The Budget shows that the Tories are in a political cul-de-sac

I will break my self-imposed silence because yesterday’s British Budget is one of those great set-piece occasions which can be used as a moment of reflection. Predictably, most in the news media squander this in a silly game of speculation about the short-term prospects of political leaders. But the Budget poses more profound questions.

The government faces two profound economic problems, which it must either learn to live with or expend political capital to solve. These are low productivity and housing. There are other big problems, of course: Brexit, austerity, regional disparities and income inequalities, for example. But Brexit is more about means than ends; austerity is symptom of the productivity problem; and the other problems are not so high on political agenda right now, though they are important to both housing and productivity. Broadly speaking, the government is being forced to embrace the productivity problem, and is doing its best to confront aspects of the housing problem, without being able to do enough.

Let’s look at productivity first. This is about production and income per hour worked. Since unemployment is now low, and immigration is looking less attractive, increasing productivity is the key to raising incomes, and, above that in my view, to raising taxes. Weak tax revenues lie behind austerity – the cutting of public spending to levels which are now unsustainably low. The government is forced each year to spend extra money to fix some crisis or other brought about by austerity. This time it was Universal Credit and the NHS. Next year it will be police and prisons, after that it will be schools and student loans. And so it goes on – this is no way to build for the future. The government could try to raise taxes, but this is so politically unpopular that not even the Labour Party is talking about it – they persist in thinking that there is easy money to be raised from big business, rich people and confronting tax evasion. So growth it must be, and productivity must rise. But productivity is stuck in a rut. The big news for this Budget is that at long last the Office for Budget Responsibility has given up hoping that there will be a bounce back, and so reduced its forecasts of income growth, which are used to set tax and borrowing assumptions. The Chancellor, Philip Hammond, talked about fixing this, as all politicians do, but in practice has done very little about it. Labour, for all their huffing and puffing, are no better. Both parties propose a number of sensible small things, like increasing public investment and education, but nothing that gets to the heart of the issue.

So the political class have chosen to embrace slow productivity, by their actions if not their words. They are right, though they need to think through the consequences. My take on the productivity puzzle is different from pretty much everybody else I have read. I think that the primary cause is what economists call the Baumol Effect. The problem is not the failure of British businesses to embrace improvements, but the limited demand for goods and services that are susceptible to advances in productivity, such as manufacturing. There are things that can be done to raise such demand, but these mainly have to do with increasing incomes for those on low incomes – people with high incomes consume less as a proportion of income, and spend more on low-productivity items that confer status. Also if demand for exports could be raised, and imports diminished, that would help – international trade is mainly about high productivity goods. But nobody really has much idea how to deal with these problems beyond tinkering at the edges with minimum wage adjustments and such.

So what of housing? What, exactly, is this about? It is about high costs to both buy housing and to rent it. This is a very complex problem with deep roots. Most analysis is superficial, but this article in the FT by Jonathan Eley is a good one. Among a number of interesting points he makes is that the low number of new housing units being built in recent decades compared to earlier ones is a bit misleading. In those earlier decades a lot of housing was being destroyed: slums and temporary housing for victims of bombing in the war. It is not necessarily true to suggest that the problem is that too few houses are being built. In fact there are deep structural problems with the housing market. One is that private borrowing has been made too easy; another is that changes to housing benefit has subsidised demand for private rental accommodation. The result of this and a number of other things has forced up the price of land relative to the housing  built on it, and made trading in land central to economics of private sector developers.

The upshot of this is that it is hard to see any solution to the housing problem without a substantial intervention by the state to directly commission house building, and social housing in particular. Another issue is building on greenbelt land outside cities, which is now forcing suburbs to turn business premises into housing, and turning suburbs into an unhealthy housing monoculture. Caution on greenbelt building is warranted, of course, as suburban sprawl, as demonstrated in so many countries in the world, is not desirable either. Mr Hammond did practically nothing on either of these critical issues. He did try to tackle the housing problem, but mainly through the private sector and private markets which are structurally incapable of making things better for the growing proportion of the population weighed down by excessive housing costs.

