Rebalancing, Recovery, Renewal
As the evidence mounts up that the UK economy is beginning to recover from the longest downturn in modern economic history, so too is the evidence that this remains an unbalanced recovery and one that is not yet feeding through into higher living standards for the majority.
As was noted in last week’s Financial Times, there are now some political question marks over the future commitment of policy makers to rebalancing and the need for a more active industrial policy.
Interestingly enough, today is the 21st anniversary of Black Wednesday* and the UK’s exit from the Exchange Rate Mechanism (ERM). After the ERM debacle the UK enjoyed 15 long years of continuous, low inflationary growth – the Great Moderation or Lord King’s NICE decade. During this long boom the need for a more balanced economy was downplayed, as long as the economy grew then the attitude of many policymakers was ‘if it ain’t broke, don’t fix it’.
Yet, by 2008 the UK economy was seriously unbalanced – business investment and exports were too low, economic activity was too concentrated in certain geographies and certain sectors, the public finances too dependent on a narrow tax base and wages for the majority had stopped rising in line with the wider economy.
From 2008 until earlier this year this was widespread political commitment to rebalancing (admittedly some people seemed to think rebalancing was simply a case of cutting government spending and slashing corporation tax, but they could at least see the benefits of a more balanced economy even if they had no real path to get there).
However, as I’ve written before, the Budget of 2013 represents (on the most generous interpretation) the suspension of rebalancing in favour of consumer and housing market led growth. The worry now is that after 5 years of abysmal economic performance, any sort of growth will be seized on as ‘good enough’. Policy makers will be tempted to put on hold the difficult job of rebalancing the UK economy and instead aim to encourage a ‘feel good’ factor through higher consumption and higher property price.
This would be a great shame.
Rebalancing is not only a route to more sustainable growth, it is also the best path to higher living standards in the future. There is a great deal that can(and should) be done on living standards now – the strengthening of the national minimum wage, the extension of the living wage, more active labour market policies to lower unemployment and through extending collective bargaining. But to really close the ‘wage gap’ that has opened up since the late 1970s, what the economy really need is more people in better paid jobs.
Getting that right is the work of a decade or more, but the earlier we start the better.
It is against this backdrop that the Guardian published two interesting comment pieces on the recovery last week, the first from CRESC’s Karel Williams and the second from NIESR’s Jonathan Portes.
Manufacturing was and is a source of decent jobs and valuable exports, but there are limits to how much more British manufacturing can deliver. Given labour productivity growth, manufacturing output has to grow faster than 3% in the long run just to stabilise manufacturing employment. There has been no sustained increase in the value of manufacturing output since the 1970s.
So isn’t it time to get real about where we are nationally and what can be done about the unbalanced economy? Isn’t it time to stop hoping for export-led recovery that will never come and to stop hyping London’s continued good fortune as a national recovery? Why not stop using the word recovery altogether – we are not, in fact, trying to return to some kind of normal. And why not recognise that rebalancing cannot be delivered by orthodox economic policy tools?
There is much to agree with here – there is of course a role for a strong manufacturing sector in the UK and more can be done to support that. But we also need to take seriously what is happening in the service sector and to differentiate between the higher waged, higher productivity parts of the sector and the lower waged, lower productivity components.
Williams goes on to argue that what is required is not ‘recovery’ but ‘national renewal’.
Turning to the second article, Portes, it must be stated, comes at these questions from a different starting point to Williams. Whereas Williams sees serious flaws in the UK’s economic performance over the last couple of decades, Portes is more positive.
The UK public remains committed to high quality public services – education, health, and social care – provided largely free at the point of use. But it remains reluctant to pay the taxes necessary to fund them. This contradiction will intensify over time.
A credible strategy would set out a coherent long-term vision for the UK economy: a high-skill, high-productivity economy with structurally higher levels of investment, and a reasoned, patient strategy for getting us there, which would be equipped to survive changes of government.
Portes’ desired end point might seem uncontroversial – who indeed is against a high-skill, high-productivity economy?
But the sad fact is, this isn’t uncontroversial. While no one may be against such an outcome, few policy makers seem prepared to take the steps to get us there. Offered the sugar rush of a housing and consumer debt fuelled boom, many seem prepared to take that instead.
Real rebalancing means recognising that for all its short term attractions, such a scenario is not in Britain’s long term interest. It means taking the harder road to economic reform not the easy path to quick growth.
The economic strategy that best gets Britain on the higher productivity, higher skilled (and higher waged) path is one that will take time. Interestingly aspects of both Portes (in particular his concern about the public’s desire for high quality services but their seeming unwillingness to pay them) and Williams (and his desire for building upon the ‘foundational’ economy and his notion that rebalancing won’t come about through orthodox economic policy) are almost entirely compatible with the Progressive Economic Strategy outlined by Wendy Carlin last year in a paper for Policy Network.
She argued that policies designed to increase growth in the high productivity sectors could be integrated into wider set of policies around expanded employment, higher living standards and less unequal outcomes.
