UK economy enters a dangerous phase

A superficial look at the UK economy is reassuring. Unemployment is decreasing, inflation is tame, gross domestic product is advancing.

London is teeming with tourists, restaurants in the central areas are full and the traditional shopping districts, like Oxford Street and Regent Street, are as busy as ever.

But look deeper and the cracks begin to appear.

Cuts in local government spending mean that areas situated further out than the traditional tourist-beaten track aren’t as clean and safe as they used to be.

The number of people using food banks has shot up. Kellogg’s has decided to make a very public promise on its cereal boxes that they would sponsor children to ensure they don’t go to school on an empty stomach – something that until a few years ago would have been unthinkable for a developed country.

The Bank of England’s policy of printing money – or quantitative easing, as the process of buying government debt to flood the markets with liquidity has been politely named – coupled with the government’s austerity measures have widened inequality.

The Bank of England pushed up inflation initially, as well as creating an asset price bubble, which has resulted in homes in London priced beyond the reach of most buyers on “normal” salaries.

The government’s welfare expenditure cuts have pushed many families into poverty, especially in London where surging housing costs have eaten into disposable revenue.

So far, the poor were the most visible victims of these policies but recently the signs that the middle class is suffering as well have been many – and worrying.

UK economy likely to slow

A visit to Sainsbury’s, for instance, shows just how desperate mainstream supermarkets are to retain shoppers. The UK’s second-largest supermarket is slashing prices, and advertising this move on highly-visible orange stickers.

Market leader Tesco – still reeling after it had to admit it had mistakenly over-stated profits – is also cutting prices and increasing the number of bargains in an effort to lure shoppers back from discounters like Lidl and Aldi, which have seen brisk business since the financial crisis started.

The main problem is one that has been insufficiently studied: falling wages. Since the beginning of the crisis, the middle classes have suffered the biggest fall in incomes in the post-war period.

UK Economy and Wages

The UK economy has been under pressure because of falling wages. Source: HSBC.

The extremist UKIP party has blamed this on immigration from the European Union, and the Conservatives in government did not openly combat this idea.

It is useful for the Conservatives to blame immigration for a problem that they cannot solve, even though wages have fallen even in sectors of the economy where immigration is negligible.

What happened at the beginning of the crisis was that companies cut wages even if they still had some room for manoeuvring, to ensure that they met profit targets.

With a lag, this has reverberated throughout the economy. The effects of the wage cuts were initially hidden by the fact that prices of imported goods rose as the Bank of England debased the currency with money printing.

But over the longer term, the weak pound compounded the problem as initial inflation cut even more into the middle classes’ purchasing power.

This explains the exodus of the middle class shoppers to the discounters and also the weakness of the recovery.

The problem now is that the cost-cutting culture has become so entrenched that it would take a very sharp increase in external and domestic demand for companies to be persuaded to raise wages.

Pushing down revenue, via fiscal austerity and cost cuts in the private sector, does not chime with increased consumption.

The Bank of England – whose Monetary Policy Committee meets this week to discuss monetary policy – now risks undermining even the weak recovery if it rushes into raising rates.

Some economists argue that it should stand pat until inflation is way above target, pointing to a cooling off of the London housing market in recent months.

It may be forced too, as well. Turbulence is likely to be on the rise for the UK before next year’s election. Issues that are crucial for the UK economy, such as EU membership, will feature high in the debates. Not the best time to be raising interest rates.