Living up to the challenges posed by globalisation is the over-arching theme of this Economic Survey. Compared with its large European neighbours, the United Kingdom has been more proactive in adapting to international economic forces. This is reflected in support for free trade, openness to foreign direct investment, a willingness to open its labour markets to the citizens from the new EU member countries that joined in May 2004, the adoption of regulatory policies that promote efficiency and a macroeconomic policy framework that has enhanced economic resilience. This willingness to embrace the opportunities offered by globalisation is generally backed by widespread support among key groups, including politicians, trade union leaders and employers. This has been rewarded with a stronger economic performance. The level of gross domestic product (GDP) per capita is now the third highest in the G7 (after the United States and Canada). Ten years earlier it was the lowest in this group. The United Kingdom’s GDP per capita ranking among all OECD countries has also improved. GDP growth has been close to its trend rate of around 2¾ per cent for a number of years, suggesting that the amplitude of the economic cycle is smaller now than in previous decades.

The United Kingdom’s good macroeconomic performance over the past decade has been underpinned by a willingness to embrace the opportunities offered by globalisation, together with regulatory policies that promote efficiency and economic resilience. As a result, productivity growth has remained strong, while the workforce has been boosted by immigration in recent years. Nevertheless, the productivity gap with the United States remains large, and a number of reforms should be pursued in order to further improve growth performance. There is also a need to further reduce the government deficit. This will require much slower growth in government spending and more effort devoted to ensuring that publicly-funded services provide good value for money. In recognition of the need to support those who are least able to benefit from globalisation, policy has focused on supporting the poorest members of the population, with a continued emphasis on encouraging participation in work. Nevertheless, employment rates among the least skilled remain too low. A key challenge is to raise education performance without significant further increases in expenditure, while a related key challenge is to ensure strong incentives for the least skilled to participate in the labour market and to progress in work. Finally, it remains important to ensure that the tax structure preserves the United Kingdom’s position as an attractive business location.

Globalisation, together with skill-biased technical change, is changing the composition of jobs in advanced economies and raising the level of skills required to do them. This has increased the importance of educating a large proportion of the population to much higher standards than in the past. The government has responded to this challenge by raising education spending and expanding the capacity of the education system in key areas such as pre-primary education and increased participation in education beyond the age of 16. The United Kingdom has also pioneered the use of school benchmarking techniques and the use of targets to raise school quality. However, targets may also have biased some measures of education performance. Socio-economic background plays an important role in explaining education performance, and the government has addressed this by the use of funding formulas which direct additional resources to areas with a higher proportion of pupils from deprived backgrounds. There has been some improvement in the most disadvantaged schools but pupils in the middle and lower half of the distribution continue to perform particularly poorly relative to students in countries with the best performing education systems. Overall, the socio-economic gaps remain large. One explanation may be that local authorities and schools are not distributing deprivation funds as intended by the central government, resulting in outcomes which can be seen as inequitable. Stronger measures may be required to correct this imbalance. This chapter proposes a number of avenues for encouraging higher educational attainment, without significant further increases in expenditure.

The United Kingdom has had a good record of job creation over the past two decades with the aggregate unemployment rate and related expenditures falling, and employment rates at close to record levels. Although most disadvantaged groups including older workers, lone parents and ethnic minorities have enjoyed significant improvements over the past decade, unqualified workers and younger people continue to fare less well. Moreover, while it has reduced significantly in recent years, there is still a considerable flow of people, including prime working age males, into disability benefits. The government has taken a number of positive steps to address these issues including tightening eligibility criteria, offering income supplements and providing personalised counselling. However more could be done, particularly in the area of skills training both prior to employment and while in employment, and in tackling distortions in work incentives that arise from the high cost of child care and through the interface of the tax and social security systems.

The United Kingdom has recorded strong productivity growth over the past decade, surpassing the performance of many continental European countries and thereby narrowing the productivity gap. However, despite narrowing substantially in the early 1990s, the productivity gap with the United States has remained unchanged more recently. While overall the United Kingdom has some of the least restrictive product and labour market regulations, it needs to guard against increasing red tape and tax complexities which can raise the costs of doing business. Restrictive planning regulations make entry of new firms in retailing difficult and inefficient land use raises property prices. Poor transport infrastructure is another potential factor reducing productivity growth, while R&D spending and adult training are relatively low.

Statutory corporate tax rates have been lowered in the United Kingdom and elsewhere, while tax bases have been broadened. This has rendered corporate tax systems more efficient. Falling tax rates are not a proof of tax competition, but consistent with it. While the United Kingdom was early in cutting tax rates and had strong tax competitiveness, others have caught up. And some countries now have considerably lower tax rates, even after the recent announcement to cut the UK statutory corporate tax rate from 30% to 28% in 2008. This chapter assesses options to preserve international competitiveness.