Rishi Sunak, chancellor of the exchequer, prefaced his Budget and Spending Review with the assertion that the UK has “an economy fit for a new age of optimism”. Yet the one bit of unambiguously good news is a quicker than expected recovery from the Covid-induced recession. Even this relief is limited by post-Covid and post-Brexit disruptions, especially high inflation.
“With real wage and income growth set to grind to a halt next year”, according to the Resolution Foundation think-tank, the recovery might soon feel over. But an even bigger concern is whether government policy justifies any optimism over longer-term economic prospects.
The truth, alas, is that the UK economy has long been mired in mediocre growth. Paul Johnson of the Institute for Fiscal Studies noted that if pre-financial-crisis trends had continued, real average gross earnings would be about 40 per cent higher than they are now. According to the Resolution Foundation, this has been “the weakest decade for pay growth since the 1930s.”
Such a long period of low growth in productivity, real earnings and real disposable incomes has made voters grumpy. It was even a good part of the reason for Brexit. But low growth also makes all policy options painful: with slow growth in revenues and strong pressure for higher spending on health, social care and pensions, either taxes must rise as a share of national income or the rest of public spending is mercilessly squeezed.
The best answer has to be faster growth, but that must also be consistent with climate commitments. What was most striking in the chancellor’s speech was the absence of an integrated response to these challenges.
So what was missing? One failure was to show how the growth strategy, taxation and the ambitious climate goals fit together. Instead of boasting of yet another year of frozen petrol duty, for example, the chancellor should have announced a plan to introduce a carbon tax at a steadily rising rate, combined with a commitment to transferring the revenue back to households. This would have created the price signals that business and households need together with a matching determination to shield the latter from the cost.
A closely associated failure was to indicate how the much higher rate of investment the economy will need to accelerate growth and climate mitigation, especially in the private sector, is to be motivated and financed.
A commitment to a rising carbon tax would help with motivation. But equally important would have been to commit to a credit against corporation tax for all investments, in the year they are made.
That could be combined with a higher headline rate of corporate taxation. The tax would then fall most heavily on companies that do not invest. In his speech, Sunak stated that his “super deduction” (a version of this idea) “makes our tax regime for business investment truly world-leading, lifting us from 30th in the OECD, to 1st. And, worth £25bn during the two years it is in place, this will be the biggest business tax cut in modern British history.” But why is it in place for just two years? Will this solve the longstanding problem of low business investment in the UK? Hardly.
Then there is the challenge of providing the risk capital for investment. A crucial issue here is the role and structure of UK pension funds. As presently constituted and regulated, these are too fragmented and far too cautiously invested. A change in pension regulation, including consolidation of funds, as well as a shift towards “collective defined contribution” schemes, should be part of a radical reform of pensions.
Yet another challenge is where the savings to fund the higher rate of investment the country will need are to come from. The UK already runs very large current account deficits. So, should the country risk relying still more heavily on foreign capital, or should there be substantially higher rates of domestic savings in the longer run? If the latter is to be a policy objective, how might the higher savings actually be achieved?
Many other challenges arise if the UK is to achieve faster growth, while making an ambitious green transition. Is the government spending enough on excellence in scientific research? Will education and skills be adequately funded? Will the ambitions for levelling up lead to anything real and enduring?
The Budget and Spending Review offered an opportunity to set out the government’s thinking on how it plans to solve such longstanding and unquestionably daunting challenges. That made it an important moment for the government, the country and the economy. What was offered fell far short of the occasion. Sunak may be optimistic. I, alas, am not.