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In her budget, due to be tabled on October 30th, Finance Minister Rachel Reeves will need to accomplish four things: First and most obvious, she must give the party and the country hope that better times are ahead. Second, she must offer prospects for improving public services. Third, she must achieve the latter without ignoring the constraints to which she is placed. It is a constraint created not only by Labor’s commitments, but more importantly by Britain’s fragility. Fourth and most important, she needs to provide a believable story of growth. Without it, very little will work.
of Green Budget 2024 The Institute for Fiscal Studies paper, as usual, sheds light on the problem. But the chapter on economics by Citi’s Benjamin Navarro is particularly impressive. The report said: “Economic activity in the UK is 36 per cent lower than it would have been had it continued to grow on trends from 1997 to 2008.” Britain’s peers also performed poorly, but not to the same extent. Despite the domestic financial crisis, the eurozone’s deficit is only 31 percent. In the US, the shortfall is 24%. To make matters worse, UK GDP is well below its already weak trajectory from 2014 to 2019. Worst of all, excluding the short-term effects of the end of World War I and the Spanish Flu, the latest 10-year average of potential GDP growth per worker was zero, the lowest in a century and a half. There is.
Yes, it could improve in the short to medium term, barring any more major negative shocks. Inflation in particular is coming under control and monetary policy is likely to be eased. But in the long run, the amount the government can spend depends overwhelmingly on high trend growth. When the economy is in a downturn, spending more on something means spending less on other things. Politics based on zero-sum choices like this is terrifying. This is a big reason why the last government became so unpopular.
Unfortunately, when seeking to address the need to accelerate growth while achieving fiscal priorities, the Chancellor must also consider: Imminent structural vulnerabilities. The former includes a public debt-to-GDP ratio of close to 100 percent and long-term interest rates on government bonds exceeding 4 percent. What is notable about the latter is that the UK is facing a “twin deficit” problem of a budget deficit and a current account deficit. A widening fiscal deficit is likely to cause a further widening of the current account deficit, requiring an increase in net inflows of foreign savings. In short, the trust of foreigners is important.
Confidence is unpredictable. It does not depend on whether deficits or debt reach a certain size. But that depends on whether the government has a credible plan and whether the country’s politics are stable. There is a harsh reality here too. In addition to being structurally dependent on inflows of foreign savings, the UK does not have a significant reserve currency, so there is no need for its citizens to hold sterling-denominated assets. However, as has been frequently demonstrated since 2007, the ability to issue government debt in one’s own currency is critical to one’s ability to cope with shocks. Sadly, the actions of British politicians over the past decade have not enhanced Britain’s reputation for decency.
For these reasons, and the more fundamental (and related) need for long-term growth, budgets need to be multifaceted. Any move towards increased borrowing needs to be framed in the context of fiscal policy and long-term plans for economic growth. This will require tax reform and tax increases. However, given the structural external deficit, an increase in investment requires an increase in savings. The obvious route would be to significantly increase pension contribution rates. If savings rates actually rose, it would be much easier to finance increased domestic investment.
In particular, given the risks posed by the UK’s low investment and savings rates and rising budget and external deficits, the government needs to find ways to generate growth that do not rely primarily on increased investment. Obvious possibilities include a radical relaxation of planning controls, well-considered deregulation, and fostering innovation. The latter is especially important given the dismal productivity performance. of National Research and Development Agency“” promoted by Dominic Cummings may be helpful. Governments also need to promote risk-taking finance for innovation.
Britain must get out of the low-growth trap. Alas, structural weaknesses in the economy will make escape difficult. The test for Reeves is not how to handle the immediate pressure, but whether he knows how to get the economy out of this trap. Britain’s future depends on it.
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