UK set to recover 5th place in global economic league
25 April 2014
The latest IMF economic forecast grabbed the headlines in the UK earlier this month when it suggested that the UK would be the fastest growing G7 economy in 2014. This encouraged me to go back to the IMF’s database and work out how often this had been the case in the past. I was pleasantly surprised by the results.
The IMF reports economic growth figures back to 1980. Since then, there have been 8 previous years when the UK economy has topped the G7 growth league (1986/7, 1993/4/5, 2001/3/7). If the IMF forecast is correct, we will match the current league champions – the United States – which has topped the G7 league 9 times since 1980. Japan has also topped the G7 league 8 times. Their glory days were in the 1980s, but they have performed much better recently – a bit like Liverpool FC in the Premier League! The other countries which have been at the top of the G7 league since 1980 are Canada (5 years) and Germany (4 years). The two other G7 economies - France and Italy - score the classic “nul points” in this competition; neither has topped the G7 growth league since 1980.
I was encouraged to look further at the UK’s performance in the G7 league since 1980. The United States benefits from having strong population growth. So a better measure of underlying economic performance is GDP per head of population. As the chart below illustrates, this comparison shows the UK is the star performer in the G7 by a long way since 1980. We are the only G7 economy in which GDP/head will have doubled between 1980 and the mid-2010s. In France and Italy, the increase in living standards has been just 40-50% over the same period. In the other G7 economies, the rise in GDP/head has been between 60% and 85% over the same period.
So what does this say for the UK’s standing in the world economy? There are two measures available which can be used to gauge how important the UK is in the current global economic order. One is the size of our economy measured at market exchange rates – the values at which currencies are traded on a day-by-day basis. The other approach is to measure the value of economies using an adjusted exchange rate called Purchasing Power Parity (PPP). The PPP concept aims to measure what your money will buy, rather than its value on foreign exchange markets. In international comparisons, this tends to favour emerging market economies where the cost of housing and services is lower than in more mature western economies.
In PPP terms, the UK is currently in a group of economies (including Brazil, Russia and France) challenging to be the 6th largest in the world – behind the US, China, Japan, Germany and India. But I am somewhat sceptical of these comparisons based on a PPP exchange rate driven by a set of economic assumptions. No investment or business transactions are conducted at PPP exchange rates. Investors and businesses use the market exchange rate, so that is perhaps the best measure for assessing the relative importance of economies in the world economy of today.
Using market exchange rates, the UK is currently the 6th largest economy in the world – and should overtake France and become the 5th largest in the next couple of years, according to the IMF’s latest forecast. Indeed, if the pound appreciates more than the IMF expects – and rises against the euro to €1.25 (which would still be considerably below its historical average level of €1.38) – that would take the UK economy back to 5th place in the global rankings by the end of this year (see chart). This outcome seems quite likely, given the prospect that UK interest rates will start to rise considerably ahead of the euro area.
The UK economy now appears set to regain the position it enjoyed in world economic rankings before the financial crisis – 5th place behind the US, China, Japan and Germany. All these economies have bigger populations than us – so 5th place in the world will as “good as it gets” for Britain in the modern global economy. With the French economy struggling, and the pound appreciating against the euro, the UK should resume its 5th position soon, quite possibly by the end of this year. That should be a cause for national celebration!