Chancellor of the Exchequer Jeremy Hunt departs Downing Street to present the Autumn Statement to ... [+]
By Linda Yueh, Adjunct Professor of Economics
The UK’s most recent Autumn Statement had three stated objectives: stability, growth and a plan for public services. As I said during the evidence session in front of the Treasury Committee of the House of Commons earlier this week, it achieved the first but the second and third require more work.
The reaction of financial markets confirmed that the new UK Chancellor in his first budget has managed to restore stability. Borrowing costs were always going to rise due to the bank rate increasing as a result of inflation. But, the spike in yields in the gilt market seen after the previous Chancellor’s mini Budget was not repeated.
This is a fundamental building block in setting out a growth strategy for the UK economy and addressing the challenges around public services. Stabilising borrowing costs affects the size of the numerator in the debt-to-GDP ratio, but the denominator also requires attention. If GDP expands, then debt stabilisation is a more manageable task. But it takes time for investments made today to generate growth in the coming years. And the UK has faced slower growth since the banking crash a decade ago, so it is a challenge to restore growth to 2.5 percent from the currently projected 1.7 percent by the Office for Budget Responsibility.
Economic growth requires investments that increase productivity, which accounts for about 2 percentage points of the previous trend growth rate. The remainder was based on labour supply. Economists have focused on the reason why the UK is growing more slowly than other G7 countries and concluded that investment is key. At 19 percent of GDP, the UK invests less than the US, Germany and other comparable economies. As the US is also a predominantly services economy, the difference cannot be solely attributed to the structure of the economy. At 10 percent of GDP, business investment is some 3 percentage points less than America. Investment in digital, physical and human capital can generate improvements in productivity and help people and firms adjust to the digital transformation of the economy.
Particularly since it takes time for growth plans to deliver, there is an urgent need to set out a strategy in the UK’s spring Budget. There were important measures around investment in the Autumn Statement as well as increasing R&D tax credits to support innovation. The planned investments around infrastructure, hospitals and broadband totalling some £600 billion were preserved, which will offer an important foundation. Although public sector net investment will be reduced after 2025, it will still be about 2.2 per cent of GDP which will be higher than before. Because the new fiscal rules which limit the deficit to 3 percent of GDP and debt to be falling as a share of GDP on a rolling basis do not differentiate between current and capital spending, it will be harder for the government to show bond markets that its spending will generate growth in the future. Day-to-day spending would not, but capital spending could. So, restoring the previous rule of borrowing to invest would help the government to deploy more capital to generate growth.
Also, the focus on physical and digital infrastructure would benefit from an expansion to include human capital. Tax credits to incentive firms to invest in factories and broadband are important to increase physical capital. But human capital is crucial for innovation and to help people adjust to digital disruption to the economy. Since four-fifths of the UK economy is services and most people work in services industries, a tax credit for firms who invest in their employees would incentivise them to put funds into the most important asset for many businesses. Increasing human capital would boost productivity and also potentially innovation, since it is people who invent and improve efficiency. Although the UK already offers firms the ability to claim for expenses for training their workers, a tax credit can do more to broaden the ways in which firms invest in their people. Several US states have offered tax credits that complement federal tax credits that include promoting education, for instance.
Any growth plan would benefit from focusing on people and their human capital in addition to the complementary physical and digital capital. Within physical and human capital, reorienting the investment towards supporting the green transition would also generate greater payoffs in terms of GDP and employment, as the IMF has stressed.
And of course health is crucial. So, the final prong of the Autumn Statement set out additional funds for the UK’s National Health Service as well as schools. The spring Budget should look to incorporate the impact of health into its assessment of the labour market inactivity rate that has risen since the pandemic. Uncovering the primary reasons why around half a million, largely older workers, has left the labour force would help to formulate an appropriate strategy for inclusive growth.
The first prong around financial stability was seemingly achieved in the Autumn Statement. The next Budget should focus on a growth plan that targets investment and makes the UK economy more productive, greener and inclusive. As we face recession, it is even more urgent for the foundations of growth to be invested in now to produce returns during a time of economic downturn so that we are able to come out of recession and ready to grow.
Linda Yueh is Adjunct Professor of Economics at the London Business School; Fellow in Economics at St Edmund Hall, Oxford University; and Visiting Professor at the IDEAS research centre, the foreign policy research centre at the London School of Economics and Political Science. She was Visiting Professor of Economics at Peking University.
