Our Opinion: 2024
US and UK Diverge
Britain and America have been adopting radically different fiscal strategies after Covid and it is increasingly clear who has been vindicated: America. America’s fiscal gamble with the Inflation Reduction Act (IRA), a 2022 package of tax cuts and government spending to encourage infrastructure investment and energy self-sufficiency, estimated to have cost $1.2trn, appears to have paid off.
America’s debt-to-GDP ratio had fallen to 30% by the early 1980s, but rose above 100% after the pandemic. The cost of Covid and the resulting slump in GDP drove the ratio above 130%, but it has since fallen back. GDP growth accelerated from 1.9% in 2022 to 2.5% in 2023, although it slipped back to an annual rate of 1.6% in the first quarter of 2024.
Inflation has been unexpectedly slow to fall back to its target rate of 2%, largely owing to a strong economy. Productivity growth has accelerated, reaching an annual rate of nearly 5% in the third quarter of 2023, a marked improvement on the average annual rate of just 1.3% per annum between 2005 and 2018. Even if, as is likely, productivity growth slows, it is expected to remain well above this rate.
Fiscal policy in the US has been tightened, with the government’s primary fiscal balance (before interest costs) coming down. The congressional Budget Office estimates that the tightening amounts to 1.3% of GDP, while the International Monetary Fund (IMF) estimates 2.1%, which more than reverses the loosening in 2023 because of the IRA.
This is driven by rising tax revenue (not rising tax rates) and broadly flat total spending, despite rising interest costs. With fiscal and monetary policy tight, there is room for more reductions in interest rates than the market now expects if economic growth is not to slow sharply.
It’s early days, but the US’s fiscal gamble appears to be working, unlike the UK’s very different strategy. Terrified of a government debt-to-GDP ratio exceeding 100%, and mindful that the world is much less interested in owning UK Government Gilts than in owning US Treasuries, the UK slammed on the fiscal brakes. Taxes have been raised to the highest levels for more than 70 years, discouraging investment and reducing incentives to work. Britain is undergoing a cost-of-taxation crisis.
The result is a flatlining economy and no discernible improvement in the state’s budgetary position. Money has continued to be thrown at welfare and public services in the vain hope that these will improve, but the Office for National Statistics shows otherwise. Public-sector productivity, it says, fell by 2.3% in 2023 and 1% in the first quarter, so it is now 6.8% below its pre-Covid level.
The private sector cannot compensate for this, so overall productivity is stagnating and economic growth relies on immigration, with income per capita stagnant. What’s more, following the US lead is regarded with horror. The attempt by the short-lived Truss government to kick-start economic growth failed. The US experience suggests it could have worked.
This is not the only example of British economic strategy diverging unsuccessfully from the US. During the pandemic, the UK spent a vast amount of money trying to protect jobs through the furlough scheme and loans for businesses, a policy that encouraged fraud and waste. The US simply mailed cheques to all taxpayers and allowed unemployment to rise. After the pandemic, job creation boomed and both economic growth and productivity took off, while the UK struggled.
While America seeks to encourage key sources of economic strength, Britain, is at war with everything it is good at. This encompasses the English Premier League (threatened with regulation), the ability of universities to attract foreign students, and tourism (via a stingier sales tax for visitors than rival destinations).
But at least the UK had political stability while America is threatened by Trump! Had, since it has now decided to call a general election which was needed until the end of the year!
All human experience is that prosperity encourages a nation to be at peace with itself while stagnation encourages strife, conflict and political extremism. Without growth, Britain will have much more to worry about than its standard of living.
24th June 2024
