Chris Hearld, Group Managing Partner, KPMG:
We're already hearing talk about the fiscal hole that the new government might be about to inherit. What are your thoughts on that? Are we already in danger of our new chancellor, whoever that might be, breaching their own fiscal rules?
David Smith, Economics Editor, The Sunday Times:
I think one thing to bear in mind, Chris, is how unusual those new Prime Ministers have come from within the government. They've been in the Cabinet and so on. Andy Burnham, of course, assuming it is him, has been out of central government for nine years. So, he is a bit of an unknown quantity.
We don't know, as you say, who the chancellor is going to be. I don't think there is a particular black hole problem that we didn't know about. We know that in the last fiscal year, the budget deficit came down from around 5% of GDP to just over 4%. And although the first couple of months of this fiscal year have been disappointing, I don't think there is any sense that things have gone wrong yet. And I would particularly criticise people who have talked about the black hole in the defence plan. 4.7 billion over four years is not a black hole.
As I wrote in the Sunday Times, it's hardly a dove grey hole. So, this is a small amount, 1 billion a year, 0.08% of government spending. That's the sort of thing the treasury should be able to find down the back of the sofa. It's not a new black hole. But there are fiscal challenges. If this Prime Minister wants to make a difference, he has to reform and switch around what he spends money on, rather than just assume he can increase spending.
The constraints are there, but there's no new black hole, I don't think, yet.
Chris Hearld, Group Managing Partner, KPMG:
One of the challenges that I have in my role is thinking about the way that government policy affects our organisation. Tax change is always being talked about at cost. Do you think there are changes on the horizon that we might have to contend with?
Yael Selfin, Vice Chair and Chief Economist, KPMG UK:
It’s something that all our clients have in mind at a worse position than when we were only a year ago, let's say, because we had the crisis in Iran that caused growth to be lower and interest rates to be higher.
But a lot will depend on what the OBI will do in terms of the assumptions that they will make and the focus that they have new forecasts, that they will publish in the next budget.
But putting it all together, I'd say it is quite likely that the Chancellor will have a room of around 15 to 20 billion in terms of the margin to meet his or her fiscal rule. So, all will really depend on what would be the spending plan and what would be the ambition of the new government in terms of their spending, if they want to spend a lot on protecting people and addressing cost of living, for example, then that could cost quite a lot of money. So, it really depends on what they want to do.
Chris Hearld, Group Managing Partner, KPMG:
Tax is only one side of the equation, of course. Spending is the other. Are there areas that you think the government might look at rebalancing spending to try and balance the budget?
David Smith, Economics Editor, The Sunday Times:
I think there are. One thing that's just to build on what Yael was saying, I think it could have been worse. If we were still in a hot war in Iran, if there wasn't the ceasefire deal and if oil prices hadn't come back down again as they have, things would be a lot worse and a lot more troubling.
So, in that respect, it's good. I think on the tax side there are radical things that a new chancellor could do.
I think those will be being thought about at the moment. One of them is to really shake up property taxes, for example. So, the idea of a single property tax levied on a percentage of a property's value to replace both stamp duty and council tax is one that has been quite widely talked about. On the spending side, one of the things I think any new chancellor has to think about is that you just look at where we are in comparison with where we were before the pandemic. Essentially, public spending has gone up from the equivalent of about 39% of GDP to around about 44%, 45%. That's a big change in a short time.
What are the things that have gone up? Welfare, including the triple lock on pensions, including health-related welfare spending, and including, of course, the NHS. The NHS is an interesting institution. Obviously, it’ a national treasure, but in the 2010s, NHS productivity was actually very strong. It was better than the private sector overall. So, if you can get back to that and you can think about how we manage better in the 2010s than we have managed since the pandemic, particularly on NHS spending, which has gone up a lot. If you can control things better, it does release funds. It releases funds for better numbers for public borrowing, but also, it makes those spending commitments to defence a lot easier to think about.
