On March 23, Rishi Sunak, the UK’s Chancellor of the Exchequer, delivered his Spring Statement, in which he announced changes to various taxes and grants. These measures were made against the background of rising inflation and falling living standards.
CPI inflation, currently at 6.2%, is still rising and the Office for Budget Responsibility forecasts that inflation will average 7.4% this year. The poor spend a larger proportion of their income on energy and food than the rich. With inflation rates especially high for gas, electricity and basic foodstuffs, the poor have been seen their cost of living rise by considerably more than the overall inflation rate.
According to the OBR, the higher inflation, by reducing real income and consumption, is expected to reduce the growth in real GDP this year from the previously forecast 6% to 3.8% – a much smaller bounce back from the fall in output during the early stages of the pandemic. Despite this growth in GDP, real disposable incomes will fall by an average of £488 per person this year. As the OBR states:
With inflation outpacing growth in nominal earnings and net taxes due to rise in April, real living standards are set to fall by 2.2 per cent in 2022/23 – their largest financial year fall on record – and not recover their pre-pandemic level until 2024/25.
The Chancellor announced a number of measures, which, he argued, would provide relief from rises in the cost of living.
- Previously, the Chancellor had announced that national insurance (NI) would rise by 1.25 percentage points this April. In the Statement he announced that the starting point for paying NI would rise from a previously planned £9880 to £12 570 (the same as the starting point for income tax). This will more than offset the rise in the NI rate for those earning below £32 000. This makes the NI system slightly more progressive than before. (Click here for a PowerPoint of the chart.)
- A cut in fuel duty of 5p per litre. The main beneficiaries will be those who drive more and those with bigger cars – generally the better off. Those who cannot afford a car will not benefit at all, other than from lower transport costs being passed on in lower prices.
- The 5% VAT on energy-saving household measures such as solar panels, insulation and heat pumps will be reduced to zero.
- The government’s Household Support Fund will be doubled to £1bn. This provides money to local authorities to help vulnerable households with rising living costs.
- Research and development tax credits for businesses will increase and small businesses will each get another £1000 per year in the form of employment allowances, which reduce their NI payments. He announced that taxes on business investment will be further cut in the Autumn Budget.
- The main rate of income tax will be cut from 20% to 19% in two years’ time. Unlike the rise in NI, which only affects employment and self-employment income, the cut in income tax will apply to all incomes, including rental and savings income.
The Chancellor announced that public finances are stronger than previously forecast. The rapid growth in tax receipts has reduced public-sector borrowing from £322 billion (15.0 per cent of GDP) in 2020/21 to an expected £128 billion (5.4 per cent of GDP) in 2021/22, £55 billion less than the OBR forecast in October 2021. This reflects not only the growth in the economy, but also inflation, which results in fiscal drag.
Fiscal drag is where rises in nominal incomes mean that the average rate of income tax rises. As tax thresholds for 2022/23 are frozen at 2021/22 levels, a greater proportion of incomes will be taxed at higher rates and tax-free allowances will account for a smaller proportion of incomes. The higher the rate of increase in nominal incomes, the greater fiscal drag becomes. The higher average rate of tax drags on real incomes and spending. On the other hand, the extra tax revenue reduces government borrowing and gives the government more room for extra spending or tax cuts.
The growth in poverty
With incomes of the poor not keeping pace with inflation, many people are facing real hardship. While the Spring Statement will provide a small degree of support to the poor through cuts in fuel duty and the rise in the NI threshold, the measures are poorly targeted. Rather than cutting fuel duty by 5p, a move that is regressive, removing or reducing the 5% VAT on gas and electricity would have been a progressive move.
Benefits, such as Universal Credit and the State Pension, are uprated each April in line with inflation the previous September. When inflation is rising, this means that benefits will go up by less than the current rate of inflation. This April, benefits will rise by last September’s annual inflation rate of 3.1% – considerably below the current inflation rate of 6.2% and the forecast rate for this year of 7.4%. This will push many benefit recipients deeper into poverty.
One measure rejected by Rishi Sunak is to impose a temporary windfall tax on oil companies, which have profited from the higher global oil prices. Such taxes are used in Norway and are currently being considered by the EU. Tax revenues from such a windfall tax could be used to fund benefit increases or tax reductions elsewhere and these measures could be targeted on the poor.
