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Time for a positive economic vision

    Ryan Bourne and Tim Knox write on Wednesday's GDP figures and how a bold, positive vision for a more prosperous Britain is required.

    This article is an extract from our fortnightly growth bulletin, published today. To read it in full, click here

    Wednesday’s GDP figures were truly abysmal. Many commentators have noted that the data might exaggerate the extent of our malaise (after all, unemployment is falling). But in truth, even a flat-lining economy at this stage of a recovery should be regarded as abject failure. The immediate danger is that these figures will lead to a further dent to confidence, at a time when it could hardly be more fragile.
     
    Despite the current difficulties, we still agree with the OECD that the Government got the original framework for macroeconomic policy fundamentally right. It came to office at a time of intense crisis, and a combination of the bold announcements made to reduce the deficit, an accommodative monetary policy and a worsening Eurozone crisis all combined to lower UK borrowing costs. The Government reviewed best practice in previous deficit closures and rightly decided on a framework which prioritised spending cuts over tax rises. This plan originally entailed eliminating the current structural deficit by the end of this Parliament, but in reaction to the downgrades to growth forecasts in Autumn 2011, this mandate was jettisoned and the government agreed to consolidate over a longer period. This already is a medium-term plan. And the idea that spending a little bit more now will solve our problems, when the deficit is already above 8% of GDP, and we’ve tried over £500 billion of deficit spending and £375 billion of QE, seems to be misguided.
     
    What, then, has gone wrong from a policy perspective?
     
    Two key areas need to be examined: the implementation of the fiscal plan, and the underestimation of the structural difficulties facing the UK economy.
     
    The Cameron-Osborne team had agreed to Gordon Brown’s spending plans right up until the global financial crisis. In the age of plenty, neither the Conservative party nor the Liberal Democrats had an agenda for government which entailed reducing or fundamentally reviewing the scope and size of the state. Therefore, coming into government and needing to cut spending, neither party had a clear agenda of how certain functions of the state could be eradicated or scaled down. The result was a Comprehensive Spending Review which largely entailed salami slicing, alongside inexplicable ring-fences for the NHS and large increases for international aid. This had two key effects: first, departments were always likely to cut those things easiest to cut, as opposed to those things which are most desirable for long-term prosperity. Second, the Coalition were unable to offer a positive vision for what they are doing – cuts are defended on the lines that they are necessary rather than desirable.

    There have also been mistakes in the timing of the different types of cuts. Thus far, real current spending has continued to rise. All of the deficit closure so far has therefore come from tax hikes and capital spending cuts. What’s more, though the overall deficit is down by 25%, the structural current deficit, the part the government initially aimed to eliminate by the end of this Parliament, is only down by 13% - highlighting the extent to which cancelling investment projects have been important thus far in reducing the deficit. Now, you don’t have to be a Keynesian to realise that tax hikes and investment spending cuts are likely to be more economically damaging than cutting current expenditure. And evidence from history suggests the Government got it fundamentally the wrong way round. Both Canada in the 1990s and the UK in the 1930s used short, sharp cuts to public expenditure and saw growth return relatively quickly. They then found themselves in virtuous circles, and were able to cut taxes substantially. Instead, we hiked VAT, national insurance, and capital gains tax, putting a further squeeze on the private sector at a time when we are looking for it to deliver growth.
     
    The Government also seemed to underestimate how easy it would be for the private sector to grow. Though 800,000 new private sector jobs have been created since 2010, this would have been far higher had the Government not front-loaded tax hikes and imposed new regulations on business. As Tim Morgan’s analysis has shown, industries with high government spending and those dependent on credit accounted for around 58.4% of GVA in 2009 (real estate, construction, finance, construction, and public administration and defence) and with real incomes falling over the last few years, retail has also been squeezed (1.2% of 2009 GVA). With credit now constrained and the need for public spending restraint, is it therefore any wonder that the economy has struggled to grow? .
     
    The most effective way to hasten these structural readjustments is to speed up the deleveraging process and allow the rebalancing of the economy, which will most likely occur if more resources are put back into the hands of private sector agents and the supply-side of the economy is liberalised. The decentralised decision making associated with the market will lead to the quickest and most efficient reallocation of resources. 
     
