If AI solved Baumol’s Cost Disease, that would be GOOD

Let us start with some generally accepted facts:

  • The UK has been mired in low productivity growth for 15 years. Fixing this would be great
  • There are structural reasons that modern growth is harder, such as ageing and increased cost of energy. A key one is the growing preponderance of service sector activities that are hard to automate, leading to Baumol’s Cost Disease
  • Digital technology has exploded in its extent and capability, but not affected productivity as much as the hype suggests it should.  It appears to affect small parts of our consumption basket and hasn’t yet transformed the big bits.
  • But artificial Intelligence (AI) is widely seen as having the disruptive potential of utterly transforming service sector jobs

So: hope at last? You would think so. And there are two prominent Labour facing think tanks pondering and publishing on this very topic: the IPPR with “Transformed by AI” and Tony Blair Institute’s “Accelerating the Future”. With Labour currently forecast to enjoy a 300 seat majority, these people are worth studying.

But the two take a very different angle on this potential revolution. Blair’s crew follow the logic of those bullet points. Their worry is that this turns out to be another technology revolution that we fail to make the most of: “the UK’s problem is the lack of development and diffusion of tech from the frontier to the rest of the economy.” For decades, the government have agonised about why capitalist businesses fail to act in their own interests and adopt the best tech; see the Business Productivity Review, the creation (and failure) of Help to Grow, Andy Haldane on the Long Tail of Unproductive Businesses.  It is genuinely puzzling why competitive markets do not weed out the laggards. Why do we have to urge companies to “be the business”? The problem is that AI is great, and we might not make the most of it, just as we haven’t with countless other improvements.

The IPPR in contrast takes what can be fairly called the Luddite point of view. (Luddites had a point! Ask ChatGPT!). Their language is riddled with a kind of nervous fatalism about the encroachment of AI. Jobs are “exposed” to AI, workers are going to be “displaced”.  Their proposals include:

  • ‘Ringfencing’ tasks from full automation, with processes involving unions, businesses and policymakers sitting down to work out which jobs should be treated in what way
  • Subsidizing jobs that have low exposure to AI
  • Efforts to ensure that any gains to productivity go to workers
  • Promotion of a “full augmentation” scenario in which workers stay in place despite becoming far more productive.

A snarkier writer would suggest their piece be called “Decelerating the Future”, because some of these measures are actively trying to prevent AI being used, and others are definitely undermining the incentive to implement it. (Can you imagine trying to persuade an international investor to come here, when we, the government, want to discuss guidelines about which jobs can use which technology?) In a historically-learned report, the IPPR are acutely sensitive to the damage felt by people who have felt on the wrong side of technological change: mentions of displacement or disruption dominate those of growth or productivity.  

Which one of these broad emphases is the right one? Without any question, it is the Blairite, optimistic view. As of 2024 we have demand for labour so high that immigration is at a record, the hospitality sector is genuinely struggling and social care is in crisis. We have had approaching half a century of the computer encroaching upon the workplace, and absolutely no sign of a negative effect on the number of jobs. From the OECD STAN Database:

For the UK in particular, admin job growth has outpaced our generally impressive overall employment record (except, oddly, in the public bit):

Whatever the problem has been, it is not a widespread displacement of administrative staff from their jobs, despite spreadsheets, word-processors, databases, email, and websites changing everything.

The IPPR has clearly noticed the phenomenon of cost-disease – occupations that passively enjoy the rise in productivity that is coming from the more innovative parts of the economy.  Modernity is full of service jobs defined by their intangible capital, hard to automate, great for providing little pools of monopoly rent, a little crud-ish, if you like. Like the Blair Institute, IPPR see artificial intelligence is one possible way this might change. But their diagnosis is that society will somehow be better off if we try to ensure as many jobs as possible retain these characteristics, even if it means impeding the spread of productivity.  

Is this the right call? It is possible to imagine good economic reasons to favour greater labour power and protections, of course: making it harder to hire and fire might boost the incentive to train and invest, goes the usual logic.  I like some of these – but not in this report, when the process is explicitly to reject the encroachment of productive technology.

In places, I even fear that the IPPR have created a new twist on the lump of labour fallacy – which imagines there is only so much work to go around.  The AI techniques under consideration are ways of making administrative work less labour-intensive, but the “Augmentation” scenario they envisage calls for keeping in the workers in place so they will “produce more and directly boost GDP”. This really isn’t how it works with admin. If the work is customer service, secretarial, producing documents, and so on, and one secretary can now do the work of four, the rational response isn’t to retain four, and generate four times as many documents, emails and so on.  No one wants these crud-like things, they are a cost of doing business.  GDP does not rise; productivity falls. We want to reduce the lump. And, yes, you might want to redeploy them – but why can’t that work through the labour market? It is how 6m or so job separations currently operate.

It is moreover hard to imagine any injunction to retain workers that would survive exposure to normal competitive forces. I would have liked a discussion of what customers, investors or competitors may want in the face of technical change. Rivals can adopt the same techniques but pass savings on to customers; capitalists will prefer to invest in the companies that reward the investment in innovation. “Innovate but pass all savings to workers” is not stable. This may sound heartlessly Thatcherite to some ears, but good analysis from the likes of Resolution Foundation (see Richard Davies’ piece) suggests that the problem has been too little dynamism and disruption, not too much.

