The writer is the author of ‘Two Hundred Years of Muddling Through: The Surprising Story of the British Economy’
Last autumn, during the short-lived terms of Liz Truss and Kwasi Kwarteng, British fiscal policy became exciting. The pair rejected what they considered to be “stale Treasury orthodoxy” and made the largest package of discretionary tax cuts in decades the centrepiece of their “plan for growth”.
It proved to be rather too exciting for financial markets and, ultimately, for voters. Expectations of the path of Bank of England interest rates increased rapidly, sterling fell in value and the price of gilts, UK government bonds, fell dramatically.
As mortgage rates jumped higher the government’s polling numbers moved lower. Kwarteng became Britain’s shortest-serving chancellor and Truss the country’s shortest-serving prime minister. Now, under their successors, Jeremy Hunt and Rishi Sunak, the pendulum has swung back in the opposite direction. Clearly spooked by what unfolded last year, the current chancellor and prime minister seem determined to make fiscal policy as dull as possible. The times, however, call for a bolder approach.
The outlook is not as bad as it appeared just a few months ago. The economy did not, as many observers expected, contract in the final quarter of last year but instead stagnated. January’s GDP figures even showed a small bounce in growth, although that mostly reflects a rebound in activity following the disruption of industrial unrest in December. Inflation, while still uncomfortably high, looks to have peaked.
Better than expected news should not be interpreted as good news, however. The Bank of England still expects a recession, even if it now only expects it to last one year rather than two. Price pressures are abating but living standards are still set to take a large hit.
More importantly for the public finances and the chancellor’s plans, the better news in the short term seems set to be matched by a grimmer view of the long run. While tax receipts have run ahead of expectations in recent months, the Office for Budget Responsibility seems likely to downgrade its hopes of relatively faster growth in the mid-2020s.
The chancellor, constrained by his desire to make fiscal policy as unexciting as possible, finds himself with less room for manoeuvre than the recent public finances returns suggest.
As has been the practice of every Conservative chancellor since 2010, he will no doubt feel the need to cancel a pencilled-in inflation-linked rise in fuel duty. The Ministry of Defence will require perhaps £10bn over the coming two years to meet its obligations in Ukraine. And given the ongoing pay disputes across the public sector, more cash will have to be found for higher wage settlements. In other words, fiscal policy looks to remain more or less on autopilot along the course set out last November.
That glide path of policy has worrying implications for capital spending. Conservative backbenchers have no tolerance for further tax rises — indeed many still seem to hanker for Truss-style cuts — but nor do they have much appetite for cuts to current government spending on public services.
With the economic outlook weak and the public finances under rising pressure, Hunt is squaring the circle in the way previous chancellors caught in the same constraints have: by cutting back on future investment plans. This week it emerged that the already pared back High Speed 2 rail project would be pared back even further and that road building projects would be paused or delayed.
Such cuts might help balance the budget in the short term, but they lead to bigger problems in the future. Stepping back from the acute cost of living crisis of the last 18 months or so, the bigger picture of the British economy is of a slower running but equally catastrophic crisis of growth and productivity.
Productivity growth since 2008 has been abysmal. In the 10 years before the financial crisis, the UK enjoyed the second fastest growth in output per head in the G7, behind only the US. In the 10 years afterwards it experienced the second weakest growth, ahead of only Italy.
According to the economic historians Nicholas Crafts and Terence Mills, the past decade has been the biggest divergence in productivity from its underlying trend since the 1760s. It is this deeper growth problem that means that real median wages are expected to be no higher in the mid-2020s than in 2008. And it is this growth problem that pushed the tax take, as a share of national income, to multi-decade highs despite an increasingly threadbare public realm. Crimping back on capital spending plans now adds to this challenge rather than alleviating it.
Hunt find himself in an unenviable position. His party is far behind in the polls, voters are seeing their real incomes fall and the next general election has to be called by December 2024. In reality there is little he could do in the short term to materially change the economic outlook, but the worry is that the steps he is planning will add to the longer-term growth problem.
Politicians and economic policymakers tend to misunderstand how they affect the economy: they overestimate what they can achieve in the short term but underplay the potential for long-run change. Hunt’s desire to be defined primarily as “not Kwarteng” and to exorcise the ghosts of last September’s disastrous “mini”-Budget has led to him placing an undue premium on keeping fiscal policy dull. Sadly, that path of least resistance approach will achieve little in the short term and stack up further problems for the future.