Our economic problems are bigger than we think | Chris Bayliss

It is simultaneously the most damning and the kindest thing one can say about Rachel Reeves’ time as Chancellor that her resignation would be an event of almost zero significance for the British economy. Yet that is now apparently on the cards, after it appears that she has accidentally presided over a potential budget surplus. 

In the aftermath of last week’s budget, it is now possible to feel a sense of nostalgia about the kind of problems we had in the 1970s. Though they may have felt insurmountable at the time, they were basically comprehensible in nature — even if it eventually took a very different kind of government to grasp and implement the solutions. 

Certainly, it’s hard to imagine the likes of Denis Healey coming quite as unstuck by an unexpected budget surplus as our present Chancellor. Apparently, earnest chatter swirling around Westminster that Rachel Reeves might actually face something amounting to personal consequences — beyond mere resignation — for her alleged dishonesty only adds to the uncanny otherworldliness around the budget. Much like the supposed surplus itself. 

Prices function more like forms of taxation than a manifestation of the balance of supply and demand

I, and others, have written previously about the weakening of the price mechanism in contemporary Britain, which is causing the nation’s capacity for economic decision-making to degenerate. This is the result of the proliferation of mandatory needs-based pricing and cross-subsidy across all key areas of the economy, from banking through to utilities, which mean that what you pay reflects your ability to pay rather than the cost of providing a good or service. This is underwritten by an approach based on economic “rights” that are guaranteed by legislation and guarded by the courts.  

As such, prices function more like forms of taxation than a manifestation of the balance of supply and demand. Whether people access a good or service is less and less a function of individual decisions about opportunity cost, and increasingly the result of whether they have a “right” to it or not. In its most extreme forms, we see people with limited incomes doing things that nobody would spend their own money on, such as paying more in taxi costs to take children with special needs to school than the cost of employing a part time chauffeur.  We also have the bizarre spectacle of people with higher incomes paying increased levels of interest on student loan repayments, despite their being better credit risks. 

This steadily removes the connection between productivity and consumption, with the obvious loss of incentives to work, invest or take potentially profitable risks. But it also removes the potency of prices as a signal regarding where resources are needed in the economy. You cannot have a market economy without the price mechanism. The alternative ought to be a socialist-style command economy, but we haven’t got one of those either.  The result of this is that many of the economic metrics we rely on as indicators are simply meaningless.  

The November 2025 Budget took this to new levels of absurdity. Rather than a renewed focus on the national crisis in productivity — growth of which is the engine of prosperity and which has completely stalled for 17 years — debate has instead concentrated on the Office for Budgetary Responsibility and its forecasts. The Chancellor had spent the months in the lead up to the election bemoaning the state of the public finances she had inherited, and trailing ideas for punitive tax-rises in the press. Most notably, in the few weeks before the election, the idea was suggested that headline rates of income taxes would be raised. It was in the backtracking from this that the Chancellor’s team dangled out to friends in the press the loose ends that may yet hang them. This indicated that Number 11 had already seen OBR forecasts suggesting that tax receipts were substantially higher than expected, and that the “black hole” which supposedly justified the tax hikes did not in fact exist. 

What is notable about the discussion and speculation that has followed is the complete lack of interest in the content of the OBR forecasts; why they say what they say, what that tells us about the British economy or, perhaps most crucially, whether or not they are accurate.  Instead, in the myopic style of Westminster, we are once again arguing about when a minister became aware of a piece of information, and whether or not that puts their integrity into question. It doesn’t seem to be relevant that the forecasts themselves are likely nonsense, and that the supposed surplus will probably never exist at all (and, even if it did, would simply be the product of an economic conjuring trick). 

Since the OBR was established by George Osborne as a political gimmick to rebuke Gordon Brown’s legacy, successive chancellors have established a sort of sadomasochistic relationship with the agency. Though the initial idea was supposedly to formalise fiscal responsibility and prevent profligate governments from buying their way out of political crises on tick, the office has evolved effectively to give cover to chancellors looking to increase public spending — providing, that is, that they defer to certain political niceties, such as maintaining high rates of immigration, which are guaranteed to make the red line go up. In return, the OBR will upgrade its growth estimates, giving the chancellor more headroom for additional borrowing. Never mind that many of the measures that supposedly boost short term growth will in fact increase the treasury’s long term liabilities, particularly in the form of increased pension and social care costs. 

