UK growth policies - the good, the bad and the unintentional

Following this week’s Spending Review and as the Labour government approaches one year in office, this blog asks whether its policies will boost productivity growth? There are some very welcome measures but there are also areas where policy seems likely to damage productivity prospects. Intriguingly there is one policy area where business opinion has generally been negative but might, paradoxically, and largely unintentionally, be good for productivity.

The good news. First, the effort to speed the planning process is very welcome. Already, various house-building and commercial schemes have been swiftly approved by central government, often over-ruling local planning decisions. There is much more to do to deregulate planning, building and environmental rules – and it is not clear how far the government is willing to go - but the intention is clear. This gives a green light for business to plan for investments.

Secondly, accelerated expensing for business investment, introduced by the previous government, has been maintained. This appears to have already boosted the investment trend in the UK, after the pause following the Brexit vote, (see chart). Higher investment is one crucial requirement for higher productivity growth, though it is not the only one.

The third area – and this is the one that is paradoxical and unintentional – is that the Labour government has made it less attractive to hire people. Increased employer national insurance contributions, a sharp higher minimum wage (especially for young people) and new worker and union rights makes investing in machines more attractive. Low productivity growth in the 2010’s was often blamed on companies hiring low wage- low productivity staff. Labour has made that a much less attractive business model.

On the negative side, although the government is prioritising capital spending, the choices of how to spend it are not encouraging for boosting general productivity. According to the Spending Review public investment is set to run at about 2.6% of GDP over the current parliament after dipping as low as 1.3% of GDP in 2013. This level of public investment is welcome, except that much of it is on defence, net zero investments and for public services (eg health and education). Many of these are welcome and needed, and there also could be growth spillovers, even for defence spending if it boosts technology development for example. But new investments in transport and science, innovation and technology – the areas usually thought most likely to boost general productivity – are modest.

Another big area of government spending is on net zero. Enthusiasts believe this will eventually pay off in lower energy costs. But we are not there yet. The UK has one of the highest electricity costs in the world – admittedly partly because of its reliance on expensive natural gas, but also because of the rapid push into renewables. While the marginal costs of solar and wind have fallen dramatically, the capital costs have risen with the return to normal interest rates and of course they need to be backed up with all-weather power sources or batteries. The costs of insulating houses and new building mandates (eg for solar panels on roofs) will lower productivity too.

As an aside, I should add that I am referring to ‘productivity as measured’. Enthusiasts for net zero policies argue that the benefits of reducing emissions are not captured in the GDP figures. I am sure this is true but I wonder whether the average person thinks they are better off driving an electric car or using renewable energy if it is actually more expensive than before.

Finally, although the budget deficit is projected to contract, investors are sceptical. The Spending Review contains implausibly low spending forecasts for later this decade which will almost certainly be revised upwards later (as usually happens). Meanwhile, the Chancellor’s fiscal rules, by separating capital spending from current spending allow for a larger overall deficit. The only constraint is that total debt is supposed to be falling three years later, (currently five years but falling to three). This is not a very binding constraint when the reference year perpetually rolls out.

UK 10-year Gilts yields moved above US yields a while back and may stay there. This is partly a reflection of higher inflation and therefore a higher path for policy rates, but also reflects worries that the fiscal picture is strained. A drop in US yields would likely help gilts yields to fall too, but cant be depended on.

Implications for investors

The trend growth of the UK economy is likely somewhere around 1-1.5%, given population growth and a continuation of recent productivity performance. This is barely enough to meet heavy demands for rising health, pension and defence spending, as well as higher interest payments. Hence the fiscal position will remain strained and there is a risk we face another summer wondering which taxes will have to increase. Nor does it allow for a rapid rise in living standards which might lift the gloom over Britain at present.

Longer term, government measures so far are unlikely to raise productivity significantly. The best hope is that business reacts to new technological possibilities, including AI, robotics and automation generally, to raise investment and hire fewer workers. Perhaps the government has unintentionally given that a boost! Relaxing planning restrictions will help it along and i hope the government persists in this direction. Absent a private sector-driven productivity improvement, the outlook for UK productivity remains lacklustre.