Recent elections in Hungary and the Netherlands, along with Trump 2.0’s flagging support, led some to speculate that world-wide political populism may be peaking. However, these hopes were dashed by the UK local election results in which Reform UK was the big winner, and nationalist parties took control in Scotland, Wales, and Northern Ireland.

In many European countries, meanwhile, mainstream parties have established coalitions to prevent populist parties from taking power. In next year’s French election, however, it’s not inconceiveable the National Rally will take control. And, while the UK general election is still three years away, can Reform’s popularity will be sustained? Meanwhile, given the collapsing support for both the UK Labour and Conservative parties, it’s not clear a coalition exists to prevent Nigel Farage from becoming the Prime Minister after the general election.

To curb the populist wave, the established parties must demonstrate they can deliver the rising living standards the populations crave. The UK economy has been virtually stagnant since the Global Financial Crisis. Indeed, the economy has never recovered properly from the shocks of the GFC, Brexit, and Covid: GDP has advanced only 1% annually since 2007, roughly half that of the USA.

Financial markets are sceptical the United Kingdom can turn things around. Indeed, UK bond yields are the highest amongst the G7 nations; exceeding those in France, Italy, Spain, and even Greece by up to 150bp. Can Labour deliver the change it promised, especially if the party lurches to the left following the recent election (regardless of who’s Prime Minister)? Can Reform UK retain the backing of the traditionally Labour-voting working class who believe they did not share in the pre-GFC economic growth? This will require delivering the prosperity and public services demanded without blowing up the UK’s already fragile fiscal position.

Populist Prescription is not the Answer

In part, Reform UK’s popularity (like that of its predecessors UKIP and the Brexit Party) reflects the grievance amongst a segment of the population that believes (correctly) the benefits of globalisation were not widely shared. Their policy prescription has been to retreat from international trade (Brexit) and end the free, international movement of labour (reducing immigration).

Brexit: Corrosive Damage to Continue

But, how’s this working? The Chart above reveals that since the 2016 Brexit referendum, the UK economy has underperformed the European Union (and even the beleaguered Eurozone). The deficit with the USA is even more pronounced. On the one hand, weak income growth has led to a huge shortfall in consumer spending — no wonder households are so discouraged. Perhaps more importantly, however, business investment has lagged for behind: rising 11% in the UK compared to 24% in the EU, and 36% in the USA.

Meanwhile, Brexit supporters have been optimistic that outside the EU the UK could negotiate favourable trade deals with third parties. And, while there have been some relatively small agreements, the UK has fallen behind other G7 nations on trade growth (Chart above), especially in terms of goods exports. Fortunately, the UK has continued to capitalise on its comparative advantage in services (to be discussed later). Given the Trump 2.0 trade and security strategy, the USA is unlikely to be a reliable trading partner in the near future. While there’s no political gain in rehashing the Brexit debate, improving ties with the EU will be important to boosting UK prosperity in the coming period.

Immigration: Turning the Corner?

The UK public’s adverse reaction to the pressures put on public services by immigration is understandable. Reform UK has capitalised on this discontent. Finally, however, recent net migration data indicates considerable progress is now being made to reduce the unsustainably high level of inflows (Chart above). Indeed, the number of new arrivals declined 20% last year.

The data also cast doubts on other public anxieties. Many have expressed concern that rising taxes are encouraging UK citizens to move abroad. However, UK emigrants totaled 246,000 in 2025, roughly the same as the past two years. The bulk of emigration out of the UK is high-skilled EU nationals going home after Brexit.

Another concern about immigration is that low-skilled foreign workers reduce opportunities and wages for less-educated local employees. Prior to Brexit, however, UK immigrants were largely high-skilled, university graduates (Chart above). On the other hand, the share of low-skilled immigrants in Germany, France, Italy, and Spain is much higher than in the United Kingdom. Post Brexit, the UK now is experiencing the worst combination: high-skilled EU workers are leaving, while low-skilled non-EU immigration has risen.

To be sure, there is still much to do. And, while illegal, small-boat crossings represent only 4% of immigration, everyone agrees these dangerous journeys must end, and no one wants to pay the bill for their accommodation. Fortunately, there’s some tenative indication that this activity is peaking, and hotel occupancy is down 65% from its 2023 peak. Nevertheless, processing asylum applications takes far too long: 80,000 asylum seekers are awaiting appeal decisions on their application, up 90% from last year (Chart above).