To give them credit, I do not doubt that the IPPR’s worries about change are genuine. But they are far too well-read not to know already that the kind of sudden disruptive change they fear would be historically unusual.  This one is meant to be different. But I don’t think that 100m people downloading ChatGPT is evidence that the UK is about to transform itself with AI at a blistering pace (it is just an app), and I would probably welcome it if it did. It would break all recent precedent, and recent precedent needs to be broken.  I think the IPPR have chosen the wrong problem to solve.*

The Blair Institute piece is therefore better, in my view, simply for adopting the right target, writing

“An AI-era industrial strategy should aim to accelerate the technological transformation of the economy that is already underway, in order to generate economic value from AI-era technology faster and reap the rewards of higher productivity sooner”

In a funny way, TBI share some similar traits with the IPPR, in particular a strong faith in the action of the state to make things happen, calling for the government to “become a platform for the innovation, adoption and diffusion of productivity-enhancing AI-era technologies”. That sounds hard!  Despite the problem lying in the adoption of technology by normal – what Rachel Reeves calls “everyday” – businesses, the TBI vision is very much about deep-tech and R&D based in a way that the early Cameron’s tech-obsessed team – or Dominic Cummings – might have produced. Apparently the answers lie with “hypercompetitive sectors” like advanced manufacturing, biotech, digital creative industries and fintech. Their proposals include some to shake up our “ossified, oligarchic research landscape”, and powerful, expert-filled central bodies driving change, developing and implementing strategies, and somehow coordinating government.  Look at what the Ministry of the Future might do:

report directly to the prime minister and be tasked with scanning the horizon for emerging trends and disruptions, and working with departments to develop new long-term planning tools, adaptive strategies and contingency plans. It could also involve regular crisis simulations and wargaming exercises to test the government’s preparedness for different scenarios, such as economic and fiscal shocks, cyber-attacks, pandemics and technological accidents.

Sounds busy – and there would also be interdisciplinary research institutes, oodles of digital infrastructure, new-ish entities like data trusts, testbeds, Trailblazers, hubs and sandboxes. I would not confidently be able to draw any of these on a napkin, but they may well be Good Things.

My concern is that there is just too much here, too much for the state to do when in reality the successful exploitation of AI will ultimately depend on the private sector.  If TBI is right and this is a transformative General Purpose Technology** then most of the right policies will be general and horizontal: the reduction of barriers, the provision of capital, the training of workers and so on.  Innovation transforms through its use, not its invention. TBI are right that the world needs breakthroughs in those deep-tech ideas, but we don’t have to invent them to benefit: after all, here we are worrying about ChatGPT, and it isn’t a UK invention.

But these are quibbles. I prefer the TBI approach to the IPPR’s, because it is more squarely targeted on solving the right problem – our weak adoption of great ideas – and doesn’t risk making it harder to solve (as I fear these IPPR “ringfences” would). I have no idea if TBI can solve it, but that is what AI policy is like right now: hugely uncertain. Throw a lot of ideas at the wall, and some of them will stick – but it does need to be the right wall.

*Curiously, a 2017 IPPR piece on Automation takes much more of a pro-change angle, worrying about how “the diffusion of technologies to the non-frontier economy has to a considerable extent broken down, slowing the pace of automation and weakening productivity growth”. 

**I happen to think AI is being slightly overhyped. In particular, the explosion of equity value isn’t proof of a giant net economic effect: those trillions in market capitalisation rather proves that whatever happens will be anything but cheap. In this gold rush, the customers are already paying a lot for the picks and shovels, before that much gold has been dug. The AI revolution has a marginal cost, even before you think about the electricity and water.

Is “competitiveness” the point – and is it getting worse?

Earlier today I had the privilege of my first in-person appearance before a Select Committee – Business and Trade interviewing me, George Dibb, Geoff Owen and Paul Swinney on Industrial Policy.

I inevitably found myself confronting a question I was not prepared for: “has the UK lost its competitive edge?”. Thankfully, George’s tweet broadcasting the event gave me some 20 minutes’ headstart before the Chair, Liam Byrne, asked each of us “Has the world become more competitive?”, or something to that effect.

To nearly everyone, it is the most natural question when thinking about why the UK has done so badly this past 15 years. Our living standards are stagnating, other countries are growing faster. This turns quite quickly into a story of how they are doing better than us, and somehow eating our lunch. Drilling deeper, the characterisation suggests a finite quantity of good, high quality economic activities, and because other people work harder or smarter (or some combination) they are taking these activities from us. This often means high value manufacturing jobs, which we end up importing instead of making, leaving us doing less valuable and virtuous things, dependent on untrustworthy foreigners, and poorer. This, to many people, is the essential motivation for industrial strategy. It is why people like David Cameron used to declaim in some doomerish way that “we are in a global race” and

“that means an hour of reckoning for countries like ours. Sink or swim. Do or decline.”

Yikes.

But I have read my Paul Krugman, who in the 1990s wrote an absolutely brilliant piece titled “Competitiveness: A Dangerous Obsession”, confronting very similar rhetoric back then under Clinton; President Bill Clinton, that great globalist, who nevertheless said each nation is “like a big corporation competing in the global marketplace”. The mental image of every nation competing with one another for a finite prize was embedded in people’s heads: in Krugman’s words

People who believe themselves to be sophisticated about the subject take it for granted that the economic problem facing any modern nation is essentially one of competing on world markets — that the United States and Japan are competitors in the same sense that Coca-Cola competes with Pepsi — and are unaware that anyone might seriously question that proposition. Every few months a new best-seller warns the American public of the dire consequences of losing the “race” for the 21st century

But as PK goes on to explain, it was a largely erroneous way of explaining why a country’s living standards are rising or falling. Productivity (the basic ability to do more with less) is what matters, not our ability to beat anyone else. The empirical data said it: “the growth rate of living standards essentially equals the growth rate of domestic productivity — not productivity relative to competitors, but simply domestic productivity“.

My emphasis. Please read his whole piece, it is one of his classics. It is fair to say that Krugman came to acknowledge caveats, that trade can restructure relations within countries, that demand a political response (read this excellent Frontier Economics blog). But his core point stands.

In the committee, I found a slightly more provocative way of putting it, doubtless less well-grounded than Krugman’s brilliant piece. As I set out in an earlier blog, the price behaviour of the stuff that we actually buy has really changed its trajectory over the past 30 years. From 1992 to 2008 we saw spectacular drops in the prices of things we really wanted to buy and spent a lot on: cars, white goods, key IT infrastructure. These price falls slowed or even stopped and went into reverse for the next 15 years. Here is the table:

The earlier price falls had been a major tailwind to our quality of life: people overseas making more and more stuff for less and less, and we getting to buy it. Economics is about consumers as well as producers! And one way of looking at this is that we benefited from the increasing productivity of other countries like China, and the subsequent slowing of that process (or our exposure to it) is a reason for our own prosperity no longer improving as fast. So: no, the world has not been getting more competitive, and that has hurt us.

