The UK’s productivity problem may not be the worst among its G7 peers – that dubious distinction goes to Italy – but it is bad enough.
Since the global financial crisis of 2008-09, UK real GDP per capita has grown by a miserable 6 per cent. Set against the US, where per capita output has risen by around 20 per cent, it is clear why UK policymakers should be forming a coherent strategy to address this.
Small tweaks around the edges will not fix the UK’s economic malaise – radical change is needed.
We can look around the world to see examples where other countries have attempted to renovate their economies: Abenomics in Japan, Emmanuel Macron’s reforms to French labour markets and Javier Milei taking a chainsaw to Argentina’s economic institutions. Even the US, at the technological frontier, has felt the need to turbocharge its economy through the Inflation Reduction Act and the Chips and Science Act.
Targeted action is required, as merely increasing government spending is no guarantee of boosting economic growth in the long run.
Looking across 20 OECD economies, there is almost no correlation between public spending as a share of GDP and the level of labour productivity. But that does not mean that government spending cannot boost growth, just that it matters how and when you spend.
Soon after becoming chancellor, Rachel Reeves gave a hint of the lines she was thinking along by asking the UK government’s fiscal watchdog, the Office for Budget Responsibility, whether all spending is equal or some deserves special exemptions in budgetary discussions.
In essence, she asked whether capital spending, which includes investment that is likely to have a more lasting impact on the UK economy, could be treated separately from current spending. As Liz Truss learned, governments must always be credible on the current Budget, or markets will kill them.
Capital spending, however, is more of a grey area. To determine whether capital spending should be treated separately – presumably with a view to changing the government’s fiscal rules – you must first identify whether public investment (another area where the UK sits close to the bottom of the G7 nations) delivers long-run economic benefits. This was the question she asked.
The conclusion the OBR reached was a ‘yes’, with caveats - typically public investment is good and benefits the UK in the long run, provided it does not fully crowd out (that is, displace) private investment that would otherwise have taken place.
That caveat is important.
A 2021 study by the US Congressional Budget Office concluded that when public investment is funded by cutting day-to-day government spending, it does not typically crowd out private investment, but when public investment is funded by borrowing, it does crowd out the private sector.
