The United Kingdom is one of the largest economies in the world today, and was arguably the single
country with the largest influence in bringing the world into the modern age as the forerunner
of the industrial revolution. That makes the economic problems we are about to explore
all the harder to hear, because the declining dominance of the UK economy, as well as the
social, political and financial problems that are coming with it, doesn't need to happen.
When an economy is going well, it's easy to keep it going well. It's currency will be strong,
people will want to invest in it, it can borrow at low rates, and it should foster political
stability, which means economic plans can be made over decades and generations,
rather than rapid election cycles. When an economy is stagnating, or worse still shrinking,
then it's currency becomes less desirable, borrowing money becomes harder, people will
avoid investing in it, and policy decisions will be made by whoever can make the biggest
promises to voters who want to weigh out of the economic mess. It's easy to see what kind of
situation the UK is in today. The country is not nearly as globally influential as it once was,
and it's economy is becoming increasingly concentrated in a few industries that don't
do a lot of good for the average Brit. The economy that led the way in the industrial
revolution and kicked off the biggest economic boom in human history is today,
struggling with very real problems like poverty and drastic regional inequality.
The biggest problem above all though, is that it might not matter.
The actual economic situation of the UK is, if anything, underreported, and that's because the
country is quickly becoming a two-speed economy, with extreme wealth concentrated in London,
and economic decline everywhere else. The two halves average out, but really,
the standard of living of most participants in the UK is going backwards.
If policy makers feel no pressure to reverse this trend, then it will likely continue,
which will be great for everybody lucky enough to be employed in the global industries of London,
all at the expense of everyone else in the country. It is, if nothing else,
a really interesting case study into what defines economic success in the modern day.
So, why despite centuries of dominance is the UK falling behind all of a sudden?
Has the growth of London come at the expense of the rest of the country?
And finally, is it going to be possible to reverse these problems now that they've taken hold?
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This month alone, we've explored the economies of Italy and Greece,
two other European economies that have been stagnant since the mid-2000s,
and it's important to make a big disclaimer here that the UK is not in as bad a situation
as these countries were, not yet at least. But the challenges that the UK is facing are both
different, and while potentially less severe, they're going to be harder to deal with.
The biggest issue is simply a crisis of confidence. There is a reason that we always include
something as potentially ambiguous as confidence in the exploration that we do of all national
economies and even include it in our leaderboard. And that's because it's one of the most important
things that any economy can build up, and once it's lost, it can do some very tangible damage.
The economy of the UK has obviously had a long, slow decline from its peak as a world-dominating
colonial power, but its economic problems as they exist today arguably started on the 16th
of September in 1992, now affectionately known as Black Wednesday. Before this,
the UK still had its problems, but it was still seen as one of the most stable and
reliable economies in the world to handle trade, finance, and investment.
The pound was still the world's second most used global currency, and it had the reputation for
being, well, as sound as the pound. Old people might remember this saying, but it doesn't make
much sense today. Two years before this fateful day, the UK entered into an agreement known as
the exchange rate mechanism, or ERM. This was almost an early precursor to the euro.
What this agreement did was link the major currencies in Europe together with a pre-agreed
exchange rate range. If a country's exchange rate between another member country got too high
or too low, the central banks of those two countries would need to intervene
to get it back within the agreed-upon range. This was a very expensive process,
and it meant that the central banks of all of the countries involved needed to keep a lot of
reserves of all of the other countries involved to make sure they could buy or sell whatever
currencies they needed to keep their own currency within an agreed-upon price range.
Now this whole thing, at least in theory, was not as stupid as it sounded. By controlling
the varying exchange rates between the countries, it would make it a lot easier
for businesses to trade and invest across borders without taking on exchange rate risk.
If a French company invested in an Italian business and then it doubled in value,
that would be great, but if the Italian lira halved in value in that time,
then the French firm would be right back to where it started.
The exchange rate mechanism made it so that this was theoretically not possible,
which did provide a big boost to cross-border interactions between the major economies in
Europe. The UK actually did not initially sign up to this scheme when it was first introduced
by the European Economic Community, the forerunner to the European Union in 1979.
It took 11 years for the UK to join the agreement after political tensions within the country tossed
up the benefits and risks of indirectly pegging their far more dominant global currency to the
rest of Europe. 1990 was unfortunately not the ideal time to jump on board the ERM because it
coincided with the collapse of the Soviet Union and the reunification of East and West Germany,
which might seem completely unrelated, but let's explain.
The east, which was the satellite state of the USSR, was far less economically developed than
the west, and the new unified Germany had to find a way to lift millions of people out of
absolute poverty, modernize massively outdated industries, and build out connective infrastructure
all without destroying the existing economy in the west, which by comparison was doing really well.
Now the reason this was important to the UK is because Germany decided the best way to do this
would be to increase their interest rates so that foreign investors would be tempted to put money
into Germany where they could make a good return, and then Germany could take some of this money
and use it to make the investments it needed to get the east up to speed.
This was an unconventional approach because normally when a government wants to stimulate
the economy like this they would lower interest rates instead of raising them so that businesses
and individuals could borrow more money to promote economic activity through spending
and business operations. The reason Germany didn't do this though was because they were
afraid of the potential for inflation if the economic shock of absorbing the east hurt production.
