U.K. Economy Driven by Government Spending Financed Abroad

According to the third reading published today, the British economy showed surprising strength and grew 1.8% in real terms during the fourth quarter of this year compared to the same quarter last year. That is not much by historical british standards and it is clearly weak compared to most other countries outside of Western Europe and adjusted for terms of trade changes it is even less but it is still stronger than one would have expected given numbers that indicate that U.K. manufacturing is in a recession.

The explanation usually given is that the U.K. economy is transforming into a service economy. True, but if you look at the numbers you see that it is to a worryingly high extent government services. Between the fourth quarter of 2004 and the fourth quarter of 2005, government consumption rose from 21.4% to 22.1% of GDP. Moreover, government investment rose from 1.7% to 2.2%. Total government purchases thus rose from 23.1% to 24.3%. This means that private sector GDP hardly rose at all last year.

Not surprisingly, this meant that both the budget deficit and the current account deficit rose last year, despite various tax increases from Gordon Brown.

Despite all the talk of "New Labour"-Tony Blair and Gordon Brown is increasingly looking like "Old Labour" with their government spending surge financed by borrowing from foreigners. This also means that U.K. economic prospects is not particularly bright. While a large inflow of Eastern European workers and a turnaround in mortgage
lending together with strong global economic growth means that total GDP growth will likely remain positive this year, the current economic policies of Blair & Brown is worsening the longer term economic prospects of Britain.