Stagnation nation: governing the UK when ‘there is no money’


Jeremy Hunt, Britain’s chancellor, will look on the bright side this week. He has no choice: his Autumn Statement comes at the start of an election year in which menacing clouds hang over the economy and a Conservative government is languishing in the opinion polls.

But the challenge for Hunt is that he is presiding over a stagnation nation. The Bank of England forecasts flatlining growth next year — an election is expected by next autumn — and little improvement in 2025. A recession is possible, it cautions.

At the same time, many of the traditional escape routes for a chancellor are blocked off. Lord Philip Hammond, a former Tory chancellor, says doing politics in an era of low growth and little money is “very difficult”. He adds: “The politician who is honest about the situation probably gets voted out.”

Taxes are at a 70-year high, yet some 7.7mn people are on hospital waiting lists, schools are crumbling and ministers want to rent space in foreign jails because UK prisons are full.

Hunt will cut some taxes next week to put Britain on “a path” to a lower tax economy, but if the government were to introduce significant reductions now, they could worsen inflation, bust Britain’s fiscal rules and exacerbate a crisis in creaking public services.

A pre-election spending splurge, fuelled by borrowing, is also off the cards. Britain’s debt is running at close to 100 per cent of national income and debt servicing costs have soared.

These are the claustrophobic economic facts that face not just Hunt but also the Labour opposition, hoping to win power for the first time since 2010. Unless Britain can boost its growth rate, the country looks consigned to high taxes and poor public services for the foreseeable future.

Michael Saunders, a former member of the BoE’s interest rate setting committee, told a pre-Autumn Statement event: “Until we break out of low potential growth, the outlook is grim.”

The correct diagnosis

Higher growth is the elixir being pursued by British politicians — and indeed their counterparts across the world — after the combined hit of the financial crash, Covid-19, the war in Ukraine and spiking interest rates.

Such was Liz Truss’s obsession with shaking off Britain’s growth torpor that it destroyed her premiership within 50 days. Her proposed shock treatment, including a £45bn package of unfunded tax cuts, spooked the markets last autumn and prompted a political crisis.

Yet everyone agrees this is the correct diagnosis of Britain’s problem. Hunt’s challenge this week is to come up with reforms in his Autumn Statement that start to nudge up the dial of potential growth, which the BoE says will remain “well below historical averages in the medium term”.

People commuting to work under umbrellas as it rains
Commuters in London. Despite taxes being at a 70-year high, about 7.7mn people are on hospital waiting lists, schools are crumbling and ministers turn to foreign jails because UK prisons are full © Hollie Adams/Reuters

But this is grinding, technical work — not normally the kind of thing to set pulses racing in an election year. “It’s bullshit — snooze,” says one Tory minister, surveying the likely options available to Hunt, including the less-than-riveting idea of reforming capital allowances.

Yet in a stagnation nation, or at least one with very low growth prospects, everyone is forced to become a technocrat. The traditional growth lever of the right — big tax cuts — is constrained by the inexorable rise in demand for public services from an ageing population and the pesky restraints imposed by fiscal rules and markets.

For Sir Keir Starmer, the Labour leader, the old left solution of hiking taxes and splurging on public services is constrained by the fact that the public are already paying record taxes, partly to cover the costs of extra borrowing incurred during the Covid crisis.

The Institute for Fiscal Studies reported in September that “the overall level of taxation will increase by more over this parliament than under any previous parliament since the 1950s”. It added: “Between 2019-20 and 2024-25, tax revenues are set to increase by 4.2 per cent of national income under the latest official forecasts.”

Politicians are imprisoned by the economics, their choices limited. When the prime minister Rishi Sunak addressed his party conference in October, his most eye-catching announcements were on scrapping parts of the HS2 high-speed rail line to northern England and a cost-free plan to tackle smoking.

In contrast, the highlight of Starmer’s party conference in Liverpool was a promise to reform Britain’s restrictive planning system, long seen as one of the biggest obstacles to growth. Many economists agreed with him, but it is not exactly a policy to quicken the pulses of voters on the left.

“We are back in a world in which the electorate knows there is no money,” says David Gauke, a former Tory Treasury minister. “They know big promises are unlikely to be fulfilled, even if the Conservatives instinctively want to cut taxes and Labour might want to increase spending.”

