The route to growth is hiding in plain sight

There is plenty of scope for the British economy to grow, but we have to be realistic - and will the means and not just the ends

Towering columns

On his Substack Sam Bowman argues that Britain is not among the world’s most advanced economies - and that means there is scope to catch up and grow:

Since the 1970s, economic growth in the world’s most advanced economies – and indeed science itself – appears to have slowed down. These “frontier” economies are the canary in the coalmine, because they have, in theory, maxxed out how much they can grow by using existing inputs (like labour, land and capital) better. For them, unlike developing countries, all that’s left is to improve the inputs they’ve got via innovation. And that rate of improvement seems to have slowed down…

A slowdown in “frontier growth” and technological progress matters a lot for the United States. But it matters less to Poland or Bangladesh – countries that are still trying to get to the frontier. While technological advances do still benefit them, most of their growth comes from using their existing inputs, like land and labour, in more efficient ways that are not technologically novel, or adding more capital that, again, is not technologically novel – some agrarian developing economies can grow simply by adding more tractors; no developed economy can…

My claim is that the UK is now a lot more like Poland than it is like the United States in terms of the kinds of growth it needs to do – driven by improved use of existing technology and inputs, and accumulation of capital, rather than driven primarily by technological advancement. With the exception of a few sectors like AI, we are so far behind the frontier in terms of economic development that worrying about technological progress doesn’t make much sense, and at worst is a serious distraction. 

In the Sunday Times, David Smith growth is possible - but only if we are prepared to do what it necessary:

What a recent International Monetary Fund report described as “slowbalization” has been a feature, “characterized by a prolonged slowdown in the pace of trade reform and weakening political support for open trade”. Exports should be a driver of economic growth, but for the UK, they have been weaker and comfortably outgrown by imports since 2010. Then there is business investment. A recent report called “Beyond Boosterism”, part of the Economy 2030 Inquiry, described the problem well. “Firms in France, Germany and the US have invested 20 per cent more on average since 2005 — a gap that has cost the UK economy 4 per cent of GDP, and workers £1,300 in lost wages,” it said.

The chancellor has now hit on a policy, full expensing of qualifying corporate investment, that the authors say is right. But it is only temporary and the UK’s corporate tax regime has changed every year since 2010. And even a better and more stable tax regime would leave a key challenge — “that too few British firms have large shareholders with a clear incentive and ability to hold management to account for having a long-term growth strategy”. Hunt has made some first steps in trying to address that. There is more to be said, and I shall return to this. We have been adept at shooting ourselves in the foot, but the UK has undoubted strengths, including world-class universities and comparative advantage in tech and artificial intelligence.

We also have plenty of weaknesses. Addressing them and playing to the strengths could give us a reasonable growth strategy, and move us away from a narrative, shared by most economists, that the best the UK can do in the coming years is eke out paltry growth.

Also in the Sunday Times Robert Colvile argues that the precautionary principle - derived from EU law - is stopping us building what we need:

The story starts, as so many do, with the EU Habitats Directive. This was designed to protect and restore rare species and conservation sites. One thing they needed protecting from was nitrogen pollution. In November 2018 the European Court of Justice ruled (after a referral from the Netherlands) that any “plans or projects” near such sites were permissible only if there was “no reasonable scientific doubt as to the lack of adverse effects”. In other words, before you could build a house or spread fertiliser on a field, you had to prove it would not increase nitrogen emissions. Which you couldn’t.

This ruling — known as the “Dutch case” — triggered the nutrient neutrality crisis, which is blocking an estimated 145,000 new homes in England. But in the Netherlands the results were even more dramatic. The country’s highest court quickly suspended 18,000 construction projects and ordered drastic cuts in nitrogen emissions. Given that 46 per cent came from cow dung, MPs proposed halving the number of cattle. Which led to outraged farmers blockading roads with tractors, and the formation of a new party, the Farmer-Citizen Movement. Which is now well ahead in the polls…

The Habitats Directive was adopted in 1992. But it took 26 years for judges to find such sweeping powers within its text… Above all, this story illustrates the dangers of the precautionary principle at the heart of EU law, and in particular our interpretation of it. This principle holds that before you do anything, it must be proved to be absolutely safe. In the nitrogen ruling, the language about “no reasonable scientific doubt” set an extraordinarily high bar. One that drove Natural England to unilaterally halt the construction of 145,000 desperately needed houses across 74 council areas, because there was a risk of nitrogen from flushed lavatories running into rivers — even though planning permission had already been granted, and the homes would be responsible for only a fraction of local pollution. What’s striking is the absolute nature of such decisions. There is no evaluation of trade-offs, no way to argue that, yes, we need to protect rivers, but also to build homes and fill bellies with crops.