Smart-Alec contrarian, me. But for an economist, it is quite hard to conceive of how your neighbours doing things better is going to hurt you. Their productive potential increases the total size of the pie- it takes quite a few contortions to produce a scenario in which Country X producing 1000 beans instead of 100 beans is somehow bad for Country Y.

Krugman also takes on the idea that the point of industrial strategy is to “choose the right high value sectors”, the (again commonsense-sounding) idea that “Our standard of living can only rise if (i) capital and labor increasingly flow to industries with high value-added per worker and (ii) we maintain a position in those industries that is superior to that of our competitors.” But this would straightforwardly argue for us to funnel cash into the most capital-intensive areas. And as I and others have explained at length (in 2021), the failure to allocate to the ‘right sectors’ does very little to explain the productivity shortfall since the Great Financial Crisis. Over 25 years before me, Krugman was knocking over the same straw men. He writes that even if exposure to overseas trade had taken 1 million people out of manufacturing, and they were 30% more productive than the rest, their small size as a share of the workforce means this would explain just 0.3% of any fall in the US wage rate.*

So does this mean I am not in favour of industrial strategy? Far from it! I think you need it for many interlocking reasons, including:

  • There are major and predictable changes coming to the economy, global and national: a total revamp of our energy system, the electrification of transport, society ageing, the onset of certain key technologies, and these all involve long term government policymaking, financial support in places, essential public goods and so on;
  • The government affects the economy in all sorts of ways and an industrial strategy is a way of being conscious and responsive about that. Most of the good ideas for intervention bubble up from beneath, and the government should build systems to identify and respond to them. But it also needs to be much better at noticing when it is clumsily damaging the business environment.
  • The government/society has essential interests, most obviously security but also environmental, which can require that it becomes involved in economic matters, like ownership, technological diffusion and the attainment of certain key capabilities.

This leaves plenty for the government to be getting its teeth into. Questioning the concept of “competitiveness” in no way argues against the great importance of productivity, but most of the work there is going to be “horizontal” rather than selecting particular high-value sectors and trying to win at them. This means: creating a better skilled workforce; improving infrastructure; exploiting agglomeration effects; improving the functioning of markets (including dynamism, the entry and exit of companies and job market churn); and above all increasing the extent of the market in which our businesses operate. And this matters in every sector, high- or low-value-add – all of them increase the national pot of wealth.

The point about extending the market is key, the real secret sauce of economic growth over the centuries. Bigger, more complete and functioning markets are a driver of growth that exceed all others, including technological virtuosity. Technological leaps drive the world forward, sure, but 98% of the benefits of innovation go to its users. Small countries cannot invent everything, and it is trade that exposes them to transformative innovations. Most of us didn’t invent the Internet, all of us use it.

Ultimately we would benefit in lots of ways from a more enlightened industrial strategy. But too much anxiety about “competitiveness” can be a risk, if it leads to protectionism and the closing off of markets.

*I unknowingly echoed him, writing “manufacturing workers were 50% more productive than all others, a shift from 20% of the population working in manufacturing to 10% would lower economy-wide productivity by only about 4.5%.” –

Final thoughts on the £28bn

I promise this is the last of it.

If you have the time, listen to Osborne and Balls on their podcast discussing the £28bn U-turn.  I missed it, but Ed Balls apparently said that for U-turns to work, they have to be big and ugly, and that way the voters really notice, and that is what was needed this time. In which case: mission accomplished! It went on for ages, involved some really ungainly and sometimes contradictory comms, and the Westminster bubble talked about it fairly constantly for a few weeks, with interruptions for that nasty PMQs, that Piers Morgan bet, Biden’s Age, and so on.

Their discussion is really good all round, covering not just the underlying policies (power decarbonization by 2030 is highly ambitious), what it says about whether Labour has any motivating reason for governing, the skill of the Tory backroom staffers in making the £28bn such a “thing”, the unwisdom of having the policy (net zero) so closely associated with a number in the first place.  Some thoughts:

  • The nuance of the argument between two people with distinct economic views shows how “bubble” it is, in my view. I don’t think voters follow to this extent. They just receive a few big impressions: Starmer and Reeves have done a U-turn; it is in the direction of annoying Corbyn types and Green types and in favour of flintier fiscal hawks; that is about it.  And I think the Labour party want to be painted in those primary colours. Only an absolute knockout blow can deprive them of power now, and that means something as awful as 1992 again. Maybe they are jumping at shadows, but it is an insurance play against catastrophe.
  • Characterising it as “fiscal circumstances have changed, blame the government, what do you do when facts change” feels both right and actually true.  Any party that had the same plans when rates were 5% as when they were 1%, and when growth/debt were expected to peak much lower, has a very odd policy. There are huge competing strains on public spending.   In government, as I blogged last week, your plans are roiled by circumstances ALL THE TIME.
  • In fact, do some basic maths and you find that this has happened a lot under this government! Here is my tweet thread, this is the punchline:
  • And do you know what? This government’s shifts of plans are fine! So they started 2020 as a low corporate tax, massive Capital spend planning government, had a pandemic, came out with higher taxes, lower capital spending and a big new allowance … All of these steps on their own were perfectly legitimate – so why wouldn’t an opposition also changes its plans in response to the same pressures?
  • What is left of this plan is still pretty big– the details I have seen suggest fiscal commitments much larger than either this government or the Coalition enjoyed. Certainly more than anyone can prove can be quickly and efficiently spent.
  • Also, timing: as Balls points out, having this row now may suit Labour? Who is going to remember all this kerfuffle in November?
  • There are a bunch of plaintive voices now worrying “oh but where oh where will the growth come from now?” And this is the bit that winds me up the most, because the implication is always that without the Government doing a particular thing, then the growth just won’t occur.  If only the officials, spads and politicians had come out with a Plan and found the Money to Fuel the plan then we could have grown, but they never did because they are nothing like as enlightened as we keyboard warriors and as a result growth came there none …

Now I am fairly pro government intervention, pro industrial strategy, against the mindless shrinking of the state that Truss and her ilk want to attempt, but I have no hesitation in saying that this is a very dismal and misconceived mindset.  Growth does not happen because some barely-qualified cabinet minister Unleashes it. The actions ministers take have some long term significance, but in the short term they are slow and tiny compared to the giant existing mass of economic activity out there. Economies literally grow themselves, fuelled by nothing but their own dynamism and resources, which are massive.