Tax cuts and the election

With a British election expected in the autumn of 2024 — the latest possible date for Sunak to go to the polls is January 2025 — it was never likely that politicians of either side would want to have a thorough debate about the brutal choices facing the winner.

Sunak’s Conservatives typically trail the Labour opposition by more than 20 points in the opinion polls and urgently need some electoral magic dust now.

Hunt set a more optimistic tone on Sunday, telling the broadcaster Sky’s Trevor Phillips that the British economy had “turned a very big corner” with inflation halving during the year to 4.6 per cent. He said there was “too much negativity around the British economy”.

He has some additional fiscal room for manoeuvre. Higher inflation has helped to swell Treasury coffers, as higher pay sucks people into higher tax bands: thresholds and allowances have been frozen, creating a powerful “fiscal drag” effect.

Cuts to business taxation are being planned — part of a package of measures intended to promote growth — but Hunt is also looking to make non-inflationary cuts in personal taxes. The message will be: “We’re on the right track, don’t turn back.”

The problem is that whoever wins the next election will face significant pressure to put taxes back up again to avoid another painful round of public sector austerity. The Resolution Foundation think-tank has warned that spending plans pencilled in by Hunt for the next parliament are “a fiscal fiction”.

Spending per person in departments such as the Home Office; Transport; Justice; and Levelling Up, Housing and Communities is set to fall in real terms by 16 per cent, or £20bn a year, between 2022-23 and 2027-28, it says.

That would mean cuts being implemented “at a similar pace to those overseen by George Osborne in the early 2010s”, a reference to the former Tory chancellor’s austerity programme after the financial crash. The think-tank says these cuts are “implausibly” steep.

The difference is that when Osborne became chancellor in 2010, hospitals and schools had just enjoyed a long spell of increased spending under Tony Blair’s Labour government. “There was some fat there,” says Gauke. Meanwhile, the state could sustain more borrowing: public sector net debt in 2010 was 65 per cent of national income, compared with 97 per cent in 2022-23.

Labour has been treading carefully around the painful economic reality that a significant increase in Britain’s rocketing tax burden would be politically unpalatable. Starmer’s plans to raise taxes are very limited — aimed at non-domiciled taxpayers, private equity bosses and private schools.

Given that Starmer has few tax-raising options, Labour cannot make many dramatic spending promises. The party’s most eye-catching growth plan — an intention to borrow £28bn a year to fund green investments — was conceived at a time of rock-bottom interest rates and is now seen by Starmer as something of a liability.

“Unlike Labour, we know we can’t borrow our way to growth,” Hunt said in the House of Commons last week. During the past few months, Labour have “clarified” that the borrowing would only gradually build up over the course of a five-year period and that green spending plans already announced by the Tories would be deducted from the total.

The bottom line is that in an era of low growth and precious little money, a Labour government would be just as dependent as the Conservatives on getting the economy growing before it can start to make traditional big choices on tax and spend.

Weak confidence

The UK may not be in recession, but to Chris Carr it certainly feels like one. The managing director of Carr & Carr, a family building firm based in Lincolnshire, says confidence was “wiped out” by Truss’s “mini” Budget last year and a succession of interest-rate rises have compounded the pressure ever since.

His firm, which specialises in high-end homes, normally sells five or six properties but this year has sold only one. With some bigger builders laying off workers, the firm has started noticing bricklayers offering their services for lower wage rates in a sign of the faltering outlook for the sector. 

“I think this is just as bad as a recession even though we are technically not in one — it’s a lack of confidence,” he says.

Many business leaders crave some economic and political stability after the upheavals of Brexit, Covid, higher inflation and a carousel of Tory prime ministers.

George Wright, the managing director of M Wright and sons, which employs 55 people near Leicester in weaving high-technology fabrics, says it has been a long slog trying to get revenues back to their pre-Covid levels — and the company still is not there.

He says Brexit caused “a whole lot of grief we didn’t need”. More recently, profits have been hit hard by raw material costs rising. “They need to promote a growth environment, and then we will start investing,” Wright adds.

