A Budget for Votes, Not Productivity

18/03/2015 15:04 GMT | Updated 18/05/2015 10:59 BST

George Osborne delivered his last budget of the current parliament today and, like many Chancellors before him in the same situation, he produced a number of populist measures designed to improve his party's chances at the forthcoming general election. Thus, we had cuts in beer duty, increases in personal tax allowances and measures to encourage saving.

Nobody is surprised by this, but - in the longer-term context - this was the wrong budget for the UK economy at this time. This should have been a budget for productivity growth.

The UK economy has grown over the last two years at a pace that before the financial crisis would have been regarded as a little below par. Real GDP increased at an average rate of 2.1% between 2012 and 2014 according to the latest figures from the Office for National Statistics. But this growth has been driven almost wholly by increases in employment and hours worked. As a result, figures published today show the employment rate is at its highest level on record (73.3% of the working age population). If further increases in the employment rate prove harder to achieve, as seems likely, future increases in economic activity will have to come much more from gains in productivity.

This is exactly what the economic forecasts issued by the Office for Budget Responsibility (OBR) alongside the budget assume will happen. The OBR's projections show a levelling off in the employment rate and productivity (output per hour) increasing at an annual rate of 2.3% over the next five years. If achieved, this would be quite an improvement from the 0.3% rate of increase seen in the last three years.

In a longer-term context, the OBR's forecast does not appear fanciful: productivity in the UK increased in every one of the 15 years up to 2007, and at an annual rate of 2.3% on average. But since 2007 productivity has increased by just 1% in total. In this short-term context, the OBR is expecting a massive turnaround in the UK's performance.

This may happen. As the employment rate increases further and workers become scarcer, firms may seek ways to make their existing workforces more productive, for example by investing in more up-to-date machinery and equipment or technology (and the OBR does predict strong investment growth in coming years). Firms may also draw back into more productive work some of the people working part-time who say they want to work full-time, or who describe themselves as self-employed but would rather be working as an employee.

The government will also argue that it has implemented measures to support productivity growth, such as reducing corporation tax rates and cutting regulations, but there is little evidence in the productivity data to suggest they are working. A prudent government would be taking more action to increase the chances of a productivity turnaround.

The last five years have shown the importance of economic growth for deficit reduction. Sustained growth is essential if the budget deficit is to be eliminated according to the timetable set out by the Chancellor in his budget. But sustained growth now requires much bigger increases in productivity than have been seen in recent years. This is the issue this budget should have addressed, but the opportunity has been missed. It is an issue that the next government will have to tackle urgently.