The most striking feature of last week’s Autumn Statement was its prevailing gloom. Not only is the immediate economic outlook grim, but the tax burden is set to reach a post-war high. Even after a forecast economic recovery, growth drops away again. How on earth did we get to this pretty pass?
The roots lie in a combination of three external shocks and some bad policy judgements, clouded by prevailing illusions about the underlying economic situation. Thirty years ago, Britain’s ejection from the European Exchange Rate Mechanism seemed to be a disaster but what followed was a sustained period of economic growth.
Moreover, the public finances improved. This happy situation continued after Labour won a landslide victory in 1997. And before the global financial crisis hit us in 2008, the ratio of public debt to GDP was 35pc. Chancellor Gordon Brown’s ambition was that it should be kept below 40pc.
Then came the first external shock – the financial crisis, which clobbered all countries and threatened to send the world into another Great Depression. But we suffered particularly badly because the financial services sector was proportionately much larger here than in most other countries.
The consequence was that the Government’s deficit soared to over 10pc of GDP. In 2010, Chancellor George Osborne began a policy of austerity. This was arguably an overreaction and tight fiscal policy contributed to weak economic growth. But the policy set the public finances on a firmer foundation and the deficit fell to 2pc in 2018-19. The debt ratio seemed to stabilise at about 80pc of GDP.
The next shock was the Covid pandemic which devastated economies worldwide. The damage to production was bound to hit the public finances severely but, over and above that, many countries, including this one, made things worse by engaging in excessively zealous lockdowns and dishing out huge amounts of public money, some of which was undoubtedly wasted. Our debt ratio rose to 97pc of GDP. Although it was initially widely pilloried, Sweden did things much better, by avoiding mandatory lockdowns. The result is that Swedish GDP substantially outperformed the UK and the public finances are now in much better shape.
The third shock was the Russian invasion of Ukraine which sent food and energy prices soaring and increased inflation rates sharply, thereby obliging central banks to tighten monetary policy, and depressing economic activity.
Some critics will say that Brexit counts as a fourth, self-inflicted, wound. Yet, although it has hardly helped economic performance, compared to the three shocks referred to above, Brexit pales into insignificance.
But our problems are not solely the result of accidents and shocks. Since the 2008 crisis, the rate of productivity growth has been extremely low. The extent of the problem was disguised, for a time, by two offsetting factors – substantial net immigration and a rise in labour market participation rates which boosted the labour force and ultimately contributed to faster GDP growth. Post-Covid, however, participation rates have fallen.
Meanwhile, the weakness of the public finances was disguised by the long period of extremely low interest rates. The result was that even as the debt ratio climbed, the burden of debt interest did not. But this was an accident waiting to happen. If higher interest rates combined with higher debt levels then the debt interest burden was bound to rise.
What is behind the weakness of productivity growth? This is the $64,000 question and there isn’t a simple answer. Most other countries have experienced something similar, although not to the same extent. We have suffered from some underlying structural weaknesses, made worse by bad policy.
Business investment has been extremely low, thereby stunting the growth of the capital stock. Businesses have been burdened with increasing regulation which has inhibited their performance. A huge proportion of our workforce has had a low level of skills. And all the while, there has been the relentless upward creep of public spending, nearly all of it inefficiently managed and much of it grossly wasteful.
Where do we go from here? Is there hope for something better? Not under the current regime. Winston Churchill promised the British people years of blood, toil, tears and sweat but he also promised them victory. And the hope of the latter managed to sustain them through the former. Jeremy Hunt has offered us plenty of blood, toil, tears and sweat, but no promise of victory.
The key requirements of a successful economic policy are not difficult to fathom. Governments cannot create prosperity but their actions can inhibit it. Their attempts at radical improvement should begin close to home. We must reduce the size of the public sector, encompassing major reductions in payrolls combined with substantial efficiencies and including a re-examination of the legitimate scope of government. The NHS needs to be radically reformed, rather than being regularly stuffed with yet more taxpayers’ money.
We need to stimulate business investment by reducing taxes on business and improving the tax treatment of investment. We need to reduce the overall burden of taxation on both businesses and people, thereby helping to persuade both of them to locate here and to remain here. The whole regulatory system needs to be reformed.
This sounds like a very tall order – and it is. But only because this government is so weak. In 1979 when Mrs Thatcher was first elected, the economic scene seemed dire. At first taxes were increased in a bid to improve the public finances. The next few years were rocky and there were a number of missteps. But before too long the economy was growing strongly and by 1988-9, remarkably, the government finances were in surplus.
Such transformations do not happen of their own accord. Mrs. Thatcher’s governments not only got on top of the public finances and reformed the tax system but also broke the power of the unions and privatised huge swathes of the British economy. What is this government going to do?
Roger Bootle is chairman of Capital Economics roger.bootle@capitaleconomics.com
This Government is too weak to fix Britain’s chronic growth problem
Jeremy Hunt has offered us plenty of blood, toil, tears and sweat, but no promise of victory