12 July 2023

Shortsighted economic forecasts are holding back growth – there is a better way

By S Singham & D McWilliams

The UK may have avoided a recession so far in 2023, but this has come at the cost of continuing inflation and squeezed living standards. Of the G20 countries only Turkey, Argentina, Brazil and Mexico have higher core inflation than the UK. Once the inflation genie is out of the bottle it is difficult to stuff it back in without considerable hardship – and the pain from rising rates is only just beginning.

What has made our problems worse is that economic growth (per head of population) has ground to a halt. With the population growing at an estimated 0.5% this year, it is likely that the latest figures to be released on Thursday will show GDP per capita continuing to decline. This will make the suffering we will have to endure to eliminate inflation very much more acute.

Yet Britain is far from alone. The West, by which we mean the G7 countries, has been suffering a stagnation crisis for decades. It is to combat this that we have called together some of the world’s leading economic thinkers to form a Growth Commission, which launches today.

Our work so far suggests that, while growth in GDP per capita was increasing dramatically until the 1980s, it started to slow in G7 economies form the 1990s. But there were many reasons why we should have expected this previous dramatic growth rate to continue and even increase. New economies were added to the global system in that decade, such as India, Latin America and the former Soviet countries. Just as the previous decades of trade liberalisation had created the transnational company, there were now new markets to access. The Uruguay Round had been negotiated and the WTO created. In 2001, China acceded to the WTO. Fast-forward to today, and emerging technologies like AI and supercomputing should be offering economies the chance to grow.

So why aren’t they?

A major constraint for the UK is the economic modelling used to determine policy. Short-term forecasts fail to take into account behavioural changes. Taxes are raised with little understanding of how they affect incentives, and regulations are adopted with little concern for the downside of higher costs and restricted competition. The result is a build-up of policy failure over three decades.

To understand the impact of bad regulation, just ask any small business how difficult it was to get a bank account or to move if they are unhappy – it is virtually impossible. This is because of rules that were put in place to counter money-laundering. Yet criminal activity still persists, while everyday banking customers are stuck with poor service and rising charges because they can’t move accounts.

The Commission’s aim is to help policymakers to understand the longer term consequences of their tax and regulatory policies.

This is particularly necessary in Britain. Although most countries have faced a post-Covid hit to public finances, inflation has been more persistent in the UK. Tax rises at a time when investment is already suppressed are unlikely to help growth. We need to understand how official forecasts have failed to account for the consequences of such policies. So we will incorporate the latest dynamic modelling approaches to better express the costs of policy choices in ways that the OBR and Treasury have overlooked.

One of the most insightful studies of the UK’s economic problems was, in fact, commissioned by Gordon Brown. His McKinsey study highlighted how distortions in the UK economy, many caused by badly thought out planning rules, were leading to low GDP per capita. When Brown received the report he shelved it, even though its analysis was prescient. One of our tasks is to update this thinking, carried out a quarter of a century ago, to deal with problems which are now much more severe.

If we succeed in encouraging better policies to get the economy growing again, there will be higher living standards, better public services and the chance to bring down tax rates. That means a better quality of life for people and more opportunities and hope for their children. If we fail, however, there is a danger we will slip into a spiral of falling living standards, restricted services and ever higher taxes.

We had better succeed.

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Shanker Singham and Douglas McWilliams Co-Chair the Growth Commission, an independent group of economic experts from the US, UK, Mexico, India and Japan.

Columns are the author's own opinion and do not necessarily reflect the views of CapX.