Opponents of increased public spending have a stranglehold on Britain’s political and public discourse. There was a brief hiatus after the financial crisis, when it was accepted that the government needed to intervene in the economy to bolster demand, but since then the deficit hawks have largely held sway unchallenged. They argue that any increase in government spending will simply push up inflation and increase already unsustainable levels of public debt and/or that a smaller state will inevitably lead to faster economic growth.
The combination of these two beliefs is doing permanent damage to Britain’s economy by unnecessarily holding back demand and further eroding the quality of the public goods—infrastructure, affordable housing, skills—upon which economic growth increasingly depends. They reflect political ideology rather than economics: the sustainable level of demand in an economy is not determined exogenously; government policy helps determine it.
Pessimism about the growth potential of the UK economy rests on a belief that the collapse in productivity growth—productivity is barely higher than a decade ago—is all down to a weakening of technological growth (compounded by population ageing). The government cannot stimulate the economy because there is no surplus capacity; boosting spending will simply push up inflation and wages, hitting profitability and hence investment and jobs. The collapse in in productivity growth has little to do with weak demand and under-utilised resources.
This reflects circular reasoning and is self-defeating. First, productivity growth has slowed in other countries, but by nowhere near as much as in the UK. And, if anything, the pace of technological change is accelerating rather than slowing. The problem is that British firms (and to a lesser extent those in other developed countries) are not investing in those technologies. Productivity growth does not simply reflect technological change but a combination of technological change and capital intensity.
Britain’s awful productivity performance is no surprise: it has easily the lowest level of business investment among the G7 economies. A major reason for that is that demand in the economy is too weak to justify firms taking on the cost of investment. Were demand stronger, firms would be able to justify that investment in new technologies and processes, and that would boost productivity.
“By failing to boost spending and with it private investment, the government is reinforcing weak growth”
In short, investment and productivity…