Stagnation Britain: Osborne has played his hand extremely badly

THE statisticians will be arguing about the last quarter’s growth figures for years. Was it really a 0.7 per cent fall in national income, a 0.9 per cent fall or a 0.5 per cent fall? If it were not for the soggy weather and extra Bank Holidays, might we have managed just a 0.2 per cent fall? These issues are, by and large, irrelevant. The big question is whether stagnation has become the new normal. My fear is that it has.

Ironically, on the face of it, we seem to have a well-functioning labour market. The private sector is creating jobs faster than the public sector is shedding them. Also, real wages are falling so we are not falling into the trap that Keynes described of rigid wages preventing economic adjustment.

But the labour market is responding well to a dire situation. Real wages are falling because productivity is falling. Falling productivity plus stable employment equals economic stagnation.

We cannot get out of this position by deficit financing or more government spending. The government is already borrowing over 8 per cent of national income. There is no hole in “aggregate demand” caused by a lack of government borrowing. The government is also already spending around 50 per cent of national income.

And this is the first part of the growth puzzle. Evidence suggests that a ten per cent increase in government spending as a proportion of national income reduces the growth rate by about 1 per cent per annum. If we could add 1 per cent to the growth rates we have been achieving recently, there would have been a quite different growth trajectory ­– though not transformational. We need to look further.

The government did have a very bad inheritance. Nevertheless, George Osborne is responsible for playing his hand badly. Rule number one in the fiscal consolidation handbook is that a government should not raise taxes by a huge amount and then – over a period of many years – reduce government spending to sustainable levels. Spending cuts should come first. The private sector of the economy is probably incapable of supporting current levels of government spending and so tax increases have been futile. They have raised little extra revenue but serve to undermine economic growth and productivity.

The government may feel it is plagued with bad luck. The current government was neither the cause of the financial crash nor of the catastrophic state of the public finances. In addition, there is no question that Eurozone uncertainty is providing a brake on private sector investment.

But, the key to success in any walk of life is playing a bad hand well. Whether you are a government with a rotten inheritance or a football manager with a horrendous injury list, how you perform when you are up against the wall is crucial. Just as the government has no excuse for its back-to-front approach to dealing with public finances, it has no excuse for increasing regulation.

The coalition chose to impose new burdens on employers by increasing the minimum wage; extending the minimum wage to younger people and apprentices; immediately imposing the EU temporary workers’ directive; bringing in pensions auto-enrolment and compulsory employer contributions; and so on. There is some sign that the government realises the errors of its ways with regard to employment regulation, but it has a lot of work to do.

The government is especially hampering the financial sector with more and more regulation. Whatever one’s view on the long-term regulatory environment for banks and other financial institutions, the timing is woeful.

In addition, the energy sector is constrained by the government’s incoherent green policies. The UK government seems determined to get the minimum possible reduction in carbon dioxide emissions for the maximum possible cost.

A recent article by the Bank of England highlighted the financial and energy sectors as the two sectors where productivity performance is especially poor. It is no surprise.

Current policy is a recipe for stagnation. In one area alone – land-use planning – the government is moving tentatively in the right direction. But, there is simply no possibility of rising growth and real incomes without a smaller state. It must be smaller in terms of how much it spends and smaller in terms of the way in which it regulates the private sector.

Philip Booth is editorial and programme director at the Institute of Economic Affairs.

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