152. Liberation Day: Will Trump’s Tariffs Kill Reeves’ Growth?

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1:14Hello and welcome to The Rest is Money with me, Robert Paxton. And me, Steph McGovern. So we've got Richard Hughes, who runs, you know, some would say the most important sort of government institution in the country, the Office of Budget Responsibility, which is supposed to keep the government honest when it comes to borrowing and taxing. And I think it was probably brought to the sort of public attention most when Liz Truss and Kwasi Kwarteng ignored it. And we then they careered into financial crisis, almost bankrupt with the country. Yeah, so Richard, who is chair of the Office for Budget Responsibility, has had quite a few jobs in the sector.

1:54He's worked at the Treasury, worked for the IMF as well. So loads to talk to him about in terms of the spring statement, OBRs, growth figures and everything else that's going on with Trump and the economy. And so here is our interview with Richard Hughes. Richard, great to see you. We're recording this before Donald Trump announces to the world the tariffs that he's imposing on America's trading partners. You've recently done some work, though, on the costs for the UK economy of tariffs of around 20 % and different scenarios for whether we retaliate or not. Can you just talk us through those? That's right.

2:43When we were putting together the forecast for the spring statement last week, US tariff policy was changing from day to day. So our central forecast didn't include any US tariffs on the rest of the world. But we did look at scenarios in which the US imposed additional 20 % tariffs unilaterally on the rest of the world, with no retaliation from other countries, as well as a scenario where the US imposed an additional 20 % tariffs and the rest of the world retaliated in kind. In the first scenario where there are just unilateral US additional 20 % tariffs taking the sort of average tariff rate up to the 25 % that Donald Trump has been talking about, at its peak you see a reduction in UK output of about 0.6%.

3:24And then in the scenario where the rest of the world retaliates, at its peak you see a reduction in UK output relative to our central forecast of around 1%. And that's a permanent loss of income in the UK. So that's at its peak next year, sort of at the height of the disruption associated with additional tariffs. In the medium term, on the first scenario of just unilateral tariffs, you see a fall in output of about a third of a percent. In the scenario where you see retaliation, there's a long term reduction in output of about three quarters of a percent. And so put that into the context of other shocks that we've had, obviously way less than the COVID shock, certainly in the short term, significantly less than the impact of the global financial crisis.

4:06That's right. I mean, in the end, we are an open economy. Trade makes up a significant share of our GDP. But the US is, you know, we don't trade a lot in goods with the US. So the direct impact on the UK is relatively small compared to some other countries which do export a lot in terms of goods to the US. Our US goods export are about£60 billion. pounds. But we do have effects directly on that goods trade. But also we face indirect effects because other countries which do trade a lot with the US feel effects on their production, on their export. That affects their incomes and ultimately their demand for our exports to other more important trading partners like the European Union.

4:44So it feels like, Richard, then, you know, we only spoke to the Chancellor last week about this, and of course, you did the forecasting around it. This headroom is going to disappear very quickly, isn't it? So it's one of the risks to what is a relatively small amount of headroom. I mean, 10 billion pounds sounds like a lot of money until you realise that we've got an economy of three trillion pounds. And also, you know, government revenue is around one and a half trillion pounds. Government spending is around one and a half trillion pounds. So this is about 1 % in five years time of variation around that total for tax and expenditure.

5:17And so in that sense, lots of relatively small changes to our forecast could affect that headroom. In terms of the long run growth rate of the UK, it would just take 0.1 off the average rate of growth over the next five years to speak for that headroom if that turned out to be lower. And these scenarios that I outlined, an additional 20 % tariffs, we ran it through our fiscal models. And what it shows is that should be also just enough to about wipe out the headroom that the Chancellor's got, because it depresses domestic economic activity. It depresses domestic tax revenues. And therefore, you lose it.