- Overview of the March 2022 Economic and fiscal outlook
Office for Budget Responsibility (23/3/22)
- Spring Statement: Key points at a glance
BBC News (23/3/22)
- Spring statement 2022: key points at a glance
The Guardian, Richard Partington and Jessica Elgot (23/3/22)
- People face biggest drop in living standards since 1956
BBC News (23/3/22)
- Spring Statement: Rishi Sunak accused of not doing enough for poorest households
BBC News (24/3/22)
- Chancellor provides minimal help to households on cost of living crisis
Financial Times, Chris Giles (23/3/22)
- Britain’s poorest left to bear brunt of squeeze on cost of living
Financial Times, Delphine Strauss (23/3/22)
- Spring statement: How does Rishi Sunak’s national insurance change affect you?
Sky News, Daniel Dunford and Ganesh Rao (24/3/22)
- Spring Statement 2022 – An initial response from IFS researchers
Institute for Fiscal Studies Press Release, Stuart Adam, Carl Emmerson, Paul Johnson, Helen Miller, Isabel Stockton, Tom Waters and Ben Zaranko (23/3/22)
- Chancellor prioritises his tax cutting credentials over low-and-middle income households with £2 in every £3 of new support going to the top half
Resolution Foundation press release (23/3/22)
- Richest handed £480 boost in Spring Statement, say researchers
- UK’s most vulnerable face crunch as Rishi Sunak helps better-off
The Guardian, Larry Elliott and Heather Stewart (23/3/22)
- Rishi Sunak tackled over failure to help poorest families
The Guardian, Richard Partington and Aubrey Allegretti (24/3/22)
- A Spring Statement for White Wealth Drivers
Byline Times, Stan Norris (23/3/22)
- Rishi Sunak’s Fiscal Drag Race
Evening Standard, Jack Kessler (23/3/22)
- Rishi Sunak fails to address the hit to living standards
Financial Times, Martin Wolf (23/3/22)
- Why Rishi Sunak refused a windfall tax on oil and gas companies
The New Statesman, Philippa Nuttall (23/3/22)
OBR data and analysis
- Are the changes made to national insurance by the Chancellor progressive or regressive? Could they have been made more progressive and, if so, how?
- What are the arguments for and against cutting income tax from 20% to 19% in two years’ time rather than reversing the current increases in national insurance at that point?
- What will determine how rapidly (if at all) public-sector borrowing decreases over the next few years?
- What are automatic fiscal stabilisers? How does their effect vary with the rate of inflation?
- Examine the public finances of another country. Are the issues similar to those in the UK? Recommend fiscal policy measures for your chosen country and provide a justification.
Policymakers around the world have used Gross Domestic Product as the main gauge of economic performance – and have often adopted policies that aim to maximise its rate of growth. Generation after generation of economists have committed significant time and effort to thinking about the factors that influence GDP growth, on the premise that an expanding and healthy economy is one that sees its GDP increasing every year at a sufficient rate.
But is economic output a good enough indicator of national economic wellbeing? Costanza et al (2014) (see link below) argue that, despite its merits, GDP can be a ‘misleading measure of national success’:
GDP measures mainly market transactions. It ignores social costs, environmental impacts and income inequality. If a business used GDP-style accounting, it would aim to maximize gross revenue — even at the expense of profitability, efficiency, sustainability or flexibility. That is hardly smart or sustainable (think Enron). Yet since the end of the Second World War, promoting GDP growth has remained the primary national policy goal in almost every country. Meanwhile, researchers have become much better at measuring what actually does make life worthwhile. The environmental and social effects of GDP growth is a misleading measure of national success. Countries should act now to embrace new metrics.
