The economic governance of Britain has been woeful for at least a decade now, and arguably we haven’t had a truly successful Chancellor of the Exchequer since the 1990s. As a result we have a low-growth, low-productivity, low-wage economy, but a high-spend, high-tax, high-borrowing state. We are sinking deeper into a hole of our own making.
The dire state of the nation is illustrated in great detail by a cavalcade of charts and stats in the first chapter of a new report by CPS Research Fellow Gerard Lyons, ‘Breaking the Cycle’. But the essential insight of Lyons’ paper, to my mind, is that politicians all too often approach economic governance in a piecemeal fashion, led by electioneering slogans or personal obsessions. The problem is not that their mental models are inaccurate – economics is an art, not a science – but that they all too often don’t have a conceptual framework to navigate by at all. Fortunately, Lyons is on hand with just such a framework.
And boy, oh boy, is it sorely needed. As the paper outlines, in GDP per capita terms – a decent proxy for living standards – we are still poorer now than we were at the end of 2019. GDP growth rates have also collapsed. Whereas the 1987-2007 trend growth rate of around 2.7% meant the economy would double in size every 26 years, on the current trend it would take 41 years – and a more realistic assessment of the outlook might point to it taking 58 years. So a freshly-minted graduate today might not see a doubling in the size of the economy during their entire working life.
The causes of this economic malaise are manifold and interlinked. Productivity growth has virtually flatlined: had it returned to the pre-2008 rate from 2010, productivity would now be 27% higher than it is, but instead, as a consequence, we are living through the longest period of stagnation in wages on record. Housing starts are on track for a 12-year low of just 192,000 in 2025/26, and we’ve already been under-building for decades, leaving us 6.5 million homes behind comparable European countries. Mass migration – net 7 million since the turn of the century – has failed to turbocharge the economy and has diluted the capital stock.
Meanwhile, British industrial energy prices are the highest in the developed world, at more than four times American levels. Gross-fixed capital formation of about 18% of GDP is well below the G7 average, and down from 21% in the 1970s-90s. Investment is discouraged anyway. First, because our tax system is complex, unpredictable and poorly-structured, with a bewildering 294 specific tax and spending decisions in the last five fiscal events alone. Second, because the growth of the unaccountable regulatory state is also seemingly inexorable – even the ‘bonfire of regulations’ in the 2010s added a net £6 billion to annual business costs.
Moreover, spectacular failures on inflation and monetary policy have compounded Britain’s economic and fiscal problems. Ultra-loose monetary policy in the 2010s and the pandemic quantitative easing fuelled inflation (prices have increased by almost 50% since 2010) and the cost-of-living crisis (even pre-Ukraine). It also boosted asset prices, notably houses, worsened intergenerational divides and it led markets to misprice risk, with zombie firms surviving and growth firms struggling to access capital, distorting the whole economy.
Yet economic weakness and slow growth has not held back government spending, which rose from £687 billion in 2010 to £1,335 billion in 2024, and is projected to surpass £1.5 trillion this decade, reaching about 45% of GDP. Given sluggish growth rates, this massive increase – over 100% in nominal terms and 27% in real terms – is being met through a combination of record taxation and perilously high borrowing. Politically expedient areas, notably healthcare, pensions and working age welfare are eating up more and more of spending. Non-ringfenced areas like justice and defence, although core functions of the state, have been subjected to deep real-terms cuts.
The tax burden is on track to reach a post-war high of 37.5% of GDP, and as Labour’s employers’ NI rise shows, further increases are only going to come at the cost of economic growth. Yet despite a record tax burden, spending is still being allowed to outpace receipts, with borrowing taking up the slack. The UK has not run a budget surplus since 2000/01. And with interest rates higher, debt interest is expected to be above £100 billion in every year of this Parliament – a huge additional burden on the public finances. Thanks to a persistent deficit, the debt-to-GDP ratio is set to surpass 100% of GDP this decade.
In short, we’re in a bad place, and yet we’re still digging. As Lyons warns, some sort of analogue to the 1976 fiscal crisis and IMF bailout is now far from unthinkable.
If we are to avert a rerun of 1976, and get the Britain on the path towards prosperity again, there are – in the Lyons’ conception – three essential foundations that need to be held in mind when devising economic strategy, policy and narrative.
Foundation one is fiscal discipline to restore fiscal credibility. Notwithstanding headwinds such as an ageing population and the need for higher defence spending, we must get back to a position where the national debt is shrinking relative to GDP. We have no guarantee that economic growth will return to historical levels in the near term, and this will mean cuts – but strategically, not via salami-slicing across the whole of government. Welfare spending is the obvious primary target. The state needs to be smaller as a share of GDP, and rather than the current trajectory towards 45%, we need to be falling back towards around a third. This would give us scope for more extensive tax cuts, though pernicious taxes like stamp duty on homes and shares should be abolished as soon as possible.
Foundation two is a supply-side agenda to raise the potential growth rate. A higher growth rate would mean that future fiscal policy could be used more meaningfully, and with a greater supply of goods and services to meet demand, interest rates could be throttled back without risking high inflation. At the heart of supply-side reform, Lyons puts the four ‘I’s: investment, innovation, infrastructure and incentives. Improvements should be sought in these four domains via tax reform and regulatory simplification – especially of the planning system. We need to reward risk-taking and enterprise.
Foundation three is low inflation, financial stability and a competitive City that serves domestic growth. This requires credible monetary policy – with a clear break from previous cheap money policies of the post-2008 period, which can no longer be used to paper over the absence of economic growth. Westminster needs to get better at holding the Bank of England to account. We also need a new version of popular capitalism to help boost domestic savings and investment.
This conceptual framework – which admittedly I’ve only had space to canter though – might seem pretty obvious. Yet throughout the last few decades, at least one foundation or another has always been absent in the way governments have approached economic policy
In the early 2010s, fiscal policy ruled the roost, and monetary policy was the dog that didn’t bark. In the later 2010s, the Brexit wars consumed government bandwidth and both public sector and wider supply-side reform stalled. Under Boris Johnson, fiscal caution was cast to the wind, and even more so under Liz Truss, when massive tax and spending commitments preceded anything concrete on supply-side reform, and were made with little regard to the monetary or global environment. After Truss, fiscal credibility was restored, for a time, but again supply-side reform – beyond maths to 18 – was relegated. And of Rachel Reeves tenure in No.11 so far, the less said the better.
Moreover, throughout the last few decades, there has also been a tendency to cling to nice sounding slogans at the expense of analytical acuity – ‘green industrial revolution’, ‘securonomics’, ‘science superpower’, ‘Global Britain’, ‘fifth-biggest economy’, ‘industrial strategy’ and ‘long-term economic plan’ to name but a few.
All of these misadventures, though well-meaning, have created a grand confluence of problems that now seem to be coming to a head – or at least that’s the way the bond markets seem to be feeling.
Politicians need to update their mental models of economic stewardship along the lines set out in ‘Breaking the Cycle’. Then perhaps, despite political or electoral pressures to the contrary, they might take a more synoptic approach to managing tax and spend and creating benign conditions for economic growth in the UK today, with full appreciation for what ‘capitalism with British characteristics’ entails. Otherwise, it is all too likely that we remain stuck in the doom loop of ever high borrowing and taxes and ever lower economic growth – at least until fiscal hubris meets economic nemesis.
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