Summary

This summary just states my main conclusions- the evidence to support each point follows below.

1. The UK faces deeper economic problems than other developed countries.
2. The blame rests squarely on major and predictable policy mistakes made by conservative Governments since 2010.
3. Restoring market trust after the disastrous Truss premiership required the Chancellor to promise harsher measures than would otherwise have been required.
4. He has tried to minimise the political cost by delaying painful measures until after 2024- gambling that the markets will be satisfied by promises that the next Government will have to deliver.
5. The specific measures in the Autumn statement appear at first sight to be well targeted: increased spending on health and education, updating benefits and the minimum wage to protect the poor and vulnerable, while the identified tax measures focus on high income earners and substantial additional revenue from windfall taxes on profits. However, the impression is misleading.
6. On the revenue side, the largest single contribution to growth in tax revenues over the next 5 years comes from the freezing of tax thresholds. These stealth taxes will require millions of low and middle income households who are already experiencing declining incomes to pay significantly more tax.
7. The increases in public spending over the next two years are welcome but totally inadequate to deal with the cost pressures that have built up over 12 years of neglect.
8. The biggest single risk is that cost and wage pressures will make the assumed public expenditure cuts that are envisaged to take place after the 2024 election impossible to achieve- perhaps less a risk than a near certainty.
9. An alternative strategy is feasible. It would involve re- joining the single market ( the most obvious near-term way to increase economic growth), introducing a significant wealth tax and other measures to raise revenue from those best able to pay. This would finance a more realistic response to public expenditure cost pressures, help reduce the impact on living standards and still keep the debt burden to a manageable level, with the prospect of a falling debt:GDP level in the medium term.

UK Economy is in worse shape than other developed countries

Compared to other G7 countries, the UK suffered by far the steepest fall in output during the pandemic with GDP falling 11% in 2020. Some of this was recovered in 2021, but the Ukraine crisis has again found the UK the least able to cope:- we are in recession with output 0.4% down over the pst year, while the Eurozone has grown by 2.2% and the USA by 4.2% (House of Commons Library, International Comparisons, Key Economic Indicators, 11November 2022). The UK is the only G7 country that has not yet recovered to pre-pandemic output levels. The OBR forecast that living standards will fall by 7% in the current and following year, and will be no higher in 2024 than a decade earlier. Recovery after that remains painfully slow:living standards as measured by real disposable income per person are projected to remain below pre-pandemic levels until 2027-28 (OBR forecast).

The Conservatives are to Blame

The war in Ukraine can explain why the global economy has slowed, but not why UK performance relative to other developed countries has been so poor. This is not a new phenomenon. UK economic performance has stagnated since the 2008-9 financial crisis.

During the 1997-2007 period, UK productivity growth of 1.9 % per annum was second only to the USA within the G7. This was achieved while also investing more in health and education and reducing poverty. From 2009-2019, productivity growth fell to 0.9% p.a., below the G7 average with only Italy performing worse (Office of NationalStatistics, based on OECD data).. Our relative performance subsequently deteriorated further due to the grotesque waste and mismanagement during the pandemic. After growing faster than our competitors and closing the productivity gap during the Labour years, the conservatives have presided over a long period of relative decline.

Previous posts on this site have looked at the policy errors that contributed to our inadequate growth performance.

BREXIT has caused a significant increase in the cost and difficulty of trade, and is estimated to have permanently reduced GDP by 4% (OBR, October 2021).

The rot however started before BREXIT. Austerity and increased inequality have both damaged the economy and increased poverty, as set out in detail in the excellent report Stagnation Nation produced by the Resolution Foundation.. The poor state of our infrastructure and public services make us an unattractive location in which to invest. Because of the poor growth performance, austerity was not even able to restore the public finances, leaving us to face the pandemic with a small and debt burdened economy, collapsing public services and rising levels of poverty.

Is the pain really necessary?

Government debt approaching 100% of GDP is high though by no means unprecedented. The problem is the increase in interest rates. Higher interest rates account for two thirds of the £75bn deterioration in the projected FY 26-27 Government deficit if no further action is taken (OBR forecast). The other factors are the energy price shock and the inflation driven increase in welfare payments.

