It is scary season, and nowhere more so than at His Majesty’s Treasury where – following a week of pre-Budget turmoil, including a spectacular reverse on likely plans for income tax – they are fighting all manner of financial demons.
Yet for Chancellors past and present, there is one word that chills their bones and scrambles their senses like no other: ‘productivity’.
The Office for Budget Responsibility (OBR) recently submitted its projections for the UK economy to Rachel Reeves ahead of her November 26 Budget.
The single most important item was the one marked ‘productivity’. And it wasn’t good news.
Although we’re yet to see the final results, it is expected that the OBR has downgraded its productivity forecasts for the UK.
By itself, that does not sound especially frightening. Nor does the likely size of the downgrade – 0.3 per cent a year. But the implications for public finances – and this Government’s political fortunes – could hardly be greater.
At the stroke of an official’s pen, the downgrade added more than £20 billion to the fiscal ‘black hole’ – a concept the new Labour Government had itself used only one year earlier to lambast its Conservative predecessors.
The Chancellor, hoist on her own petard, now faces an even larger black hole. And that, in turn, means significant tax rises are now likely for many millions of Britons.
As we saw last year, warnings of black holes tend to absorb all economic energy.
The Chancellor, hoist on her own petard, now faces an even larger black hole. And that, in turn, means significant tax rises are now likely for many millions of Britons, writes Andy Haldane
It is expected that the Office for Budget Responsibility has downgraded its productivity forecasts for the UK
Rabid speculation about the prospect of tax rises over recent months has drained confidence and paused spending among households and businesses. Numbers published last week showed the economy grinding to a halt.
What, then, is this mysterious ‘productivity’ and why does it matter?
It measures how much we as a nation produce given our resources, how much value our businesses add given the workers and technologies at their disposal. It is about working smarter, not harder.
In the 20th century, improvements in skills and technologies meant we produced ever more as a nation despite working shorter hours. We worked smarter.
Productivity rose by around two per cent each year. That might not sound much, but for our living standards it was transformational.
Productivity increases for businesses fund pay rises for workers. So, the rise in productivity meant two per cent increases in inflation-adjusted pay for workers.
This resulted in UK living standards rising more than sevenfold in the 20th century.
This century, however – and in particular since the global financial crisis – the story has soured. Since 2008, UK productivity growth has averaged a mere 0.5 per cent a year. And where productivity leads, pay has followed. The average British worker is no better off now than in 2008.
Andy Haldane, former chief economist of the Bank of England, says public sector spending risks crowding out private investment with dangerous consequences
What explains this slump? The Chancellor has blamed Brexit and the effects of fiscal ‘austerity’. The truth, though, is the UK’s productivity problems long pre-date Brexit.
As for austerity, just how ‘austere’ have the UK’s public finances really been? No government has balanced the books – tax revenues covering government spending – in any year this century.
As a result, public debt has tripled this century, rising to something approaching 100 per cent of annual national income. With borrowing costs also having risen, merely servicing the debt now costs around £100 billion each year.
If this weren’t bad enough, it is the implications of our growing deficit – and ever-rising debts – for long-term productivity and pay that are the real stinger.
A government that runs a fiscal deficit needs either to borrow (including from households and companies) or raise taxes (on those same households and companies). In other words, it transfers resources from the productive private sector to the less productive public sector.
That transfer is currently running above four per cent of national income each year.
This might be considered a price worth paying for improved public services. Yet evidence of that is thin. Efficiency in the public sector is no higher today than at the start of the century.
The entire rise in the UK’s overall productivity in the past 25 years has come courtesy of the private sector. Businesses have worked smarter. Government has not.
It’s true that we have under-invested in skills and technologies. But a bigger contributor has been the shift in resources from the high-productivity private sector – which pays the bills – to the low-productivity public sector. This is the ‘doom-loop’ now trapping Reeves.
Public sector spending risks crowding out private investment with dangerous consequences. And every time taxes rise, the doom-loop risks getting worse.
Breaking free of that vicious spiral demands a radically different approach.
It seems settled that, one way or another, Reeves will increase taxes to balance the books – even though to do }so will place the full burden of balancing them on households and businesses, the engine of productivity.
Much more responsibility should, instead, be carried by government itself.
To coin a phrase, a reasonable rule of thumb might be ‘one-in, one-out’: for every pound raised in tax, public spending should be cut by a pound. By that I mean lasting, root-and-branch reform of the state, its size and efficiency.
The size of the state in the UK has roughly doubled relative to national income in each of the past three centuries. It currently stands at more than 40 per cent.
Without reform, the costs of an ageing population and increased defence spending could push it above 50 per cent of the national economy. These are dangerously uncharted waters for the British economy.
Curbing that tide means confronting some key challenges. Why are almost a third of the UK workforce neither learning nor earning? Why are almost 1 million 16-24 year olds – young men and women in the prime of their lives – in neither education nor work?
Why is the UK’s tax code the longest in the world, its planning laws the most sclerotic, its regulation the most intrusive? These are among the key questions we need to answer if any government is to resolve the UK’s productivity problem.
This needs to be accompanied by greater candour with the public about the limits to what the state can and should provide.
‘Tread softly because you tread on my dreams,’ said poet W B Yeats. Keir Starmer channelled Yeats when coming to power 16 months ago, promising to tread more lightly on our lives. So far, there is little evidence of this pledge being kept. The Government’s fiscal footprint has been more hobnail boot than ballet pump.
The Budget is an opportunity to change that, lightening the load on businesses and households and enacting genuine reform of the public sector.
But doing so will require the bold leadership notably lacking so far – not just politically but from business too, something I hope to encourage as President-elect of the British Chambers of Commerce.
The dream of improved living standards has not died but, like the fortunes of the Government, it hangs by the slenderest of fiscal threads.
Andy Haldane, former chief economist of the Bank of England, is President-elect of the British Chambers of Commerce
