The UK needs a coherent economic strategy
The writer is a former chief economist at Goldman Sachs and served as UK Treasury Secretary
It has now been more than 12 years since the Conservative Party regained power. As the members ponder their fourth leader during this time, the country urgently needs their choice – and our next Prime Minister – to have a credible vision of how to meet considerable challenges.
Liz Truss and Rishi Sunak, the remaining candidates, must consider how they would put the UK on a more constructive path than that taken after the economic devastation of the 2008 financial crisis – the backdrop to the initial election victory of the left two years later.
Since then, UK gross domestic product figures have been disappointing, but not dramatically. Job growth has been surprisingly positive, although much of it is low paid. But it’s also highly unproductive – the annual productivity growth rate has been about a third of what it was for the previous 15 years. Unless we repeat the expansion of our workforce or increase productivity significantly, the UK’s own growth will slow rapidly.
One of the problems is that when the country voted for Brexit, “taking back control” of Brussels meant losing control of the workforce. The end of free movement, exacerbated by Covid-19, has led to an increase in job vacancies. And without a surge in productivity, the levers of monetary and fiscal policy to help improve our economic performance are extremely limited.
For now, the only constructive role that monetary policy can play is to target inflation, which could mean a deliberate weakening of demand and hence of short-term cyclical economic growth. Without it, the challenge of longer-term growth will be even more difficult.
Fiscal policy can play a broader role, but the new prime minister needs to think carefully about what that should be. Tax cuts, the dominant topic of the leadership campaign, must be judged on whether they will stimulate cyclical demand in the economy or on the supply side. Under current circumstances, the cyclical consequences would almost certainly translate into the need for even more monetary tightening by the Bank of England.
So what good are the immediate tax cuts advocated by most leadership candidates? They would only be justifiable if they were found to stimulate supply or productivity. And even then, one wonders if they are currently affordable, given the broader social challenges.
The evidence that corporate tax cuts will stimulate investment is unclear. Yes, they will increase business revenues, as they have done for the past 15 years, but that has not translated into increased capital spending. Indeed, one of my broader concerns post-crisis is that many of the rules of a traditional economic formation no longer apply. Strong corporate earnings, along with low interest rates, are a classic recipe for a solid investment, but in recent times they have found their way into shareholder and executive returns. Arguably, this conundrum is at the heart of the dilemma of productivity and low real wages that has plagued the UK economy.
What fiscal policy should do is stimulate productivity, rather than fuel demand. This can be done by providing incentives for truly risky business investments, such as venture capital, and for much-needed infrastructure. It also requires a more imaginative approach to public spending.
Sunak, the former chancellor and future leader, had a pre-pandemic policy of borrowing only for investment spending, but the country is now demanding bolder action from the government. To address infectious disease risks, education challenges, regional imbalances, leveling, and massive infrastructure needs, an ambitious government would increase its planned investment in a very transparent manner – to allow financial markets to judge the potential impetus for future growth.
Away from monetary and fiscal policy, the new Prime Minister needs to be more sincere in turning the twin aims of global Britain and leveling into reality. On the first, we desperately need a credible, independent British role in the world – or we risk becoming increasingly dependent on the United States.
On the second, unless the government focuses seriously on the huge regional imbalances in England, it will receive little respect from disgruntled regions. Internal battles must not interfere with the name, branding, promotion and, most importantly, the execution of this program. Accelerating decentralization is a good starting point.
The next Prime Minister will be chosen by a very small segment of the population. If it doesn’t focus on the long-term interests of the nation, it won’t last much longer than the previous one.