When the UK was growing just fine in the early 2000s, the Government’s fiscal impulse was negligible, and the Bank of England’s balance sheet little larger than a building society’s. When Mervyn King was comparing himself to Maradona, in his ability to bewitch all around him, the Bank’s ‘credibilty’ meant that the economy could just motor along on its own juice. Functional economies provide the conditions by which billions of microscopic improvements take place: job moves, market entry and exit, mild operational improvements, markets growing, ideas spreading. Do you think this all happens because some minister and his team had the right plan?

This isn’t a call for complacency. The next government faces a big challenge: a knackered public estate, underfunded services from social care to military, a slowly deteriorating relationship with our largest overseas market, and so on. That dynamism I go on about is diminished.  I am not saying that 2.4% growth is round the corner.  The many people I speak to who fret about this are in many ways hoping something good turns up – a favourable supply shock for once, a dividend from eradicating the instability associated with this government, perhaps.

But for goodness sake no one should be saying “without this promise of £28bn a year in 2029 there is no plan for growth”. There is just as much of one as there was before.

Industrial strategy, its quantity and the Certainty Fixation

As of February 2nd 2024 there is a gigantic and ongoing fuss about the exact status of Labour’s £28bn climate investment promise. It is probably the exact fuss that the dying and likely departing current government wants to see happen, the last Balrog-whip of an attack before they plummet into the abyss.*

You can probably tell that I think this is an argument grotesquely exaggerated on all sides. The markets, insofar as they ‘think’, do not see a rise in climate-related capex in 3-6 years’ time as likely to drag the UK into a debtor’s prison.  Respectable opinion everywhere thinks that climate-related investment does need to rise, and sober reflection on what investing in government is actually like (bloody hard: see the Housing Infrastructure Fund) suggests it will not be straightforwardly ramped up anyway. Even when it is granting money to others (see the £11bn commitment from COP).

And you would be deranged to think that not writing £28bn in the blackest of inks into some PRE-ELECTION Labour HQ spreadsheet of future capital commitments somehow means that party no longer prioritising climate.  It cannot mean anything. Between now and 2028-9 there are about 10 new OBR forecasts, the planning and delivery of several trillion pounds of spending, many COPs and far more than can’t be predicted. No one in opposition can in good faith promise anything that far out – a “confident ambition” is in fact the most that anyone can do. Commitments even more concrete than that – ideas like a Tax Lock or a Pensions Triple Lock or a Tuition Fees Pledge, invariably concocted by the most cynical spads with some leaflet in mind – are invariably a very bad idea.  Make the ink too black and indelible, and you do indeed invite some horrible multiple-choice game with journalists about whether your five years’ time House Cladding money is going to drive out NHS capital spend, or whatever.

I am meant to be thinking about industrial strategy, and want this fuss to pivot onto that topic.  The Labour opposition means to be an industrial strategy government, with multiple exhausting policy pamphlets as proof. In many minds the £28bn is linked to industrial strategy, of course: climate change is the best, easiest motivation for a planned, strategic approach (high capex, long term, high commitment goals, inextricably linked to government policy, room for export growth in places, regionally varied – it’s a dream!), and this £28bn was meant to be the “fuel” for such a strategy. Is it not cut off at the knees as a result? When America is spending trillions on Bidenomics and all that?

And there is a simple answer, which is: god no. Standard critiques of industrial strategy as an idea (see The Economist, of course) picture a state doling out giant wads of cash to favourites on favourable terms – a 100x larger version of what Teesworks were accused of (it is more complicated than that, just read Jen Williams). All sorts of other accusations are made – protectionism, industry distortion, capture by well connected insiders, choosing second-best technologies that cost consumers unaccountably, and so on. But the money thing is key – if industrial strategy were just some very small hobby as small as the DCMS budget, then it really would not deserve the fuss.

The thing is: industrial strategy IS very small, in this country!  Compared to when the state owned most of the utilities, construction companies, engineers, banks and airlines, the amount of investment the government actually influences or helps finance is just not very much.

The OECD’s Quantifying Industrial Strategies work is unintentionally very clear on this point.  The first sentence looks like it says the opposite – “Compared to other countries, the United Kingdom is spending more on industrial policy grants and tax expenditures” – and then your curiosity leads you to ask how.  And the answer is tax expenditures on employment and jobs/skills policies, “particularly towards reducing the national insurance contributions of the self-employed”.  There are also R&D tax credits and direct spending on R&D and other stuff that governments naturally do, but again which are hardly what people normally think of as industrial strategy.

Overall actual spending on what anyone sane might think is real industrial strategy is tiny. Giving employers £5000 off the NICs bill for the first employee isn’t industrial strategy! Nor, really, is the “reduced rate of NICs contribution for the self-employed ” – not unless you think favouring those particular kind of one-man-bands with 0.2% of GDP is our big industrial strategy. These may or may not be good policies – another blog – but they clearly aren’t attempts to reshape the economy in a chosen, long term strategic direction. I am fairly sure the first of these, the Employment Allowance, was produced in large part to make the 2013 Budget go down well, after the disaster in 2012.  

Here is an astonishing thing. The biggest actual industrial strategy intervention I was ever involved in, the Aerospace Technology Institute of 2013, which Vince Cable won horse-trading with the Conservatives in 2012, is at a £2bn over 10 years too small for the OECD to give it any notice.  Nor is the Automotive Propulsion Centre.

