Reasons to be negative about the UK’s growth prospects
In the 15 years to 2007, the British economy had on average faster growth (by about 0.5% to 0.75% a year) than its large European neighbours. A similarly benign context of rising trend output and tax revenues would be very helpful for a new government seeking to reduce government borrowing. There are, however, a number of reasons to be negative about the UK’s prospects for growth.
Firstly, labour force growth will slow from 2011, partly because that is the year the baby boomers start to retire, and partly because the heavy net immigration of the Labour years has become politically unacceptable and seems certain to be checked. In the years leading up to the recession UK employment typically rose by about ¾ per cent a year. From 2011 labour force growth is expected to be only ¼ per cent a year.
Secondly, while the rate of growth of productivity growth in the private sector was very satisfactory in the first decade of the New Labour government, the level of productivity in the public sector actually fell. Under Labour the public sector has also expanded relative to the private sector, with public sector employment up about 15 per cent since 1997.
Thirdly, associated with the expansion of the public sector has been a rise in taxation, particularly taxation on high earners and income from capital. This has started to cause the emigration of high-productivity, high-income people in international business services, the area in which the UK had been a leader after the Thatcher supply-side reforms and tax cuts of the 1980s. The City of London has been knocked off its perch, which may please the high proportion of the British population who are jealous of its success. The fact remains that the boom in international financial services accounted for about a fifth of the UK’s GDP growth in the 1997 – 2008 period.
Fourthly, in contrast with the reforms to energy supply under the last Conservative government, the environmental movement has led to a long pause in power station investment, and now an apparent rush for high-cost and wasteful renewable energy sources. The heavy resources required for, for example, offshore wind will not available for other more productive uses.
Fifthly, regulatory pressure on the banking industry will increase the cost of bank finance, with adverse effects on the financial viability of a wide range of projects, including investment projects in the utilities sector. A degree of leverage has been helpful in the past, because the return on capital has usually been higher than the rate of interest on borrowing. But with the banks widening margins and increasing fees, the utilities cannot borrow or invest as much as before.
The above is rather ad hoc, but the overall message has to be that the trend growth rate has fallen. No one can know how much. The drop in labour force growth might take about ½ per cent off the trend growth rate and the other factors may altogether have a similar effect. That implies a future trend growth rate of 1½ per cent a year, markedly less than the 2½ per cent a year which has been “normal” in the post-war period. The new government faces an economic challenge every bit as daunting as that which confronted Margaret Thatcher and her colleagues when they took office in 1979.