My perspective on the prospect for 2023 remains very much as I have been predicting since mid-2022.
The global economy as well as the UK economy is caught in a repeat of the stagflation of the 1970s and 1980s. Oil prices quadrupled in October 1973 and again rose in 1979. Memories may be short, but the very word ‘stagflation’ was invented then. Until then we were all Keynesians and thought inflation and unemployment were alternatives, as along the famous Phillips Curve.
We abandoned Keynesianism (Butskellism as it was then called) as official policy and adopted monetarism. High levels of inflation (20% plus) and unemployment (3m plus) were experienced. It took Margaret Thatcher’s third election victory in 1987 and Chancellor Nigel Lawson’s tax cuts to achieve a turnaround. The US had a similar trajectory, with inflation untamed until Paul Volcker became Federal Reserve chair in 1979 and President Ronald Reagan reaped the benefits of the Arthur Laffer tax cuts.
The difference now is that the UK government lacks the depth of Thatcher’s cabinet. Prime Minister Rishi Sunak is clever but not a politician with much experience. The UK’s departure from the European Union is irreversible and will continue to exact its price on the UK economy. There is no end in sight for the Russia-Ukraine war. China is slowing down.
So I do not expect much cheer in the immediate short run. The US economy is showing greater resilience in its employment numbers but then it has no Brexit to contend with. It also has its own energy supply and never gave up on nuclear power. The EU is more in the same situation as the UK.
The question then is: is there any drastic change likely in the current stagflation compared to the last one? My guess is that the political turmoil in the Conservative party (which is profligate in discarding old prime ministers and taking on new ones – we are on the fifth since 2015) may yet come to the rescue of the UK economy. We could see an election in 2023. I would put the probability at somewhere over 60%. If that happens, the conditional probability of a change in the party in power is very high, say 80%.
The Labour party has not revealed its economic strategy, but Shadow Chancellor Rachel Reeves inspires confidence. When carefully examined, the Labour manifestos even in 2017 and 2019 were fiscally prudent (apart from the compulsion of nationalising everything in sight). Keir Starmer may yet prove to be a much more dynamic prime minister than leader of the opposition.
The advantage of a change in regime (even with a multi-party coalition of Labour, the Liberal Democrats and the Scottish National Party) is that there could be a settlement with the trade unions. The Conservatives were generous throwing money around on personal protective equipment and the furlough scheme during the pandemic but are reluctant to grant pay rises to public sector workers.
Labour could take a much more sensible attitude and pay up to repair the public sector damaged in the stressful days of the pandemic. (In any case, real interest rates on gilts are unlikely to move into positive territory.) The payment to unions could be justified as paying up for the extra depreciation in the public sector during the pandemic.
In the longer run, the prospect is more uncertain. During the last crisis from 1971-90, manufacturing moved from the West to Asia and not only globalised the economy with long supply chains but released developed economies to move on to services following the cyber revolution.
What can the British economy do to stay prosperous? Its financial market advantage is being eroded by Frankfurt and Paris. The UK economy will have to move to research and development-intensive areas like artificial intelligence, robotics and university-based scientific research to regain its prosperity.
It will require some hard political graft on part of whoever is in power.
Meghnad Desai is Emeritus Professor of Economics at the London School of Economics and Political Science, Chair of the OMFIF Advisory Council and Crossbench Peer in the House of Lords.