United Kingdom’s Long-Run Prosperity Hinges on Ambitious Reforms

IMF News, July 11, 2023

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Growth projected at 0.4 percent in 2023 and 1 percent in 2024.
Energy price shock due to Russia’s war in Ukraine disrupted the recovery and, together with a terms of trade shock amid historically tight labor markets, pushed inflation to record levels.
Bringing down inflation is a prerequisite for lasting stability and growth; authorities have tightened monetary policy, most recently with a 50-basis-point rise in interest rates in June, and tightened fiscal policy to fight inflation.

Potential growth currently estimated at about 1.5 percent.
Prior to the 2008 global financial crisis the UK was a strong G7 performer; momentum was lost in the middle of the last decade.
By 2022, real business investment was still slightly lower than in 2016, in contrast to the 14 percent increase among other G7 economies.
Labor supply has just reached its pre-pandemic level and has been weaker than peers.
Productivity growth has been sluggish, reflecting a slower pace of innovation and technological diffusion.

“Windsor Framework” and a more measured approach to reviewing retained EU laws expected to reduce Brexit-related uncertainty.
Enhanced childcare support and tax relief on investment in plant and machinery (introduced in the Spring budget) to support labor participation and business investment.
Chancellor’s “4Es” strategy (enterprise, education, employment, everywhere) targets high-productivity growth areas such as advanced manufacturing, life sciences, and clean energy.

Establish a stable, long-term strategy to promote business investment, including a permanent set of tax incentives that could potentially apply to investments other than plant and machinery to strengthen investor confidence.
Increase public infrastructure investment—notably in transport, health, networks, and the green transition—to “crowd-in” private investment.
Liberalize the planning system to reduce barriers to investment in new industries and facilitate mobility of firms and workers.
Consider unlocking pension and insurance savings for investment in higher-return projects, while being mindful of implications for financial stability.

Long-term sickness and, to a lesser extent, early retirement are the main drivers of the post-pandemic spike in inactivity.
Improving health outcomes is critical; consider additional targeted mental-health interventions.
Expand good quality apprenticeships and career counseling in schools to tackle high youth unemployment.
Promote flexible working and coaching services to enhance female labor participation and complement childcare expansion.
Measures that enhance labor supply in the near term can also ameliorate inflationary pressures from a tight labor market.

Upskilling and knowledge development, and higher investment in education and training of young adults, can strengthen human capital and raise labor productivity.
Increase R&D support for businesses to ensure the UK remains a global leader in innovation.

Future budgets should accommodate critical public investments and the level of recurrent spending needed to maintain high-quality public services (especially health, social care, and education).
Meeting these needs while ensuring that debt stabilizes in relation to gross domestic product will require savings from additional tax and spending measures.
Report highlights options to strengthen carbon, property, and wealth taxation; to close loopholes in the income and social-security tax systems; and to reform pensions.

Growth: 0.4 percent in 2023; 1 percent in 2024.
Potential growth: about 1.5 percent.
Interest rates: most recent monetary-policy move was a 50-basis-point rise in June.
Real business investment by 2022: slightly lower than in 2016 (vs. a 14 percent increase among other G7 economies).

United Kingdom’s Long-Run Prosperity Hinges on Ambitious Reforms, By the UK team, IMF European Department, July 11, 2023.