It is no secret that the UK is currently under extreme socio-economic pressure. Three consecutive economic shocks – Brexit, the COVID-19 pandemic, and the conflict in Ukraine – have left the UK burdened with additional debt. Net debt as a percentage of GDP has surged from 36.3% in 2007 to an estimated 98.1% in 2024. The initial catalyst for this increase in debt can be traced back to the 2008 financial crisis, when the UK government borrowed an additional £137 billion to bail out British banks and opted for austerity measures to focus on managing public finances and debt. While austerity reduced the deficit, it also curtailed public investment, contributing to stagnant growth and declining productivity over the following decade.
The UK’s fiscal policy did not include a tangible increase in the minimum wage or inflation-controlling policies, resulting in a flattening effect on real household disposable incomes. Real household disposable income per capita in the UK saw a meager increase of £3,017 between 2005 and 2023, while in the US, it rose by $12,745 over the same period. This era is often referred to as a “lost decade,” during which consumer living standards declined and economic growth stagnated. This stagnation in real household disposable income was significant, as consumer spending is by far the largest driver of economic stimulus, accounting for 60% of the UK’s GDP.
Alongside the flattening of household incomes, there has been a sharp decline in labor productivity. This has been attributed to chronic underinvestment by the private sector in new capital and worker skills. By improving labor productivity, an economy can enhance its capabilities and produce more goods and services with the same labor input. This facilitates higher wages and increased tax revenues for the government through greater corporate net profits. This automatic function of fiscal policy, which provides positive cyclical returns where the government reinvests funds into its economy, has unfortunately not materialized in the UK. UK productivity is now 24% below its pre-crisis trend and is the second lowest in the G7. Productivity growth in the UK has stalled since 2008 due to low investment in technology, infrastructure, and labor skills. In 2013, only 6.1% of government spending was allocated to economic investment. Political uncertainty, including Brexit, further weakened business investment, prolonging the economic slowdown.
Brexit was the first of the three recent economic waves and has had the largest impact on foreign direct investment. Investment fell by almost 25% after the UK’s decision to leave the EU. According to the Bank of England, “we estimate that over 90% of this investment impact is due to higher uncertainty.” Following Brexit, the COVID-19 pandemic exacerbated the brewing economic crisis. The UK borrowed an additional £313 billion in 2020 and 2021, representing 13% of its GDP. This was deemed necessary to support the economy during the pandemic through job retention measures such as the Furlough Scheme and the Coronavirus Job Retention Scheme. Those furloughed were entitled to 80% of their original salary, capped at £2,500 per month, fully funded by the UK government.
The subsequent government borrowing led to a rise in the yield of UK government bonds (gilts) and, consequently, an increase in the cost of servicing the national debt. UK private sector debt (households and businesses) was estimated at £2.8 trillion in 2023, or around 110% of GDP, compared to £2.6 trillion in government debt, which is around 100% of GDP. In comparison, German government debt in 2023 was €2.6 trillion, around 66% of Germany’s roughly €4 trillion GDP, while private sector debt was around €3.5 trillion, or 87% of GDP. The difference in debt levels between the two countries as a percentage of GDP indicates that the UK’s relative debt is roughly 50% higher than Germany’s.
As UK debt increased, investor confidence in the debt capital markets declined, leading to a fall in the price of issued UK gilts. This was because bond coupons had to offer higher yields to match the yield levels of newly issued bonds. The yield on 10-year UK gilts rose from 0.3% to 4.6% since 2021, a 4.3% increase equivalent to a 15-fold rise. In comparison, the yield on 10-year German bonds increased to around 2.5% – 3.0% from negative values, representing roughly a 1.5% lower debt servicing cost compared to the UK. Subsequent borrowing required to fund government spending (the budget deficit was £127 billion in 2024) is contingent on the market environment and expected inflation and is likely to remain in the 4.5% to 5% range.
to be continued
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