The UK may have returned to growth, but with its budget deficit still dangerously high, the economy largely failing in its drive to develop non-banking sectors and a lack of political ambition to solve either of these problems, it is only a matter of time before it falls back into a recession. 

The UK’s economy may be growing at 2.5% and creating lots of new jobs but there is a high risk of it returning to crisis before long. Things are not helped by national elections on May 7, in which none of the contesting parties has a watertight plan to deal with even the short-term challenges the country faces, yet alone the long-term ones.

For banks, the good news is that they cannot be blamed solely for the next crisis, as they were for the last one, but it also means that raising return on equity levels to reasonable levels will become that much harder.

What is the problem? Quite simply, the key numbers are terrible. According to the OECD, after five years of 'austerity' the UK’s budget deficit is 5.3%, down from 11.2% in 2009. In other words, it has gone from being close to meltdown to a situation that is merely dreadful. Since the government is spending more than it earns, it is hardly surprising that it is borrowing more, and that the debt-to-GDP has risen from 68.95% in 2009 to 93.30% in 2013, again according to OECD figures.

US economists Carmen Reinhart and Kenneth Rogoff argue that once the debt-to-GDP level breaches 90%, a country’s debt burden starts to impact on growth rates and there is a risk of market panics. In other words, it gets into a debt spiral from which breakout becomes increasingly harder. While this is not happening to the UK yet there are clearly risks ahead.

As the UK is currently growing it should really be running a budget surplus, providing it with the means to run deficit financing during the next downturn. This is one of the tenets of the Keynesian philosophy that underpins a lot of left-of-centre economic thinking. Unfortunately Europe’s political parties of all persuasions have bastardised Keynes' ideas – running deficits in both good and bad times – so as to render them almost meaningless.

The UK needs a big structural shift to make it competitive again. It was definitely too dependent on banking and finance prior to the crisis, but while regulation has clipped that sector’s wings, progress in other areas, such as advanced manufacturing, has been mixed. 

Rising inequality in the UK and other advanced economies is caused by technological advancement and globalisation. The white-collar admin and accounts jobs that provided middle-ranking jobs are now being outsourced overseas leaving highly paid professionals at the top, and low-level poor-paying service jobs at the bottom.

To make matters worse the UK, again similar to most advanced economies, is an ageing society with pension, welfare and healthcare systems that are wrongly structured and financially unsustainable. 

No UK political party contesting the election has anything serious in the way of a solution to any of these problems. They do not even have a proper solution to the short-term problem of making the books balance. There is a set of marginal tax increases and marginal spending cuts on offer but no single policy that would change the game or 're-engineer' the economy.

We can blame the politicians for failing to be honest with the electorate about the challenges ahead. Or we could blame the voters who punish at the ballot box any party that tells them anything other than good news and wants to hear that taxes can be cut, spending raised and the budget balanced all at the same time.

Either way, the prospects for the UK, as well as for other European countries stuck in a mire of debt and deficits, are far from good. Asian economies can be expected to outgun them in the next few years. For banks confined to the UK domestic market, the going may be tougher than expected, and for banks that were obliged to retreat from overseas markets, such as Royal Bank of Scotland – as a consequence of being bailed out – finding growth opportunities will be that much harder.

Brian Caplen is the editor of The Banker.

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