That is entirely unsurprising. Solving the crisis, especially in an environment of low economic growth, means that current levels of house prices and rents have to fall. That is a direct attack on the sense of wellbeing of the Conservatives’ core constituency: older and better off voters. And if that isn’t enough, property developers and others with a vested interest in the current system are showering the Conservatives with money. A politically weak government is no shape to take this on.

And that, I think, is the most important political fact in modern Britain. Housing costs are not an intractable problem that we must learn to live with, like productivity. One day it will solve itself in an immense period of pain as land prices, and much of the financial system, collapses. The sooner it is tackled the less the pain will be. Labour may be useless on productivity, but they are much stronger on housing. They have a much better prospect of doing something useful. That does not mean they will win the next election – the forces of darkness on the right should not be underestimated. But it does mean that Labour is looking to be the lesser of two evils.

For my party, the Lib Dems, this is important. It means its stance of equidistance between Labour and the Tories needs to be modified. The turning point, in hindsight, should have been that moment in coalition with the Tories when the then Chancellor George Osborne said that he could not support the building of more council houses because that meant more Labour voters. The coalition should have been ended then and there. Just as in the 1990s when the Lib Dems leaned towards Labour, the party needs to accomplish the same feat now. It is much harder because Labour has abandoned the centre ground. But that is where the country is at.

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10 thoughts on “The Budget shows that the Tories are in a political cul-de-sac”

  1. You left out one major possibility from the productivity issue – that of effective use of employment time. By that I mean whether or not some British workers are as effective at their jobs as workers doing similar jobs (manufacturing or services) in other more successful countries. If they are less effective but demand high wages then productivity would be poor in comparison with other countries.

    If some British workers are not as effective at their jobs as some in other countries – that might not be due solely to technology issues. It might also be due to other factors such as inadequate training, poor attitude (e.g. poor timekeeping, messing about with mobile phones at work etc.) and poor management.

    1. Firstly I don’t want to suggest that governments should not be encouraging businesses to be more efficient, and workers to be more effective. And there is plenty of room for improvement when it comes to education and training. Incidentally it shouldn’t be so much about high wages – that is more a matter of how the income generated by their work is shared out between them and their employer.
      I’m not quite so sure that British workers are that much less effective than anywhere else. We are often told that British productivity is less than France, Germany and the US. My question is how much are we comparing like with like? France has much higher unemployment, so perhaps their efficiency is coming at a high cost. Germany has a lot of export business, and so a higher share of high productivity work. I did suggest if we exported more then we might well see an increase in productivity. In the US there is quite a low worker participation rate. I think Britain’s high rate of employment is a success. The question is whether improvements to productivity would undermine this.
      Which is the nub of the argument. If businesses improve efficiency they either produce more with the same workforce or lose workers. If demand for their goods is constrained (which I think it is) then it is the latter. But, economics teaches us that this should create jobs elsewhere in the economy. The cost savings translate into extra demand (better paid workers, or consumers with more to spend elsewhere from lower prices, etc). My argument is that these new jobs are being created in low-productivity services – personal trainers, care assistants, tailored cancer treatments, etc. This is the Baumol effect. If, as seems to be happening in France and (perhaps) the US, people are being kept out of the workforce altogether, that isn’t a good thing for the economy, even if the productivity figures rise.

  2. I’ve previously made the claim to a Martin’s Law (maybe not too seriously!) which says, that at the macro level of economics, cause and effect are usually the opposite way around from conventional thinking. So, for example, I would say that such comments as :

    “austerity is symptom of the productivity problem”

    “increasing productivity is the key to raising incomes”

    should be the opposite way around too!

    One day it will solve itself in an immense period of pain as land prices, and much of the financial system, collapses. The sooner it is tackled the less the pain will be.

    I’d agree with this though. If the property market is over inflated then prices need to come down which will leave many recent buyers in negative equity. If prices don’t fall then property unfairly remains out of reach of the younger generation.This will inevitably fuel the intergenerational conflict.

    So there simply cannot be a pain free solution.