5:53You lose it in terms of your domestic revenue generation capacity. And what we also showed is that if you retaliate and you levy your own tariffs against the US, you get some additional tariff revenue of about nine or 10 billion pounds from trade with the US. But because the impact of the higher inflation and the consequences of retaliation on the part of the rest of the world depresses UK output, you lose roughly the same amount in domestic tax revenues. So even in the retaliation scenario where you're putting up taxes on US imports, fiscally you're not net better off because ultimately you're depressing your ability to generate revenues from your domestic economy.

6:24So there's lots to unpick here. Just on that point, would you argue, therefore, particularly given that our manufacturing sector and our agricultural sector, what collectively not much more than 10 % of the economy, that the rational thing for the UK to do is not to retaliate? I mean, these are decisions for policymakers and for the people who are responsible for the negotiations. But the straight short to medium term economics would say don't retaliate, wouldn't it? I mean, trade wars in general are not optimal for any of the parties taking part of them. And if you're if you're a small open economy, you know, you feel the effects of not just tariffs on yourself, but also the tariffs that are levied on the rest of the world.

7:05Now, I want to get back, though, to the point that Steph made, which is the risk to the Chancellor that come the autumn in her budget, the headroom will have been wiped out. She'll have to raise taxes again or cut spending again. you put in your recent report on all this that there was only a 54 % probability that she would meet her targets, that the headroom would be preserved. Can you just tell us, on the basis of, you know, the OBR has been in existence, what, for about 14 years now? Yeah. Is that the lowest ever probability of the fiscal targets being met? Is she taking the biggest risk of any chancellor in that period?

7:57It's one of the lowest. And if you think about it in terms of the level of headroom different chancellors have set aside against their respective fiscal targets over the last 15 years, the average has been about 30 billion. And this chance has set aside about a third of that. So it's the third lowest amount of headroom a chancellors set aside against their fiscal objectives. But that's an absolute number. There are also relative issues here, which is why I'm wondering whether 54 % is an all-time low in terms of the risk she's taking. It'll be one of the lowest. And we've certainly had numbers in the very low 50s.

8:28And I should say that the probability against the other target she has, which is to get net financial liabilities falling in five years time, is even lower at just 51%. So almost even odds. And again, that's just a measure of in an economy of£3 trillion with a public sector, which is getting up to nearly half of that in terms of revenue and spending. £10 billion is just a very small amount of money, especially when you take into account the amount of volatility we've seen economically in this country over the last few years. and are likely to continue to face in the next few years. We've seen interest rates going up by 100 basis points just in between our two forecasts, the one we did in the autumn and now.

9:04Just half of that amount of volatility going forward would be enough to wipe out the headroom that the Chancellor's got. Very small changes about assumptions for the rate of growth and also what we've already seen in terms of threats to global trading arrangements. I mean, we've talked a lot about the volatility there. It kind of feels like, and it sounds like every day you're having to kind of re-forecast based on what the latest thing is quite often Trump said is there any point given the world we're in at the minute and how unstable it is at forecasting because you know like when we interviewed Rachel Reeves last week she must have mentioned the OBR about 15 times and it feels like the government have become so obsessed with your what you're saying it feels like political decisions are kind of bound by what you say rather than guided yet it's really impossible to forecast at the moment.

9:52And it just feels like, should everyone just take a breather and stop forecasting and just, you know, focus on getting growth, but without thinking about all the uncertainty? It just feels like forecasting is pointless and she's only going to come back in a few months and tell us the figures are wrong again. Since I've been at the job which started in 2020, we've always been forecasting in the midst of uncertainty and shocks to the UK economy. I started in this job in the middle of COVID. We then had the Russian invasion of Ukraine, big rise in energy prices. We then had a period where interest rates rose very rapidly from below 1 % up to where they are now at around four and a half.

