Ahead of every recent budget and autumn statement, the right-of-centre think tanks have come out with a set of recommendations that support the broad thrust of government policy and argue for more of the same. True to form, earlier this week Reform made the case for sticking to Plan A on deficit reduction, abolishing the 50p tax rate and cutting workers’ employment rights.
But, with the economy having grown by just 0.5 per cent over the last year, and the Prime Minister hinting in a recent speech to the CBI that the government’s deficit reduction plan is being blown off course, more of the same is the last thing the economy needs.
In an attempt to show there is a real alternative to the government’s approach, IPPR has published its ‘10 Ways to Promote Growth’. These range from short-term measures that address the lack of demand in the economy right now to longer-term measures designed to address structural weaknesses that threaten to hold back the economy in the medium-term.
These measures include an overhaul of the deficit-reduction plan, first to spread it out over a longer period (something that may well be forced on the government in any case) and second to make it responsive to growth in the economy. Quite simply, there would be a set of rules that meant deficit reduction would be speeded up when growth was strong and slowed down when, as now, growth is weak.
This would create some flexibility for the Chancellor to guarantee the long-term young unemployed a job (matched by an obligation to take up the offer); to follow the CBI’s advice on introducing capital allowances; and to announce an immediate increase in public infrastructure spending, amounting to £10 billion by 2012/13. It would also allow the government to extend free childcare to make it easier for parents to return to work, as a first step towards a system of universal childcare.
Eventually, this will require offsetting action to make the deficit reduction arithmetic add up. Spending cuts and tax increases are not appropriate now, while the economy is so weak. But, when it is stronger, options for additional revenues include abolition of the winter fuel allowance, introducing a capital receipts tax to replace inheritance tax and restricting tax relief on pensions to the basic rate of income tax.
The Chancellor is expected to announce a policy of ‘credit easing’ in his Autumn Statement. This should focus on ensuring small companies are getting the funding they need to survive and expand in the current tough climate. Large companies already have large cash surpluses, and so are in less need to help in this regard. There has also been talk of seeking investments from pension and insurance funds to finance infrastructure projects. Past experience suggests this is a lost cause. Instead, the Green Investment Bank should be developed into a fully-fledged National Investment Bank, designed to raise capital to finance infrastructure spending.
The government also needs to offer firms more support for innovation – through the creation of ‘innovation zones’ – and for exporters – through an expansion of the Export Credit Guarantee Scheme. It also needs to encourage employers to lift productivity levels by making greater use of the existing skills in the workforce and to place skills centre-stage in its growth strategy.
Finally, the government should reverse its clampdown on students, who bring revenues to the higher education sector, and on skilled migrants from outside the EU, who businesses say are needed if they are to maximise their potential. The economy cannot be ‘open for business’ while also being closed to those who want to study and work here.
The government’s plan for growth is based on a set of miscellaneous policies agreed in coalition negotiations. This is the wrong approach. Instead, it needs to identify what is needed for the economy to grow: more demand in the short-term and increasing supplies of capital, labour, skills and land, together with better ways of utilising them, in the medium-term. Then it can work out how best it can help to deliver them.
* Tony Dolphin is Chief Economist at IPPR
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5 Comments
To me this all seems very sensible, so the question I have to the author is whether you think growth is possible given the horrendous problems in the EU at the moment?
A good article. I have one main point of difference – you write that for the economy to grow you want more demand in the short term. Do you argue that maintaining the massive structural deficit for longer is your solution?
Broadly headed in the right direction but a couple of points.
1) A big reason the economy is so weak is the debt overhang – not just the public debt but especially the much larger private sector debt. While this was being built up it added to earned income so creating a Keynsian-style artificial boost to the economy but successsive govts didn’t see it as such because their neoclassical economics straightjacket told them that private sector activity must be beneficial and right. The excessive accumulation of debt has been going on since the time of the Major Govt – since North Sea oil revenues started to wane in fact – suggesting that we have been living way above our sustainable level for a long time; we have a “Wil E Coyote” (of Roadrunner cartoons) situation and face a big drop unless we get it right for a change.
Now the debt overhang, generally put at around 500% of GDP in total, is working like a sea anchor holding us back by reducing demand. Medium to longer term we will discover that the real economy is too weak to support the load of debt. What can’t be repaid won’t be so the only solution is a debt jubilee.
2) We have an enduring problem with skills training at all levels; every time there is an upturn the pool of talent sucks dry almost immediately. Right now engineering firms in depresssed areas like Tyneside complain that they cannot expand because they cannot find good engineers. So people are unemployed in the midst of plenty.
It’s not that successive govts haven’t tried – they have poured resources into skills but with remarkably little result. The underlying reason I suggest is that Govt and the “skills industry” adopt a push approach. They are trying very hard to turn out good little sausages and only getting messed up mince. “Push” approaches always fail.
What they need to do is devise a “pull” approach where demand from firms drives the system and directs the spending (and, in effect, determines the budget). Also one not driven by numbers (which will inevitably deliver only numbers but not quality) but by quality (which will deliver the quality of engineers etc needed to compete in global markets). This will mean that qualifications are easy to fail but that is as it should be.
Liberal Eye, I agree when you write, “What can’t be repaid won’t be, so the only solution is a debt jubilee.”
The sovereign debt crisis will lead to some defaulting. These defaults or the fear of these defaults will then further expose the private sector debt level you identify with even greater paralysis of the banking system and the destruction of money.
One weekend the G80 will meet and agree to press the Reset Button and on Monday morning it will all begin again. History will see it as The Great Moderation, The Great Ponzi, The Great Recession, The Great Reset or The Great Haircut. And we must hope the lesson remains learnt for generations.
The big question is will it take 2 years or 20 before that G80 meeting? Each year that passes will see tensions on nationalistic lines intensify with its potential for fear over investment, barriers to international trade and the scape-goating of minorities.
Only a strange Puritanism that blames the borrower exclusively and holds that ‘he must pay’, prolongs this process. Yet in every case the lender was culpable and has derived benefit from the bargain and if he does not want to destroy the market he must see that sometimes its essential to write drown, to move on.
Thanks for the comments. There are two main alternatives on offer:
1. Stick with the current Plan A for deficit reduction and hope that the private sector quickly increases its demand (note that the EU is not the main problem – in the OECD’s forecasts published yesterday GDP increases by 0.5% and this is wholly accounted by net trade; domestic spending is unchanged from 2011)
2. Cut the deficit less quickly now and accelerate the pace of deficit reduction when the economy is growing more strongly
The problem with the first – as we are seeing – is that while the public sector is cutting back so aggressively, there is little incentive for the private sector to invest and recruit more workers. The potential problem with the second is that it may be some time before growth is strong and you could have taken on a lot more debt in the short-term – and eventually (not I think immediately) bond investors will react negatively.
Perhaps the truth is that we are in for a decade of poor economic growth (like Japan in the 1990s) because households and the financial sector have to deleverage and all the government can do is to try and not matters worse by cutting its borrowing aggressively at the same time as the private sector. Hence my proposal that the deficit shoudl be eliminated over six years, but that the pace of reduction should vary dependent on growth (i.e. indirectly on the pace of private sector deleveraging).