Why Britain can’t grow its way out of trouble

What do Rachel Reeves, Kwasi Kwarteng and a whole host of other contemporary finance ministers — British or otherwise — have in common? They all dream of discovering the secret elixir of economic growth.
For Reeves, the answer lies in stabilising the public finances, boosting public sector infrastructure investments, various public/private partnerships and a relaxation of planning laws. The last of these, unless truly radical, threatens to continue a long tradition of “cutting red tape’ — the sort of thing that provided many of the laughs in Yes, Minister back in the day.
For Kwarteng, the answer — ahead of his premature defenestration after the Tory mini-budget in September 2022 — was tax cuts. These, in his febrile imagination at least, would raise the “trend” growth rate of the UK economy from less than 1 per cent per annum in the years between the 2008 financial crisis and Covid to a rather punchier 2.5 per cent. The gilt market — and, within a handful of days, much of the pension system — thought otherwise.
The political obsession with boosting economic growth is not just about putting a few more pounds in our pockets, nice though that might be. Quite simply, a dose of extra gross domestic product (GDP) helps a government’s fiscal numbers add up. The revenue coffers overflow with abundance, public spending projects can more easily be funded, political promises can more generously be met, and, with luck, politicians keen to take the credit will be re-elected.
Without growth, we are condemned instead to a higher tax burden, grinding austerity and broken promises. As time goes by, voters who once believed in a holy grail of low tax rates and generous public benefits lose faith in “mainstream politicians”. They opt, instead, for the simplistic — and, often, plain wrong — narratives of populists and nationalists.
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Yet boosting economic growth is not very easy when the underlying trend is heading in entirely the opposite direction. Chancellors in the 1950s and 1960s — the likes of “Rab” Butler, Harold Macmillan, James Callaghan and Roy Jenkins — enjoyed average annual economic growth of 3.2 per cent. In the 1970s, Denis Healey had to clear up the mess left by the “Barber boom” and the 1973 oil price shock, but growth was still a smidgeon over 2 per cent per annum. In the 1980s and 1990s, GDP expanded at a 2.7 per cent lick. Thatcherite free market policies established a newly entrepreneurial state, and Tony Blair and Gordon Brown happily hung onto its coat-tails.
Sadly, average annual growth since 2000 has been a paltry 1.5 per cent; an upbeat start to that decade has been completely eclipsed by all that’s followed. Government revenues have been sub-par and public spending pressures have continued to mount, with the result being higher tax rates, persistent attempts at spending “discipline” and unprecedented (in peacetime) increases in government debt.
To be fair, Reeves’s growth ambitions are nothing like as impressive (or laughably fictitious) as Kwarteng’s were. Her — vague — aspiration is to have the fastest-growing economy in the G7 (more easily achieved, I’d imagine, with a US collapse than a UK boom). And she can quite happily argue — with good reason — that the past 20 years have been unusually miserable, due most obviously to the costs associated with the financial crisis, the impact of Covid, and the energy shock that followed Russia’s invasion of Ukraine.
I fear, however, that these events are no more than convenient excuses. They mask the underlying — and lasting — reasons for lower growth.
The question to ask is a version of Harold Macmillan’s famous boast in 1957. Why, in the second half of the 20th century, did we have it so good? Why was growth so much stronger than it had been before (and has proved to be so after)?
There was, I believe, a remarkable confluence of positive influences, most of which are now either at least partially exhausted or heading into reverse: the opening up of world trade; the expansion of tertiary education; the entry of women into paid employment; the expansion of consumer credit; and, most obviously, the absorption of millions of boomers into the workforce.
For much of the second half of the 20th century, the UK, and other industrialised nations, benefited from a positive population pyramid: even as life expectancy increased, the number of people in work rose more quickly than those in retirement. Now, the reverse applies. As such, spending on pensions, healthcare and social care is set to surge, with the burden falling on — sometimes shrinking — productive parts of the economy. And a poor fiscal position threatens to become worse, characterised by relentless further increases in government debt as a share of GDP (not fully consistent with the Labour government’s fiscal rules — but, let’s face it, fiscal rules are there to be broken).
We, as voters, don’t much like to hear these home truths. We are happier, instead, to soak up the unrealistic promises contained in party manifestos. Our political leaders will boost growth via artificial intelligence/new trade deals/efficiency gains/technological advances/infrastructure revolutions (tick as appropriate). Fiscal constraints will disappear, as if by magic.
If it were that easy, however, someone would already have done it. Yet Germany is stagnant, France is not much better, Italy has hardly grown, and Japan has gone sideways. The US has outperformed but is not as dynamic as it once was. And, in recent years, Washington has increasingly relied on the support provided by large budget deficits — easier to fund if you enjoy the privilege of issuing the world’s predominant reserve currency.
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What if growth in the UK doesn’t pick up? The options are limited. Raise the retirement age. Increase immigration to boost the working-age population — not that this helped after the financial crisis. Bump up taxes — more than just those on employers, private schools and farmers. Cut public spending. Force saving more via the regulation of financial institutions to lend more to the government (at the expense of other would-be borrowers). Or deliver higher than expected inflation — for, throughout history, inflation has proved the great temptation, reducing both the real value of nominal debts, including those of the government, and the real value of nominal savings.
None of this is very edifying. At least some of it, however, may come to pass.
PS
While president-elect Donald Trump has already made a whole heap of what might be described as intriguing nominations in his attempt to form a new administration, he hasn’t said very much recently about the Federal Reserve — America’s (and, arguably, the world’s) central bank and in charge of decisions such as interest rates. He had previously publicly criticised the Fed’s current chair, Jerome Powell, but the most he has hinted at lately is the idea that “the president should have at least [a] say in there — yeah, I feel that strongly”.
Powell’s current term in office comes to an end in May 2026. Investors are wondering if change is in the offing.
Economists like to think that nowadays, central banks are independent and thus free of political interference. It’s a comfortable conclusion for those who have no desire to return to the upheavals of an inflationary past. Yet it’s a conclusion that doesn’t sit comfortably with reality.
Some central banks, after all, enjoy more independence than others. The European Central Bank, for example, chooses its own inflation target; the Bank of England does not.
And personalities matter. Constitutionally and legally, the Federal Reserve of the 1980s was little different to the 1970s version. But Paul Volcker, chair of the Fed from 1979 to 1987, proved a tough inflation fighter — a far cry from the seemingly meek behaviour of Arthur F Burns, who was in charge from 1970 to 1978, taking in most of the Richard Nixon presidency and the early years of the Jimmy Carter administration.
Nixon pressurised Burns into doing his bidding. Ahead of the 1972 election, he wanted stimulus and Burns seemingly acquiesced.
In his memoirs, Volcker admitted to coming under similar pressure ahead of the 1984 election. He was urged by then chief of staff James Baker III — in the presence of President Ronald Reagan — not to raise interest rates. Volcker walked out of the room without saying a word. Some central bankers, it turns out, are more independent than others.
Perhaps Trump will keep his central banking powder dry. Should he act, however, expect jitters in both the bond and currency markets. Ten-year US Treasury yields — the benchmark for long-term borrowing costs around the world — have already surged. Investors sense that change is afoot.
Stephen D King has written several books on economics, including We Need to Talk About Inflation (Yale, 2023). He is HSBC’s senior economic adviser
David Smith is away