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In October, the jobless rate in Britain was reported at 8.1 per cent, the highest in 17 years – further evidence that the recovery is stalling. Youth unemployment has surpassed one million, the highest since the early 1990s. (Darren Staples/Reuters/Darren Staples/Reuters)
In October, the jobless rate in Britain was reported at 8.1 per cent, the highest in 17 years – further evidence that the recovery is stalling. Youth unemployment has surpassed one million, the highest since the early 1990s. (Darren Staples/Reuters/Darren Staples/Reuters)

Britain caught between its debt and a hard place Add to ...

As the chief executive officer of Fiat, one of the world’s biggest auto groups, Sergio Marchionne isn’t prone to taking swipes at Britain, where he builds no cars. But he couldn’t resist doing so at the Confederation of British Industry conference in London.

Britain, he said Monday in his keynote speech, made a fundamental mistake in the 1980s with its “conscious decision” to ditch grubby, large-scale engineering and manufacturing so it could concentrate on services such as banking. Industries that took decades, even a century or longer, to develop – machine tools, cars, trains, ships – melted away. “The equilibrium of the entire [British]economic system has been undermined,” he said to an auditorium of executives and entrepreneurs.

His point was that Britain gave away key export industries that might have protected its economy as the euro zone debt crisis morphs into a recession. Germany’s export juggernaut has kept the German economy intact. Britain lacks a similar fallback position when it needs one most.

Indeed, the British economy doesn’t have a lot going for it at the moment. Britain managed to use a clever combination of austerity, monetary easing and devaluation in the past two years to keep the economy afloat and retain confidence in its sovereign bonds.

But Britain is fully integrated into the European economy and suddenly finds itself sinking as some of its biggest trading partners, from Ireland to Italy, succumb to pressures of excess debt, ailing banks and rising unemployment.

Speaking after Mr. Marchionne at the CBI conference, British Prime Minister David Cameron warned about the “chilling effect” of the euro zone slowdown on the “lopsided” British economy and said reining in Britain’s debt is “proving harder than anyone envisaged.”

Translation: Britain could become the next victim of the debt crisis. Britain’s own growth forecasts are being revised downward and it is almost certain that the government’s ambitious debt-crunching targets will prove elusive. “High levels of public and private debt are proving to be a drag on growth, which in turn makes it more difficult to deal with those debts,” he said.

Total U.K. debt, including household, government and corporate debt, has reached a troublesome 492 per cent of the country’s gross domestic product as of March, consulting firm McKinsey calculated, according to reports this week.

In his March budget, George Osborne, Chancellor of the Exchequer, said the structural deficit would be history by 2014-15. Mr. Cameron’s comments on Monday were interpreted by economists as preparing the groundwork for a two-year delay in vaporizing the deficit. The official acknowledgment is expected to come on Nov. 29, when Mr. Osborne is to make his fall statement.

If that weren’t bad enough, British inflation has been running at about 5 per cent, much to the distress of pensioners and others on fixed incomes. While inflation is expected to come down, it could remain well above the Bank of England’s 2-per-cent target. The combination of high inflation, low growth and rising unemployment – known as stagflation – was the dominant feature of the shell-shocked American economy in the aftermath of the 1973-74 oil embargo.

The European slowdown and Britain’s austerity programs are chewing away at the British economy. Jens Larsen, economist in London with RBC Dominion Securities, said consumers are getting hurt by tax increases and rising energy and utility prices. “All these factors have hurt disposable incomes,” he said.

Britain’s 1.8-per-cent growth in 2010 is expected to fall to a paltry 1.1 per cent this year, according to Deutsche Bank, and other forecasts are more bearish. RBC’s forecast is for 0.9-per-cent growth in 2011 and 1 per cent in 2012. Unemployment, meanwhile, is climbing. In October, the jobless rate was reported at 8.1 per cent, the highest in 17 years – further evidence that the recovery is stalling. Youth unemployment (16- to 24-year-olds) has surpassed one million, the highest since the early 1990s.

When growth stalls and unemployment rises, any government is tempted to open the stimulus spigot. Britain probably will not for the simple reason that it can’t. Its budget deficit, forecast at 8.2 per cent in 2011 – twice as big as Italy’s – leaves little room to manoeuvre.



Even if the government announces no major new spending programs, bond sales are bound to rise as the economy slows and the hefty budget deficit persists. Bond sales will rise to £182-billion ($295-billion) next year, up from £167.50billion, predicts Sam Hill, RBC’s fixed-income strategist in London. “This, alongside severely reduced headroom for the government in terms of meeting fiscal objectives, represents a material risk to gilts [British bonds]in the short term, given such a strong run and near-record yield lows.”

In other words, yields are far more likely to go up than down. The extra borrowing costs, of course, would only increase the strain on Britain’s finances, possibly delaying the recovery even more.

What will save Britain? With manufacturing reverted to B-industry status and little flexibility on the stimulus front, it appears only a rebound in the euro zone will prevent sluggish growth or even a contraction. That’s why Mr. Cameron has been pleading for “decisive steps” to cure the euro zone debt crisis. In effect, the British economy is out of his control.

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