Global trade disparities have been a persistent issue. Back in June 2006, prior to the onset of the 2008 financial crisis, the International Monetary Fund (IMF) initiated the first “multilateral consultation on global imbalances” to address these challenges.

This initiative aimed to methodically rectify imbalances while promoting global economic growth. Countries with trade surpluses, including Germany, Saudi Arabia, Japan, and China, were urged to engage in stronger spending and allow for increased currency valuations. In contrast, deficit countries such as the US and the UK were encouraged to enhance their savings. The IMF also issued warnings about the risks of protectionist policies.

While adjusting currency values, spending, and savings remains a valid approach to correcting trade imbalances, the tactics employed by the US regarding tariffs lack justification. Moreover, the current global economy may not possess the resilience required to withstand the repercussions of such tariff implementations.

Recently, the IMF revised its global growth projection for this year from 3.3% to 2.8%. For context, during the pre-crisis era, the IMF’s five-year growth estimates hovered around 4.5% to 5%. Over time, these expectations have steadily diminished to approximately 3%, a figure that was once considered indicative of a global recession but has now become the accepted standard.

Furthermore, the key drivers of global economic growth were already under threat prior to the current trade tensions. For much of this century, the combined growth of China and the US has accounted for half of global expansion.

Despite China’s economy showing a surprisingly robust growth rate of 5.4% over the last two quarters, its overall growth trajectory appears to be slowing. Concurrently, the US economy’s recent strong performance has been largely supported by an unsustainable budget deficit.

A global recession seems likely if the trade conflict remains unresolved. At a global scale, policymakers have only limited tools at their disposal. Debt levels are nearing historical highs, and central banks seem hesitant to pursue aggressive easing measures.

The changing landscape of global economics is further complicated by structural transformations. Globalization has begun to give way to fragmentation, free trade has been overshadowed by protectionism, and the intertwining of national security with economic viability has intensified since the pandemic.

Given the UK’s status as a major open economy, a global downturn would likely lead to diminished growth, lower trade volumes, reduced investment, and decreased confidence. This prevailing uncertainty complicates economic forecasting. The risk lies in policymakers reacting solely to the latest data instead of adopting a proactive approach.

Prior to the tariff announcements, financial analysts projected that the Bank of England would begin reducing interest rates from 4.5% to 4% this year, but current forecasts suggest a reduction to 3.5% now. Additionally, the value of Sterling has strengthened against a weakening dollar.

This situation also highlights the precarious state of the UK’s public finances, characterized by uncontrolled public expenditure and inadequate tax revenues amid a slowing economy and wealth outflow. Given the fiscal constraints and the need to maintain the confidence of international investors, Rachel Reeves is expected to pursue a pro-cyclical fiscal approach, leaning towards borrowing rather than increasing taxes.

This situation suggests that modest growth in the UK is the most likely scenario moving forward, prompting the question of whether there are effective policy measures to consider.

Domestically, the government’s adjustments to planning reforms are viewed positively and may yield benefits in the near future. Internationally, positive sentiment could also rise from finalizing trade agreements with India and the US. As two-thirds of the UK’s trade with the US is service-based and tariff-free, any potential trade deal needs to be beneficial to both parties and should not hinder the UK’s policy flexibility elsewhere.

Next month marks a pivotal moment for UK-EU relations, and while improved ties are welcome, it is vital to remember that regulatory alignment should not be equated with an all-encompassing solution. Germany’s economic downturn, Italy’s stagnation, and France’s sluggish growth reflect ongoing structural issues in the largest EU economies. Last year’s Draghi report on EU competitiveness indicated little immediate relief.

Significantly, the UK does not need to rejoin the EU’s single market or customs union, irrespective of the developments concerning US tariffs. Remaining outside the single market affords the UK regulatory autonomy in areas like artificial intelligence, a crucial sector for future growth, while also allowing for independent immigration policy management. Additionally, avoiding the customs union positions the UK favorably in a rapidly evolving global economy, particularly as most future growth is anticipated to emerge from the Indo-Pacific region, whereas Western Europe faces slow growth.

A new industrial policy is on the horizon. Historically, it was said that governments did not choose winners; rather, loss-making companies turned to the government for support. Fortunately, this notion has evolved, yet there remains skepticism regarding whether the forthcoming policy will effectively address the UK’s challenges of low growth and low productivity. According to a recent analysis by the Competition and Markets Authority, the eight sectors identified are already among the most productive, albeit with notably low investment levels.

All sectors, including the wider economy, grapple with high energy costs. This demands a strategic response while still adhering to commitments to a green agenda. An incremental approach is necessary; energy prices in the UK must be at least comparable to those of European counterparts. The focus should be on expanding energy supply, not merely substituting energy sources as many other nations strive toward renewables.

The economic rationale supports the integration of renewables into the existing energy landscape. As the costs decrease and technology improving reliability, renewables are expected to eventually replace fossil fuels. Currently, the UK is pursuing a strategy of substitution at a moment when renewable energy generation is minimal and is incurring high energy costs. A diversified energy mix requiring supplemental sources, such as nuclear, would be prudent.

In a climate of uncertainty, it is imperative for policy to manage controllable factors and implement credible measures that reduce expenses and stimulate the domestic economy.

Dr. Gerard Lyons serves as Chief Economic Strategist at Netwealth