The Productive Foundations of a Middle Power

What a US-UK rift would really mean for the UK economy

On Thursday, Donald Trump threatened to impose “a big tariff” on the United Kingdom unless it drops its digital services tax — a 2 per cent levy on US tech firms that raises roughly £800 million a year (CNBC; Time). It was the third such threat in a fortnight. A week earlier, Trump told Sky News that the May 2025 trade deal itself “can always be changed” (Bloomberg). Days later, Reuters reported a leaked Pentagon email floating a review of US diplomatic backing for “European imperial possessions” — explicitly including the Falklands — as leverage over allies deemed insufficiently supportive in the Iran war (Time). The ostensible trigger in each case is different. The deeper context is consistent: mounting US frustration with Britain’s posture on the Iran war (LSE US Politics blog; Chatham House), and a relationship both sides had treated as a permanent feature of the international landscape now under pressure across three instruments at once — trade policy, the trade architecture itself, and diplomatic support for British sovereignty claims (CNBC).

The timing — days before King Charles’s state visit to Washington (Washington Post) — may yet produce a diplomatic smoothing-over. These things often do. But the episode is a useful invitation to ask a question we should probably be asking anyway: if the US-UK relationship were to deteriorate not for a week but for a sustained period, what would actually happen to the UK economy?

The honest answer is more than the direct trade numbers suggest. And the reason is the subject of this substack.

A category our economic vocabulary tends to miss

Most of the time, when we ask how the UK economy is doing, we reach for productivity. Productivity is the variable economists measure most carefully, the one ministers cite most often, and the one industrial strategies are designed to shift. The UK’s record on it is well documented: output per hour roughly 20 per cent below the United States (ONS; Commons Library), business investment the lowest in the G7 for 24 of the last 30 years (IPPR), with a capital shortfall The Productivity Institute estimates at roughly £2 trillion (TPI, 2025), and pre-pandemic growth running at roughly half the rate that prevailed before 2008. The Modern Industrial Strategy responds in kind: eight growth sectors, an additional £4 billion through the British Business Bank, £1.2 billion a year for skills by 2028-29, and targeted electricity cost reductions for energy-intensive manufacturers (GOV.UK). Productivity is the right focus, raising it is the right ambition, and the instruments are largely the right instruments.

But productivity gains do not sustain themselves. They are achieved within a given environment — markets that remain accessible, institutions that remain coherent, a political coalition that continues to support openness. Those conditions are doing enormous work in any productivity number. They are usually invisible because they are usually stable. I want to call them the productive foundations of an economy: the institutions, the external architecture, and the distributional settlement on which productivity rests. The foundations are what determine whether productivity gains, once made, are durable — and whether the conditions for the next round of gains hold.

For a great power, the distinction is partly academic. The United States can underwrite many of the conditions under which its own productive economy operates. For a middle power and a trade-dependent economy, the foundations are partly exogenous by construction. They depend on choices made in Washington and Brussels and Beijing as much as in Whitehall. That asymmetry is what the question I posed at the top brings into view. A sustained US-UK rift is not just a tariff story. It is a stress test on the foundations of the productive structure of the UK economy.

The first wave: the external foundation

Begin with the part that is most legible. A serious deterioration in the US-UK relationship would land first on the external foundation — the trade and security architecture within which the UK’s productive economy is embedded.

The direct exposure is large. The United States is the UK’s single largest export market for services, accounting for 27 per cent of services exports in 2024 (ONS) — and services are where the UK’s comparative advantage actually lives.

Note: UK trade with the United States, 2024. The US is the UK’s largest single market for both goods and services, but services dependence — 27 per cent of all UK services exports — runs far deeper than the goods relationship. Source: ONS.

The US is also the largest single source of foreign direct investment, accounting for 30 per cent of the FDI stock in the UK at the end of 2024 (ONS Foreign Direct Investment ad hoc release, January 2026) — more than three times the next largest source.

Note: UK inward FDI stock by source country, end-2024. Source: ONS Foreign Direct Investment Survey, January 2026. Note: country rankings reflect the immediate investing country. The Netherlands and Luxembourg rank highly in part as holding company jurisdictions.

The City of London’s role as an offshore dollar hub depends on regulatory accommodation from Washington. Five Eyes and NATO are woven into the institutional fabric of UK national security. Tariffs are the visible instrument; the more consequential variables are equivalence regimes, dollar clearing access, financial regulatory cooperation, and the willingness of US-headquartered firms to keep treating the UK as a privileged location for their European operations.

Pull on any one of these and the UK absorbs a serious shock. Pull on several at once, as a sustained rift would, and you are looking at a structural challenge to one of the principal markets and one of the principal investment sources on which UK output depends. The Industrial Strategy’s growth sectors do not sit outside this exposure; they sit inside it. Life sciences, advanced manufacturing, financial services, and the digital and creative industries all depend on continued US market access and continued US capital. The investment case for each is built on top of that assumption.

The point can be made concrete. In March, the UK government blocked a £1.5 billion investment by Chinese wind turbine manufacturer Mingyang in a factory at Ardersier in the Scottish Highlands — up to 1,500 jobs in one of the Industrial Strategy’s designated growth sectors, in exactly the kind of region the productivity gap hits hardest. The reasoning was national security; the decision aligned with broader US-led pressure on allies to restrict Chinese involvement in critical infrastructure. The investment has since moved to Spain (Bloomberg, April 2026). Whatever the merits of the decision, its logic rests on assumptions about the US-UK relationship delivering reciprocal economic accommodation. If that assumption fails, the UK has foreclosed a major investment to maintain an alignment whose returns are now uncertain.

