Westminster, we have a problem. A growth problem. The economy shrank in January and economists are cutting their forecasts for 2025. Sub-par growth means stagnating living standards and less cash for public investment, including in the growth enhancing energy transition.
Bad headline GDP figures mask an even deeper malaise. Strip out the effects of inflation and a larger population, and growth (measured by real GDP per capita) has essentially flatlined since the global financial crisis fifteen years ago. A fast ageing population, meaning a shrinking workforce and soaring future bills for pensions and social care, makes a rapid turnaround in growth imperative if we are to avoid long term stagnation.
It’s no wonder the government’s number one mission in opposition was to achieve the fastest growth rate in the G7 by 2030. Confusingly, Keir Starmer later softened this target, saying it was the quality and distribution of growth that mattered. Pretty soon, though, it was back to simple old growth again. Last month, Chancellor Rachel Reeves announced a flurry of big projects to jolt the economy into life.
There’s been too much state, not enough market
The government’s problem is that last autumn’s budget undermined short term growth prospects by loading extra taxes on business, while many of the sensible investment projects it greenlighted will deliver growth only over the longer term, quite possibly in the next parliament and beyond.
Alongside the welcome extra public capital investment, the government has arguably had too little to say about other supply side measures, such as tweaking taxes and making regulation more business friendly (but without relaxing environmental standards) to incentivise the private sector to invest. Too much state, not enough market, in other words. Arguably the mirror image of the previous government.
This might be less of a problem were the state less hamstrung in what it can do to leverage private investment. But the government is operating at the very edge of its fiscal room for manoeuvre. Many economists expect that the recent slowdown in growth will mean it will breach its fiscal rule on debt. This may require spending cuts, particularly now defence spending is being ramped up.
Broadening the NWF’s remit will constrain green investment
The National Wealth Fund (NWF) is being touted as an alternative source of finance. But it only has £22 billion of existing capital from its forerunner, the UK Investment Bank, of which around £3.1 billion had been invested by April 2024, and an additional £5.8 billion for a limited set of sectors was promised in the manifesto. Broadening the scope of the NWF beyond clean energy, or even to fund the defence budget, as has been touted, would further constrain spending on net zero. This risks repeating past mistakes of sacrificing long term growth opportunities in response to short term pressures.
Rachel Reeves’ growth speech was an attempt to plug gaps in the government’s economic strategy in advance of the long promised, but much delayed, industrial strategy, now not expected until early summer. But many of the things she promised, like more runways, will do little to boost the economy, even over the very long term over which they could feasibly be delivered, while wrecking the government’s chances of meeting its carbon budget.
Recommitting to green growth is a better strategy
A much better economic strategy would be for the government to recommit to clean growth but provide much more detail than it has so far about how it will deliver it. The low carbon economy offers some of the best prospects of any sector, with CBI analysis showing that between 2023 and 2024 the net zero sector grew by over ten per cent.
Investors have noticed this potential. They may worry about the size of the government’s overall debt burden, but many still see Britain as a good place to invest, especially if it can avoid the worst of Donald Trump’s tariff wars. The FTSE 100 index of leading shares reached an all time high last month and the pound has been trading at the top of its post-Brexit referendum range against the euro, at around €1.20.
To seal the deal with investors, the government needs to show it is ready to commit to growth by cutting through the negativity surrounding the UK’s prospects, and by taking different action.
Here are some ideas it could get going on.
1. Sort out sky high power prices for industrial users
UK industry faces some of the highest electricity costs in the world – 24 per cent above the EU average – despite an abundance of cheap renewables. Bringing electricity costs for industrial users more into line with prices in the rest of Europe will increase competitiveness and attract more investment in highly efficient industrial heat pumps and other electrification technologies. The government can do several things to make this happen. First, it should underwrite power purchase agreements (PPAs) between industries and renewables generators to reduce business risks and lower prices and look at shifting some levies away from electricity bills onto more progressive general taxation. Second, it should also offer an electrification contract for difference (CfD), in addition to the business models for hydrogen production and industrial carbon capture and storage (CCS).
2. Build out supply chains for renewables
While capital expenditure for wind power projects is mostly funded through CfDs, too much of the supply chains for their components are based abroad. Only two per cent of the steel used in British offshore wind projects over the past five years was made in the UK. Government analysis published last year suggested severe capacity risks in onshore and offshore wind, solar PV and transmission and distribution. There has been progress with, for instance, several new cabling factories taking shape in the last year, the new Clean Industry Bonus and, most recently, funding has been given for a new floating offshore wind hub in Cromarty. But further links could be made, including to the steel industry where the support being planned by the government under its steel strategy needs to ensure that the UK can make the steel plate and electrical steels needed for an expanding power system. Previous Green Alliance analysis suggests that the areas of north east Scotland, East Anglia and south west England could be leaders in offshore wind in future and, therefore, will have the greatest ability to leverage public funding.
3. Plan properly to green (and preserve) the car industry
The automotive industry is a cornerstone of the UK economy, contributing £19 billion in 2023, but it faces threats from low cost Chinese imports. The government should hold fast on the ZEV mandate, or risk spooking investors looking to the long term future, as has happened at BMW’s Oxford factory. But the industry desperately needs a plan to guide OEMs and – crucially – their suppliers through this transition. In the very short term, there is a need to stabilise demand for EVs and produce the conditions for growth, with options including better communications, reduced charging costs, a social leasing scheme and grants for electric vans. In the medium term, the government needs to develop a plan dealing with primary issues to reassure investors, including addressing persistent skills gaps with better links between education and industry, supporting suppliers to the EV market with offtake agreements and other measures, and upgrades to the electricity network.
4. Use tax and regulation to encourage green investment
According to Make UK, 92 per cent of manufacturers see net zero as a priority for their business. It is important that the tax and regulatory system encourages rather than undermines these ambitions. The CBI has suggested a new tax credit with a headline rate of 40 per cent to unlock private sector R&D and innovation in a range of green technologies and more favourable capital allowance rates for some investments too. We add that green investments should have a minimum of three years’ relief to reflect the payback period for business investments, as opposed to the current 12 months.
5. Give the Northern Arc the go ahead
The chancellor has recognised the potential of the Oxford-Cambridge corridor, an economic zone and new rail link between the two leading universities, with the aim of developing a hi-tech cluster in south east England. She should do the same with a similar scheme linking the major cities of the north of England: Manchester, Liverpool, Sheffield and Leeds. Unlike the Oxford-Cambridge corridor, the area has significant brownfield land, an international port and a surplus of water. It also has extensive motorway and public transport assets and half a dozen leading universities. Following the same principle, there will need to be investment in the area’s science and research base, both public and private, and existing transport links should be upgraded. Going ahead with this could provide an even quicker boost to the economy than its southern counterpart, partly because investors know it would be easier to deliver quickly. It will also be much greener, demonstrating the ingredients needed for truly green growth.
Image rights to HM Treasury on Flickr.
Discover more from Inside track
Subscribe to get the latest posts sent to your email.
