Connor MacDonald

Head of Economics and Social Policy Read Full Bio

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From energy to employment, how Sunak can draw up a blueprint for prosperity

Mar 17, 2022

 

Rishi Sunak could not have guessed what was in store for the economy when he became Chancellor a little over two years ago. One thing is certain now: he could be one of the most consequential chancellors in the post-war period.

Faced with Covid-19 and now a land war in Europe, Sunak now has to deliver a Spring Statement; what was once intended to be a smaller intervention has grown in importance in the face of yet another geopolitical crisis.

It is a reminder that an open and dynamic economy like ours is not immune from the vagaries of global economic circumstances. As the Chancellor put it succinctly, it is not in the power of the British Government to stop a nuclear power plant going offline in Germany, nor spikes in global energy markets.

Nevertheless, he will want to cushion the blow to British consumers and businesses.

The Treasury should not think that the inflationary pressures we are experiencing can be solved simply through fiscal restraint. Inflation appears to be driven mostly by a huge spike in energy and commodity prices, and the Bank of England will have to raise interest rates.

The Government should therefore think creatively about fiscal policy and use it as a tool to shield businesses and consumers from the worst effects of the cost-of-living crisis.

Ministers should not rely on monetary policy to ensure a benign macroeconomic environment, and indeed there may have been overreliance on this tool in the past. What is more, the Chancellor should not feel bound by the OBR forecasts to premature fiscal action, particularly tax rises.

As we have seen this past year, such projections can be remarkably pessimistic about the future of the public finances. Sunak should consider suspending the fiscal rules he put in place – these are not normal times.

The Chancellor has already announced £9 billion to assist households with their energy bills, and the price cap will hold this April. This may be enough in the current moment, though more will likely have to be done by Autumn. The Government should act urgently to encourage the development of other energy sources, including oil and gas (such as fracking), to reduce medium and long-term prices.

It should invest heavily in nuclear and energy storage. Energy resilience must become a British raison d’état.

Not only is the price of energy up sharply, commodities and food prices are increasing at pace, with some staples predicted to rise by 50 percent. More therefore needs to be done to help lower-income families, and those surviving purely on benefits, to deal with immediate pressures that have emerged from a war in Ukraine and new coronavirus measures imposed in China.

Again, these are not pressures from underlying problems in the British economy, and the Treasury should think of them in a similar way to how interventions to deal with Covid-19 were formulated.

The Chancellor also needs to address the tight labour market. The Government has to contend simultaneously with the lowest vacancy ratio in 50 years with a large participation gap; the Institute for Employment Studies suggests that there are 1.15 million more people out of the workforce than would be expected at the start of the pandemic.

Ministers should consider spending on new programmes to boost participation. For example, the gap between disabled and able-bodied people is widening. That should be addressed.

Sunak should also put resources towards integrating new Ukrainian refugees. We owe it to those fleeing war and to our own society to ensure that newcomers are integrated and that they can flourish in a dynamic economy.

There is of course the elephant in the room – the national insurance rise. The fact is that delaying or scrapping the increase now will help those at the very bottom little. Instead, the Government should raise cash transfers above the projected 3.1 per cent and, for those in the middle of the distribution, they should unfreeze the income tax and NIC allowance thresholds – perhaps even raising the NIC threshold too.

The Government’s energy support package also included direct funding to local councils. They should consider expanding this pot; as we saw in Covid-19, councils have been effective in delivering support to those who need it. Ministers should also consider cutting fuel duty and increasing the Energy Bills Rebate announced last month.

The national insurance rise is intended to fund current spending on healthcare, which is an expenditure that will not go away. By endorsing more temporary measures, the Chancellor will be able to deliver targeted help without leaving a long-term gap in finances.

The Spring Statement also needs to focus on the long-term drivers of productivity. Sunak noted in his Mais Lecture that British businesses spend only half of the European average on training, for example. Along the lines of the super-deduction for capital investment, he should consider a similar scheme for firms that invest in formal skills training, over and above current forms of relief.

The Chancellor could also help SMEs by defraying the full cost of training apprentices, which is currently the arrangement for candidates who have left care.

He should also move to give business certainty by scrapping the corporation tax rise and the end of the super deduction announced for 2023. They should become permanent. Without the super deduction, the UK has a much less competitive tax environment, and a rise in the corporate tax rate would make us one of the least competitive in the OECD.

Sunak also mentioned in his Mais Lecture that he wants to beef up research and development spending and encourage more private spending. Hopefully the Spring Statement delivers on this, and in particular looks at ways to increase innovation diffusion (a metric on which Britain lags).

These supply-side measures will be expensive, but the OBR has indicated there is substantial fiscal room this year (about £20 billion). Given this space, the Chancellor should raise defence spending to at least three per cent of GDP, which would mean at least £12 billion more a year. This will return us to the level seen in the 1990s and further cement the UK’s place in the NATO alliance.

This does however raise the wider question of public service reform, which will be essential if Britain is to return to a stronger fiscal position. This Government has been too quiet on this front. If we are going to try to restart economic growth, the Chancellor must push his colleagues to embrace substantial reforms. An ever-larger state cannot itself justify increased taxation in the long-term.

Similarly, the Government should not sacrifice Levelling Up on the altar of current difficulties. It is in fact the weakness of so many parts of the UK economy that has left us relatively exposed to the current challenges. The Government’s devolution reforms should continue, as should its high levels of public sector net investment (the highest since the 1970s).

This moment has revealed the extent to which a chancellor is ultimately at the mercy of events, and reliant on the strength of economic fundamentals. That’s why, if Sunak is going to embark on new spending now, he should insist that his colleagues embrace a growth agenda, and aim to leverage private investment, rather than stifle it.

For example, it would do no one any good if a company wants to use the super-deduction to finance a new factory, only to be hamstrung by anti-growth planning rules. Similarly, sky high energy prices because we can’t build nuclear plants shouldn’t defeat a competitive corporate tax environment.

More than anything else, that needs to be the tone of this Spring Statement – that the temporary measures announced here will ultimately be followed by growth-oriented reforms. That is the best way to improve the fiscal situation, and the best way to avoid further tax rises.

The Chancellor has dealt with crisis before, now he must lay the foundations for prosperity in the midst of one.

 

This was also published on ConservativeHome

Connor MacDonald

Head of Economics and Social Policy Read Full Bio

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