation. Indeed, the decoupling of US and UK living standards has not coincided with a relative slowdown of nominal GDP growth in the UK. In the last 15 years UK growth has averaged a very spritely 4.5 per cent a year by that, inflation-unadjusted, measure. That is precisely the same rate of growth as the 1990-2010 period.<\/p>\n
\u2022 How rich is the UK compared with the US? The growing gap, in charts<\/a><\/p>\n It is when the impact of inflation is added back in that the picture deteriorates. Up to 2010, UK inflation averaged 2 per cent a year. Since then it has averaged 3 per cent a year. In short, conducting economic activity in the UK has become more costly, and firms have passed these higher operating costs on to households. This process has diluted the spending power of households, and the level of growth that UK businesses can achieve.<\/p>\n Normally questions of inflation would place the Bank of England<\/a>, firmly in the dock. But a review of the stance of interest rates, the Bank\u2019s balance sheet, and monetary aggregate growth since 2010 does not suggest the Bank has been any more stimulative than its peers in either the US, or in Europe. Demand-pull inflation over the last 15 years \u2014 where interest rates are too low for the domestic economy \u2014 has been notable by its general absence. By contrast cost-push inflation is everywhere you look. The loss of control of UK inflation has been triggered by decisions taken by MPs in Westminster.<\/p>\n One policy area stands out more than most. In the mid-2000s the UK had the same industrial electricity costs as the United States. At 3.8p\/kWh the UK\u2019s electricity costs were the same as the average of all the countries that are members of the International Energy Agency (IEA). Two decades on, this price has risen six-fold. UK electricity prices are now the highest in the IEA, and 2.5 times higher than US industry electricity prices. This permeates all parts of the economy from the hairdresser\u2019s heating its salon, to the pub warming its bar area, to the manufacturer powering its machines<\/a>. Hyperscalers are not going to bring their AI-fuelled activity to the UK given their huge appetite for energy. Almost every domestic price, at some stage in the production process, comes into contact with energy costs.<\/p>\n While some of this higher energy price \u2014 particularly since 2022 \u2014 has been the result of volatile gas prices associated with the Ukraine war, that commodity price has now reverted close to its pre-war level. Yet the prices facing business remain penally high<\/a>. In November, Neso, the National Energy System Operator, released a discouraging report on the outlook for UK gas supply security. The UK is on track to supply just 3 per cent of its own peak gas demand by the winter of 2035, having supplied an average of 36 per cent over the last decade.<\/p>\n More maddening still is that the shortfall is being filled by Norwegian supply<\/a> from the same geological area as the UK, or by more polluting and less secure imported liquefied natural gas (LNG) from countries such as the US and Qatar. It is hard to think of a more damaging policy for living standards, for inflation, for tax revenue and for growth than the UK\u2019s approach to securing a stable supply of natural gas. This failure also enables alternative suppliers of energy to the UK to keep their prices elevated, rather than face the scrutiny of competition. <\/p>\n The inflationary energy picture has been amplified by repeated failures surrounding nuclear power. The Nuclear Regulatory Taskforce recently identified that the cost of building UK nuclear capacity is the highest in the world. A culture of risk aversion<\/a>, perverse incentives, and a focus on process over outcomes is identified as a key driver.<\/p>\n The real killer for UK economic growth, however, is that this abject failure in one sector \u2014 energy \u2014 has permeated through the entire economy as MPs have chosen to embed energy-driven price increases in regulated prices for labour, for pension payments, and in the tariffs of key goods and services. The national living wage, the triple lock, and the prices for water, transport, telecoms, and electricity all take some form of the previous year\u2019s inflation rate and apply it to future prices. Prices in an efficient economy respond to supply and demand conditions to send important signals to suppliers and consumers. The UK has taken large parts of the economy and removed this price signal, and diluted the message that prices should send on where to allocate investment, and where to consume.<\/p>\n