GEORGE Osborne’s Budget must deliver a range of market-friendly policies to increase the rate of return on investment in the UK. That is the message from a group of economists, including Derek Scott, for years Tony Blair’s economic adviser, in a paper for the Reform think-tank. Their analysis of Britain’s accelerating relative decline, which started even before the bubble burst, is sobering. Scott is a gifted economist who spent years battling Gordon Brown and Ed Balls; had Labour listened to Scott, Britain today would be a very different, much wealthier place. His explanation of the financial crisis as a massive intellectual error by central banks draws on the work of Bernard Connolly (now of Connolly Global Macro Advisors, the London-based economist who most precisely saw the crisis coming) and the Austrian economics of F.A. Hayek. It is highly compelling.
Between 1974 and 1997, the UK went from being the 18th largest economy measured by GDP per capita to the 16th, out of 25 OECD countries. This was a dramatic break with decades of decline; the legacy of the supply-side reforms of the 1980s meant that the UK continued to improve its performance for several more years after that. By 2005, the UK ranked 12th out of 34 OECD countries, having overtaken the United States, Germany, France and Italy, though this performance was partly inflated by the bubble. Crucially, the UK’s renewed decline was apparent even before the bubble burst, with tax, spend, educational and regulatory policies emerging as a drag on GDP per capita: Britain’s relative position has dropped every year since 2005. By 2009, the UK had fallen back to 16th, overtaken by Sweden, Finland, Germany and Belgium, with the effects of the crisis kicking in.
There are other fascinating revelations in the report. Out of the 27 OECD countries, only Greece, Estonia and Denmark had worse household savings ratios during 1995-2008. Manufacturing has declined so much in Britain because wage costs per unit of output have gone up (in part because of regulations and wage rises) at a time when they were falling in the UK’s main rivals, including Germany, the US and Japan. Financial services, by contrast, are the most productive sector of the UK economy at £308,000 in economic value per head (the reason why wages are so high in that industry). Finance has become increasingly productive, with employment remaining constant as a percentage of total UK employment since 1978 (at roughly 4 per cent), while the sector’s contribution to GDP has increased by 6 per cent in the last 15 years. But finance’s economic value per employee may not hold up as leverage declines to a more reasonable level.
What of the crisis? Interest rates were kept too low by central banks, while the launch of the euro and China’s manipulation of exchange rates helped fuel asset bubbles. For interest rates to return to “normal” – and for them to rationally balance the cost of spending today with that of spending in the future, rather than distort everything – anticipated rates of return on investments need to rise to ensure profitability at the new, higher, interest rates. This requires lower tax rates, reduced employment regulations, a less restrictive planning system and more besides. The answer, Scott and his colleagues argue, is “more capitalism, not less.” Brown ignored Scott – let us hope Osborne doesn’t make the same mistake.
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