Since the 2008 global financial crisis, the United Kingdom has faced a period of productivity growth unprecedentedly weak. Also troubling is what this means for future tax increases. Historically, the UK’s output per hour increased by 2% per year on average between 1971-2009. But this number has plummeted in recent years to a meager 0.4% per year starting in 2010. While this troubling trend is not limited to the UK, its scale has been the most acute among advanced economies.
The large slowdown in productivity growth is one of the fundamental economic challenges we face. It directly affects the productivity which is how much value of goods/services the UK’s workforce produces for every hour worked. The most meaningful measure, known as “output per hour,” has plummeted. This would mean that the UK’s average annual growth rate is 1.9 percentage points lower than it was in the decades prior to this one. Naturally, economists and policymakers are monitoring the impact of this unexpected, major slowdown. They are especially focused on how it would affect future fiscal policy, even requiring tax increases.
According to the Office for Budget Responsibility (OBR), total UK productivity is set to grow by just 1% per year on average over the next five years. This rate of growth is far below historical averages, as well as lower than many expected. The OBR’s long run supply growth forecast is 1.79%, with the Bank of England’s forecast slightly lower at 1.5%. Compared to this, the International Monetary Fund (IMF) has offered a more pessimistic forecast of 1.36%. These projections paint a sobering picture of economic performance that bodes ill for the health of our public finances for decades to come.
The UK’s productivity growth is grinding to a halt. One very big reason is the ridiculously low levels of public investment in both our human and physical economy. Both private sector investments and government spending have fallen woefully short, stifling innovation and development opportunities. This lack of investment stifles productivity improving measures and will soon contribute to anemic economic growth.
Moreover, the UK’s heavy reliance on financial services, particularly through the City of London, has created an uneven economic landscape. We understand that financial services are important to the economy. Our excessive reliance on them has crowded out investment and innovation in other sectors that would more meaningfully accelerate productivity growth. The financial services concentration of the boom could have suppressed wider gains in productivity from other sectors of the economy.
Related to this, the government’s overall fiscal framework is an important factor to consider in tackling productivity challenges. The selected borrowing rules require the federal government to pay for its daily expenditures with current tax receipts. This approach would effectively limit borrowing to investments that boost economic development and productivity. This limitation squeezes public investment, particularly as the economy slows. Perhaps even more concerning, it would stymie congressional efforts to increase productivity-enhancing investments.
Rachel Reeves, one of the leading lights of UK politics and shadow chancellor of the exchequer, has recognized the burden created by these borrowing rules. She has left herself almost no “headroom”—a measly £9.9 billion—for passing these fiscal rules in 2029-30. This change has sent the signal that there is little room to maneuver in fiscal policy going forward. Such constraints can prevent investments that are needed to make our economy more productive and improve long-term economic growth.
At the end of the day, the consequences of stagnating productivity are deep for the UK economy and its people. If labor productivity grows at the anemic levels seen in recent years, higher taxes are almost inevitable. The government must make fiscal space, as the need for public spending starts to create pressure to newer issues.