As for energy, according to the OECD, UK support for this vital, protean sector is around 0.07% of GDP. Less than £2bn? It would once have been larger, but CFDs on Offshore wind are currently deemed to have almost no subsidy in them.

There is much you can conclude from this. First, that reshaping the “spend” the UK directs towards industrial strategy is quite possible without increasing resources. Second, that if even a fraction of the originally mooted £28bn finds its way towards direct grant subsidies or loan guarantees or finance in energy, then that will almost certainly represent a huge increase.  Much of it won’t – because the £28bn isn’t an industrial strategy pot, as such, as far as any of us know what it was meant for specifically. 

A third key point is that it is a mistake – and one that pleases your opponents – always to think in terms of direct fiscal spend. Yes, sometimes that is needed (and many mistakes have been made trying to avoid that conclusion) but a lot of the change the economy will need will happen through regulation, carbon pricing, the natural flow of activity when relative technology prices change. The 2030 EV target, for example.  Ultimately net zero is something all of society needs to pay for, and not all has to flow through the Exchequer.

A final point. Lacking for money, it is understandable that policy wonks look to a wonderful, money-less idea, the creation of more certainty through institutions and mission-commitments as an alternative. I can understand why this is tempting – after the past few years, promising certainty is electorally quite potent as well as relevant to how businesses think. 

But too much emphasis is put on macro-certainty as the one great driver of investment, in my view. It is necessary, but not alone sufficient (see my business investment piece).  No business in the UK operates on a macro-scale, which is why making reassurances to business on the level of the whole capital budget is almost irrelevant. I honestly don’t think many finance directors think “I would have signed off on this investment, but I don’t like the way the Chancellor has allowed the future CDEL allocation to deteriorate through inflation”. The sort of certainty they need is likely to be more micro on the whole – at an industry, sector or project level.  When you read about how our European peers build more cheaply than we do, the sort of “certainty” they get is over a pipeline of actual investments. Credible, ten-to-fifteen year plans without the boom-bust so endemic to this country. It certainly helps not to have a Treasury constantly trying to pull the capital rug from under departments’ feet. But since this has been achieved by countries much more fiscally troubled than the UK, it is about more than that.

Anyway, all of this is a way of saying that nothing that has been announced or briefed in the last week on the £28bn means very much at all for the UK’s future industrial strategy!

*yes I appreciate this means I am comparing the opposition to a band of elves, hobbits and bearded men led by a magician, what is your point

What is your favourite explanation for our fall in growth?

For someone who spends as long as I do noodling over the UK economy, it is flat out embarrassing that I do not have an immediate and confident answer to this question.

Here is a reasonable contender for the most important chart of the era.

Taken from OBR figures (so easy to do), this shows successive key eras of RGDP growth: the last 7 years of Thatcher, the long Goldilocks recovery under Major and Blair, and then the years of the four crises: Financial, Brexit, Covid and Ukraine – including projections. In each new era, the average growth rate has fallen down a step: 3.4% per annum in the first, 2.5% in the second, 1.22% in the last. I have snipped off the axes to prevent the ridiculous Covid years ruining the appearance of the chart.

Why has this happened? It is easier to dismiss the bad or lazy takes than provide a really strong positive answer. For example, it is not a matter of “being in all the wrong sectors”, or bad industrial policy as some would characterise it: we are not that different from the USA or other growth champions (I tried to take on this thesis and much more in a 2021 piece here). Fantasize all you like about what might have happened had we not allowed manufacturing to wither somewhat, but when a sector is 10-15% of the economy, it simply cannot explain a fall in the whole of it to that degree. Had we continued to grow at 2.2% since the financial crisis, by 2019 we would have had an economy £240bn larger: that is more than the entire manufacturing sector.

It is more feasible to look at the failure of the big services that provided a lot of pre-crisis growth: IT/comms, Financial services, Professional services all failed to grow since the GFC like they did in Goldilocks, with IT a particular failure. We maybe fail to appreciate how extraordinary the dozen years up to 2007 were; we should also be alert to the difficulty of properly capturing the value of services like the Internet suddenly arriving. And we can all appreciate how the Financial Sector could not easily have replicated the 75% real terms growth that happened in those miracle years.

What are the other theories? Some admirable folk are obsessed with our low building rates, but the charts they publish tend to show the problem started way before the big growth slowdown (as far as I can see, the last birth cohort to head into its late twenties not needing to spend 20% of its income on housing costs was the one born in the mid 1960s. That is at least how I see this chart)

And I do not think you can easily make the housing sector responsible for the failure of the whole: I tried to do the numbers once here.

Can you blame slowing technology? Perhaps, though you need to dig deeper. These charts of mine suggest that improvements in certain key, big consumption items may have just run out in the last 10 years – clothing, automobiles, big appliances – and the things that kept improving somewhat (online digital things, say) are just not that important to the consumption basket. Add in the sharp increase in energy prices recorded to the last year, and Baumol’s Cost Disease wearing away while our need for services rises relentlessly, and slowing graph, decade by decade, is almost inevitable. But it does little to explain why the UK is perpetually behind other countries with much the same access to finance and technology as we have, in terms of labour productivity. Nor is it easily a story of poor educational outcomes.

So what DO I think? Obviously a mishmash of everything, but with a particular emphasis on structural inevitabilities, bad luck and some bad government. 

In the last 15 years we have been hit by three crises that might be once-a-generation (the financial crisis, Covid and the Ukraine price shock), while managing a historically large governance blunder (Brexit, and the governing uncertainty that came with it), all at a time when structural headwinds are against us (an ageing society, the end to some of the easier wins from globalisation, and the energy transition). We have, in my opinion, been ruled by governments mostly with the wrong mindset: too lazily laissez faire on industrial strategy, and for a few years a little blithe about the risk of weak demand, though I don’t think these two failings account for more than two or three ppts of lost opportunity. The year 2007-8 marks an unusually difficult high point to match, because financial sector output was unsustainable in some way, the UK particularly exposed to it, through other services too.

