Richard Wellings argues that the Coalition’s economic policies have been founded on mistaken assumptions about growth, leading to a politically convenient embrace of smaller cuts than would otherwise be deemed necessary. He argues that much more radical supply-side reform is needed to get the British economy moving again.
The 2013 Budget was characterised by a large number of gimmicks but little of substance. There were tax breaks for favoured sectors such as ceramics and low-emission vehicles, as well as extra government help for property buyers. More radical measures designed to bring the deficit down more rapidly and to promote economic growth were, however, almost entirely absent.
This was a mistake. Government borrowing, at around 7 per cent of GDP this year, remains at dangerous levels. And this alarming situation cannot entirely be blamed on difficult external conditions such as the ongoing crisis in the eurozone. It also reflects a major error made by George Osborne in his previous budgets and repeated in this one. The Treasury wrongly assumed that the economy would recover quickly and higher growth would lead to a rise in tax revenues. Growth would do most of the hard work when it came to cutting the deficit. This would be politically convenient since spending cuts could be relatively small – less than 5 per cent in real terms during the current parliament.
The growth forecasts the government has relied on, produced by the Office of Budget Responsibility (OBR), have been highly inaccurate however. Back in June 2010, the OBR forecast growth of almost 3 per cent a year for 2012. The outturn was just 0.2 per cent. This extremely poor record raises questions about the extent to which the OBR understands the problems facing the British economy.
Certainly George Osborne and the OBR failed to recognise the scale and persistence of the current slump. This is surprising given the insights of economic theory into the causes of the business cycle. The sheer size of the recent credit boom meant that a painful correction was almost inevitable. Moreover, the stimulus/bailout policies implemented by the Brown government and the Bank of England hindered the market adjustments needed to reallocate resources and restore growth on sound foundations. Instead of being liquidated, many of the bad investments of the boom period limped on, supported artificially by state action. Fiscal and monetary stimuli arguably prevented a very severe initial loss of output, but the trade-off has been a prolonged period of stagnation with little immediate sign of a healthy recovery.
But slow or non-existent growth is also the legacy of harmful policies introduced under New Labour and largely continued under the Coalition. It is well established that as public spending rises as a share of GDP, the long-term rate of economic growth declines. This is because a larger government sector takes resources from the productive, wealth-creating private sector. Particularly after 2005, New Labour indulged in substantial spending increases focused on the National Health Service, top-up benefits for pensioners and higher tax credits for low-income families.
Added to this was an agenda to regulate business more heavily. While much of the new red tape originated in Brussels, it was enthusiastically adopted by UK agencies. For those not actively involved in running businesses, it is difficult to grasp the devastating impact these regulations have had on costs. Vast resources have been allocated to satisfy these bureaucratic diktats, which have had a very significant and negative effect on long-term growth. The Chancellor and the OBR have arguably failed to adequately incorporate the impact of growing state intervention on the long-term ‘trend rate’ of growth.
While the Coalition has at least attempted to reduce public spending as a share of GDP, it has enthusiastically embraced the regulatory legacy of Labour. New rules such as the Equality Act and mandatory workplace pensions have made it riskier and more expensive to hire staff. The Minimum Wage remains in place even though it worsens unemployment among young people. Perhaps worst of all the Coalition retains a strong commitment to environmentalism, with the aim of becoming, in David Cameron’s words, ‘the greenest government ever’. As green regulation proliferates, the cost of basics such as energy, transport and housing is being driven ever higher, choking off growth in the process.
Unfortunately the 2013 Budget largely failed to deal with the various harmful policies that are negatively affecting the UK economy. While there were some positive moves, such as the planned reduction in corporation tax, there were also negatives, such as the addition of further complexity to the tax system. The Budget was therefore a missed opportunity. A more prudent Chancellor would have sought to make much larger cuts to public spending in order to secure stability for the public finances over the medium term. He would also have implemented radical supply-side reforms to lift the regulatory burden on firms and thereby promote growth.
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Dr Richard Wellings is Deputy Editorial Director at the Institute of Economic Affairs.