Economy: Growth

Lord Hollick Excerpts

Tuesday 29th January 2013 Lords Chamber

[Lord Hollick]

My Lords, I, too, would like to congratulate the Minister on his leading role in a brilliantly successful Olympic and Paralympic Games last summer. He is the living embodiment of the vital role the Government can play to promote growth in the short term and, thanks to the legacy infrastructure, in the long term too. His appointment provides welcome substance to the Government’s claim to wish to boost infrastructure investment but will the Government provide the means to do it? He and his partners at the ODA received £9.3 billion from the previous Government, a level of support that was maintained by the coalition. We must hope that he will be successful in persuading his new boss that the entire economy is badly in need of this kind of commitment to invest in infrastructure.

As we have heard from other noble Lords, the UK economy is profoundly stuck. Real GDP is more than 3% below the 2008 figure and a significant 15% below where it would have been if long-term growth trends had been maintained. This sustained underperformance can be expected to impact adversely on the underlying production capacity of the economy and our skill base. The corrosive effect on the social fabric is high and under-investment in education, housing and public services is all too evident. Unemployment is up from 5.2% to 7.8% despite the recent downward trend and more than 900,000 young people are unemployed with a similar number of the total workforce out of work for more than 12 months. Yet the Chancellor’s response to this grim state of affairs was to say in his Autumn Statement that,

“turning back now would be a disaster”.

Turning back from his failed and indeed nonsensical policy of “expansionary fiscal contraction” would have been a wise choice. Expansionary fiscal contraction works as an oxymoron but not as an economic policy. The belief that cutting the fiscal deficit would boost business and consumer confidence and lead to economic growth and that private sector investment would fill the gap left by the coalition’s austerity plan was and remains profoundly flawed. In 2010, the OBR predicted that business investment would grow in real terms by 8.1% in 2011 followed by average annual growth of 9.5% in the following four years. In reality, it grew by 2.9% in 2011, 3.8% in 2012 and is forecast to grow by 4.9% in 2013. Many of our larger companies hold high levels of cash on their balance sheets but uncertainty about the outlook for demand—a word that was curiously missing from the Minister’s remarks—is proving to be a deterrent to investment. This flawed approach was in part sustained by a naive belief in the sanctity of the UK’s credit rating as measured by discredited rating agencies. Markets are sophisticated enough to realise that without growth the deficit will continue to balloon leading to further austerity and further weakness in the economy—a spiral of doom. As Larry Summers has pointed out, we are facing not just a fiscal deficit, but also growth, jobs, investment and skills deficits.

If the Chancellor is to address these deficits, he must first address the UK’s dramatic lack of aggregate demand. This is not just the view of his opposite number, my honourable friend Ed Balls, whose analysis has, most gallingly for the Chancellor, proved to be all too correct, but is also the view of the IMF, the World Bank, the WTO and many other major economic institutions which have all warned that austerity was hurting growth and have urged economies—not just the UK—to embrace stimulus.

The Chancellor is, of course, a realist. He knows that he must alter course and boost growth. Over the past year, he has introduced a number of supply-side measures, many good, some less so, but taken together they are unlikely to have much impact in the near term. The Funding for Lending scheme is to be applauded. The 89 steps of the noble Lord, Lord Heseltine, to leave No Stone Unturned in pursuit of growth are most welcome and were warmly embraced by the Government. However, his principal recommendation to gather together all business funding in Whitehall and pass it to the regions appears, unsurprisingly, to have encountered some resistance at the centre. All these supply-side measures provide evidence of a quickening pace but no real determination to boost demand, which is essential if these measures are to achieve their purpose.

However, I detect a change in the economic weather. Surely the most significant step towards a more balanced policy is the appointment of Mark Carney—not on a white horse—as the next Governor of the Bank of England. The Chancellor was initially rebuffed in his quest to hire Mr Carney but, to his credit, he persevered, upped his offer and landed his man—a man with a record of openness to monetary policy innovation, who has advocated that central banks target both inflation and nominal growth and believes that monetary policy measures to help the economy grow are not exhausted. Last week in Davos he advocated an activist monetary policy with the immediate aim—indeed, priority—of ensuring that the economy reaches “escape velocity”. I take this to mean that growth in the economy reaches a sustainable level where increased tax receipts can take over from austerity as the principal driver of debt reduction—a virtuous cycle of growth replacing a vicious cycle of cuts and persistent recession.

Therefore, Mr Carney is part of the plan B that dare not speak its name. He may deploy a range of initiatives such as forward guidance targeting growth and expanding the supply of Bank reserves to purchase a range of long-term assets with the aim of increasing spending. However, monetary policy can, as Mr Carney himself has emphasised, only take us so far. Bold fiscal measures are needed to help the economy move forward. Mark Carney has shown that he is adept at taking full advantage in a sellers’ market. I expect that in his discussions with the Chancellor he has emphasised the limits of monetary policy, however innovative, and secured an acknowledgement from the Chancellor that a series of fiscal measures need to be introduced to create the demand the economy so badly needs. It is vital that the Chancellor and his new governor work closely together to develop a co-ordinated monetary and fiscal approach to reach “escape velocity”. For his part, the Chancellor must adopt the most effective fiscal initiatives to increase demand and promote investment, particularly in infrastructure.

Temporary fiscal measures which boost growth will make it more likely that the medium-term targets can be met and will, I believe, so long as the medium-term framework remains intact, be welcomed by financial markets which have become increasingly concerned about the depressive consequences of untrammelled austerity, as we have heard from other noble Lords. I would like to see the Chancellor introduce a UK version of the successful temporary payroll tax cut in the US and reduce employees’ NIC by 2p in each of the next two years. The cost, after taking account of the tax generated by the additional economic activity, will be around £5 billion a year.

This weekend, the Deputy Prime Minister acknowledged that the coalition made a mistake in cutting much of its capital spending. Now is the time to reinstate the capital spending on the school build programme and on social housing. If we are to tackle the growing investment deficit in infrastructure and in energy, estimated to be £350 billion and £175 billion over the next 30 years respectively by McKinsey Global Institute, the Government must take action. Offering loan guarantees is a welcome step but only if it is accompanied by measures, such as the introduction of road pricing on motorways, which can provide private investors with an adequate rate of return.

Funding infrastructure remains a challenge, despite the Government’s exhortations to the pension funds to invest. The Government could consider the introduction of tax-free infrastructure bonds for individuals, taking advantage of historically low long-term interest rates and providing hard-pressed savers, who have been badly penalised by low interest rates, with improved returns. Many infrastructure projects are, inevitably, medium-term or long-term in nature and so is their effect on demand. Boosting short-term demand could be achieved by a reduction in VAT on building works at domestic residences from 20% to, say, 5% over the next two years. This would encourage households to invest to improve their properties and utilise the currently under-employed pool of construction skills.

The Government have a vital role to play in promoting growth. The Chancellor made a bold move in appointing an activist and innovator as the Governor of the Bank of England. He now needs to display a similar appetite for activism and innovation by adopting bold measures to promote investment and growth.