10:30All of those things were very big shocks to the UK macroeconomy. Now there is uncertainty about future trading arrangements. And so one of the things which we always try and emphasize when we put together our forecasts is the law requires us to produce a central forecast and produce an assessment about whether based on that forecast and the government's policies at the time, are they on track to meet their fiscal targets? That's a question Parliament wants us to answer every time that we do a forecast. But what we also try and do in our forecasts is emphasise the uncertainty around those forecasts, the risk fans around each one of those central forecasts.

11:03We also produce another publication in the summer called the Fiscal Risks and Sustainability Report, where we try and look in more depth at what are the kind of risks and vulnerabilities in the UK public finances, Where might future shocks come from that policymakers need to think about? And I think those reports, I think, are just as important as our central forecasts, which end up getting a lot more attention, I think, in the media. But they look at what might drive our forecast off course over the next five years, as well as what are the longer term trends that policymakers need to think about when making fiscal policy.

11:36things like demographic change, things like climate change, things like what might happen in global debt markets, which in the longer term can also create issues and challenges for Chancellor. So I think we do want to come back and talk about those long term trends, because many of them are deeply troubling. I agree with you. I think we both agree with you that part of the problems of British governments is they focus a bit too much on the short term and not enough on these enormous challenges from an ageing population or the cost of climate change. But I'm actually interested to ask Steph what she thinks about, actually what she's just been talking about.

12:21What we've identified in the conversation with you so far is this is a Chancellor who, in her spring statement, built in the smallest possible cushion against shocks, things going badly wrong. And I'm wondering, actually, weirdly, in a world where Donald Trump arguably is changing all the rules about how the global economy is managed, all the rules actually about how we defend ourselves, whether actually weirdly, you know, some people think it's really irrational for her to put herself in a position where she's almost certainly got to raise taxes or cut spending in the budget. But if this is a government which is thinking, actually, we're just going to have to totally reset our whole approach to government because of Trump, maybe you just have to see the spring statement as, you know, just something she had to get over.

13:22And they've now got to sort of absorb precisely because at the moment, none of us are quite sure what a Trump world looks like. They've got we've all got to understand what that world looks like. And then they've got to have a conversation with the British public about what that means in terms of potentially quite significant changes to taxation and spending of a sort that we don't yet know about. Just to bring this into context of real life, I've been having conversations this week with my business partners of the various businesses I'm involved in. And obviously this week is when a lot of the tax changes from last year come in around employment.

13:58So for example, with business rate relief, off the back of the pandemic, businesses in the hospitality, leisure and fitness sector were given a big discount on pain rate reliefs. That discount has now fallen from 75 % off to 40 % off, which is a huge increase in business rate costs for businesses like mine. So are we looking at the wrong things at the moment? because from a real life perspective, it's very hard out there and it doesn't look like it's going to get any better, Richard. So I think the story that you're telling about how the UK economy feels for households and businesses, I think is a microcosm of how the whole UK economy feels, which is that we've emerged from a series of shocks with relatively slow growth in our incomes, relatively high inflation, although real incomes are starting to catch up a little bit, and also a big increase in interest rates over the last few years.

14:50And that kind of stress is also reflected in the public finances. And if you look at this through the prism of the finances that Rachel Reeves and her predecessors have managed as chancellors, what they've seen is that their income growth has been relatively slow, which is in the form of tax revenues, because productivity has been relatively sluggish since the financial crisis and also now coming out of COVID and the energy crisis. She's come out of those shocks with quite a large stock of debt. And the interest rate on that debt has gone up. And that's left us at the moment with a deficit of around four to five percent of GDP, which over the medium term would mean if you left it where it was, it would just keep rising and rising and rising.

15:27And so the situation that we're currently in is not sustainable. And what you've seen over a period of time is a set of chancellors trying to make a set of choices to bring that deficit back down to something which looks more sustainable. And I think when you look around the world, every advanced economy is going through some version of this. They've emerged from a series of shocks. They've got much higher debt. The cost of servicing that debt has gone up. They're struggling to raise the revenues in order to meet both the cost of servicing the debt, but also a society which is aging and pushing up the cost of pensions and health care and other things.

