The UK economy is slipping into recession. Cebr’s numbers are not very far apart from the OBR’s forecast of -1.4 per cent GDP growth next year. Yet, driven by the US Federal Reserve Bank, interest rates are still rising around the world, and it will be hard for the UK to reverse that trend for a few more months at least.
With Covid largely over in terms of its economic effects in the UK, and with growth post-Brexit roughly in line with Germany, serious analysts may be puzzled that the latest forecast for the budget deficit for the coming financial year 2023/24 is as high as £140bn.
Our analysis of the Autumn Statement starts by working out how we got here.
The budget deficit is essentially the difference between public spending and tax revenue raised. Both have underperformed.
Tax revenue is heavily driven by GDP and there is a GDP shortfall. GDP is a function of hourly productivity and hours worked. The recent trend in hourly productivity for the UK as a whole has been essentially in line with the pre-pandemic trend growth of 0.7 to 0.8 per cent per annum. On the other hand, hours worked have fallen by 1.3 per cent in the past three years, while if they had continued the pre-pandemic trend they would have increased by 4.6 per cent. As a result, there is a GDP shortfall of 6.9 per cent compared with where the economy would have been had the pandemic never occurred. According to the OBR ready reckoners, this should produce a shortfall of tax revenue of 4.7 per cent of GDP, or £123bn, in 2023.
Meanwhile, public sector productivity has slumped. The new experimental series from the ONS shows public sector productivity down by 7.1 per cent over the past three years. This has left public sector productivity 9.5 per cent lower than it would have been had the gentle upward trend over the pre-pandemic decade continued. After allowing for those parts of public spending not affected by productivity, mainly transfers and debt interest, we estimate that public spending in 2023 will cost £71bn more than it might have, had public sector productivity risen at its pre-pandemic rate.
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So, compared with pre-pandemic trends, there is a shortfall of £194 billion resulting from the combination of fewer hours worked and from falling public sector productivity.
On top of that, there is the cost of the energy bailout which is planned to cost £25bn in 2023/24.
Not all the changes have gone in the same direction. For example, higher inflation has probably boosted public finances through fiscal drag, especially as tax allowances have been frozen. Public sector wages have fallen by even more than those in the private sector in real terms, creating a negative relative price effect. Our estimates are that these factors have boosted the fiscal position on net by about £60bn.
But, even allowing for this, there remains a structural fiscal problem. The Chancellor has chosen to face this problem with a mix of spending cuts and measures to raise revenues. He has largely decided to use inflation to squeeze real public sector budgets and to squeeze the real value of tax allowances. This means that the bulk of the fiscal tightening is to come in the latter years of the five-year fiscal forecast. In the short term, there is remarkably little, particularly given the blood curdling threats spun into the media.
The Chancellor’s first priority today was to take sufficient fiscal action to stabilise the markets after the chaos that emerged after the last mini-Budget.
This he may have done, though with many of the measures post-dated and designed only to affect the fiscal stance after the economy starts to recover in 2024, the scale of borrowing that remains in the short term leaves the UK vulnerable to any change in sentiment.
But what has been done today is the relatively easy part. What is now needed is to turn around the trends that got us into this mess. This means boosting GDP growth and raising public sector efficiency. Neither are easy.
The measures in the Autumn Statement to boost growth are a damp squib and seem unlikely even to reverse the negative impact of the higher Corporation Tax already announced.
So, it’s hard to see the country getting out of its current vicious circle of higher taxes, slowing growth and reduced spending under the existing plans. Already Blair-era advisers, Sir Michael Barber and Patricia Hewitt, have been drafted in to try to help. It looks as though the Tories have decided to hand the country’s key economic problems over to whoever is in power after the next election, in the hope that it’s someone else.
In some sense the Keir Starmer era has already started…
Douglas McWilliams is Founder and Deputy Chairman of Cebr.
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