Liz Truss's economic growth plan: Why tax and spending cuts are not going to work – John McLaren

The new UK Government wants the long-term economic growth rate to return to its historical average of 2.5 per cent. But what exactly does that mean and is it realistic?

If the UK Government's 2.5 per cent growth target is not recognised as realistic then Chancellor Kwasi Kwarteng's 'ironclad commitment to fiscal discipline' is dead in the water (Picture: Daniel Sorabji/AFP via Getty Images)

First, we need to be clear that this is a real-terms measure, it excludes inflation. So, for example, if inflation stood at ten per cent then growth of 12.5 per cent would be needed to achieve real-terms growth of 2.5 per cent.

Next, we need to better understand what that average of 2.5 per cent is composed of and how it has changed over time.

In terms of composition, most economic growth can be broken down into three main sources: population growth – whereby more people simply produce more stuff; growth in the economic activity rate – ie, a higher share of the existing population are working; and productivity – where improved technology and practices allow each worker to produce more.

Over the past 70 years, covering the reign of the last Queen, the size and make-up of economic growth has changed considerably.

In the early period – 1952 to 1972 – growth was at its highest, averaging 3.5 per cent a year. This was mainly driven by a post-war surge in productivity, with the baby boom-led rise in population having little impact on the size of the workforce.

In the middle period – 1972 to 2002 – growth was still around 2.25 per cent a year, but now driven by more women joining the labour force, helping to offset the slowing pace of productivity growth.

In the later period – 2002 to 2022 – growth fell to 1.5 per cent a year as productivity plummeted. Even that low growth rate was only possible due to the fillip of a working-age migrant-led rise in the population.

The changing circumstances of past growth rates highlight a number of issues with the 2.5 per cent target.

First, is it pure growth or growth in living standards – GDP per person or per household – that the UK Government wants to see rising at this target rate?

Second, is it content for higher growth to be driven by rising migration, rather than coming from the existing potential workforce?

Third, what are the chances of replicating the key sources of higher growth over the last 70 years?

In terms of this last, key, question, the omens are not good.

Declining productivity, especially of late, is a worldwide phenomenon and remains stubbornly difficult to reverse. Furthermore, some past sources, like increased higher education participation, may not be repeatable.

An increasing economic activity rate will also be difficult to duplicate as the employment rate for women is already similar to that for men. Indeed, as the population ages, the labour force will shrink rather than grow.

A return to the high rates of migration seen post-2000 would increase growth, but have less impact on the standard of living. In addition, the political impetus remains one of capping migration at a low level.

So what to do?

First of all, a growth boost will not arrive on the back of tax and spending cuts. The latter are either untenable – in relation to cutting pensions, the NHS and social care – or self-defeating, in terms of cutting infrastructure, education and local government.

Such a rebalancing of tax and spend levels may even lower the long-term growth rate rather than raise it. This is why, when it finally publishes its revised growth forecasts, the Office for Budget Responsibility (OBR) will only alter their long-term growth assumption marginally, if at all.

A second route to higher growth is to try to increase business investment and trade. However, this will be difficult for the government to achieve as the former is largely down to the private sector – who seek stability above all else – while the latter is hampered by de-globalisation and Brexit.

A third route might be termed ‘being sensible’, the reverse of the big ideological gamble currently being taken.

This would involve getting the basics working better. For example: getting infrastructure up to scratch; rebalancing activity across the UK to take pressures off south-east England and raise opportunities elsewhere; teaching students in a way that encourages them to be more innovative; and improving childcare and care for the elderly in order to release more people into the workforce.

Much of the above has long been recognised as the best way forward and indeed has been part of recent government economic agendas, but they have not been followed through on.

The political difficulty has always been that they are long-term projects that need focus, upfront funding and to be implemented fully and, well, not attempted quickly and on the cheap. They still remain our best hope of improving productivity, the key objective in all this.

Even with a successful programme of reforms, it is debatable whether the economy could return to an annual growth rate of 2.5 per cent. The OBR forecasts 1.5 per cent as the long-term growth rate for GDP per capita and for productivity, so adding a full percentage point would be a considerable achievement.

If the 2.5 per cent growth target is not recognised as realistic then the Chancellor’s “ironclad commitment to fiscal discipline” is dead in the water. The market knows this so they are left, like the rest of us, thinking “what next”? Constraining benefits and cutting selected services is looking increasingly politically untenable.

It all points to a reset being required, where the growth target is reduced to an aspiration and the budget gap is narrowed by means of a series of tweaks that reflect economic orthodoxy.

John McLaren is a political economist who has worked in the Treasury, the Scottish Office and for a variety of economic think tanks