Britain’s long-term fiscal challenge is easily diagnosed. The country combines an ageing population with lacklustre growth. Maintaining sustainable public finances, while the pension system and health service face increasing demand, will therefore mean higher taxes. Yet with the rate of taxation as a proportion of national income already due to rise to the highest level in decades there will be little room for generous spending on other parts of the state. That is a recipe for resentment and irritation among working-age taxpayers. The only option to avoid this fate is to try and boost growth.
Chancellor Rishi Sunak, who will present his third budget on Wednesday, should prioritise spending on areas that could help to lift productivity and increase the economy’s potential output. That means skills, infrastructure and research rather than welfare and public services. It means that increased spending on healthcare should be targeted at raising efficiency and value for money. The government’s drive to “level up” the economy — a loosely defined aim to reduce gaps between the UK’s regions — should focus on reducing the big divide in productivity between the south of England and the rest rather than embellishments for marginal Tory seats.
This does not mean taking a narrow approach to productivity, focusing only on frontier technology and the kind of big physical infrastructure projects beloved of prime minister Boris Johnson. Services such as education — making up for lost time due to the pandemic, for example — can pay dividends in terms of growth too. Indeed there are a number of areas where small amounts of focused spending on public services would produce big benefits. It would not take much in terms of financial resources, for example, to help improve access to justice and clear the backlogs in the courts.
Sunak has already seen the impact that better than expected growth has on the public finances and the ability for the Conservative government to meet both its objectives of increased spending on public services and running a balanced budget. The Office for Budget Responsibility, following a faster-than-forecast recovery, is likely to reduce its estimates of the “scarring” from the pandemic. Upgrades to the UK’s potential output would give the chancellor more headroom while staying within a mooted fiscal rule of matching day-to-day spending with taxation within three years.
It is in the longer term, however, that the growth outlook presents a problem. The OBR estimates that the UK’s potential growth rate is now only about 1 per cent to 1.5 per cent a year, after a decade of dismal productivity improvements since the 2008 financial crisis. Combined with Sunak’s goal of balancing the current budget by mid-decade, this suggests only moderate increases or cuts in spending outside health and social care.
The timeframe to meet the balanced current budget rule should be extended: there is no immediate pressure from bond markets and a more supportive fiscal stance might help the economy to recover, reducing scarring further. Sunak is rightly concerned that higher interest rates will raise the cost of financing the UK’s debt, but they are likely to increase only slowly. Indeed, many investors worry that the Bank of England will make a “policy mistake” if it withdraws support too soon.
That is no excuse for indiscipline, however. With tight spending for most departments, Sunak must make sure the UK gets value for money on its spending, including on infrastructure or research. Britain vitally needs growth, not white elephants.