The limitations of GDP growth as a measure of economic wellbeing and national strength are becoming increasingly clear in today’s world. Some of the world’s wealthiest countries are plagued by discontent, with a growth in populism and social discontent – attitudes which are often fuelled by high rates of poverty and economic hardship. In a recent report titled ‘The Living Standards Audit 2018’ published by the Resolution Foundation, a UK economic thinktank (see link below), the authors found that child poverty rose in 2016–17 as a result of declining incomes of the poorest third of UK households:
While the economic profile of UK households has changed, living standards – with the exception of pensioner households – have mostly stagnated since the mid-2000s. Typical household incomes are not much higher than they were in 2003–04. This stagnation in living standards for many has brought with it a rise in poverty rates for low to middle income families. Over a third of low to middle income families with children are in poverty, up from a quarter in the mid-2000s, and nearly two-fifths say that they can’t afford a holiday away for their children once a year. On the other hand, the share of non-working families in poverty has fallen, though not by enough to prevent an overall rise in poverty since 2010.
Their projections also show that this rise in poverty was likely to have continued in 2017–18:
Although the increase in broad measures of inequality were relatively muted last year, our nowcast suggests that there was a pronounced rise in poverty (measured after housing costs[…]. The increase in overall poverty (from 22.1 to 23.2 per cent) was the largest since 1988. But this was dwarfed by the increase in child poverty, which rose from 30.3 per cent to 33.4 per cent. […]The fortunes of middle-income households diverged from those towards the bottom of the distribution and so a greater share of households, and children, found themselves below the poverty threshold.
A simple literature search on Scope (or even Google Scholar) shows that there has been a significant increase in the number of journal articles and reports in the last 10 years on this topic. We do talk more about the limitations of GDP, but we are still using it as the main measure of national economic performance.
Is it then time to stop focusing our attention on GDP growth exclusively and start considering broader metrics of social development? And what would such metrics look like? Both interesting questions that we will try to address in coming blogs.
- What are the main strengths and weakness of using GDP as measure of economic performance?
- Is high GDP growth alone enough to foster economic and social wellbeing? Explain your answer using examples.
- Write a list of alternative measures that could be used alongside GDP-based metrics to measure economic and social progress. Explain your answer.
According to the theory of the political business cycle, governments call elections at the point in the business cycle that gives them the greatest likelihood of winning. This is normally near the peak of the cycle, when the economic news is currently good but likely to get worse in the medium term. With fixed-term governments, this makes it harder for governments as, unless they are lucky, they have to use demand management policies to engineer a boom as an election approaches. It is much easier if they can choose when to call an election.
In the UK, under the Fixed-term Parliaments Act of 2011, the next election must be five years after the previous one. This means that the next election in the UK must be the first Thursday in May 2020. The only exception is if at least two-thirds of all MPs vote for a motion ‘That there shall be an early parliamentary general election’ or ‘That this House has no confidence in Her Majesty’s Government.’
The former motion was put in the House of Commons on 19 April and was carried by 522 votes to 13 – considerably more than two-thirds of the 650 seats in Parliament. The next election will therefore take place on the government’s chosen date of 8 June 2017.
Part of the reason for the government calling an election is to give it a stronger mandate for its Brexit negotiations. Part is to take advantage of its currently strong opinion poll ratings, which, if correct, will mean that it will gain a substantially larger majority. But part could be to take advantage of the current state of the business cycle.
Although the economy is currently growing quite strongly (1.9% in 2016) and although forecasts for economic growth this year are around 2%, buoyed partly by a strongly growing world economy, beyond that things look less good. Indeed, there are a number of headwinds facing the economy.
First there are the Brexit negotiations, which are likely to prove long and difficult and could damage confidence in the economy. There may be adverse effects on both inward and domestic investment and possible increased capital outflows. At the press conference to the Bank of England’s February 2017 Inflation Report, the governor stated that “investment is expected to be around a quarter lower in three years’ time than projected prior to the referendum, with material consequences for productivity, wages and incomes”.
Second, the fall in the sterling exchange rate is putting upward pressure on inflation. The Bank of England forecasts that CPI inflation will peak at around 2.8% in early 2018. With nominal real wages lagging behind prices, real wages are falling and will continue to do so. As well as from putting downward pressure on living standards, it will tend to reduce consumption and the rate of economic growth.
Consumer debt has been rising rapidly in recent months, with credit-card debt reaching an 11-year high in February. This has helped to support growth. However, with falling real incomes, a lack of confidence may encourage people to cut back on new borrowing and hence on spending. What is more, concerns about the unsustainability of some consumer debt has encouraged the FCA (the financial sector regulator) to review the whole consumer credit industry. In addition, many banks are tightening up on their criteria for granting credit.
