Firstly, the stimulus policies adopted after the onset of recession have hampered the necessary market adjustment process by which resources ‘malinvested’ during the artificial boom are reallocated. In other words, stimulus measures have cushioned the decline in the short term but at the expense of recovery in the longer term. Secondly, the expansion of the state under New Labour will have reduced the long-term growth rate of the economy by crowding out wealth-creating private sector activity. Finally, there are a number of more specific negative factors, including an ageing population (contributing to slowing labour force growth); regulatory pressure on the banking sector; the euro crisis; and the potentially disastrous impact of various green policies on business costs.
Since the government can no longer rely on growth (and the extra tax revenues that flow from it) to bring the deficit down and stimulus measures would be counterproductive, spending cuts are the only realistic policy option. And the likely scale of the tax shortfall resulting from the double-dip recession means that these cuts will have to be very substantial indeed. Many of these cuts can, however, be combined with reform to produce long-term economic benefits, as set out in the recent IEA study, Sharper Axes, Lower Taxes. In particular, spending reductions should be combined with deregulation. Reducing unnecessary burdens on business feeds directly into higher productivity. Strict planning controls, green energy policies and restrictive employment legislation are key restraints on business growth and should be urgent priorities for liberalisation.