My Lords, in his Spring Statement, the Chancellor saw,
“light at the end of the tunnel”.—[Official Report, Commons, 13/3/18; col. 718.]
The light is pretty dim, and the tunnel has been much too long. The two are connected, the dimness of the light being largely the result of the length of the tunnel, as I shall try to demonstrate.
First, I have a question about the light. Real GDP is expected to grow by an average of 1.4% a year for the next five years. This is just over half of the trend rate of growth before the crash. GDP per head is expected to grow by under 1% a year in that period. This is a picture of a stagnant, becalmed economy. In the 1950s and 1960s, Britain was often called the sick man of Europe because its annual growth rate was a miserable 2.8% a year. Now we are promised half of that as the new normal. Note that it is by no means the new normal for other countries. The United States is expected to grow by 2.2% over the next three years, the eurozone by 2% and the rest of the world by 3.7%. So our new normal is actually quite a lot worse than the expected new normal of most of our trading partners. The noble Lord, Lord O’Neill, asked whether this pessimistic estimate is credible; possibly not. I am not a great fan of five-year growth forecasts. But what I would say is that it has nothing to do with Brexit. As the OBR made very clear, these poor economic prospects that it sees are rooted in structural problems in the British economy, which have been there for quite a long time.
The OBR characterises the British problem as one of lack of supply, stating that the main indicator of this is,
“stagnation in productivity … since the financial crisis”.
I do not disagree with that, but what is lacking from the analysis is how a demand-side shock produced by the financial crash morphed into a supply-side problem. That is an interesting point of analysis which is underresearched. The explanation lies in the Government’s reliance on a market-led recovery. We now have a labour market that works pretty much as the classical theory tells us it should; that is, very flexibly and with a trade-off between wage growth and employment growth. With this kind of labour market, the economy rapidly returns to full employment, but it is a low-productivity level of full employment that leads inexorably to a low-productivity trap.
Output per hour worked grew by 2.3% between 1998 and 2008. Since the crash, it has grown by 0.3%. The fall in productivity growth would have been even greater had not hours worked fallen somewhat. The OBR has therefore said, rightly, that,
“a revival in productivity growth is essential”,
to sustain even the 1.4% annual growth of GDP.
This requires a return to the pre-crash level of investment. Public investment as a share of GDP has fallen from 5% in the 1960s and 1970s to roughly 3.5% today. Instead of compensating for the fall in private investment after 2008, George Osborne cut the state’s investment programme as part of his austerity Budgets. Low productivity is a direct consequence of the austerity policy.
We have now entered the Chancellor’s long tunnel and need to ask why it has been so long. This is the Chancellor on “responsible budgeting”:
“First you work out what you can afford. Then you decide what your priorities are. And then you allocate between them”.
This is absolutely fine, except that what you can afford is not independent of what you can do. If you can do nothing, there is an absolute limit to what you can afford, but that is not true of government. Government can raise taxes and increase its borrowing. The Treasury view, echoed by the Chancellor, is that such measures cannot bring about a net increase in government revenue because they reduce private sector activity by an equivalent amount. That is the real meaning of that little moral tale that the Chancellor has advanced.
This is exactly the same as the old Treasury view of the 1920s. For example, Winston Churchill when he was Chancellor of the Exchequer said in 1929 that,
“very little additional employment and no permanent employment can in fact and as a general rule be created by State borrowing and State expenditure”.
We thought that Keynes had demolished that doctrine, but it has returned with a vengeance. Since 2010, the Treasury and the OBR have been united in the view that there has been little or no spare capacity in the economy and therefore no scope for fiscal expansion. Rather, the only contribution fiscal policy could make to recovery was to cut the deficit. This would restore confidence and bring about a rapid bounce-back in private spending and investment. That was the doctrine; as far as I know, it still is. In fact, as the Minister says, the deficit has been coming down, but at a much slower rate than expected or forecast. And because austerity has lengthened the tunnel, it has postponed the solution of the budgetary problem.
Every competent authority agrees that the austerity policy lengthened the tunnel by two to three years and made the average household at least £5,000 poorer than it would have been. In doing this, it reduced the capacity of the economy to produce output.
Is there nothing fiscal policy can now do to raise the growth rate? Is it true that there is no spare supply in the economy? I should like to make two observations on that. The OBR estimates that unemployment, which is expected to stay at just over 4% over the next five years, is at an equilibrium rate. That is, that any expansion of fiscal policy now will simply lead to inflation, not produce any extra employment.
Is that true? I doubt it. I do not believe that headline unemployment figures are a true measure of spare capacity in the economy. I would question the idea that 4.4% unemployment represents the equilibrium rate of unemployment in this country, for two reasons. First, 4.4% is an average. It disguises the fact that there is overheating in some parts of the economy and underheating in others. In the south-east, unemployment is down to 3%; in the north-east, it is nearly 6%.
Secondly, and more importantly in my view, the 4.4% disguises the extent of underemployment—people working less than they want to. In 2016, the International Labour Office estimated that 6% of those in employment wanted to work longer hours than they were allowed to. In the United Kingdom, there are 32 million in employment, and 6% of that is 2 million. If we add this number to the headline unemployment figures, we get 3.4 million. That is an underemployment rate of 10.4%, not 4.4%. That seems to me a more accurate measure of the extent of spare capacity.
To conclude, I think there is more spare capacity in the economy than the OBR believes to be the case. If I were in charge of the Treasury—many noble Lords might say, thank goodness you are not—I would loosen fiscal policy, expecting to create a demand draught, and I would want monetary policy tightened to any extent needed to repress inflation. We have the spare capacity. What we lack is spare imagination.