OECD Economic Surveys: United Kingdom 2024

Executive summary

The UK economy has been on a weak growth path since the financial crisis

The United Kingdom faces a challenging economic environment of high interest rates and low growth limiting macroeconomic policy options. Recent economic shocks, shared across countries, magnified long-existing challenges in the United Kingdom, raising the urgency for the government to continue supply-side reforms and stimulate growth potential.

The UK economy has been on a weak growth path since the global financial crisis. Labour supply largely drove GDP growth between 2010 and 2019, but was not met with productivity-enhancing investments (Figure 1). Productivity growth has been lacklustre, mirroring the slow pace of technological innovation and diffusion. Policy uncertainty has been weighing on business investment, and a high degree of policy churn reduced the effectiveness of government’s long-term growth strategies. Inadequate infrastructure, significant skills gaps, persistent inequalities across regions, in income and wealth, and trade barriers created by the departure from the EU Single Market and Customs Union further weaken the UK’s medium term growth potential, as discussed in previous Economic Surveys of the United Kingdom.

Figure 1. Labour supply supported growth

Contribution to average annual GDP growth, % points

Source: OECD Productivity database.

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An already high employment rate requires a more efficient use of available labour resources to sustain growth over the longer term. Advancing supply-side reforms to accelerate investment and reduce the recent and persistent rise in economic inactivity to support labour supply, while providing a transparent long-term policy environment that raises planning certainty for households and businesses, will be essential to increase potential growth.

The growth outlook is improving

Headline inflation is moderating towards target, but core inflation is projected to stay elevated, requiring monetary policy to remain restrictive until inflation returns durably to the 2% target. Economic growth is projected to pick up as the effect of past monetary tightening wanes.

Economic activity picked up in 2024 following a significant slowdown since late 2021 (Figure 2). A key driver of post-pandemic growth, private consumption was held back by high inflation, until nominal wage growth caught up in the second half of 2023 to deliver real wage increases. Momentum improved in the first half of 2024, with GDP growing by 0.7% in the first quarter and 0.6% in the second, and inflation slowing to 2.2% year-on-year in July. At the same time, the labour market continued easing from exceptionally tight conditions, with unemployment rising and vacancy rates returning to pre-pandemic levels.

Figure 2. Growth is resuming

Real GDP, index 2019Q4=100

Note: G7* refers to the G7 average excluding the United Kingdom.

Source: OECD Economic Outlook database.

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The fiscal and monetary policy mix is adequately restrictive. The fiscal balance is expected to improve between 2023 and 2025 (Figure 3). Monetary policy remains restrictive on the back of persisting inflation pressures. In August 2024, the Bank of England has lowered the policy rate to 5%, after maintaining it at 5.25% since August 2023. Quantitative tightening continues as planned with the gradual winding down of the stock of government bonds.

The financial sector has remained resilient despite successive economic shocks. The UK banking system maintains capitalisation and liquidity positions well above prudential requirements. A large non-banking financial institution sector with heterogenous groups of actors warrants caution, as interconnectedness between actors and the financial sector is not fully understood. It remains necessary to continue to improve monitoring of the non-banking financial sector, as high interest rates can create vulnerabilities.

Figure 3. Fiscal tightening will continue

Government net lending, % of GDP

Note: APF refers to transfers to and from the Bank of England under the Asset Purchase Facility indemnification arrangement.

Source: OECD Economic Outlook database.

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Table 1. Economic growth will pick up

Annual growth rates, % unless specified

	2023	2024	2025
Gross domestic product	0.1	1.1	1.2
Private consumption	0.3	1.0	1.7
Government consumption	0.5	2.3	0.8
Gross fixed capital formation	2.2	0.7	0.4
Exports	-0.5	-0.8	1.9
Imports	-1.5	2.5	2.9
Unemployment rate (%)	4.0	4.3	4.5
Consumer price index	7.3	2.7	2.4
Core consumer price index	6.2	3.7	2.8
Current account balance (% of GDP)	-3.3	-3.8	-3.4
General gov. fiscal balance (% of GDP)	-5.4	-4.7	-3.7
General gov. gross debt (% of GDP)	101.3	101.2	102.6

Source: OECD Economic Outlook database.

