Friday, March 24, 2023

Bold (but not crazy) solutions to Britain’s growth problem

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This article is an on-site version of Martin Sandbu’s Free Lunch newsletter. Sign up here to get the newsletter sent straight to your inbox every Thursday

There has been a flurry of attention recently to the fact that the UK needs a growth plan and it does not have one. Why this is happening just now is slightly mystifying — after all, as my colleague Tim Harford pointed out last week, Britain’s economy has been failing to deliver for 15 years (at least, we may add).

The sudden urgency may have something to do with the IMF’s forecast update which painted the UK as the only major economy to contract this year. Or with the chancellor of the exchequer’s speech ostensibly setting out a plan for growth (plot spoiler: it didn’t). Or with the recent polls showing record numbers of Britons saying Brexit has been bad for the country (54 per cent, against 23 per cent who think it has been positive) — and revealing a lot of unhappiness with the state of things all round.

Whatever the reason, the need to get the UK growing faster and better is on a lot of people’s minds. And some more sustainable growth in one of Europe’s biggest countries wouldn’t be a bad thing. But those in a position to make that happen are very far from doing so. There are three main reasons and they apply respectively to the government, the official opposition and the real internal opposition.

The government, as I hinted above, does not have a plan for growth but a “plan for growth”. That is to say, laudable aspirations — even targets! — but without policies, much like last year’s levelling up white paper. Another term for it is willing the ends without willing the means.

The Labour party, meanwhile, is not offering much more meat on the bone. The Economist had fun with this in its last issue with “Ms Heeves” — the blend of actual and shadow chancellors (Jeremy) Hunt and (Rachel) Reeves, whose policy proposals are, if not indistinguishable, little less than variations on a theme. On the growth-killing phenomenon of Brexit, Labour solemnly vows to only tweak it at the edges, if that. Even Conservative trade envoys reassure international investors that a Labour government would be safe, according to Politico.

Then there are the government’s own backbenches. These do have big ideas for radical change, it is just that their radicalism for restoring growth would achieve the opposite. You may have noticed that Liz Truss is back. The most arresting sentence in her long Daily Telegraph essay at the weekend was (my italics): “while I saw the power of ‘the blob of vested interests’ within many a Whitehall department during my more than 10 years in ministerial office, I seriously underestimated the strength of the economic orthodoxy and its influence on the market”. There you have it: the market thought Truss’s libertarianism would hurt growth. And you don’t get to say “markets are wrong” if your economic philosophy is based on the opposite.

Which leaves us with an unsatisfied hunger for (good) bold ideas that fit the magnitude of the problem. So can we do better than either tweaking at the edges or vandalising what is left of the economy? Let me share my thoughts — and encourage Free Lunch readers to share theirs. Here is a three-pronged policy programme I think is bold without being unrealistic.

First, a policy for investment. Every country needs to build more capital, but investment has been particularly stagnant in the UK since 2016. So greater public investment and stronger incentives for private investment should be a no-brainer. That should be politically attractive too — not just because it’s always a good look for politicians to be getting things built, but because this government could build on its own recent policies of boosting public capital spending and granting a temporary “super-deduction” to business investment. Why not make the deduction permanent?

Greater investment would not be politically painless, admittedly. The spending and tax incentives would need either to be covered by higher taxes or more borrowing. Either makes good economic sense, of course. But not in the standard Conservative narrative. Either the narrative or the country’s growth prospects have to give. Other Conservative shibboleths are threatened by the most obvious supporting policies for a Britain that builds more: deregulating planning and building more publicly owned housing.

Second, a policy for creative destruction. The UK is unproductive because too many people work in unproductive jobs. Productivity will come from getting rid of those jobs and over time moving more workers into jobs that create more value per hour and can therefore pay higher wages. Those jobs could be within the same companies and sectors as where the bad jobs are eliminated, but are more likely to be offered by better and expanding employers in the same sector or in other sectors altogether that grow to take the place of declining ones.

What I have described is what creative destruction looks like. It is a process of healthy growth. Here it is true that economic orthodoxy stands in the way, though not in the way Truss has in mind. For the way to encourage such a reallocation is to combine policies that make it unprofitable for companies to hire people to do what machines could do — bettering and enforcing labour standards, pushing minimum wages up — and sustain demand growth enough to give more productive companies the confidence to expand, invest and hire. Both sides of that equation run against some conventional tenets held dear by “responsible” policymakers. Politically, creative destruction requires a tolerance for the sort of wage inflation that accompanies a reallocation into higher-productivity activities, and a willingness to explain that the death of inefficient businesses is how the country progresses.

