InsTEAD Annual Lecture Prof Tim Besley (LSE)

Policy Challenges for the UK Economy

@insteadsheff #insteadAL15

Policy Challenges for the UK Economy

Tim Besley

October 6th 2015

Preamble

• I prepared these slides before George Osborne’s Party Conference Speech on October 5th and I have not update them.

• BUT while I was typing them ….

To My Surprise

To My Further Surprise

Preamble

• I prepared these slides before George Osborne’s Party Conference Speech on October 5th 2015 and I have not update them.

• BUT while I was typing them ….

• I have made no attempt to update what I say based on this

– But a few comments on all this later.

Key Issues

• Recent political and economic events have widened the debate about economic policy in the UK

• Following the financial crisis, there was a near obsession with short term factors – Stabilizing the financial system

– Repairing the damage to the public finances

– Learning to live with and understand the implications of the zero lower bound

• The risk is that this focus crowds out discussion of longer time challenges. – This will be main focus today but in the context of recent events.

Outline

1. General discussion of the role of government particularly in enhancing prosperity.

2. The economic story of the UK and how it relates to this.

3. Some proposals

- Some of which come from the LSE Growth Commission

4. Speculations

Prosperity

• Increasing GDP is not an end in itself

– It is valuable only if it enhances human capability.

– But whose capability and how measured?

• In the long-run economic prosperity is driven by:

– Technological advancement

– Moving towards the technological frontier

– Reducing resource misallocation

• Turning it in greater well-being depends on

– How any gains are distributed

– What negative bi-products are created in the process

The Role of Government

• The role of government is implicit in

– Enforcing property rights (especially intellectual property rights)

– Funding/promoting innovation

– Supplementing market through infrastructure

– Funding collective goods

– Regulating negative externalities

• Traditional focus of economics was on market failure with a benevolent government

The Role of Government

• Two problems of government failure

– Ignorance

• Does government know which policies to implement?

• Cost-benefit analysis as a tool

– Institutional failure

• Do institutional arrangements create good incentives for identifying and delivering growth enhancing policy?

• Do governments create too much background noise? – Macro-economic uncertainty

The Role of Government

• Institutions for promoting prosperity

– The role of politics

• Important in a democratic society

• But role for a balance of independence + accountability

– Accepted in areas like

• Central banking

• Regulation

• The Law

Getting Interventions Right

• Shift in focus to building institutional structures which support policy-making.

– Had created a post-Thatcher policy consensus – which continued under New Labour

• Since 1980s less acceptance of state-led solutions – Suspicious of state ownership

– General move towards de-regulation

• Less focus on inequality

– Peter Mandelson was • “intensely relaxed about people getting filthy rich as long as they pay their taxes"

The UK and the Post-Thatcherite Consensus

• UK has – long-established rule of law and robust parliamentary institutions

– strong tradition of press freedom

– Openness immigration

• Thatcher reforms (continued by New Labour) included: – Tougher competition through privatization; independent regulators; competition policy

– Flexible labour markets through reforms to employment services, benefits & union law

– Increases in university education (5% had degree in 1980 compared to 31% in 2011)

– Openness to FDI & immigration

• There was a reversal of the UK’s relative decline in the three decades leading up to the financial crisis.

USA

USAUSA

USA

GerGer

Ger

Ger

Fr

Fr

Fr

Fr

0

20

40

60

80

100

120

140

160

1870 1950 1979 2007

Per

cen

t

UK

DECLINE AND REBOUND:

RELATIVE GDP PER CAPITA FROM 1870

Source: LSE Growth Commission

UKUSGer

Fr

-40

-20

0

20

40

60

80

100

120

140

160

1950 1960 1970 1980 1990 2000 2010

Per c

en

t

UK US Ger Fr

A REVERSAL OF MISFORTUNE:

GDP PER CAPITA, 1980=100

Source: LSE Growth Commission

0.4 0.5

0.6 0.5

0.6

0.1

0.1

0.5

0.7

0.3

0.8

0.2 0.4

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

1979-1997 1997-2007

An

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gro

wth

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es i

n p

erce

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ge

poin

ts

Financial intermediation

Business services and

renting of m&eq

Distribution services

Personal and social

services

Other goods producing

industries

Manufacturing

excluding electrical

Electrical machinery,

post and communication

Reallocation

PRODUCTIVITY GROWTH (GDP PER HOUR ) :

IT WASN’T ALL FINANCE

Source: LSE Growth Commission

Deficiencies (Debated to varying degrees)

• Inclusivity: rise in inequality

• Long-term investment problems – Human capital (especially bottom third)

– Infrastructure (especially transport & energy)

– Private investment & Innovation

– Low productivity

Men

Women

0.85

0.95

1.05

1.15

1.25

1.35

1979 1984 1989 1994 1999 2004 2009

90

-10

Log

FT

Wee

kly

Wag

e D

iffe

ren

tial

s

Men Women

THE INEQUALITY CHALLENGE: GROWING

WAGE DIFFERENCES

Source: LSE Growth Commission

Investment and Innovation

UKUS

GerFrJp

0

5

10

15

20

25

30

35

40

1970 1975 1980 1985 1990 1995 2000 2005

Per c

en

t

UK US Ger Fr Jp

Low Productivity

25,000

30,000

35,000

40,000

45,000

50,000

55,000

60,000

65,000

70,0001

97

9

19

81

19

83

19

85

19

87

19

89

19

91

19

93

19

95

19

97

19

99

20

01

20

03

20

05

20

07

20

09

20

11

GDP per working age adult (2011 $ , PPP)

