After the cuts, the growth story. Addressing the Confederation of British Industry in Birmingham at the start of the week, David Cameron tried to sound a more optimistic note on the economy. It wasn’t just going to be about slashing benefits, closing down theatres and arts centres, and making everyone work until they are 95. The economy would soon be expanding.
That is surely right. Britain can’t simply cut its way out of a budget deficit of 11% of GDP, the highest in our peace-time history. Unless tax revenues rise and jobs are created to replace those lost in the public sector, the books are never going to be balanced again. Rising unemployment and collapsing firms will mean that tax revenues keep on going down. Very quickly you get into a vicious circle of cutting spending, leading to lower tax receipts, which means even more cuts. Growth is the only way out.
Despite the simplistic Keynesianism that seems to have gripped much of the media, it is perfectly possible for economies to expand at the same time that the government is reducing its spending. There are two reasons for that. The government doesn’t create any money itself, it merely takes it from other people, either by taxing them, or by borrowing it. So its spending decreases demand as much as it increases it. Next, as government gets smaller, there are more resources for the private sector to exploit. The smaller the state, the faster an economy can grow.
Indeed, the last time Britain embarked on significant spending cuts – under John Major’s government – two million jobs were created between 1992 and 1997. These more than made up for the 700,000 jobs that were cut out of the public sector. Under Mrs Thatcher’s Tory government in the 1980s the experience was similar: after the peak of the recession or the early 1980s, 2.97 million new jobs were created by 1990, which more than made up for the two million lost in manufacturing. There is no reason why Britain can’t repeat that experience in the coming decade. But it isn’t going to happen by magic.
Expect to hear a lot of waffle from the government about boosting infrastructure spending, encouraging more lending to small businesses, promoting investment in green technologies, and cracking down on short-termism in the City. Most of it is nonsense. The government has no idea which green technologies will work, or whether this country has any real competitive advantage in any of them.
People have been fretting about the short-termism of the financial markets since Victorian times without ever finding a realistic way of doing anything about it. Nor does the government have any idea whether the banks should be lending more to small businesses. And if so, which ones. No, the four steps it should take to get growth going again are far simpler.
1. Cut corporation tax
In Ireland, a 12.5% corporate tax rate made the country a magnet for investment from all around the world. It could do the same for Britain. Over the coming few years, dozens of ambitious new companies are going to emerge out of the fast-growing economies of Brazil, China, India and Russia. Just as the Japanese did a generation ago, they will be looking for a base to expand into Europe. Britain should be the natural destination for them, as it was for the Japanese. But that won’t happen unless there is plenty of incentive for them to come here – and a low tax rate trumps just about everything else.
2. Reform welfare aggressively
The huge numbers of Polish immigrants who came to this country and found work in the last decade tells us that Britain can easily create jobs for those who want them. There is no simpler way of boosting growth than increasing the employment rate; GDP, remember, is just output per worker, multiplied by the number of workers. If you can move some of the roughly five million people now living on benefits into jobs, you not only save on their welfare cheques, you also boost the economy.
3. Deregulate protected parts of the economy
The Thatcher government of the 1980s freed up the economy to generate growth – most notably through privatisations. This government should do the same. The most obvious candidate is land and building. It’s virtually impossible to build anything, particularly in the South East, which is one reason that, for example, we have a relatively small tourist industry. Make it easier to get permission for new buildings, and the jobs will follow.
4. Create tax-free zones.
Big parts of Britain – Wales, the North East, Northern Ireland – have reached Soviet levels of state dependency. The public sector has crowded out any kind of private economy. Nothing can grow when the state accounts for 60% or more of GDP. But just slashing state spending won’t work by itself. Instead, create virtually tax-free zones to encourage the private sector to move into those areas as spending is cut.
Growth is not about picking winners, or choosing which sectors of the economy to promote. But if the government frees up space for entrepreneurs, the economy will respond – it has in the past, and it will do so again.