Why Britain Stopped Growing

Paul Johnson

We've had now nearly two decades of really poor economic growth. Average earnings today are pretty much the same as they were 20 years ago — that is really unparalleled in British history, for probably 200 years. So you get a fed-up electorate, you get chaotic politics, you get less growth, and you get an even more fed-up electorate. And I think that's the horrible spiral we're in at the moment.

Paul Johnson

You're right, it's nevertheless extraordinary. The Labour Party won an enormous majority, having been out of office for 14 years — and actually in 2019 looking like they might be out of office for another 14 years. So it was an amazing turnaround, a big, big victory a couple of years ago.

But the prime minister lost popularity very quickly, partly because the manifesto on which he ran didn't really reflect the decisions he was going to take as soon as he got into office. So he started doing things some of us would argue were quite sensible — small reductions in some of the benefits that people at state pension age received — but there were also some very big tax rises, despite the fact his manifesto said he wouldn't introduce big tax rises. And then there has been a series of missteps around personnel. Peter Mandelson, our ambassador to the United States, appointed by Keir Starmer, turned out to have unhealthily close connections with Jeffrey Epstein. There have been a series of other issues with the prime minister's judgment, and he's become incredibly unpopular — probably more unpopular than it's easy to explain. He's a decent, hardworking, honourable man, but has really failed to connect with the electorate since the election.

Just looking at previous prime ministers: we saw that when Rishi Sunak was coming to the end of his time, he was pretty unpopular too, or at least the Conservative Party was very unpopular. You had Liz Truss, which was as close to a disaster as you could get — at least that's how she's remembered at this point. And you had a lot of resentment towards Boris Johnson, especially coming out of COVID and all his antics there.

Paul Johnson

You're right. It's been a combination of the two. I think it's fair to say we've not had the world's greatest leaders over the last ten years, but they've also inherited a really, really difficult situation. The first couple tripped up over Brexit and how to actually achieve it. Then we had absolute chaos, as you say, with Liz Truss. Part of the problem is that between elections, prime ministers are effectively elected by a very small number of people in their own political party, and we got a slightly strange outcome with Truss.

But I think the overall story is: prime ministers are unpopular because people are not feeling well off. We've had now nearly two decades of really, really poor economic growth. Average earnings today are pretty much the same as they were 20 years ago — that is really unparalleled in British history, for probably 200 years. That's why people now talk about a cost-of-living crisis. Inflation in the UK has been higher than in most other developed economies for quite a long time, and the result is that the electorate is really pretty fed up. Now, with a fed-up electorate, we're getting fairly chaotic politics — but of course chaotic politics makes it difficult to produce the stable policies and the growth that might get you out of that spiral. So you get a fed-up electorate, you get chaotic politics, you get less growth, and you get an even more fed-up electorate. That's the horrible spiral we're in at the moment.

Paul Johnson

In one sense it's that lack of growth. We've had very little in the way of productivity growth for a very long time. Why? Partly we were particularly badly affected by the financial crisis — we've got a very big financial sector, particularly in London. Partly Brexit and the uncertainty that happened after 2016; there's a general acceptance that cut a few percentage points off growth. But I think it's a combination of that with some pretty poor policy choices. We've got a very difficult planning system — it's very hard to build stuff here. There are certainly elements of our education system that could be better. And an incredibly complicated tax system, which is definitely creating problems for growth. It's worth saying many European countries are struggling — we're just struggling more than most of the rest.

Paul Johnson

That's a very good question. The straightforward answer is: we don't know. And it's quite remarkable — it looks like he's almost definitely going to become prime minister very quickly, because Labour politicians are essentially all going to back him, but they're backing him off the back of a general sense that he's a better politician than Keir Starmer, and a general sense that he might be a little more left-wing, because the Labour Party is probably a little to the left of what Starmer has been doing.

What he would actually do, he's said very little. There's a bit of a joke, to be honest, over here — he's changed his views a lot over the last 30 years. He's been in politics a long time; he's moved from the Blairite, New Labour, quite moderate Labour of the 2000s, went quite a long way left in the 2010s, and has painted himself a picture as an independent mayor up in Manchester — he calls it a form of business-friendly socialism. How that plays out on the national stage, we don't know. He's toyed with greater public control of some industries, but we don't know what that means — highly unlikely to be full-scale nationalisation. He's gone back and forwards on higher levels of taxes, and back and forwards a bit on whether he's going to borrow more. So the only honest answer I can give you is: I don't know what his economic policy is going to be, except that I think his instincts are somewhere to the left of the current government.

Paul Johnson

Well, it depends — a consensus among whom. I think there's a little bit of a consensus among technocrats, but we technocrats tend to have solutions that politicians find rather difficult to implement. Tax reform is quite difficult when people aren't getting better off, because that will mean some people are left worse off by reforming the tax system. Making it much easier to build things is quite unpopular with people who live near where the roads, or whatever it is, are going to get built. Spending more on investment, if that means spending less on welfare, for example, is also unpopular in the short term. So among technocrats there are some pretty well-worn ideas about what you need to get growth, but politicians for a long time have shied away from doing those things because they appear electorally unpopular.

