Reforming Global Finance

Britain’s Self-Defeating Blame Game

How justified are claims by Chancellor of the Exchequer George Osborne that the eurozone crisis is killing Britain’s economic recovery?

Bank of England (Credit: R. Nagy/


  • Portraying Britain as an innocent victim of eurozone policy errors misses the point that Britain's is a genuinely homemade malaise.
  • In Britain, the conservative-liberal coalition has largely lost its initial zeal for reform. It mostly lets the Bank of England paper over the cracks.
  • Even if the eurozone is not adjusting at the optimal speed, the region is at least adjusting. In a year or two, the hard work in the eurozone will be over.

At long last, Britain has found its villain. As Chancellor of the Exchequer George Osborne reportedly suggested in early June, it is the eurozone crisis that is killing the British economic recovery.

Osborne has a point. As a medium-sized island off the coast of the much larger European continent, Britain’s economy is bound to move up and down in line with the fortunes of its dominant trading partner on the other side of the English Channel.

Still, portraying Britain as an innocent victim of the eurozone’s policy errors misses the point that Britain’s is a genuinely homemade malaise. The eurozone crisis cannot explain why, in 2011, Britain had a fiscal deficit of 8.3% of its GDP, twice as high as the eurozone’s 4.1%. And if it is only the eurozone that is dragging Britain down, why did the UK’s GDP decline by 0.3% in the first quarter of 2012, while the eurozone’s only stagnated?

It helps to first look at the longer term. Since the start of Europe’s monetary union in 1999, Britain boosted its real GDP by 26.3%, ahead of the eurozone’s 20.4% gain. But Britain achieved this extra margin only at a terrifying cost.

To finance a giant surge in public spending and deal with the debris left over from the bursting of a real estate and financial bubble, the UK government borrowed so heavily that its ratio of public debt to GDP surged by 45.4 percentage points during that period.

This feat — for which the Labour governments (1997-2010) rather than the Conservative Osborne have to bear the blame — puts Britain ahead of even the 38.5 percentage point increase in the United States. For sure, the eurozone did not manage its public finances prudently either. However, with a rise in its debt-to-GDP ratio by a mere 13.6 points, the region did much less badly than the UK.

Why then is the eurozone rocked by such a dangerous crisis, while few investors seem to worry about Britain’s more dismal numbers? The simple answer has nothing to do with either economic growth or the public deficit. Think of the central bank instead.

In Britain, the Bank of England has readily bailed out its government at abandon. Whenever the economy sagged or financial markets got nervous, the BoE stepped in. Since the onset of its “quantitative easing” in March 2009, the BoE has bought £325 billion of bonds, equivalent to more than 21% of annual GDP.

Meanwhile, the European Central Bank purchased sovereign and mortgage bonds only to the tune of 3% of GDP. If the ECB had intervened with the same ease as the Bank of England, it would have acquired additional assets worth €1.6 trillion. That dwarfs the size of all “rescue shields” or “firewalls” ever discussed for the eurozone.

Put differently, Britain uses the printing press to postpone the day of fiscal reckoning. The eurozone does not. The ECB deliberately holds back until the last moment and lets a crisis happen before it finally intervenes. Yet the hard-nosed ECB approach has a major drawback: The eurozone is engulfed in a crisis that is scaring the world. Britain is not.

But the eurozone crisis strategy also serves a purpose. Under pressure, the eurozone is delivering much-needed fiscal repair and structural reforms. In Britain, the conservative-liberal coalition has largely lost its initial zeal for reform. It mostly lets the BoE paper over the cracks.

The “Three Ms” and the “Two Ps”

Of course, relying on the central bank is the easier option for Britain to pursue. But the fact that aggregate demand in Britain is not faring much better than in the eurozone says a lot about the innate problems of Britain’s overleveraged economy.

Yes, the euro crisis is extremely painful. The “Three Ms” — Markets, Merkel and Mario Draghi — are forcing countries such as Italy, Spain, Portugal and Ireland to repair their budgets and reform their economies in a rush.

And yes, the fiscal adjustment is too frontloaded and hence more painful than it should be. But even if the eurozone is not adjusting at the optimal speed, the region is at least adjusting. In a year or two, the hard work in the eurozone will be over.

The same cannot be said for the “Two Ps” – the two punters, Britain and the United States. For them, the pain will then still be ahead. And remember that Britain and the United States have a much bigger need for fiscal repair.

Britain’s inclination to distance itself ever more from the eurozone reflects not just a delusion that it is managing its affairs better than the benighted continentals. It is outright dangerous for Britain.

Britain’s economy has long been split into two different parts, the booming Greater London and the rest of the country, which is lagging far behind. The only major exception to that rule is the eastern part of Scotland, which is still living off gradually dwindling oil and gas reserves.

Thanks to Margaret Thatcher’s reforms in the 1980s, Greater London has become the services hub for Europe well beyond the realm of finance. But by distancing itself ever more from its neighbors, Britain has taken a first step toward transforming London from the onshore services center of Europe to the offshore services center for the eurozone.

And being an offshore center is a dangerous position to be in. At a European Union summit last December, for example, Britain obstructed a major change to the EU treaties, blocking a new set of fiscal rules that weren’t even meant to apply to Britain.

Other European countries were thus forced to find an awkward legal avenue around it. The more Britain resorts to such tactics, the bigger the risk that the continent will eventually strike back by limiting free access to the giant eurozone market to those countries who sign up to the rules of the club.

Doing so would be a huge mistake for everybody concerned, and we very much hope it will never come to that. But the ultimate risk that could arise from a widening split between Britain and the rest of Europe needs to be spelled out. If Greater London lost its access to its dominant market, all of Europe would be worse off — but Britain would suffer most.

Without a thriving Greater London as the services center for Europe, the British economy would no longer look much better than the economies of those small countries on the eurozone periphery that have been so much in the news lately.

Maybe a prudent Chancellor of the Exchequer should think twice before raising tensions by wagging a self-righteous finger at his country’s major partner and market.

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About Holger Schmieding

Holger Schmieding is chief economist at Berenberg Bank in London. [United Kingdom] Follow him @Berenberg_Econ

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