07 November 2016

ChatHam House: Increasingly apart: Post-crisis growth trajectories in the UK and Eurozone

Summary

• The UK’s economy has performed considerably better than that of the eurozone since the 2008–09 financial crisis. Between 2010 and 2015, real GDP growth in the UK averaged 2 per cent, slightly above the G7 average. Real GDP growth in the eurozone, in contrast, averaged 0.9 per cent. This paper examines why the UK has followed such a different trajectory.
• We argue that the divergence reflects the relatively rapid process of banking resolution that occurred in the UK. This helped the economy to return to its pre-crisis growth model, which favoured household consumption over savings. In the eurozone the adjustment has taken longer. Deleveraging – that is, reducing indebtedness so that more normal rates of growth can resume – was further impeded by the sovereign debt crisis in 2010–12 exacerbating structural problems in the banking sector. The result has been a significant contraction in credit, domestic consumption and investment in the eurozone.
• The UK’s much more aggressive and more sustained monetary and fiscal policy easing in the aftermath of the financial crisis has been another key factor in the economy’s ability to rebound from the recession. In contrast, conflicting views among creditor and debtor countries in the currency union prevented decisive moves towards the establishment of a common fiscal policy. As a result, debtor countries have had to bear the brunt of the burden of fiscal adjustment, exacerbating downturns in these economies. Monetary policy, as well, has been hostage to ideological divergences among member countries, slowing down the eurozone response until deflation became a real threat.
• A further problem for the eurozone is that those economies most in need of stimulus were also unable to adjust to the constraints imposed by the monetary union. This inhibited economic convergence inside the monetary union, further complicating the political environment for policymaking. Sluggish economic growth and high youth unemployment in these countries have become a major source of discontent, eroding popular support for the currency union and muting business sentiment. This contrasts sharply with the UK, where employers were able to shed jobs quickly in response to the events of 2008–09, but also started hiring quickly once a basic level of consumer and industrial confidence had been restored.
• Controversially given the current political climate, however, the UK’s economic success partly seems to reflect its openness to inflows of foreign capital and labour. Annual net migration to the UK quadrupled between 1994 and 2014, rising from 78,000 to 313,000. Although the ‘Brexit’ campaign reflected popular antipathy towards immigrants and the perception that uncontrolled immigration was bad for the economy, we argue that in fact this substantial import of human capital has led to faster output growth.
• However, inflows of foreign capital and labour into the UK may decrease in the future as a result of the country’s June 2016 vote to leave the EU. In effect, the ‘Leave’ vote threatens to undermine the very consumption-centric economic model that has enabled the UK to outperform the eurozone.
• As if the challenges of managing the economic impacts of ‘Brexit’ weren’t enough, the UK’s growth prospects face additional challenges. Limited rises in productivity growth and persistently high household debt, now compounded by a higher public debt burden, also pose significant constraints for the country’s consumption-led growth model.

Full research paper

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