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Patrick 00:00

Welcome back to the Barclays Brief podcast. It's a sunny day and it's a sunny day here in London. And I'm joined by Jack, meaning our Chief UK Economist. Jack, we've got lots to discuss today. Thanks for being here.

Jack 00:10

Absolute pleasure Patrick.

Patrick 00:13

Okay, so ten years after the Brexit referendum and Britain faces a new question, what should its economic model look like for the next decade? And earlier today, just a couple of hours ago, Andy Burnham, potential Labour leader, argued that the answer lies in devolving more power to Britain's cities and regions. So I want to talk about that today, and I'm sure we're going to talk about many other things.

But before we get into the politics of what happened today, when you step back and look at the past decade. What do you think has been the single biggest economic consequence of Brexit?

Jack 00:47

Undoubtedly, Patrick, you have to look at the fact that the level of GDP, the size of the economy is smaller because of the decisions we made in 2016 around Brexit and in the years after that. So by most estimates in the academic, economic literature and studies, it's somewhere between 6 to 8% smaller as an economy than we would have been otherwise.

Investment is a significant amount lower, somewhere between 10 and 15%. And all of that obviously has consequences for productivity as well. So all of those are the things that will increase people's standards of living, increase the tax intake, so therefore the government's fiscal position becomes better and just in general help the UK to grow and be a good place to be.

So that has had material consequences, whichever way you look at it.

Patrick 01:30

Yeah. Okay, so clearly Brexit casts a long shadow over the UK economy. Before we talk about the next ten years. Give our listeners a quick snapshot. on what's going on in the economy today.

Jack 01:42

So look, we have an economy that's got some slack, some spare capacity in it.

So the unemployment rate is around 5%. We think it's going to go a little bit higher as the year goes on. We are talking about growth over the next few months and quarters of say, 0.1%, 0.2% each quarter. Which is significantly below what we would think of as the trend rate of growth in the economy. And we have inflation, which is just below 3% at the moment, but we think we'll go back above 3% in the next few months and stay there for much of the rest of the year.

So all of that is eaten into the spending power of consumers and probably ad interferes, you know, lack of confidence.

Now, the positive signs are that if we are right about the outlook, then actually that inflation will be relatively short lived. By the end of next year, we will be back down to 2%, which is the level of the Bank of England is aiming for.

We should start to see growth pick up as we move through into next year. So we think we'll be back to trend, maybe even starting to close some of that gap in the economy. And the unemployment rate will probably peak in the second half of this year and then start to come down next year.

So overall, the near term is pretty difficult to get through and it will be a bumpy road, but the medium term looks a little bit more positive.

Patrick 02:55

Okay. Against that backdrop, just a couple of hours ago up in Manchester, Andy Burnham argued that he wants to see much greater devolution in the UK. Is there economic evidence that this kind of decentralisation delivers better economic outcomes?

Jack 03:09

Well, first of all, Patrick, let's just look at the context of just how centralised the UK is.

So you can look across a whole range of metrics. They all tell you broadly the same story that the UK is one of, if not the most centralised economy, economically and fiscally across most of the developed economic markets. For a specific number, let's say if you look at the share of total taxation that comes from local sources rather than national sources, the UK, that's around about 5%: that's the lowest in the G7. The next lowest in the G7 is Italy. That's double the rate, more like 10%.

And what that means is that local regions and authorities in the UK are much more dependent on central government for their revenue through the form of grants, and they have much less autonomy in terms of defining their own fate.

Patrick 03:59

Okay. So those are the stats. But what about the impact on growth from devolution. How do you think about that?

Jack 04:05

So there's a number of interesting studies from places like the Industrial Strategy Council that show that actually what you get, the more centralised an economy is, is lower growth. You don't get the same diffusion of productivity enhancing technology across the country, and therefore, the country as a whole suffers from lower growth because you're centralised in a small place like London and the South east instance.

Patrick 04:27

Okay. But ultimately every government has to choose from pretty much the same menu. They could borrow more, tax more, spend less, and try and grow faster. Given the fiscal rules and Andy Burnham a couple of hours ago committed to the existing fiscal rules, which of those policy levers realistically is available to a future Labour leader?

Jack 04:48

I mean, it's an unenviable choice at the moment, Patrick, I think when we look at borrowing, the fiscal rules are pretty much constraining the ability of any chancellor to borrow at the moment, we think there's probably headroom of around £20 billion. And particularly for current expenditure to day-to-day spending, it means there's not very much scope to borrow.

Not just that, but if you could get around the letter of the fiscal rules, then actually the spirit of the rules means that the market is very nervous about any additional borrowing that there would be, and therefore they would ultimately exact a price if you were going to ask for more borrowing from the market, which would be higher rates.

Patrick 05:23

 Yeah, and that's when we see these big spikes in the guilt market and the and the kind of knock on effect of that.