All About Growth: Creating an Innovation Economy

The Starmer government understands the importance of lifting the nation’s long-term growth potential. Indeed, its 2025 industrial strategy outlines the need to foucus on the countries strengths in AI, health care, services, finance etc. Indeed, the Chart above illustrates the UK’s success in capitalising on its competitive egde in service trade. Despite the best intentions, however, the government has not delivered the promised growth.

#1 Boosting Chronically Low Investment

All government policies, as well as alternatives offered by opposition parties, must be assesses as to how they address the key headwinds to growth. First of all, the UK suffers from a chronically low level of investment (Chart above). Public sector infrastructure investment must be a priority (as it is). The UK also lags other key countries on R&D spending — both public and private (next Chart).

Despite a world-class university system, the UK fails to turn innovation into commercial success. The fragmentation of the European Single Market incentivises entrepeneurs to move the USA. Likely, venture capital and financing for start-ups lags the USA. Strict planning regulations impeded both public and private investment.

#2 Solving the Productivity Puzzle

In addition, like many other countries, the UK has experienced a sharp deceleration in productivity growth since the GFC (Chart above). The UK slowdown, however, has been more dramatic than other advanced economies, largely reflecting the nation’s heavily reliance on the financial sector in the pre-GFC boom. The expanding gap with the USA is particulary acute and worrisome.

#3 Boosting Labour Supply

Finally, post-Covid the UK has been experiencing some skills shortages, largely reflecting greater health-related labour inactivity (Chart above). Not only does this strain public finances, but represents a drag on labour supply and long-term potential economic growth. Given the government’s success in reducing net immigration, Reform UK is now suggesting the number of foreign workers is also a problem. However, the share of foreign-born population is roughly similar to other European countries (next Chart). I think annual net migration of of 150,000 would help offset labour shortages; further cuts would be a drag on growth.

#4 Energy Security and Climate Change

The United Kingdom has an enviable climate change track record. Carbon Dioxide emissions per capita are amongst the lowest in advanced economies. And, the 60% decline in CO2 emissions in recent decades leaves other nations in the dust (next Chart). Much of the UK’s stellar performance stems from the development of renewable energy. Indeed, nearly half of UK electricity now is generated by renewables compared to 33% in the EU and only 18% in the USA.

Nevertheless, even though renewable sources now cost less than fossil fuels, UK industry and households pay much higher energy prices than other countries (next Chart). Businesses are left at a competitive disadvantage. One reason is that the UK relies more heavily on natural gas whose price has soared in recent years. Indeed, NG accounts for 30% of UK electricity generation compared to 15% in the EU. Further development of renewables and nuclear power would reduce reliance on natural gas. To be sure, increasing North Sea NG and oil production has important national security attributes. However, as the price is higher than more sustainable sources, electricity prices are unlikelt to benefit much.

Fiscal Policy: Priorities and Prosperity

Unfortunately, the UK confronts the need for structural change at time of historic budgetary vulnerability. Indeed, government debt is now over 100% of GDP compared to the 37% pre-GFC average — the Eurozone debt ratio stands at 87%. Unavoidable GFC and Covid spending is the main culprit, which now stands at 5% of GDP above the long-term average (next Chart). Complicating matters further, the spending pressures arising from an aging population and higher interest rates are more severe than in many other countries.

To it’s credit, the Starmer government has begun taking steps to stabilise spiralling debt. And, Chancellor Rachel Reeves understands that economic growth is the best remedy. However, given the government’s pledge to improve public services (after the previous Tory austerity era), the Chancellor’s efforts have relied heavily on higher taxes , which are now at unprecendented levels (next Chart).

The UK can’t tax its way to prosperity. Consequently, spending priorities need to shift toward public investment. Inevitably, the UK’s social benefits budget will need to be reformed. If the local election results (and perhaps a new PM) produce a shift to the Left, however, it’s hard to envision such a politically-damaging shift in spending priorities.

Market Implications:

• Given the economic challenges and upcoming political risks, one would expect UK markets to be cheap. However, the UK is expensive relative to other markets and its own history (Chart above). The UK could underperform other advanced markets in coming months.

• Likewise, sterling is not particulary cheap either (Chart above). I would expect GBR to weaken a bit in the months ahead.