Monday, 1 November 2010

How To Fix The British Economy...

In my Money Week column this week, I've been looking at how to get the British economy growing again. Here's a taster....

After the cuts, the growth story. Addressing the Confederation of British Industry in Birmingham at the start of the week the Prime Minister David Cameron tried to sound a more optimistic note on the economy. It wasn’t just going to be about slashing benefits, closing down theatres and arts centres, and making everyone work until they are ninety-five. The economy would soon be expanding again.
That is surely right. The U.K. can’t simply cut its way out of a budget deficit of 11% of GDP, the highest in out peace-time history. It needs to start growing again, and at a faster rate than it did in the last decade.
Unless tax revenues rise, and jobs are created to replace those lost in the public sector, the books are never going to be balanced again. Rising unemployment and collapsing firms will mean that tax revenues keep on going down. Very quickly you get into a vicious circle of cutting spending, leading to lower tax receipts, which means even more cuts. Only growth is the way to break out of that.
But how? In fact, there are plenty of good places to start. Cut corporation tax to encourage investment: reform welfare aggressively to increase the labour force: deregulate those industries that are still too protected: and create tax-free zones in those areas of the country where the state has crowded out the private sector.
There is no reason why the economy shouldn’t expand at the same time as the budget deficit is bought under control. Despite the simplistic Keynesianism that seems to have gripped much of the media, it is perfectly possible for economies to expand at the same time that the government is reducing its spending. There are two reasons for that. The government doesn’t create any money itself, it merely takes it from other people, either by taxing them, or by borrowing it from them. So its spending decreases demand as much as it increases it. Next, as government gets smaller, there are more resources for the private sector to exploit. As a general rule, the smaller the state is, the faster an economy can grow,
Indeed, the last time the UK embarked on significant spending cuts – under John Major’s government in the early to mid-1990s – the UK grew at an impressive rate, and plenty of new jobs were created. Two million jobs were created under the Major government of 1992-1997, which more than made up for the 700,000 jobs that were cut out of the public sector. Under Mrs Thatcher’s Tory government of the 1980s, the experience was similar: after the peak of the recession or the early 1980s, 2.97 million new jobs were created by 1990, which more than made up for the two million lost in manufacturing. There is no reason to suppose the UK can’t repeat that experience in the coming decade.
But it isn’t going to happen by magic.
You can expect to hear a lot of waffle from the government about boosting infrastructure spending, encouraging more lending to small business, promoting investment in green technologies, and cracking down on short-termism in the City. Most of it is nonsense. The Government has no idea which ‘green technologies’ will work in the future, and whether this country has any real competitive advantage in any of them. People have been fretting about the short-termism of the financial markets since Victorian times without ever finding a realistic way of doing anything about it. Nor does the government have any idea whether the banks should be lending more to small businesses, and if so, which ones.
In fact, the steps the government should take to get growth going again are far simpler. Here are four good places to start.
One, cut corporation tax. In Ireland, a 12.5% corporate tax rate made the country a magnet for investment from all around the world. It could do the same for the UK. Over the coming few years, dozens of ambitious new companies are going to be emerging out of the fast-growing economies of Brazil, China, India and Russia. Just as the Japanese did a generation ago, they will be looking for a base to expand into Europe. Britain should be the natural destination for them, as it was for the Japanese. But it won’t happen unless there is plenty of incentive for them to come here – and a low tax rates trumps just about everything else.
Two, reform welfare aggressively. The huge numbers of Polish immigrants who came to this country and found work in the last decade tells us the UK can easily create jobs for people that want them. There is no easier way of boosting growth than increasing the employment rate; GDP, remember, is just output per worker, multiplied by the numbers of workers. If you can move some of the roughly five million people now living in benefits into jobs, you not only save on their welfare cheques, you also boost the economy. That is what reforming welfare can achieve.
Three, deregulate protected parts of the economy. The Thatcher government of the 1980s freed up the economy to generate growth – mostly notably through privatisations.. This government should do the same. The most obvious candidate is land and building. It's virtually impossible to build anything, particularly in the South-East, which is one reason we have, for example, a relatively small tourist industry Make it easier to get permission for new buildings, and the jobs will follow.
Finally, create tax-free zones. Big parts of the UK - Wales, the North-East,
Northern Ireland - have reached Soviet levels of state dependency. The public
sector has crowded out any kind of private economy. Nothing can grow when the
state accounts for 60% or more of GDP. But just slashing state spending won't
work by itself. Instead, create virtually tax-free zones to encourage the
private sector to move into those areas as spending is cut.
Growth is not about picking winners, or choosing which sectors of the economy to promote. No one really has any idea, and least of all the government. But if it frees up space for entrepreneurs, the economy will respond – it has in the past, and it will do so again.

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