December 4, 2022

The writer is director of the London School of Economics and Political Science

The government’s recent budget plan is not responding to the UK’s twin economic crisis in a way that takes into account evidence or experience. While they are absolutely right to focus on absorbing the shock of the skyrocketing cost of living and trying to boost growth, the policies they have outlined do neither of them any good. The market’s extreme reaction to the ‘mini-budget’ reflects the government’s failure to tell a credible story about its economic strategy.

The British economy has two pressing problems. The first is a cost of living crisis fueled by dramatic shifts in the demand and supply of goods – especially energy – at a time of war, plague and other trade disruptions. The second is more than a decade of low growth and productivity, or what the Economy 2030 Inquiry calls memorable”Stagnation Nation”. With the highest inflation rate in the G7, labor productivity growth well below the OECD average, stagnant real wages since 2010, and a host of other dire economic indicators, it’s no surprise that the Bank of England predicts UK households will face their biggest collapse standard of living since such records were first kept 60 years ago.

We need to let the BoE do its job by raising interest rates to fight inflation. Now is not the time to do anything that could undermine central bank independence, which has led to the low and stable inflation that we have all benefited from. A massive fiscal expansion and a collapsing pound will only complicate the BoE’s job and mean that interest rates will have to rise even more to contain prices.

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In a good society, we must provide the greatest cushion to those who need it most. The energy price cap is a very expensive response (around £100bn) that provides support to many who don’t need it and reduces incentives to make progress on climate change. Instead of a cap, the government should provide a universal lifeline rate for energy consumption up to a certain level to protect the poorest households and small businesses, and make those who consume more pay a market price. This would cost less, help everyone and maintain incentives to use energy more efficiently.

When it comes to driving growth, we need a serious plan to deal with the chronic underinvestment that is driving Britain’s stagnant productivity. Despite economists having spent many years on the productivity puzzle, it’s becoming clear that the answer is quite simple: chronically low investment rates by both the public and private sectors.

When I worked at the World Bank, we conducted hundreds of investor surveys about what determined their willingness to invest in a country. The main reasons were almost always the same: first came macroeconomic and political stability (which has been compromised in the UK), high-quality infrastructure and skills. Low taxes and business zones have always been at the bottom. The key to growth is to create an environment where there are great business opportunities – tax rate differences of a few percentage points are largely unimportant if you make a lot of money.

A better policy response would be to use the remaining fiscal space to invest in a serious productivity agenda. This would include mechanisms to increase investment in infrastructure, skills, research and innovation, as well as incentives for companies to use technologies to increase productivity and achieve net-zero targets. A £100bn investment in those areas would be transformative for the UK, impacting far more than the same amount of tax cuts for high earners and businesses. The markets would also react a lot more favourably.

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The government is right about something else: redistribution is not a panacea. A better option is to invest in people so that they can earn a decent wage in the labor market – what economists call “pre-distribution.” The current policy proposals are actually doing a lot of redistribution (to the benefit of the rich) in the hopes that some of it will seep through. A much better alternative is to invest more in pre-distribution — early childhood education, adult education, research and innovation and infrastructure, especially in deprived areas. In this way everyone has the chance of a decent standard of living.

The current proposals are bad economically. They are also a missed opportunity that will close options for the future. A better option would be to tackle the short-term energy problems more efficiently and use this crisis to tackle the longer-term productivity problems facing the UK, so that the economy can grow, provide a good standard of living for all and can continue to make progress in tackling climate change. Modify.