Strong and stable economy? Forgotten macroeconomics in the manifesto debate

Submitted by sglenister on Thu, 25/05/2017 - 17:00

25 May 2017

By Özlem Onaran, Professor of Economics, Director of Greenwich Political Economy Research Centre, University of Greenwich

Economist Özlem Onaran analyses the expected impact of both Conservative and Labour Party manifesto pledges on the UK’s economic productivity – a key issue this election, as the nation’s productivity gap with its major G7 competitors is now at its widest point on record.

The Conservative election manifesto’s novelty is a new discourse of rejecting social division, injustice, and inequality rather than concrete policies to reverse inequality and falling real wages. Beyond promises, it lacks details and factually it offers more of the same: continued austerity, punitive sanctions instead of social security, and low wages and insecure jobs. Further decreases in corporate tax rates are still seen as the core policy to stimulate investment. There is no clear costing of the manifesto pledges. The social care crisis is wished away by an unfair “dementia tax” muddled with an uncertain cap on costs to the elderly after the chaotic U-turn rather than fair, progressive taxation on wealth and income.

The Labour Party manifesto challenges this status quo by offering a comprehensive policy mix prioritising investment, decent jobs with decent pay for all women and men, equality, and ecological and social sustainability: higher public investment in both physical and social infrastructure embedded in a broad industrial policy; long-term finance for investment via the National Investment Bank; progressive taxation of income, wealth and corporate profits and broadening of financial transaction tax; corporate governance policies to create incentives for long-term investment and disincentives for short-term speculation; and labour market policies to decrease inequalities targeting the bottom, middle, and top of the wage distribution – a minimum wage at the level of a genuine living wage, enforcing a 1:20 pay ratio in the public sector and companies bidding for government contracts, and an excessive pay levy for the rest of the private sector to tame the excesses at the top, banning zero hours contracts, improving collective voice and collective bargaining coverage, and closing gender wage gaps.

The assessment of these competing manifestos in the media is rather static, as comments mostly ignore the impact of the policies on macroeconomic demand, investment and productivity. If anything, mainstream media and think-tanks claim that Labour policies such as the rise in corporate tax rate will, in the long run, decrease private investment and productivity.

Is the conservative policy of a further decrease in the corporate tax rate the magic bullet to solve our productivity puzzle? Not according to the data about the performance of the British economy in the recent past. Despite decreasing corporate tax rates and increasing profits since the 1980s, Britain has some of the lowest productivity and private investment among the developed countries. There is a missing link between profits and investment. Rising inequality and financialisation have been the main reasons behind this missing link. Private investment responds to both demand and public infrastructure, and not just to profitability. Britain’s reliance on low public spending and low wages has led to a fragile, unstable growth model based on high household debt, which has also discouraged investment. Rather than investing, firms have exploited low labour costs. Furthermore firms have increasingly directed their profits to financial speculation. According to our research, the non-financial corporations’ profits devoted to real investment declined from about 80% in the 1980s to less than 50% in the last decade, while their financial assets increased substantially. High dividend payments and surging financial activities have crowded out private investment in physical machinery and equipment.

Labour policies to provide a decent physical and social infrastructure, patient, long-term finance via the National Investment Bank, a stable macroeconomic environment, incentives to remove new plant and machinery from business rate calculations and disincentives for speculation via broadening the financial transaction tax can lead to higher private investment and productivity and help to rebalance the economy. The Conservative’s policies imply a continuation of the wage stagnation, high household debt and the shaky debt led consumption driven growth model in Britain. Labour policies encourage a healthy growth in wages that could reverse this economic fragility and improve domestic demand, which can also stimulate business investment.

Our recent research shows that a policy mix of higher public spending, progressive taxation and higher wages would have a favourable impact on not only growth and private investment but also the public budget in Britain. Higher economic growth leads to further increases in tax revenues beyond the impact of tax increases and more than offset the impact of higher public spending on the budget. An increase in public spending alone would also increase GDP and finance itself by about 15% because it leads to higher GDP and tax revenues for a given tax rate. The positive impact of public spending on economic growth is further enhanced when they are combined with labour market policies improving wages and progressive taxation.

If anything, the Labour Party manifesto is cautious, as the fiscal credibility rule limits public borrowing only to financing physical infrastructure spending under normal circumstances, while day-to-day spending is financed by tax revenues. Even the OECD and the International Monetary Fund recommend borrowing for public infrastructure investment, particularly as interest rates are so low. However, the vast majority of the day-to-day spending pledges in the manifesto are composed of health and social care, education and child care, which indeed have long-term benefits to the society as a whole, with substantial potential productivity impact by increasing the supply of high-skilled, innovative and healthy labour force. They will also increase productivity by improving gender equality and unleashing the hidden potential of women by increasing their participation in the paid labour force. The necessity of such spending is praised by even the critiques of the manifesto. Indeed, social spending can be regarded as investment in social infrastructure, as recommended by the Women’s Budget Group, and therefore could be financed by borrowing, if need be.

The existing status quo in Britain is a political, social and economic time bomb. The Labour Party manifesto offers a credible and feasible alternative in this election to reverse this status quo on the 8th of June.

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