Britain is heading for a fiscal crisis
Without immediate, credible action to rein in spending, contain debt and keep inflation under control, Britain will sleepwalk into disaster, says Gerard Lyons
The UK is in danger of sleepwalking into economic torpor. The issues we face are real, sizeable but, crucially, solvable. However, solutions have too often been evaded through short-term fixes and political timidity.
The UK is a low-growth, low-productivity, low-wage economy. The trend rate of growth has slowed sharply since the 2008 crisis. The economy is deeply imbalanced, and its twin budget and current account deficits highlight the need to boost national savings and raise investment.
The economy is not competitive and the country is living beyond its means. Of course, we should acknowledge the impact of the financial crisis and the pandemic. But the policy record is still stark. Current policy is stifling risk-taking and failing to empower the private sector.
By the end of the decade, the ratio of debt to GDP is set to exceed 100 per cent. It will keep rising as elevated debt-servicing costs and weak growth propel the economy towards a debt trap – an inescapable cycle of rising debt.
Without immediate, credible action to rein in spending, contain debt and keep inflation under control, a fiscal crisis may be looming.
In a report for The Centre for Policy Studies – Breaking the Cycle – I have set out a new strategic direction for the economy. This has one overarching goal; raising GDP per capita.
To achieve it, the UK needs a return to sound fiscal management, pursue targeted supply-side reforms and deliver monetary and financial stability.
Fiscal discipline
Foundation one is fiscal discipline. Fiscal credibility is essential. The status quo is unsustainable, locking the economy into a Groundhog Day of weak growth, rising taxes and stagnanting living standards.
We need to shift from a short-term obsession with fiscal headroom, and instead address the longer-term trends and need for fiscal solvency. Debt must fall relative to GDP.
An ageing population, higher defence spending and untenable public demands on government make spending restraint unavoidable.
This means curbing welfare spending – such as tightening controls on benefits, re-examining the triple lock on pensions and addressing issues linked to immigration such as Indefinite Leave to Remain. There is also the need to control health spending. It dominates spending reviews and squeezes other areas in the allocation for funds.
Alongside this, policy should reverse the upward trend in the tax-take and pursue tax simplification, including removing the ‘Manhattan skyline’ of high marginal tax rates. Stamp duty should be cut immediately but broad-based tax reductions may prove counterproductive in the current fiscal climate and should await improving public finances.
Foundation two is a supply-side agenda to raise the potential growth rate. This must be built around the four I’s of investment, innovation, infrastructure and incentives.
This is not only necessary in its own right but – often overlooked – by raising trend growth a supply-side policy would allow future fiscal policy to be more effective. It would also allow the neutral level for the bank rate to be lower, as the economy could grow at a faster pace before hitting bottlenecks.
Foundation three is low inflation, financial stability and a competitive City that serves domestic growth.
Instead of tax, spend and borrow the UK must save, invest and compete
This requires a clear break from previous cheap money policies. Inflation must be brought under lasting control. The Bank should abandon its damaging QT programme. It should cease paying full interest on commercial bank reserves and adopt a tiered system, reducing the fiscal burden while retaining monetary control.
We need a more competitive financial sector that serves domestic growth as well as international markets. This includes narrowing the gap in patient capital available to small and medium-sized firms. A revival of popular capitalism, in which more people are encouraged to save, invest and build wealth, should be central to the UK’s long-term resilience.
These foundations suggest a range of other policies to help growth. One example being lowering energy bills while addressing the green agenda by energy addition, not energy substitution. Also bad policies like wealth taxes should be resisted.
In short, it is time for a sea-change in economic management to boost growth in GDP per capita. Instead of tax, spend and borrow the UK must save, invest and compete.
Dr Gerard Lyons is a fellow at the Centre for Policy Studies