‘High interest rates and strict fiscal rules box Labour in – but it still has options’

Labour is going to face a potentially existential problem if – as seems very likely – it is elected at the next general election.

The risk is that there won’t be any money to spend which is not already committed. Labour has vowed not to hike most taxes, and with interest rates sustained at a 15-year high yesterday, government borrowing is increasingly costly. Labour risks having to spend the next few years presiding over just the same sort of cuts and retrenchment that it has castigated the Tories for achieving during all the years since 2010.

It need not be this way. Labour could get the UK economy growing again, but it won’t do so by continuing with the same sort of financial orthodoxy that has brought us to our present pass. What needs to be done instead?

Britain’s economy is not competititve enough

The key starting point, if the economy is to grow, is to home in on how vital it is that, as a country, we are competitive. A crucial economic truth is that any country which is losing share of world trade is bound to grow more slowly than the world average. Very clearly, for a long time, the UK has done very poorly, judged by this criterion, and this is at the root of many of our problems. In 1950, as much as 25% of all goods sold overseas world-wide were made in UK factories. Now, less than 2% do so. If services and commodities are included, over the same period our share of total world trade has gone down from 10% to less again than 2%.

The lack of competitiveness which caused these steep declines has had two disastrous consequences. In the short term, it has led to perennial balance of payments deficits, financed by large scale borrowing from abroad, which have constantly constrained fiscal and monetary expansion.

In the longer term, the uncompetitively high cost of producing anything in the UK, particularly in manufacturing, has made broad swathes of investment in the UK unprofitable. The UK spends only 17% of its GDP every year on investment, compared with a world average of 25%, and more than 40% in China. Indeed, total UK investment barely keeps up with depreciation charges on existing assets. This is why we have little or no growth.

With @RachelReevesMP as Chancellor, my Labour government will bring growth and stability back to Britain’s economy.https://t.co/09iRzeQZMS

— Keir Starmer (@Keir_Starmer) September 22, 2023

UK policymakers prioritise price stability over growth

Why is the UK so uncompetitive? It is because we have constantly tried to sell the goods and services we produce with an exchange rate which is far too high. It is easy to see why the strength of the pound is so critical. On average, about 80% of all the costs involved in producing exports are incurred in the domestic currency – sterling of course in our case. The exchange rate determines the prices at which all these costs are converted and charged out to the rest of the world. The fact that we have seen our share of world trade plummet decade after decade shows how much too high our exchange rate has been.

Why have we allowed this to happen? A legacy from the nineteenth century is partly responsible, when sterling was the most important currency in the world and keeping it stable was crucial to world trade.  UK policy makers have been left ever since with a fear of inflation which has given price stability top billing in economic policy goal terms, at the expense of economic growth.  The policies needed to keep inflation at 2% per annum are the same as those needed to keep the exchange rate far too high.

Dealing with this legacy is not easy, however, as public opinion likes a strong pound. Devaluation is a dirty word even though a more competitive currency is the only way to get the economy to grow. There is a solution to this dilemma, however, and it is to promote the revival of manufacturing. This would both generate the right incentives to get the economy growing and would be well worthwhile and appealing to the electorate on its own account.

The key is education, infrastructure, long-term investment

Many of the policies needed to promote manufacturing are popular with almost everyone. These include better education and training, more expenditure on infrastructure, tax breaks for investment and R & D, and more patient capital. A lower exchange rate – vital for an industrial revival’s success – can then be bundled in with these other popular policies to produce a mix with a strong appeal to the electorate.

This would certainly be buttressed by what an increase in manufacturing could itself provide. Nearly everyone thinks that we should make more of what we consume ourselves rather than relying on imports from foreign suppliers.

Levelling up the economy is much more likely to be achieved by bringing industry back to our erstwhile industrial heartlands than by anything else. Manufacturing generates better paying and more reliable jobs than much of the service sector. It is much easier to increase productivity in manufacturing than it is in the rest of the economy.

If we could achieve all of this, electing a Labour government would indeed be a prize worth treasuring!