What Next? Time for a Change of Direction

Excerpt posted with permission of Prospect magazine

December 13, 2012

While serving on the Monetary Policy Committee, the committee at the Bank of England that sets interest rates, I avoided addressing directly the current government's Plan A for economic recovery through austerity. I felt and feel that sitting central bankers should not publicly comment on fiscal policy beyond forecasting its short-term effects, or on structural matters. Silence, however, was not assent on my part. For two-and-a-half years, the coalition government's economic policies have focused on the wrong narrow goal, been self-defeating in pursuit of that goal, and in so doing have eaten away at British economic capabilities and confidence. It is past time for me, and far more importantly for the chancellor, to say so. Unfortunately, his Autumn Statement reiterated the same misguided priorities of deficit reduction and the same failed approach, with only minor variations.

The coalition government has failed to address the shortfall in productive British investment. As many have pointed out, British capital investment, public and private, has been well below the level of that of its international competitors like Germany, France, Japan, and the United States. Addressing the shortfall requires structural, supply side measures, as well as a demand or stimulus agenda that fits with those measures, and is by definition business supporting. It requires confronting the real deficiencies of the British financial system with the same reformist zeal with which governments took on labor market liberalization in the 1980s and 1990s. For at least 100 years, the City has far better served global finance than British domestic business, and that means the UK government needs to develop alternatives to the City for internal investment.

First, fiscal stimulus—or at least significant slowing of fiscal consolidation—should be adopted in the form of aggressive investment tax credits to non-financial business. Investment tax credits channel investment to directly where the shortfall lies, raising productive capacity and thus tax revenue over the longer term—certainly far more than consumption tax cuts. The UK government should go further, changing corporate governance rules to make it less attractive for businesses to sit on cash, e.g., by making large cash corporate holdings that are neither invested nor returned to shareholders as dividends over a two-year period automatically subject to a vote at the Annual General Meeting. It is understandable in the aftermath of the crisis that businesses want cash buffers and are risk averse. What is incomprehensible is the government playing with a long list of proposed tax adjustments from the Pasty Tax on up over the last two years, and never proposing a serious investment credit.


RealTime: What Is Wrong with the UK Economy? December 13, 2012