In my last post, I missed out one potential benefit from the switch in emphasis from the deficit to growth under Truss and Kwarteng. During the dark days of Osborne’s austerity, the idea that the ultimate goal of fiscal policy was to manage the deficit became firmly established in the media. This idea was always absurd, although I analyse the origin of this belief here. The primary aim of fiscal policy, along with economic policy more generally, should always be to increase social welfare. While it is up to politicians how they weigh the welfare of different parts of society, pretending the government’s deficit is a proxy for this welfare was always nonsense.
Economic growth is related to social welfare, but we should never forget that they are not the same thing. The most obvious example of that, which I will talk about below, is a demand led boom that leads to higher inflation. In addition aggregate growth figures ignore how income gains are distributed among different groups. Furthermore, additional growth achieved today at the cost of yet lower growth tomorrow is not worth having. An obvious example of this is extraction of oil or gas that would add to growth today, but because of global warming would reduce the social welfare of future generations.
Before discussing the merits of Truss/Kwarteng saying they are targeting growth, we should ask why they are doing this. After all, and with the caveats above in mind, all governments before 2010 tried to raise the growth rate in various ways, so this is hardly something new. So why are Truss/Kwarteng making a big deal of it?
Part of the answer comes from the first paragraph of this post. They want to signal a departure from policy that placed a high weight on deficit targets. But another reason is also important. As many have noted recently (see myself here in February), at some point after the Global Financial Crisis the UK economy went from being a success story in terms of growth relative to other G7 countries to being a failure. For a long time the government successfully (in terms of the mainstream media) hid this decline by talking about the deficit (see first paragraph again) and repeatedly pretending we had ‘strong economy’, but now the decline has become undeniable. In addition it is also clear that this decline has happened under Conservative (or Conservative led) governments.
The implication Truss/Kwarteng would like you to draw is that the Conservative governments of the recent past allowed this era of decline to happen because they didn’t prioritise growth, and this new Conservative government will be different because it is going to prioritise growth. While I think there is a lot of truth in the first part of that sentence, I see nothing to suggest the second part is true.
Take, for example, the two major policy mistakes that in my view played a large role in creating this recent era of UK decline. Austerity at the depth of the GFC recession both killed any chance of a normal recovery and probably also reduced the long run level of UK output, but implicitly Sunak had already acknowledged that mistake by not repeating it during the recession caused by the pandemic. In contrast the second major policy mistake, Brexit, continues and neither Kwarteng or Truss show any sign of acknowledging the negative impact of Brexit on growth.
So compared to the last 12 years of economic decline, this new administration is keeping one of the main reasons why it happened and is agreeing with the last government about not repeating the other. In addition, its big idea about how to raise growth, tax cuts including low corporation tax, had already been tried without success by Osborne during this period of UK economic decline.
Behind the unashamed promotion of fiscal measures that increase inequality (not just tax cuts but not imposing additional windfall taxes on energy producers and lifting the cap on bankers bonuses) is the idea that greater inequality encourages growth. The evidence suggests either no such association or the exact opposite. Here, for example, is a quote from one IMF study: “Thus the combined direct and indirect effects of redistribution - including the growth effects of the resulting lower inequality - are on average pro-growth.” More recently the IMF points to a robust result that higher inequality at the top of the income distribution reduces growth. There are many reasons why greater equality might promote growth.
Tax cuts aimed at the rich, therefore, are if anything a growth reducing measure, and almost certainly reduce social welfare. That is why removing the cap on bankers bonuses, or not imposing a windfall tax on energy companies, is more likely to reduce rather than increase growth. The idea that the last 12 years of economic decline under Conservative governments were because those governments prioritised redistribution over growth is nonsense, as Jonathan Portes shows. Once again, fiscal measures that favour the rich were tried by Osborne and it did nothing to stop, and may even have assisted, the last 12 years of UK economic decline.
Its other big idea is to reduce the ‘red tape’ that they believe is holding back UK business. First, we should note the huge increase in red tape for our exporters to the EU created by Brexit, which the current government intends to continue. Second, there is no general relationship between regulations and economic growth. For example, the government has ordered a review into anti-obesity measures. It is not obvious why these measures hold back economic growth, but it is clear that more obese people implies a greater burden on the NHS, requiring either higher taxes to fund it or a reduction in social welfare as other care is rationed. Or take the absence of regulations, since Brexit, to keep our beaches and rivers clean, which benefits monopolies and their shareholders but is likely to encourage imports and reduce exports (UK residents taking holidays to cleaner beaches overseas and less overseas tourists coming to the UK) implying less growth.
The idea that less regulation always increases growth, just like the idea that lower taxes always raise growth, is just right wing wishful thinking. However, like much right wing wishful thinking, there is a whole industry out there trying to manufacture evidence to support these ideas sponsored by those that benefit from such measures. It should be no surprise, therefore, that Conservative governments keep enacting measures that favour wealthy interests rather than favouring growth, when they are advised by newspapers and think tanks funded by those interests. It’s very important that we avoid right wing wishful thinking becoming received wisdom in the mainstream media, as the wisdom of austerity was allowed to do.
Where there is good evidence that fiscal measures can assist growth tend to be on the government spending side: investing in certain types of skill for example. Right now the UK appears to be suffering a negative labour supply shock caused by a rise in long term illness, due partly to Long Covid but also because of the growing waiting lists for other treatments in our overstretched and understaffed NHS. Improvements in these areas can be achieved from more public investment or targeted incentives for private investment (better ventilation for example) but they also require permanent increases in public spending and therefore higher, not lower, taxes.
An indication that nothing has really changed is empty gestures. Having a target for 2.5% growth is just nonsense for two reasons. First, it’s GDP per head that influences social welfare, not GDP, so the target is for the wrong thing! Second, setting a target does nothing to help you achieve higher growth. At best it is an attempt to pass off measures that are rightly unpopular, like removing the cap on bankers bonuses or not extending windfall taxes on energy producers, as necessary to achieve the growth target, but of course neither will have any positive impact on economic growth. Equal nonsense is removing the Treasury’s permanent secretary for no other reason than wanting to show things have changed. One empty gesture might be an accident, but two perhaps suggest there is in reality little substance to this proclaimed change in direction.
If a growth target makes no sense, and none of the measures advertised so far will help increase growth, how will this work politically? It is possible that Truss/Kwarteng may try to cut taxes and increase spending, producing a sufficiently big enough increase in effective demand such that output growth exceeds their target just before the next election, allowing them to proclaim their policies a success. Comparisons have been made with the Barber boom of the early 1970s, a boom that helped create the largest rise in inflation in UK post-war history.
Today, with an independent central bank, such a policy combination would create a rapid increase in UK interest rates. For this reason among others, manufacturing an unsustainable short term boom is likely to damage long term growth rather than improve it. However raising interest rates to counteract fiscal largesse is not a precise science, and it is possible that for a quarter or two annualised growth could exceed 2.5%. If it does, expect many proclamations of a new dawn from Conservative politicians and their press. But even if that does happen, and it may well not, it will be yet another deception. This decade or more of economic decline will not end by cutting taxes, deregulation, making exporting harder, and increasing inequality.