    Despite the doom and gloom surrounding our current economic plight, there are reasons to be positive. Where rebalancing is occurring, it is bringing results. Exports to the fast growing developing countries are growing rapidly, and the age of globalisation and innovation provides untold opportunities. Our relatively free labour markets have meant employment has proved much more robust than previous recessions. The mainstream media are now beginning to follow us in advocating pro-growth supply-side measures which are absolutely necessary to raise long-term productivity and competitiveness. A new generation of politicians on the backbenches of the Commons are determined not to let stagnation become the new normal.
     
    The successes suggest we need more capitalism, not less. And this should be advocated positively. As Allister Heath has cited from the great Ronald Reagan - there are no limits to growth because there are no limits to human intelligence, imagination and wonder.
     
    The Government should now learn from the difficulties it has experienced in the implementation of its fiscal strategy and the structural problems of the UK economy:

    • Recognise that the state is still too big, and it does too much: the Comprehensive spending review salami sliced various budgets. But it should be fundamentally re-opened, with everything on the table. The Government should scale back on the functions of the state, and merge some current government departments to encourage more joined up thinking (e.g. DFID and the Foreign Office, Energy and Business). The Government should not be ashamed of these cuts, but should offer a positive vision for why they are both absolutely necessary AND desirable. There is lots of evidence that smaller government countries grow more quickly, without fundamentally worse public service provision.
    • Bring forward current spending cuts, and delay key capital spending projects whilst reversing damaging tax hikes: Current spending cuts should be brought forward and accelerated. These should be used to fund targeted tax cuts and maintain infrastructure spending on projects essential to long-term productive potential (e.g. aviation capacity). The Capital Gains Tax hike should be reversed, and the Government should aim to also reduce income, corporation taxes and employers’ National Insurance Contributions. These should be advocated not as ‘stimulus’ measures, but as fundamental to improving incentives, competitiveness and medium-term productivity.
    • Deregulate the small business sector and planning now: Whilst our labour markets are fairly liberal, the regulations and employment legislation we do have disproportionately affect small businesses, which have been the key drivers of new employment growth over the past ten years. A fundamental liberalisation of small and micro businesses along the lines of Dominic Raab’s suggestions would be a huge boost to job creation. It’s time to put the rights of the unemployed above the employed. In addition, it’s time to start focusing on development – housebuilding is desperately needed, and yet the planning laws exclude vast amounts of green belt land and put existing homeowners (who have vested interests at that stage to restrict new supply) in a strong position to block new development. This is not just bad for growth prospects, but artificially inflates house prices. From a social justice perspective, it’s vital to democratise home ownership to the next generation.
    • Implement a pro-growth energy policy: As noted in the previous edition of this bulletin, our current energy policy is incoherent and inconsistent. The Government wants more gas, but next year is set to make gas more expensive by introducing a carbon price floor. This must be abandoned – it will make us uncompetitive, and merely export carbon emissions elsewhere. A cheaper energy policy is essential to a rebalancing away from credit-based industries, and in many industries the UK is well placed to expand advanced, high-tech manufacturing if these conditions are realised.
    • Give up on hobby horses: George Osborne said the focus is now 110% on the economy, but yet the Government has invested huge effort in other pieces of legislation which do no nothing to aid our economic situation. These should be postponed for now. What’s more, MPs should avoid advocating new policies which entail subsidies and fixing prices to appease special interest groups.

    A bold, positive vision for a more prosperous Britain is required, based primarily on competitiveness, productivity and economic freedom. Tinkering with a bit more spending here, or a few credit guarantees there will not provide the lasting prosperity we need to avoid stagnation. With the 100th anniversary of Milton Friedman's birth early next week, Government ministers would do well to re-read his works over the summer for inspiration.

     

    Ryan Bourne and Tim Knox

    This article is an extract from our fortnightly growth bulletin, published today. To read it in full, click here

    Tim Knox was Director of the CPS from 2011-2017. Before he was Director, Tim was the Editor at the CPS - a position in which he was responsible for publishing papers by every Conservative leader since Mrs Thatcher as well as by hundreds of leading academics and opinion formers.

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