Will productivity ride to the Chancellor’s rescue?

Will productivity ride to the Chancellor’s rescue?

What does Budget 2016 mean for the UK economy?


KPMG in the UK


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George Osborne’s 8th Budget since taking office as Chancellor of the Exchequer proved one of the most challenging for him so far. With the economy taking a turn for the worse, forecasts as recent as those made in November’s Autumn Statement had to be significantly paired back. In the short term, the economy could weaken further than the current numbers suggest. Many of our clients are starting to register genuine concerns about the potential prospect of a Brexit, and latest data also point at confidence ebbing, with important implications for short term investment and employment growth that could see a further dent in the UK economic performance.

Public finances have proved to be in a more perilous state, with a weaker economy expected to see a bleaker outlook for tax receipts. The Chancellor can count on some alleviating factors, such as the expected lower spending on debt interest in coming years, but that still left him with no wiggle room to exercise much magic.

This deteriorating economic environment required some bold decisions. The Chancellor abandoned his aim to lower net debt as a share of GDP each year, while the promise to eliminate the deficit by 2019/20 looks shaky. Prudence was not thrown out of the window, however, with announcement of further cuts in departmental spending pencilled in for later years, closer to the next general election. How much of the cuts will actually take place is hard to tell, as the Chancellor may have room to have them reversed in subsequent Budgets and Autumn Statements, when the course of the economy and public finances become clearer.

Sacrificing financial rectitude at a time when record low interest rates make the cost of public debt relatively low could be the right decision, provided that the extra money is well spent in propelling the economy into a better growth path. Productivity remains the Achilles heel of the UK economy and this budget announced a number of measures that could help address that. But the challenge ahead should not be underestimated. The Office for Budget Responsibility anticipates continued weak productivity growth, which provided a no-confidence vote in the Chancellor’s plans to boost economic growth.

Three of the themes promoted in the budget could go some way in lifting productivity performance in the UK. These are education, infrastructure and devolution. Our analysis shows that improvements in infrastructure and human capital can have a major impact on the future of a country’s economic growth and wealth. The UK performs relatively poorly compared to its peers on transport infrastructure in our Variables for Sustained Growth (VSG) index, ranking only 20th, well behind Germany and France. But there is unarguably more to be done on education, with the UK ranking only 65th in our VSG index of 181 countries. Further devolution could boost productivity by improving the level of transparency in government policymaking, an area where the UK does not currently score strongly in our VSG index.

The UK could see real benefits from investing in schools and transport infrastructure, but it will be important how the money will be spent as certain investments would deliver more ‘bang for buck’. The Chancellor will need to make sure that the investments he makes maximise our country’s growth potential.

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