Sunday, January 29, 2023
Growth is the problem, and there's no obvious solution
Posted by David Smith at 09:00 AM

My regular column is available to subscribers on This is an excerpt. Not to be reproduced without permission.

In the end, it is all about growth. Generating economic growth is the way to boost prosperity, to improve living standards. We have seen in recent months a cackhanded attempt to boost growth, the excruciating but mercifully brief Liz Truss premiership, and That September 23 mini budget from which the mortgage market and many pension funds are still recovering.

The growth debate is exercising the Tory party, with some even urging unaffordable tax cuts, despite the Truss catastrophe. Jeremy Hunt, in a speech on Friday, tried to head off these calls by insisting that he has a long-term plan for growth.

It is tempting to think that worries about growth are a recent phenomenon, but let me quote to you a prime ministerial speech. This prime minister, a Tory, apologised for doing things that were against his party’s instincts, but it was, he said, in a good cause. “I need long-term growth. A stronger, more prosperous country…” he said. “My target is growth every year; higher living standards every year; manufacturing growing every year; public services improving every year – and to do that without fear of inflation.”

That was John Major, speaking to the Conservative spring conference in April 1995. He made two predictions. The first was that “present policies” could double living standards every 25 years, the second that the Tories would win the 1997 election.

I find this quite interesting, and not just because many see parallels between the situation Rishi Sunak finds himself in now and that of Major in the 1990s. The Tories were riven by sleaze and disagreements over Europe, to the point that even four years of strong economic growth in the run-up to the 1997 election did not rescue them from a landslide defeat. People no longer trusted them and doubted their economic competence after earlier episodes, including sterling’s “Black Wednesday” exit from the European exchange rate mechanism (ERM) in 1992.

The other thing is that, in the middle of that strong growth period, which we would now give our eye teeth for, there was dissatisfaction. We would also give our eye teeth for a doubling of living standards every 25 years. It sounds like a mad ambition, but it was not so odd.

We have official figures for real disposable income per head, the nearest proxy for living standards, going back to the start of 1955. Over the following 25 years, to the start of 1980 (when the economy was in recession), this measure rose by 88 per cent. At the end of 1979 it was up by 93 per cent, so not far short of doubling.

Over the next 25 years, to the start of 2005, it rose by a further 88 per cent.

But then, and you know where this story is going, it slowed. We did not yet have a 25-year period from 2005 but in 17 years real disposable income per head is up by 11 per cent, or barely 0.5 per cent a year compounded. Major did not stay around to deliver the policies he hoped might deliver a doubling of living standards, though the rise from 1995 to 2020 was 45 per cent.

He would have strongly opposed Brexit, one key factor reducing growth, and did so from his position as a former PM. Latest figures show real incomes per head last year were running below their levels in the spring of 2016, the eve of the referendum.

What is the growth outlook? You could be forgiven for being confused. WE will not know for certain until fourth quarter figures are published on February 10 – soon after which I shall do my annual forecasting league table – but the chances of the economy having avoided a two-quester recession in the second half of last year improved with the release of monthly data for November.

However, we know that December was a bad moth for retail sales, that the government has been spending a lot in energy support and that, according to the widely-followed purchasing managers’ index, the year has started on a weak note.

This week we will get a new global and UK economic forecast from the International Monetary Fund and we will also get a forecast update from the Bank of England. In November, the Bank predicted that a recession it believed had already begun would last until the middle of next year, before a painfully slow recovery.

This week it may say that the short-term outlook has improved. One reason is that market expectations for interest rates, which the Bank uses in its forecasts, have come down. Another is the softening of gas prices. For similar reasons, the next forecast from the Office for Budget Responsibility (OBR), to be published alongside the March 15 budget, is likely to show a shorter and shallower recession than it expected in November.

There is a “but” to be attached to the OBR’s next forecast, before which the question is what will the Bank do this week on interest rates. The link between the Bank of Canada and the Old Lady of Threadneedle Street is not necessarily a close one, though Mark Carney acted as governor of both.

Last week the Canadian central bank did something interesting. Having raised rates eight times in a row, the latest a quarter-point rise to 4.5 per cent, it said it would now pause to assess the cumulative effect of the increases so far.

That makes a lot of sense. Market expectations are for a half-point rise in official interest rates here to 4 per cent, though some think it could only be a quarter. I think that could and should be the peak, but a conditional pause, in Canada, would be well-judged. If more is needed later because of inflation persistence, so be it, but ploughing on with rate rises would risk a deeper downturn than is necessary.

As for the “but” attached to the OBR’s growth forecast, The Times reported a few days ago that it has warned the chancellor of a downgrade to its medium-term forecasts, which could be crucial in terms of prospects for the public finances.

This is not surprising. One thing that stuck out like a sore thumb in the OBR’s last forecast in November was its optimism on medium-term growth, which it predicted would be 2.6 per cent in 2025 and 2.7 per cent in 2026. As I said at the time, armed with these forecasts, Truss would have said she had cracked the growth problem. For comparison, the Bank in November expected 0.5 per cent growth in 2025.

It is not surprising that these forecasts, which will be formally presented to the Treasury this week in round 1 of the forecasting process, are being revised lower. The government is aware it has a growth problem, hence Hunt’s speech on the issue on Friday. Slow growth is like quicksand. Once you get stuck in it is hard to get out. Tax cuts, in the mid-1990s and late 1980s, were the product of stronger growth, not the cause of it. Getting to that stronger growth, in the face of many headwinds, remains the challenge.