So, I think those are the kind of things that a new chancellor should be doing. It would be a waste of time and a waste of all this political process if all you have is a new face at number 10, and number 10 in the north as well, and all they do is the same as the previous lot were doing.
So, I think there has to be change. And I think everybody is looking forward to change in that respect.
Chris Hearld, Group Managing Partner, KPMG:
You mentioned productivity, Yael. That was the big mantra of the previous regime, if I can call them that, was to try and drive some growth back into the UK economy. We've seen that productivity in the UK stay stubbornly lower. Are there areas that you think are the obvious ones to look at to try and drive some more growth out?
Yael Selfin, Vice Chair and Chief Economist, KPMG UK:
I think there's some easy wins. Well maybe not that easy wins in the sense that if you have a bigger market, it's easier to have economies of scale. It's easier to grow.
So, closer links with the EU and with our bigger markets is one area that is definitely a potential focus. Another one is energy costs. If you have a lower energy cost, then companies may invest more in capital.
That would make them more productive. And then, when you look at individual sectors, maybe more of a focus I'd like to see of those sectors that drive growth in the UK economy. So, particularly thinking about financial services, professional services, where productivity is relatively strong, as well as thinking about the future headwinds, for example, when you look at China and where we could play a role and remain competitive and strong and really double down on those sectors.
And then, as David mentioned, there's a lot one can do with productivity in the public sector. Public sector represents a big chunk of the UK economy. And by making that more productive, using technology in the healthcare, for example, more is one way where you could improve people's health outcome as well as productivity. And then, just looking on the labour side, if you like, I think increasing access to childcare at a bigger scale, maybe offering 50 hours a week for the eligible working families to bring more people back to the labour force is one thing that will be helpful, not just because of productivity, but actually also in terms of welfare.
And then my pet subject, if you like, is stamp duty. We're related a little bit to David. I think we need to get people moving more across the country to jobs, not just try and bring jobs to people. And by reforming stamp duty, especially on prime residencies, that could help.
Chris Hearld, Group Managing Partner, KPMG:
Looking at the council house building programme that Andy Burnham has talked about, do you want to talk a little bit more about that and any other areas that you would like to seem focused on?
David Smith, Economics Editor, The Sunday Times:
One of the things the outgoing regime, if you like, set in motion when they were elected in July 2024 was the idea of one and a half million net new homes, net housing additions in England. So, roughly 300,000 a year. Now, we haven't built 300,000 new homes in England since the late 60s, early 70s. And at that time, almost half of those were built by local authorities. So, council houses were very important.
Capacity in the private house building sector is quite low. 150,000 - 170,000 is about what they can do. I think it would have to be different to what it was in the 1950s and 1960s under Harold McMillan and Harold Wilson and all the new towns we had then and so on. But there is certainly scope there. I mean, Andy Burnham, when he said this, about the one half million gap in the council house market, was really referencing the Margaret Thatcher's right to buy legislation, which is a very popular policy, but it's one that took the heart out of the social housing sector in the UK.
House building is a great way of generating jobs and growth. One of the things we've suffered from in the house building sector in recent years has been the loss of workers, particularly from the EU. So, a lot of EU workers involved in construction have gone back. But we also have, as you well know, we have a lot of young people who are either economically inactive or would value apprenticeships in construction and so on.
So, it seems there is a good win-win here. If you can get young people into construction, which has a very old workforce, if you can get building council housing, private house building, housing associations, council house, local authorities, get those things operating together and lots of benefits flow from that, including the geographical mobility that Yael referred to.
If you've got lots more houses, you've got lots more opportunity for people to move around in search of work and so on. So, I think there's a real win-win possibility there. And I just hope the sector isn't stuck in a kind of rut in which you can't respond to new policies, new incentives from this change of regime.
Chris Hearld, Group Managing Partner, KPMG
Andy Burnham, the king of the north, is very keen on devolution, very keen on number 10 in the north. What are your thoughts on that? I spent a big part of my career working in the UK regions as part of our north business. Is it going to make a difference?
