Professor Christopher Martin from the Department of Economics at the University of Bath discusses the recent budget and what it might mean for UK growth and workers.
The build-up to last week’s budget was chaotic, with multiple leaks and talk of last-minute U-turns. But, after all the soap opera, the budget was broadly as expected.
The famous ‘headroom’ – the margin for meeting the two main fiscal rules (that non-investment expenditure be funded from taxation; and that debt as a share of GDP should be falling; both conditions to be met in three years’ time) – was increased. This was achieved by a £26 billion rise in taxes. Much of this will come from an extended freeze of tax thresholds. The rest will come from a mix of other sources that will mainly kick in towards the end of the parliament.
As the Office for Budget Responsibility (OBR) has emphasised, there is a lot of uncertainty around future tax receipts, and it is doubtful that all the projected future tax rises will actually happen in the run-up to an election. So a future tax raising budget is likely. But hopefully with less drama.
Much of the pre-budget speculation focused on the influence of the bond market, with many critics of the government suggesting that it was given too much importance. They argued that fear of an adverse reaction from the ‘markets’ should not prevent strong action to address the country’s many current social and economic challenges.
The budget probably did give more prominence to bond markets than these critics would like. But it is difficult not to factor in possible market reaction when that market determines the interest rate on the more than £300 billion of borrowing that is planned for this year. The recent 0.1 percentage point rise in the interest rate on bonds increased debt repayments by £2.5 billion, pushing the total above £100 billion. Increasing headroom to £22 billion will be partly self-financing if lower anxiety in financial markets leads to significant falls in the interest rate on government bonds.
Although there has been less discussion of the OBR’s revised economic forecasts, the new projection of 1.5% growth for the rest of this parliament is quite encouraging. This is particularly the case given the context of accumulating evidence of the deep adverse impacts of Brexit and of a reduction in immigration that has underpinned a lot of recent growth.
Critics often argue that the government lacks ‘a theory of growth’ – in other words, although growth is prioritised, there is no strategy for achieving it. I disagree with this view. The Chancellor has often stressed the role of public investment, in infrastructure, energy and transport, as an engine of growth. Consistent with this, public investment has been increased (although probably by less than she would like) and the temptation to cut it in order to meet fiscal targets has been resisted.
This is a marked change from the previous Conservative government and, to some extent, from the earlier Blair-Brown administration. This strategy has the support of many economists. But the benefits of such investment will only accrue slowly, which is a challenge in our current short-term and headline-dominated political culture.
It has often been said that UK business is addicted to the ‘sugar rush’ of a ‘low-wage economic model’ (to misquote Kwasi Kwarteng). Firms hold back from investment, it is argued, because labour provides a low-cost alternative to capital (assets such as machinery or IT systems). And indeed, investment has fallen as a share of GDP, opening a wider gap between the UK and competitor economies – a trend that has been made worse by Brexit.
The logical response to this is to increase the cost of labour, especially for lower-wage occupations, inducing firms to invest more. Arguably, this is what the repeated recent increases in national minimum wage will help to achieve. Commentators have expressed concern that these increases risk making parts of the hospitality and other low-wage service industries unviable. But perhaps that is the aim. As Chris Dillow has argued, the government needs to engineer the movement of workers into construction and social care if it is to succeed. A higher minimum wage may well be one way of achieving this.
All articles posted on this blog give the views of the author(s), and not the position of the IPR, nor of the University of Bath.
