When the Chancellor stood up to deliver his budget last week, the latest quarterly GDP data showed UK GDP 0.8% lower than pre pandemic three years earlier while we remain pretty well at full employment.
The problem of dealing with stagnation existed even before the banking crisis became apparent. Since then, with liquidity now in short supply, the issue is even more pertinent.
In the event, Hunt applied at best a sticking plaster to the gaping wound of growth stagnation.
He produced some costly plans for increasing the size of the labour force (which should add about ¼% to GDP according to both Cebr and the OBR) and produced a new regime for 100% allowances on some investment.
The latter will do a bit for investment but both the OBR’s estimates and those of my own organisation, Cebr, are sceptical that it will do much. One of the reasons why the tax changes won’t do much is that most IT spending in the UK is already treated as operating expenditure and indeed accountants encourage this. On the latest figures which are for 2020, though the proportions were scarcely affected by the pandemic, £63.3 billion of IT spending on systems, software and services was expensed and only £32.5 billion treated as cap ex. This doesn’t include IT hardware but that is normally a relatively small part of IT investment.
So the Budget did little for growth stagnation.
Repairing the UK’s growth problems is difficult without addressing the country’s productivity problems.
Many are unaware how severe these problems are compared with other countries.
The UK has been moving backwards for a quarter of a century now, compared not only with the high fliers in Asia and Eastern Europe but even the US.
Between 2000 and 2021 productivity measured as output per hour has risen by 16% in the UK, 17% in France, 21% in Germany but by more than double, 37%, in the US.
And just to illustrate the gap in productivity growth between UK and the really fast growing economies, the equivalent figure for Korea is 116%, for Turkey 102% and for the fast developing Eastern European economies range from 64% for Hungary to 137% for Latvia. Meanwhile the equivalent figure for Ireland is a staggering 135%.
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The UK’s productivity gap with the US was only 7% when Tony Blair became Prime Minister. It is now 21%.
When Gordon Brown became Chancellor he commissioned a study by the McKinsey Global Institute into the causes of the productivity gap. The McKinsey report rejected the simplistic explanations of under investment and lack of skills and instead blamed lack of exposure to global best practices and low competitive intensity.
McKinsey argued that these were often the result of product market barriers such as trade restrictions, price constraints, and land use regulations which in turn were the causes of low investment in capital and skills. It was a good report that was more insightful than most such. But it didn’t say what the then Chancellor wanted it to say and so got buried.
We need to focus on underlying causes, not symptoms, if we want to get the economy back to growth.
A significant part of the productivity problem is in the public sector. The latest data shows productivity in government a staggering 6.8% lower than pre pandemic. Admittedly productivity in government is hard to measure and the statistics are experimental but the data on increasing costs does suggest that spending is out of control. The gap between the productivity growth we are estimated to have had and that we would have had if the pre pandemic trend had continued has added about £70 billion to government spending.
Meanwhile white elephants like HS2 continue to roam around the jungle. With HS2 the route keeps being shortened while the cost and timetable keep getting lengthened.
Unless the UK gets back to productivity growth, we are unlikely to get back to GDP growth to any significant extent.
Without GDP growth we might well temporarily fall into a vicious circle of revenues failing to grow fast enough to pay for expenditure and then rising taxes leading to even slower or negative GDP growth. This will eventually fail (a bit like companies who try to combat falling sales by putting prices up!). But a lot of damage will done while the strategy is being tried out.
Getting spending and taxes down is only one part of an agenda to end growth stagnation. The agenda needs to boost competition and reduce unnecessary regulation.
Without restoring growth, not only will our relative (and possibly absolute) living standards continue to decline but also we will be unable to pay for not just the levels of public service to which we aspire but even the levels of welfare and public services we already have. The need to turn this round is urgent.
This is an updated version of a talk given to the Centre for Policy Studies post Budget Seminar on Monday 20 March 2023