Can the new government solve the UK’s economic growth problems?

The landslide victory of the center-left Labour Party after 14 years of Conservative rule in the UK marks a major shift in British politics. Prime Minister Keir Starmer is now in the spotlight and is expected to push a pragmatic, business-centric agenda that prioritizes economic growth. Improving the UK economy is a major challenge, especially given the recession in recent decades.

In recent decades, average annual UK real GDP growth has fallen from 3% between 1995 and 2007 (before the global financial crisis) to 2% between 2010 and 2019 (before the Covid-19 pandemic), and is expected to fall further, by an average of 1.2% between 2023 and 2028. Given this trend, economic growth has become a “national mission” for the new government.

UK real GDP growth
(% year/previous year)

Source: IMF World Economic Outlook, QNB Economics

Crucially, the new government has limited fiscal space to revive the economy. Public debt is close to 100% of GDP, the highest level in more than 60 years. Moreover, the tax burden (measured as the ratio of public revenue to GDP) is close to its highest level in more than 70 years. Moreover, the new government has pledged not to increase corporate tax, income tax, social security contributions and VAT, which together account for 75% of revenue. Therefore, compared with UK historical data, the current fiscal situation is tight and the space for aggressive fiscal policy is limited.

The UK tax burden: government revenue as a percentage of GDP
(General public revenue as a percentage of GDP)

Source: Haver Analytics, QNB Economics

In this article, we explore three priorities for the new administration in its mission to achieve stronger long-term economic growth.
Firstly, multiple proposals are underway to strengthen the country’s residential infrastructure, support new investment, reduce bureaucracy and lower project costs. The UK’s building planning system is widely regarded as expensive and overly restrictive. Unpredictable and lengthy planning permissions significantly increase development costs, discouraging residential and commercial construction and infrastructure projects. The system has come at an extremely high cost to the economy: the country’s per capita built land area has not increased since 1990, in stark contrast to other G7 economies. It has also led to lower rates of business investment compared to countries with less stringent planning systems. Chancellor Rachel Reeves has pledged to review the national planning framework and “restart building in the UK”, setting a target of building 1.5 million homes over the next five years. This reform will be one of the main pillars of the strategy to improve the UK’s growth performance.
Second, a newly created National Wealth Fund will be set up to mobilize finance and increase investment in priority sectors. Since 2000, public and private investment in the UK as a share of GDP has been below the G7 average. It is therefore not surprising that the new government is taking steps to increase investment. While the mandate and organizational structure of the new fund remain to be determined, it is expected to work closely with private financial institutions to direct resources to key economic sectors such as ports, steel, carbon capture and green hydrogen, and factories. The government has allocated £7.3 billion ($9.7 billion) for the project and expects to attract £3 of private sector investment for every £1 invested by the government. By tapping the resources of the private sector, the National Wealth Fund can circumvent tax restrictions and increase investment to levels consistent with higher economic growth rates.

Third, the government plans to make promoting trade a core part of its strategy to foster stronger growth. New legislation is planned to promote the alignment of product standards with those of the EU. This regulatory alignment will reduce uncertainty and additional costs associated with adapting to EU rules for businesses. In addition, the UK has resumed negotiations with India, the Gulf Cooperation Council, South Korea, Switzerland, Israel and Turkey to reach new trade agreements after an election-enforced break in the negotiations.

Given the importance of global value chains, trade barriers affect trade with all partners. Higher trade barriers increase the cost of overseas supply, reducing the competitiveness of UK production and the ability of businesses to benefit from international trade. Greater alignment of product standards with the EU and new trade agreements will boost external competitiveness and open up new markets for businesses, further boosting economic growth.

The details of the government’s plans have yet to be clarified and implemented, so it is too early to assess the overall impact on the economy. However, we believe that reforms to the planning system, the creation of a national fund to increase investment, and improved trade relations with the EU and other trading partners are all measures.