Earlier this month government’s independent economic forecaster admitted it would need to “significantly” lower its estimates for the productivity of British workers, citing a decade of stagnant growth since the financial crisis. The Office for Budget Responsibility said the average rate of productivity growth of 0.2 per cent over the past five years was a better guide to the future than its March 2017 forecast of 1.6 per cent.
This has far-reaching implications. Treasury officials believe the downgrade will wipe out around two-thirds of the £26bn set aside by government for an anticipated slowdown after Brexit, from 2017 to 2021.
It seems that the government and their advisers – not least the OBR – have made two quite fundamental errors, which are reflected in their forecasting. First, they don’t seem to appreciate what, precisely, generates increased output per hour and thus increases productivity. It is only investment in a narrow range of economic activities revolving round mechanisation, technology and power which will shift the dial here – and nothing much else. However valuable social investment in roads, schools, hospitals and housing are in themselves, they do very little to increase productivity or boost economic growth.
Over the past few decades, however, light industry – where investment in mechanisation, technology and power is typically to be found – has been decimated in Britain. The percentage of GDP resulting from manufacturing has declined from around 30 per cent in 1980 to below 10 per cent today. Even more significantly, investment in the most important high-growth sectors has plummeted to less than 3 per cent of GDP. Once you factor in depreciation, there is vanishingly little left. It is hardly surprising, in these circumstances, that productivity is static.
The second fatal assumption has been to conclude that the deficit has been caused by excessive public spending – that Labour “crashed the car”, as is now commonly believed – and that raising taxes or reducing public expenditure will therefore reduce the need for government borrowing. On the contrary, the government deficit is driven principally by the need to replace demand which is drained from the economy by our foreign payments imbalances, causing the government to have to borrow to fill the gap. To keep up demand, it has no alternative but to pay out more than it receives.
Cutting taxation or public expenditure, therefore, will make little difference in reducing the deficit unless they are implemented on a draconian scale as, for example, they were in Greece, where deflation caused the national income to fall by about 25 per cent. Imports then fell sufficiently for the foreign payments and government deficits to be eliminated together – but at huge economic and social cost. So long as we have a large balance of payments deficit, the government simply has no choice but to spend more than it receives. One deficit is the mirror image of the other.
As John McDonnell said in his conference speech last month, “the City is not channelling investment into high value, high productivity businesses”. The reality is that there is no incentive, at present, for them to do so. Investment in most manufacturing operations in Britain is simply unprofitable, the root cause being that our exchange rate is too high.
A crucial question for Labour, therefore, is whether the party’s economic policy is going to be orientated towards rectifying this situation by making manufacturing investment profitable again – and getting the economy to grow at 3 per cent or 4 per cent per year. The alternative: continue to rely on our service industry, where exports and productivity gains are much harder to attain, and see our growth continue at the meagre rate of less than 2 per cent per year. The result? Another decade without wage increases for most people.
The only way to ramp up productivity is to get the exchange rate down to a level that makes investment in low and medium tech profitable again. This will allow us to rebuild our manufacturing base and to pay our way in the world once more. We would then no longer need to borrow either as a country, through our government or as individuals, or to sell assets to maintain living standards which we are not earning. Only then will we finally have the money to spend the roads, schools, hospitals and housing that we so desperately need.