My Lords, I had the opportunity to watch the Budget from the Gallery in the other place last Wednesday alongside a handful of noble Lords, including my noble friend Lord Lawson. I could not help but reflect that he, and some of his predecessors, enjoyed more degrees of freedom than the present occupant of No. 11.
Our economy, while surprisingly resilient in the near term, is in a holding pattern until we have greater clarity on the road ahead after Brexit. The Chancellor is operating in a macroeconomic straitjacket defined by four important and mutually reinforcing constraints: first, the continuing high deficit and debt levels, which benefited from a windfall in 2016-17 but are otherwise largely unchanged from the Autumn Statement. The only saving grace is that while debt to GDP has more than doubled from under 40% prior to the financial crisis to well over 80% today, the cost of debt service, net of the Asset Protection Fund, remains constant at around 2% of GDP, underpinned by abnormally low interest rates.
Secondly, protected departments now represent 75% of the entire government budget, a point which the chair of the Treasury Select Committee, Andrew Tyrie, has also highlighted. It therefore makes finding savings ever more difficult. Thirdly, in a similar vein, the tax lock and commitment to reduce corporation tax now covers 80% of the base, which makes it difficult to raise revenue other than by increasingly creative means. The national insurance controversy should be seen in this context. In addition, with the tax burden rising above 37% of GDP, the highest for 30 years, I believe that we have reached the limits of what we can sustainably squeeze from taxpayers.
Fourthly, with the uncertainties ahead and OBR’s disclaimer that it has not factored in different economic scenarios for Brexit, the Chancellor quite rightly wants to build in some headroom for unexpected outcomes. With forecast net borrowing reducing to 0.9% of GDP by 2020-21 and a ceiling on the structural deficit of 2%, the implied buffer is about £25 billion—frankly, more of a contingency than a war chest.
The irony, of course, is that if consumers and companies did what the Chancellor is doing and held back, then their individual prudence would, at an aggregate level, have led to a sharper slowdown—something which economists will recognise as the fallacy of composition. We are therefore fortunate that UK consumers have done exactly the opposite. When the going gets tough, the Brits go shopping. However, this predilection comes at a clear cost in terms of rising household debt and eroding savings rates, now at negative levels excluding pension saving. The most recent retail data from the high street indicate that this party is ending as price squeezes from sterling’s depreciation come through and real wages are squeezed. Therefore, we are in the awkward position that our future economic trajectory will largely be determined by factors beyond our control.
Apart from Brexit, I would highlight two other factors. The first of these, which has worked in our favour so far, is the more benign global growth environment, particularly in the US where we have seen the “Trump Bump”, China’s relatively soft landing and signs of economic life from the EU. Indeed, the Eurozone PMI Index has just crossed 55 for the first time in six years while the comparable UK data are heading in the opposite direction. Mark Carney, in the Bank of England’s latest quarterly inflation report, attributed about a quarter of our economic outperformance to more robust global growth. The financial markets are also chiming in, with the VIX Index, commonly known as the “fear index”, currently enjoying its longest period below average levels since the crash. It goes without saying that these favourable trends might easily reverse.
The second factor is potentially more seismic—namely, our preparedness for future interest rate increases. The financial markets have already factored in three US rate increases from the Federal Reserve this year, starting later this week. Although UK rate increases do not appear imminent, their eventuality is now closer on the horizon. We have enjoyed almost a decade of morphine from quantitative easing. The process of weening us off will involve some major adjustments and I would encourage Ministers to pay close attention to the consequences.
So with few macro levers available and big external influences at play, what should we do? The scarcity of options is thankfully focusing the Government’s mind on supply-side reforms which address the underlying structural challenges of the UK economy and prepare us for the consequences of Brexit. It is a strange paradox that we are close to full employment, which the OBR estimates at around 5%, but capacity utilisation is 81.7%, towards the upper end of its historical range, and the output gap has turned positive for the first time since 2008. Yet productivity has been downgraded yet further in the OBR forecasts, so we cannot grow much faster without risking inflationary consequences.
We are effectively stuck in a rut of relatively low growth, low inflation and low productivity, which might be compounded in the future by lower immigration. I therefore welcome the measures and resources allocated to improving skills and vocational training such as the T-levels and offering maintenance loans for further education. There are some additional areas raised by honourable friends in the other place which we should also consider carefully. One of these is from Alan Mak, chair of the All-Party Parliamentary Group on the Fourth Industrial Revolution, who has advocated a skills audit at the start of each Parliament. This strikes me as highly sensible since disruptive technologies such as artificial intelligence or robotics can make seemingly valuable skills obsolete almost overnight while other more emergent skills become highly sought after. Another welcome idea has been put forward by my honourable friend Rishi Sunak about the creation of a vocational skills equivalent of UCAS, targeted particularly at apprenticeships, creating a unified portal. I would like to ask the Minister whether that is being investigated seriously.
As well as human capital, our physical capital is equally important in galvanising an enterprise economy and wealth creation. This was recognised in the Autumn Statement with the creation of the £23 billion National Productivity Investment Fund. If you delve into the OBR forecasts for growth, it is apparent that a rebound in both public and private investment is essential in taking up the slack as household consumption falls off. I would therefore urge Ministers to make every effort to crowd-in private sector investment, particularly attracting capital which is trapped offshore by our tax system and should logically find the UK an attractive destination at current exchange rates. At the Autumn Statement, it was announced that business investment relief would be simplified and made more attractive. I ask my noble friend the Minister: what progress has been made on this front?
In conclusion, I make one final observation. Large sections of the business and financial community are currently biting their lip until they see how the Brexit negotiations progress, but we should not mistake their compliant behaviour for acquiescence. More than ever, we need strong, evidence-based policy-making grounded in economic realities and facts and not a blind pursuit of ideology. This is a time, more than ever, when our national trait of economic pragmatism must be unleashed and allowed to prevail.