Welcome to Britain’s era of ‘permanent stagnation’
There were reasons to be cheerful on Thursday as the Bank of England's latest economic projections showed the current downturn will not only be shorter, but shallower than it predicted just three months ago.
Fewer people will be out of work in the coming recession, while a fall in energy prices is helping to push down inflation. Lower inflation suggests the Bank's tenth interest rate rise, which took the headline rate to 4pc, may be one of its last of this cycle.
However, leaf through the Bank’s latest Monetary Policy Report, which sets out its outlook for the economy, and the short-term optimism quickly gives way to long-term gloom.
Typical incomes are on track to fall by 7pc over the next two years and the Bank is predicting a radical slowdown in the growth of labour and capital available to fuel the economy.
So-called “potential supply” growth, a key indicator of real GDP growth, is forecast to more than half to 1.3pc this year before dropping again to 0.7pc in 2024 and 2025.
Torsten Bell, chief executive of the Resolution Foundation, says the outlook puts Britain on a path to “perma-stagnation” and at risk of “a prolonged, and far deeper living standards downturn”.
Even the Bank's short-term upgrade to forecasts are not quite as rosy as they seem: Threadneedle Street's prediction that the economy will shrink 0.5pc this year and a further 0.25pc in 2024 is still more gloomy than the International Monetary Fund’s forecast of a recession in 2023 and slight growth next year, of 0.9pc.
Under the Bank's projections, annual growth is expected to average just 1pc between 2006 and 2025 – a disastrous performance that rivals the Great Depression.
“While the UK’s economic prospects are improving, they remain bleak,” says James Smith, a research director at the Resolution Foundation.
“Families are living through a sharp two-year living standards downturn, and Britain is living through a 20-year growth stagnation – the worst since the interwar years [between 1919 and 1938].”
Weak productivity growth in the post-financial crisis years underpins much of this run.
However, part of what is holding back the economy now is a shock decline in the size of the workforce in the aftermath of the pandemic.
Andrew Bailey, the Governor of the Bank of England, described his surprise at the “marked increase” in inactivity among 50 to 65 year-olds since the pandemic.
“Many say they have retired early, making a choice about the life they would like to live. At the same time, however, many people report that they are affected by long-term illness. A number of these people say they are unlikely to come back into the labour market.
“This significant and lingering fall in the labour supply weighs on the UK economy’s potential,” he said at a press conference on Thursday.
People are crucial to the growth of any business, and by extension the economy, and a shortage of qualified staff is increasingly hobbling Britain.
The outlook for the economy not only depends on how confident people feel about spending their money, but also whether the economy can sustain that growth in the medium term. The Bank's view on this point has become increasingly pessimistic.
Around half a million people stopped looking for work altogether during Covid, with some going back to study and others retiring early. It's this second group that policymakers are now trying to tempt back into the jobs market.
However, history suggests that the longer you spend out of work, the more likely it is you won't come back and the Bank fears there are increasing numbers of people who will never return.
“Many of the people who have left the labour force since the start of the pandemic were aged 50 to 64, suggesting that early retirement could be playing a significant role,” officials said. The Bank warned that “there appears to be increasing detachment among those who have left the labour market recently”.
Weak investment and productivity means the economy and living standards may never again grow at the same pace as seen before the financial crisis, the Bank fears.
Bailey accepts the challenge facing the economy is big, describing labour supply as “unusually weak”. Part of that is a result of the baby boomer generation retiring, which the Bank notes will be the “most important force weighing on participation” in a few years time.
“We have to recognise it's a long term feature of an ageing population,” he said. “It would have happened whether Covid happened or not. But there is clearly another substantial part of it in terms of inactivity, and that's going to be important therefore it seems to me for tackling that labour supply issue.”
The ideas on reversing the shrinking workforce keep flooding in. One solution would be to allow people to keep sickness benefits, or offer people more tax breaks. Job coaches could even be stationed at GP surgeries under plans being drawn up by the Government to get unemployed over-50s back to work.
In the meantime, a tight labour market will keep interest rates higher for longer than they otherwise would need to be.
Deputy Governor Sir Dave Ramsden said the smaller workforce affected what he called the economy's “speed limit”, which is how much it can grow before inflationary pressures start to build.
Before the financial crisis, the Bank believed that number was around 2.7pc. That slowed to less than 2pc in the wake of the financial crisis and it now stands at 0.7pc. He said the outlook for the economy remained challenging, even if the UK would see higher catch-up growth than the 0.7pc potential supply growth implies.
The stakes are high.
“If you can get potential supply up, that means the economy can grow at a faster rate over the long term,” Sir Dave says. “So it's definitely worth any policies that will increase labour supply or will increase productivity.”
Unfortunately, the track record on tackling these twin issues is not encouraging,
“Those have been the focus of successive governments ever since I've been working in the public sector, which is over 30 years,” says Sir Dave.