Populist politics have recently been in retreat – at least in the UK, the USA, Australia and Brazil. But one major feature of populism remains: magical thinking about economics. The theory is that painful choices can be avoided by conjuring a magic money tree. Shaking one branch of the tree means public spending or tax cuts can be funded by cutting vast sums from “government waste” or – as in the NHS – “bureaucracy”, or by stopping “tax avoidance” by billionaires and multinational companies. Shaking another branch means growth can be “manifested” to produce more government spending or lower taxes at no cost. Another shake miraculously redistributes wealth without creating losers.

We live in a new world of shocks, chronic uncertainty, multiple crises and reduced growth

Unsurprisingly, some politicians are greatly attracted to this fairyland, because fairies wave a magic wand so we can have our cake and eat it. Remember how we were assured that EU negotiators would be outwitted to produce endless Brexit dividends? Dividends that would multiply through a more rapidly-growing, newly-liberated Britain and save the NHS. A more recent version of this narrative is “Trussonomics”: tax cuts that will “pay for themselves” by stimulating economic growth. Other disruptive “supply-side” measures would help to generate the growth to pay for better health and other services. There are similar fantasies on the Left, such as “austerity” always being unnecessary, because governments should “prioritise” economic growth: “green growth” and “inclusive growth” to boot.

The financial crisis and its aftermath fed a hostile political mood that produced Brexit

A Brief History of Growth
Politicians have agonised and fantasised about Britain’s growth performance for centuries. The Victorians worried that Britain was failing economically and being overtaken by Germany. Later came a National Efficiency movement aimed at raising productivity, backed by David Lloyd George and Winston Churchill. After World War II, Britain’s relatively anaemic growth rate was exposed by the first use of GDP statistics and lay behind successive currency crises. Harold Wilson sought to harness “the white-hot heat of the technological revolution” with Britain’s first Five Year Plan. A sterling crisis overwhelmed it. Failure hardened into “declinism”: the belief that Britain was failing due to businesses that wouldn’t invest, managers who couldn’t manage, workers who wouldn’t work, hostility to innovation, lack of competition and over-valued exchange rates.

Was there an alternative to inexorable national decline? We joined the EU mainly to boost economic growth. The Thatcher “supply-side revolution” of privatisation and deregulation was tried, and succeeded for a time, before another financial crisis derailed it. Then we had Gordon Brown’s “post-neoclassical endogenous growth” model based on investment in education and science. It also succeeded for a while but was over-dependent on the finance sector and finished off by the global financial crisis.

Throughout the 75 years from the War to the crisis of 2008, Britain sustained, despite the setbacks, a remarkably steady if unremarkable trend growth of around 2.5%. It was just enough to provide rising living standards and enhanced public services. But that world has now gone. We live in a new world of shocks, chronic uncertainty, multiple crises and reduced growth.

Braving the New World
Since 2008 there have been four major shocks that have hit growth and living standards and left a damaged and diminished economy. The biggest of these was the global financial crisis: an economic “heart attack” for which the life-saving treatment of ultra-cheap money is only just ending. The UK acquired one of the world’s largest fiscal deficits, caused by a bank bailout and measures to combat recession. Public debt doubled relative to the economy. The unavoidably painful measures to correct the fiscal deficit, combined with seriously constrained lending by damaged banks, caused a serious slowdown in growth. That “austerity” – including public sector pay freezes, and cuts in even relatively protected areas like the NHS – largely explains the current unrest.

The financial crisis and its aftermath fed a hostile political mood that produced Brexit. Brexit has led to a stagnation of business investment, serious disruption to EU trade, labour supply problems, a one-off loss of income and, perhaps, a reduction in the trend growth rate.

The pandemic was the third shock. There was a drastic reduction in incomes for around a year and a further increase in government debt as the state absorbed much of the cost; further disruption and higher inflation kicked in as normality returned.

On top of all this we’ve had an energy price shock that has fuelled inflation, necessitating higher interest rates and a slowdown in the economy – probably to the point of recession – and further pressure on government finances as the state absorbs some energy costs.

The shocks have largely stopped economic growth. They have created fragile public finances, weakened further by the collapse in market confidence following the unfunded Truss tax cuts that resulted in the “moron premium” on borrowing costs. And the absence of growth makes several looming problems – best summarised as the five Ds – even more difficult.

The Five Ds
Demographic: a major problem is our ageing population: the increased health and care costs of the very old, the contraction in tax-paying labour force, and a political veto by an elderly electorate over growth-enhancing changes, such as more immigration and developments that threaten property values. The UK is far from unique. But the costs are real.

De-globalisation is growth-reducing and is happening as Western firms shorten their supply chains and decouple from countries considered a political risk, especially China. For the UK the biggest step in de-globalisation was leaving the EU Single Market.

Debt: alarmed by high levels of public debt, governments need to maintain the “kindness of strangers”, as they exercise greater caution in relation to, say, public investment in infrastructure. This hurts growth. And higher debt service crowds out other public spending priorities like health, as we see in Italy and Japan.

Declining productivity: government debt wouldn’t matter if growth outpaced it. But annual productivity growth of around 2.5% before the financial crisis has since slowed to 0.5%. There’s a vicious circle in which declining private investment leads to less innovation, lower productivity, less profit and less investment. Less public investment in turn leads to less efficient infrastructure, lower productivity and fewer resources for investment.

Deep green policies: politicians wax lyrical about “green growth”, and there’s a nice story around offshore wind generating local supply chains and a hydrogen economy. It may even happen, in part. But much environmental policy is necessarily restrictive – for example, the preservation of endangered species and eco-systems. And if we are remotely serious about zero-carbon, we must reduce demand for a carbon-guzzling lifestyle, from plastics to foreign travel. That means curbs on economic growth.

Governments can’t magically create higher growth

What is to be done?
Governments can’t magically create higher growth. There is little scope for boosting demand since monetary and fiscal policy are constrained by the Bank of England and bond markets, respectively. Governments should expand public investment in infrastructure, science and education, but off-balance sheet funding is tricky, and the growth benefits are uncertain. I would promote an industrial strategy to encourage investment and innovation. And mobilise older workers through continuing education. But, again, the rewards are long-term at best.

The problem remains: how can government afford higher public sector pay, now – needed to address recruitment and retention issues – over and above urgent spending on health and social care? Roughly four per cent of spending growth on health is needed just to stand still. Without more revenue, the government will have to cut other key services like schools and colleges, policing and defence.

The logic is clear: higher taxation. British tax levels are still well below those of well-run, prosperous Northern European countries. The big challenge for a government of any hue is how to raise taxes in ways that don’t harm growth. Taxes on property, land and polluting goods like fuel best meet that requirement, but all of these are potentially unpopular. Perhaps understandably, both the current government and opposition refuse to spell out the inevitable, substantial tax increases they will need to make. But, unless they believe in fairies, there is no alternative.

Vince Cable is a former cabinet minister and Leader of the Liberal Democrats. His latest book, “How to be a Politician: 2000 Years of Good (and Bad) Advice” (Ebury), is out now

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February 2023, Main Features

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