Monday, 31 December 2012

Growing Pains: How to restore economic growth and rebalance the UK economy

A paper by Glyn Gaskarth published by Civitas  (December 2012)

Executive Summary

The UK growth review does not fully address the structural problems the UK economy faces. Both the Growth Review and the Trade and Investment White Paper prioritize measures which directly harm UK growth and exports. Diplomatically supporting Less Developed Countries (LDCs) defence of their domestic protectionism restricts the market for British goods in those countries. Environmental measures such as the soon to be introduced carbon price floor make energy more expensive for UK firms and export UK jobs to countries which often have much lower environmental standards. The retention of the anti bribery rules make it very difficult for UK firms to trade in high growth emerging markets many of which have very high levels of domestic corruption.

Attempts to reduce regulation exist more in rhetoric than in practice. Rules such as the one in one out rule for new regulation are not universally enforced. Additional business costs are being imposed by the coalition government. Efforts to increase UK airport capacity are being blocked. Energy policy is not delivering sufficient capacity to meet projected demand. The benchmarks in the Growth Review seem to be set deliberately low and/or general so that they may be easily achieved. The Government gives the impression that deficit reduction alone will solve the UK’s problems, it will not. Britain needs to develop a clear plan which does not affect the rate of reduction in UK public expenditure but does increase the long term growth rate of the UK economy. To discover how we looked at proposals made by fourteen groups from across the political spectrum.

The Confederation of British Industry proposes making equity finance tax deductable, establishing an aggregation platform for small businesses to raise bond finance and introducing a National Exports Strategy with an export enabling test for all regulation. The Federation of Small Businesses urge the government to bypass the existing banks, create a Post Bank to lend to local businesses and introduce a Community Reinvestment Act to direct bank funding to poorer communities. UNITE and UNISON urge a clamp down on tax avoidance and the introduction of a Robin Hood tax on financial transactions to end public spending reductions and provide financial assistance to repair the balance sheets of indebted households. Reform advocate reductions in health and welfare expenditure and a broadening of the tax base to fund tax simplification and reduction.

The British Chambers of Commerce proposes a long term manufacturing strategy for the UK, the formation of a British Business Bank and a government procurement strategy which recognizes the costs of UK regulation when selecting government suppliers. Policy Exchange want increases in the ISA allowance to encourage private investors to invest in small firms debt, the abolition of national pay bargaining to increase public sector efficiency and planning reform to allow the construction of new ‘Garden Cities.’ The Institute of Public Policy Research seeks to increase aggregate demand and the long term growth potential of the economy by increasing quantitative easing and additional infrastructure spending funded by tax increases such as a mansion tax. NESTA in cooperation with he Work Foundation identify six barriers to growth that potential high growth firms and existing high growth firms say need to be overcome to convert more of the former into the latter.

The Social Market Foundation believe the government should increase the efficiency of public spending and boost demand by spending less on items with a low fiscal multiplier such as the winter fuel allowance and more on items with a high fiscal multiplier such as infrastructure investment. The Centre for Policy Studies advocate measures to increase house building, which helped Britain’s economy perform well in the 1930’s, suspending the National Minimum Wage for under 21-year-olds to tackle youth unemployment and more rapid increases in the personal tax free allowance.

The TaxPayers’ Alliance and the Institute of Directors urge the adoption of a programme of tax reduction and simplification by introducing spending targeting to reduce public expenditure, which would fund the abolition of eight taxes, the merger of national insurance and income tax and the greater localization of taxation and expenditure to increase public sector efficiency. The IMF supports the targeting of funds to the most indebted households to help them to repair their balance sheets and resume consumption levels. The OECD propose structural reforms including reducing welfare payments, controlling health expenditure, reforming planning regulations and targeting resources at improving the education of the poorest to reduce education inequality in the UK. Civitas recommend a British industrial policy to aid British firms to develop comparative advantages in the marketplace and to build a stronger UK manufacturing sector.

