8 policies to kickstart the UK economy

In the past five years, the UK has experienced an unprecedented period of stagnant economic growth. The fall in real GDP is longer than even the great depression.  Given the unusually depressed nature of the economy, what policies could the UK pursue to boost economic growth and recovery? Here are eight  possible policies with their pros and cons.

1. Government spending on infrastructure

With low borrowing costs, the government should be increasing spending on public sector investment projects to provide an injection into the economy and help get unused resources active. Traditionally spending on infrastructure has a large multiplier effect (knock on benefits to related industries) so there could be a significant boost to economic growth from higher public sector investment.

Furthermore, government spending on public sector investment projects can help reduce business costs and boost productive capacity. This doesn’t necessarily have to be high profile projects like HS2, there are many smaller projects which can give a good rate of return (e.g. potholes in roads, need for more rail carriages e.t.c)

If the government announced a series of new investment projects it will also help improve consumer and business confidence. This would be better than concentrating on the need for austerity and ‘things will get worse’. High profile investment projects would create a greater sense of dynamism and hope. By contrast, the recent austerity measures caused a fall in consumer confidence.

  • Evaluation: Some say that given the size of UK budget deficit, we can’t afford to borrow any more. But, bond yields are very low and concerns over the UK debt are partly driven by lack of growth as much as the actual deficit. Counter cyclical spending to boost economic growth, could help reduce the cyclical deficit.  At worst, spending on public investment could be financed by spending cuts which have less negative impact on growth.

2.  Public Investment Bank

Despite low interest rates, bank lending in the UK has been very low since the credit crunch. Banks are seeking to improve their balance sheets and many firms struggle to gain finance for even moderate expansion plans. In the absence of normal commercial bank lending. A public investment bank could make greater lending facilities available to small and medium term firms. The UK is the only G8 country not to have a public investment institute. (see: case for public investment bank)

  • Evaluation: Critics may argue that the government doesn’t have expertise to evaluate whether loans are desirable, and it may lead to government failure. Also, in the short term, it would be costly if the government gave out loans. 

3. Change nature of fiscal consolidation

Some argue we should  delay fiscal consolidation until the economy actually has some positive economic growth. Government spending cuts during a recession have arguably been counter-productive and unnecessary. It has led to lower aggregate demand because the private sector haven’t taken the place of government spending. The government could delay the bulk of any spending cuts for one or two years and focus first on promoting demand and economic growth.

Yet, there does need to be a credible plan to reduce the long-term structural deficit. This can involve making commitments to tackling spending and considering higher taxes in the future. For example,

  • Raising retirement age – which will reduce pension spending and not cause lower economic growth
  • End the ring fencing of NHS spending. Health spending more than doubled between 2000-01 and 2011/12 from £59.8 billion to £121.4 billion. Yet, that spending is ring-fenced. Many fear that the increase in spending has been absorbed into administration costs and doesn’t necessarily reflect improved health care standards.
  • Ending universal benefits, such as  free bus passes, winter fuel allowance. (like the ending of universal child benefit)
  • Consider taxes on unhealthy foods to raise funds for the NHS and promote healthier lifestyles.
  • Increase other green taxes like petrol taxes.
  • Evaluation. Some fear, the UK has no room for manoeuvre and must cut the deficit now before we lose credibility. But,Given the current low borrowing costs, there is no immediate  necessity to cut spending now. Markets would see the sense of pro-growth deficit reduction.

 

4. Funding for Lending scheme

Some hope that the Bank of England’s funding for  lending scheme will give commercial banks a greater incentive to lend to business because they can borrow at low cost. An expansion of this programme could help boost investment and demand.

  • Evaluation. Others are more sceptical arguing that, lower costs are insufficient to get over main problem that banks don’t want to lend in the current climate. On the other hand, others argue, encouraging excessively cheap borrowing costs may cause a misalignment of lending to inefficient businesses.

5. Negative interest rates

Since 2008, the UK saving rate has increased from 0% to 7% in 2012. UK consumer spending accounts for 63% of GDP. With consumers cutting back on spending and increasing their savings, it is no surprise that the UK economy is stagnant. If the rate of saving marginally decreased and consumers spent more, we would see a significant boost to economic growth.

  • Evaluation. The Bank of England is unlikely to introduce negative savings rates over fears that savers have already lost out due to high inflation and low real interest rates.

6. More competition in banking

Another way of tackling the lending problem is to encourage more local, small scale banks which operate on traditional lines of attracting savings and lending to business.

  • Evaluation It would take a long time to encourage more small, local banks to offer loans to companies.

7. Encourage the Pound to keep falling

The UK has a significant current account deficit, implying UK exports are still uncompetitive. If the Pound falls further, this will improve the competitiveness of UK exports, and help boost demand. Demand for imports will also fall as consumers switch to domestic goods.

  • Evaluation. A depreciation in the exchange rate will increase the price of imports and increase cost-push inflation. This will offset some of the increase in domestic demand. Critics say there is a danger of encouraging the Pound to fall as the Bank of England may lose credibility of inflation targeting  (does devaluation really help economy?)

8. Deregulation and more reduced government intervention.

Those of a free market approach would argue the UK economy is held back by a range of government regulations. For example, planning laws which make construction difficult; laws and regulations on labour, health & safety, which increase cost for business. If the government reduced unnecessary regulation and encouraged more competition, there would be a supply side boost helping the economy.

  • Evaluation. The UK labour market is already quite flexible. Even greater flexibility of labour markets and cuts in the minimum wage could actually reduce wages and reduce demand. Critics argue the problem is more lack of demand and spending.

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