Third, a policy for trade. Brexit has, of course, imposed huge costs on UK companies’ international trade. It would be best to reverse it. But short of that, what direction gives the best ratio of economic benefit to political cost? I would say seeking to join a full customs union with the EU. That would at a stroke remove rules-of-origin obstacles, giving UK battery production a place in export-orientated supply chains of electric vehicles, for example. It would also solve most of the friction in Northern Ireland-Great Britain shipments. A customs union would not solve the cost of regulatory divergence, of course, but Great Britain exporters will, for now, simply have to stick with EU rules and pay the cost of certification and border controls.

Why do I say the political price would be worth paying? Because it would be smaller than many think. It would, of course, be giving back control to the EU in a very specific and limited way, to coin a phrase. But much less control than rejoining the single market would. And it would give up control that is demonstrably not terribly worth having. There will be no trade deal with the US. The deals the UK has struck have largely been adaptations of the EU’s deals with the same partners (which helps ease the way back). Elsewhere, the EU is at least as likely to conclude new deals and more likely to strike a hard bargain than the UK on its own. Meanwhile, the EU would have gained a big economy as its rule-taker in trade policy.

If rejoining the EU is conceivable in the mid-term future, as Gideon Rachman wrote this week (and I wrote in 2016), then a customs union is surely a reasonable ambition. Somehow that seems more likely than the two other prongs, which rely on the UK getting its domestic policy act together.

The EU strikes back, sort of

EU leaders congregate today to discuss the bloc’s response to the US’s green subsidy programme. Alan Beattie has delivered his preliminary verdict on the European Commission’s proposal for a “Green Deal Industrial Plan”.

My own take is that it checks all the available boxes but doesn’t overcome the main issue that companies mention when they swoon about the Inflation Reduction Act: that the US tax credit system is so much simpler and more predictable. EU countries arguably put at least as much money available collectively, but it is spread across a patchwork of support schemes (even those at EU level). Many require an approval process after being granted, or have to be applied for, or involve officials selecting only some project among many. All this causes delay and uncertainty.

But it is structurally almost impossible for the EU to overcome it, for several reasons. The biggest is that the power of the purse remains in the hands of national capitals. You can loosen the power of 27 governments to subsidise, but there remain 27 of them. Tax credits, while a more straightforward tool than allocated subsidies, do not overcome this problem since there is no EU-level tax against which credits can be given, so again there will be 27 different tax credit schemes on offer in the best of cases. And, of course, all this means EU governments get into competition with one another more easily than they compete against the US — the reason why state aid is rightly and tightly controlled at EU level.

What to do, then? There is the good intention to streamline some of the subsidy streams; consolidating them would be better but harder. More EU-level funding, but without adding yet another structure, would help too. But perhaps the most promising solution is the commission’s suggestion for a “common scheme” that national capitals could align their tax incentives with. A standard template would do wonders if it let companies know that the 27 different taxmen would all grant the same tax credits.

Other readables

  • President Joe Biden’s State of the Union address was largely focused on domestic policy. That makes sense: Biden has to begin to convince voters in next year’s presidential election that he has delivered for them. As importantly, he has in fact delivered a lot; just look at The Economist’s latest briefing on just how transformative his policies are for the US economy. It is gratifying to those who from the start commended the magnitude of Biden’s policy goals and achievements.

  • My colleague Andrew Jack tells a tale of two business schools: one in Kyiv, the other in St Petersburg.

  • With rising interest rates, many central banks will record accounting losses. A new article from the Bank for International Settlements (known as “the central banks’ bank”) sets out why this does not matter, because “losses do not compromise a central bank’s ability to fulfil its mandate”. Nor does having negative equity. Agustín Carstens, BIS head, makes the point forcefully in an FT op-ed.

Numbers news

  • OECD inflation peaked in October and is at its lowest since last April, says the latest data release from the club of mostly rich countries.

  • US police officers receive only one-eighth as much training as their Finnish counterparts — and less than one-sixth of that required for US plumbers.

Britain after Brexit — Keep up to date with the latest developments as the UK economy adjusts to life outside the EU. Sign up here

Trade Secrets — A must-read on the changing face of international trade and globalisation. Sign up here



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