The OECD has warned that the UK is set to record the highest inflation in the G7. That should ring alarm bells. In the past, inflation brought the Treasury some hidden benefits, but today it poses much more of a problem. Instead of filling the government’s coffers, it is draining them.

There was a time when higher inflation worked in the Treasury’s favour. Rising prices meant higher VAT receipts and more taxpayers being pushed into higher bands, boosting revenues. Inflation also eroded the value of debt: economists estimate that between a quarter and a third of Britain’s huge post-war debt effectively disappeared this way. By keeping interest rates below the rate of inflation — while banks and pension funds were obliged to buy government debt — the Treasury could steadily reduce its real burden. The drawback was pressure for higher public sector pay and welfare spending, but as long as these were contained, inflation delivered more money than it cost.

But the government’s old inflation trick doesn’t seem to be paying off like it used to. The fiscal watchdog, the OBR, had expected tax revenues to jump by just over 8% this year. In reality, they’re only up about 6%. That difference might sound small, but it already leaves the Treasury £7.7 billion short of where it thought it would be. If the trend continues, the hole could widen to more than £21 billion by the end of the year — money the government was counting on, which has now gone missing.

The biggest shortfall comes from VAT, which is bringing in almost £7 billion less than expected. In fact, VAT revenues are essentially flat, which is surprising, given that inflation is running higher than forecast.

Poor debt management has also left the UK far more vulnerable to inflation than other G7 nations. Almost a quarter of government debt is tied directly to inflation, compared with less than 8% in the US. That choice has been costly, with a Times analysis showing that it added £62.8 billion to interest payments in just two years.

Unfortunately, Britain does not appear to be any closer to solving the problem. Policies like the pension triple-lock mean that higher costs are baked in just at the time when revenue is being squeezed and debt costs are higher. This means that the Treasury is now getting all the negatives of higher inflation with little of the upside. So, where Gordon Brown would have rubbed his hands at the news of slightly higher inflation, Rachel Reeves will be sweating.

The obvious response at the Budget will be to try and do something to help households through this period of inflation. There are rumours that the Chancellor could reduce VAT on energy bills from 5% to zero, saving households on average £86 each. That might be smart politics, but it’s poor economics.

Since 1979, the pound has lost more than 30% of its value against the dollar, the currency of global trade. That decline makes everything we import — energy, food, clothes — more expensive. Because Britain depends so heavily on imports, our weak currency is driving higher inflation than in many other rich countries. Handing out a bit of extra cash won’t solve the problem, because foreign suppliers will simply raise their prices as the pound keeps shrinking in real value.

The only way to really tackle inflation is to boost domestic production, growing more of our own food, producing more of our own energy and, crucially, selling more of what the rest of the world wants. Rebalancing our trade will increase the value of the pound, reduce the cost of our imports, and provide real relief to households.

This obviously cannot happen overnight, which leaves the Chancellor in a difficult position. But ultimately the choice is between a bold economic rebalancing or death by a thousand price rises. Every day we delay and waste money on alleviating the symptoms of inflation, the harsher the reckoning will be.

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Andrew O’Brien is the former Director of Policy at the think tank Demos and currently Head of Secretariat of the Independent Commission on Neighbourhoods. He writes in a personal capacity.

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China is trying to catch up with America on artificial intelligence. The Wall Street Journal has reported that Zhipu AI — one of China’s six “AI tiger” LLMs — has released a new model that can rival leading US systems, including Anthropic’s Mythos, in cybersecurity tasks such as pinpointing security bugs. While this marks a milestone in China’s drive to catch up with Western AI capabilities, strong performance on a single benchmark does not mean it has taken the lead. Chinese models still lag behind their Western counterparts in broader capabilities, such as autonomous operation. Skepticism is therefore warranted before resorting to hysterical conclusions, but complacency about the geopolitical implications of China’s AI advances would be an even greater mistake.

On the infrastructure side, Chinese AI is still constrained by access to advanced chips, with American labs way ahead in computing capacity as well as investment. Analysis from earlier this year suggests that Chinese models are likely to be at least a few months behind those in the US. But they are still continuing to make progress, or that the geopolitical importance of AI will be decided only by whose LLM has ventured deeper into the technological frontier. The practical applications of AI, countries’ to capture foreign markets, and the application of AI into the real economy will matter just as much.

Here, China may hold an advantage. As with its dominance across many critical supply chains, Beijing may not need to produce the most advanced AI systems — only those that are affordable and widely deployable. In doing so, it could consolidate global influence by supplying functional, low-cost AI at scale.

Beijing seems to be pursuing exactly that path, developing an AI “open-source” strategy that offers affordable, widely available AI models for companies and individuals to use and modify as they wish. The production of the DeepSeek AI model, which matched the performance of Silicon Valley tools such as ChatGPT at a fraction of the cost for users, created goodwill among Chinese models with developers.

The four most popular models on OpenRouter, an AI hardware platform for developers, are now all Chinese. The goal for China is not only to win the frontier-model race, but to make its systems the default layer of AI adoption across industries and global markets. For most economies, the choice is increasingly between an affordable tool they can deploy now and a more robust one that may be out of reach.

And while the countries adopting Chinese models may be exposed to political pressure and cyber threats from Beijing, safer and more capable alternatives matter little if they are unaffordable. American AI companies are already under pressure to monetize products whose operating costs are rising. If Chinese open-source models become the cheap default for startups, universities, governments and businesses across the developing world, then America’s AI lead will be eroded from below.

Perhaps more concerning for America in the long run is how AI can give Chinese manufacturing even more strength, through the ongoing integration of AI as a general-purpose technology. China’s new Five-Year Plan mentioned AI more than 50 times and includes an “AI+” action plan aimed at spreading AI across the economy.

Beijing has been pioneering automation of its critical infrastructure for years, with promising recent results in increasing warplane production capacity. In that regard, China’s open-model strategy and manufacturing dominance will reinforce each other. Cheap, adaptable models accelerate deployment across the real economy while those deployments generate real-world data and use cases that can feed back into further model improvement.

The United States should not dismiss the importance of its lead in the AI race. That lead worries Beijing, not least because a more automated Chinese economy would also become more vulnerable to AI-generated cyber threats. But nor should Washington assume that China cannot catch up with American capabilities over time.

This AI competition represents part of a broader struggle over tech supply chains and geopolitical influence. Decisions over whether to adopt US or Chinese models could produce a more fragmented global reality, with different regions relying on different cloud providers, chips and security structures. The result will likely be a global economy which is divided into competing spheres, rather than one which produces a single winner.

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Miquel Vila is a political and geopolitical risk consultant focusing on industrial strategy, critical infrastructure and global supply chains.

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