THE “”HOW?”, THE “WHY?” AND THE “WHERE?” OF THE BRITISH ECONOMY
Although the focus here is avowedly global rather than local, it isn’t difficult to justify another examination of the British predicament. The situation is, after all, quite remarkable. Having opted for withdrawal from the European Union (“Brexit”), Britain now finds herself on the brink of critical negotiations without a credible government to do the negotiating.
The horrific fire in Kensington shines a disturbing spotlight on economic and social policy assumptions, as well as on disparities between rich and poor. With the economy deteriorating, there is no consensus on what to do about it. Rather, the “Brexit” affair revealed the rancorous nature of divisions within society.
In order to examine the economic situation in a succinct way, this discussion looks at three issues in sequence. The first is the state of the economy. The second is how it got where it is. The third is what, if anything, might be done to put it on the road to recovery.
An economy in trouble
The economy of the United Kingdom is in a pretty parlous state, which makes it all the more remarkable that economic issues were given little or no attention in the recent election. Labour did propose some changes, but the workability of nationalization, in particular, has to be debatable. The Conservatives essentially offered more of the same, which would have ensured continuity along a path of proven failure.
Growth seems to have fallen sharply, and may now be nearer to zero than to prior forward assumptions of around 2%. Reported growth (of 12%) over the decade to 2016 comes with serious caveats. The expansion in GDP between 2006 and 2016, expressed at constant 2016 values, was £203bn, but this was accompanied by a £1.18 trillion expansion in debt, equivalent to £5.80 of net borrowing for each £1 of reported growth.
Of this borrowing, businesses accounted for just £40bn, or 3% of the total. The vast majority of borrowing was attributable to government (86%) and households (11%). Both are consumption-related forms of borrowing, strongly implying that growth has been flattered by the simple spending of borrowed money.
Adjusting for this, SEEDS estimates underlying GDP in 2016 at £1.51 trillion, 22% below the reported £1.94 trillion. Though large, the £420bn gap between these numbers isn’t hard to find. Underlying trend growth for 2016 is estimated at 0.4% – which is lower than the rate at which the population is expanding (0.7%) – and seems certain to fall still further, given the challenges going forward.
This is bad enough, but the implications for individual prosperity are even worse. The cost of household essentials has been rising at roughly twice the rate of reported inflation, implying that a steady rise in ECoE – the energy cost of energy, emphasised in the Surplus Energy Economics approach – is undermining prosperity. Adjusted also for the increase in population numbers, SEEDS puts average per capita prosperity last year at £20,600, a fall of 13.4% since 2006 (at 2016 values, £23,900). No other major economy has fared this badly.
This SEEDS view is corroborated by a host of “conventional” economic data. Average real wages have been declining since 2009, and no-one seriously expects this to change in the foreseeable future. The current account is heavily (£85bn) in the red, whilst productivity is lamentable. Reported debt (of £4.88 trillion) excludes huge shortfalls in public- and private-sector pension provision, and the tax base seems to have deteriorated to the point where the government cannot fund public services to the standards to which people have become accustomed. There is a very real prospect of “stagflation”.
The reason why – a damaging policy vacuum
In terms of effectiveness as a system of representative democracy, Britain’s political processes have some significant weaknesses. Elections to Parliament are conducted on a first-past-the-post (FPTP) basis which guarantees the dominance of the two established parties. The upper chamber isn’t elected at all, which impairs its ability to advise and restrain. There is no American-style “separation of powers” between the executive and the legislature.
The biggest single weakness with this system is that it relies on confrontation between the two major parties. Tragically, this historic antagonism disappeared in the mid-1990s, when the opposition re-styled itself “new” Labour, and adopted the same economic tenets as the Conservatives. As a result, a politically-influential check on the incumbent economic orthodoxy ceased to exist.
Lacking such a challenge, pro-market economics morphed into a dogma which extended prior policies into dangerous extremes. Even more than the United States, Britain became the poster-child for “liberal” economic ideas taken to their (il)logical conclusions.
The resulting orthodoxy had some glaring weaknesses. It misunderstood risk, deregulating the financial system to the point at which Britain lectured other countries on the supposed virtues of “light-touch” regulation. It assumed that public services could be managed along lines of internal quasi-competition, and welcomed private encroachment into the role of the state. In a climate which emphasized “spin” over substance, government horizons became excessively short-term, which caused particular problems in fields as different as debt and energy. It failed to distinguish between making money and adding value. The virtues both of prudence and of the mixed economy were rejected.
