Jamie Parker explains why Keynesianism has lost in the UK, and where macroeconomic policy may go from now.
Little over a year ago now, and after yet another quarter of GDP flat-lining, the Coalition’s mandate for fiscal austerity looked increasingly fraught. As George Osborne sat in Whitehall reflecting on 2012, there was little to console him from the gloom and despair. In April, his ‘Pasty Tax’ Budget had been awash with disastrous U-turns and was overshadowed by a downgrading of Britain’s AAA rating. Not even the country’s gold medal haul in the Olympic Games could create the ‘feel good’ needed to dispel the dark clouds hanging over Britain.
When the Chancellor actually went on to blame the poor weather for dismal growth figures, one could not help but feel the argument for spending cuts was becoming a rather desperate one. For the duration of this period, at least, it seemed that the combined forces of economic stagnation and a public wary of further cuts had handed the initiative to Keynesian expansionists on the Labour front benches. Indeed, Ed Balls’ warnings against cutting “too fast and too far” and kicking the economy while it was flat on its back seemed to be gaining currency.
The picture we are presented with today is, for ministers in the Treasury anyway, undoubtedly a rosier one. And it is amazing just how quickly the initiative can change hands. For now it would appear, it is for those on the political left, the advocates of ‘Plan B’, to explain why, in spite of their predictions, the government is running down the deficit and at the same time the economy is achieving growth figures of 2.7%. Of course this is made little easier given how the alternative is playing out across the Channel. Hollande’s crippling ‘Robin Hood’ tax policy and fiscal expansionism, far from promoting growth and prosperity, has sent unemployment soaring and the country’s finest talent packing for London. The mantra of ‘tax and spend’ appears as unattractive an alternative as ever. Indeed, everywhere it is the advocates of fiscal expansion who are in retreat and ministers in the Treasury muttering ‘I told you so’.
For them, the events of the past 12 months have played out as well as they could have hoped. Recent data suggests that all sectors of the economy have been expanding rapidly and the Confederation of Business and Industry argue that growth has become “entrenched” here in Britain. This is supported by news that record numbers of people are in work, of which full time work is showing the greatest increases. Such overwhelmingly positive data, quick in succession, gives reason for optimism and is likely to put a smile back onto the Chancellor’s face. I suppose then the question going forward now is whether austerity has won out, is this recovery balanced and sustainable as the treasury would claim? And, what’s more, can we believe Ed Balls when he argues that the “three wasted years” of ‘damaging flat-lining’ were, as he would claim, suffered needlessly?
I think the first thing to concede, before supporters of the government get too excited, is that the economy is far from fixed. Of course, there are now clearly ‘green shoots’. The labour market, which has remained fairly robust throughout, seems to be showing signs of further strength – any week now the unemployment rate is likely to fall below that elusive 7% target the Bank of England is so interested in. This is supported by strong, slightly above trend growth figures, stable inflation and increased consumer confidence. However, it is also worth pausing and considering the risks that still threaten a sustainable recovery – I share Vince Cable’s “cautious optimism” about what we are seeing happening in the economy at the moment. There are the devil’s advocates who, rightly or wrongly, remain unsettled by the kind of recovery the country is experiencing.
The first concern relates to the notion of a ‘balanced’ recovery, something which arouses particular attention from economists. A return to growth in the long-neglected manufacturing sector is of course a welcome diversification away from the country’s decades-long reliance on financial services. However, the strong performance we are seeing in these industries is coming from a very low base and exports are still far from sufficient to eradicate, lesser still exceed, the nation’s hunger for imported goods. What this seems to suggest then, is that Britain’s economic success continues to rest precariously on an uneasy compromise between consumer spending, cheap credit and the City of London. These are, of course, vital elements of the economy. It is important that they continue to flourish. However, it is important mistakes of the past are not repeated. It would be wrong and foolish to lay all eggs in one basket only to see them all then break if something goes horribly wrong again, as it did in 2008. The easy solution now would be to let financial services and credit cards do all the hard work, and not accept that sustainable, long-term growth lies in business investment, productivity gains and competitiveness in our exporting industries.
Now that the demand-side of the economy is recovering, it is important to remain focused on the more intractable weaknesses in Britain’s ‘supply-side’. Successive governments have cowered from making firm commitments to invest in long-term capital spending projects. These are needed if the UK is serious about modernising and revitalising its infrastructure. If London is to remain a destination for business and investment, aviation capacity must be able to meet demand from China and the Middle East. If the North East and the Midlands are to share in the country’s wider prosperity, then they must be well-connected and receive investment to grow. Furthermore, schools and colleges must provide young people adequately with the skills and competencies they require to succeed in competitive, globalised labour markets. This may require a more rigorous reassessment of the subjects students take – orientating back towards more traditional disciplines, such as maths and science. With a competitive tax regime, a pool of skilled labour and modern infrastructure, Britain will be far better placed to address the gap in productivity which has emerged with her European competitors.
What’s more, these issues have become compounded within a wider criticism of the government over the ‘cost of living’, which is Labour’s new strapline now that the economy has returned to growth. Putting aside political point-scoring, hard-working people have been squeezed by rising utility bills, rail fares and commodity price fluctuations. All this in the context of stagnant, or even declining, real wages. The 2008 recession did enormous damage to the country. It would of course be wrong not to expect a pinch in the pocket as a result. However, what people seem to be asking, six years on, and at a time of public pay freezes and stagnating living standards, is why is it that bankers in Canary Wharf continue to enjoy such generous bonus packages while we, the innocent victims, pay the price? Prolific amongst alienated, working people is a sense that the taxpayer is carrying the burden of risk and private enterprises are enjoying the profit. The government may well stress the need for London to remain ‘competitive’ and ‘open to business.’ However, defending the questionable practices of the City is becoming more and more difficult. To many, we should be concerned more with issues of fairness and morality than merely with profit and greed.
