Published on 14 November 2023
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The Chancellor’s impossible task

The Chancellor and his team in the Treasury - in anticipation of the November Autumn Statement - are no doubt pondering how they might be able to deliver faster economic growth. The challenge for Jeremy Hunt is that not only does each sector of the economy have different drivers therefore requiring different policies, but many pro-growth policies are also likely to be unpopular, writes Thomas Aubrey.

One of the Prime Minister’s five key priorities is to “grow the economy, creating better-paid jobs and opportunity right across the country.” Unfortunately, the most recent labour productivity data indicates that the UK’s private sector is growing at about 0.6% per year. While better than the annualised 0.2% between 2010-2019 it is lower than the 1.7% seen between 1997-2006. And although 70% of the private sector (excluding real estate) is experiencing growth (in green in Table 1) largely thanks to financial and business services, 23% is stagnant (in blue). This includes manufacturing, which is concentrated in the Midlands and North of England. Despite experiencing a decent increase in the value added it creates (labelled ‘within effect’), this is offset by the ‘between effect’ due to labour being reallocated to lower productivity activities. At least just 7% of the private sector has experienced an absolute decline in labour productivity (in red) which is a marked improvement from prior quarters.

Table 1: Sectoral productivity disaggregation Q2 2019 – Q2 2023[1]

A more detailed sub-sector analysis summarised in Table 2 highlights which types of firms are contributing positively towards growth and which ones are contributing negatively. The computer programming sector continues its positive story experiencing both an increase in value added (within effect) as well as a contribution from the reallocation of labour share from lower productivity activities (between effect). One thing that has helped here is the government’s more open policy towards skilled worker immigration. The Information and Communication sector has been awarded the most work visas across the private sector due to UK firms not being able to meet the pent up demand, which was evident in prior surveys. Hence increasing work visas may further drive up growth across the digital sector – although a group of Conservative MPs is demanding immigration to be halved.

The financial services sector has continued to contribute to growth since 2019 – partly driven by the fact that the UK has received the most inward investment projects into Europe in this sector. The size and depth of talent within the UK financial services sector makes it very difficult for other hubs to outcompete it, despite Brexit. One challenge for the Chancellor, however, is that London remains a major recipient of this inward investment which does not help distribute good jobs to the rest of the country thereby exacerbating regional inequality.

Table 2: Positive and negative subsector disaggregation Q2 2019 – Q2 2023

The drivers of negative growth are in the Agriculture + Mining & Quarrying sectors, which have been amalgamated in the data as the Labour Force Survey data is now insufficient to provide a more detailed breakdown. This is problematic for those interested in sectoral productivity analysis given that Mining & Quarrying is a high value sector in decline due to the fall in North Sea oil & gas extraction, whereas Agriculture is a low value-added sector.

The most negative contributor to growth was the Transportation & Storage sector. This has been negatively impacted by the post-pandemic shift towards working from home, with real Gross Value Added (GVA) of rail transportation down 36% since Q2 2019. The ongoing rail strikes have also contributed due to lost ticket revenues. In addition, the real GVA of land transport, which includes local public transport and road freight traffic, has fallen 19% since Q2 2019. Although local public transport has also been impacted by changing work patterns, the fall off in road freight traffic appears to be a direct consequence of Britain’s exit from the EU with direct traffic on ferries from Ireland to France now around one third of all roll-on roll-off traffic whereas prior to the UK’s exit from the EU it was about one sixth. The balance of payments data for road freight traffic also show a fall in both imports and exports since 2019, indicating that demand for UK freight traffic services has fallen. This is the result of the policy decision post-referendum to remove the UK from the single market and customs union.

The problem for the Chancellor is that while voters and their representatives in Parliament might like the idea of growth, many policies that have been implemented actually reduce growth. This indicates that there is a fundamental misalignment of incentives in the economy.

This is particularly the case when it comes to new housing, given that new developments in the UK tend to rely on existing infrastructure, which can result in a deterioration of local services for existing residents. This is a major reason why there is local opposition to development. It is clear from the historical data that for the rate of housebuilding to increase, a significant increase in infrastructure investment is required (Chart 1).

Chart 1: UK public sector net investment vs UK housing completions per 1,000 population

But the UK hasn’t performed particularly well on this front in recent decades, with its infrastructure stock as a % of GDP at 57% compared to 71% in Germany. This is why the effective cancellation of HS2 from Birmingham to Manchester (and possibly Euston to Old Oak Common) is likely to negatively contribute to growth.  

Large scale European infrastructure projects such as the €36bn Grand Paris Express, which is building four new metro lines, extending two existing lines and adding 400,00 additional homes by 2030, tend to do three things differently compared to major projects in the UK.

First, infrastructure projects are integrated with housing, which increases their financial viability, whereas in the UK these two components tend to be separate. Second, land value capture is a major driver of funding as the land compensation arrangements preclude alternative land uses being taken into account with regards to the level of compensation paid often described as ‘hope value’. Third, these European projects tend to be financed by the capital markets with government guarantees, where the combination of public and private money improves financial viability, compared to the funding of a project like HS2 from general public expenditure.

Bond investors also demand greater transparency so costs are estimated better. In addition, capital markets can provide additional oversight and governance on the operational management and delivery of projects. This would have helped prevent the kinds of delays that impacted Crossrail, as well as the accountability issues that have arisen in HS2. Finally, this approach prevents politicians from cancelling projects on a whim as with HS2.

So where does this leave the Chancellor? Higher immigration, the pull of London’s financial centre, rejoining the single market, more infrastructure and new housing – all could help drive growth.  But none of the associated policies are very popular.

[1] The sectoral disaggregation uses GEAD (Generalized Exactly Additive Decomposition) based on Tang & Wang 2004. The ‘within’ effect is productivity growth in activities within the sector, the ‘between’ effect measures the reallocation of labour between sectors.

Image: The Chancellor Jeremy Hunt walks outside Downing Street with the Budget box. Photo by Zara Farrar / HM Treasury. CC BY-NC-ND 2.0 DEED

The views and opinions expressed in this post are those of the author(s) and not necessarily those of the Bennett Institute for Public Policy.


Thomas Aubrey

Thomas Aubrey is the founder of Credit Capital Advisory. He has written widely on financial and economic issues including All Roads Lead to Serfdom (2022), Profiting from Monetary Policy (2012)...

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