Yael Selfin, Vice Chair and Chief Economist, KPMG UK
I think it's a good policy in the sense it's very popular. I think one of the... Well, there's a few things that need to work. One is; you do need to have the capacity within the local government and the regions to execute.
So you do need to make sure that you've got the right people in place to be able to do that. And then the other thing that I think is really important is the coordination of policy between different departments. So, for example, if you build a new housing estate, you need to make sure that the education provision and the utilities and staff and all of that is also there.
A lot of it can be done locally, but some of it is not necessarily devolved. So you just need to make sure the departments still work together. And then you do need to work across regions a little bit as well, because especially when you look at infrastructure projects, they tend to be across regions. So you need to have the different regions to coordinate between themselves, even though they're devolved.
David Smith, Economics Editor, The Sunday Times
You just see the downside of even positive announcements of the sort that Yael was just talking about. So number 10 in the north is going to be in Manchester. So you get complaints from Newcastle, Leeds, even Cornwall saying, "What about us?" They don't seem to mind when it's all run from Westminster, but when it's in other parts of the north. And I think there have been initiatives over the years. So, for example, in Darlington, there is this treasury, this economic campus which has got a thousand people there.
Young treasury officials love to be placed there because they can afford housing in a way they can't afford in London. It's a positive initiative. What you always have to think about is whether, which has been the case with regional policy in the UK forever, that you put bits of government departments out in the regions, but you don't really move much decision-making there. And that means that they're outposts. They're outposts of an empire which still is run from London. I think that is a risk for turning around the north-south divide, if we might call it that.
And as Yael says, collaboration between regions is very important. Economic differences within regions are bigger than economic differences between them. So Greater Manchester doing very well under Andy Burnham's term as mayor and before that. But differences between Greater Manchester and other parts of the north-west are enormous. So there's prosperity which doesn't necessarily spread. You go up to the north-east, you've got places there. Newcastle is doing pretty well. Other parts of the north-east are not. So doing something on a scale that doesn't leave most people dissatisfied is, I think, really a huge political challenge. So people will say, "What about the equalising opportunity, equalising incomes and so on? Where did that all go?" And there's a great danger of failure in this, in promising something, promising devolution which doesn't really make much difference and so on.
So I think the jury is still a bit out on this. It's obviously something he wants to do because it's worked in Manchester. But I've always thought that Greater Manchester was almost unique in the sense that you could get all those local authorities cooperating together in a way that you couldn't do in the north-east, you couldn't do in the west-midlands to the same extent. So there's work to be done there, I think, and there's a great danger of disappointment on that.
Chris Hearld, Group Managing Partner, KPMG
One of the challenges of the current Prime Minister has been his focus on foreign rather than domestic policy. How easy do you think it is to separate the influence that the international markets have on the UK economy as opposed to lots of what we've talked about so far as being the domestic policy agenda, hasn't it?
Yael Selfin, Vice Chair and Chief Economist, KPMG UK
What’s really interesting that when you look at public opinion, for example, at the moment you have the actual people, if you like, the people are much more in favour of closer relationship to the EU than previously. I think the issue that we have now needs, it's a broader issue about regulation and deregulation, that businesses want more stability.
So it's really a question of how you go about it. And whether it's actually going to help or not. And it's not just what we want, it's also how we approach the EU and what deal we get. So it's two-sided and I think there's a fault in both sides, if you like. We haven't necessarily always negotiated it well, but it's also the EU that demanded maybe a little bit too much. So I think you have to have a much clearer approach and focusing on sectors that really matter. For example, financial services that is never discussed, or hardly ever discussed, whereas we focus on sectors that are not really that big for the economy.
David Smith, Economics Editor, The Sunday Times
I don't think Andy Burnham will be rushing to the White House with an invitation from the King, because I think the Sir Kier Starmer established a little bit of a reputation as the kind of Trump whisperer, everything we've seen suggests it didn't really work very well. It didn't stop the insults; it didn't really make much difference in the long term when it came to tariffs. So I think he'll have a different approach. One of the things where we are very sensitive and very dependent, of course, is the government bond market.
