Friday, 6 July 2012

The Coalition must do Something Radical for the Economy. Anything.

The UK has officially re-entered recession for the first time since Autumn 2009. This has coincided with a collapse in the popularity of the Coalition government. Unsurprisingly. The 'double dip' of 2012 is far more important than merely being a problem for the government, or even temporary unwelcome news for the country though. It shows that the British economy is in far deeper long-term trouble than anyone could have thought even in the bad days of 2009. Hopes that the economy would just spring back from recession, the way it did in the 1930's, the 1980's and early 90's have vanished. Inflation has been higher, borrowing has been higher and growth lower than anyone predicted from 2008 to early 2011.

The Government's economic plan, known as Plan A, has failed. As far as most people are aware Plan A just means large spending cuts. But Plan A was never just cuts. Cuts would secure confidence in the government's control of the deficit and lower inflation, thus securing low interest rates and allow monetary stimulus to work, bringing money into the economy, allowing banks to rebuild their balance sheets and increase lending. Sharp devaluation in the currency and corporate tax cuts would tilt the economy in favour of exports and business investment, helping to drag the economy back to health. And increases in VAT and bank taxes would further encourage re-balancing away from financial services and consumption while also providing tax revenue to cut the deficit.

This plan has not worked though. Whether due to fear of cuts or the reality of higher inflation or fear of the eurozone crisis, business confidence collapsed. The eurozone crisis has made export led growth an impossibility. Rock bottom interest rates and massive quantitative easing have been tried for years but have not made enough difference. Increased capital requirements designed to make banking safer have led to lending contracting even in the face of QE and considerably high inflation has cut consumer spending much deeper than anyone expected. But that means things are even worse than we feared. We've tried running a massive deficit, and it hasn't been enough. We've tried printing hundreds of billions of pounds and it hasn't been enough. We've tried a huge devaluation of the currency and we've tried bailouts and we've tried subsidising lending, and we've tried raising taxes and we've tried cutting interest rates and none of it has worked. We've run out of buttons to press and levers to pull in an attempt to push the economy back to health and none of it has worked. The only possible conclusion is that the economy is in much worse fundamental health than after any previous recession.

Nor is there any simple Plan B alternative to austerity. The deficit is already sky-high leaving little room for further stimulus, and the deepening euro-crisis both sign-posts and increases the dangers of the markets losing confidence in the state's ability to pay its debts. The UK is a small, open economy with a floating exchange rate meaning any stimulus would just leak abroad, even before the danger of increasing interest rates. The facts don't support blaming austerity for poor economic performance anyway. The reality is that state spending has increased in both real and cash terms while the Coalition has been in power, adding to GDP in almost every quarter. The problem isn't the lack of growth in state spending, it is the fact that the wider economy has become unproductive. From 1999-2010 state spending grew 6% a year in real terms, and still overall growth fell from 3% to 2%, even ignoring the period actually in recession. A short-term fiscal stimulus can't solve these long-term problems even if we could afford it.

What that means is that the situation is not just going to get better on its own. With the failure of Plan A the government seems to have been reduced to just sitting there and hoping things turn out alright.  But this cannot work.  It was hoping that just managing the recovery would be enough to win the Coalition the next election.  But the recovery has failed, and this means that just managing the decline will lose the next election.  This cannot be stressed enough.  Unless the government does something dramatic, anything, then it is a dead certainty that Labour will win the next election with a decent majority and both the Lib Dems and the Conservatives will be devastated. However scary radical action may appear at this point, and however many people it annoys in the short term, is irrelevant for both Lib Dems and Conservatives because without it they are going to lose anyway.

They have to do something.  But fiscal stimulus and monetary stimulus have both been maxed out. There is no extra money to spend. The only thing the government can do is undertake radical reform to make the UK economy more efficient. To attempt to squeeze more bang out of each buck we do have. There are clear ways of doing this. Clear ways that the government can boost and liberalise the economy, show that it has not run out of ideas, and thus also support wider confidence. Each possible measure will annoy certain groups of people very vocally. But neither the Lib Dems or Conservatives have a choice, because without such radical reform they are definitely going to lose. With radical reform there is hope.  Even if these measures do not save the economy, they may save the government. The public are not unreasonable. A government can get re-elected with a weak economy, but only if the public can visibly see that the government has done everything to help that it could do. Governments lose when either they are blamed for causing it or they visibly have no ideas how to fight it.

If we wish to support a large welfare state with high taxes it becomes even more important, not less, to make sure the entire economy is functioning at peak, responsive efficiency. This is the major lesson to be learned from the Scandinavian countries, which are often held up as paragons of successful Socialism. These countries are not socialist countries in the way Britain was in the 1970's: ridden by restrictive practices, inefficient nationalised industries, powerful vested union interests etc. They are highly liberalised, solidly free-market economies just with high levels of taxation and public spending. On every measure of economic freedom they regularly score as well or better than the UK or the USA, apart from on measures of taxation and spending alone. Of course these measures are a drain on the economy, and that means that they can only be sustained, as they have been in Scandinavia, if the rest of the economy is operating at pitch efficiency.

