Why has the UK economy contracted vs its peers?

UK GDP growth slowed sharply in the third quarter, to 1.3% from 5.5% in the second quarter

A recent blog post from the IMF showed that the UK is in a worse position in terms of higher inflation and slower growth than any other significant economy compared to pre-Covid trends. Should we be surprised? Mr. Steve Barrow, Head of Standard Bank G10 Strategy, said he doesn’t think so. However, he thinks the underperformance is down to Brexit and not the pandemic. After all, it was not as if the UK was the worst prepared for a pandemic. 

In fact, surveys before the pandemic struck suggested that the UK was one of the best-prepared countries in the world in terms of things like medical resources. Indeed, it showed in the fact that the US was the first significant developed country to develop a vaccine. The UK’s poor performance is not down to a lack of policy response either. Sure, the UK was not on a par with the US when it came to fiscal stimulus but it was not far below and certainly ahead of most of its peers. 

On vaccinations, not only did the UK roll out the first vaccines but the pace and take-up of vaccines have been around the best seen in comparable nations; something that allowed an easing of lockdown restrictions earlier this year that was ahead of most others, especially European countries. 

While vaccines don’t seem to be the reason for the UK’s bad performance, there might be more to be said for the dominance of the service sector in the UK. For instance, in 2020 the World Bank calculated that the UK service sector accounted for almost 73% of the value added in the economy compared to around 66% for the EU. However, Mr. Steve Barrow finds it hard to believe that this fact alone could have accounted for the UK’s underperformance. Instead, the Covid crisis hid another crisis called Brexit. Supply-chain pressures that have been felt around the world seemed to be more acutely felt in the UK because of Brexit. “One manifestation of this has been a shortage of lorry drivers. For while many countries around the world complained about this shortage, the fact that workers from the EU did not come to the UK for employment says as much about their Brexit concerns as their pandemic fears. It is why things like a petrol crisis happened earlier this year in the UK, not elsewhere”, Mr. Steve Barrow stressed.

If it seems that Brexit has been a failure, at least so far, how has the pound responded? It has not fallen recently but, at the same time, it has not recaptured the losses seen during 2016 when the June referendum on the EU knocked the stuffing out of the pound. For instance, at the time of the referendum euro/sterling was trading around 0.75 but, since then, the euro has quickly rallied to a new range between 0.82 and 0.95. In trade-weighted terms too, the pound is currently running around 13% below its pre-referendum levels. 

What this suggests is that the market immediately presumed a very bleak future for the UK economy and the pound as soon as the referendum result was known, and has been proved broadly correct. Hence the pound has not regained the ground lost at the time of the referendum. In some senses, this may seem strange as currencies very often overshoot when such shocks occur. For instance, when the Swiss National Bank abandoned the 1.20 euro/Swiss floor at the start of 2015 euro/Swiss slumped to below parity straight away, but was back to 1.20 by 2018. 

“That was because the SNB’s decision was not detrimental for the economy; unlike the UK’s decision to leave the EU in 2016. Of course, in time, leaving the EU might look like a better decision if political challenges can be overcome on the Northern Ireland protocol, supply chain pressures ease and the UK concludes more free trade deals with non-EU nations. But at this stage, it all looks a bit out of reach and, for this reason, so does a recovery to the mid-0.70s pre-referendum levels that we were seeing for euro/sterling”, Mr. Steve Barrow emphasized.