GDP is projected to grow by 1.1% in 2024 and by 1.2% in 2025. Strong real wage growth will support private consumption. Headline inflation is expected to continue moderating towards target as energy and food prices have eased substantially, but persistent services price pressures will keep core inflation elevated at 3.7% in 2024 and 2.8% in 2025. Unemployment will rise, reaching 4.5% in 2025 as the labour market cools. Risks to the outlook are balanced, with limited fiscal space to confront possible shocks on the downside and higher domestic demand through the rundown of excess savings on the upside.

Addressing fiscal challenges

Low growth and high interest rates have aggravated already limited fiscal space, following substantial support during the pandemic and the energy price crisis. Real public expenditure has fallen since the global financial crisis, limiting the scope for further spending adjustments. Enhancing revenues through a more efficient and fairer tax system could help address fiscal pressures and rebuild buffers.

The government is committed to a gradual medium-term fiscal consolidation plan, but getting net debt on a declining trajectory is surrounded by risks. The freeze of personal tax thresholds is raising tax receipts, more than offsetting the fiscal cost of the cut in national insurance contributions rates and the increase in the threshold at which the child benefit is tapered away. However, the fiscal headroom to meet the current self-imposed target to put public sector net debt (excluding BoE) on a declining trajectory by 2028-29 is small. The government faces tough choices on public spending and service delivery across departments beyond 2024-25, which reduces policy options or entails cutting back some departments’ spending.

Fiscal pressures are set to increase in the longer term due to mounting spending caused by population ageing, necessary investments in the green transition, and exposure to more frequent and severe climate risks. There is scope to mobilise additional tax revenues as numerous exemptions and reliefs make the tax system difficult to navigate, while their effectiveness is uncertain. Tax compliance has decreased, especially of smaller businesses. Identifying ways to make the tax system fairer, reduce distortions and close loopholes will be key to support revenues over the longer term.

The current fiscal rules may lead to short-termism and to a trend deterioration of public finances. The two main targets of falling public sector net debt as a share of GDP, and public sector net borrowing not exceeding 3% of GDP, are both defined as rolling targets to be achieved in the fifth year of the OBR forecast, which by construction never arrives. The timing and horizon of the fiscal rules entail sub-optimal fiscal policy, as they impede large-scale public investment with longer planning horizons. To support debt management over the longer term, the fiscal rules should strive to better accommodate public investment needs, while balancing stability and adaptability of fiscal rules.

Raising business investment

Low business investment has contributed to sluggish productivity growth. The United Kingdom benefits from a regulatory framework that is generally supportive of businesses, but a high degree of economic and policy uncertainty and a lack of policy continuity have weighed on investment. To support business investment, a transparent long-term strategy is needed, encompassing planning legislation and business taxation.

An overly stringent and complex planning system creates barriers to investment. Business development is held back by lengthy and complex procedures for planning permits. The current planning system, where each planning application faces review and potential opposition from residents, leads to unpredictable outcomes, raising uncertainty and costs for businesses. Moving from the current discretionary system towards a rule‑based system could speed up planning procedures and reduce uncertainty for businesses.

The corporate tax system distorts investment decisions towards debt financing by allowing interest payments to be deducted against corporation tax. The raise in the main statutory corporate income tax rate has been accompanied with full expensing on qualifying plants and machinery on top of the existing annual capital allowance. The combination of immediate expensing while allowing for interest rate deductibility can make unprofitable investment viable through the tax system. Expanding qualifying investment for full-expensing while ensuring that interest rate deductibility is adjusted to avoid subsidising unprofitable investment could support business investment in productivity-enhancing assets and reduce distortions at a limited fiscal cost.

Decarbonising residential housing

Meeting the net zero target requires decarbonising the residential housing sector, which contributes about 14% to domestic emissions. A holistic policy approach will be needed to steer consumer behaviour towards low carbon choices. Necessary measures include clear pricing signals to encourage a shift from fossil fuels towards decarbonised heating, reliable timelines for regulatory changes, and financial support measures to stimulate the market.