Like any form of extremism, this extended exercise in orthodoxy had serious consequences. The economy became increasingly unbalanced, with value-productive activities like manufacturing displaced by real estate, “out-sourcing”, and simply moving money around. Public services were fragmented, whilst the fiscal system increasingly favoured speculation over innovation. In the mistaken belief that Britain could compete with emerging economies (EMEs) on the basis of price (rather than quality), real wages were allowed to deteriorate, which undermined the tax base whilst encouraging an undue reliance on consumer debt.
An avowed policy of “openness”, together with a lack of concern over debt, resulted in asset sales and overseas borrowing being used to finance trade and income deficits with the rest of the world. This in turn created a self-reinforcing deterioration in the current account, as returns on past capital transactions turned relentlessly into outward flows.
To an unquantifiable (but undoubtedly serious) extent, the logic of economic policy eroded ethics, particularly where the treatment of customers and employees was concerned. This is why banking (but other industries too) became scandal-prone, and neither in the public nor the private sector was much done to enforce accountability. Thus, when a business is discovered to have engaged in dubious practices, it is invariably the shareholders, not the decision-makers, upon whom sanctions are imposed.
The prevailing orthodoxy described here can be identified as the cause, not just of Britain’s economic woes, but of many of its social problems as well. Thus, inequalities between rich and poor, and between young and old, can be traced to the same economic extremism which has undermined prosperity, reduced real wages, prompted excessive borrowing, channelled investment into the “capital sink” of overvalued properties, created asset bubbles, worsened working conditions and security of employment, and eroded the tax base.
The abandonment of confrontation, then, set Britain’s political elite free to embark on an increasingly extreme and dangerous economic path.
Is there an escape route?
Given the scale of the economic and social harm inflicted by a political consensus around a failed orthodoxy, the election of Jeremy Corbyn as leader of the opposition Labour party should have been welcome even to Conservatives – the return of Labour to its social-democratic (or perhaps socialist) roots should help ensure that extreme policies no longer go unchallenged. Changes now seem inevitable, and this has to be positive. What matters, though, is whether the right kind of changes will take place.
Labour has declared itself hostile to the over-domination of important sectors by small numbers of players. The party is surely right to target rail, water and energy, and could usefully add telecoms to the list. Unfortunately, Labour’s preference for nationalizing these sectors seems less than ideal. The public might be better served by breaking them up, such that no single player has a share of 10% or more of any important market.
Similarly, Labour’s preference for imposing higher taxes on “the rich” needs to be nuanced differently. The real problem isn’t income inequality so much as the imbalance between income and assets. Increasing taxes on high incomes is likely to be counter-productive. Instead, and whilst Mr Corbyn might contemplate a wealth tax, the real imperative is to rebalance fiscal and other incentives towards innovation rather than speculation. Logically, taxation of capital gains should be increased, not least because many of these gains have been the direct result of monetary policy – in other words, the authorities are surely entitled to claim a sizeable share of asset gains that they have themselves created.
If higher taxation of capital gains is imposed, there are several glaringly obvious areas in which these proceeds can be used in the interests of economic regeneration. One of these is a much-needed programme of building homes at affordable rents. Another is to reduce the tax burden on small and medium enterprises, most obviously by freeing them from the regressive Business Rates levy. A third would be to reduce the taxation of low wages, which ideally would include merging income tax with NI (national insurance). Another would be to reintroduce dividend tax exemption for pension funds, a pro-saving policy which had been accepted by all parties prior to Gordon Brown’s notorious 1997 “tax raid”.
Perhaps even more importantly than these “mechanical” measures, Britain needs a renewed emphasis on ethics, and needs to legislate enhanced protection for employees, customers and tenants. This needs to be accompanied by enforcing much more accountability on decision-makers, not just in business, but in the public sector as well.
Will such desirable changes happen? Perhaps ironically, the sheer scale of Britain’s current problems gives some grounds for optimism. The rise of Jeremy Corbyn to unchallenged leadership of the Labour party has effectively smashed one half of the unhealthy consensus around a mistaken economic orthodoxy. The loss of Mrs May’s majority may prove to have been a humbling as well as a crippling blow to the other half of that consensus.
Meanwhile, public opinion is palpably shifting against perceived “unfairness” between rich and poor. The chancellor having stated that “economic” considerations will guide negotiations about “Brexit”, it is to be hoped that he did mean economic factors, not simply ‘profit’.
The final issues have to be those of whether the necessary changes can occur harmoniously, and without a swing to opposite extremes – and whether the economy can respond in the limited time which Britain still has at its disposal.
Even if the right lessons are learned, and quickly, it’s going to be – in the words of the Iron Duke – “a damned near-run thing”.