Growth is low. Not unsurprisingly so. Not disastrously so – yet. Fundamentally, growth is low because the economy's underlying capacity to grow fell dramatically during the period of the last Labour government, and because the economy has yet to complete its adjustment to a new equilibrium, following Britain's worst recession of the modern era.
Can anything be done to make growth more rapid? First, of course, we must stick to the course on the deficit reduction programme. If there were to be any wavering from that, we could rapidly be dragged into the international sovereign debt crisis and disastrous further recession and financial crisis. Mercifully, Ed Balls' mañana prescription is not taken seriously by anyone (no-one even believes he'd do it himself). But is there anything else?
The two most powerful weapons the government has for increasing the rate of growth in the economy are:
- reducing government spending, relative to GDP
- increasing the rate of productivity growth in public services
Reducing public spending should add about 0.1 per cent to annual growth for every 1 per cent of GDP taken off spending. Increasing the longer-term capacity for the economy to grow should help even in the short term, as it will make it more likely that households will be able to service their debts (since their wage growth will be higher).
The government is already planning to reduce public spending, relative to GDP, from 48% to below 40%. That will help, certainly. There are two problems, though. (a) Its plans are "back-loaded". That is to say, whilst tax rises occur early in the Parliament, the spending cuts come later. It could bring some of the spending cuts forward. (b) Since the underlying growth rate is unlikely to be the 2.1-2.35% that the government assumes, but instead more like 1-1.5%, the government is very likely to miss its target. Eventually that is likely to mean that there need to be additional spending cuts, if the deficit targets are to be met. One could imagine making a virtue of that, and doing some of these extra cuts early, to try to promote growth as well as reduce the deficit.
The other most direct growth-promotion tool the government has is the productivity of public services – the growth-promotion of its own spending. Productivity in the public sector was appalling during the decade from 1997 to 2007, actually falling by 3.2% (0.3% per year) in a period when private sector productivity rose by 26 per cent (2.3% per year)! A rise in public sector productivity from -0.3% to +2.3% per year could add up to 0.5% to GDP growth.
How to do this? If productivity growth is what you seek, you want more use of markets, of private sector suppliers (whose productivity growth will more closely resemble that of the private sector more generally), of competition (which is a stimulus to growth and innovation), and profits (which provide a motive to enhance productivity and achieve growth). The most chronically-inefficient part of public services is known to be the health sector – unsurprising, given the vast increases in health spending after 2002, which continued right up to 2010 (up one third in real terms over the last Parliament alone), and which were never likely to be able to be absorbed efficiently on those timescales with a monolithic public sector provider. Other large elements include education and defence. Defence spending is being cut, so productivity there is likely to increase. Education and health are they key decision areas.
If the government wants more rapid growth, it needs to unashamedly promote markets, competition, and profit-seeking in health and education. If it refuses to countenance competition or profit-seeking in health and education, we can confidently assert that though it may will the end of more rapid GDP growth, it does not will the means.