Can the Government restart growth?

On Friday, the new Chancellor is expected to announce a new Growth Plan, with at its centre a new target to raise average annual real growth to 2.5% a year. Is this a good idea? Is it possible? And how would you start going about it?

Let’s start with the easy bit. Almost nobody would dispute that the UK has a significant problem with growth, both historically and compared to other leading economies. According to the World Bank, average GDP per capita is around 30% less in the UK than, say, the US. Even more serious, over the long term we’ve seen a continual slide in the UK’s rate of growth, whether you measure that by real growth, labour productivity or total factor productivity (very loosely, a measure of overall productivity and innovation). This predates Covid-19, Brexit or even the financial crisis. 

Can we reverse this decline? In 2012, Liz Truss and Kwasi Kwarteng, alongside three other MPs wrote a book Britannia Unchained argued that the UK needed to reject 1970s style declinism, to be more ambitious and take inspiration from a broader range of countries, from South Korea to Israel. (Disclaimer: I worked for Kwasi at the time, and helped with the book.) Or to put it another way, it was firmly on the booster side of Sam Bowman’s booster-doomster spectrum. This new Growth Plan looks like to be the first step of putting this ambition into action.

Will it work?

Many commentators in recent days have complained that it is impossible to have a growth target in a market economy - and trying to achieve it is likely just to achieve an inflationary bubble. If the UK were at the growth or technological frontier, this might be true. In practice, however, most of the UK's biggest obstacles to growth, from planning to tax cuts to trade liberalisation are political. When your choices are political, having a temporary hard target to clarify trade offs can be helpful. It is notable that many of the people complaining about a growth target seemed to have much less objections to targets for levelling up, Net Zero or even entire Industrial Strategy - all of which have much bigger unknown unknowns. The UK does not need to invent entirely new technologies to grow faster: it just needs to catch up some of its current gap with the US,  Germany, Australia or Switzerland.

A 2.5% growth target is ambitious, but not an impossible reach. It is less than the average 2.7% growth seen in the Great Moderation period of 1992 - 2007, albeit still a step change above the 2% seen between 2010 and 2019. Having faster growth would make every other economic variable easier: more money for tax cuts, spending in the NHS or deficit reduction. The OBR used to estimate that every 1% of additional growth led to around a 0.7% improvement in the deficit. Based on that, a 0.5% increase in average growth from 2 to 2.5% after five years could grant the Government around an extra £45 billion to play with.

If the 1980s were the last time the economic direction of the UK was turned around, what made that possible? To start with, it’s helpful to recall some of the elements that led to the 1970s:

• The idea that you needed to be a superpower to matter. The UK was never going to be as powerful as during the heyday of the British Industrial Revolution - and in the 1970s that led many to believe that it would basically be an irrelevance compared to the superpowers of the USA or USSR. The only way to matter was as part of the growing European Community.
• State spending and control was always going to grow. We were on a one way ratchet where the spend always got bigger, not smaller. Free markets had been seemingly discredited by the perceived experience of the Great Depression.
• A wider secular sense that progress was slowing down. The thirty glorious years of post war growth was over. Advanced economies had used up the backlog of revolutionary new technologies developed during the Great Depression and World War 2, and future progress would be much slower. 

There were many elements that helped change this perception, from the fall of the Soviet Union to the Falklands War, but I’d pick out three in particular that are relevant today:

• Supply side reform. This probably included both the direct impact of Thatcher’s reforms - curbing unions, privatising the utilities, lowering tax rates - as well as just a wider Deirdre McCloskey cultural style shift in favour of free markets.
• Monetary and Fiscal policy. After leaving the Exchange Rate Mechanism in 1992, the UK entered a new Great Moderation era of low and stable inflation, with politicians no longer trying to fine tune demand in the economy through deficit spending.
• Digital technology. As important as any policy change was the wider technological landscape. The 1980s was the decade of the Personal Computer, and the 1990s it became truly mainstream. For the first time, you could no longer 'see the computer age everywhere but in the productivity statistics' - but saw real boosts to productivity across advanced economies. In the last thirty years, ICT has been by far the most significant driver of our productivity growth.

