Following major speeches from Ed Balls and Ed Miliband a couple of weeks ago, the shape of Labour’s economic policy is becoming clearer. Another intervention from Ed Miliband this weekend provided more clarity.
So, what have we learned in the last month?
I think there are three key takeaways. The first is a new emphasis from Labour on the importance of capital spending – an emphasis which makes a great deal of economic sense.
This was evident in Ed Balls’ Reuters’ speech. For most of the past two years Labour’s oft repeated ‘Five Point Plan for Growth and Jobs’ has had at it’s centre a call for a temporary cut in VAT.
There are advantages to a VAT cut – as demonstrated in late 2008 and 2009 it has the immediate impact of putting money in people’s pockets and the useful side effect of lowering inflation (and hence providing some relief from the ongoing squeeze in real wages). However there are also draw backs – it acts in consumption whilst the aim of ‘rebalancing’ is to reduce our reliance on consumption as a driver of growth and in terms of ‘bang for the buck’, it is one of the more expensive ways (in terms of additional borrowing to growth boost) to support the economy.
There are (perhaps more) advantages to a focus on capital spending.
As is now well known the best way to measure the potential impact of a fiscal stimulus is to look at the fiscal multipliers – the relationship between an additional pound of government spending and the boost to growth.
Whether one uses the multiplier estimates of the OBR, the IMF or any other major forecaster the evidence is clear – capital spending has the highest multiplier. In other words, it is the most effective way to support growth.
One disadvantage of capital spending as a way to support the economy has always been the supposed lag in terms of a lack of ‘shovel ready’ projects. This is less of an issue at present with an obvious, clear and pressing need to build more affordable and social housing and also the convenient existence of the National Infrastructure Plan providing a list of potential projects.
We now seem to be in the midst of an extremely weak recovery – weak by international comparison, in terms of the UK’s own historical experience and by contrast to the OBR’s initial forecasts. At this stage in the cycle, when the challenge is to embed, sustain and accelerate a recovery rather than prevent the economy falling off a cliff, there is a clear case for capital spending over VAT cuts as a form of fiscal support.
At this point it is worth remembering that, on the current OBR forecasts, there will still be a substantial output gap in 2015. I.e. the economy (if, and it’s a big if, the OBR is right) will be growing bit weak with room for a boost in demand.
Another obvious advantage of capital spending is that it not only boosts growth in the short run through its impact on demand but also can provide longer term benefits. A VAT cut boosts growth, but capital spending also provides some form of longer term asset – be it more houses, better infrastructure or more roads.
Putting this all together brings us to some extremely useful research by NIESR (funded by the TUC) earlier this year. They found that a capital spending stimulus, funded by additional borrowing, if done when the economy remained depressed (e.g. When there is a substantial output gap) and assuming some positive long run impact of more infrastructure (not especially heroic assumptions!) then the impact would be not just higher growth and lower employment in the short run but also a lower debt/GDP ratio in the medium term. In other words if done at the right point in the cycle, then more capital spending means more infrastructure, higher demand, lower unemployment, faster growth and a better debt/GDP ratio. As I noted at the time, this is as close to a free lunch as macroeconomists are ever likely to get.
As noted above, a focus on capital spending also dovetails neatly with the need for rebalancing. A VAT cut is a blunt instrument that acts through consumption, capital spending is a more targeted lever than acts on investment. It is much easier to ensure that the benefits of capital spending are more evenly spread across the various sectors of the economy and geographies of the UK than is the case with a temporary VAT cut.
Given the benefits of capital spending, it is no surprise that most economists (including Vince Cable) recognise it’s vital role in supporting the recovery.
The second part of Labour’s emerging policy position is a nod towards new fiscal rules.
This is often presented as Labour accepting Coalition spending plans, but I’m not at all sure this is the case. It is worth remembering that the forthcoming CSR is only taking spending to 2015/16 and, under the current fiscal framework, even more savage cuts ate required in the following years – as excellent analysis from the Resolution Foundation pointed out last week. Of course that analysis was premised on the old fiscal framework being in place.
The current framework has utterly failed. It targets something that can only be estimated not measured and which is subject to huge uncertainty (a target chosen I would venture for political rather than economic reasons). It has failed to get the deficit down as intended or to safeguard the AAA rating.
In many ways the current framework is the worst of all worlds – too flexible to actually ‘deal with the debt’ but too short term to allow any support for growth.
It is perfectly possible to design a better framework – one that acts over a longer period, is responsive to the economy and which recognises the key role of growth in getting the debt/GDP ratio down in a sustainable way.
As I’ve often argued – a short term focus on debt risks the UK underinvesting in its future. You can’t cut your way to victory in the ‘global race’ the Prime Minister is so keen to remind us of.
The final element in Labour’s emerging position is perhaps the most important. What is often called ‘responsible capitalism’ but what could be thought of as ‘supply side reform’. Something I’ve written about at some length over the past year.
It is important to remember that as well as a pressing problem of weak demand, the UK faces deeper problems. Things were starting to go wrong well before 2008 – median wages stagnated, consumer debt rose, the economy was unbalanced.
Fixing these wider problems requires more than a new fiscal policy. It needs wider changes to our national business model.
Questions of course remain – what role does taxation play on Labour’s plans? What will their fiscal rules look like? How do they see the role of monetary policy? But the outline of the agenda is now pretty clear.