There is much to cheer for in Tuesday’s release of the International Monetary Fund’s World Economic Outlook. In its quarterly update, the Fund upgraded the United Kingdom’s expected growth for this year, crediting the economy’s success in capturing some of the growing demand for AI. More generally, the Fund noted that amid the challenges resulting from America’s war with Iran, the world economy has proved surprisingly resilient.

Nevertheless, smile though Chancellor John Healey may that his budget preparations just became a touch easier, he will still need to roll up his sleeves for the task ahead. As the Fund declares, the resilience of the world economy is “reaching its limits”. Several vulnerabilities have emerged, any of which could change conditions sharply.

The AI boom that is doing so much to sustain economic growth, especially in the US, may well be approaching its moment of truth. So far, the prospect of an imminent productivity revolution has powered the share prices and revenues of the hyperscalers, enabling a massive infrastructure bailout.

Sooner or later, the AI firms will have to deliver on their promises to change the economy’s long-term prospects. Thus far, there are few signs of an economy-wide breakthrough of the sort that would justify the lofty valuations of AI share prices. Recent productivity increases, such as the upgrade to Britain’s record, have been derived less from new technology than the continuation of existing trends in such things as automation. Moreover, as Britain’s experience has revealed, higher productivity, if coupled with fewer working hours, can do little to raise overall growth.

So too the fiscal position of western governments looks increasingly troubling. Fiscal deficits have reached levels last seen during the Covid pandemic and are now starting to drive up interest rates. Britain is no exception, and the interest rate the government must pay on its debt is the highest in the G7.

Meanwhile the country’s growth performance requires some context. Although the IMF has raised its growth forecast for this year by 0.5 percentage points since its April report, the projected rate remains just 1.3%. Meanwhile next year’s projected growth rate has been tweaked downward to 1.2% — well below the pace set by Spain, let alone the highly dynamic economies of several developing countries (with India’s growth rate forecast to rise to 7%). Although Britain is expected to enjoy more success than other countries in reducing inflation — the Fund expects it to reach 2% in Britain next year, a year ahead of the US and Europe — the added risk premium the country currently pays on gilts will limit any benefits that come from it.

So, while it’s a sunny day for the Chancellor, he’ll be all too aware of how rapidly the economic weather can change these days. The government’s room for maneuver remains tightly constrained, and any attempt to engage in ambitious spending is likely to encounter resistance among bond investors.

Britain remains trapped by weak growth, high borrowing costs and an AI boom that has yet to deliver its promised productivity revolution. With little fiscal room to maneuver, the government must hope that today’s economic resilience lasts longer than its luck.

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John Rapley is an author and academic who divides his time between London, Johannesburg and Ottawa. His books include Why Empires Fall: Rome, America and the Future of the West (with Peter Heather, Penguin, 2023) and Twilight of the Money Gods: Economics as a Religion (Simon & Schuster, 2017).

jarapley

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