To get to this conclusion requires fully understanding the role of ‘Baumol’s cost disease’. As explained by Carlin:
If productivity growth in the important service sectors of health, personal (elderly) care, and education is systematically slower than elsewhere in the economy, then the relative price of these services will go up. In the American economist William Baumol’s original example, the relative price of a live performance to 100 people of a Mozart quartet goes up as productivity improves elsewhere in the economy. The quartet still requires 4 people and 20 minutes as the centuries go by but the number of minutes of work a concert-goer has to do to pay for a performance goes down. This highlights the fact that the benefits from the productivity growth in the dynamic sectors of the economy allow us to enjoy more live concerts and better health care as well as more manufactured goods and or more leisure. A logical consequence of the existence of sectors with relatively low productivity growth (Baumol’s stagnant services) is that their share in employment and in GDP goes up…
Baumol’s ‘cost disease’ has important implications for the financing of public services. It predicts a rising share of the stagnant services in GDP – properly interpreted this is an indicator of the success of the capitalist economy in driving up productivity growth in other sectors. We can all become better off as a result of falling prices for the goods and services where productivity growth is fastest. Because of the cheapening of the products of other services, we can more easily afford the products of the stagnant services. And if the stagnant services are financed through taxation, a higher tax burden is inevitable. Again, this is a sign of success not failure of the economy – the higher tax burden is paid for by the higher living standards that come from the higher productivity growth elsewhere. (My emphasis)
As Carlin concluded:
A thriving dynamic sector of the economy is crucial to provide the resources for high quality labour-absorbing sectors. The dynamic sector is also the tradeable sector and in many countries the ability of government policy to help uncover new sources of comparative advantage has been neglected.
Where does this all leave us?
I think it is possible to map out a kind of Williams-Portes-Carlin economic strategy. (I make no claims that all three would agree with all of what follows, I imagine Jonathan would have doubts about industrial policy aspects, whilst Karel probably thinks it’s all a bit modest).
The first step to which is rejecting the easy option of estate agent-led growth. Instead such a strategy would focus on growing higher productivity sectors through an active industrial policy with accompanying reforms to banking (a state investment bank, some form of local lending institutions), corporate governance to encourage long-termism and sector specific work to rebuild supply chains , help set direction and work on skills issues.
The aim though is not just to grow high productivity sectors but to also not only grow what Carlin calls labour-absorbing sectors (which have a lot of overlap with Williams’ ‘foundational’ areas) but to actively improve wages, terms and conditions in these sectors.
More ‘good jobs’, for example in high tech manufacturing (to quote an often used example), are not by themselves enough. What is needed is more’ good jobs’ coupled with actively making other jobs better. The benefits of high productivity in some sectors can be used to actively support better conditions elsewhere.
To use vogue-ish political terms, I think of this as ‘predistribution’ at an individual level – boosting skills and increasing productivity – and redistribution at the macro level between sectors.
So, if this is the broad vision of how we get to a higher productivity, higher skilled, higher waged economy with more long-termism, more investment and higher living standards, then the question becomes how do we get there?
The first thing to realise is that we don’t get there overnight. This is the work of a decade or more, but the necessary first steps are clear enough to me. Many by themselves seem modest, but the cumulative impact is greater (I believe) than the sum of the parts. My ten point (and incomplete) list to begin with would look like this:
1. We need an active industrial strategy of the kind supported by Vince Cable and Chuka Umunna – with proper funding and buy in across Whitehall. There’s no point having an active strategy from BIS if DECC, HMT, DOT, DCLG and the rest aren’t pushing in the same direction.
2. We need proper banking reform – an active British Investment Bank focussed on lending to SMEs and infrastructure coupled with new financial institutions to serve local markets.
3. We need strong ‘macroprudential polices’ to help curb the credit cycle, restrain bubbles and prevent speculative excess.
4. We need active policies to boost wages for those at the bottom – a stronger minimum wage, the extension of the living wage and higher collective bargaining coverage.
5. We need to seriously look at how the labour market is functioning in the ‘labour absorbing sectors’ and discourage business models which exacerbate the problems of low pay and insecure work. The point has to be to make these sectors into providers of viable careers, not low paid jobs.
6. We need to look at how markets are working in some sectors (rail and energy come to mind) where there is evidence of rent seeking behaviour and consumers being ripped off.
7. We need more and better housing. The best macroprudential policy for the UK would probably be to simply build more homes.
8. We need to think again on infrastructure spending. We won’t be a successful economy with second rate infrastructure, this means a more long term approach from government but it also means more capital spending in the short and medium term.
9. We need to look at how the corporate tax system in this country works. A successful tax system would encourage genuine long term investment rather than seeing large cash piles developing on firm’s balance sheets.
10. We need sensible, long term fiscal rules that ensure sound public finances in the long run. Rules that focus on measurable, long-term drivers (such as debt/GDP) rather than short-term immeasurable factors (such as the structural deficit), that recognise the role of growth as a way of reducing the deficit and that don’t choke off much needed investment by focussing on too narrow a timeframe.
I think these ten steps together represent the best way to grow the economy we want – one that is sustainable and underpins rising living standards for the majority. I don’t especially care if we call it ‘rebalancing’ or ‘renewal’. This is an agenda that doesn’t promise the moon on a stick tomorrow, but does offer a long term route to building a better economy.
*Some insist on calling this event ‘White Wednesday’. This strikes me as silly. The exit from ERM was no doubt the right decision but the key point is the UK should never have gotten itself into this situation in the first place.