But we are fundamentally still a good capitalist economy with trusted institutions, stable rule of law, financial markets that broadly work, quite well educated people and an underlying openness to the world in spite of some of our worst politicians. We ought to be able to do better in the years ahead than people fear, or perhaps than the OBR projects. It doesn’t need a “plan” for growth, any more than the 60 years after the War needed one: approximately free markets are always trying to seek out new demands, new techniques, new uses of capital and so on. 

So I am pretty optimistic, particularly if we see an improvement in the quality of political leadership over the next five years. On average, it ought to be better than the last five.

Please read Ed Conway’s Material World, it is really good

Here is the question I think you must answer before formulating a strong opinion on technology and growth: what do you think are the real binding constraints that limit our productive future? Are they labour, technology, energy, food, environmental sustainability, a decent level of security or something else?

Professor Richard Jones, a polymath able to moonlight as a thinker on science/growth while conducting fundamental physics research, put it pithily in recent blog (“Productivity and artificial intelligence”). Musing about why our technological advance has not generated outstanding growth recently, he writes this:

The lesson here, then, is that AI is very good at the solving the problems that it is well adapted for – well posed problems, where there exist big and well-curated datasets that span the problem space. Its contribution to overall productivity growth, though, will depend on whether those AI-susceptible parts of the overall problem are in fact the rate-limiting steps. (my emphasis)

We have all had this thought when playing around with ChatGPT: this is a lot of fun, and yeah sure I can imagine it taking some tedium out of my white-collar work, or even helping me being creative – but does it strike at what is really limiting my potential, and that of the economy as a whole?

Or take this angle on the question: the British state is facing an unenviable crunch in the years ahead. The tax burden is at a historic high, the public paying those taxes suffering a horrible cost of living crisis, and yet public services are starved of cash – if you find this hard to believe, just read carefully the IfG’s Performance Tracker.* By my rough calculations, we need £20-30bn just to restore funding in real terms to where it was planned in the last spending review.  Now ask yourself: what recent technological breakthroughs might ride to the rescue and close these funding gaps, improve people’s quality of life, restore public finances to something less scary? When you read a PwC report that Artificial Intelligence might “contribute $15.7tn to the global economy by 2030”, do you emit a sigh of relief, tot up the UK’s modest share (call it 1%, or $157bn) and conclude that we just need the right AI policy for prosperity to follow?

I would suggest the answer is no, the simple reason being that whatever AI is set to achieve in the next 5-10 years does not address the rate-limiting barriers holding us back.  One of the motivations for blog posts like the last one I wrote on the public’s evolving consumption basket (trust me, it is more fun than it sounds) is to get at the facts about what it is we want or need. Demand is a neglected topic in discussions of economic growth! It is of limited use that society demonstrates stupendous, Moore’s Law-driven advances in the ability to supply cat videos, look up our mates on social media, or that the cost of taking a photo or listening to a string quartet has dropped from pounds to pence to nothing; these are small shares of our consumption, and the other stuff rises in relative price (read Richard on Baumol, too).

What you need for incredible, sustained rises in economic prosperity is a combination of rising demand and supply. Energy breakthroughs epitomise this: for two centuries, economic progress and the ability to generate more useful energy went hand in hand.  But material progress more generally captures the substance of economic growth. Material of some kind or other is very, very often the limiting factor in determining growth. 

And that is why I think Ed Conway’s wonderful book, Material World, is such an influential read for me.  I don’t have a copy to hand, so have to put this down from memory, but somehow in the course of three years’ research Ed visited copper mines, semiconductor foundries, blast furnaces, shale wells, lithium salt flats, the place where polythene was invented, and so much more to build for the reader an astounding account of the incredible materiality of the world around us (the title really wrote itself). The book combines history, technology, analysis and really vibrant description. You are frequently astonished at the virtuosity of the materials geniuses that have laid the foundations for the world we live in. It also reminds the reader constantly of the interconnectedness of everything – how different commodities and manufactures combine to create the objects that make modern life what it is. Our world is a miracle of interdependence.  Ed gives you a flavour of all this, without fallaciously pretending at any point that he can capture all of it. It really is such a wonderful achievement that I have quite passed through the envy stage to one of pure admiration.

I am guessing that Ed did not intend to write the book as an argument, but as my overlong preamble suggests I think it can be read as one.  Most of its subject matter touches upon the limits of the material commodities in question, even if those limits have been locked in a tight, competitive race with humanity’s ingenuity at getting more out of less.  Material limits, either gradually realised or suddenly imposed (2022!) are all too frequently the limits that matter – the “rate limiting” variables Richard Jones refers to.  Conversely, material breakthroughs are a key part of the puzzle we must solve if we want to break back into a higher-growth plane.  Even if AI, the Internet and the rest somehow generate sustainable productivity growth in ineradicable human services (social care, healthcare, security, education and the rest) my conclusion from the past few years is that the material limits will continue to bite. The green transition alone, which brings its own limit (carbon) and material demands (the multi-trillion revamp of industry, energy, agriculture and transport) is going to ensure that we will worry about stuff for a long while yet.

If I were to recommend books to help us understand the world we live in today, one pair I would give to students would be Ed’s Material World, to be read in conjunction with Westlake and Haskel on Intangible Capital.** (I am not so simple-minded as to promulgate an either-or vision of our world: you need both perspectives. They are intertwined: perhaps better institutions for the intangible capital world will be what unlocks material limits. And intangible progress certainly needs its physical inputs). I rave more about Ed’s book right now, because he has made the very familiar both new and surprising: the stuff all around us, and how it got there.  

Like I said, read it.

(ps: if you think I am repeating myself, you are probably right: a lot of these thoughts were expressed in other piece like “Umpteen reasons I am so uncertain about growth“. But that is what makes these books useful: they elucidate things we are struggling to articulate.)

