HOW TO AVOID 20 LEAN YEARS / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( A MUST READ )

How to avoid 20 lean years

By Martin Wolf

Published: March 24 2011 23:32

Which member of the Group of Seven leading high-income countries has registered the largest increase in real income per head over the past 20 years? The answer, according to the Conference Board’s database of gross domestic product, at purchasing power parity, is the UK. Between 1990 and 2010, its GDP per head rose by 36.5 per cent. This was ahead of the US (up 32.9 per cent), Canada (32.0 per cent), Germany (29.3 per cent), France (23.1 per cent), Japan (18.4 per cent) and Italy (17.1 per cent). The UK performed well over this period. The question is whether this performance was also unsustainable. Must 20 lean years now follow 20 relatively fat ones?


The government’s answer is: yes and no. Growth was unsustainable, but the economy need not stagnate.

According to its Plan for Growth, presented with the Budget, UK performance was characterised by excessive debt accumulations, unsustainable rises in house prices, inordinate fiscal deficits and inadequate business investment. Growth was also concentrated in the south-east, while other parts of the country grew increasingly dependent on public spending. Moreover, the financial sector’s share in GDP rose from 6.5 per cent in 1997 to 8.5 per cent in 2007, while that of manufacturing fell from 20 per cent to 12.5 per cent over this period. Moreover, it argues, the economy was becoming ever more regulated, and the tax system increasingly complex and inefficient.


This is a case for the prosecution of the previous, Labour, government, not a balanced assessment. What is missing is an appreciation of how far these processes were driven by market forces – the inflow of funds from abroad and high profitability of the financial sector, and so the high value of the pound and squeeze on manufacturing. I have little doubt a Conservative government would have made some of the same errors.


Yet the coalition government is correct that, whatever the reason for it, some part of this pre-crisis growth was unsustainable. Moreover, the financial crisis, with its legacy of huge fiscal deficits, has made the degree of unsustainability greater. The government’s response is to argue that near-term stagnation can be avoided by focusing on incentives for supply rather than on fiscal support for demand. This is not altogether implausible: the right policies might increase investment spending, for example. Some would argue that eliminating the huge fiscal deficits would promote consumption directly. Yet, at bottom, the government’s position is that there is no alternative to stringency, anything else would be even worse.


Let us not rehash this argument. Will the supply-side policies at least raise underlying growth in the longer term? The answer is: to a modest extent, perhaps. Remember that every government – including the previous one – justified its policies by the proposition that they would raise growth. But growth is a complex process, governed by deep historical forces. It is extremely hard to manipulate, especially in high-income countries, where easy opportunities have, by definition, already been exploited. One should be extremely sceptical of any simple propositions that suggest otherwise.


How well, then, does the coalition’s agenda stack up? Its broad objectives are to make the tax system the most competitive in the Group of 20 leading economies, make the UK one of the best places in Europe to start, finance and grow a business, to encourage investment and exports, and produce a more educated, flexible workforce. These are reasonable aims. Moreover, a number of sensible initiatives are advanced under these principles. The question is how much difference any of these would make.


The easier changes, of course, are those where the government gets out of the way, by reducing regulation, lowering and simplifying taxes, removing obstacles created by the planning system and so forth. But some of all this requires positive action by the government, in education, for example, or investment in infrastructure, or support for advanced manufacturing.


It is very hard to be optimistic about the government’s ability to get such things right. The UK has a long record of underinvesting in infrastructure, which is being continued under the current government. Similarly, the clearest lesson from the review by my wife, Alison Wolf, of the UK’s vocational education is the dismal absence of coherent policymaking by governments over a generation. Indeed, their efforts have made already bad situations even worse.


So has the government a growth strategy that will make a positive difference? Over the short to medium term the answer is no, except to the extent that it has averted a fiscal calamity. For the longer term, the answer is: maybe. Its broad directions are sensible. But how much difference these efforts will make is also highly uncertain. This is not an argument against trying. It is an argument against belief in a growth fairy. The UK faces a hard slog. That is the grim reality.
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Copyright The Financial Times Limited 2011