BU's emeritus Professor Nigel Jump writes the latest in his series of blogs on the Dorset economy.
The State has increased its share of, and role in, the economy in recent times. Since the changes wrought by Brexit and COVID-19,
Many expect the government to solve problems with unemployment, growth, and inflation, as well as a wide range of other socio-economic issues
Few remember that, ultimately, nearly all government spending comes from taxation on the private sector, through current tax receipts or loans repaid later.
Calls for government intervention in the economy implicitly say, “the Treasury can use my money better than I can”. Objectively analysed, this can be true or false on an individual case basis. More subjectively, this choice often underlies political debate. It seems to have become more difficult to agree on the right balance between public and private activity in particular industries and/or services.
First, some facts.
UK public sector net debt increased over 40% from £1,835bn to £2,599bn between the end of 2019 and the end of June 2023. Since 2010, the UK’s public debt is up almost 150%. Net debt is now about 100% of GDP – a level that used to be associated with ‘third world’ basket cases. Given the recent modest performance of consumer spending, private investment and exports, real GDP is only above pre-pandemic levels because of government spending. This is reflected in the large rise in public-sector employment versus a fall in private-sector employment since 2019. The State is huge, creating high debts and deficits, but it is not always efficient. From HS2 to the NHS, there is popular frustration with the effectiveness of many State operations.
Second, some analysis.
After recent ‘shocks’ to the system, the UK economy has experienced a ‘super’ Keynesian expansion in the role of government in the economy. At the same time, there has been a massive monetary injection through Quantitative Easing. The economy, awash with ‘unproductive’ money, has an inflation problem.
An expanding State as a share of GDP is unlikely to yield a productivity-driven, sustainably growing, economy. Historically, if the government redistributes more of the nation’s income and wealth, a lower growth potential tends to result. Moreover, an economy dependent on State expenditure is not one where taxes or interest rates can be lowered easily. Debt ratios are higher than they used to be in many countries, but ours seems to be one of the more intractable.
Meanwhile, monetary policy is a mess. Quantitative Easing ballooned the Bank of England’s reserves, ending up as deposits on bank balance sheets. Banks have held more deposits than they would otherwise have done, whilst the central bank has fixed interest rates below inflation. With a rise in base rates to 5.25%, banks are vulnerable to holding assets that they bought at much lower interest rates/higher real prices. Hopefully, economic behaviour will now adjust back to the ‘norm’ of positive real interest rates, but it may be painful getting there for a range of borrowers, including the government.
At the ballot box (and in general discourse), we choose the scale of the State together with how, and on what, it spends our money. We choose where the State will intervene and at what cost, both now and for future generations. In turn, this determines the direction of specific spending and taxation policies and, importantly, sets key behavioural incentives for businesses and households.
Local economic development reflects the level and growth of productivity. In turn, productivity reflects investment, innovation, skills, entrepreneurship, and competitiveness. Given the ‘Big State’ highlighted here, the forthcoming election needs to include conscious decisions about how to make fiscal and monetary policies more effective = productivity-enhancing.
Increasing the long-term growth rate is the avowed focus of many policymakers. Most political parties cite ‘growth’ as the key to success (as we heard throughout the recent party conference season). They all claim to have policies for growth but have yet to outline fully convincing answers. The next electoral ‘winners’ will start from a point of great weakness in the fiscal and monetary numbers. They need to explain which fiscal levers their State is going to pull in order to boost which productivity drivers.
There are areas where the government needs to get out of the way – where the State detracts from growth - e.g., some aspects of regulation and service provision
There are areas for government to engage - where the private sector cannot or will not drive public values - e.g., where future returns are hard to assess/resolve and/or where international cooperation would be advantageous – such as aspects of economic ‘greening’
There are areas of value that the people want addressed e.g., cost of living, health and education, and climate and environment.
The State is an important economic player. Sometimes it makes things worse and sometimes it intervenes effectively. The traumatic years since 2016 have increased peoples’ expectations about what the State can and should do, especially where the private sector has proved unreliable or ‘greedy’.
The growing State has not delivered in important areas. We need to think carefully about whether the State is too big or too small. Clarification of ‘how, when and where’ the government should allocate resources is required. We need efficient and effective interventions, rigorously tested against objective data and analytical criteria. Faced with a scarcity of funding, the State must make difficult choices. We all need to interrogate closely the different ‘offers’ before reaching a viable consensus.
