Merlin Weekly Macro: Is the UK government all at sea on growth?

“Our first mission is to grow the economy!”. It is a robotic mantra repeated parrot-fashion by both the Chancellor and the Prime Minister. It is almost as though someone has told them to say it. They seem to believe that at if they say it often enough then like being granted a wish by a fairy godmother, perhaps dreams will come true and growth will appear by magic.

But back in the real world, in the absence of a benign wand being swished by an ephemera to goad the economy into life, it is clear that between Reeves and Starmer they have little idea of how to achieve growth. When a principal strategy is to appeal to government regulators to help stimulate growth, you have a fair notion that the ideas cupboard is bare.

A tour around the south of England, particularly the area in the south-east under a line roughly from Southampton to Cambridge reveals colossal development already under way. New roads being rolled out like carpets, vast distribution sheds popping up like mushrooms, houses by the thousand spreading like amoeba across the countryside, and the enormous environmental scar searing through the Chilterns that is HS2. And yet we still have no real GDP growth as the economy flatlines persistently.

Jam tomorrow?

The government confuses the strategic with the tactical. It is quite right that long-term economic prosperity and development rely upon long-term strategic infrastructure planning to support it. Whether HS2 and a third runway at Heathrow are the answer is questionable, particularly in the context of the spend: as the saying goes, ‘a stitch in time saves nine’ but shaving nine minutes off the journey time from London to Birmingham at a cost of over £100 billion seems a poor reward; as for Heathrow, it is a constant over decades that a third of all passengers using the airport are on transfers to another flight and from whom the economy derives almost zero direct benefit.

What the government should be doing is putting in place the infrastructure required to support a society in profound change. Its principal economic concern should be energy. And here it is hell-bent on pursuing the wrong path entirely. On the 8^th January, during the very cold spell when there was a high pressure system over the UK and the North Sea, the National Grid came withing a gnat’s whisker of a blackout when for a number of technical (interconnectors off-line) and meteorological (no wind, not enough sun) reasons national demand for electricity was almost unable to be met by either domestic generation or imports. Demand is likely both to surge and to become constant over the next decade thanks to the switch to electric vehicles (which every household will charge overnight), and the gradual replacement of gas for heating and cooking, as well as the considerable demand created by new technology applications. But the government’s answer is total decarbonisation of the Grid by 2030, with 100% reliable gas to be replaced by intermittent sources such as wind and solar. The current plan indicates that generation is going to struggle to keep up with today’s demand, let alone meet the significant increases that are entirely forecastable over the next two decades.

As President Trump understands, energy is the bedrock of a functioning and developing 21^st century society. Without secure, reliable energy as the most basic foundation, the Chancellor, the Energy Secretary and the Prime Minister have no credible strategy to sustain the current economy, let alone grow it from here.

A runway in 2040 does not buy a shirt today

Shifting from the strategic to the tactical, Rachel Reeves is under pressure to stimulate growth now, today. That is not going to be achieved by tampering with the supply-side mechanisms of the economy (relaxation of planning laws etc). They may accelerate progress but they cannot produce immediate results. Short-term growth is entirely a function of demand-side dynamics: domestic consumption. Announcing a third runway at Heathrow or the new Silicon Valley Corridor between Cambridge and Oxford, or a sustainable aviation fuel plant in Hull might deliver prosperity in 15-20 years’ time, but they will make zero difference to GDP in 2025. To that extent they are a political smokescreen. Near-term growth will only be achieved when consumers feel sufficiently confident and secure not only to spend, but also to save and invest. As Churchill accurately observed a century ago, “for a country to tax its way to prosperity is like a man standing in a bucket and trying to pull himself up by the handle”. Try standing in a bucket, lifting the handle and see how far you get.

While talking big on future long-term developments, Labour refuses to acknowledge that the current lack of economic confidence is directly a result of tax policies introduced in the October 2024 Budget exacerbating the already historically high tax burden they inherited from the Tories. Horribly high debt, a persistent deficit and high interest rates make a difficult situation worse. With rising employment costs and the prospect of reduced public services (in hoc to the unions, Labour’s chances of fundamental public sector reform are tending to zero, even for Wes Streeting in the Health Department who alone among ministers has some modest ideas in the right direction) business and consumer confidence are at a low ebb.

A contorted mass of contradictions

The new government finds itself all at sea. As laid out only too clearly in its manifesto in which Keir Starmer stated flatly that the capitalist model had failed and only government could provide the solutions, its natural inclination is to want to direct and control. In trying to face down its critics and engineer growth, it is having to fight against its own ideology and instincts. It needs the private sector but remains deeply suspicious of it. It is averse to wealth creation and the continuity of long-term capital for private businesses. It is a technocrat administration with neither experience or understanding of how to create a fully integrated match-fit, competitive economy capable of restoring 2+% real GDP and keeping it there sustainably. It lacks confidence. It is certainly not alone in the western world as any French, German or Belgian will tell you (in sharp contrast with the US), but that is of little consolation to us in these damp islands today.

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