And Andy Burnham in an earlier incarnation, I happened to be up in Manchester in February, and it emerged then that he might stand for that earlier by-election, Gordon and Denton, I think it was. And the Gill market responded badly to that, because he'd said things about we shouldn't be prisoners of the bond market. I think he's learned the lesson there, but why do we have what is sometimes known rather insultingly as the moron premium? Why do we have higher government bond yields than any other advanced economy, with the possible exception of Australia? We're very close to Australia in that respect. I think it's because suspicion was more than suspicion, it was established in that brief period when Liz Truss was prime minister, and it hasn't really gone away. So the combination of is the UK more inflation-prone than other countries?
Has our debt gone up? Our debt is still lower than most other G7 countries, but it has gone up faster than all of them, I think. So there is still that suspicion about whether we are fiscally credible, whether we are fiscally responsible, and those two things add up to a high cost of government borrowing, which is going to be the constraint on whoever is the next chancellor. And I think the people who were candidates for that are fully aware of that. How do you respond to that? And you have these little episodes where 30-year yields go up to the highest since 1998, 10-year yield move up again. It's been the bane of Rachel Reeves' chancellorship, that every so often it comes back again. Often not because of anything she's done, but because of the war with Iran and things like that. And that means that... I remember when I used to talk to Rishi Sunak when he was chancellor, and that worried him more than anything, the cost of government borrowing, and its interaction with inflation was the real worry. If you're sitting there in the treasury, it used to be that chancellors would look and they would see
The foreign exchange reserves running down in a desperate attempt to support the pound. The pressures these days are almost all through the bond market, through the cost of government borrowing, and that is going to be a constraint. And I think how governments deal with that constraint is very important. It's a mixture of things. You can't do as I think Rachel Reeves did, which is to introduce and announce unpopular policies on the assumption that they will satisfy the guilt market even if voters hate it. Because you need to do two things together. You need to have policies which are both popular with voters and go down well with the markets. The two things, they're not that different. And I think that is a big challenge for the next chancellor.
Chris Hearld, Group Managing Partner, KPMG
You were talking about employment levels and young people. Do you think there is more opportunity there in terms of the supply side of the labour market? Could we do more to encourage more people back into the workplace? You mentioned childcare credits, for example, but other ideas around that topic?
David Smith, Economics Editor, The Sunday Times
One of the things that we've got iss: people think that economic inactivity as people of working age who are not in the workforce, is something new. We've always had it. We tended to have it in the past because, taking Yael's childcare point, a lot of mothers did not work in the old days. So we had fairly low female participation. But that changed enormously.
So where is the inactivity now? It's the fact that we've got 2.8 million who are economically inactive because of long-term sickness compared to the 2 million pre-pandemic. And it's not long COVID. It's other conditions which are keeping people out of the workforce. It's those young people, a million 16-24 year olds who are not in education, employment or training, all of whom should properly be brought into the workforce, as Serana Milburn's reporter said. So there's work to be done there. There is a supply... At one time, we had roughly 75% of working age people in employment in the UK. Getting that up to 80% or so should not be an enormous barrier to economic growth. We should be able to do that.
Getting the inactive into the workforce, creating opportunities. Some of the things that this chancellor has done, for example, employee national insurance, big increases in the national living wage, the minimum wage, have not helped in that regard. But it's also attitudinal. The people who can see what's the point of working. I'm not saying that you can have a better life on benefits than in work. But when jobs are so difficult to come by for young people, when it's a grind of putting in hundreds of applications, getting no responses. There's work to be done for businesses as well. Businesses have got to be mindful of the next generation. The next generation wants more than a non-response to an employment application. When you advertise a job, every person who's applying for that job should get a response of some sort. They shouldn't be met with silence. It's a kind of tripartite thing there.
There's something for the workers to do, there's non-workers, there's something for businesses to do, there's something for government to do. It could be a lot better than it is. We're wasting...
