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Q: As much as there is a debate about the best policy mix to achieve sustainable growth in the UK, do you think there is growing consensus that current policies are unlikely to achieve this?
A: Well I think there’s a growing sense that the current stagnation is not optimal and so there are calls from both sides to do something about it. A lot of that seems to me to be too optimistic about the role of government in changing the course of the recovery. The real division occurs between the Keynesian viewpoint that says the government should be actively pursuing policies that will help the economy in the short term and the more supply-side outlook that we advocate which seeks to improve the growth rate in the longer term. From our side we broadly support the parameters of the original policy, which was to eliminate the structural deficit over the course of a parliament and get net debt falling. Clearly there were some mistakes in the way that was implemented such as including tax rises and cuts to capital expenditure. Indeed these went against best practice according to academic literature that suggested if you cut current expenditure quite hard and keep control of welfare spending whilst at the same time protecting investment spending and in some cases cutting taxes you tend to get better output results. But I think having done those front-loaded things it would now be a mistake to abandon the plan completely. What people are looking towards now is what can be done to improve the growth rate given the cuts to current spending that are to come. Here I think supply-side reforms and targeted tax measures could do the business.
Q: Surely tax cuts are as much a fiscal stimulus as an increase in government spending?
A: This is where our position is often misunderstood. We don’t believe in demand management and therefore we don’t support tax cuts as a way to provide a temporary deficit-financed boost to the economy. Our preferred tax cuts are all about the effect they have on incentives to work, produce and invest. There’s clear academic evidence that cuts to corporation tax and capital gains tax actually lead to long-term benefits to medium-term growth rates. Even then, however, I wouldn’t be supportive of as drastic measures as some supply-siders have suggested because I think the idea that you would deficit finance those when you are already running a deficit of around 8% of GDP could potentially be quite dangerous – not in terms of bond markets, but in currency markets. Indeed the performance of Sterling over the past three months could suggest we’re already at that point.
Q: It has long been suggested that weak Sterling could be beneficial to the UK’s recovery prospects. Given the relative weakness of the pound and apparent lack of an improvement in the UK’s balance of trade figures does this argument still hold?
A: The Bank of England certainly seems to be actively trying to talk down the value of Sterling as part of their policy armoury but I’m not convinced that it has particularly positive effects. Expansionary monetary policy coordinated between a number of major economies has helped to push up commodity prices as people diversify into different assets. So we’re helping to generate inflation in commodity prices and then paying the cost again when we import them. I’m not convinced from what I’ve seen so far since 2008 that even a significant fall in the value of the pound would have a particularly positive effect on real GDP growth.
Q: Do you think that there is a danger that these discussions underplay the potential role of the UK’s services industries in any recovery?
A: There’s almost an outbreak of a mercantilist view at the moment whereby producing hard things is seen as somehow more valuable than providing value- added in the service industry. I think this is a mistake. When you look at areas where growth is likely to come from you can see the growth of the Chinese middle class and there’s clear evidence that as people get richer they demand more and more services relative to goods. The UK can get into a position whereby we can make our exports more attractive to China but clearly at the moment we’re not doing enough to get into those sorts of markets. I don’t see any reason why the UK couldn’t become a huge exporter to fast- growing emerging economies where there will be a huge increase in per capita wealth over the next 20 years.
Q: Is the focus on reforming the banking system, and in particular on remuneration of bank employees, helpful for the UK’s growth prospects?
A: I think people on our side of the debate have conceded too much on the financial crisis. There was clearly some extraordinary behaviour by some institutions but we tend to overlook the fact that the starting point of the crisis in the US was the extending of mortgages to people who couldn’t afford them, which was actually actively encouraged by politicians and policymakers. Policymakers have got away with things quite lightly. People on our side of the debate need to stop playing up to the populist stuff and start looking at how we can solve these problems from a free market perspective. As much as I can understand the sentiment behind the desire to cap bankers’ bonuses, the idea that this would in any sense be beneficial to the UK’s competitive advantage is bizarre.
Q: A growing number of commentators are suggesting that central banks holding interest rates at ultra-low levels may be detrimental to medium- term growth prospects. Do you think there is an argument now for the Bank of England to consider raising rates?
A: I don’t think you’d want to do it yet, but where I agree with somebody like [former MPC member] Andrew Sentance is that the new Governor and the MPC have got to set clear metrics for how they plan to exit current policy. I get the sense that there has been no real thought so far given to how you go about reversing QE in the event that you would have to do that. I also get the impression that there’s been little thought given to how we might change current policy if the economy continues to stagnate and low interest rates are playing a role. If the new Governor were to set out a clear direction for policy that included when and under what conditions the MPC would consider raising rates, which is something that Mervyn King has been unwilling to do in his time at the Bank, it might remove some of this uncertainty. More broadly I think people expect too much of policy. In the short term fiscal and monetary levers can avert a greater crisis – I don’t have any doubt that the initial round of QE helped to avert a particularly nasty depression. Yet I’ve never seen much evident that these types of stimulus policies lead to a self-sustaining recovery and in most instances a recovery comes from the supply side of the economy.
Q: Are there some policy improvements that can be achieved before the end of this parliament?
A: There are definitely some supply side things that could be done which aren’t even being debated at the moment. For example, there’s huge scope to reform our tax system. George Osborne set up the Office for Tax Simplification but I couldn’t name you one substantive thing that they’ve actually done. We could do with a cross-party Simpson-Bowles style commission just on tax reform as there’s a hell of a lot of common ground and it could be an easy win for the UK economy.
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Visiting Professor of International Economic Policy, Princeton University10 articles | View profile
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