16:01And they are trying to look for ways to get what are relatively high deficits back down to something which looks more sustainable and ultimately get their stock of debt under control, which in the UK and in most other countries at the moment is still rising. What Steph has said, and we all agree with this, government says it all the time, is that in the end very little will be possible in terms of improving the majority of people's living standards, improving public services unless we get the growth rate up. Rachel Reeves over the moon that you basically gave the government a little bit of a boost in your growth forecast as a result of the changes they're making to planning rules being less restrictive when it comes to big developments in terms of the planning regime.

16:56As I say, she was absolutely cock-a-hoop. You talk about it in your report as a very modest increase in the size of the economy. And sort of try and reconcile these two points of view, her extraordinary euphoria that you've given her anything and your view that actually it's quite small. So I suppose what we scored in terms of the impact of planning reforms on residential investment in this forecast and then over the medium term on potential output added 0.2 to the level of output in five years time. So that is relatively modest by the grand scope of other changes that you might make. It's less, for example, than Trump may wipe out with his tariffs.

17:39That's right. But I think what it illustrates is the fact that one of the ways out of the squeeze that Steph was highlighting from the public finances point of view is to try and get the economy to grow faster, because that generates more tax revenue, allows you to meet all the other spending pressures that governments need to face in the public finances. As a forecaster, we do try and think about and reflect where governments do make significant, durable and meaningful changes to policies that can affect the drivers of long term growth in the UK. We do try and reflect those in our forecast for what is called the supply side or potential output of the UK.

18:21I think the challenge that all policymakers face is that the things that really matter for the long run growth potential of the UK are a bunch of stocks. It's the stock of labor, which is about 30 million people. It's the stock of capital, which is about 200 % of GDP. And it's the stock of human ideas and our ability to make use of them, which is sort of some measure of productivity. And the things which government policy leaders act upon are mostly flows of things. They can affect the flow of people into and out of education in a given year. But in a given year, that's a relatively small share of the total stock of working people in the economy who have already been educated.

18:57and I've got the skills that they've got. They may learn some on the job, but if you're focusing on things like further and higher education, that's fine, but that's going to get maybe a few extra tens or hundreds of thousands of people into the labour force in a given year. On the housing side, you've got a stock of housing of 32 million houses. In our forecast, we think the government's planning reforms are going to add an extra 170 ,000 to that, on top of existing plans. That's adding 0.5 to the total stock of housing in five years' time. It's not going to solve the housing crisis, Yeah, so it's not going to solve the housing crisis, but it is a sort of thing which, if you are persistent and you stick to, over longer periods of time does build up into making a meaningful difference.

19:35And the same is true of things like public investment. The total stock of capital in the UK is 200 % of GDP. The government invests about 2 % of GDP in a given year. So, again, the government's adding 1 % to the total stock of capital in the economy from one year to the next. But most of what the economy runs off are the roads and trains and airports that we've already got. And you can see out there and the quality of those. Yeah, not great is the answer. On that point, because I was really interested in this point about where the growth was coming from and this upgrade and the sense that it's from planning and the increase in house building and things.

20:09And you alluded it to there when you mentioned about education. Do you factor into this that it's going to take ages to get all the right skilled people ready in time? And how do you measure that? I mean, one thing you have to do is look beyond five years, because you're right that over a five year period, some people are leaving school. Quite a lot of people are still in school and being educated. It then takes them time to find the right job, which is the right match if they get better skills. And then it could also take time for those better skills to be reflected in higher wages. So there can be significant time lags between when you make an investment in, be it residential investment, be it physical capital, be it human capital.

20:47there can be significant time lags before you see any kind of return from that economically. That's one of the reasons why in our forecast, we don't just look five years ahead to try and estimate these benefits, but we look 10 years ahead, sometimes 50 years ahead to say, if this policy was sustained for a long period of time, what would be the cumulative impact of this on a stock of people, on a stock of capital, on a stock of houses, and what kind of long-term effect might that have? I think one of the challenges that you then confront is that government policy does change relatively frequently in a lot of these areas.

