Why is the UK economy doing so well given the current political instability?

Economists are not very good at predictions. All the stuff the profession has accumulated to try to forecast the economy depends on past performance. Trouble is, there was no last time for the Brexit vote

It’s odd. The UK government is staggering on from knife-edge vote to knife-edge vote in the House of Commons. Companies are warning of cutting investment in the UK and are starting to plan for a no-deal Brexit. Frankfurt, Paris, Amsterdam, Paris and Dublin are gleefully welcoming bankers from the City, while sterling is at its lowest against the dollar this year.

However, the economy continues to grow. As we learnt this week it has been creating jobs in the past three months at an annual rate of more than half a million a year. Employment as a proportion of the population is the highest since records began and unemployment is at its lowest since May 1975. And all this is two years on from the Brexit vote, taken after the treasury warning that a vote for Leave would, in two years, lead to an increase of between 500,000 and 800,000 being unemployed. That report noted that both the Bank of England and International Monetary Fund (IMF) warned that the vote might lead to a recession.

Well, they were wrong on every point except one: that sterling would fall sharply. It has done. On the wider issue, the resilience of the UK economy, we don’t have a satisfactory explanation yet and won’t for some time. But I think we can see bits of the story.

The first is that while domestic economic policies certainly influence what happens to an economy, big global agreements (and disagreements) seem to be less important. For example, much is made of the UK’s membership of the EU single market, formally founded in 1993. Since then, UK exports to the EU have grown on average by about 1.5 per cent a year. Exports to the rest of the world, however, have grown by about 2.5 per cent a year. That does not mean that the single market has been a failure, for it is possible that our exports to Europe would have grown even more slowly. It does mean that other forces – general competitiveness, quality of management and labour force, growth of export markets and so on – matter more.

A second is that exchange rates matter a lot. If a country has an overvalued exchange rate, as has for example Italy, it is a real struggle to generate growth. If you have an undervalued one, as sterling is at the moment, there may be long-term costs, but in the short and medium term it will sustain demand. The more open an economy the more impact it has and the UK is unusually open.

A third is that all developed world economies are driven mainly by consumer demand. In the case of the UK, household final consumption as it is called, is 66 per cent of GDP – rather high when compared to most other countries, bar the US. How much money we spend is determined by many things. Pay is at the top of course, but other things matter too: job opportunities, ability to borrow cheaply, the value of our assets including our homes and the feeling of a need to save. As long as the job market holds up and there is no crash in house prices, people will keep on spending.

As a side bar to that, Britons and Americans seem particularly relaxed about spending. If they have a bit of extra money they use it to buy something. Contrast that with Germans or Japanese, who will save it. National stereotyping? Well, yes, but supported by facts: consumption in the US is 70 per cent of GDP, whereas in Germany it is 56 per cent and Japan 55 per cent. This is not to say that having high consumption is good or bad as such. The point is simply that consumption does give a certain resilience to external shocks.

I think there is a wider point here. Economists are not very good at predictions. All the stuff the profession has accumulated to try to forecast the economy depends on past performance: what happened in similar situations last time. Trouble is, there was no last time for the Brexit vote. Add to that what is, I am afraid, a negative bias among a majority of economists towards the UK at the moment and you have a series of forecasts that have been plain wrong. Because people have been led to expect disaster, they are surprised when things turn out not too badly – or in the case of employment and unemployment, very well.

To be clear, that Brexit vote probably has had some negative impact on the economy. We would have grown a bit faster, created yet more jobs and sucked in even more immigrants to fill them. Interest rates would have risen faster and the pound would be stronger. It is possible too that were there to be a so-called hard Brexit next year – leaving the EU without a trade deal – that this current resilience would be sorely tested. I am worried too about some sort of general global downturn. But the past two years have been a lesson for us all: if you have a reasonably successful economy it takes a lot of political nonsense to muck it up.