    1. Actually I’m not being very coherent on the income-productivity issue. Later I say that the real problem is lack of demand for products and services where productivity is high – especially from people with lower incomes, and net exports. That fits with aspects of your argument that austerity is part of the problem, not just a symptom. But it also fits with another point that I like to make, that looking at aggregate figures for demand is all very well, but it is critically important to look at where money is being spent. Government spending on some things won’t have macroeconomic benefits, but others it might.

  3. I mainly agree. But there is this quote by JMK to consider:

    If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again… the note-bearing territory), there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is.

    Not that Keynes actually advocated Govt doing this. He went on to say:

    It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing.

    1. Alas those were simpler times. With globalised markets, online shopping, advanced automation, high levels of employment and low unemployment it is not self-evident that this sort of thinking is relevant. It is now much harder to promote the right sort of demand that creates the right sort of job in the right places, rather than simply piling up more cash in tax havens… Some slicker from America would turn up with robots, dig out the money employing nobody local except in the local Premier Inn and Starbucks and bank it somewhere. Meanwhile landfill has become so valuable that the authorities will have to make strenuous efforts to ensure that the town rubbish gets put back in the mines after it is dug out. Maybe that would involve employing a few local people…

  4. @ Matthew,

    I don’t think we need take Keynes’ point quite so literally. He’s generally credited with a “digging holes and filling them in again” argument. This looks to be the source. I think we can just take him to mean that Govt spending which is generally unproductive in terms of the general welfare of the population can be “better than nothing”.

    Spending on military equipment probably comes into the same category. Leaving aside the rights and wrongs of our nuclear deterrent , spending on nuclear submarines obviously has a social benefit in places like Barrow where they are built. Nuclear submarines may not be the best use of our available resources but building them may be “better than nothing” in Keynesian terms.

    1. Indeed. My more serious point is that the modern economy means that multiplier effects are going to be much less than in Keynes’s day, so that badly designed stimulus really isn’t better than nothing.

  5. Matthew – I’m not generally a fan of Philip Hammond, except when I compare him with some other Tory ministers, but last week I thought he came in for some unfair criticism when he cited an increase in the employment of disabled people as a factor contributing to the sluggishness of growth in UK productivity – https://www.theguardian.com/politics/2017/dec/07/philip-hammond-causes-storm-with-remarks-about-disabled-workers

    The creation of employment opportunities for disabled people might well have the effect of reducing productivity, particularly if they are new to the workforce or returning after a long absence. The point he was making was not against the employment of disabled people but about the way some statistics can be skewed in a negative direction by factors which in other ways are beneficial. If anything, this reflects on the limitations of productivity as a statistic. Low productivity may be an indicator of something good that is happening in the economy. I think this chimes with what you have been saying about the Baumol Effect.

    If unemployed people are brought into the workforce they will normally make some sort of contribution to production, possibly at below-average productivity. They will therefore increase production per person of working age and hence contribute to economic growth. This might be a more useful statistic than the conventional measure of productivity, namely production per person-hour worked. This may also underline the need not to rely on a narrow range of indicators.

    Looking beyond pure economics, if most of the newly-employed disabled people find their work satisfying and that the quality of their lives has increased as a result, then this will be a benefit not measured by the economic statistics. This underlines the limitations of GDP as a statistic.

    There is, of course, another issue. The Guardian article doesn’t mention any evidence (other than anecdotal) about the effect on overall productivity of employing marginal groups. The point being made might be a figment of Philip Hammond’s imagination, or that of a Treasury official. It may be that Hammond is merely casting round for excuses for the UK’s poor performance on productivity. However, the idea sounds plausible and, unless contradicted by available statistics, is quite appropriate in a serious and honest discussion of economic issues.

  6. I agree there are worse than Hammond – and also that the criticism of him for this comment was unfair. It got a mention in today’s FT in an article that said that France may have better productivity but its income per head was about the same because employment is less. It is hardly self-evident that France has made the better choice. The article then went on to point out that Germany had both high productivity and and high employment, and that Britain should aim at this. But my argument is that Germany has a massive export surplus, which creates high productivity work, but is impractical for the UK to follow. Not that I’m against investment and training, but that the I don’t think that productivity is the biggest economic problem right now.

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