Brian Kersmanc

Thank you very much for having me. The first thing I'll go back to is that we were actually fairly constructive on energy even before any of this started. Our view was that we came into this year expecting a bit of a supply glut in crude oil, because a lot of the energy companies globally — especially the swing producers in the US — were slowing things down; you saw rig counts coming down, adjusting for the oversupply that was supposed to happen this year into next. And some really high-quality operators are going to put up extremely strong earnings even at a $60-a-barrel price tag. What you can definitively say is that even if the strait magically opened tomorrow and everything came back on line logistically, you're looking at an $80-plus environment — the glut is gone. Even now, a company like Exxon, if the price of oil stays at $65 a barrel, can still do almost 20% total return, with about 13% EPS growth, or CAGR, over the next couple of years. That looks really attractive either way.

To get to your question more directly: one of the things we've seen come out of this is that Iran can talk about closing the strait, and there's an almost asymmetric impact to that information — just the talk of closing it back down sends insurance prices through the roof, slows shipping, and makes people reluctant to send freighters back in, regardless of how many are getting out at any given point. So there are a lot of logistical challenges, and you can argue that supply will stay constrained for a bit longer than the market has priced in.

Brian Kersmanc

What I think is the case at this point is that you probably do have a higher floor. Number one, you've taken out that supply glut, so the price of oil should permanently be a little higher. There should be some level of risk premium to compensate for getting that oil out of the Persian Gulf. A lot of the energy companies we talk to, when they go to contract ships, aren't necessarily sending ships in anytime soon — they're waiting several months to see if there's more clarity. Maersk itself has talked about not necessarily changing its plans and sending ships back in. So there's a delay, a lag, and I think it'll be a long time before there's a true return to normality.

So then the next question is: why is oil sitting at the price it is right now? That's really interesting, because with everything going on — you're taking almost a fifth of the world's energy capacity out and locked in the strait — you'd expect energy prices to be substantially higher. Yet here we are, sitting in the 70s, almost $80 a barrel. What I think you're seeing is two things. First, you've offset a decent amount of that lost supply through inventory draw — well publicised, but what's interesting is that even last week we had a 17-million-barrel draw off both US inventories and the SPR, on top of about 16 million the week before and maybe 15 the week before that. So you're getting these subsidised barrels working their way through the system, consistently offsetting whatever you'd have lost from the strait. You've also seen China tap the brakes a little — they have massive oil reserves, so they've slowed their imports and drawn down their own finished-product inventory, which is also helping keep the price a little lower. That, combined with the fact that shipping through the strait is so expensive, means everybody's sitting on their hands, telling themselves this thing will be over in six weeks, eight weeks, another month or two, so they'll wait for the price to come down a bit before refilling inventories. It's a bit like the transitory argument, or the old variable-mortgage-rate argument — I'll take the lower rate now because I believe it'll go down later. That works unless it doesn't. If the strait stays closed or constrained for longer, you have to start buying barrels at a higher price, and that's when physical prices come back up as inventories hit bottom.

What concerns us a little is that when you look at the data, Cushing, Oklahoma is essentially at effective tank bottoms — about 20 million barrels. Go any lower and you start getting rust and sludge coming through; it's not really usable below that level. US gasoline inventories are around 214 million barrels right now, and from what we've heard, about 195 to 215 is the operational minimum — get any less fuel in the tanks and you start seeing plastic over the gas pumps. So we're at pretty low levels right now, and Trump even said as much: we'd be in a really bad situation within four weeks if things didn't clarify themselves. That's why you're seeing the negotiations being pushed as hard as they are, and the concessions being made in the Iranian situation.

Brian Kersmanc

One of the things you can already see, in terms of higher fuel input costs and energy costs, is that it's starting to have an impact — though it may be somewhat muted, because we've only gone through one earnings cycle and had a partial impact so far. Retailers like Walmart, Costco, and the dollar stores have all talked about consumers facing sharper pricing, and having to absorb some of that on their behalf. They particularly benefit because consumers trade down to so-called inferior goods, moving away from more expensive places to shop — so that helps them, but in the grand scheme of things it's hurting purchasing power. You hear this from industrial players too, who say they'll have to start incorporating higher transportation and diesel costs on a longer-term basis over the next couple of quarters if this doesn't rectify itself. Shipping companies like Maersk have said spot rates are up 40% since the strait closure began. That filters into everything in the global economy, so I'd argue it does put upward pressure on inflation — you saw that in the PPI data, which was incredibly strong in May, almost double digits, on both goods and services.

So I think this is starting to come through, and what you're hearing from the markets is that people are moving out of the mode of "we need Fed cuts because the economy might be struggling" — the economy seems to be doing okay despite all this. What you're hearing instead is that we've undershot on inflation for so long, and Powell has said more recently that the Fed has a singular focus now on price stability — he made that very clear in his comments. If that's becoming more of a focus, it has large implications, especially for a market that's so lopsided on tech right now, and tech is generally extremely sensitive to interest rates in terms of long-term valuation, while also going through massive debt-raising at this point in time. That's going to be much more expensive for all this capital build-up.