In the Financial Times Robert Shrimsley argues that there will be no low-tax option at the general election:

The need to contain debt means tax cuts require spending reductions but Tories have lost their taste for serious retrenchment. In the short term, spending cuts may be a greater risk to growth than high taxes. Until trend growth is reliably over two per cent there is little room for manoeuvre. Tory tax rises will continue to bite until 2027/8. The Institute for Fiscal Studies describes Sunak’s freezing of income tax thresholds for six years as “the single biggest tax-raising measure since the 1970s”. By 2028, around 14 per cent of UK taxpayers will be higher-rate taxpayers, compared to 3.5 per cent in 1991/2. With decent growth, a long-term Tory tax-cutting agenda becomes viable. But the state of public infrastructure, the desire to cut debt, raise public sector pay with reduced immigration, meet climate targets and the cost of upfront investment to power reforms preclude anything but a steady or rising tax burden till then.

Labour sees a reputation for economic prudence as the key to Downing Street’s door. There must be no unfunded pledges. Keir Starmer’s current fight with the Labour left over his refusal to commit to reversing the two-child cap on welfare payments serves the purpose of demonstrating his fiscal rectitude and readiness for hard choices. But few Labour figures believe it is a sustainable position in power and even fewer think his commitment to reform is an alternative to spending more. In a recent article, Starmer wrote that Britain requires reform “rather than just more money”, a phrase which does not actually preclude extra spending. Assuming both parties again commit to not increasing the rates of income tax, VAT and National Insurance, Labour will be forced to seek its extra funding elsewhere. Potential targets include taxes on assets or investments and the removal of higher rate reliefs. It does not take a seer to imagine a new Labour chancellor sorrowfully declaring that having looked at the books, she has discovered things are worse than expected.

On ConservativeHome Henry Hill says parliamentary democracy cannot be subordinate to international law:

If it turns out that it is not possible to execute an immigration policy that meets public approval without breaking international law, that gently-smoking caldera will, at some point, erupt. At that point, the tension between the theory and practice of the British approach to it will be thrown into stark relief.

In theory, the British constitution remains a political one. Parliament is sovereign, and may legislate as it wishes. The will of Parliament, expressed in legislation, cannot be gainsaid. This legal truth is indeed reflected in the Human Rights Act (HRA); the courts may declare something inadmissible with the HRA, but (with limited exceptions for legislation which preceded it), cannot overturn legislation they deem to contradict it – a crucial difference between our system and that of the most obvious comparator, the United States.

Day-to-day practice, however, is different. Again, the HRA illustrates this: whatever their legal rights, successive governments have proven loathe to simply endure a declaration of incompatibility and proceed with a policy. Even prisoner votes, the one issue on which Parliament held out, ended in a face-saving compromise. Beyond that, our “international legal obligations” seem very often to be held up as if they carry greater moral force than the legislative agenda of an elected government…

Why should a previous government’s commitment to the international community trump (in practice if not in legal theory) a later government’s commitments to the British people? One need not desire to withdraw from all our international obligations, or indeed any of them, to concede that they should be subject to the ongoing democratic consent of the nation.

Wonky thinking

In Fiscal Risks and Sustainability the Office for Budget Responsibility warned that the 2020s are “turning out to be a very risky era for the public finances”:

In just three years, [the public finances] have been hit by the Covid pandemic in early 2020, the energy and cost-of-living crisis from mid-2021, and the sudden interest rate rises in 2022, whose consequences continue to unfold. This rapid succession of shocks has delivered the deepest recession in three centuries, the sharpest rise in energy prices since the 1970s, and the steepest sustained rise in borrowing costs since the 1990s. And they have pushed government borrowing to its highest level since the mid-1940s, the stock of government debt to its highest level since the early 1960s, and the cost of servicing that debt to its highest since the late 1980s.

From this more vulnerable position, governments face growing costs from an ageing society, a warming planet, and rising geopolitical tensions – challenges that no longer loom in the distance in our 50-year projections but pose significant fiscal risks in this decade:

• as the ‘baby boom’ cohorts enter retirement and high inflation ratchets up the cost of the triple lock, state pension spending is expected to be £23 billion in today’s terms (0.8 per cent of GDP) higher in 2027-28 than at the start of the decade;

• as global temperatures rise and the 2050 deadline for reaching net zero draws closer, rising take-up of electric vehicles is expected to cost £13 billion a year in forgone fuel duty by 2030, while the public investments needed to support the decarbonisation of power, buildings, and industry could reach £17 billion a year by that date; and

• in response to growing security threats in Europe and Asia, the Government has said it aspires to increase defence spending – for the first time in seven decades – from 2 to 2.5 per cent of GDP, at a potential cost of £13 billion a year in today’s terms.

Mark Mills from the Manhattan Institute examines the case for electric vehicles - and asks if they represent the impossible dream:

In contrast to cars with internal combustion engines, it’s impossible to measure an EV’s CO2 emissions. While, self-evidently, there are no emissions while driving an EV, emissions occur elsewhere—before the first mile is ever driven and when the vehicle is parked to refuel.

