What the UK worry should be

By Raz Koroh

In its latest alarming annual report, the Bank for International Settlements (BIS) recently slammed governments who use their central banks to prop up economic growth, principally by loosening interest rates (i.e. borrowing costs), fuelling an unsustainable debt growth through unproductive private consumption (e.g. speculative real estate purchases), in order to support a consumption-led economic growth.  The BIS warned that this will lead to systemic banking crisis similar to the last one in 2008, especially that economies big and small are not exactly growing in pace with private debt growth.

According to most analysts, the Brexit vote was not expected, or perhaps it was expected but unwanted.  This is understandable, given the calamity that befell on UK and European banking stocks when the adverse results streamed in, and therefore overall stock market valuations, which equates a predicted recession given the prominence of financial service sector in the UK economy. Given what the BIS has warned, shouldn’t a recession be the lesser worry of the British government, and instead to focus on preventing the bigger financial crisis?

The BIS especially warned that the risky trinity we should be concerned about are low productivity growth, narrow policy response options, and  high debt growth.  The issue that arises from this is that the so-called trinity of risks are in fact inter-dependant.  The present British economy is a prominent example of this.

Here are several factors to consider.

Government debt.  The UK government debt-to-GDP ratio is quite high (88.6%), with annual expenditure exceeding revenue by quite a large margin despite having among the highest sales tax rate (20%) and personal income tax rate (45%).  This is due to a low economic growth rate of merely 1.9% (2015), although the unemployment rate is quite low (5.1%) and inflation rate also low (0.3%).  The low economic growth in turn is caused by an under-performing trade; the UK suffers a current account (export less import) deficit of -5% of its GDP (2015).  As to how much of this is due to the UK economy operating within the confine of a trading bloc is in fact the relevant issue, as EU members overall do not do well as a bloc (a mere 1.6% GDP growth in 2015), with Greece contracting by -0.7% and Germany the bloc’s best performing economy at just 2.1% (2015).

Interest rate.  The high public debt environment is the main reason for the Bank of England’s low interest rate policy, as the only policy option left available to support the UK economic growth.  Growth through this avenue is based on encouraging the growth of household debt.  Hence, what the BIS terms as debt-fuelled growth.  With the loosely deregulated environment in which the financial sector in the UK is currently operating under, it is conceivable that high street banks are also participating in high risk investing activities normally associated with merchant banks.  This will replay all over again the activities that ultimately led to the financial crisis in 2008.

The dilemma that the British government should be addressing is not simply whether or not there is still life after Brexit.  Indeed, what should be of more concern is whether the UK economy is pursuing the right kind of growth strategy.  For it is one thing to ensure that investors still continue to be interested in the UK despite having lost its European continental hinterland, but it is quite another to say that all this while it has followed the right economic policies even when it was inside the EU.