The Oxonia Lecture 2012

How can Government get the UK Economy to Grow?

The Rt Hon. Dr John Redwood, PC

November 2012

1.Why do people want more growth?

Leaders like to be able to offer people rising living standards.

Growth offers ways out of poverty for the poor, and incentives for the better off.

Growth allows governments to collect more tax revenues to pay for their treasured programmes.

Growth makes servicing and repaying outstanding state debts easier.

Growth makes it easier for people to set up and grow businesses – there is more new business to win.

Models for Growth

2

2.Are there drawbacks to growth?

If growth is based partly on substantial inward migration this can lead to social tensions.

Growth means more construction and development, which offends those who wish to preserve all greenfields and open spaces.

Growth entails burning more energy, which might lead to more pollution and higher outputs of CO2.

Growth may increase inequalities of income, as the able are often better at exploiting its opportunities.

Growth is popular with those who like material advance, but is less popular with those who think the pursuit of material wellbeing is overdone and can be damaging spiritually.

Models for Growth

3

The Coalition view is the government has to curb the public sector deficit and expand the private sector to “rebalance” the UK economy.

The Opposition view is that the government has proceeded too far too fast on the course of curbing the deficit, though they themselves accept that a sensible programme of deficit reduction is needed.

The government argues that you cannot get out of a debt crisis by borrowing more.

The Opposition says that borrowing more in the short term would boost demand and should lead to lower levels of borrowing as growth accelerates.

Both the Coalition and the Opposition agree with monetary stimulus. Both agree with accelerated national infrastructure investment plans.

Labour just before they left office cut capital spending plans substantially. The Coalition approved most of these cuts.

The UK Debate about Growth

4

At the heart of the debate between government and opposition is a disagreement over Keynesian stimulus.

The simple minded interpretation of Keynes’s work argues that recessions can be brought on by inadequate demand. If the state increases its spending, borrowing money to pay the bills, it can increase demand.

Some today argue that a “Keynesian” stimulus would yield more tax revenue and lower spending on items like benefits as more people went into work. It might not, therefore, be so damaging to the deficit as some fear.

How Keynesian should you be?

5

Others argue that such a “stimulus” might not be helpful. If the money is borrowed, it cannot be spent by those who do the lending, so their contribution to demand may be lower.

If the borrowing worries the markets, it could put up interest rates, leading to reduced activity.

There is no correlation between the size of the deficit and rate of growth, or no positive one. Today the countries with the largest deficits have slow growth rates or remain in recession. Indeed, a large deficit can be the result of a recession.

Both Coalition government and Opposition agree that the government should allow the deficit and borrowing to rise as a result of lower levels of activity, the so-called automatic stabiliser.

The argument is over the structural deficit.

How Keynesian should you be?

6

*Growth rate Debt/GDP

China 7.8% 22.15%

USA 2.2% 107.18%

Greece -6.0% 170.73%

Spain -1.5% 90.69%

Switzerland 0.8% 46.70%

*Real GDP and deficit projected (as percent of GDP) for 2012 by the International Monetary Fund. Source: World Economic Outlook (October 2012).

Deficits and Growth rates – some modern evidence

7

In 1976, 1981, and 1993 UK governments took action to cut public spending plans as part of a policy geared to get the UK out of recession and financial crisis. In 1976, the cuts were part of an IMF programme. In 1981, the Conservative government ignored the advice of many economists, and cut spending during the recession. In 1993-4, the Conservative government cut spending and raised taxes as part of its adjustment programme following the failure of the UK’s ERM membership.

In each case, the UK economy proceeded to recovery. In each case, the restrictive fiscal action was complemented by monetary easing.

The UK’s past experience

8

The UK’s past experience

9

1975-6 Public sector net borrowing 7% GDP Growth Rate for Year -0.6% 1976-7 5.5% 2.6% 1977-8 4.3% 2.4%

1980-81 4.8% GDP -2.1% 1981-2 2.3% -1.2%

1993-4 7.7% 2.2% 1994-5 6.2% 4.3% 1995-6 4.7% 3.1%

2009-10 11.1% GDP -4.4% 2010-11 9.9% 2.1% 2011-12 7.9% 0.7%

*Source: World Bank.

The recessions of 1974, 1981, 1992 and 2008 were the results of shocks to the monetary and banking system.

In 1974, the crisis was brought on by difficulties in recycling oil revenues following the oil price shock from OPEC and followed by a property crash and banking stress.

In 1981, the crisis resulted from excessive credit and inflation, followed by a sharp correction through monetary action to curb price rises.

In 1992-3, the Exchange Rate Mechanism had first forced the creation of too much money to keep the value of the pound down, resulting in inflation, and then too little money as the Bank fought to keep the pound up, resulting in a downturn.

In 2008, the excessive build up of credit in the banking system was corrected too violently by the authorities, threatening the banking system as a whole and ushering in a period of banking retrenchment.

Monetary easing

10

The UK government has tried a £375 billion Quantitative Easing programme. This has lowered bond rates to abnormally low levels, and has been part of a policy with very low short term interest rates.

At the same time the authorities have required banks to keep more cash and capital, and to take action to tidy up their balance sheets, stressed by lending too much money to weak projects or against overvalued security in the good years. This has restricted the banks’ ability to lend on the extra money created by the Bank of England.

Aware that QE is not solving the private sector credit problem, the government has now instituted the £80 billion funding for lending scheme, and the £50 billion plus National Infrastructure plan.

Small and medium sized enterprises claim there is still not sufficient credit at sensible rates for them to expand. The banks claim there is insufficient demand for loans.

Current problems with easing money

11

The UK government decided to rely on a large increase in tax revenue to bridge the gap between spending and income.

In their June 2010 forecasts they assumed tax revenues would rise from £515 billion in 2009-10 to £700 billion in 2014-15.

This would support a £90 billion a year rise in current spending over the same time period, and still reduce the amount of new borrowing needed.

Both government and Opposition use the language of fairness to justify higher taxes on the rich at a time of national need.

The Opposition claims the Coalition has not been tough enough on the rich, and has proposed a higher rate of income tax than the government intends from next year. Both supported higher rates of Capital Gains Tax and Stamp duty on more expensive properties.

Is tax too taxing?

12

As a result of the disappointing growth and the higher rates, the government has experienced a shortfall in receipts, especially from the higher rate income tax.

It is also forecasting a drop in CGT proceeds this year as we see the full effects of the higher rate.

The government has lost revenue from the drop in city jobs and bonuses, from people leaving London to undertake highly paid financial work elsewhere and from the decline in oil and gas output.

It has gained some revenue from tax exiles from various countries including France, coming to London where they do pay some of the taxes.

There is a high correlation between low tax jurisdictions and faster growth.

Is tax too taxing?

13

Some say the answer to the problems of faster growth is a series of supply side measures designed to make it easier for companies to do business and expand. These include:

Faster and easier planning permissions for new build

Faster and easier permits and licenses to install new energy, water, telecoms and transport capacity

Improved education and training to raise the capabilities of the workforce

Deregulation, to cut the costs of doing business

Assisting the rise of the third sector

Detailed plans for individual sectors

Selective government subsidies and interventions to help particular sectors, regions, types of company

Can they go down the supply side?

14

Tougher action to sort out the broken banks

Splitting the large state owned banks, and creating new competing commercial banks from them

Tax cuts to boost revenue and make enterprise more worthwhile

Faster action to agree infrastructure projects to improve energy, transport, telecoms and water capacities

What might a more effective growth strategy look like?

15