This is not the “productivity” budget, but how to make it one?

Some of the critical stepping stones are being laid but it will all depend on execution.

BART VAN ARK

The first budget of the new Labour government has been presented as one for investment in the economy and a restoration of public services for the population. While the public debate is overwhelmingly about the fiscal side of things, what clues does it provide for the path to reviving growth and productivity?

Slower growth but high ambitions

At the aggregate level, the Office for Budget Responsibility forecasts that the budget will not add anything to GDP growth until 2029, and except for the first year (2025) even slightly detracts from it. Even so, the baseline forecast of GDP growth from the OBR of about 1.7 percent on average from 2025 to 2028 is, in itself, quite optimistic. It means we will need to see an improvement in labour productivity growth from about zero to at least 1 percent per year on average over the next 5 years. Does this budget gets us on the way?

From the productivity lens, the key is what the budget proposals mean for public and private investment. After more than 15 years of malaise, productivity beyond London and the South East has fallen to levels which are so low that any small interventions (a road here, a housing development there, a business centre somewhere else) won’t suffice.

The step change in spending and investment on public services, with much emphasis on health, education and infrastructure, is therefore good news. These are important priorities because they should help to lift many public services out of the doldrums of massive underspend, reduce waiting lists, provide education in proper and safe environments, and get people on the road (potholes) and on buses and trains.

But we also need a broad-based investment agenda for the longer term, including investments in structures, equipment and new technologies, but also in people’s skills, infrastructure, housing and the net zero transition. It is definitely helpful that the fiscal rules have been somewhat widened to create more headroom for large-scale public investment.

Crowding in or crowding out?

Critically, public investment also needs to crowd in private investment. However, the verdict by the OBR is that, at least in this budget cycle (the next five years), we are more likely to see private investment being crowded out. Even if government investment increases incentives for businesses to invest, for now it seems more than offset by the crowding out effect of rising costs. For example, the rise in employers’ national insurance contributions to fund the NHS is without doubt a cost-factor for business. So is the increase in the minimum wage. This squeeze might make businesses cautious to commit to new productive investments.

Crowding in of private investment may still occur in the longer term, but such projections are characterised by a wide range of uncertainty. For example, they may be larger for infrastructure than for health and education. The renewed commitments to net zero projects, like onshore wind and carbon capture, may also bring in more private investment, in part through the new National Wealth Fund and help deal with slowing the pace of climate change. The productivity effects from public investment may also differ between sectors of the economy.

The bar on public sector productivity is being raised

With the large increase in public investment, much of which will be frontloaded in 2025, the bar on raising productivity in the public sector will be high. The budget sets out ambitious productivity targets for the public sector (for example, 2 percent for the Department of Health and Social Care). This needs a clear plan to deliver those results, and the new Office for Value for Money can play an important role.

Increasing public sector productivity is a tall order. New investments need to be complemented with innovation in technological and organisational productivity drivers and the formation of skills in the public sector. We shouldn’t expect quick wins, but a sustained focus on public sector productivity can deliver more output and improve the quality of those services.

From short-term pain to long-term gain

While the government is wisely separating its funding for long-term investment commitments from the day-to-day increase in expenditure, some of the revenue-raising measures will create short-term pain. The key is therefore to build a credible case that there will be long-term gains. One could easily argue that we have been here before. The road to heaven is paved with good intentions. The road to hell with the chopping and churning of policies over the past two decades.

To translate the budget into a genuine long-term agenda for productivity growth requires three things: how we do it; where we do it; and when we do it?

Stability

Investment does not automatically translate into productivity growth for the long-term. Companies and organisations (including public sector ones) need to have the confidence that the commitments (financial and political) are real. This doesn’t imply a guarantee that governments will never tax or levy anything, or that policies cannot be changed if there is genuine room for improvement.

One element of a sustained growth agenda is an industrial strategy that makes choices about the growth bets we are taking as a nation. The recent green paper on industrial strategy is a good start, and so are the financial commitments to the aerospace and automotive sectors and a new Life Sciences Innovation fund.

Another key element is to bring the population along. Not everyone will benefit from the industrial strategy or become more productive overnight. The path to productivity growth therefore also needs to become more inclusive. This means giving more people, places and firms access to the sources of productivity growth, including skills, housing, transportation and health; to use innovation and technology to turn our limited resources efficiently into outputs; and to let as many people, places and firms benefit from better outcomes.

In sum, the budget needs to balance not only in terms of outlays and revenues, but also in terms of going for the best opportunities while not leaving many behind.

A place-based perspective

Good execution of a growth strategy also means more attention for place. The large regional diversities in growth and productivity performance in the UK are well-known. Among the many reasons for it is the wide gap between a highly centralised system of public governance and a fragmented structure of devolved governments and public authorities, often under-resourced and disconnected from the centre and each other.

The budget is not the place to resolve the devolution agenda. But where it can help though is by aligning national and local growth strategies and allowing them to build on each other. The funding of a place-based agenda will have to be a key element for the Spending Review in the spring of 2025.

Time is short and precious

Even if all goes well, it will take more than this 5-year budget cycle before we will see sustained multi-year improvement in productivity growth. That is a big challenge because too many people, firms and places are anxious about their prospects and have little time to wait. Plans therefore need to have timelines for deliverables and milestones, but also flexibility to adjust if circumstances dictate (“events, dear boy”) and an attempt to somewhat isolate the long-term growth agenda from the daily political pressures.

The Productivity Institute has previously suggested that a Productivity Commission, at some distance from day-to-day governance, could help in creating that long-term focus. This idea has been moved a bit to the background through the focus on the Industrial Strategy. But the Industrial Strategy cannot do everything for everyone. It would still be helpful to consider how we can make sure that not only the ingredients for “real” economy growth are there, but that the mix of pro-productivity policies is such that is helps realising the potential for long-term growth and prosperity.

Find out more

• Read Tim Leunig’s Budget review for Politics Home.
• Read the National Institute of Economic and Social Research’s response to the Budget.
• Read Tony Venables’ comment on the Office for Budget Responsibilities’ Discussion Paper about the impact of public investment on private investment.