Britain should not accept its status as the ‘sick man of Europe’

The writer is a former permanent secretary at the UK Treasury

The IMF has held a totemic place in British discourse ever since 1976, when the country lost the confidence of the markets and had to apply for an emergency loan. So when the Fund predicts, as it did this week, that the UK will grow slower than any other advanced economy, it needs to be taken seriously.

Add to the mix a level of industrial unrest not seen in decades, the Bank of England revising down to 1 per cent its view of the economy’s trend rate of growth, a rate not experienced since the 1970s, and the general gloom around the third anniversary of Brexit — and it’s tempting to ask whether Britain has regained its status as the “sick man of Europe”.

Forecasting is a mug’s game. Britain’s economy may or may not grow this year. Germany and France may grow faster. But none of the big European economies are predicted to grow by more than 1 per cent. This is a world of small numbers in which no country will be satisfied with its performance.

Gross domestic product statistics are notoriously unreliable in the short run, which is why, when I was at the Treasury, I preferred to focus on revenues. These rarely lied. They may be flattered by inflation at present but they still indicate that the economy has been stronger than many had feared. Falling energy prices will provide further support.

Britain still has a lot going for it. It has strong university cities, not least London, a thriving research base, great creative industries and an irrepressible financial sector. Unlike in the 1970s it has a dynamic labour market. We should not get too downhearted.

But there is no denying that Britain has a problem.

First, Rishi Sunak, the prime minister, and Jeremy Hunt, the chancellor, are still picking up the pieces from their disastrous inheritance. To regain credibility, they have had to pursue a much more restrictive policy than would have been the case had Liz Truss never become premier. At the same time, the Bank of England will have to keep interest rates higher for longer, having kept policy too loose in 2021. Macroeconomic policy will hold back growth in the short run. But that’s a price worth paying for restoring stability.

Second, there was a perfectly respectable political case for Brexit. And many of Britain’s problems predate its departure from the EU. But the evidence that Brexit is a drag on economic performance is compelling. Britain’s trade is growing more slowly than it did in the past. Inward investment is lower now that the UK is no longer a gateway to the single market. In a protectionist world dominated by large trading blocs Britain finds itself isolated. The tide of competition, which was a central driver of British productivity growth in the 1990s and 2000s, has receded.

Third, the UK has an inefficient and underpaid public sector. The government’s solution has been to use inflation to impose the biggest cuts in real wages in generations. History suggest this policy is unsustainable.

Finally, the economy is suffering from chronic under-investment, both in the private and public sectors. Infrastructure policy has been driven by prestige projects rather than a hard-headed focus on which ones might yield the biggest economic return. Lack of house building and poor land use remain major barriers to growth. Every government promises planning reform; every government backs off.

But all is not lost. The pendulum has begun to swing. The Sunak government is showing signs of wanting to tackle problems rather than to deny their existence, notably by making the NHS one of its “five priorities”. A re-energised Labour party is waiting in the wings.

Positive noises are also emerging from the negotiations on the Northern Ireland Protocol. If the government can finally get Brexit done, it can begin to focus on how Britain co-operates with the EU. This will be a slow process. But the country will find a new equilibrium consistent with the wishes of the electorate to make it easier to do business with our main trading partner.

Next, it needs to create an environment that encourages investment and innovation. Macroeconomic stability should help, as would a supportive tax regime. Public investment needs to be focused on maximising returns. At some point, a government will create a better planning system and more efficient taxes on property. But above all ministers need to prioritise skills, now that we no longer rely on the central European taxpayer to train our workforce.

Sooner rather than later the government needs to accept that it can’t cut wages in the public sector year after year. But the quid pro quo needs to be a renewed focus on reform and productivity. The obvious starting point is the NHS.

The country needs an honest conversation about what an ageing population and a more dangerous world means for taxation. Simply raising the age of eligibility for the state pension is not enough. Sunak missed a trick when he repealed the health and social care levy. He should resist backbench Tory calls for pre-election tax cuts the country can’t afford.

For much of the last 40 years, the British economy outperformed those of our near neighbours. If the nation grasps the nettle of sensible structural reform, there is every reason it can do so again.