*if you are the kind of person who thinks you can counter this kind of information with some lazy jibes about something or other you read about civil service salaries on the Daily Mail then this probably isn’t the blog for you

** a third book would have to cover the other key input, labour: something like The Wealth of Humans by Ryan Avent.  But labour is a unique, Janus-faced input to the economy: it provides both a factor of production and the means by which people gain the right to what is produced. Makes it a different topic altogether.

The Economist’s assault on the new industrial policy

You don’t have to follow me for long on Twitter to realise I rate the Economist, and also have an interest in industrial strategy, so this week’s special section hammering it is essential reading for me. It is worth summarising and keeping it to hand – because for an industrial strategy to be any good, it cannot just ignore these sorts of criticisms. The author has done his research. I find this well worth re-reading.

Personally, I think there are a fair few straw men in here, but the case for such a piece is strong: Bidenomics comprises a pretty vast field of action, and the backlash against free-trade that most people date to the fateful year of 2016 is showing no signs of abating. And The Economist was created to fight that very fight.

What are the arguments? Here, at a rush:

Globalisation has helped to create huge numbers of winners. This is certainly true and there are clear signs (shameless plug for previous blog) that it slowing down has contributed to slowing gains in prosperity, right here in the UK.

The combination of the financial crisis, geopolitical shocks, energy price rises and generative AI has created the pretext to go after the assumed downsides of globalisation. As description I think this is broadly fair, though I think events like the tsunami of 2011 also contributed to a sense that we had undervalued resilience, and the naivety of policy makers towards China back then seems truly odd in retrospect. (Let alone towards Russia).

Money “is sloshing around in huge quantities“. I find this, in fiscal terms, is often exaggerated (see “Birth a Lion”). Even if Labour reaches the full £28bn, it will be around 1% of GDP, and in truth it is going to be just “a slightly higher capital budget”. The UK needs more investment, and the erosion of two or three tax breaks would fund it halfway. The big learning from the OECD “Quantifying Industrial Strategies” work, for me, is that the UK has casually given away giant amounts in breaks like the Employment Allowance without any supporting analysis at all. Industrial strategy is definitely affordable, the question (which the Economist poses so well) is: is it effective, wise, good at achieving its objectives?

People are overstating how much neo-liberal economics has failed, and overconfident about how easily they can tear free from China – and storing up trouble, because the invisible losers from bad policy will eventually learn about it. I have a lot of sympathy for this, though I do wonder at the end-of-history flavour of assuming the model that worked for 1998 is forever the right one. “Permanent West Wing World” is my mental bookmark.

I think the accusation that it is really hard to make supply chains resilient is one of the strongest (in this section). Ever since reading about how hard it is to make a pencil I have wondered at how much magic takes place in the market that we just don’t see (see the classic 1958 essay). Also read Ed Conway’s book to see how staggeringly complex the silicon supply chain is. We maybe exaggerate how badly supply chains broke during the quite extraordinary shock of Covid. It is right to point out that separating from China can only be partial and will certainly be costly.

So, as they argue in the next section, there is a real risk of the worst of both worlds: less efficiency means we are poorer, but no more resilient. Bad policy can do that! But the case for the current phase of industrial policy being bad is cloudy. The piece passes rather quickly over examples of failed interventions, like Sematech, and successes like DARPA and South Korea, before a literature review that one can only call inconclusive. I simply cannot chose which of the papers should be given the final word on this. But the author is right to warn against the Nelson-eyed approach people often take to this topic: looking simply at the industry being helped, and not the productivity of the whole country. And we should be constantly aware of failures, like the difficulty that America has had trying to get TSMC to set up on its shores. Even where they succeed, the ongoing cost of subsidies needs to be considered very carefully.

But ultimately, given how halting, new and in my view small the efforts have been so far, I think the word “inconclusive” is the best verdict we can make at this stage.

Causes of the longstanding fall in productivity growth since the mid 2000s will keep economists arguing for years and years. Unlike what I think is the gist of this piece, I see much more to be blamed on the financial crisis, demand weakness and a certain structural inevitability than the West suddenly rushing towards industrial strategy. And I know plenty of people who draw the opposite conclusion, that too long a period mired in neoliberal, low-investment policy world is finally bearing its rotten fruit.

This brings me to a possible incoherence in the overall argument, made clearer in the next section. The author, persuasively, argues that the jobs impact of China’s entry into global trading networks is exaggerated, and at 2m out of 130m in the case of the US is easily absorbed. OECD employment rates are near record highs. So neoliberalism is unfairly tarnished. OK – so is the assumption that neoliberalism has been in charge, or resurgent industrial strategy? It feels like it was the latter when the issue was declining productivity growth, but the former when it is robust employment. Ultimately, it is hard to disagree that the most important structural fact is the continuing decline in manufacturing, virtually inevitable given its productivity growth and a relative shift away from physical product (I would also throw in energy costs).

Another really important criticism is that “Green Protectionism” will undermine the cause it is meant to further. While I don’t think the author pushes the mega-naive argument that all we need is a high carbon price and the market will do the rest, he worries that efforts to divert business from overseas suppliers will undermine attempts to reach economies of scale and raise global costs, citing valuable ECB research. He also worries that starting NEW industries will slow the transition. In short: quicker to trade with the existing lowest cost provider than try to learn-by-doing.

But even here I think The Economist realises it has to pull its punches. Climate policy, away from a political podium, is a second-best world. Political opportunities have to be seized when they can be. Highly visible winners must be created to prevent the inevitable losers stopping difficult, expensive investments from even getting started. So much needs to be done, and so much of it is inherently local (can the UK buy off the shelf a whole new transmission grid?) that trade alone feels like an inadequate answer to targets that quite rightly have a very hard date on them. In fact, I think the Economist puts it very well:

Any plan to free an economy from fossil-fuel dependence will create losers. To succeed politically, it must therefore mobilise groups of winners more powerful and passionate than those losers. Millions more people working in clean energy could mean millions more people with an economic incentive to resist attempts by fossil-fuel interests to roll back the clock.