21:19We've seen in the past public investment be a kind of residual in the fiscal equation. It's the thing that booms when the public finances do well, but then it's the first thing that gets cut back when the public finances are under stress. So you don't always see a sustained high level of public investment in the UK. It can look a lot more volatile. And again, that means that you have years where you're not actually adding very much to the capital. And there's nothing is possible in terms of growth and prosperity unless productivity improves, productivity output per person, output per hour work.

21:52Now, you do expect productivity to improve a bit in the coming years, but you also say that there's a pretty good chance you'll be wrong. So tell us a bit about why you are more optimistic than some forecasters about that, as I say, absolutely vital trend in terms of us getting better off. But why you say that there are some pretty big uncertainties around it. Yeah, so one thing to say is it is very difficult at the moment to try and understand what is going on with the productivity of the UK economy, because in the end, what it requires you to do is divide the total workforce of the UK and the total output of the UK.

22:43And both of those numbers at the moment are proving to be very volatile. There are well-known problems with what's called our Labour Force Survey, which gives us an understanding of how many people there are in the UK economy, how many of them are working, how many hours they're working. So can I stop you for a second, because this is something Steph in particular is very interested in, which is that, you know, you've got a big problem at the moment because as the government has recognised by saying it needs to actually investigate the Office of National Statistics, you know, the data, to use a technical term, quite a lot of it appears to be crap.

23:14It's certainly proving to be very volatile. I mean, there are, they're running up against a set of challenges, which is this data comes from face to face surveys with individuals and the response rates of those surveys have been dropping and dropping. It's out of date. It's so out of date. Given the technology and what AI can do now on my phone, how can we not know where people are employed, how they're employed, what they're doing? How can we not know more? One thing we do as forecasters is try and look at a range of different indicators and not just what comes from these surveys, but also what comes from HMRC in terms of what they call real-time information, people who are paying payroll and other taxes through the tax system.

23:52So you can try and look at these kind of big data solutions. But if you want to know if you want to know a lot in detail about people, then these kind of surveys tend to be your best source. But so uncertainty about the size of the workforce is one issue. The ONS has also has has severely revised its GDP data in recent years. Again, understandable, given all the shocks that the UK economy has been through and trying to understand how they how they work their way through the economy. But then when you're trying to figure out what is output per worker, that is basically the product of two numbers, both of which are quite uncertain.

24:24And so extracting a clear signal from that about the future productivity potential of the UK at the moment is particularly difficult. Where in this forecast we have arrived is somewhere between the relatively strong productivity performance we saw pre-financial crisis, where productivity growth was around 2%, and the very dismal productivity performance we've seen since the financial crisis, which is around 0.5%. In our forecast, productivity kind of recovers to around 1 % over the medium term. So depending on whether you think the period before the financial crisis was a good reflection of our long-term growth potential or whether the period since the financial crisis is a better reflection of where we'll end up in the medium term, you could describe us as being either too optimistic or too pessimistic.

25:05Do you know when obviously you do all this analysis and then you have to go to the government and say this is what we think? Obviously, like we saw with the welfare reforms analysis, the government was saying it was going to save five billion and the newer guys were like, no, it's not going to be that much. What's it like when you have to go and tell them that? Do you get nervous? How do you feel when you have to tell the government they've got it wrong? I think those conversations, and I should say they're entirely confidential. I think they're always respectful. And I think one of the things which I think is a real credit to all the chancellors that I have worked for is that, Whether it's good or bad news, they use our forecast and our analysis as the basis for their fiscal decision making.

25:48And it's a relationship which I think works well into the service of Parliament, who set it up in legislation. And I think over time, which chancellors have come to see is an advantage because it gives them a clear basis on which to operate. It gives them a credible forecast on which to make policy. Statistically, it's important to have a break in the show. So we better go to that now.