Lord Flight is Chairman of Flight & Partners Recovery Fund, and is a former Shadow Chief Secretary to the Treasury.
Philip Hammond has a demanding task in balancing economic – fiscal and monetary – policy for which, in the light of Brexit, the priority will likely be to keep the economy afloat in the face of Brexit uncertainties. This means sustaining consumption, which is the main driver of the economy, at least until infrastructure projects can come on stream. But addressing the longer term imbalances in our economy requires conflicting measures which will need to be addressed sooner or later.
The UK’s increased current account deficit appears to be financeable, but to allow it to increase yet further runs the risk of financing problems and a larger than desirable Sterling depreciation. The current account deficit can only be reduced, however, by either an increase in private sector saving or a decrease in the Government’s fiscal deficit – or a mixture of both. An increase in the savings rate is also necessary to finance more people living longer.
I, like many others, am confused about what the Bank of England’s current monetary policy actually is. It looks like an attempt to have even easier money to sustain consumption and support investment in the near term. But, arguably, its tiny decreases in interest rates – e.g. 0.25 per cent – have little or no effect on the wider economy. These do, however, reduce bank margins yet further, in turn reducing bank profitability and capital accumulation. The pressure on the capital bases of banks serves in the aggregate to reduce their lending ability, with negative impact on the overall economy.
If we move to negative interest rates for savers this will, moreover, reduce the savings rate yet further and increase the current account deficit. My impression is that we already have an easy money regime, and that monetary policies to reduce interest rates marginally further are neither necessary nor would have any worthwhile impact. There is also the issue of Sterling’s depreciation. This may not cause any material inflationary pressures – although the increase of two million in those employed over the last decade implies there is not that much immediate slack in the economy.
This, in turn, raises the issue of productivity. The reason why productivity growth has been negative is that there has not been an increase in GDP matching the two million increase in those in employment. As Alastair Darling has pointed out, Labour’s working tax credits have served to put downward pressure on wages (why should employers pay up if tax credits are subsidising employment), in turn encouraging ‘labour hoarding’ when labour costs are cheap. The inevitable result is a fall in productivity. Arguably, the Universal Credit will also increase the downward pressure on pay. The coming increase in the minimum wage should serve to address this issue, but at the cost of pricing some people out of employment altogether.
A major positive economic trend of the last five years has been the large increase in entrepreneurship, with over a million new companies created. Much of this rise has been in the new high tech sectors. Many young people coming out of higher education have had the courage to set up their own businesses. While no doubt many of these will not succeed, some will and will become tomorrow’s giants. Here the Enterprise Investment Scheme (EIS) and Venture Capital Trusts (VCTs) have been important contributors to the provision of SME risk equity - trebling between 2012 and 2015.
But the complexities of EIS qualification forced on the UK by the EU, and HMRC “gold plating”, have served to reduce dramatically the flow of SME risk equity over the last 12 months. They have also added to costs, since legal advice is now required to avoid the several potential pitfalls where, for modest risk equity capital raisings, the legal costs can become significant. While getting rid of the EU imposed requirements has, ultimately, to await Britain leaving the EU, I suggest that some easing of both the interpretation of the EU requirements and HMRC “gold plating” are needed now, if we are to see a revival in the much needed flow of risk equity for SMEs.
Overall, my advice is not to seek to reduce interest rates yet further which could have contrarian effects; to continue to seek to get infrastructure investments financed, as far as possible, by overseas investment in the UK, both avoiding the need to increase the fiscal deficit and helping to finance the current account deficit; to ease up on the complicated requirements and pitfalls for EIS, VCT and SME equity financing, and to put in place objectives and policy options to increase the savings rate over the longer term.
Finally, I would advise the new Government against socialist-leaning Government sponsored measures, intended to address perceived inequalities and perceived market failure. These are inevitably costly, and often have unexpected outcomes.