Jack 05:29

Exactly. That can become self-reinforcing because ultimately higher rates means there's a higher debt interest burden for the government. And that eats away at the money they have left, for other things.

Obviously, on the taxation side, Andy Burnham has said repeatedly that he will stick to the Labour manifesto commitment to not touch the big three tax rates. That's National Insurance, VAT and income tax. That's about two thirds of the tax base. So he's only leaving himself a third, and the taxes in there would raise relatively little money without wholesale reform and potentially be quite distortionary on how they affect people's behaviours.

So then that comes to expenditure. And really we've had a spending review that will set spending plans for most departments for the next few years. And really the only place that you think you can make significant savings there is then in the welfare budget.

And that's politically very difficult to get through. Although we did hear Andy Burnham say a little bit on that today in his speech, suggesting he will try and find savings there.

Patrick 06:26

Yes. He said that he could reduce that welfare bill by focusing on in-work support for mental health issues and devolution of Labour market support, again designed for local agencies.

Okay, so clearly there's a big debate at the moment about the makeup of a future cabinet. Any future UK Chancellor of the Exchequer is going to be presented with a long list of potential policies to think about. Are there any that investors should be keeping a close eye on over the next weeks and months?

Jack 06:55

Yeah, I mean, look, things that have come up repeatedly in the debate around equalising capital gains. So increasing the rate of Capital Gains Tax, to be closer to the tax rates paid on labour income. That's the kind of rewarding work not just holding assets type argument. The difficulty with that is that most of the costings that are done by the Treasury in the office for Budget Responsibility suggest that won't raise very much money.

Other things are around reforming stamp duty, land tax, whether that ultimately morphs into some reform of council tax and land value tax that's done on properties. So essentially a wealth tax kind of shifted around. Those types of things are in the discussion, but we're still lacking a lot of detail.

And then there are other things that are a little bit more left field. So one is potentially splitting out the functions within the Treasury to be separating out the Finance Ministry functions, which is the counting the pennies and keeping on top of budgets, versus a Department for Economic affairs or growth, with a mission to try and work across government to boost growth. That could be quite interesting, fiscally pretty neutral but could potentially have long run growth implications

And another thing that is, I think in the background of the missed by investors and maybe policymakers as well at times is there is scope to save, we think roughly £20 billion a year in terms of the debt you need to issue to the market just by changing the way you account for the interaction between the Treasury and the Bank of England.

So as it stands at the moment, the Bank of England makes losses on the government bonds it holds that it bought through quantitative easing, and the Treasury has to send that money to them, and it has to raise that through taxation or from other sources. And if you were to change the account in a technical but relatively simple way, then ultimately you could remove the need for them to send that money across and save the government essentially £20 billion a year by smoothing it out at the Bank of England.

Patrick 08:47

And how do you think the market might react to that accountancy change?

Jack 08:50

So I mean it's technical so it doesn't change a lot of the underlying fundamentals. But interestingly, if you're asking the market for £20 billion less in terms of borrowing, you would probably see rates come down a little bit.

And that again changes the net debt interest burden of the government. So that frees up a little bit more space in other areas.

Patrick 09:10

And that's what they do in the US as well isn't it?

Jack 09:12

Yes, exactly. You'd be moving to a similar style to you have in the US.

Patrick 09:17

I think any future Chancellor that would be very happy with an additional £20 billion to play with.

Okay. So we've spent a lot of this conversation thinking about some of these challenges that Britain faces and a new Labour leader would face. Let's end on a positive note: What do you think is the one thing in the UK economy that investors underestimate?

Jack 09:34

I think the UK has pretty good underlying fundamentals. When you look at household balance sheets, when you look at corporate balance sheets, when you look at levels of government borrowing and government debt to GDP, we're actually in the middle of the pack with international peers, if not a little bit better. And so, you know, we all get caught up, you know we live here. It's sunny at the moment. But maybe there's always a little bit of UK doom and gloom.

Patrick 09:54

So if it's sunny it's too hot. If it’s cold, it's too cold.

Jack 09:59

Exactly that. And there's a little bit of that around financial markets I think. So you know I think actually the underlying fundamentals being pretty good in the UK economy is something that when we get through all of the political noise, is something investors should keep in the back of their minds.

Patrick  10:11

Jack, thanks a lot for joining.

Jack 10:14

Brilliant. Thanks for having me. Patrick.

Patrick 10:15

So as we sit here today, ten years on from Brexit, the focus is increasingly on the choices that will define Britain's next decade. Just today, Andy Burnham has set out one vision centred on devolution and growth. So the policy choices being made over the next few weeks and months will shape the UK's economic future for a generation to come.

Thanks a lot for listening. Do hit subscribe.

Clients can read more from Jack on Barclays Live, and we'll be back at the same time next week.