The Government needed to convince the markets that debt would not spiral out of control. They needed to be convinced that action would be taken to ensure that debt:GDP would peak within the next 5 years, and would then begin to come down.

The OBR forcast shows that, with no further action, Government would still be borrowing 3.7% of GDP in FY 27-28.. With real GDP growth of 2.2% and inflation on target at about 2%, the cash value of GDP would grow by more than 4%. This would be just sufficient to ensure that debt would begin to decline as a share of GDP, even if Government took no further action and was still borrowing 3.7% of GDP. The markets might well have reacted calmly to this scenario had it not been for the ludicrous policy turbulence of the last few months. A new Government with a reputation for honesty and competence might still be able to be convincing.

The Conservatives probably had to do more. The poor reputation our Government has for economic competence is reflected in the’moron premium’, the extra interest that HMG has to pay in order to borrow money. The increased cost of Government borrowing has come down slightly from the premium demanded when Liz Truss was in charge, but it remains significant, reflecting the perceived risk of lending to an unstable and unpredictable Government. The implicit interest rate on 10 year bonds issued by HMG is currently about 3.2%, having peaked at 4.5%. It is perhaps no surprise that stolid and dependable Germany only has to pay 2% on 10 year bonds, but France is able to borrow at 2.5%, still much more cheaply than the UK (rates checked 20 th November). This matters: according to the OBR, a1% increase in borrowing costs adds £25 bn to the annual deficit in FY27-28, equal to one third of the increased deficit that made the autumn statement necessary.

HMG are Delaying some of the pain–

Measures in the Autumn statement actually increase public expenditure in the current and two subsequent years, with increases focused on health and education. Significant cuts in spending are envisaged from 2025-26, but these are not specified and will be for the next Government to decide and implement. They are planned to be very steep: holding current budgets to a 1% per annum increase, rather than the previously planned 3.4% while capital budgets are maintained in cash terms, implying a real terms cut in both.

On the revenue side, the big tax increases that are explicitly identified are targeted towards windfall taxes on energy companies, and higher taxes for high earners.

The most politically challenging of the explicitly identified measures is the change to the energy price guarantee in FY23-24, implying a £500 increase in average bills, but the £14 bn saving is offset by £12 bn of targeted support for the poor and vulnerable in cost of living payments to pensioners, the disabled and those on means tested benefits.

– While disguising and shifting the blame for most of the pain

The autumn statement contains a detailed table setting out the impact of each of the policy measures in the statement. On the face of it, this appears to show very little impact on the tax that most people will pay. The decision to freeze the income tax and NI thresholds for two further years is shown as raising just £1.26 bn, and that in the final year. The reduction in the additional rate threshold is more significant in money terms, but is better targeted, hitting those on relatively high incomes. However, the table is entirely misleading.

The decision to freeze the tax thresholds was made when inflation was far lower. The acceleration in inflation has massively increased the yield of this stealth tax. Supplementary tables published with the OBR forecasts show that income tax is forcast to increase by £97 bn between FY21-22 and FY 28-9, accounting for 34% of the forcast increase in receipts over the period. Most of this is the result of higher incomes with unchanged thresholds dragging more people into paying tax and subjecting existing taxpayers to pay tax on a higher share of their incomes. In the period from FY20-21 to FY 28-9, the economy is expected to grow by about 12%, but income tax receipts will increase by over 20%, adjusted for inflation. These tax increases will fall on households who have experienced a prolonged period of falling incomes as wages have failed to keep pace with inflation.

The public expenditure increases to address pressure on education and health and social care are welcome, but fall far short of the amounts needed. Average pay awards of 5% across the public sector are not fully funded when budgets have been increasing by only 3%, and they involve a real terms cut when inflation is at 10%. The NHS confederation estimate that the NHS needs an additional £4bn just to make up for inflation in the current FY 22-23, before considering the cost of tackling the backlog of maintenance, the staff shortages, the waiting lists, and the social care underfunding. The £5-6 bn p.a. extra over the next two years will not address these problems. Similarly, school funding restores FY 20-21 per pupil funding, but it remains significantly below 2010 levels in real terms.

