What is wrong with Britain’s economy?

As we approach the General Election this Thursday, politicians are battling over the question of ‘what is wrong with Britain’s economy’? The usual suspects are out in force: “Benefit-scroungers”, “fat cat bosses”, “price gouging energy companies” to name a few. What I find frustrating – not to mention depressing – is the lack of substance behind many of these arguments. Rarely is any evidence actually presented, beyond the odd suspect anecdote such as immigrants supposedly causing traffic jams on the M401.

Here is what I think is the biggest problem facing Britain’s economy: low productivity. I’ll suggest three policies that I am confident would help solve this problem. Unfortunately, I fear that none of these policies have much chance of being implemented.

Productivity is a term economists use to describe how effectively the economy uses its inputs. For example, if the economy can produce the same level of output (GDP) with less workers or factories then it has become more productive. Those workers or factories no longer needed can be used to produce something else. This way overall output per worker increases, which means everyone should become richer. In contrast, simply building more factories or employing more people won’t necessarily make the economy more productive, even it leads to an increase in GDP.

Britain’s productivity track record is very poor. Not only is our productivity – measured as output per hour – below 2007 levels, it is has also substantially lagged all other post-recession recoveries. It is also way below the US, France, Germany and even lags Italy (!). (These three charts are taken from two recent articles on this subject from the Telegraph2 and The Economist3.)

UK prod history

UK prod post recessions

UK prod country comparison

The reasons for Britain’s low productivity (good at employing people but not very good at using them effectively) have been relatively well charted. But what changes can the Government make to help correct this problem?

Here are three policy suggestions:

Rip up the Town and Country Planning Act. In the 1970s, Britain built 300,000 new homes a year. Today we build less than half this amount, despite having a larger population, vastly more expensive housing and an obvious demand for more homes. That is a dysfunctional market. Extortionate housing costs reflect the arcane planning system, which itself stems from the 1947 Town & Country Planning Act that empowered local planning authorities to block new developments. The system worked for a while in the 1950s and 1960s when the home ownership rate was low and there was huge demand for new homes, but in recent times it has served to protect the interests of those who already own property.

Whatever your views on the ethics of this situation, there is no question it is highly unproductive for the economy. Land is not a productive asset. As its price spirals upwards, those workers who need to find shelter have to pay more for it either in the form of higher rent or mortgage repayments. Firms who employ those workers may also need to pay them more. This raises the overall input cost to the economy – and yet for no good economic reason. In my view, the Government should repeal the Act, replacing it with a new system that will ensure more land and housing development so that housing costs start to come down. That so few of Britain’s OECD peers have this problem suggests it shouldn’t be too difficult to achieve.

Promote more skilled immigration. The UK Independence Party (UKIP) will no doubt try to claim otherwise, but the evidence I have seen paints a clear picture. Immigrants are a positive for Britain’s economy. They contribute more in tax payments than they take out in benefits. A recent study4 of EU migrants concluded they had made a net £20bn contribution to the economy over the past decade. No doubt there are individual examples where the system has been abused (there always are) but it seems this is not the case in aggregate. Immigrants are particularly positive for productivity when they have useful skills. That Polish construction company that built your loft conversion for 20% less one week faster than you expected is making a healthy contribution to the UK’s productivity. I do accept, as UKIP frequently protest, that immigration places pressure on public services. But this is not an argument to stop immigration. It suggests we need to invest more in our public services in order to service a healthily growing demand.

Lay off on austerity. It surprises me that all the major political parties agree on the necessity of achieving a balanced budget. Of course it sounds very responsible, and it is – if you are a household or a company. But the Government is in a very different position. They have the power to tax, spend and borrow. Currently, the UK Government can borrow money for 10 years at 1.6% and for 30 years at 2.3%. This is an exceptionally low cost of capital, and certainly does not indicate any current funding difficulty.

We often hear politicians say that austerity is necessary to avoid tax increases. But this is only the case if money is spent unproductively. Long-term capital projects such as better infrastructure, public services or scientific research are very likely to pay for themselves through higher productivity, GDP and tax revenues in future years. The Government should take advantage of the current exceptionally low funding costs and make these investments now, or provide incentives for others to make them. This is not to suggest going on a massive irresponsible spending spree; the fiscal deficit ultimately will need to come down. But it is possible this could be achieved through future economic growth rather than simply cutting fiscal spending today.

I hold very little hope that any of these policies would even be seriously considered by politicians. Property speculation is so endemic within British society that rocking the boat with controversial policy change seems unlikely. Meanwhile, the rise of UKIP in the polls has terrified the main parties from saying anything sensible on immigration. And now it seems even Labour have become converts to the balanced budget mantra.

Matthew Tillett

 

1. http://news.sky.com/story/1464020/polish-prince-challenges-nigel-farage-to-duel
2. http://www.telegraph.co.uk/finance/economics/11452004/British-productivity-is-a-national-disgrace.html
3. http://www.economist.com/news/britain/21646235-if-britain-cannot-get-more-its-legion-cheap-workers-recovery-will-stall-bargain
4. http://www.ft.com/cms/s/0/c49043a8-6447-11e4-b219-00144feabdc0.html?siteedition=uk#axzz3Ygz7Btta

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Author - Matthew Tillett

Matthew Tillett

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