• Dr Gerard Lyons

My latest column: Britain must go for growth – which means lower taxes now

This column appeared in ConHome on Tuesday 30th November, 2021.

Dr Gerard Lyons is a senior fellow at Policy Exchange. He was Chief Economic Adviser to Boris Johnson during his second term as Mayor of London.

There has been a strong recovery this year, although the path to it has been impacted by the pandemic. The uncertainty surrounding the latest variant will slow it during the coming weeks and possibly months – directly, as new restrictions are introduced to curb its spread and, indirectly, as confidence suffers and people change their behaviour.

That path is less predictable than usual but, with high vaccination rates and an effective booster programme, the UK should hopefully now be able to cope with living with Covid.

The economy is still below its pre-pandemic level, and does not look set to return to it until early in the new year. Even then, however, there is still much lost ground to make up.The Bank of England’s recent forecasts, which are indicative of current widespread thinking, show that after contracting by 9.7 per cent last year, the economy will grow by seven per cent this year, five per cent next and by 1.5 per cent in 2023.

Many economic challenges confronting the UK are not unique to us. A major worry for Western economies is that, after the post-pandemic rebound, growth will stagnate at the low rates seen pre-pandemic.

This concern is exacerbated by global public debt levels being at an all-time high, and central banks needing to exit from unconventional cheap money policies.

The economic outlook suggests a heated political and policy debate in the UK.

First, during coming months there will be a cost-of-living crisis as inflation rises sharply – outstripping wage growth. Furthermore, higher taxes, soaring energy bills and possible increases in interest rates and borrowing costs will hit peoples’ spending power, exacerbating the problem.

In the wake of the 2008 crisis , the UK experienced a short-lived cost-of-living crisis that may give a flavour of the future debate. Then, a collapse in the pound triggered a rise in imported inflation. Unlike now, there has been a limited pass-through, since firms have been unable to make higher prices stick.

But the events of 2008 still led to a spike in inflation. By 2012 and 2013, the political debate focused on how the cost-of-living crisis was hitting the poorest and the “squeezed middle”. This time, the impact may be longer-lasting: current shortages have already pushing wages up in some sectors, and the minimum wage has risen.

At present, inflation is 4.2 per cent and looks set to exceed seven per cent by the spring – far above the Bank of England’s two per cent target.

Will this rise in inflation pass through, persist or become permanent? It is unlikely to be the latter, since some factors contributing to it are temporary – linked to transport and supply problems caused by the pandemic that have impacted all countries. But rising costs are being passed on by firms.

Whether inflation passes through or persists may be influenced by the actions central banks take.

Importantly, part of the role of a central bank is to ensure that it does not accommodate the pass through of inflation into the economy. The Bank of England has chosen not to act. Having been care-free in the wake of the global financial crisis, it is now careless. It has kept policy rates at 0.1 per cent, and continued to print money through quantitative easing.

Inflation will persist through next year. By 2023, inflation will be lower, but then the risk is it may settle around three per cent to four per cent or above, not the one to two per cent that we have become used to. Wage demands will adjust accordingly.

Next year, interest rates may rise, but they will be below where they should be. According to the financial makers, interest rates look set to reach just above one per cent by the end of next year.

For many, it will be the first time they have experienced rising interest rates. At a time when discretionary spending is already squeezed, this will perpetuate the challenges people face. It may also give renewed focus on wider policy issues, particularly housing, which are unlikely to be politically popular.

As borrowing costs rise, house prices, which are already high, may come off their peak. By contrast, as costs rise it lessens the ability of many in Generation Rent to save for a deposit to become Generation Buy.

It is the politicians, though, not the central bankers, who will feel the wrath of the public.

Though rising interest rates will benefit savers, this effect may be more than swamped by other factors. For instance, financial markets – namely stocks and bonds – will be more volatile. The trouble in the UK won’t just be inflation. Taxes are already set to rise this spring – with personal allowances being frozen and national insurance increasing.

That leads to the second economic challenge for policy makers. With growth set to slow by 2023 attention will return to low UK productivity.

Over time, economies with high productivity have higher growth and living standards. If productivity is higher we can work less and pay ourselves more, or both.

As we approach the next election, this is likely to manifest itself in a renewed debate about the Government’s finances, public services and taxes.

Before 2008, the UK’s trend rate of growth was around 2.4 per cent. Before the EU referendum, this had decelerated to around 1.4 per cent. If trend growth is lower, it means that more of the budget deficit is explained by ‘structural’ and not by ‘cyclical’ factors. If structural, the implication is that implies taxes will have to rise to sustain a given level of government spending.

Ahead of the pandemic, part of the economic debate was that, if trend growth remained low, then the tax take would have to rise to fund an ageing population. In all likelihood, the public finances will be on an improving trend in coming years, allowing scope for taxes to fall even before the next election. But while politically it is effective telling people before an election that taxes will fall, the reality is the country needs them lowered now.

There is a global angle too. UK taxes are no longer competitive by global standards.

That leads onto the third key political challenge and opportunity linked to the economy – the need to outline a clear pro-growth vision.

This should include a supply-side agenda with lower taxes and lighter regulation. This means more than just refining onshored EU regulations – namely, fully embracing the ability to diverge.

A successful policy would encapsulate three arrows: monetary and financial stability; fiscal policy that reduces debt to GDP; and supply side policies to boost infrastructure, investment, innovation and incentives.

While the Government has numerous consultations underway to convert Brexit freedoms into economic wins, these positive steps risk being drowned out if people wrongly associate post-Brexit economics with high taxes and cost-of-living pressures.

Policy must also embrace the ambitious move to Net Zero by 2050. The cost of adjustment is not low ,and change needs to be delicately managed so that people and firms can adjust.

Context and vision are important. People need to put any cost-of-living crisis in context and believe it will be short-lived. Likewise, investors and firms need to have confidence that the high taxes they are paying now will not be prolonged – and the rhetoric of less burdensome regulation does materialise. Going for growth is the answer for these fears.