The most valuable resource we have is our people. We're wasting those by letting them go onto the scrap heap almost from the time they leave school. I think there's an enormous amount that could be done in that regard.
Chris Hearld, Group Managing Partner, KPMG
With regards to Net zero, one of the potential candidates to be chancellor, as we understand, obviously very committed to that particular goal. Where do you sit on the influence that that agenda has and how consistent is it with the search for economic growth?
Yael Selfin, Vice Chair and Chief Economist, KPMG UK
I think ultimately in the long term it's important. There are ways of funding it. So, we in the UK have funded it more in terms of adding it to the cost of households than others. Other countries funded it more through general taxation. So, it means that our energy costs are higher as a result of that, which is to some degree okay in the sense that you want to discourage wasteful energy usage.
But it is making us less competitive as well at the same time.
David Smith, Economics Editor, The Sunday Times
I think all these things are a problem of; we've got slow growth and we've had slow growth for almost two decades now. People were very comfortable with the kind of policies associated with net zero when we had stronger economic growth because we could afford it and we have quite a good record in terms of carbon emissions in this country. Obviously because we've farmed some of them out to China. But at the same time, I think when growth is not there, when people feel squeezed, and when businesses feel squeezed, there are problems. We've got the highest industrial electricity costs in the advanced world.
I think when you've got slow growth, people are going to be dissatisfied with anything that they can pin on it. I don't think that net zero policies are that much to blame for our slow growth. But if you read certain newspapers, you'll think they're entirely to blame for it. And you don't want to give people the excuses which give environmental policies a bad name. And I think they have got a bit of a bad name at the moment because it's easy to pin net zero onto Ed Miliband, onto Labour and so on.
But we've had a problem with high electricity costs for some time, and we need to do something about it. And I think there was a view around 15, 20 years ago that we don't have all that much heavy industry anymore.
So, it doesn't matter so much. But now you've got data centres which need electricity. You've got everything. I was down at the Port of Southampton a few months ago. And there are available electric cruise ships, but they don't have the capacity to charge them there because we don't have the capacity within the system. All those things we need to do in terms of better electricity supply and so on. So I think the net zero story needs to be amended from the government. It shouldn't be seen as a barrier to growth in a way that it is at the moment.
Chris Hearld, Group Managing Partner, KPMG
So any organisation commercially, and I'm sure it's true of our government looking for productivity gains is thinking about technology. They're thinking about AI specifically.
Are you believers that this could be the unlock in terms of improving labour force productivity, economic performance generally?
David Smith, Economics Editor, The Sunday Times
I think it would be terrible if it wasn't. I think we all see AI as the cavalry that's coming over the hill to rescue almost two decades of weak productivity growth. There are two dangers. One is that we're not particularly high AI adopters in this country within businesses, particularly SMEs. You need a mission there, which is saying a lot of the focus needs to be on the benefits of AI.
AI is going to be a productivity driver, but we shouldn't forget about all the other productivity drivers. We need higher levels of business investment, 10% of GDP in the UK compared with 14% for most of our competitors. Better infrastructure, more innovation and better skills. You can't forget about all those traditional drivers of productivity just because AI is coming along.
Yael Selfin, Vice Chair and Chief Economist, KPMG UK
I'll just add that it is probably going to be a bit of a longer journey that people are hoping, and it's been very important to be patient. It could take up to 10 years before we see the full fruit of the new technology, which is relatively fast. There's still a lot to do in terms of investment, and we know that as a firm, how long it takes for our clients to embed AI. It's still early stages. And I agree with David that it's a lot about upskilling people and also, it's an opportunity for young people. Rather than, I think, a threat, we just need to make sure we turn it around. But it's also a big question on infrastructure. We touched on earlier in terms of giving AI and giving where us as a nation is going in terms of what we will be producing, what type of infrastructure we need.
And given that we don't have a lot of money to spend it on, we need to make sure that our government focuses on the infrastructure we need in the future.