Now, the OBR has produced a statement demonstrating that, due to a variety of inflationary interventions the government and its predecessors made themselves, the tax take in 2029-2030 is likely to be substantially higher than previously estimated. The Chancellor therefore has the headroom she so desperately needed — liberating her from a doomed embrace with a hostile sovereign bond market. But she is so limited in even the most mundane skills of superficial Westminster politics that she has still turned that deliverance into disaster. 

None of this matters though. The supposed uplift in revenues will not materialise; or not to anywhere near the extent to which the forecast suggests. That is because people respond to incentives, all of which currently point to people not doing the things that ultimately result in them paying more taxes. The highest commercial energy costs in the developed world point against starting or continuing all kinds of businesses in this country. Increased minimum wages and national insurance contributions point against offering people jobs. Fiscal drag, plus the array of needs-based pricing and cross subsidy, makes working harder to secure promotions or pay rises a pointless effort. 

The OBR have clearly anticipated further downgrades in productivity growth — based on their record of constantly overestimating it (the graph including their previous estimates resembles a porcupine due to all the lines shooting off at 45 degree angles to the flat reality).  But despite being as gloomy as they can possibly bring themselves to be about Britain’s productivity, they are probably still being too optimistic about it. The only possible explanation for this is an environment in which it is politically incorrect to dwell too heavily on the relationship between policy and people’s behavior. 

Compared with all of this, the problems that Britain faced in the 1970s seem relatively straightforward

There was a time when Labour people were far more comfortable with all of this. New Labour wonks of Blair’s vintage had lived through the marginal revolution and the 1980s, and had internalised the idea that they needed to get their heads round this stuff if they were to break out of electoral irrelevance. They adopted it with gusto, and used it in all kinds of annoying ways to “nudge” us into the sort of lifestyles they approved of. But now a younger generation, embodied by Reeves, have returned to the dark ages of Labour thought that is deeply hostile to the idea that human beings respond to incentives, and certainly cannot build it into a mental model of how policy might work out in practice. This is a problem that would be considerably less serious if the official fiscal regulator didn’t indulge in it itself. 

Compared with all of this, the problems that Britain faced in the 1970s seem relatively straightforward, at least in hindsight. Successive governments needed to increase revenues in order to address growing budget deficits. This meant increasing productivity and boosting exports, in the context of a world in which British industry was losing ground to more modern and efficient foreign competition. Most of the country’s largest, and most loss-making industries were in state hands, and the treasury was in no mind or position to invest in the kind of upgrades and modernisation of plants that would have given flagging export industries a shot in the arm. So, instead, governments tried to incentivise productivity by raising wages in state-owned enterprises. But this merely contributed to the inflation that was already rampant, as a result of the government’s original sin of financing its budget deficits by printing money. 

Perhaps it’s easy to look back at the past and see straightforward paths that we were predestined to discover, even if there were fights to be had over which turns to take along the way. Maybe, a decade or two hence, it will be possible to roughly summarise our current economic woes in a single paragraph by looking back at the trail that a wise and resolute generation of leaders will hack through the thickets. Maybe the real basis of the crises they faced seemed just as nebulous to people in the 1970s as ours currently do to us; although it did appear that Jim Callaghan had managed to get his head around the fact the underlying issue was with monetary policy, even if he lacked the political wherewithal to implement the solution in earnest. 

But once the politics were better aligned, and a government that was in place that was willing and able to withstand serious short-term unpopularity as it effected a course correction, the mechanics of doing so weren’t impossibly complicated. It feels very difficult to say the same today.  Even if those of us who point to the sabotage of the price mechanism and the consequent breaking of positive incentives are correct, we are still a long way off a workable plan to fix it.  

It will require work on multiple fronts; to remove the legislation that underpins the rights-based approach to economic distribution and to reform the judicial apparatus that oversees it. But more than anything, it will require a state with the legitimacy and the vision to persuade people to accept tough sacrifices in return for long term prosperity and security.  In the meantime, a state and regulators who at least accept the theoretical existence of incentives and second order consequences would be an improvement.