Britain’s economy: is the right right?

Britain’s economic performance since the Coalition government took over in 2010 has been as dismal as today’s cold, damp and grey London weather. Negligible economic growth; government finances that stubbornly refuse to improve, even as services and benefits are cut; and although unemployment is trending down, this is at the cost of pay and hours being squeezed. In political and media circles most of the debate about this state of affairs is around managing total economic demand: the “Keynesian” critique (quotation marks since using a dead economist as a source of authority does not do justice to the critique). Much less prominent is a right-wing critique. Yesterday Allistair Heath, Editor of City AM produced a 10-point plan in The Telegraph online, which neatly summarises this perspective. It is worth thinking about this a bit.

Mr Heath’s 10 points, in his “Supply-Side Manifesto” are as follows:

1. Cut corporation tax to 11pc; abolish capital gains tax

2. Cut current government spending by 2pc this year

3. Wage war on zombie firms

4. Reform the labour market

5. Allow private sector to finance big transport projects

6. Build 300,000 homes a year

7. Scrap renewable energy targets

8. Create mini-jobs for welfare recipients

9. Allow for-profit firms to run schools

10. Make it easier for consumers to switch suppliers

The basic premise of this is that it is what Britain needs is a supply-side revolution to get going. In other words it must be made easier for businesses to grow, and there must be greater incentives for private sector investment. There is something to this. Britain’s economy before the crisis struck in 2007 was unsustainable, and much of the growth in the preceding half-dozen years was a mirage. The most convincing evidence of this is the country’s current account deficit – consistently 2-3% of the economy (and the trade deficit much worse). This seemed to be the result of an inflated exchange rate. As the crisis struck, the pound duly depreciated. And yet, as the Economist pointed out a couple of weeks ago, the current account deficit has not recovered (unlike after 1992, when the pound fell out of the ERM). This bespeaks a deep malaise in the economy. This is much more that a dip in the business cycle that can be cured with fiscal stimulus and/or loose monetary policy. Indeed both such policies could make things worse by pushing out needed investment.

It is common wisdom that the British economy needs to be “rebalanced”: but this seems to be happening only very slowly. Reduced dependence on financial services and public expenditure are clearly both part of any such rebalancing, and we do seem to be making some headway here. But what is to take their place? Thinking about the “supply-side”, or how the economy actually delivers the goods and services it needs, is a welcome relief from banging on about aggregate demand, and its assumption that all this can be left until later. But it is here that I mostly part company commentators such as Mr Heath. Let’s have a quick look at the ten points.

  1. Cut capital taxes to encourage investment. This idea has a respectable intellectual history, but there is a problem. It tends to encourage wealth creation by the rich without much impact on the rest of society. And as the rich tend to save rather than spend their incomes, this doesn’t do much to fix the wider malaise. I’m not so sure that attracting footloose international capital will help much in an economy of our size anyway, (unlike Ireland).
  2. More cuts to government spending: no ring-fences. I do agree that government has to be smaller and more efficient – but the country is very dependent on government sponsored services, such as education and health. We are up against what economists call “Baumol’s Disease”, as well as demographics; there is a limit to amount we can expect from efficiency savings. There is plenty to discuss about how these services are to be funded and structured, but crude cuts are a blind alley.
  3. Allow more companies to go bust. I have more sympathy with this one, though I am not convinced that this is really what is blocking investment.
  4. Labour market reform: reduce job protection. I am more ambiguous on this than most liberals, perhaps hardened by my experience as a middle manager. Improvements can be made, but the evidence that this is what is holding us back is weak.
  5. Big transport projects financed by private sectors (tolls, etc). Easier said than done. The cost of big capital projects is escalating, and returns less certain. I think the current government is pushing ahead with this as fast as politics will allow.
  6. Housebuilding. Here the right wants to unleash the private sector by overcoming planning constraints. Mr Heath is being a bit disingenuous here: he means plastering the green-belts with cheap and shoddy new housing estates. But there is a housing shortage; and we do need to compromise on the green belt. But we need good quality homes and more social housing, with development gains being used to finance social infrastructure, such as schools.
  7. Junk renewables for coal and gas. I’m not sure that an economy built on cheap, carbon intensive energy is the right way to go. I expect that Mr Heath does not believe in climate-change. Moving away from cheap energy dependence is one of the pieces of rebalancing that has to be achieved. Green energy should be part of any growth strategy.
  8. 9., & 10. These are throwaway ideas given a sentence each. I don’t necessarily disagree, even with for-profit state schools, but I don’t think they will help the supply side by much.

