The writer is director of the London School of Economics and Political Science and a former deputy governor of the Bank of England
The government’s recent fiscal plan fails to respond to the UK’s twin economic crises in a manner that takes into account either evidence or experience. While they are absolutely right to focus on cushioning the shock of the skyrocketing cost of living and trying to stimulate growth, the policies they have outlined do neither well. The market’s extreme reaction to the “mini-Budget” reflects the fact that the government has not told a credible story about its economic strategy.
The UK economy has two urgent problems. The first is a cost of living crisis fuelled by dramatic shifts in the supply and demand for goods — particularly energy — in a time of war, plague and other trade disruptions. The second is more than a decade of low growth and productivity, or what the Economy 2030 Inquiry memorably calls “Stagnation Nation”. With the highest inflation rate in the G7, growth in labour productivity well below the OECD average, stagnating real wages since 2010 and a host of other terrible economic indicators, it is no surprise that the Bank of England projects British households are facing the biggest collapse in living standards since such records were first kept 60 years ago.
We should let the BoE get on with doing its job of raising interest rates to fight inflation. This is not the time to do anything that might undermine central bank independence, which has delivered the low and stable inflation that we have all benefited from. A massive fiscal expansion and a collapsing pound just make the BoE’s job harder and will mean that interest rates have to rise even more to control prices.
In a good society we should provide the greatest cushion to those who need it most. The energy price cap is a very expensive response (to the tune of about £100bn) that provides support to many that do not need it and reduces incentives to make progress on climate change. Instead of a cap, the government should provide a universal lifeline tariff for energy consumption up to a certain level to protect the poorest households and small businesses, and let those who consume more pay a market price. This would cost less, help everyone and maintain incentives to use energy more efficiently.
When it comes to stimulating growth, we need a serious plan to deal with the chronic under-investment that is the cause of Britain’s stagnating productivity. Despite many years of economists’ time devoted to the productivity puzzle, it is becoming clear the answer is pretty simple — chronic low rates of investment by both the public and private sectors.
When I was at the World Bank, we did hundreds of investor surveys on what determined their willingness to invest in a country. The top reasons were almost always the same: first came macroeconomic and political stability (which has been put into jeopardy in the UK), high-quality infrastructure and skills. Low taxes and enterprise zones were always near the bottom. The key to growth is to create an environment where there are great commercial opportunities — tax rate differences of a few percentage points are largely unimportant if you are making a lot of money.
A better policy response would be to use any remaining fiscal space to invest in a serious productivity agenda. This would include mechanisms for increasing investment in infrastructure, skills, research and innovation, alongside incentives to firms to adopt technologies to increase productivity and achieve net zero targets. A £100bn investment in those areas would be transformative for the UK and have far more impact than the same amount in tax cuts to high earners and corporations. Markets would react a lot more favourably as well.
The government is right about another thing — redistribution is not a panacea. A better option is to invest in people so that they can earn decent wages in the labour market — what economists call “pre-distribution”. The current policy proposals are actually doing quite a lot of redistribution (in favour of the rich) in the hope that some of it will trickle down. A much better alternative is to invest more in pre-distribution — early years education, adult learning, research and innovation and infrastructure, especially in deprived areas. That way everyone has a chance at a decent standard of living.
The current proposals are bad economics. They are also a lost opportunity that will close off options for the future. A better option would address the short-term energy issues more efficiently while using this crisis to deal with the longer-term productivity problems facing the UK so that the economy can grow, deliver good living standards for all and continue to make progress on tackling climate change.
Source: Economy - ft.com