Today, you could argue we're seeing similar patterns. Many people despair that the UK is powerless and irrelevant post Brexit, that an ageing population will inevitably lead to an ever growing NHS and tax burden, and that we’re running out of useful new ideas or inventions.

Just as importantly, the likely way out could echo the patterns of before too. If the UK is to restart growth and innovation, it needs to do more to reduce regulatory burdens that stand in its way. The UK might look like it has relatively lightly regulated product markets compared to other OECD countries as Martin Wolf argues, but it is just not true that the areas that matter mostly for either innovation or the cost of living are lightly regulated. From housing and the Green Belt to childcare rules, restrictions on gene editing to an increasing attempt to plan the digital sector, there is much more than a Truss administration could do if it wanted to.

If your goal is for the UK to become a middling European social democracy, then our tax burden is not particularly high. That clearly however is not the only choice available - the UK tax burden remains notably higher than in the US, Switzerland or Australia. In the medium to long term, stopping future tax rises will require renewed discipline on public spending, which could be difficult. That said, with an independent Bank of England interpreting its mandate strictly there is no need for short term tax cuts to be inflationary - and in the medium term, there is still the scope for the Truss administration to revisit its past hints of changing from an inflation to an NGDP level target. (This, in itself, would probably make it much easier to smooth out the business cycle and consistently hit a real growth target whatever it was too.)

Finally, here is a chance that the new Government might just be lucky with its timing. After a decade or so where AI always seemed to be the next big thing, but with little noticeable impact on productivity, in the last year technologies like Github Co-Pilot, Dall-E or Stable Diffusion look to have passed a threshold of potential economic significance. AI could be the new personal computer - not showing up initially, but eventually becoming a major driver of growth. As Europe’s digital hub, the UK is potentially well placed.

None of this means that accelerating growth in the UK is inevitable, or even likely. It is noticeable that even with all the upheaval of the Thacher period, it managed to slow decline in the underlying growth rate, but not stop it. The fact that many of the UK’s most important barriers are likely political rather than economic, might make them harder rather than easier to solve. Announcing new capital investment or a reform to skills is a lot more straightforward than taking politically unpopular decisions on a regulation or business tax. 

On the fiscal side, this is still a big gamble that extra growth will in the medium term play off currently unfunded tax cuts, and a long way from the kind of debt brake or permanently balanced structural deficit that the Chancellor previously called for in a paper I co-wrote with him for the IEA.  (The announcement of the paper even went so far as to argue that the Chancellor should lose 20% of his personal salary if the structural deficit wasn’t balanced.)  The best defence might be that in the early 2010s it looked like we had a one off financial crisis to recover from and pay off. Given another decade of stagnating productivity,  you could argue more radical actions are called for.

To make real change, the Government will have to make difficult political choices, and even then, making a noticeable difference in the short couple of years they have before an election is going to be incredibly challenging. Some signs I think that the Government is serious are:

• as Rachel argues, the first and most important signal is real action on planning reform
• introducing real post-Brexit regulatory changes to help gain a first mover advantage in AI, pharma, etc
• resurrecting the Oxford-Cambridge arc
• revising down Spending Reviews assumptions around forecast spending growth in Departmental (DEL) spending
• repealing or significantly revising measures such as the Online Harms act or sugar levy
• reining the CMA back from following the FTC in an ideological drive against big tech  (Another disclaimer: Public First regularly works for many major technology companies, including Google, AWS and Uber.)
• prioritising consumers rather than producers in future trade deals
• re-labelling BEIS (again, sorry) to the Ministry of Growth, splitting off energy and incorporating Digital within it

Tax cuts and setting a target are the easy bit. It is everything else that will be hard.