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UK economy – labouring?

23 May 2025

4 minute read

What factors have held back the UK’s economic growth, and what are the reasons for optimism about its recovery?

“Why should I want to make anything up? Life's bad enough as it is without wanting to invent any more of it.” (Marvin, The Hitchhiker’s Guide to the Galaxy – Douglas Adams)

The UK’s economic outlook remains better than widely feared. That is not to say there is nothing that could blow a nascent recovery off path (again). However, the warning again here is of the risks of sampling the recent past too vigorously in attempts to shed light on the path ahead.

This week, we explore again some of the reasons why the past needs to be interpreted with great care and why there are still more reasons for hope than doom.

UK – early millennium funk

The story of the millennium so far is one of stagnation, both relative to its own history and many comparable economies. There has been nothing like it in 250 years of the UK’s economic history. There are several factors in this, some self-inflicted, most not.

Britain’s primacy in financial services, a central reason for the country’s success in hauling the world out of millennia of stagnation in the 18th and 19th centuries,1 was an important Achilles heel in the global financial crisis (GFC) of 2007-2009.

The UK experienced this financial system heart attack far worse than many others and paid a heavier price in the aftermath. The fact that the UK’s financial sector had managed to swerve the epicentre of many of the world’s worst banking crises in the century before perhaps worsened the hangover.

The rolling turmoil of the ensuing Euro crisis weighed further – as we would rediscover with Brexit, proximity matters in economics. Persistent worries about the solvency of various heavily indebted European states, with Greece singled out, provided further cover for the forced diet inflicted on the British state.

The hysterical focus on government debt levels, given academic cover by the now infamous2 Reinhart and Rogoff paper on the subject, restrained many states from stepping into the GFC-spurred slump in private sector confidence.

Meanwhile, Brexit is certainly touted by at least one half of the country as being unhelpful. However, it comes too late to explain all the flatlining in productivity growth. It has so far probably resulted in a little less growth and a bit more inflation relative to our major developed world peers, much as we pointed out on the day of the vote. Beware of the more extreme claims on either side of the debate, as they mostly reflect ideology rather than facts on the ground.

Throughout this period, much as with the 1950s and 1960s, it is the pace of technological change that can answer for a lot. This time it was its apparent absence that provides vital context. The last productivity surge surrounded the Information Communications Technology cluster arriving in the early 1990s. Between 1995 and 2005, many countries realised huge efficiency gains as these technologies transformed the world around us, essentially making it much smaller and more navigable.

The period since that surge in growth, living standards and interconnectivity has been remarkable for the lack of productivity growth, in both the UK and wider world. There have been wondrous new technologies for sure. However, they seem to be only just beginning to change the trend in productivity growth.

The investment shortfall…

This cocktail of factors has had some influence on notably subdued trends in investment in the UK (Figure 1). The factor where this Labour government may enjoy the greatest agency surrounds the provision of stable and predictable background conditions (from legal framework to access to workers/markets) emphasised by the OECD literature.

Figure 1: Private sector investment in the UK is low compared to other major OECD countries

Private sector investment in the UK has averaged 15% of GDP in the last decades, below other major OECD countries.

Source: OECD, Barclays

There is intuitive sense here. Businesses have plenty to deal with in their daily battle with ever-shifting consumer preferences, competitors and more besides. Most will want as much of the rest of the unknowable future fixed to whatever extent feasible.

This is something the UK has appeared to struggle with for the last couple of decades, having invented it in the long run up to the First Industrial Revolution. The most recent Nobel prize winners are among those who see causation here3 – strong, stable and predictable institutions appear to be a necessary (if not quite sufficient) precursor to sustained economic growth.

The fact that the last 18 or so years have seen the launch of almost as many industrial strategies hints at a hyperactivity hindering policy efficacy. Some will argue that in an ever-changing world, the industry strategy needs to follow suit to stay relevant. However, the reality is that the bulk of innovation and adaptation is likely better sighted closer to the economic action, primarily within the private sector.

This is clearly recognised in the industrial strategy consultation. However, sticking to it may require lower turnover in cabinet and other government leadership positions. Changes of management always bring new ideas (otherwise everyone wonders why the change). However, as above, this risks misunderstanding where the state’s edge actually lies in the innovation/investment ecosystem.

Investment conclusion

The UK occupies a top-5 place in the world for innovation.4 Our universities and some emerging (linked) regional clusters of excellence in various industries, from life sciences to parts of AI, represent something substantial to build on.

However, the bigger opportunity has long been thought to be outside of the top-dog firms – that frontier is globally competitive and continues to flourish. However, it is the next block – beyond the top 5-10%, but above the top 50% – where most of the productivity slump this last couple of decades has been felt.

There is a literal mass of explanations for this surprising slump of previously successful firms (from sectoral to the deterioration in management quality documented by Nicholas Bloom and others). The former Bank of England’s famous ‘all hub, no spokes’ speech5 remains well worth a read for its assessment.

Even so, the economy has managed to surprise a determinedly gloomy consensus so far this year. Consumers have proved more resilient and businesses more adaptable. The global technological context is as helpful as it’s been for some time, particularly to the parts of the corporate sector that have lagged on investment, as is true for much of the UK.

Meanwhile, the fact that workers are increasingly scarce and expensive may help. Many past periods of accelerated technological change have mixed the dangled carrot of attractive technology, with the stick of relatively scarce expensive workers – relatively high real wages (which endure today based on the last read) played a key role in the timing of the First Industrial Revolution for example.6 All is not lost.