Things could and should be better
[This note was prepared for the Policy Network economy conference, "The quest for growth".]
The UK economy has many underlying strengths and things could and should be better. If only policymakers would actThere is plenty of spare capacity in the UK economy. The Office for Budget Responsibility’s (OBR) estimate of the "output gap" (a little over 2 percent) is unrealistically low; both we at NIESR and the International Monetary Fund (IMF) think it is higher (around 4 percent). And we may well be too pessimistic.Indeed, even with an improving labour market, unemployment is still nearly a million higher than official estimates of the "structural" rate (the NAIRU), while on the OBR's forecasts (which are likely to be too optimistic on growth in the short term, and too pessimistic on supply potential) unemployment will remain well over the NAIRU, and output well below potential, for years to come.
All this represents an inexcusable failure of macroeconomic policy. So what should we do?The main short-term problem (as the IMF says) is a lack of demand. Long-term interest rates are at historic lows; and as such, the government can borrow money for essentially nothing (the yield on long-term index-linked gilts is close to zero). The UK suffers from both creaking infrastructure and a chronic lack of housing supply, especially of affordable housing. In these circumstances, bothcommon sense and basic macroeconomics argue that it is the role of government to channel those private sector savings into demand and investment, by borrowing more if need be.Would borrowing more lead to higher interest rates?
This is unlikely. Every single major advanced economy with monetary independence - that is, outside the eurozone - has seen long-term interest rates fall sharply over the past two years. It is simply false to say that we have low long-term interest rates now because the deficit has been cut: projected future borrowing is now higher than before the austerity plans were announced. As theIMF says, low interest rates are the result of weak growth, here and around the world.So we can afford to borrow, spend and invest. Indeed, we can't afford not to. The quickest and most effective way to do this would be to boost house building. Whether this is by direct government borrowing or through complicated off-balance sheet guarantees, as the government is now considering, matters little in economic terms, although the latter approach will result in some money going unnecessarily into bankers' pockets.
More broadly, there are plenty of other infrastructure projects that could be taken off the shelf. The coalition government points out that it has cut the deficit by a quarter; but two-thirds of the reduction came from cutting public investment: schools, roads and hospitals.In addition, a temporary, but large, cut in National Insurance Contributions for both employers and low-paid employees would boost labour and consumer demand at the same time as improving work incentives.Broader and more comprehensive measure to tackle youth unemployment would also help.The Bank of England could also do more. Rather than simply buying gilts, quantitative easing could help unblock financing constraints for SMEs, at a time when the banking system is transparently incapable of doing so.Medium-term growth: the supply-sideSo in the short term, there is plenty that can be done to help the UK economy. The main thing holding back growth in the UK is bad policy, here and of course in the eurozone. But over the longer term sustainable growth will require a whole host of policies: planning reform, increased aviation capacity, better quality education for disadvantaged children, better childcare provision, clearer pathways from school to work for those who don’t go on to higher education.On all of these, we know what the problems are, but successive governments have failed to address them. One policy area that currently works very well, however, is the labour market, which has performed extraordinarily well of late. Three decades of successful reform have given the UK a flexible and generally well-functioning labour market, suggesting that there is little to gain from further deregulation. Spain and Italy need radical labour market reform; but we don't.There is however one area where deregulation is urgently needed, and that is immigration. The government has introduced a set of new burdensome and bureaucratic rules and regulations, including a quota on skilled migrants, that are designed expressly to make it more difficult for businesses to employ the workers they want. By the government's own estimates, this will reduce growth and make us poorer. But another consequence has been to take a thriving, dynamic and high value-added export industry - further and higher education - and stop it from selling its product to foreigners.As long as the UK policy debate focuses on immigration as a threat to be minimised, rather than as a potential driver of growth and innovation, then the UK will not be "open for business."The UK economy has many underlying strengths. Since 1995, GDP per capita has grown faster than in Germany, France, Japan or the US. This reflects improvements in the UK labour market, a more skilled workforce and a more competitive economy. There is, of course, plenty to worry about. We are still stuck in the longest period of stagnation in recorded economic history, thanks to damaging and unnecessary policy failures, both here and globally. But things could and should be better. If only policymakers would act.