To ascertain how other countries are dealing with the Great Recession I chose three countries which have each returned to economic growth. The United States has experienced high productivity growth and more rapid bank deleveraging than similarly indebted states. German labour market reform and industrial policy are analyzed to consider how this nation has increased its proportion of world exports while the UK’s has declined. Israeli success at innovation is considered to identify how that small country became a world leader in ICT with greater Venture Capital Investment per capita than America and more countries on the NASDAQ than the whole of Europe combined. Each of these case studies helped inform the fifteen proposals I have identified for immediate adoption by the Government which are listed below.
  1. The UK should not exceed international regulatory standards unless the enhanced UK regulation can be shown to not damage UK economic growth. This rule should apply not merely to the scope of the regulation but also to whether competitor nations are effectively enforcing the rules they have signed up to. Areas requiring immediate reform include:
    • The Bribery Laws which should be amended to exclude application to countries not in the OECD.
    • Bank capital requirements which should be reduced to the internationally agreed standards to allow more lending.
    • The Carbon Price Floor which should not be introduced.
  2. Cease UK diplomatic support for trade protectionism against UK goods by Less Developed Countries and push for full market access as a condition of opening the EU market to these countries.
  3. Cease the subsidy for green industry and develop a comprehensive energy policy to exploit the UK potential in shale gas.
  4. A British Business Bank should be launched using the funds from the Green Investment Bank, which should be abolished, and the sale of shares in UK state owned banks. This new entity should be given the explicit function of providing funds to small and medium sized enterprises denied access to private bank finance with private institutions being given the right of first refusal.
  5. International development aid should be eliminated and the funds used to endow a UK infrastructure bank with a set charter instructing it to finance enhancements in UK road, rail and energy infrastructure.
  6. Spending targeting should be adopted in addition to targets relating to the debt to GDP ratio and the elimination of the structural deficit to enhance the government’s deficit cutting credentials and ensure the UK government deficit is reduced on schedule.
  7. Merge Income Tax, Employers National Insurance and Employees National Insurance into a single tax rate for all workers under 65 before 2015 to simplify the personal taxation system.
  8. The one-in-one-out rule should be increased to a one-in-two-out rule and extended to cover all UK regulation with no exemptions and enforcement of the rule by all departments should be subject to an annual statement before Parliament with a new system of fines being applied to departments which do not implement the policy in full.
  9. End the opposition to Heathrow expansion, allow the construction of an additional runway and work with private operators to expand the number of flights to emerging markets arriving in London and the regional airports.
  10. Cancel High Speed rail and divert a proportion of this funding to improve the existing rail commuter links into our major cities, widen platforms, increase the number of carriages and cap fare increases and a proportion to make up the funding for a UK infrastructure bank taken from the Green Investment Bank which itself was raised by the sale of High Speed rail licences.
  11. Privatise the existing UK Motorway Network and introduce a toll based system combined with the elimination of fuel duty and road tax. Use the funds raised through privatization to further reduce UK indebtedness and the income raised from taxing the new private entity to allow for the maintenance of the local road network.
  12. Introduce a triple lock for welfare payments pledging to increase them by the lower of three indicators, inflation, average earnings or 2.5 per cent until 2015 (excluding those on disability benefit). Earmark any savings to reduce the basic rate of income tax to increase work incentives for poorer citizens.
  13. Regionalise the national minimum wage to ensure the incentive to work is maintained in areas where private sector wages are low and match this with full implementation of the governments cap on immigration into the UK to reduce the competition these low wage workers face.
  14. Reform the planning system to provide cash incentives to households affected by development to back construction, increase the thresholds those wishing to block planning applications must exceed and introduce reviews of the planning burdens imposed by each local authority with financial penalties for those which do not reduce regulatory costs.
  15. Review the UK’s association with the European Union and negotiate the repatriation of powers to decide UK employment and social policies or withdraw from the EU.

In November 2010 Chancellor of the Exchequer George Osborne and Business Secretary Vince Cable initiated a Growth Review to increase UK economic growth. The background was not fortuitous. The government deficit, the difference between tax revenues and public expenditure in the fiscal year, was 11 per cent of GDP in 2009-10.1 Government was borrowing one pound in every four it spent.2 Government debt, the sum total of present and past borrowings not yet repaid and accumulated interest, was set to increase to 74.4 per cent of GDP by 2014-15 from 44 per cent of GDP in 2008-09.3 Increasing the rate of UK economic growth offered the coalition a less painful means of adjustment, possibly reducing the amount of cuts to public expenditure and increases in taxation necessary to balance the budget.

Two years after the Growth Review began UK economic output remains around 3 per cent below its peak and the National Institute of Economic and Social Research do not predict it will surpass the 2008 level of economic output until 2014.4 The Government deficit has been reduced by a quarter, mainly through tax increases and reductions in capital expenditure. The deadline to eliminate the structural deficit, the gap between tax revenues and spending that will not be addressed by a return to trend rate economic growth, has been postponed from 2014-15 to 2016-17. Plans to stop Government debt still rising as a share of GDP by the end of the Parliament are in danger. Reductions in Government consumption spending have barely begun. They will need to be deeper and last longer than originally forecast. The deficit reduction plan is essential but it alone is not enough to restore the UK to economic health.

Excuses can be made for the current economic woes. The previous government badly mismanaged the economy. In 2010 the IMF estimated the UK had the highest structural deficit in the OECD.5 Britain entered the crisis with a high structural deficit, recently revised up, of 5.2 per cent of GDP in 2007/08.6 The opposition Labour party is vocal in opposing each proposed reduction in government expenditure but more quiet on how they would close the deficit without matching reductions in public expenditure or further increasing taxes. The Eurozone is the UK’s major export market and its continued stagnation will affect UK growth in the short term. The IMF note that “economies with the strongest trade ties to Europe have generally seen the largest downgrades” but the British public expects economic growth to resume.7 The coalition did not create this economic crisis. They now own it. We need a proper roadmap for economic growth rather than excuses for continued hardship.

1 HM Treasury, Budget 2010, Budget Report: Deficit Reduction: Rebalancing the UK economy, P8.
2 HM Treasury, Key Spending Review Announcements
3 HM Treasury, Budget 2010, June 2010
4 National Institute of Economic and Social Research, Estimates of Monthly GDP, 9 October 2012
5 HM Treasury, Budget 2010, P9
6 The Telegraph, Labour ran a structural deficit in 2007, 25 October 2012
7 IMF, World Economic Outlook, April 2012: Growth Resuming, Dangers Remain, P49

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