By Linda Yueh, Adjunct Professor of Economics
The UK’s Budget has been dubbed a “Budget for Growth.” Today’s economic forecast by the independent Office for Budget Responsibility (OBR) reinforces that moniker since the UK is now expected to avoid a technical recession. GDP is expected to contract by 0.2 percent this year with growth returning by the third quarter in the summer. That good news is tempered by slower growth over the longer term from next year. It’s also tempered by the OBR forecasting that real household disposable income per person, which measures standards of living, is expected to decline by 5.7 percent until April 2024, which is the worst drop on record. That’s also when the economy is forecast to finally recover to its pre-pandemic level. So, in early 2024, the economy will only be as large as it was in 2019. Thus, there is an urgent need for a Budget that gets the economy going and growing.
As I wrote in Forbes after the Autumn Statement, “the UK’s next focus needs to be on growth.” The UK faces growth challenges that need addressing in order to not only weather the current challenging environment but also to help stabilise its fiscal position over the medium term. In other words, the Chancellor’s stated aim of stabilising the debt-to-GDP ratio depends on the denominator as well as the numerator. GDP growth has slowed considerably since the banking crash a decade ago. The previous growth rate of around 2.5 percent has slumped to about half that rate. Faster economic growth would help stabilise the debt-to-GDP ratio and crucially improve standards of living in the country.
As each fiscal event is an occasion to set out how the government would like to shape the economy, Budgets should always be deliberate in setting out the incentives and constraints that govern the growth trajectory. And this Budget does so by targeting three factors: labour supply, investment and technological innovation. These are the three levers in a standard economic growth model: workers, capital and technology which can increase the productivity of the first two levers.
Taking each one in turn, there are challenges for each. The increase in the economic inactivity rate is not specific to the UK but it alone among major economies has not seen the significant return to the labour market, particularly among the over 50s, evident elsewhere. Around 5.8 percent of the working age population is inactive, which is the highest rate in 16 years. Moreover, the Office for National Statistics estimates that an ageing population will add to the inactivity rate in the next three years. The reasons for dropping out of the labour force are wide ranging, including long-term illness, childcare, and the structure of the welfare system and pensions. There is no one policy lever that can address all of the various causes, so the Budget includes a range of measures such as 30 hours of free care for very young children per week, raising the annual tax-free pension contribution limit, supporting occupational health in the workplace, and reforming the welfare system by removing the link between benefit entitlement and the ability to work.
In addition to these and other fiscal incentives, there are other ways to encourage those who have chosen to leave the workforce to return. For instance, firms could offer greater flexibility, target their recruitment to attract older workers, and run positive campaigns to provide a straightforward avenue of return for ex-employees. In terms of immigration, the targeting of specific segments of workers for roles that cannot be filled domestically is another avenue.
Investment is the other important factor. The UK’s lagging investment is an important cause of the slowdown in GDP growth rate, particularly since 2016 when Brexit introduced uncertainty which makes firms wait before committing funds. The Chancellor announced that businesses will be able to offset 100 percent of their investment in their tax bill. Such a tax break should encourage firms to invest. It should help firms manage the increase in corporation tax from 19p to 25p that is in effect from April. The Budget also creates 12 investment zones north of Birmingham which would give flexibility to localities to design an economic system that works for their local area.
Thus, these two factors – labour and capital – together would go a long way to increasing the potential growth rate of the economy to get it back to its pre-banking crisis rate.
The third component in the Budget focuses on increasing the growth rate through technological progress. There is a new “enhanced credit” for research-intensive businesses of £27 for every £100 invested. The targeted R&D tax credit focused on high tech investments aims to generate innovation that is essential to increasing the productivity of the economy which in turns raises its potential growth rate.
Since investment in people and capital takes time, putting in the fiscal incentives in place now is important if the fruits of the policies are to be seen by 2024 and beyond.
Every Budget is a statement of the government’s aspirations for the economy. This one has fleshed out what was only touched upon in the Autumn Statement, which was largely geared at stabilisation of financial markets. This one has budgeted for growth. It is indeed welcome though more will likely be needed and perhaps be possible once the economy is on a surer footing.
Linda Yueh is Adjunct Professor of Economics at the London Business School; Fellow in Economics at St Edmund Hall, Oxford University; and the author of The Great Crashes and The Great Economists.