Regulatory backstops set out in the government’s 2021 Heat and Building strategy to stimulate the heat pump market have been weakened. In late 2023, the government exempted about 20% of households from the phase out of fossil fuel boilers by 2025 and delayed a ban on new oil boilers from 2026 to 2035. The obligation on boiler manufacturers selling in the UK market to gradually increase the proportion of heat pump sales compared with the number of gas boilers from 2024 has been delayed to 2025. These policy changes complicate households’ decisions on how and when to invest in clean heating, and businesses’ planning of investments in skills and supply chains. A transparent and credible long-term strategy is urgently needed to guide markets.

Effective carbon prices in the housing sector are low (Figure 4) and gas heating is less expensive than electricity heating. High up-front installation costs and the risk of higher running costs deter households’ investment in heat pumps, the most energy efficient solution to heat homes. Stronger price signals are needed to encourage the shift from fossil fuel to decarbonised heating.

The energy efficiency of UK homes has improved over the past decade, but more needs to be done. About 45% of rated UK homes have an Energy Efficiency Certificate below the government 2035 target of a C rating. The government’s plan to tighten energy efficiency in the rental sector, which comprises about 20% of UK’s housing stock, to EPC C by 2028 was scrapped in late 2023. Better availability of green financing products can help smooth the high upfront cost for households investing in clean heating and energy efficiency.

Figure 4. Carbon taxation in building use is low

Effective carbon rates, EUR per tonne of CO₂

Source: OECD 2023, Brick by Brick Vol. 2.

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Boosting labour supply

Employment growth stalled in the wake of the pandemic, and inactivity is on an upward trend (Figure 5). The government made increasing labour supply a priority, but more is required to strengthen work incentives and raise growth potential, including improved activation for the long-term sick, indexed tax thresholds, full rollout of the childcare reform, and better support for school-to-work transitions.

Inactivity increased by about 750 000 people since the pandemic, with long-term sickness accounting for about 90% of the overall rise, in part driven by worsening mental health. Family or home caring responsibilities keep about 1.4 million women from the labour force, while lack of skills accounts for about 1.2 million inactive people in England alone.

Activation requirements for incapacity benefit recipients are weaker than for the unemployed, providing those who are only temporarily unfit for work with incentives to seek and maintain long-term sickness status. Focussing incapacity assessment on individuals’ abilities instead of limitations would promote labour supply, including by ensuring that income support is not conditioned on being found incapacitated for work.

Figure 5. Inactivity has increased

Inactivity rate, % of 15-64-year-olds

Note: G7* refers to the G7 average excluding the United Kingdom.

Source: OECD Labour Force Statistics (database).

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All the main personal tax thresholds and allowances are frozen until 2028 rather than indexed to inflation, weakening work incentives. The freeze supports public finances but weighs on labour supply, dampening the boost from the recent cuts in the National Insurance Contributions rate from 12% to 8%, especially for lower-income earners. Indexing thresholds is key, with National Insurance Contributions prioritised as labour supply effects are larger.

The ongoing expansion of childcare support promotes labour supply, especially for women, but faces significant implementation risk. The reform is needed and welcome, but care staff shortages jeopardize the fast rollout timeline. Contingency planning is required to ensure effective response in case childcare supply falls short of demand.

The dual vocational education and training system insufficiently supports early school leavers into employment. An increasing number of businesses use apprenticeships to upskill current employees rather than hire low-skill youth. Reforming subsidy rates under the Apprenticeship Levy could strengthen employers’ incentives to take on young people with low skills.

