The UK seems to have fallen in line with a growing international consensus on the need for fiscal stimulus. Central banks seem to be “running out of ammo”, to use the favoured expression, so higher public spending and tax cuts are gaining political support.
Infrastructure spending in particular is coming into favour. Not only does infrastructure across the developed economies need more investment, but such spending could bolster economic activity more widely. Its advocates contend that improving infrastructure makes economies more efficient and so helps generate future growth. Better roads, railways and telecommunications are all welcomed in this respect.
The UK’s plans were announced on Wednesday in what is known as the Autumn Statement (one of two annual sets of parliamentary proclamations on the government’s fiscal plans). In broad terms there were two reactions to it. First, it was hailed as a dramatic break from the harsh austerity of the previous government. Second, there was a lot of excitement about its implicit estimate of the likely cost of Brexit to the British economy (£58.7bn (€69bn) judging by additional borrowing costs).
But a closer examination shows that, at best, these points are secondary. The plans should be judged in relation to their stated goals.
In that respect Philip Hammond, the Chancellor of the Exchequer (finance minister), was right to identify the UK’s weak productivity as a key problem to address. In his official speech he noted that: “We lag the US and Germany by some 30 percentage points. But we also lag France by over 20 and Italy by eight.”
He went on to spell out what this means in practice: “It takes a German worker four days to produce what we make in five; which means, in turn, that too many British workers work longer hours for lower pay than their counterparts.”
The subsequent news that real wages look likely to be lower in 2021 than they were in 2008 underlined the scale of the problem. If productivity does not increase then wages will continue to stagnate.
Hammond’s proposed solution is the creation of a National Productivity Investment Fund that will provide £23bn of additional spending over five years. Its focus will be on transport, digital communications, research and development (R&D), and housing.
The most striking thing about this proposal is how small the planned spending is relative to the scale of the problem. The UK’s GDP is about £1.9trn so an extra £4.6bn a year is a tiny amount in contrast.
In addition, £7.2bn of the proposed new fund will go to housing. There is nothing wrong with that in principle – on the contrary, the UK’s decaying housing stock could do with much more investment – but it will not raise productivity. Investment in housing is essential to improving living standards, which is welcome, but it does not contribute to making future production more efficient.
Increasing productivity cannot be achieved simply by spending more money. Another key requirement is a willingness to stop state support for unproductive or “zombie” companies. In the authorities’ desperation to keep the economy ticking over, for instance by allowing the provision of cheap credit, otherwise defunct firms are often allowed to survive. Such action hinders the economic process of creative destruction that is essential to dynamic growth in any market economy. This problem is apparent in Japan where economic growth has remained weak despite several attempt at fiscal stimulus.
From this perspective the two common reactions to the Autumn Statement can be put into context. For a start, the scale of the fiscal boost, at least on the spending side, is tiny relative to the huge task of bolstering productivity.
In addition, the discussion of Brexit in this context is a diversion. It is hard to make any meaningful estimate of its likely cost when the form it will take remains so uncertain. Meanwhile, the preoccupation with the subject obscures the fact that Britain’s weak productivity record long predates the Brexit referendum. The problem would exist whether or not the UK was in the European Union.
Although the UK’s circumstances are unique, there are broader international lessons to be learnt. The widely anticipated fiscal stimulus from the incoming Trump administration in the US could also be on a smaller scale than much of the discussion suggests. Talking about improving infrastructure is much easier than doing it. Ensuring it bolsters innovation and economic growth is particularly tough.
With the global pendulum swinging towards fiscal stimulus it is more important than ever to separate the reality from the hype.