Jeremy Corbyn’s big state policies would be disastrous for long-term economic UK growth
Over the coming months, the new leader of the opposition and his shadow chancellor are likely to set out a very different economic worldview, with policies built on the premise that big is beautiful in the case of the size of the state.
For many, this isn’t a great concern, with received wisdom that Jeremy Corbyn is unlikely to still be Labour leader in 2020 and that, even if he is, he’s likely to get thrashed by the Conservatives.
This may well prove to be true, but what happens if between now and then an economic crisis of some form erupts and the government becomes deeply unpopular?
At that point, it would be rather useful to have ready to hand all the reasons why a big state is bad for economic growth.
When I talk about a big state being bad for growth, I’m referring to the long-term impact of the state on the supply-side of the economy, as opposed to the short-term impact on the demand-side of the economy, captured in the debate over the impact of austerity and the relevance or otherwise of expansionary fiscal contractions.
Assessing the impact of the size of the state on the long-term potential growth rate of the economy is not straightforward, owing to issues of causality. Does the large state cause slower growth, or does the slower growth cause a larger state?
There are also significant issues around the nature of the state, not just its size – productive versus unproductive public spending, and distortionary versus non-distortionary taxation.
But the most recent tranche of research, which deals with these and other methodological challenges, is fairly conclusive that there is a negative relationship between the size of the state and economic growth, and that this relationship is probably non-linear – i.e. the bigger the state, the greater the damage.
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If Corbyn ever reaches Number 10, the fiscal consequences could be dire. His policies could easily add 3-4 per cent of GDP to the public spending and taxation ratio, on top of any recession-induced increase of the same order of magnitude.
Throw in the increased costs of an ageing population and the government spending to GDP ratio could get stuck around 50 per cent of GDP.
Based on the research literature, this could knock 0.5 to 1.0 percentage point off the long-term rate of growth in potential output.
We could then be talking of a potential growth rate in the UK of 1.5 per cent or less! Dire indeed.
An economy growing at 1.5 per cent per annum would take nearly half a century to double in size. In contrast, an economy growing at 2.5 per cent would take around 28 years – almost half the time.
It doesn’t take rocket science to realise that, if you transfer resources from a higher productivity growth private sector to a lower productivity growth public sector, overall GDP growth will suffer.
But the threat doesn’t stop there, owing to the negative impact of higher taxation (to pay for the public spending) on the incentives to work, save and invest.
Corbyn would do well to take some Swedish lessons.
Swedes work shorter working hours than Americans (no surprises there), but they actually have less leisure time, because the knock-on effects of the size of the welfare state – and taxation to pay for it – mean that Swedes have to undertake household activities themselves, as opposed to purchasing them.
My own research suggests that the Nordic economies’ relative success over recent decades is in large part attributable to the retreat of the state from stratospheric to very high levels.