This is not helped of course by alarmist fears that there is an asset bubble being reflated in the housing market. According to some commentators, the market is being fuelled artificially by the government’s ‘Help to buy’ scheme, accelerating foreign demand and severe supply constraints. While I think there is reason to be wary of the fragile nature of this recovery as it takes hold, media headlines warning of “double digit” rises in house prices do not tell the whole story. House prices have started to rise again, as we would expect. Indeed, in some places they have done so quite spectacularly. However, giving the impression of an ‘asset bubble’ or a ‘crisis of liquidity’ is unhelpful when we are talking about a phenomenon almost entirely exclusive to London. Furthermore, the construction sector has remained in the doll-drums for six years now. As private building firms return to more normal, pre-recession levels of investment, the supply of new housing will restore equilibrium in the market. It is comforting as well to see is that it is the Bank of England that is overseeing the ‘Help to buy’ scheme and not a defunct regulatory authority like the FSA. Perhaps, then, we are starting to learn some lessons from the past.
So how would the alternative to fiscal tightening have fared?
Counterfactuals are always dangerous because circumstances change and of course that impacts the decisions that would have been made anyway. That said, Ed Balls has admitted that a Labour government would have had to have made cuts. I suspect as well we would have seen more interventionist initiatives, such as jobs programmes, aimed particularly at young people. Taxation would likely have been more progressive – both on income and also possibly in the form of an inheritance or a banker’s tax. What’s more, the public applause for Ed Miliband’s Conference pledge to freeze energy prices tells a story. Laissez faire policies, which allow unregulated markets to do as they please, generate a climate of discontent. Energy prices have been steadily increasing for years now. In the meantime the ‘Big Four’, mostly foreign owned, energy companies have been making record year-on-year profits. The public want a fair solution and the Labour Party have offered one.
This is not necessarily to say that what they have suggesting is right, or indeed, feasible. From the opposition benches it is easy to criticise and offer hypotheticals. In reality, breaking up the energy market would be hard. The high fixed and sunk costs of production and distribution necessitate large scale operations. Moreover, freezing prices for a year may provide respite for squeezed households in the short term. However, if investment seizes up, what are the medium and long-term prospects for our, and future generations?
The core issue here is that the energy industry has become cartelised, with a few large firms able to maintain profit margins by exploiting their share of the market. The solution must address the cause, that there is a private monopoly in operation, and not the symptom, which is that prices are rising. Opening up the energy market to greater accountability and transparency would help to ensure that prices fairly reflect wholesale costs. It would also offer a more sustainable solution than a price freeze. As too would exploring and investing in alternative sources of energy. It is important that the government follow up on the findings recently published in the Wood Report, which lay out the prospects for North Sea Oil. They must also remain negotiable to the potential nuclear power and renewables offer. The energy problem faced by the UK is intractable, and ultimately requires a more considered, long-term solution than that which regulation can provide. This is not merely a case of fat cat directors at EDF and British Gas exploiting helpless consumers.
In reality, these concerns run deep into the ideological differences which separate the two major political parties. The Labour Party argues the need for greater government intervention to address structural weaknesses in the economy, such as youth unemployment. Of course, no-body wants to see large numbers of young people without the fulfilment and prospects work can provide them with. However, subsidising labour markets, when the national debt stands at 86% of GDP and is set to grow further still, is difficult to reconcile. Last month, a Shadow Treasury Minister conceded that Labour’s Job scheme could only be supported for one year after a student leaves school or college. In reality then, the only way to sustainably improve work prospects for young people is to channel resources into education and training. Forcing firms to take on school-leavers, who lack sometimes even the most basic skills and competencies, passes the buck unfairly from government to business. This will have either the effect of eroding competitiveness in the UK or will simply drive employers away to Europe and America.
Again, the causes and not the symptoms must be addressed.
The causes of youth unemployment lie in the inadequacy of the education system to provide young people with relevant and useful skills. This is what creates occupational immobility and bottlenecks in the labour market. Given that the government spends roughly £4000 per year per pupil in England, there is something inherently concerning in the fact that some young people are leaving secondary school still unable to read and write. That is a damning indictment, not of businesses and labour markets, but of schooling here in the UK.
The public’s enthusiasm for government intervention is quite often matched by an enthusiasm for redistributive taxes, particularly targeted at wealthy bankers and property-owners. Nick Clegg’s proposed Mansion Tax on millionaires carries a strong political message. Indeed, it ties in well with the party’s more organic vision – for a society built on the foundations of equality and fairness. However, taxes such as these must be considered within a wider perspective. As I said before, one need only look at what is happening in France to realise the impact ‘Robin Hood’ scare taxes are likely to have on national wealth. What, on the surface appears to be a well-intentioned levy on the assets of the very rich may, by the law of unintended consequences, adversely affect the interests of the nation as a whole. Driving away wealth and talent to safe havens overseas is no way to encourage investment, employment and opportunities at home. Last year, Senior Liberal Democrat officials conceded that the party’s tax proposal would derive ‘in the grand scheme of things…relatively little revenue.’ Creating a political culture which is opposed to wealth creation and ambition is damaging for all. The key is to strike the balance between doing what is right, out of principle, and doing what is needed in practice, to make British people better off and more prosperous.
In many ways, presenting a false dichotomy between fiscal expansion and ‘austerity’ is unhelpful. An eclectic approach is needed here. On the one hand, this means rolling back the frontiers of the state where it has become bloated and bureaucratic. On the other, it means recognising that government has an immense capacity to restore the economy to more normal levels of output and demand.