In the past six years, the economic performance of the UK has diverged notably from that of the rest of the EU, and in particular from that of the eurozone. Growth has been consistently slow across the eurozone, with the exception of the rebound recently seen in Spain and Ireland. In contrast, the rate of GDP growth in the UK has been among the fastest among advanced economies, and similar to the relatively strong growth trajectory seen in the US.
We argue in this paper that this divergence is due to the much more aggressive policy stimulus in the UK from the outset, and the fact that – partly as a result of rapid government intervention in the banking sector – the crisis-resolution period following the 2008–09 downturn was shorter in the UK than in the eurozone. The UK’s relatively short, sharp adjustment helped the economy to switch back to its pre-crisis model of growth, one that favours consumption over savings. In the eurozone deleveraging has taken longer – partly due to the complication of the 2010–12 sovereign debt crisis and neglect of structural problems in the banking sector. This has resulted in a significant contraction in domestic consumption and investment.
The greater resilience of the UK economy has proved attractive to both foreign investors and foreign workers. The economy’s integration into the EU single market and its openness to both capital and labour have facilitated and expanded financial inflows and inflows of workers. Since the early 2000s, and especially in the years after the global financial crisis, the UK economy increased its stock of overseas capital and labour. Net foreign direct investment (FDI) flows shifted in the UK’s favour, from a net outflow equivalent to 5 per cent of GDP in 2007 to a net inflow worth 4 per cent of GDP in 2015.1 Net immigration also quadrupled in the two decades between 1994 and 2014, rising from 78,000 a year to 313,000 a year. Currently the number of immigrants from EU countries is almost equal to the number of non-EU immigrants.2
Not only is the UK an attractive market for both foreign investors and foreign workers, but – contrary to some popular perceptions – its economy has been able to absorb these inflows smoothly. Its domestic demand-driven model of growth, characterized by plentiful cheap capital, low labour costs, flexible employment conditions and a large supply of workers, has proven effective. Real GDP grew at an average rate of 2.1 per cent per year during the period 2012–15.3 Moreover, since the onset of the financial crisis the UK has been an overall contributor to global aggregate demand – so its domestic recovery has helped the world economy to grow. In contrast, the eurozone has been a major drag on global growth – running a persistent current-account surplus and therefore importing less than it exports.
The UK’s successful economic performance is not without flaws. In this paper we argue that limited productivity growth and still-high household debt, now compounded by a higher public debt burden, present significant constraints for a growth model driven by consumption. Up to now, inflows of financial and human capital have helped overcome these constraints. However, the effects of the June 2016 referendum on EU membership could cause these inflows to decrease in the future, as more isolationist British policies and, potentially, retaliatory measures by the EU could increase the barriers to free movement of people, goods, services and money. In light of ‘Brexit’, does the UK therefore need to reconsider its model of growth? Will the current model, which relies on attracting and absorbing high levels of foreign capital and labour, be sustainable in the event of a new relationship with the EU that reduces market openness and integration?
1 This was mainly due to repatriation of funds. Codogno, L. (2016), ‘Brexit poses serious political ramifications for the rest of the EU’, LSE Brexit Blog, 5 May 2016, http://blogs.lse.ac.uk/brexit/2016/05/05/brexit-poses-serious-political-ramifications-for-the-rest-of-the-eu/ (accessed 21 Sep. 2016).
2 Office for National Statistics (2016), ‘Migration Statistics Quarterly Report: August 2016’, 25 August 2016, http://www.ons.gov.uk/peoplepopulationandcommunity/populationandmigration/internationalmigration/bulletins/migrationstatisticsquarterlyreport/august2016 (accessed 21 Sep. 2016).
3 OECD.Stat (2016), ‘Gross domestic product (GDP)’, https://stats.oecd.org/index.aspx?queryid=60702 (accessed 5 Oct. 2016).