Growth is back: let’s fortify Britain with a ‘do no harm’ budget

The Chancellor, John Healey, is putting his finishing touches to next week’s UK Budget. He is doing so against the backdrop of conflicting economic signals. How he, and his Treasury team, interpret these signals are key. Will it be a Budget that is mindful of the messages from the bond market on inflation, debt, and the insatiable demand for capital from the build-out of the AI technology stack – all factors that have combined to push U.K. government borrowing costs to a 30-year high? Will it be a Budget that seeks to support households and businesses that are poised to spend a lot more on their energy and food in the New Year? Or will it be a Budget that seizes the political disarray of opposition parties and positions the government for an early General Election and a fresh, Burnham-approved, mandate? All three of these have claims to be the most powerful framing agent.

But there is a fourth option. And one whose attractions have increased after the release of last week’s economic growth data for the UK. A “do-no-harm” Budget. One that dispenses with the rhetorical nonsense of unpicking forty years of neoliberalism. One that ignores the siren voices of pushing the UK tax burden ever higher. But rather frames this as a Budget that recognises that economic growth is ticking along nicely – at an annual rate of 2.1% a year – the highest in the G7. It is growth that is backstopped by business investment growing at 5.2% a year. And that data comes amidst signals that the UK labour market has begun to stabilise after the shock of a £25bn/ year increase in the employer National Insurance unveiled by Healey’s predecessor, Rachel Reeves, in October 2024.

The case for more radicalism in the Budget is clear. It is rare that Prime Ministers and Chancellors enhance their political capital during their tenure so if difficult financing choices need to be made in areas like defence, welfare, and social care then it is better to do these in what may still be described as a honeymoon period. Even though the International Monetary Fund (IMF) has recently praised the UK for its relatively austere plans for the remainder of the decade, those plans assume some very challenging commitments to slow the pace of public spending as the Parliament draws to a close. I have lost count of the number of economic observers - from all parts of the political spectrum - who don’t believe these are achievable. Next year at the Spending Review those abstract plans need to translate into which departments, which projects, and which functions must feel a fresh squeeze. That squeeze is going to be larger if, as seems inevitable, the financing requirements for the Ministry of Defence are going to have to rise from 2.6% of GDP to 3.0% of GDP by 2030 - a further £12bn/year. The credibility of a Chancellor who resigned his previous Cabinet role over this exact issue will be at stake.

The counter argument is that six months - if we assume the next Spending Review will be next spring – is a long time in politics. It is also an age in financial markets. The can-kicking proclivity of politicians may also envelop John Healey and lead him to conclude that a peaceful settlement in the Gulf, or a downward reappraisal of how much capital AI will demand will push down global interest rates and reduce the cost of UK government debt. In doing so this could yet free up resources without swinging the scythe through other forms of public spending. This approach would resemble something of a hope trade. But hope is not a strategy. Events could conceivably unfold to make a tough job, even harder. On the other side of the fiscal aisle, this is a government short on the democratic legitimacy to make large tax changes that were neither outlined - and in some cases were explicitly ruled out - in the 2024 Labour Party manifesto.

It is also just possible that the investment boom in AI capability generates the very economic growth and productivity momentum that has been so hard to sustain since the onset of the Global Financial Crisis – eighteen long years ago. But this is where an understanding of what generates sustainable growth is vitally important. The governor of the Bank of England, Andrew Bailey, has recently warned that the current pace of economic growth - welcome as it is - is insufficient to sustain itself. He is correct in this assessment. One of his fellow policymakers at the Bank, Megan Greene, has suggested that even modest growth might generate too much UK inflation to be able to avoid raising interest rates. This speaks to a much bigger issue than living hand-to-mouth from one fiscal event to the next. Can the UK generate the rate of economic growth it needs without running into supply frictions that in turn generate inflation? The answer is that it cannot.

An economy with labour costs, energy costs, a cost of capital, and cost of construction that are some of the highest in the developed world cannot reach “exit velocity” without the Bank of England being forced to slam on the brakes with higher interest rates. Every politician in Westminster wants to understand how to escape the fiscal doom loop. Governing is no fun when simply lurching from one financial crunch to the next. From an economics standpoint there is no conceivable way out without radical supply side reform.

Such reforms can be done from a centre-left standpoint by a Chancellor prepared to explain that high costs of energy, a high cost of building, and burdens on employers hurt the poorest in society. There is nothing progressive about inflating the cost of economic activity. Governments that have offshored the UK’s manufacturing base through costly tax and regulatory measures need to use Budgets to pry these barnacles off the competitive hull of the U.K. economy. China and the US don’t fear competitive challenge from the UK. They should. Given the UK sits third behind these two economic giants in creating innovative start-ups this damns the UK as a rather less attractive venue for businesses to then scale up, and for entrepreneurs to recycle their capital. A do-no-harm Budget would recognise that fact. And so start the exercise of prising off those barnacles.