The author is a former Chief Economist at Goldman Sachs and was UK Treasury Secretary
It is now over 12 years since the Conservative Party regained power. As members ponder their fourth leader at this time, the country desperately needs their election – and our next prime minister – to have a credible vision of how to tackle significant challenges.
Liz Truss and Rishi Sunak, the remaining candidates, will have to consider how they would put Britain on a more constructive path than it did after the economic devastation of the 2008 financial crisis – given the party’s first election victory two years later.
Since then, UK gross domestic product figures have been disappointing, if not spectacular. Job growth has been surprisingly positive, even if much of it is poorly paid. But it’s also highly unproductive — the annual productivity growth rate is about a third of the last 15 years. Unless we repeat the expansion of our workforce, or productivity increases significantly, Britain’s 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 a surge in job vacancies. And without a boost in productivity, the monetary and fiscal levers to boost our economic output are extremely limited.
For now, the only constructive role monetary policy can play is to target inflation, which could mean deliberately weakening demand and hence cyclical economic growth in the short term. Without this, the longer-term growth challenge becomes even more difficult.
Fiscal policy can play a broader role, but the incoming prime minister needs to think carefully about what that should be. Tax cuts, the dominant theme of the leadership campaign, must be judged on whether they boost cyclical demand in the economy or on the supply side. In the current circumstances, the cyclical fallout would almost certainly mean that even more tightening by the Bank of England would be required.
So what’s the point of the immediate tax cuts advocated by most leadership candidates? They would only be justifiable if they demonstrably increase either supply or productivity. And even then, the question is whether they are currently affordable given the broader societal challenges.
The evidence that corporate tax cuts will boost investment is inconclusive. Yes, they will increase corporate income as they have for the past 15 years, but this has not translated into higher capital spending. In fact, one of my major concerns after the crisis is that many of the rules of traditional economics education no longer apply. Strong corporate earnings and low interest rates are a textbook recipe for strong investing, but lately they’ve found their way into shareholder and executive returns. This conundrum arguably lies at the heart of the productivity and low real wage dilemma haunting the UK economy.
What fiscal policy should do is increase productivity rather than fuel demand. This can be achieved by providing incentives for truly risk-taking business investments such as venture capital and much-needed infrastructure. It also requires a more imaginative approach to government spending.
Sunak, the former chancellor and potential leader, had a policy of borrowing only for capital spending before the pandemic, but the country now requires bolder action from the government. To deal with our infectious disease risks, educational challenges, regional imbalances, expansion and massive infrastructure needs, an ambitious government would increase its planned investments in a very transparent way – so that the financial markets can assess the potential boost for future growth.
Monetary and fiscal policy aside, the new prime minister needs to be more forthright about turning the twin goals of a global Britain and alignment into reality. First, we desperately need a credible, independent British role in the world – or we risk becoming increasingly dependent on the US.
Second, if the government does not seriously address the huge regional imbalances in England, it will have little respect from disgruntled regions. Internal struggles must not interfere with the name, branding, promotion and most importantly the execution of this agenda. Accelerating devolution is a good place to start.
The next prime minister will be elected by a very small proportion of the population. Unless he or she focuses on the nation’s long-term interests, they won’t last much longer than the previous one.
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