Why Is UK Going Bankrupt?

In the simplest of words, Murphy’s law says, if anything has to go wrong it will. The United Kingdom (UK) is a perfect example of this adage, who are now going through a perfect storm. Whatever can go wrong in their economy is going wrong. Fuel prices are rising, the cost of living is going up, people are losing their jobs, salaries are getting cut, and the European Union (EU) cushion for trade is no longer there after Brexit. The Russia-Ukraine war has added fuel to the fire, with energy supplies being cut down. The last hammer on the head is the new government in power which may or may not survive its tenure. In fact, Paris-based OECD is saying the UK economy is set for a zero per cent growth rate.

CPI Inflation, source: Office of National Statistics, UK 

As we can see in the graph above, inflation is rising constantly, and has hit a double digit as we read this today. 

What led to this crisis?

  • The 2008 financial crisis and Covid 19

The UK stood for stability, especially in the last 500 years. Be it the era of colonisation, world wars, pandemics, or epidemics. It is this stability that attracts the top banks globally, like HSBC, Barclays, Standard Chartered, etc who have their global headquarters there. These stalwarts were set to collapse after the 2008 financial crisis. The solution to this was to push more money into the hands of the people. For example, the housing loan interest rates collapsed from 6.3 per cent to 2.5 per cent. The money remained in the hands of the people, increasing their Purchasing Power Parity (PPP). In economic terms, we call it ‘quantitative easing’. The catch is, these rates kept collapsing and were at 1.2 percent a few months ago. This is not sustainable for an economy and can lead to cascading issues like inflation.

The UK government had to take corrective measures for the same, especially once the Covid-19 pandemic struck. The interest rates were highest in the last 14 years. Now families were spending about one-third of their income just paying up mortgages. Given how suddenly this burden came, people were not prepared. As per Office for National Statistics, the UK, the CPI (consumer price index) rose by 8.8 per cent in 12 months to September this year. 

Britain was a part of the European Union, so it had many trades and mobility perks. For a country to grow, you need a skilled workforce. Workers from other parts of the EU would visit the UK to work, which has slumped after Brexit. For example, if you do not have transposition personnel, you cannot deliver goods to the market on time. This will push up the cost of essential goods, leading to inflation. UK today is in a position of stagflation (rising unemployment and nil economic growth, that is, the price of goods is rising, there is no economic growth, and people are losing their jobs).

Even before Boris Johnson resigned as the prime minister, the UK economy was in a bubble. After him, Liz Truss became the new PM. She tried the techniques of tax reforms, deregulation, and reforms to provide relief to big businesses. The rich (earning more than 1.5 lakh pounds a year) used to pay 45 per cent tax, which was cut down substantially. Corporate tax was set to be anything between 19 to 25 per cent from next year onwards. This angered the people even more. In effect, if tax cuts are implemented, the UK will have to take up a loan which will add to its deficit. After this scenario came to the forefront, Lis Struss took some hard decisions to salvage the scenario. For example, she fired the UK finance minister, the 45 per cent tax bracket for the rich will remain, and corporate tax will be 25 percent from 2023.

As we mentioned earlier, UK’s biggest strength is its stability, which is what is being threatened now. Investors are selling the Pound, weakening its value against the Dollar. In fact, it is at its lowest value ever. The International Monitory Fund (IMF) has also issued a warning to the UK regarding its economic state. The Russia-Ukraine war has led Russia to cut off gas supplies to UK, pushing up the latter’s electricity cost by almost 100 per cent. Given that winter is about to set in, the energy consumption will be at an all time high in Europe, including UK. Even if energy is stored, it lasts only an average of 90 days. Given the high cost of energy, the cost of manufacturing has gone up, at a record level of 9.9 per cent. Recognising this, the UK PM announced a mini budget in September 2022. This too backfired and created more disruption. in the budget, the government introduced a cap of 280 pound per MW hour for electricity prices. The power companies were not able to even recover their cost of production, leave alone make a profit on this cap.  In a nutshell, whatever can go wrong in an economy is going wrong.

The UK is quintessential to what isolation tendencies without allies can do. An inward-looking economy is not sustainable in the long run. Also, countries globally have to re-evaluate their policies a hundred times before implementing them, especially regarding interest rates. All these factors are not just bad for the economy of a country, but its image in the international market as well. There are no free lunches in the world, and a country will have to pay for them sooner than later.

Source