For local Government, the cap on rate increases has been raised to enable local authorities to finance higher expenditure. This may be astute politics, with brutal implications. Wealthier authorities with mostly conservative controlled councils will be able to raise more and improve services. Poorer local authorities will struggle to raise more revenue, and will face resentment for the state of public services, but the conservatives will hope to place the blame on the party that controls the council- which in most cases will not be themselves.

Risks

The biggest risk is that the envisaged public expenditure cuts from FY 24-25 will not happen. Indeed, that is a near certainty given the dilapidated state of our public sector after 12 years of austerity. The growth and inflation assumptions are also subject to wide margins of error. The OBR forecast is for average growth of about 2.5% per annum over the last three years to FY 27-28, in line with most other forecasts but more optimistic than the Bank of England.

Does it matter if events do not turn out as forecast? Probably not very much. The key point is that the statement commits HMG to targets to reduce the deficit below 3% of GDP and begin to reduce the debt: GDP ratio by FY 27-28. Forecasts are a polite fiction, setting out a plausible scenario for how this might be achieved. In present circumstances, I doubt that anyone is paying too much attention to them. The key point is for the Government to convince the markets that it will take necessary action to manage the public finances and meet the targets in the light of whatever circumstances it finds itself in.

What is the alternative?

An alternative strategy with less pain is feasible.

It would include a closer relationship with the EU, preferably including a commitment to rejoin the single market. When both major parties acknowledge the importance of restoring growth to the economy, it is bizarre that neither will support the one measure that would do most to achieve this quickly and at minimal cost.

Public expenditure plans will need to be increased in order to address the many legacies of past neglect. In a situation where dire poverty also afflicts so many households, the safety net which is currently one of the least generous in Europe needs to be enhanced.

Increased growth alone will not be sufficient to pay for this without spooking the markets. We will need increased taxation to come from somewhere. The obvious source if we are concerned to shield lower and middle income households is to implement a wealth tax. The wealthy largely escape tax by declaring low incomes, letting wealth accumulate, and financing their lifestyle by borrowing against their assets. Detailed proposals for raising large sums by taxing wealth have already been prepared setting out how a wealth tax might work (Wealth Tax Commission: A Wealth Tax for the UK, LSE 2020). There may also be scope for raising taxation of Bank profits that have been swollen by higher interest rates, and for saving money by cancelling some of the large scale mega projects and focusing instead on supporting local initiatives.

An increase in the tax GDP ratio in the UK would raise it to a level that would be high for the UK, but not out of line with successful European countries. The tax:GDP ratio is projected by the OBR to reach 37.1% in FY 27-28, which is high for us but compares with 45% in France and 39% in Germany according to OECD data for 2019. Loading more tax onto an economy in such a weak state would only be reasonable if it is targeted towards those best able to pay- hence the attraction of a wealth tax.

The positive attraction of this alternative is that faster growth and higher taxes paid by the wealthy should enable us to reduce debt and the interest burden sooner. The earlier we can implement higher taxes, the sooner we can begin to reduce the interest burden and create the scope for spending more on public services. We are currently in a doom loop, where slow growth and high interest payments swallow money that could be used to restore public services and reduce the high tax burden on struggling households. Reversing this can potentially create a virtuous circle with earlier action both reducing the debt and encouraging the markets to reduce the premium they charge on our borrowing.

Digging our way out of the mess we are in will not be easy. But for a credible Government, it need not be quite as difficult and painful as implementation of the Tory Autumn statement will prove to be.

Before discussing future economic policies, it is important to recall when we last had a successful economy, and to understand how we arrived at our present chaotic mess. Data to support most of the points made can be found in Stagnation Nation, the excellent interim report published July 2022 by the Resolution Foundation.

The Labour Government that took power in 1997 is the only post war UK Government to achieve faster economic growth than the average of the developed economies. It achieved this while also sharing the benefits, with major reductions in poverty (especially child poverty) and big improvements in public services including access to education and the performance of the NHS.

The progress was interrupted by the financial crisis of 2007-8, but it was the years of unnecessary austerity that followed that did the most damage.