Hunt’s Autumn Statement will focus on growth, and he is looking at extending or making permanent the government’s flagship “full expensing” capital allowance regime, which he claims is among the most generous in the world and is scheduled to expire in 2026.

His statement, one of the last big chances for Sunak’s government to change the political weather before the next election, will contain measures to help businesses, including reforms to get people with physical or mental health problems back into work.

Prime Minister Rishi Sunak talks to local residents
Prime Minister Rishi Sunak at a resident Q&A. The Autumn Statement will include planning reforms, connecting green energy schemes to the electricity grid, and getting more pension money into start-ups © Peter Powell/PA

There will be planning reforms, measures to connect green energy schemes to the electricity grid, moves to get more pension money into start up companies, and a shake-up of government efforts to attract more inward investment.

All these things are likely to be welcomed by business, but there are also concerns that Hunt will shift scarce money — which might have been used to promote growth — into gimmicky pre-election tax cuts for voters. “I would like a stable, benign, supportive government that allows us to plan for the medium term with a lot of confidence,” Wright says. “But that is a very, very unrealistic request.”

Benjamin Nabarro, UK economist at Citi, says he fears the government’s attention is “increasingly torn between meaningful reform on the one hand and electorally expedient personal tax cuts on the other”.

A defining challenge

Britain’s growth problem is deep-seated, but is far from unique among G7 nations. Hunt argued in the Commons last week that, since 2010, Britain had grown faster than Spain, Portugal, Italy, France, the Netherlands, Austria, Germany and Japan.

Torsten Bell, director of the Resolution Foundation, notes that this will come as little comfort for politicians who have to confront what lies ahead: “It’s a slightly better past than expected but the future looks rubbish.”

Hunt points to IMF forecasts that Britain’s growth rate will be better than France, Germany and Italy after 2025, but it is still nothing to shout about.

Higher productivity is the goal: it would lead to an economy that could grow more without exacerbating inflation, permitting higher living standards. But the UK economy appears to be notably less dynamic and productive than partners, particularly the US. 

Data from the OECD show that between 2007 and 2022, labour productivity grew less in the UK than in the US and was below the average in the club of richer countries. 

Total factor productivity, an alternative measure that attempts to capture how efficiently resources are being used, rose by a mere 1.7 per cent between 2007 and last year, according to UK government statistics. 

“Especially since the early 2010s, we have seen the UK economy increasingly firing on only one or two cylinders, notably productivity in IT manufacturing and services,” says Bart van Ark, the head of the Productivity Institute, a UK research organisation. “Otherwise the slowdown is very widespread and quite chronic.” 

It is a conundrum of which Hunt is acutely aware and that will sit at the heart of many of the policy measures in the Autumn Statement.

UK business investment has grown only 4.6 per cent since the start of 2016 when it began stagnating — in part reflecting high uncertainty following the Brexit referendum.

By contrast, there has been a 32 per cent expansion in US business investment since the start of 2016 and 15 per cent growth in the eurozone, according to data collected by Oxford Economics. 

The UK’s recent performance compares poorly to earlier periods: capital spending grew by 26 per cent from the third quarter of 2008 to the first quarter of 2016. 

Higher interest rates are further squeezing business investment intentions. A quarterly survey by the CBI reported that, in November, only 18 per cent of businesses planned to invest more in plant and machinery — with only 12 per cent planning to invest in buildings, down from 31 per cent and 23 per cent in the same month last year. 

Chancellor Jeremy Hunt interacting with some a machine in a factory
Chancellor Jeremy Hunt visits Factory 2050 in South Yorkshire © Kirsty O’Connor/HM Treasury

Getting the British economy growing faster is the immediate test facing Hunt on Wednesday, but it is likely to be the defining issue for British politicians of all colours for the rest of the decade.

Holding an honest debate on the subject in the heated environment of an election campaign could be difficult. Supply side reforms are less “sexy” — in the words of one minister — than eye-catching tax cuts. Questioning the future size and role of the state in an era of persistent low growth is unlikely to prove a massive vote-winner.

“We are now at a stage when there are a lot of pressures on public spending and there’s a good case for extra spending,” says Gauke. “That means there needs to be a big discussion about what the state does, but neither party really wants to address it.”

Additional reporting by Valentina Romei in London

Data visualisation by Keith Fray

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