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The following OECD assessment and recommendations summarise Chapter 1 of the Economic Survey of the United Kingdom 2005 published on 12 October 2005.

What are the main challenges ?

Over the last decade, macroeconomic performance has been impressive: GDP growth has been robust and cyclical fluctuations in output have proved smaller than for almost any other OECD country, while inflation has remained close to target. This performance is a testament to the strength of the institutional arrangements for setting monetary and fiscal policy as well as to the flexibility of labour and product markets. But fiscal easing, while supporting demand since the global downturn in 2000, has led to a deficit of around 3% of GDP. However, the main challenges relate to long run structural performance, given that the United Kingdom still only ranks just above the median in terms of GDP per capita among OECD countries and has made little progress in closing the income gap with the best performing countries. Particular priorities, where the government is already taking action, in this respect are:

• Boosting productivity by addressing weaknesses in innovation, skills and infrastructure investment.
• Raising labour utilisation through reforms that help people claiming incapacity benefit back into work.
• Ensuring public money is spent efficiently.

The sources of income differences
2003, in 2000 PPP terms

1. Percentage gap with respect to the United Kingdom level.
2. Labour resource utilisation is measured as total number of hours worked divided by total employment.
3. Labour productivity is measured as GDP per hour worked.
Source: OECD, National Accounts and Labour Force Statistics database, August 2005.

What is the short-term macroeconomic outlook?

Output growth has moderated since mid 2004 from rates clearly above potential growth to rates clearly below it; growth in the year to the second quarter of 2005 was 1.7% compared to potential growth estimates of about 2½ per cent. Some moderation of growth is perhaps not unwelcome given that OECD estimates, as well as survey based evidence, suggest the economy has been operating at, or slightly above, capacity. Inflation, as measured by the Consumer Prices Index (CPI), has picked up from a trough of just over 1% in autumn 2004 to 2.4% in August, above the 2% target. The unemployment rate has remained below 5%, but private sector wage inflation remains consistent with the inflation target. Substantial net immigration, boosted recently by immigration from the new EU countries, has probably been helpful in providing additional labour market flexibility. Responding to the subdued growth in output in the first half of the year, the Monetary Policy Committee (MPC) of the Bank of England voted  to cut the repo rate by ¼ of a percentage point in August, following a year in which it had been left unchanged. This move provides some insurance against the downside risks – especially from prolonged weakness in Europe and higher oil prices as well as, domestically, from the housing market – that cloud the short term growth outlook. However, given that the level of output is currently close to capacity, that inflation has been increasing and is now above target and short term indicators suggest growth may return to trend, there is not a compelling case for further rate cuts.

Is fiscal policy on track?

The fiscal easing since the global downturn in 2000 has been second only to the United States among all OECD countries. This has pushed the government deficit to around 3% of GDP. The public sector has accounted for about half of all new jobs since 2000. Whether the government has met its “golden rule”, that over the course of the cycle the public sector should only borrow to invest, depends on judgements regarding the timing of the cycle. The government’s recently revised judgement that the current cycle began two years earlier than they had previously thought will help to meet the golden rule over the current cycle. But given that the margin by which it will, or will not, be met during this cycle is likely to be small, using this criterion to judge whether fiscal policy has been a “success” or “failure” is inappropriate. Clearly, the new fiscal framework has been helpful in restoring credibility to fiscal policy and the economic consequences of slightly missing the golden rule over the current cycle should be regarded as negligible, particularly in the context of relatively low net government debt. A common feature of both official and OECD projections is that under current spending plans an increase in the tax ratio will be required to meet the fiscal rules and significantly reduce the deficit over the coming cycle. In the case of official projections this comes about through a rise in the tax GDP ratio, reflecting fiscal drag, improved tax compliance and an improvement in corporate profitability, whereas on OECD projections additional measures would be needed.

• If fiscal developments were disappointing beyond what could be explained by weaker than expected growth, so that the deficit in cyclically adjusted terms was worse than projected, then the government would need to take measures to keep fiscal policy on track.

OECD projections of general government finances
In per cent of GDP

Source: OECD (2005), Economic Outlook, No.77.

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Return to the Economic Survey of the United Kingdom 2005

A printer-friendly Policy Brief (pdf format) can also be downloaded. It contains the OECD assessment and recommendations, but not all of the charts included on the above pages.

To access the full version of the OECD Economic Survey of the United Kingdom:

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For further information please contact the United Kingdom Desk at the OECD Economics Department at webmaster@oecd.org.  The OECD Secretariat's report was prepared by David Turner and Jens Lundsgaard under the supervision of  Peter Hoeller.

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