George Osborne argued that the deep cuts aimed at reducing the debt to GDP ratio were ‘repairing the roof while the sun shines.’ It turned out that nothing much was repaired during those years. Austerity in practice meant that problems were simply deferred, resulting in a mountain of costs for a future government:- neglected maintenance of schools and hospitals, failure to train enough doctors and nurses, local authorities starved of cash resulting in fewer and poorer quality services, collapse in the value of benefits resulting in increased poverty, and a mounting pressure for public sector wage increases after a decade of relative decline. The main effect of the policy was to slow economic growth- with the tragically ironic consequence that the pain and suffering that was inflicted did not even succeed in reducing the debt burden. Net public debt to GDP actually increased under the coalition government.

A key point is that the subsequent economic shocks of BREXIT, the pandemic, the Ukrainian war, and the calamitous policies of Liz Truss hit an already enfeebled economy suffering stagnant growth and rising poverty, with public services under visible distress.

In the current economic crisis, a partial reversal of the most damaging aspects of the extreme version of BREXIT is one of the few areas of economic policy where the UK can take back control ( I think I might have heard that phrase before somewhere).

We have little control over the war or it’s economic consequences. The period of economic lunacy under Truss was brief but resulted in an expensive loss of control over our economic policies. The measures that had to be brought in to try to restore market confidence are significantly harsher and more expensive than they need have been, reflected in higher borrowing costs than other major economies and a weak exchange rate. Replacing irresponsible tax cuts with Austerity 2 may calm the markets, but will do nothing to increase economic growth and will further exacerbate the already critical state of our public sector.

It is bizarre that both major political parties ignore the one economic strategy that offers the fairly certain prospect of boosting economic growth and improving the public finances, at minimal cost ( or possibly negative cost if we are able to save on the army of public employees doing jobs only necessary because of our divorce from the EU). I refer of course to improving our trading relationship with the EU. The strongest single conclusion from the literature on economic growth is that more open trade policies boost the growth rate.

It is beyond dispute that leaving the EU has made trade in both goods and services more expensive and more difficult, resulting in a precipitous 9% decline in trade openness from 2019 to 2021, far steeper than the 2% decline in France (Resolution Foundation, op cit). Cutting ourselves off from the EU has made trade more difficult in all markets, not just the EU, because we are no longer covered by the many EU trade deals with third countries.

The second strongest conclusion from the growth literature concerns the importance of investment in human capital through education, training and research. Here also we have severely damaged our prospects by cutting ourselves off from collaboration in research through the EU Horizon programme and making ourselves a more difficult and less attractive place to live, research, work and invest.

It might not be politically realistic to argue for re-joining the EU and overturning the referendum result. However, the case for far closer trading arrangements is overwhelming, and how far we can and should go deserves to be at the centre of our political discourse.

Liz Truss says she wants to overturn Treasury orthodoxy on economics- but where on earth did she find anyone who thinks her alternative prescription makes sense?

We have high inflation- higher than other countries similarly affected by energy prices. Living standards are falling further and faster than at any time in living memory.

We have a high level of Government borrowing, adding to a public debt that is already at historically high levels relative to GDP.

We have a large balance of payments deficit, and declining exchange rate.

Financing these deficits has been relatively cheap but that is changing, with higher interest rates and a declining exchange rate both raising the cost of Government borrowing.

After 12 years of austerity there is a massive backlog of public expenditure costs that will have to be addressed. Almost every area of public spending is in crisis, before even considering the intense pressure to begin to restore the value of public sector pay.

All this follows a prolonged period of slow growth and declining real wages since the conservatives took over in 2010.

Her solution to this perfect storm of economic problems is to cut taxes and cut public spending.

In normal times, there is no reason to believe that this would increase economic growth. In a situation where the Government already faces high inflation and large fiscal and balance of payments deficits, it will have the opposite effect. Irresponsible economic management will drive investment down even further.

There is a narrow path out of the problems. It requires higher taxes on the better off ( preferably on wealth which largely escapes tax), support targeting those on low incomes, and a rebuilding of public services including local Government. It requires serious policies to rebuild economic growth- including a closer economic relationship with Europe. It doesn’t require the Government to throw more fuel on the fire through unnecessary tax cuts for those who don’t need them.

It beggars belief that she was employed as an economist.