The public purse is stretched. The budget deficit is still carrying heavy scarring from the pandemic, while muted growth has combined with above-target inflation to push up 10-year gilt yields, suggesting increased pessimism about UK economic performance. This presents a unique challenge for the chancellor. Borrowing to kickstart growth is increasingly expensive and risks further raising both the risk premia on government bonds and inflation. It would also push her up against the already tight fiscal rule of running a current surplus by 2030. On the other hand, significant tax rises or spending cuts in the November Budget represent significant risks to growth and could also see bond markets respond with additional caution, further pushing up financing costs. The situation could not be clearer: for the fiscal rule to be met, growth is essential.
It is a grave concern for Number 11, therefore, that the Office for Budget Responsibility (OBR) is expected to downgrade its productivity growth forecast. Productivity growth is essential for maintaining tax receipts and keeping cyclical spend down. Assuming a downgrade in productivity growth to an average of 0.4% a year over this parliament, in line with Cebr’s current forecast, from the OBR’s current rate of 1.0%[1], the expected fiscal situation in 2030 flips by £47.5 billion, from a £9.9 billion surplus to a £37.6 billion deficit.
What levers could the chancellor pull to remedy this situation? One answer could stem from this year’s Nobel Prize in economic sciences, which was awarded recently for work on sustained economic growth. The winners, economic historian Joel Mokyr, and theorists Peter Howitt and Philippe Aghion, were celebrated for their work in demonstrating how innovation can translate to long-run growth following periods of stagnation. In the application to the UK’s position, their research suggests that innovation to production processes is essential in driving the productivity growth that would allow adherence to the fiscal rules.
Herein lies the puzzle: innovation in the UK is extremely strong. The country sits sixth in the World Intellectual Property Organisation (WIPO) Global Innovation Index[2], including a fifth-place ranking for its intangible assets and a first-place ranking for its citable documents. Of the QS World University Ranking top 10, four are from the UK, matched only by the USA[3].
Innovation also goes beyond the country’s academic institutions, with high entry rates and start-up shares relative to cross-country averages signalling strong entrepreneurial dynamism[4]. Research, innovation, and entrepreneurship are clearly strong, yet productivity and potential output growth are anaemic.
Our Nobel Prize winners may provide valuable explanations for this mismatch. A key insight from Mokyr’s work is that sustained growth is driven by the flow of useful knowledge[5]. He argues that, while the period before the Industrial Revolution birthed significant innovations, economic stagnation was subsequently widespread owing to weaknesses in the mix of prescriptive and propositional knowledge. Loosely, these correspond to ‘what works’ and ‘why it works’. Sustained productivity growth relies on the ability to create feedback between these two knowledge types in such a way that innovations can successfully build on one another. In the modern world, this suggests that a combination of practical, technical, and commercial knowledge is required to create innovative production processes that build on existing developments[6].
This can be achieved by maintaining strong connections between research institutions and businesses. The National Centre for Universities and Business (NCUB) has stated that, despite a small recovery in university-business interactions in 2024 following a post-pandemic fall, the picture for this relationship is firmly negative[7]. New academic spinout registrations have fallen consistently since the pandemic[8] and hanging over the slightly improved interaction figures is the spectre of worsening financial conditions for UK universities. Looking ahead, universities are increasingly seeing business interactions as unaffordable luxuries, putting productivity growth further at risk.
Moreover, utilising Aghion and Howitt’s contribution, innovation may not be translating into productivity growth due to low levels of creative destruction. A widely explored research topic, this is the process whereby desire for market power creates incentives for new firms to innovate their product and processes to replace market incumbents. The continual ‘churn’ of businesses and job reallocations allows innovative firms to gain market share, ensuring that innovation yields strong growth in productivity and potential output.
The UK lags here too. A recent study by the International Monetary Fund into the productivity differences between the UK and the USA reveals that, while small start-ups and young businesses benefit from a strong venture capital market, obtaining capital to scale up sufficiently to gain market share and unseat incumbents is far more challenging[9]. It could be argued that this funding gap has allowed the UK’s frontier firms to ‘get away with’ far slower growth in total factor productivity compared to the USA since the Financial Crisis. Without the ability to scale up, the innovation present in UK start-ups has been unable to spark meaningful productivity growth.
The UK is one of the world’s most innovative countries, yet low productivity growth could cost the Treasury £47.5 billion by 2030. By analysing the UK’s poor knowledge transfer and low business churn, it is clear that, while innovative potential and research institutions are strong, the UK does not have the adequate structures in place to translate this into the productivity growth that would ensure the chancellor can stick to the fiscal rule. Unfortunately, the UK’s inability to translate innovation into productivity growth is largely a legacy challenge, with no quick fix at the chancellor’s disposal that can reverse the outlook. Future governments may well depend on Reeves’s success in addressing these issues to capitalise on such a high level of potential.
Cebr’s next Forecasting Eye will be released on 21st November.
[1] OBR: Economic and Fiscal Outlook – March 2025 https://obr.uk/docs/dlm_uploads/OBR_Economic_and_fiscal_outlook_March_2025.pdf
[2] WIPO: Global Innovation Index https://www.wipo.int/web-publications/global-innovation-index-2025/assets/80937/global-innovation-index-2025-en.pdf
[3]QS World University Rankings 2026 https://www.topuniversities.com/world-university-rankings
[4]OECD: United Kingdom: Business Dynamics https://www.oecd.org/content/dam/oecd/en/publications/reports/2025/06/oecd-insights-on-productivity-and-business-dynamics-country-notes_2e4ed11c/united-kingdom_85e176cb/07254bf7-en.pdf
[5] The Nobel Prize in Economic Sciences 2025: From stagnation to sustained growthhttps://www.nobelprize.org/uploads/2025/10/popular-economicsciences2025-1.pdf
[6] The Nobel Prize in Economic Sciences 2025: From stagnation to sustained growthhttps://www.nobelprize.org/uploads/2025/10/popular-economicsciences2025-1.pdf
[7] NCUB: University-business interaction in 2025: An initial view https://www.ncub.co.uk/insight/university-business-interaction-in-2025-an-initial-view/
[8] ibid
[9] IMF: Bridging the Gap: Understanding the UK-US Productivity Decoupling https://www.imf.org/en/Publications/selected-issues-papers/Issues/2025/08/12/Bridging-the-Gap-Understanding-the-UK-US-Productivity-Decoupling-569567
For more information contact:
Daniel Smith, Economist
Email: dsmith@cebr.com Phone: 020 7324 2841