Today’s Budget is the first against a background where economic growth in the UK has virtually ground to a halt. Official estimates of GDP for the end of last year (Q4) is estimated to have been 0.8% lower than in Q4 2019 pre pandemic and yet the labour market remains tight with unemployment stubbornly below 4%.
It is true that a technical recession is now expected to be avoided (though with GDP forecast by the OBR to be down 0.2% this year this implies very weak GDP in Q1, a fall of 0.4%). The OBR currently expects much faster growth than either the Bank of England or Cebr in the years from 2024 but given the OBR’s own assessment of the impact of the measures announced today which are much the same as Cebr’s, this probably owes a lot more to the “mean reversal” inbuilt into their forecasting techniques than to any reasonable assumption for growth.
When an economy is growing at best slowly, there are two things to do:
First, you can use whatever limited resources you have to try to raise the number of hours that people work and/or number of people in work. In addition you want to increase the amount they produce in each hour that they work. To be fair the Chancellor has done a lot of work here.
The second is that the government has to adjust its spending plans to suit the country’s new more straightened circumstances.
You have to reduce your spending because if you don’t, taxes end up having go ever higher. There is plenty of debate about the precise trade-off between tax and growth but economists accept that at some point there is a risk that the economy slips into a vicious circle where high spending requires higher taxes, higher taxes hit GDP growth, slower GDP growth hits tax revenues, and taxes then are put up further in a vain attempt to pay for the spending.
In today’s budget the Chancellor has introduced a major series of measures which are likely to help increase the number of hours worked and number of people in work. These are the additional free childcare made available for one and two-year olds which will help young parents and especially women get back into work and the raising of the lifetime pensions limit. There is a wide range of other labour market measures focussing especially on child care and help for the ill and disabled to continue working. A 100% investment allowance regime was also announced that might partly compensate for the impact on investment and hence productivity of the rise in the rate of corporation tax previously announced.
Both sets of measures will have a beneficial effect. But detailed analysis by both the Centre for Policy Studies and Bloomberg has shown that a major part of the UK’s problem reflects it being uneconomic for many benefits claimants to work. It will be hard to make work economic for many people without reducing benefits which governments are generally unwilling to do.
On productivity, research indicates that this will have some beneficial impact for large companies already operating in the UK. But it also indicates that inward investment is much more sensitive to the headline rate of corporation tax, which goes up in April from 19% to 25%. The Treasury claims that they need the revenue from this rise. We believe that this is wrong, first, because we estimate that the money that will be raised even in the short term is much less than the Treasury estimates and secondly because in the long term – as the Irish experience shows right on our doorstep – lower taxes, at the right level, generate more revenue not less.
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But put in perspective, Cebr estimates that today’s measures might raise the labour supply by 0.2% and investment by 5% per annum. In total we estimate that GDP might be ¼% higher after two years. This is worthwhile but doesn’t fundamentally change the low growth picture. The OBR’s numbers are very similar which is what makes their fairly rapid growth forecast from 2024 onwards implausible. Some of the OBR’s estimates admittedly do look on the low side. For example they expect the childcare measures only to boost employment by 60,000 which looks low for a package costing over £5 billion per annum.
Nevertheless it is critical to trim public spending into line with the country’s reduced means.
This is where Sunak and Hunt have had limited success so far. In fact, public spending, which exploded during the pandemic, has not been brought back into line since. Their current plans show public spending continuing to rise 1% per annum in real terms.
Cebr research has shown that public sector productivity on its latest data was 6.8% lower than pre covid leading to additional borrowing of over £70 billion compared with the position had the slight rise in public sector productivity during the 2010s been continued.
This will mean action in three different areas.
The first is benefits. Based off recent trends in economic inactivity, it does seem like benefits are currently too high for many at the bottom end of the labour market to be able to earn enough to make it worthwhile working, a trade-off made worse by the high cost of living. Anything that can bring down the cost of basic living makes this trade off much less harsh for people who are at the bottom end of the income spectrum. Food, rent, energy and mobile phone charges make up over two fifths of the spending of the poorest 10% There seems to be little that can be easily done to reduce food prices, but there is a lot that can be done to make landlords more willing to increase the supply of property and put downward pressure on rents. And almost certainly the mobile phone oligopolies who seem to be imposing charges that are hard to justify, could be looked at by OFCOM. Fortunately, energy costs seem now to be falling.
The second is public sector productivity. The loss of productivity during the pandemic period has to be recovered and a target of raising productivity in the public sector each year brought in. The public sector may have to limit working from home where productivity cannot be independently monitored. In addition, measures to bring in digital productivity tools can surely help.
The third is major projects. There is a wide range of projects in the public sector that seem to have got out of control in cost terms. HS2 is only the most obvious example. There are many defence projects where the underperformance and the cost overruns are even more extreme. Long term the planning and other regulations that so inflate the costs of infrastructure projects have to be addressed but short term many of these projects will have to be cut.
As a country we are still living beyond our means. Do Sunak, Hunt and the Treasury and indeed the rest of the Westminster/Whitehall establishment including the Opposition really understand this?
Douglas McWilliams is Deputy Chairman of the CEBR.
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