The government needs to unveil a pro-growth economic strategy. There is too much uncertainty about the consequences of the necessary policy-easing that has taken place.
The Treasury is pushing for tax rises to bring the deficit down, while some in the financial markets fear that the scale of policy stimulus will trigger inflation.
Tax increases are not needed and higher inflation is not inevitable, but in the absence of a clear policy vision, uncertainty and fear persist.
The government needs to make clear that boosting growth, reducing unemployment and raising living standards are centre stage and this means not raising the tax-take but reducing the ratio of public debt to GDP gradually, over time.
Such a growth agenda should focus on the three arrows of: credible fiscal activism; monetary and financial stability; and a supply-side plan aimed at ensuring the private sector leads the recovery. The government needs to aim for a bullseye on each. Premature policy tightening must be avoided, lest it derails the recovery.
The UK’s economic turnaround began in May and has gained momentum since. While some sectors, such as retail and housing, have rebounded quickly, others, such as the arts and hospitality, will be left in limbo through the vaccine gap phase. As a result, it will not be until the end of next year at the earliest that the economy returns to its pre-pandemic level and even then unemployment will be far higher. In addition to the lay-offs already announced, ancillary businesses will suffer as more people work from home and jobs will go as small firms are hit by a debt overhang next summer.
It is a similar story worldwide, where recovery is taking place against a backdrop of unconventional monetary and fiscal policies, with bloated central bank balance sheets and global public debt at a record high. Financial markets have soared and are no longer pricing properly for risk. The big unknown is the virus, but in recent days the economic recovery has faced another threat from the pressure for higher taxes now and in the future.
I would favour a focus on stronger economic growth in order to reduce the ratio of debt to GDP gradually over time, albeit as quickly as possible. If not, the danger is a self-feeding downward policy spiral, with growth seen as low, debt then seen as too high, so taxes are proposed, which in turn dampens growth.
Policy Exchange has highlighted that there is sufficient fiscal space. Low inflation, rates and yields provide the UK with a window to live with the present high ratio of debt to GDP.
The government needs to be careful, both in the timing of its fiscal actions and its message. The tax-take is already high and, despite the case for specific changes, the focus should be on not raising the overall tax-take but on cutting taxes, simplifying the tax system and ensuring that it remains progressive and as neutral as possible. The government’s actions also need to send the right signal to international investors and companies that Britain remains an attractive place in which to invest. While generous tax breaks to the rich need to go, raising corporation tax or introducing an online sales tax does not fit with this.
All this confusion reinforces the need for greater clarity and policy vision. Balancing the budget should not be as high a priority as balancing the economy in the aftermath of the pandemic.
Now is not the time to contemplate tighter policy. In fact, further help may be needed for the arts and others whose business models cannot return to normal to help them through the vaccine gap phase. Also, although costly, it may make more sense in the long run for the government to write off the bounce back loans to small companies as grants as opposed to debts to be repaid.
A sustainable recovery needs to be led by the private sector. The challenge is that many people and firms may spend the next few years focused on rebuilding their savings or repaying debt. This would restrain growth.
Even with a cyclical recovery, underlying structural challenges persist. Despite some world-class areas, the UK is seen as an economy with low growth, productivity and wages. That will not change in the years to come if we emerge from this crisis with the private sector nursing debts and the government lifting taxes to pay for its recent spending.
Even before this pandemic, we faced a significant challenge. Since the 2008 global financial crisis, there has been a ratcheting down of expectations of Britain’s trend rate of growth to a low 1.3 per cent or so. With a rising population, we need to raise that rate, or else living standards will stagnate.
The UK needs to remain competitive, and to clearly articulate its global vision post-Brexit, while levelling up the economy. Such rebalancing should involve a shift away from an over-reliance on consumption, imports and private sector debt to stronger sustainable growth with still-high consumption, but also increased investment, innovation and infrastructure, supported by the right incentives of sensible regulations and lower taxes when it makes sense.
The ratio of public debt to GDP is more than 100 per cent. This is not ideal, but it does not mean that we should panic. Historically, we have seen the ratio far higher, for instance after the Second World War, when it reached 260 per cent. Then it was reduced, gradually, through a combination of stronger nominal GDP growth and what became known as financial repression, as rates and yields were kept low.
It would be the wrong policy response to conclude that higher taxation or austerity is needed now. Two wrongs do not make a right. The first wrong is not to run surpluses in good economic times. The second wrong would be pro-cyclical policy tightening now.
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