It is a truism that politics trumps economics. Indeed, with the prospect of our fourth prime minister since the EU referendum was called in February 2016, it seems that politics has become trump and joker rolled into one. The swiftest turnover of PMs since the 1920s and, again, the 1970s, suggests economic doldrums and some national atrophy. Politics, though, both decides the feasible space for many economic decisions and affects decision-making by households and firms. Turbulent political situations can increase uncertainty to such an extent that plans are delayed and opportunities lost: for example, business investment lies some 20 per cent below its pre-Brexit referendum trend. I am afraid that is where we have sat as a country for the past six years.
As the Office for Budget Responsibility indicated recently in its “Fiscal risks and sustainability” report, we have entered riskier times. Meeting the challenge of climate change, as well as an ageing population and an increasing demand for health and social care, will push up our level of public indebtedness to extraordinary levels—unless the tax base is widened, or we find some way of returning to higher levels of productivity. But the risk may also manifest itself in other ways. Our modelling suggests that higher levels of risk may mean we have returned to more frequent booms and bust than we have come to expect in the post-industrial period. In a book published in 2016, The UK Economy in the Long Expansion and its Aftermath, I termed the period of growth between 1992 and 2007 the “long expansion.” That period already is looking like an arcane piece of economic history; a third-year Special Paper. Climate change may re-enforce this change as patterns of production are disrupted. Such patterns will provide an acute challenge for fiscal policy.
As we have been recently reminded, downturns are most keenly felt by poorer households who may need new forms of income support. During the Covid lockdowns, the government changed fiscal policy by introducing a furlough scheme; it has done it again in the current cost-of-living crisis by overseeing the rapid deployment of funds to help households pay their energy bills. It seems that, in this new and riskier world, fiscal support may have to be redesigned and targeted like this more frequently. The best way of funding this over time will be through taxes levied on wealthier households, but no politician who wants to get elected will say such things.
However, managing risk requires a redesigned tax system to raise revenues more efficiently and establish a consistent, long-term commitment to public sector investment. Our ability to withstand future increases in economic volatility will be much easier if our physical and digital infrastructure is modernised, and if we address the gaps exposed by Covid in the provision of our health and social care. In the short run such needed interventions imply, unfortunately, a greater encroachment of the state in the private sector. But as growth is spurred, injections of public investment now will not look overwhelmingly large in the long run.
Fiscal policy must be transformed while the main economic priorities are addressed. The monetary policy committee must rein in inflation by normalising interest rates and embark on rapid quantitative tightening while communicating its stance over time more clearly. The government’s objective of levelling up or regional regeneration is to be applauded but, as of yet, no targets or measures of success have been agreed or even suggested. And there will have to be some acceptance by the Treasury that levelling up will require not only more public investment, but also some devolved powers to local and devolved nations—perhaps through fiscal federalism, such as by allowing local tax and expenditure plans to be formulated. The huge fall in real disposable incomes this year, which primarily arises from the trade shocks of war in Ukraine and Brexit, will greatly strain industrial relations in the public sector and will lead to considerable hardship for many families in lower income brackets. The incoming PM will have an overflowing in-tray of economic problems to resolve.
The prizes awarded for success are huge. If we fail, the UK will continue to decline in importance on the international stage. Indeed, the rate of decline may accelerate as the main actors fail to take a lead from the traditional British approach of evidence-based policy, as we fall further into the trappings of the post-truth age. But if we can adopt the right set of policy interventions, we can avert the worst of those global risks and make the UK an attractive place for global investment. And that is where we can benefit from a riskier world by nurturing good governance, lively debate and wise choice at home.