Too often the argument about a growth plan oscillates between crude left wing demands for high public spending, without any regard for how efficiently that money is spent or raised, and crude right-wing demands for deregulation, without ever specifying what deregulation or how particularly this will benefit the economy.  In reality there are a wide range of possible radical measures that could help make the UK more responsive and more productive that come neither under the heading of slashing worker protection or just opening state money taps.The government has already previewed some of these ideas, but they have then gone quiet.  They seem have rejected them as too difficult to bother with.  But in our current situation nothing can be rejected out of hand without good reason. And now is the time to bring in reform, if there is any hope either that the country will see the benefit in the next 5 years or for the government to get re-elected. There are many such possible measures.  But they all involve various common themes, which I went into on my previous posts about pro-growth measures. Increasing investment, making government policy more responsive, reducing the distortions on incentives created by government action, ensuring stability etc.

On investment the government could engage in a below the surface stimulus. That would mean spending the same amount of money over-all, but shifting significant money from current to investment spending.  Basically that would mean cutting spending on government departments, programs and welfare and spending the money on infrastructure investment. Government estimates suggest that investment spending has 3x the benefit to growth of current spending. Britain's economy has suffered from chronic under-investment throughout the post-war era. Shifting £10 billion a year from current to investment spending could have a significant economic stimulus. Of course the downside is this requires deeper cuts in current spending.

The government could introduce immediate local differences in rates of public sector wages, the minimum wage and benefits, within some maximum variation of, say, 10%.  All these measures would face fierce opposition from those who lost out, but they would all make the UK Labour market more responsive and flexible to local conditions, which should produce a significant over-all gain. And much of the criticism could be muted by guaranteeing that no region will lose out monetarily over-all, either by ensuring money saved on wages or benefits remains within the region to be spent in other areas, or by deliberately increasing investment spending in those areas hit by a fall in wages.

Reform in the private sector could concentrate on boosting competition and ensuring markets function correctly. Those large banks under government ownership should be split up with the deliberate attempt to create more viable competitive retail banks.  It should be made an immediate legal requirement for current accounts to be fully transferable the way phone numbers currently are, to encourage consumers to switch bank. Legal measures should be introduced to remove all future possibility of bank bailouts, to allow failed banks to go broke like all other businesses. A FAT (financial activities tax) should be introduced for financial services, removing their VAT exemption and bringing their tax treatment into line with other businesses, and cutting the cost of financial services for businesses. Capital requirements should be temporarily reduced to encourage lending.

The manner in which we structure utilities should be broadly reviewed for value for money with the aim of boosting productivity.  This should cover both transport utilities, such as road and rail, and utilities such as gas, electric, water etc, as well as power generation.  All these utilities function as markets to the extent whereby competition is possible.  In gas and electricity competition is real, if limited, and legal efforts can be made to force greater transparency of tariffs and to make it easier for people to switch supplier. For rail there is competition from other transport options, but rail providers have local monopolies and the system of franchises has been claimed to cost the taxpayer and commuter vastly more than public ownership ever did. Options could include merging track and train ownership, mutualising network rail, cutting subsidies, increasing investment, fines for service disruption, or even wholesale re-nationalisation.  Road is the only one that is currently entirely publicly owned.  There should be consideration given to boosting investment through either privatisation or long-term leasing, or other options, and the introduction of road pricing on all motorways and major cities, with a corresponding cut in petrol duty, to take account of the cost of congestion. Speed limits on motorways could be raised to 80mph with a corresponding increase in the limit for HGV's. Water operates under a system of local monopoly with fixed prices.  There is claim and counter-claim as to whether this means improved, stable investment or just increased profits for monopoly providers. This should be reviewed with the aim of speeding up investment, renationalising bodies, or conversely, if possible, increasing the possibilities for competition along the lines of gas and electricity. Compulsory metering should be introduced. Etc.

Another area that could see wholesale reform is the structure of UK taxation.  Income tax and Employee NI should be merged immediately producing one single progressive tax on all income. CGT should also be merged with income tax in terms of rates and thresholds, with the exception of an annual rate of return allowance to avoid taxing purely nominal gains. This should also be applied to personal savings. This would massively simplify personal taxation, reduce distortions, cut admin costs and increase the transparency of how much tax everyone is paying. Housing and Land taxation could be massively overhauled removing stamp duty and establishing flat housing and land taxes for domestic and business property respectively, instead of the mess of regressive, our of date taxes and transaction taxes we have at the moment. VAT should be broadened to reduce distortions and reduce the economic impact of the tax system, as shown by OECD research. Corporation tax should be reformed to remove the tax incentive towards debt financing and incentivise investment in a clear manner.

If all these measures were introduced before the next election it would constitute a big bang in favour of growth and efficiency in our economy.  These measures may not begin to bear visible fruit by 2015 but it would certainly demonstrate that the government was doing everything in its power to reform Britain and improve our economy, while tackling fundamental inefficiencies and unfair distortions. And if not these measures, then others. The point is that there are options for radical action.  The only thing there isn't is politically cost-free options. But business as usual has fundamentally failed economically, and will therefore fail politically.  The government has the choice between doing nothing, and going down to defeat, or trying something, and possibly succeeding. This choice is the most important facing our government, dwarfing all others. The Coalition surprised observers by starting in 2010 with a burst of radicalism. Now in 2012 that radicalism has been worn down. The Coalition needs to find new radicalism, it needs a new landmark agreement to get it through the 2nd half of this parliament, for the good of the political parties and the whole nation. And given the failure of the economy then a radical growth package must be the heart of this new agreement.  If either party will not accept this then the government has no purpose anymore and a general election should occur. If it cannot agree on the radical action that we need, any radical action, then it has no point, and better to lose an election now and have it replaced by a government that may be willing to do something, than a zombie government that will coast through to 2015 before going down in defeat while Britain goes down the drain with it.


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