What are the UK’s economic challenges and how can they be addressed?

Parliament has returned from recess with the country facing challenges on multiple fronts.

A general election is looming in the not-too-distant future and the Government will be pushing to build momentum towards achieving Rishi Sunak’s five priorities in the hope of reversing stubbornly unfavourable numbers in the polls.

Meanwhile, the newly-reshuffled Labour frontbench will continue preparing for government with disciplined messaging on spending and the economy.

But the party faces some awkward decisions in the light of the amount of money that is expected to be available if, as many expect, they secure power.

A range of experts, brought together by Full Fact and the UK in a Changing Europe research network, have given their assessments of major policy issues that decision makers will have to grapple with.

The health of the economy is clearly key to the quality of people’s lives and the outcome of the next election so what follows is a summary of perspectives on relevant policy.

– Tax and spend

The Government’s main problem is that inflation has remained high for a long period, leading to the largest two-year fall in living standards since records began.

Ben Zaranko, senior research economist at the Institute for Fiscal Studies (IFS), said both main parties are more or less aligned in their commitment to fiscal rules, spending plans and tax rises.

This means whoever is chancellor post-general election, the target to have debt falling as a fraction of GDP in five years’ time will severely limit options available to them, he said.

Beyond the pressing problem of bringing down inflation, Mr Zaranko said four other major policy challenges stand out.

The first is reversing the trend of “stagnation” by boosting economic growth, while the transition to net zero would create “difficult trade-offs” and “a raft of fiscal challenges”, such as preparing for the loss of tens of billions of pounds of revenue from fuel duties, he added.

With an ageing population many argue that the Government has no choice but to spend more on the NHS, social care and pensions, but there are questions over whether the implications of this are widely understood.

Mr Zaranko said: “Neither party seems willing to confront the public with the reality that even maintaining the quality of our public services, let alone substantially improving them, almost certainly means higher, rather than lower, taxes.

“Talk of pre-election tax cuts feels increasingly detached from that fiscal reality.”

– Economic growth

UK growth over the past 15 years has been poor by historical standards and GDP per capita is less than 4% above the level in 2008.

This compares to an increase of 40% in the previous 15 years, but it is important to note that large western European economies have experienced a sharp slowdown over the recent period.

Jonathan Portes, professor of economics and public policy in the department of Political Economy at King’s College London, said a political consensus that slow growth is a problem in itself and makes almost everything that government want to deliver harder to achieve is arguably stronger than at any time in recent history.

In this context, he said the parties should focus on longer-term structural problems.

Low levels of housebuilding, particularly in areas of high demand, is a severe constraint on growth caused by a rigid, localised planning system, while major infrastructure projects take too long and are too expensive, Prof Portes said.

“Both parties plan to address these issues, but this will require both political will and a sustained focus on delivery, which have been conspicuously absent in recent years,” he added.

Also highlighted as a major problem was a lack of focus on “consistency in delivery” with regard to implementing the numerous industrial strategies published in recent years, as was a lack of investment in improving the quality and quantity of the workforce.

While there is a general consensus on the need for action in these areas, other factors are more controversial.

Prof Portes said Brexit is “undoubtedly a drag on growth” with minor improvements to the trading arrangements with the European Union highly unlikely to deliver the major improvements to growth required.

“The next government will have to decide whether that is all that is politically feasible, or whether – at least over the medium-term – the potential economic benefits of a more ambitious renegotiation of the UK’s economic relationship with the EU outweigh the obvious political risks,” he said.

Prof Portes also acknowledged the varying opinions within and beyond the main political parties over the economic benefits of the net zero transition.

But he said: “Continued policy uncertainty combined with inconsistent and/or incompetent delivery will both raise costs and reduce opportunities.”

In addition, Prof Portes said there is “little evidence” that the UK is “overtaxed”, but added reform to remove elements of the system which are “inefficient and unfair” could boost growth.

He also warned that poorly performing key public services, including the NHS and social care, are likely to reduce growth by reducing labour supply.

While there is a degree of consensus on appropriate policy responses to these challenges, Prof Portes said: “What has held back the UK in recent years from addressing these issues is not lack of analysis, but lack of political will, delivery capacity, and relatively poor quality of public administration and governance, with little sign of improvement on any of these fronts.”

– Living standards

The Government is focused on bringing down inflation to improve living standards, after the majority of previous major support interventions are phased out.

Labour’s strategy is not radically different, but the party does plan to make energy temporarily VAT-free, paid for by a windfall tax on energy firms.

Mike Brewer, deputy chief executive and chief economist at the Resolution Foundation, said an alternative approach to improving living standards would be “aggressive tax increases” for the better-off to restrain demand and reduce inflation.

But he highlighted that while some taxes are rising this year, it is pre-election tax cuts that appear to be on the agenda.

As well as the regular debate on the affordability of the triple lock on state pensions, Mr Brewer said there may also be calls for planned benefit rises to be suppressed. This is because increases in April are pegged to the level of inflation in the previous September, when it is expected to be higher than at the start of the new financial year.

But he also points out the expected 6% increase will be needed just to restore the value of benefits to pre-cost of living crisis levels.

Mr Brewer said low productivity and the impact on wages is a key concern, with wage growth falling below zero in the 2010s.

This means if wages had continued to grow at the same rate as they were before the financial crash of 2008, real average earnings would be around £11,000 per year higher than they are now.

In addition to low wages, the UK had greater income inequality than any other large European country, Mr Brewer said.

“The period of rapidly-rising prices may be over, but if we are ever to have shared prosperity, the UK will need both higher growth and lower inequality,” he added.