So there’s me being very negative about a whole series of practical ideas. So what do I think? First point is that we need to accept that, for a whole variety of reasons, growth in most developed countries will be very slow for the foreseeable future. We need to adapt our expectations to this, and think more clearly on how to deliver improved human wellbeing without it. Second, we need to think hard about under-used human resources: that means mainly people living outside the English South-East and a few other hot-spots. Simply building more houses across London’s greenbelt and moving people there does not feel right. There are no big ideas here, but lots of little ones. Dumping big government agencies in these places is not one of them, though. Third we have to rethink public services. The reforms need to focus on improved commissioning and getting results. But we also need to think about such politically toxic issues as co-payment – since taxes will not be enough to fund the nation’s needs. Plenty of ideas for future blogs, but that’s enough for now.

So the left bangs on about Keynesian demand management, in the hope that longer-term problems can be solved later; the right chases a fantasy of growing businesses unleashed by smaller government. The public seems sceptical of both. Rightly so.

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3 Responses to Britain’s economy: is the right right?

  1. Martin says:

    Thanks for doing this, I was eager to hear your views. I too think we need a bit more supply side intervention by government, but for me, Heath and his ideological fellow travellers have drunk the Kool-Aid when it comes to supply side as panacea to all economic ills.

    I like the idea of a corporate rate tax cut to signal to business that UK is a good place to come. Labour reform is pretty essential in my view (like idea of high compensation for instant dismissal). Definitely agree that government needs to be smaller but don’t think you can do this so quickly without social chaos. Promoting private transport infrastructure sounds idealistic. Definitely agree we should do everything we can do to build more houses (Heath doesn’t mention that this would have a knock on effect on house prices). But the rest I am sceptical about, shale gas (cost? feasibility?), for-profit state schools (unless some kind of pricing flexibility can be introduced does nothing for government’s balance sheet and could offer wrong incentivizes to providers) and making it easier for consumers to switch suppliers (again, how on earth does government solve that problem?).

    • Matthew says:

      Thanks Martin. The corporate tax rate thing is interesting. People forget that companies aren’t people so letting them off corporation tax doesn’t necessarily mean that you are letting them get away without tax at all: provided that you tax the ways in which people extract income and assets from companies (dividends, salaries, capital gains, etc). I also instinctively prefer a lower rate than generous capital allowances, which some other countries do (with some rather bitter memories of how 100% allowances worked in the 1980s). Still I think capital taxes are a good idea and corporation tax is one of the more efficient ones.

      The argument against labour reform is that the country is already pretty liberal, so this is not a deterrent to inward investment. But like you I am tempted by no-fault dismissals if compensation is set high enough: but it is considered politically toxic. There’s a blog post in there.

      We need to be a little bit careful about house building, given the British developers’ habit of building shoddy housing for a quick sale – though I suspect standards have improved. But we do need more housing and in principle any housing that is actually used will help. Also as new houses are more energy efficient this may help improve energy efficiency. I would like to see more social housing – though this more about social policy than economic policy.

      The reason I am quite relaxed about for-profit schools is that it widens the choice of potential school managers, and that should lead to more innovation. Once you allow non-state school managers, you might as well allow in for profit ones. But many local authority schools are excellent – it is actually one place where we have shown that public sector doesn’t have to be inefficient.

  2. Martin says:

    Very good point on social housing over private development. Agree with that.

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