 

MAIN FINDINGS	KEY RECOMMENDATIONS
Monetary and fiscal policy in a low growth, high inflation economy
Headline inflation has been slowing towards the 2% target. Core inflation has been stickier as wage-driven underlying price pressures persist.	Maintain the data-dependent restrictive monetary policy stance until inflation is durably around the 2% target.
High interest rates create vulnerabilities in the non-bank financial sector, which accounts for around half of total financial sector assets and holds more than half of UK corporate debt. But the interconnectedness of actors is not fully understood yet.	Closely monitor the non-bank financial sector and consider adequate action to prevent potential transmission of credit defaults from the corporate sector to the financial sector.
High interest rates to contain inflation, combined with low real GDP growth and high public debt limit fiscal space.	Pursue a restrictive fiscal stance over the short term to support inflation falling durably to the inflation target.
The fiscal rules may lead to short-termism and to a trend deterioration of public finances. Current rules provide clear guidance about the medium-term plan for returning to debt sustainability. But the rolling target window leads to sub-optimal fiscal policy and works against long-horizon public investment.	Shorten the time horizon of fiscal rules and define escape clauses with clear conditions under which fiscal rules can be suspended and reactivated.
The UK faces mounting spending pressures related to population ageing, aggravated by needed investments in the green transition, infrastructure, skills and innovation. There is scope to improve the efficiency and fairness of the tax system. Tax compliance has decreased, especially for smaller businesses with less capacity to navigate the system.	Conduct an in-depth tax review to make the tax system more efficient by reducing distortions, closing loopholes, and ending reliefs and exemptions that do not serve economic or social objectives.
Enhancing business investment
Uncertainties resulting from subsequent economic shocks and policy churn weigh on business investment. Since 2017, the UK government introduced three different growth strategies adding to planning uncertainty for businesses.	Establish stable framework conditions and comply with a transparent long-term government strategy for business investment based on clear rules for review and revision.
An overly stringent and complex planning system leads to unpredictable outcomes and lengthy decision processes hampering investment.	Speed up permitting decisions for development by moving towards a rule-based planning system.
The corporate tax system distorts investment towards certain types of assets and encourages firms to finance themselves with debt rather than equity by allowing interest payments to be deducted against corporation tax.	Monitor investment incentivised through full expensing and reduce interest deductibility to avoid subsidising unprofitable investment.
Decarbonising residential housing
The UK government has a broad strategy to decarbonise the housing sector. Policy progress, however, has been slow creating difficulties for households and businesses to make key decisions. Uncertainties increased further when the government delayed and backtracked on previous commitments.	Update the 2021 Heat and Building strategy with a concrete and credible timeline for tightened energy efficiency standards and clean heating regulation.
Gas heating is less expensive than electricity heating and effective carbon prices in the housing sector are low. The risk of higher running costs of heat pumps and high installation costs deter households’ investment in heat pumps, the most energy efficient solution to heat homes.	Explicitly price emissions in the building sector by broadening the scope of the UK ETS to cover heating fuels according to their carbon content.
Rental homes make about 20% of UK’s housing stock. Phasing in minimum efficiency standards of EPC C by 2028 was scrapped late 2023.	Reinstate the minimum efficiency standard for rental housing to band C with a concrete and credible timeline.
Access to green finance is growing slowly and can help smooth the high upfront cost for households investing in clean heating and energy efficiency.	Develop common methodologies and ratings criteria such that energy consumption-related risks and benefits of energy efficiency improvements are incorporated in credit analysis.
Boosting labour supply
Incapacity assessment focusses on individuals’ limitations rather than abilities, so that claimants risk losing their incapacity benefits if they re-enter the labour market despite their health condition.	Reform the Work Capability Assessment so that income support is not conditioned on being found incapacitated for work.
The freeze of personal tax thresholds weakens work incentives, including for low-income workers and despite cuts in the rate of National Insurance Contributions.	Index personal tax thresholds to inflation, prioritising National Insurance Contributions thresholds if fiscal space is constrained.
The fast timeline for childcare reform, the lack of contingency planning, and staff shortages create implementation risks.	Set and monitor interim implementation milestones, and prioritise low-income households if childcare supply falls short of demand.
Employers increasingly use apprenticeships to upskill current employees, rather than hire and train young low-skill people and early school leavers.	Reduce subsidy rates for current employees under the Apprenticeship Levy scheme and channel support to young people.