Retail spending, although rising in February itself, fell in the three months to February – the largest fall for nearly seven years. Such falls are likely to continue.
So if the current boom in the economy will soon end, then, according to political business cycle theory, the government is right to have called a snap election.
Gloomy economic outlook is why Theresa May was forced to call a snap election The Conversation, Richard Murphy (18/4/17)
What does Theresa May’s general election U-turn mean for the economy? Independent, Ben Chu (18/4/17)
It’s not the economy, stupid – is it? BBC News Scotland, Douglas Fraser (18/4/17)
Biggest fall in UK retail sales in seven years BBC News (21/4/17)
Sharp drop in UK retail sales blamed on higher prices Financial Times, Gavin Jackson (21/4/17)
Shoppers cut back as inflation kicks in – and top Bank of England official says it will get worse The Telegraph, Tim Wallace Szu Ping Chan (21/4/17)
Retail sales volumes fall at fastest quarterly rate in seven years Independent, Ben Chu (21/4/17)
Retail sales in Great Britain: Mar 2017 ONS (21/4/17)
- For what reasons might economic growth in the UK slow over the next two to three years?
- For what reasons might economic growth increase over the next two to three years?
- Why is forecasting UK economic growth particularly difficult at the present time?
- What does political business cycle theory predict about the behaviour of governments (a) with fixed terms between elections; (b) if they can choose when to call an election?
- How well timed is the government’s decision to call an election?
- If retail sales are falling, what other element(s) of aggregate demand may support economic growth in the coming months?
- How does UK productivity compare with that in other developed countries? Explain why.
- What possible trading arrangements with the EU could the UK have in a post-Brexit deal? Discuss their likelihood and their impact on economic growth?
Productivity has been a bit of a problem for the UK economy for a number of years. Earlier posts from 2015 have discussed the trend in Tackling the UK’s poor productivity and The UK’s poor productivity record. Although the so-called ‘productivity gap’ has been targeted by the government, with George Osborne promising to take steps to encourage more long-term investment in infrastructure and create better incentives for businesses to improve productivity, the latest data suggest that the problem remains.
The ONS has found that the UK continues to lag behind the other members of the G7, but perhaps more concerning is that the gap has grown to its biggest since 1991. The data showed that output per hour worked was 20 percentage points lower in the UK than the average for the other G7 countries. The economic downturn did cause falls in productivity, but the UK has not recovered as much as other advanced nations. One of the reasons, according to the Howard Archer, chief UK economist at IHS Global Insight is that it ‘had been held back since the financial crisis by the creation of lots of low-skilled, low-paid jobs’. These are the jobs where productivity is lowest and this may be causing the productivity gap to expand. Other cited reasons include the lack of investment which Osborne is attempting to address, fewer innovations and problems of finance.
Despite these rather dis-heartening data, there are some signs that things have begun to turn around. In the first quarter of 2015, output per hour worked did increase at the fastest annual growth rate in 3 years and Howard Archer confirmed that this did show ‘clear sign that UK productivity is now seeing much-needed improvement.’ There are other signs that we should be optimistic, delivered by the Bank of England. Sir John Cunliffe, Deputy Governor for financial stability said:
“firms have a greater incentive to find efficiency gains and to switch away from more labour-intensive forms of production. This should boost productivity.”
The reason given for this optimism is the increase in the real cost of labour relative to the cost of investment. So, a bit of a mixed picture here. UK productivity remains a cause for concern and given its importance in improving living standards, the Conservative government will be keen to demonstrate that its policies are closing the productivity gap. The latest data is more promising, but that still leaves a long way to go. The following articles consider this data and news.
UK productivity shortfall at record high Financial Times, Emily Cadman (18/9/15)
UK productivity lags behind rest of 7 BBC News (17/9/15)
UK’s poor productivity figures show challenge for the government The Guardian, Katie Allen (18/9/15)
UK productivity lags G7 peers in 2014-ONS Reuters (18/9/15)
UK productivity second lowest in G7 Fresh Business Thinking, Jonathan Davies (18/9/15)
UK is 33% less productive than Germany Economia (18/9/15)
UK productivity is in the G7 ‘slow lane’ Sky News (18/9/15)
AMECO Database European Commission, Economic and Financial Affairs
Labour Productivity, Q1 2015 ONS (1/7/15)
International Comparisons of Productivity, 2014 – First Estimates ONS (18/9/15)
- How could we measure productivity?