This is the foundation the Trump episode dramatises. But it is only the first wave.

The second wave: the institutional foundation

A sustained external rift does not stop at the border. It pulls on the institutional foundation — the governance environment that converts investment into durable capability through regulatory predictability, long-term policy commitment, and the state capacity to coordinate across sectors.

The mechanism is straightforward. A government managing a deteriorating relationship with its largest services market and largest FDI partner is forced into reactive, short-cycle policy: emergency tariff responses, hurried sectoral support, rushed deals with alternative partners, mid-cycle revisions of regulatory positions to accommodate diplomatic pressure. Each is rational in the moment. Each crowds out the long-cycle institutional work that productivity gains actually require — the stable framework within which firms commit to multi-year investment, the durable skills strategy, the patient coordination between Treasury, the Department for Business and Trade, and sectoral regulators.

The constraint is binding even without a full rift. The IoD’s most recent Policy Voice survey (November 2025) recorded UK investment intentions at −39, the second lowest reading on record after May 2020, with respondents identifying policy uncertainty and “flip-flopping” as the binding constraint on investment. The Bank of England’s Decision Maker Panel tells a complementary story: firms identifying tariffs and trade policy as a top-three source of uncertainty are also the firms expecting to lower investment (BoE DMP, Q2 2025). The British Chambers of Commerce reported in January that “tariff fatigue” had set in among UK businesses, with 12 per cent of firms exposed to US tariff threats already planning a strategic shift to reduce their dependence on the American market (BCC, January 2026). A deteriorating US relationship does not introduce a new institutional problem. It amplifies an existing one — at the moment when the Industrial Strategy needs the institutional environment to be at its most stable.

The instruments meant to raise productivity require predictability to work. External pressure consumes the policy bandwidth that produces predictability. The harder the external environment, the harder it is to deliver on the productivity strategy designed to make the economy more resilient to that environment.

The third wave: the distributional foundation

The third wave is the one discussed least and matters most. A sustained US-UK rift would land disproportionately on the parts of the country whose political support for the open economy is already most fragile.

Consider where the exposure actually sits. US-facing services and financial services are concentrated in London and the South East, and London has deep adjustment capacity. But US-facing FDI in advanced manufacturing — autos, aerospace, pharma manufacturing — is overwhelmingly located in the Midlands, the North, and parts of Wales and Scotland. University towns dependent on US research funding are spread across the country, and the loss of US research collaboration would hit institutions outside the golden triangle disproportionately, because they have less domestic alternative funding to fall back on. The communities most exposed to a US shock are, in significant part, the same communities that already sit on the wrong side of the UK’s regional productivity gap: Inner London West produces output per hour more than 50 per cent above the UK average; parts of Wales and the West Midlands sit roughly 15 per cent below (ONS, M2023; McCann, 2025).

This matters because the political economy of openness in the UK is already strained. The Brexit vote was driven significantly by communities marked by deindustrialisation, low income, and weakened public services (Becker, Fetzer & Novy, 2017) — communities that had not shared in the gains from openness and that the UK’s institutional architecture had given few tools to absorb adjustment costs. A US shock would land on the same map, at a moment when the political coalition supporting an open, trade-dependent economy is already thinner than it has been at any point in the post-war period.

The loop closes here. The external shock travels through the institutional foundation and lands on the distributional foundation. The distributional damage erodes the political coalition that supports openness. A weaker coalition makes it harder to rebuild the external architecture, harder to commit to long-cycle institutional reform, and harder to sustain the productivity strategy on which recovery depends. A shock that begins as a tariff dispute ends as a structural pressure on the conditions for productivity itself.

Why this is a productivity question

The cascade does not imply that the Industrial Strategy is misconceived. The instruments are sensible, the sectoral choices are defensible, and the case for raising business investment is overwhelming. It does imply that productivity strategy in a middle power has a companion analytical task — making the foundations explicit, naming them, measuring them, and treating them as part of the strategic object rather than as the stable backdrop against which strategy is conducted. This is not a move away from the productivity question. It is a recognition that what makes productivity gains durable is itself among the most consequential productivity questions a middle power can ask.

The cascade is not a story about three separate problems. It is a story about how an apparently external shock travels through institutions and distribution because the foundations are coupled. Standard productivity analysis, focused on the drivers of output per hour, does not typically bring that coupling into view. The foundations frame is meant to. For productivity research, that means complementing the analysis of the productivity variable with sustained work on the conditions under which productivity gains are durable — what allows them to occur, what stabilises them, what transmits shocks between them, and what a middle power can do to strengthen foundations it does not wholly control. For policymakers, it means recognising that the distributional politics of openness, the resolution of external trade architecture, and the institutional capacity to hold these together across political cycles are not adjacent concerns to be handled elsewhere. They are constitutive of the productive economy itself.

For middle powers more broadly — Canada, Australia, Korea, the Netherlands — the same point holds. Prosperity is built on foundations one does not wholly own. Treating those foundations as a strategic object, rather than as the weather, is the analytical move the moment is asking for.

This fortnight’s threats will probably recede. The cascade they let us see should not.

Jun Du is professor of economics at Aston University and incoming managing director of the UK Productivity Institute at University of Manchester. She writes The Trade Strategist on Substack.

A note to readers: this piece was not the one I had planned to write next. The second instalment of the competitiveness series that began with "Making Devolution Deliver: Who Coordinates the Coordinators?" is still coming, as is the China piece I promised — though that one requires working through a substantial body of research and I want to do it properly. But when Trump threatened tariffs three times in a fortnight, the argument felt too timely to hold. Both are on the way. And thank you, as always, for the comments, thoughts, and questions — they shape what I write and how I think about it.