Growth matters

Ahead of the UK’s Budget, we look at the insights from our series of articles on economic growth. Unlocking the country’s economic potential is vital to boost incomes and protect jobs, as well as paying for the public services that people rely on.

Successive governments have put growth at the centre of their policy agenda. This week’s Autumn Budget will set out Chancellor Rachel Reeve’s latest policies to balance the government’s spending priorities with her fiscal rules. It will also include the latest economic forecasts from the Office of Budget Responsibility (OBR).

Ahead of the Budget, we’ve published a series of articles delving into the latest trends in economic growth and why these matter for broader policy making. Economic growth (usually measured by changes in GDP) provides more money in people’s pockets and boosts the tax revenues needed to fund public services. Recent trends in the sectors featured in the UK’s Industrial Strategy show both reasons for optimism and room for improvement. Technologies like artificial intelligence (AI) are growing rapidly while the country’s traditional strengths like financial services are struggling to shake off slow productivity growth.

Evidence from around the world also sheds light on the relationship between growth and wellbeing. While higher incomes are associated with higher reported happiness at the individual level, this isn’t the case when looking at national averages in wealthier countries like the UK. This suggests policies that strengthen social support networks, improve public health, and promote freedom and trust might have a more substantial impact on happiness. But of course, growth helps to pay for these things.

How does growth affect public finances?

Economic growth has big implications for the amount of money available for the government to spend. The biggest revenue raising taxes – income tax, national insurance, VAT and corporation tax – all go up if the economy grows, as people earn more, spend more and companies make greater profits. At the same time, large areas of spend like social security payments also fall as more people find work.

The OBR’s March 2025 economic and fiscal outlook showed how relatively small changes in growth have big implications for the Chancellor’s fiscal rules. These self-imposed rules set out how much the government can spend relative to what it raises in taxes. The OBR showed nominal GDP growth of just 0.1 percentage points per year lower than their forecast would wipe out the Chancellor’s £10 billion headroom on the ‘stability rule’ for a current budget balance or surplus.

Globally, bond markets have become increasingly jittery about these sorts of questions on the sustainability of national debts. Even in Germany – the least indebted of the G7 economies – announcements of a new fiscal package in March led to the biggest bond-market jump since the fall of the Berlin Wall. This leaves governments around the world walking a fine line to meet spending pressures while balancing the books to restore market confidence. Any boost in economic growth provides some pain relief to this fiscal headache.

How do tax policies affect growth?

As well as providing much needed revenues, tax policies can themselves boost or constrain growth.

There has been a lot of debate about UK income taxes in the run-up to this week’s Budget. Our recent article by Jack Pepin-Hall looks at why some people in the UK face marginal tax rates of over 60%.

There is a particular spike in effective marginal tax rates – the amount of extra tax paid (net of benefits received) for £1 of extra income – for higher earners at the £100,000 threshold. For example, a London family with two young children, where one parent’s income crosses £100,000, would need to earn at least £145,000 (before tax) before being better off again.

Such cliff-edges in the tax system have real implications for people’s work decisions which can add up across the economy. In his piece, Jack points to analysis by the Centre of the Analysis of Taxation, which shows a clear spike in the number of taxpayers that reported an annual income of just under £100,000 in 2022-23. This suggests these taxpayers are choosing to keep their income just below this point to avoid moving into the high-tax region.

How does the UK’s economic growth compare with other countries?

The UK has struggled to shake off sluggish GDP growth. Recent data shows that in 2025Q3 real GDP was just 0.1% higher than in the previous quarter. Real GDP is now 5.3% above its pre-pandemic level (2019Q4), compared with 6.4% growth for the euro area and 13.3% in the United States over the same period.

Our article with the LSE Growth Lab digs further into recent growth trends, focusing on the eight high-potential sectors identified in the UK’s Industrial Strategy. These are: advanced manufacturing, clean energy industries, creative industries, defence, digital and technologies, financial services, life sciences, and professional and business services.

Figure 1. Gross value added of selected IS-8 sectors, 1998-2023

Source: Economic Observatory using DBT Industrial Strategy Sector Definitions List, ONS
Note: 2022 prices, adjusted for inflation. Three of the IS-8 sectors are missing as they have no relevant SIC codes, or codes are absent from the ONS dataset. DBT notes that the SIC system does not adequately cover many of the sectors.

This analysis highlights that the largest sectors in the Industrial Strategy – financial services and professional and business services – are long-standing strengths for the UK but have stagnated in terms of productivity growth in recent years. Digital and technologies has been one of the fastest-growing sectors, driven in part by the rise of AI. Many of the other sectors also show promising signs, like rapid export growth in the creative industries and substantial inward investment in the life sciences.

Ultimately, achieving growth across these target sectors hinges on attracting the investment in skills and innovation needed to deliver jobs and business growth across the country.

How much does AI contribute to growth?

There has been a lot of attention on the increasing potential for AI to be a catalyst for growth. Our article with Perspective Economics looked at AI’s current contribution to the UK economy and what could come next.

Drawing on Perspective Economic’s work for the UK AI Sector Study, the article shows AI’s growing contribution, focusing on employment, firm count, gross value added, and revenues. Each metric shows steep and rising growth.

Figure 2. Growth in UK AI activity, 2022-2024

Source: Department for Science Innovation & Technology, Perspective Economics

Perspective Economics also highlight the UK’s future prospects. For example, Britain has opportunities to draw on its strengths – like chip design and cyber security – to play a major role in the continued development of edge systems (the use of AI in local/decentralised devices like cameras and sensors), improvements to efficiency, and more sophisticated cyber security.

Does growth make us happy?

While growth might make the Chancellor happy, its impact for everyone else is more nuanced. Our article with the LSE’s Wellbeing research group looks at the international evidence on how growth affects happiness.

The article shows that the latest evidence supports a longstanding relationship observed in wellbeing data – while increasing income improves reported wellbeing at the individual level, as countries get richer their populations don’t necessarily get happier. This relationship still holds for wealthier countries where social variables, like health and social networks, appear to be more important for wellbeing. But in less wealthy countries, increasing national income is associated with greater average happiness, even after accounting for the social factors.

Conclusions

Growth is undeniably important for putting more money in people’s pockets and more tax revenues in the government’s coffers to pay for public services and other policy priorities.

The articles in our latest series show that underneath the broad national GDP trends there is a varied picture in the sectors that drive growth. Unlocking this potential takes time but is vital for easing the pressure on public finances.

Finally, growth doesn’t necessarily make everyone happy, but a lack of growth makes most things harder – especially if you happen to be the Chancellor of the Exchequer.