Germany in the period between the first and second world war suffered through terrible
hyperinflation which spread poverty throughout the country, and even 60 years later that memory
had not been lost. The high interest rates in Germany did exactly what they were designed to do,
they attracted investors from all over the world that wanted to keep their money as deutschmarks
because they could earn a much higher interest rate on it. This included investors from the UK
who had a comparatively much lower interest rate, and since the values of these currencies were
tied together with the ERM there was theoretically no risk in having money saved in Germany.
The result was that the value of the British pound wanted to go down and the deutschmark
wanted to go up, but the British central bank was not allowed to let that happen because of
the rules of the ERM. The UK ended up having to sell huge reserves of foreign currencies
to try and keep the value of the pound artificially high, and they were also
forced to start raising interest rates at a time when the UK economy itself
wasn't doing that well and probably would have benefited from lowering interest rates.
To make matters worse lots of investors had the suspicion that even an institution as powerful
as the bank of England couldn't hold back these market forces forever, and that eventually the
value of these currencies would shoot back to where they wanted to be according to the laws
of supply and demand. This meant that they changed even more of their money into German deutschmarks
because if they were right not only would they earn a higher interest rate while they waited,
they would also profit if the ERM failed and the value of currencies was allowed to equalize at
the levels where they should be. Of course this did eventually fail, but not before increasingly
desperate attempts by the bank of England to maintain their commitment to keeping the foreign
exchange rate steady. On the day of the collapse the bank raised interest rates from 10% to 15%
before admitting defeat and lowering them back down to 12%, again all within a day.
The UK was hurt by this in the short term as was the rest of Europe, but it did something far more
damaging than that in the long term for the country. It started to raise doubts over just
how well-managed the United Kingdom really was. In the years since the country was one of the
worst-hit economies by the GFC and was then collateral damage from the eurozone crisis,
it went through a very uncertain break-up with the EU and is now probably best known
for its revolving door of prime ministers, although as an Australian I really can't say
too much about that last one. The problem this has created is that now nobody has much certainty
about the future of the UK, which means that it's risky to make investments or trade deals or really
do anything with the country because it hasn't displayed the consistency that it was once famous
for. Now of course it should hopefully go without saying that the UK is still far more stable than
a country like Somalia, but it's all relative. The UK has become highly dependent on the financial
industry above all else. This has been great for the city of London where most of this business
is conducted, but it hasn't done much good for the rest of the country. Unlike a financial centre
such as New York, most of the money that flows into London isn't flowing into domestic companies
and projects, instead it's going into opaque financial investments made all over the world
on behalf of people that choose to do business in the city because of its willingness to look the
other way rather than the markets it grants access to. London is still the second largest
financial centre in the world, but the type of finance being done here is in many ways doing
more harm than good to the rest of the country. The British pound has been on a slow and stable
decline compared to other global currencies for basically the past century, but it's arguably
still overvalued compared to where it should be because of its use by the financial industry in
London. Domestic British industries have also been hurt by this because it's made it harder
to compete with regional peers in the EU, who also have the advantage of more favourable trade
deals now that the UK is no longer a member, as well as other emerging rivals around the world.
What's more is that the UK, which was once the global leader in industrialisation,
now has ageing infrastructure, declining education and weak utilisation of technology,
which is making its workers less productive, less globally competitive and therefore less
well compensated. Workers in the UK in high-skilled jobs can earn much more in places like the USA,
Canada, Australia and even Asian financial hubs like Singapore, Hong Kong and Shanghai.
This is causing a weird situation where the UK has a lot of people migrating to the country from
undeveloped economies to find a better life with better opportunities, and equally a lot of people
moving out of the country to find an even better life with even better opportunities.
The net result of this in and out gaming is clear though, the UK brings in more people
than it loses for now, but it's losing a lot of highly skilled workers and it's been losing more
and more every year since 2007. If the trend continues the UK will end up with a declining
population, it's missing all of its most productive workers. This overall negative
outlook has in turn made the UK an even less desirable place to make investments,
or start a business or begin a career. Advanced high-income countries, which again the UK still
is on average, usually have one last defence against these problems, which is that their
own wealthy citizens can make up for the lack of foreign investment and ease problems like
national debt. Japan for example has the highest debt to GDP ratio in the world, but not too many
economists are particularly concerned about it, because most of their debt is owed at very low
interest rates to their own people. The UK also has lots of wealthy residents that can make
necessary investments into the economy, but just like foreign investors they are choosing to invest
their money into other countries that have a more predictable future. The gap between foreign
direct investment outflows and inflows is at its highest level ever in the UK since the GFC.
Now while all of this might seem overly theoretical, it's having very real impacts in the UK as the
country struggles with regional poverty from a growing number of people that can't afford to
live in their own country. Unfortunately if these problems persist they are likely to only feed off
each other just like in 1992 as more and more desperate attempts are made to maintain the sinking
ship. Now we've made an entire video last year on the other challenges the UK economy is facing,
so for regular viewers we didn't want to repeat too much here, but if you haven't seen that video
you should be able to click to it on your screen now. Thanks for watching mate, bye.