The UK economy may end up growing a bit faster by the end of this decade than the Office for Budget Responsibility expects – but if it does that will be no thanks to Rachel Reeves’s Budget.
The OBR’s projections are unambitious. This is their summary: ‘Having stagnated last year, the economy is expected to grow by just over 1 per cent this year, rising to 2 per cent in 2025, before falling to around 1½ per cent, slightly below its estimated potential growth rate of 1⅔ per cent, over the remainder of the forecast. Budget policies temporarily boost output in the near term, but leave GDP largely unchanged in five years.’
It does add that if the increase in public investment were sustained it ‘would raise supply in the long-term’, but the huge question remains: is the OBR’s estimate of the potential growth rate of 1⅔ per cent right? That’s higher than some other projections. For example, in May the NIESR said it expected ‘growth from 2025 onwards to fluctuate around a trend growth rate of 1 per cent – which is low both by historical and international comparison’. You could say that again. The long-term growth rate over the past couple of hundred years has been around 2.25 per cent and the more recent trend, between 1980 and 2014, was growth of 2.2 per cent a year. That is a good marker, because it takes bad years as well as good ones. It covers the recessions of the early 1980s and 1990s and the banking crash of 2007-08, as well as the late 1980s boom, the New Labour (arguably unsustainable) burst of growth, the recession that followed the banking crash, and the early years of fiscal consolidation under the coalition.
There is a further, massively important, factor to be considered: population growth. The OBR’s forecasts are about overall growth, not growth per head. The Office for National Statistics assumes net annual inward migration of 315,000 a year through to the middle 2030s, which will push the population through the 70 million mark in 2026 and to nearly 74 million by 2036.
Given these levels of inward migration we surely ought to be growing far faster. The long-term assumption of the ONS is that we will add roughly 0.5 per cent to the population each year. In the past couple of years it has been around 1 per cent. Add in population growth and surely we should be growing at least at that 2.2 per cent figure we achieved from 1980 to 2014? What on earth is happening to productivity?
Economists trot out all sorts of explanations for the poor productivity performance of recent years, including low public investment in infrastructure, the weaker performance in the UK’s smaller firms, a sclerotic planning system, inadequate training of the workforce, and so on. But overriding everything is the general truth that increasing productivity in service industries, including the public sector, has proved much harder that lifting it in manufacturing. Since UK is a service-driven economy – the second largest exporter of services in the world after the US – it was always going to find it tough to boost its productivity. But the US has managed to do so. So too have Switzerland and Singapore.
Rachel Reeves acknowledged the need to do something about the public sector, requiring it to improve its productivity by 2 per cent next year. That is a tall order. Earlier this year the ONS reported that public sector productivity was lower in 2021 than it had been in 1997. It fell during the Blair/Brown years from an index of 100 in 1997 to 96.7 in 2010, rose slowly under the Coalition and Conservative governments to reach 104 in 2019, only to plunge during the pandemic. But – and here may be the sliver of light – there will not only be enormous pressure on the public sector from now on, but there is also the potential for artificial intelligence to improve its performance.
It always takes time to learn how to apply any new technology and we are at the very early stages of the AI revolution. But as Capital Economics reported earlier this year the UK, along with the US, Hong Kong, Singapore, Taiwan, South Korea, and the Nordics are expected to be the biggest beneficiaries. For what it is worth, the UK was ranked number three, behind only the US and Singapore, on the Capital Economics league table. They forecasted that productivity growth in the US would average 2.3 per cent a year by the 2030s, which would be slightly higher than it was during the 1990s internet boom.
Britain won’t do as well as America. But we ought to do better than we have been in recent years. Now, this has nothing to do with the policies of this new government, and the OBR is not designed to pick this up, but if the UK can get anywhere close to that US projection on productivity, and you add in population growth, the OBR will have to revise upwards its idea of trend growth to well over 2 per cent a year.
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