The challenges the UK faces to thrive over the next decade are enormous.
On the day following the Brexit referendum the whole country had a sense of a new beginning. Whether that sense was redolent with optimism or dread, we understood that the future had changed profoundly for our country.
Since the 1970s, our economic model had been clear. We would embrace the sort of higher-taxation economy that enabled us to have a strong European-style social and health safety net, but we would do it in just a slightly more market-friendly way. In this way, we reasoned we would position ourselves in the mid-Atlantic with some hope of
enjoying American-style growth without having to stump up for our own healthcare.
The referendum forced us to re-think this assumption. Could we become the Singapore-on-Thames beloved of the Tory right? In this vision we would aggressively de-regulate, cut taxes and become a global centre for business. The
right’s plan on this was frustrated by their own champion. Boris Johnson was all for de-regulation but with plenty of government spending too, without the tax revenue to pay for it. Then of course his successor, much more a true believer, tried to do everything, everywhere, all at once and triggered a market crisis.
Following that mini budget we have had to confront a hard truth. The international bond markets will not allow us to cut taxes and reduce our revenue unless we also dramatically cut spending, and the British people will not stand for that. We are, as only the British would say, in something of a pickle.
So where does that leave us? As a nation seeking out a solution in the muddy waters of the political centre; seeking to borrow from both the right and the left, to find a means of reviving our prospects. All the evidence shows that we are a nation that has systematically under invested in our future and that this has led to weaker productivity
growth than almost any other rich country. As the Nobel Laureate economist Paul Krugman famously said about economic growth; ‘productivity isn’t everything, but in the long run it is almost everything.’
Our investment in technology, infrastructure and people has been around 3% below the average of the rich world since 1990 and this cap is equivalent to about £35 billion of growth a year.
The leading management consultants EY claim that cumulatively this gap has sapped about £1.5 trillion from our economy. Or, as the former chief economist at the Bank of England, Andy Haldane, characterises it, our ‘capital stock’ – the amount of useful stuff we have for every person – is about half that of the US, France and Germany.
Haldane believes that a serious plan to solve this problem and close this gap would cost about £100 billion a year for the next 25 years. Into this difficult situation comes a new government and a dramatic budget that aims to tackle the problem. It contained a huge £40 billion of additional tax raising and yet effectively was only really sufficient to keep the lights on in the NHS.
However large the numbers felt it was mathematically not of a scale that could measurably be said to put us on a path to improving living standards over the coming decade. Indeed, the Economics Observatory points out that even if the UK was to double its current 0.5% productivity growth rate to 1%, this would only enable us to roughly achieve the same GDP growth as we have seen over the past decade. To really improve people’s lives we would need to triple it.
At the best of times, the borrowing required to close this gap, boost productivity and recover UK growth to an extent that living standards improved over the next generation, would be incredibly hard. And this is not the best of times. Rather, every penny the UK borrows from international markets today is extracted from investors who are still weighted down by the memory of the mini-budget and demanding tight fiscal rules to stop any profligate spending.
This hard truth has confronted the new chancellor, Rachel Reeves. She is unable of course to
blame Brexit, that is too politically toxic. Therefore, she is left casting around for an explanation for this dire
state of affairs that can be overcome. In truth though, blaming the last lot does not come close to identifying
the scale of this problem.
There are a number of imperatives for the chancellor, all of which are evident in her first budget. Firstly, public investment is surely going to be vital to tackle productivity in any way. After all, the revenue required to keep the lights on means that businesses are to be taxed heavily and it feels naive to believe that at the same time they will unleash a wave of new investment. Her plan of around £100 billion of new capital spending over five years could be characterised as around one fifth of the sum that Haldane argues is needed to really close the productivity gap, but it is a start.
Raw capital though, looks unlikely to be enough to really revive the UK’s prospects. We simply do not have enough firepower to use. We will instead have to find ways to deploy an education and skills strategy that speeds ahead of the competition and adopt new technologies faster than others.
As investment managers, our role is to find the best global opportunities for our investors. It is a climate that leaves us reluctant to over-commit to the UK simply because its stock market becomes ever-cheaper compared to the rest of the world. The reluctance we feel around the stock market pales into insignificance though when we look at the UK gilt market, where it seems highly likely we do not yet know the scale of the borrowing required.
Yet, as citizens, could we put together any kind of an action plan? All the analysts who accurately describe the scale of our problem try hard to end their research with some optimistic intone to better things. It is worth trying; but it is for the reader to decide whether they can share the optimism.
Here goes.
New public investment is vital, but it must be done more shrewdly than ever before so that it can have a multiplier effect by ‘crowding-in’ new private investment. By proving our ability to do this, perhaps we can persuade bond markets to allow us to borrow more and do more over the next decade.
Whilst we have been a world leader in the areas of science and knowledge creation – ranking fifth in the Global Innovation Index –we have used this expertise on a tiny number of companies. In the United States you can drive for miles away from the major innovation universities and see acres of business parks full of the start-ups that have sprung up from graduates. In the United Kingdom, the closest thing to a start-up you will find is a new branch of Greggs. Our lack of innovative start-ups using our world-class academic institutions is staggering and requires urgent action. Perhaps more importantly, in the United States, innovative technologies are diffusing far faster away from start-ups to medium-sized companies and this is the real productivity gain. This is happening more slowly in the UK and denies us the ‘network effects’ which improve productivity rapidly. It is a problem that policy could tackle.
We need a plan for a growing workforce. This must include rapid re-deployment of the burgeoning long-term sick by driving down NHS waiting times and welfare reform. However, it is realistically going to require a new settlement with the European Union to allow for more skilled immigration and more rapid re-deployment of talent that can improve productivity.
If we are serious about solving our productivity problem, we will have to aggressively knock-down the political obstacles to growth. This includes, as Labour has proposed, much more central control of even deeply unpopular planning decisions.
One final reason for optimism could be that we do have a government with a large majority and that government has at least picked an economic model. Some will disagree with it, but surely pursuing an approach with enough political clout to drive it through is better than doing nothing. As they teach in the Army; ‘if you are hiding in a hole and they are firing shells on your position then almost any decision is better than no decision.’
Source: Foundations https://ukfoundations.co