UK

US

Germany

France

UK Political Economy

• Core structure based on Parliamentary system – Typically with stable majorities/coalitions

• But Institutional Reforms included significant use of independent bodies: – Competition Commission & OFT

– National Institute for Health and Care Excellent (NICE)

– Bank of England MPC

– Office of Budgetary Responsibility

– Migration Advisory Committee

– Low Pay Commission

– Pay review bodies

• Why? – Allowed politicians to avoid politicizing tough decisions

– Brought in external expertise

Investment and Policy Challenges

• Policy failures (procrastination, reversals)

– Difficulties of investing for the long-term • Short-term political horizons

– Adversarial politics causes tinkering, rebranding, reversals • Lack of commitment to policy

– Lack of independent expert advice & evaluations • Tradition of secrecy and celebrity reviews which lead to inaction

– Populist pressure • All elections are won and lost by a relatively small number of swing voters

• Outcome is high uncertainty & low investment in long-term assets

– Core to understanding our low productivity

Human Capital

• Arguably in the end, little else matters for prosperity beyond the skills and motivation of the work force.

• Strong relationship between skills & growth – Quality not just quantity of schooling matters

– Teaching most important input

– “Double Dividend” of increasing human capital of disadvantaged: boosts growth & reduces inequality

• Specific UK problems – Mediocre test scores (e.g. OECD PISA)

– “Long tail” of underachievement

– Stronger link between disadvantage and low academic achievement than in other countries

BETTER COGNITIVE SKILLS ASSOCIATED

WITH FASTER GROWTH

Source: Hanushek & Woessmann (2012)

What the UK Needs?

• There has been an emerging consensus across the past two governments:

– Flexible ecology for schools with accountability and autonomy

• But mixed views on whether to focus on disadvantage

• Insufficient attention to improving teacher quality

– Evidence is overwhelming

• Have made progress with all but: – Vested interests

– Too much focus on average

– Adversarial political culture makes consensus difficult

Infrastructure

• Problem areas

– Transport (roads, aviation, rail)

– Energy

– 40% cut in capital spending during the first part of coalition government.

• Government induced policy risk

– Lack of clear sense of strategy – uncertainty

– Vacillation in and politicisation of policies and projects

• Rigid planning framework

– Rationale with little economic content

– Limited scope to share benefits

• Rigid and misleading public accounting conventions

A New Institutional Architecture (as proposed by the LSE growth Commission)

Investment and Innovation

• Low investment as a share of GDP

- heavily weighted towards property and buildings

• Weak intangible investment

– Low R&D and patent intensity

– Weak commercialisation

– Poor management quality

• Aggravated by lack of skilled labour and infrastructure investment

Issues in UK Capital Markets

• Short-termism in equity markets

– Link voting to length of share holding

• Lack of competition in retail banking

– Referral to competition and markets authority

• Lack of scale economies in SME financing

– Should UK have a business bank?

• Excessive reliance on debt

– Introduce allowance for corporate equity in tax system

Taxation and Public Finances

• Move beyond austerity debate

• Recognize the implications of ncreasing dependence on taxing the rich:

– top 1%: 1980: 11%, 1990: 15%, 2000: 20%, 2010, 25%

– top 10%: 1980: 35%, 1990: 42%, 2000: 50%, 2010: 54%

• Focus on role of state and worthwhile intervention

– Especially in infrastructure

• Common sense tax reform

– VAT base broadening

– Reform of property taxation

– Merger of income tax and NI

– Restore expenditure tax treatment of savings

Speculations

• The future of independent institutions

• The Localism Agenda

• Measurement and change

• Back to the future

The future of independent institutions

• Proposals to change how the Bank of England operates

– The Bank has been asked to take on a wider range of tasks some of which will prove to be highly political.

• Minimum wage proposals

– Current government has directly announced policy without consulting the low pay commission

• OBR has limited domain

– Especially in accounting for debt which funds infrastructure.

The Localism Agenda

• UK is one of the most centralized political systems in the world

• Which policy and investment challenges be solved locally?

• Thinking behind building appropriate local state capacities is still in its infancy.

• What is the right balance between a national strategy and local engagement though LEP’s?

• Blueprint still unclear

• How to find funding for needed investments?

• Whitehall strangle hold on debt finance

• Is Presidentialism the right model?

Measurement and Change

• Finding ways to encourage publication of non-GDP based measures of progress

– LSE growth commission proposed a focus on median household consumption

• Follow on work of Sarkozy commission

– National happiness measures??

– Measuring capability

– Distribution

Back to the Future

• Are we about to have a debate about reversing the post-Thatcher consensus?

– Who is now making the case for the market?

– Will we see the return of public ownership and industrial subsidies

– How far will we go on activist Industrial policy?

– What reforms in tax policy

Concluding Comments

• Retrospective on the Thatcher-Blair era of policy making

– Saw strong economic performance (reversal of misfortune?)

– But rising inequality

• Where next?

– A more interventionist future?

– How can we address the investment challenges? • This will ultimately determine how far we remain a prosperous nation in future

• And the institutional structure will be key

Thank you very much!