- Why should we be optimistic about productivity if the real cost of labour is rising?
- If jobs are being created at slower rate and the economy is still expanding, why does this suggest that productivity is rising? What does it suggest about pay?
- Why is a rise in productivity needed to improve living standards?
‘Employment has been strong, but productivity and real wages have been flat.’ This is one of the key observations in a new OECD report on the state of the UK economy. If real incomes for the majority of people are to be raised, then labour productivity must rise.
For many years, the UK has had a lower productivity (in terms of output per hour worked) than most other developed countries, with the exception of Japan. But from 1980 to the mid 2000s, the gap was gradually narrowing. Since then, however, the gap has been widening again. This is illustrated in Chart 1, which shows countries’ productivity relative to the UK’s (with the UK set at 100). (Click here for a PowerPoint.)
Compared with the UK, GDP per hour worked in 2013 (the latest data available) was 28% higher in France, 29% higher in Germany and 30% higher in the USA. What is more, GDP per hour worked and GDP per capita in the UK fell by 3.8% and 6.1% respectively after the financial crisis of 2007/8 (see the green and grey lines in Chart 2). And while both indicators began rising after 2009, they were still both below their 2007 levels in 2013. Average real wages also fell after 2007 but, unlike the other two indicators, kept on falling and by 2013 were 4% below their 2007 levels, as the red line in Chart 2 shows. (Click here for a PowerPoint.)
Although productivity and even real wages are rising again, the rate of increase is slow. If productivity is to rise, there must be investment. This could be in physical capital, human capital or, preferably, both. But for many years the UK has had a lower rate of investment than other countries, as Chart 3 shows. (Click here for a PowerPoint.) This chart measures investment in fixed capital as a percentage of GDP.
So how can investment be encouraged? Faster growth will encourage greater investment through the accelerator effect, but such an effect could well be short-lived as firms seek to re-equip but may be cautious about committing to increasing capacity. What is crucial here is maintaining high degrees of business confidence over an extended period of time.
More fundamentally, there are structural problems that need tackling. One is the poor state of infrastructure. This is a problem not just in the UK, but in many developed countries, which cut back on public and private investment in transport, communications and energy infrastructure in an attempt to reduce government deficits after the financial crisis. Another is the low level of skills of many workers. Greater investment in training and apprenticeships would help here.
Then there is the question of access to finance. Although interest rates are very low, banks are cautious about granting long-term loans to business. Since the financial crisis banks have become much more risk averse and long-term loans, by their nature, are relatively risky. Government initiatives to provide finance to private companies may help here. For example the government has just announced a Help to Grow scheme which will provide support for 500 small firms each year through the new British Business Bank, which will provide investment loans and also grants on a match funding basis for new investment.
OECD: UK must fix productivity Economia, Oliver Griffin (25/2/15)
The UK’s productivity puzzle BBC News, Lina Yueh (24/2/15)
OECD warns UK must fix productivity problem to raise living standards The Guardian, Katie Allen (24/2/15)
Britain must boost productivity to complete post-crisis recovery, says OECD International Business Times, Ian Silvera (24/2/15)
OECD urges UK to loosen immigration controls on skilled workers Financial Times, Emily Cadman and Helen Warrell (24/2/15)
OECD Economic Surveys, United Kingdom: Overview OECD (February 2015)
OECD Economic Surveys, United Kingdom: Full report OECD (February 2015)
- In what ways can productivity be measured? What are the relative merits of using the different measures?
- Why has the UK’s productivity lagged behind other industrialised countries?
- What is the relationship between income inequality and labour productivity?
- Why has UK investment been lower than in other industrialised countries?
- What are zombie firms? How does the problem of zombie firms in the UK compare with that in other countries? Explain the differences.
- What policies can be pursued to increased labour productivity?
- What difficulties are there in introducing effective policies to tackle low productivity?
- Should immigration controls be lifted to tackle the problem of a shortage of skilled workers?