Politicians and voters must learn that every policy has a cost and an impact on growth

The runners and riders battling for leadership of the Conservative Party are setting out their stalls. Tax, lockdown, defence and Brexit are all key issues which have been raised. On some of these, at least, there are marked differences between the candidates.

But there is an elephant in the room: how to raise the underlying rate of economic growth in the UK. In the immediate short-term there may well be a recession. Some economists are suggesting it could be severe, with the worst squeeze on living standards for decades. Any serious politician should focus on this.

Yet the real issue goes much deeper. It’s not so much a question of how much growth – or lack of it – we can expect over the next year or two. It’s about how much there will be over the next decade and beyond.

The Office for Budget Responsibility published last week a closely argued document entitled “Fiscal risks and sustainability”. They highlighted three major areas where demographic changes will put increasing pressure on the public finances. An ageing population means increasing demand for health, pensions and social care.

The OBR projected that in 50 years’ time these would lead the ratio of public sector debt to GDP to exceed 250 per cent. As a benchmark, the current ratio, even after the massive splash of cash on Covid-19, is just over 90 per cent.

These problems don’t really kick in until the late 2030s, but the basic issue stays the same. How can we afford the increasing demands of the electorate?

The only way of doing it is higher economic growth.

Higher spending can always be paid for in the short term by issuing debt. That is, until the terrifying moment when the markets decide that enough is enough.

As a broad rule of thumb, each additional 1 per cent on the level of GDP yields an additional £10bn in tax receipts. An increase of 1 per cent in the growth rate would generate almost £100bn over the course of a decade.

Unfortunately, across the West as a whole, the underlying long term rate of growth has not been rising. It has been going into reverse.

Inspired by the late Angus Maddison, economic historians have put a lot of effort into constructing historical estimates of GDP. Maddison himself began by estimating the size of the economy in each of the 17 countries which he considered to be properly industrialised in 1870.

Over the pre-pandemic decade – from 2010 to 2019 – the average annual growth rate of real GDP was lower in all 17 economies than their long term average over the 1870-2019 period as a whole. Some were very much lower, with the 150 year average in Italy being 2.4 per cent compared to the barely perceptible 0.3 per cent of 2010-2019.

The most challenging and important task when it comes to political economy is how to get growth back to the rates which it sustained for well over a century. Without it, much of what is written in manifestos – whether of would-be Tory leaders or of opposition parties – does not have much meaning.

Everything on the wish lists of both politicians and the electorate has to be paid for. Tax cuts, more money for the armed forces, better social care – whatever the policy, it costs money. And without sound growth, there will simply not be enough of it.

As published in City AM Wednesday 13th July 2022
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