The CO2 emissions directly associated with EVs begin with all the upstream industrial processes needed to acquire materials and fabricate the battery. The received wisdom that EVs will have a “huge impact” on reducing emissions is, whether the claimants know it or not, anchored in assumptions about the quantities and varieties of materials mined, processed, and refined to make the battery.

The scale of those upstream emissions emerges from the fact that a typical EV battery weighs about 1,000 pounds and replaces a fuel tank holding about 80 pounds of gasoline. That half ton battery is made from a wide range of minerals, including copper, nickel, aluminium, graphite, cobalt, manganese, and, of course, lithium. Critically, the combined quantity of these specialty and so-called energy minerals is 10-fold greater in building an EV, compared with an ICE car.

As researchers at the U.S. Argonne National Labs have pointed out, the relevant emissions data on such materials “remain meagre to non-existent, forcing researchers to resort to engineering calculations or approximations.” And, per IEA, data on the emissions intensity of specific minerals can “vary considerably across companies and regions.” That is a consequential understatement. The fundamental fact to keep in mind: every claim for EVs reducing emissions is a rough estimate or an outright guess based on averages, approximations, or aspirations. The estimates entail myriad known unknowns about what happens upstream to obtain and process materials to fabricate the giant battery. Those factors not only vary wildly but can be big enough, alone, to wipe out from one half to all the emissions saved by not burning gasoline.

Book of the week

We recommend Dani Rodrik’s The Globalisation Paradox: Why global markets, states and democracy can’t co-exist. Rodrik presents the causes of democracy, national independence and free trade as an incompatible trilemma. Globalisation’s long-term sustainability is not a given, he argues, and free trade has winners as well as losers.

College students learn about the gains from trade not from Martyn, Smith, or even Ricardo, but from a diagram which is the stable of every introductory economics textbook. The professor draws a couple of demand and supply curves, points to where the market prices are with and without tariffs, and then asks how much the economy would gain from removing the tariff. He carefully labels areas representing income gain and loss to different groups in society: area A captures the loss to competing producers at home, area B the gain to domestic consumers, and area C the loss in tariff revenue for the government. And the “net” gain to the economy? He adds and substracts all these areas as appropriate, and voila! We are left with two triangles that represent the gains from trade to the economy - or equivalently the “deadweight loss” of the tariff. Here is why tariffs are a bad idea, and here is how much we gain by removing them.

…income redistribution is the other side of the gains from trade. If trade causes some activities to contract and others to expand - as it must if the full gains from trade are to be reaped - those groups whose economic fortunes are tied to shrinking sectors will necessarily take a hit. These losses are not transitory. If I have skills specific to garment production, I will suffer a permanent fall in my earnings even if I manage to avoid unemployment and find a job doing something else. Such income losses are estimated to lie between 8 and 25 per cent of pre-displacement earnings in the United States. Any temporary adjustment costs - such as transitional unemployment or a dip in earnings below their long-run level - would be additional to these losses.

Here lies a common misunderstanding in the public debate on trade. Free trade advocates will often grant that some people may get hurt in the short run, but will continue to argue that in the long run everyone (or at least most people) will be better off. In fact there is nothing in economics that guarantees this, and much that suggests otherwise. A famous result due to Wolfgang Stolper and Paul Samuelson states that some groups will necessarily suffer long-term losses in income from free trade. In a wealthy country such as the United States, these are likely to be unskilled workers such as high school dropouts. This renders the whole notion of “gains from trade” suspect, since it is not at all clear how we can decide whether a country as a whole is better off when some people gain and others lose.

…Advocates who claim that trade has huge benefits but only modest distributional impacts either do not understand how trade really works, or have to jump through all kinds of hoops to make their argument halfway coherent. The reality is more simple: no pain, no gain.

…I once quantified the ratio of redistribution-to-efficiency gains following the standard assumptions economists make when we present the case for free trade. The numbers I got were huge…For example, in an economy like the United States, where average tariffs are below 5 per cent, a move to complete free trade would reshuffle more than $50 of income among different groups for each dollar of efficiency or “net” gain created…It’s as if we give $51 dollars to Adam, only to leave David $50 poorer."

Quick links

Overall crime is falling.

Inflation has fallen by more than expected to 7.3 per cent.

Last month saw the third-highest June public borrowing since monthly records began.

Bricklayers and plasterers are now on the shortage occupation list.

There is still no sign of improvement in British labour productivity.

There may be more slack in labour markets than we think.

This week British electricity demand provided by wind dropped to 0.61 per cent.

Tom Scholar, the Treasury permanent secretary sacked by Liz Truss, received a pay-out worth nearly half a million pounds.

The Church of England has defended teaching critical race theory in its schools.

44 per cent of millennials say misgendering somebody should be a crime.

The Government has promised to crack down on low-value degrees.

The Tories lost two by-elections but held Uxbridge.

Coutts really did close Nigel Farage’s bank account because of his political beliefs.