As I see it, the Green Transition is the ultimate example of a kind of wicked policy dilemma that cannot be solved without vigorous intervention. The natural economic incentive to free-ride is very strong – you hear it from recent Conservative policy announcements – and the investments are very, very long term. I just cannot accept the case against, and am not sure The Economist can make it.

The last chapter, warning against promises from Governments to prevent future instability, is perfectly sound. Even during the heyday of industrial strategy that was not achievable. The 1970s and 1930s were faily tumultuous, I do believe. But I think you don’t have to believe – as the Economist accuses its antagonists of thinking – that globalisation of the 1990s and 2000s ‘failed’ for there to be a call for new policies now. I loved those decades but don’t think that the circumstances they existed in can be bottled up and re-released today. It is a huge challenge that productivity has stuttered since the gigantic event of the financial crisis, and some of this may be put down to a misconceived retreat from globalisation, but surely not most of it.* The facts on the ground have changed, the challenge posed by Net Zero and a newly hostile world is real, and – I hate to face this – perhaps some of the benefits of globalisation had a natural end-limit. How much cheaper could clothes and food get?

Ultimately, of all the sayings I find myself repeating on this topic, the one that I keep returning to most of all is this: both the advocates and critics of industrial strategy tend to grossly exaggerate their case. Its advocates can over-promise, and its critics often pretend that a policy often focused on just 5-10% of the economy is responsible for damage to 100% of it. We can re-introduce elements of industrial strategy without becoming anti-trade. Small countries like the UK will have no choice but to take that approach. Calm down everyone.

*and the only point at which the piece is rather too glib is when it attempts to ‘solve’ this problem with “Productivity growth in the rich world is weak. And yet the fault lies not with globalisation per se, but elsewhere: badly designed welfare states, a lack of retraining, and restrictive planning systems which prevent the construction of new housing or commercial space.”. Can we not all agree to avoid simple diagnoses here?

A blob-chart way of dissecting Britain’s prosperity failure

It’s been a fairly bad 15 years or so for economic growth, hasn’t it? There are plenty of ways of discussing this – charts of a line rising steadily up to mid 2008, turning sharply down and then never quite getting back on track. I have quite a few in this somewhat downbeat attempt from two years ago, still as relevant as the day it was posted.

Here is another way to look at it – through consumption, and prices. Consumption is the ultimate purpose of economic production, and prices are the major information tool within our grasp. Throw in quantites, and you have a fairly complete picture of economic change, from the consumer point of view. Brace yourselves: it looks like this.

Don’t throw up and close this down; I swear it makes sense.

The chart depicts the change from 2008 to 2023.

The horizontal axis shows how much more, in cash, the representive household spent on each category. The vertical axis is how much they got in that category. So, for example, we spent around 39% more on clothes, and got 32% more clothing for that.

The position of the bubbles tell us about technological change, and changes in habits/spending propensities.

There are a few obvious observations. Firstly, the blobs veer to the right, because there has been inflation; incomes are about 50% higher, so is spending. But, secondly, we get about the same amount of stuff as before – the chart is as much above the horizontal as below. If incomes had grown a lot, and prices and consumption habits were constant, the chart would look the same, but higher

Thirdly, the blobs MOSTLY sit along a straight line sloped line. A lot of the economy displays little in the way of productivity gains over those 15 years. Habits have changed – we have apparently increased our real consumption of household appliances, and cut that of package holidays – but these items neither helped nor hurt prosperity. Here we can zoom in on those bogstandard things:

These are about 60-70% of the whole consumption basket* and mostly but not all services, and therefore classic cases of Baumol’s Cost Disease. Largely provided by humans, with steady real productivity, their price just rises with wages, more or less. Read your Vollrath and you learn that they are inevitably a bigger part of our future.

But we have had 15 years of technological change, no? Um, yes we have, but in terms of the weight in the final consumption basket, it isn’t so enormous. Here they are in blue:

This buckets together quite a few varied items, for their virtue of being well above the line. All they have in common is that the fall in their effective prices means that they have contributed towards the consumer being better-off, all together. Their price has not risen with incomes. Ergo: prosperity. See clothes and shoes:

The only direct experience of the tech miracles from the smartphone era is found in “Audiovisial etc”, which means: Reproduction of Sound, Making photos and videos, “Data processing” i.e. computers. These have shown spectacular price falls. For example, the price series for “Data Processing Equipment” has fallen from 4998 in 1988 to 227 in 2008 to just 80 now. For the same £100, you can get 60 times as much of that processing as in 1998, and almost three times as much as in 2008. Unfortunately, this whole Audiovisual category takes up just 1.5%-2.5% of the consumption basket (that is why it it is a small blob). We get a lot more of it, but it ain’t much. More on that later.

Finally, there are the really bad news items – the commodities that have gotten way more expensive, and the services that appear to offer less for more. Here they are in red.

The obvious worst item – our energy bills – take almost 5% of the overall consumption basket (up from 3.3% a few years ago). Their price index is up from 62 in January 2008 to 235 in January 2023. Ouch.

Enough with the charts. What does this all tell us? I have some reflections: on technological progress, its relationship with economic growth, the importance of trade, and the importance of not forgetting demand.

Rapid digital technological advance does not generate huge prosperity directly via the consumer basket. The size of that “Audiovisual” dot is a reflection of what all these videos, music streaming and photo sharing mean, according to the statisticians. They haven’t ignored gigantic improvements – they are in the price indices. But we have responded by spending about as much of our wallet on them, and getting way more. Nice for us. But it is a 2% thing.

Technological advance has not shown up enormously in other goods and services. I find it striking how few other services have shown a big improvement – apart from financial! You may doubt the latter but think about it – online banking, pay by tap, all have improved a lot. But “Cultural services”, Restaurants, transport – these are much more about the price of fuel and of labour than digital tech.

Inelastic demand is a total downer. Gas is up 250% in price since 2008, but the ability to switch from it is limited. Hence its increase in the consumption basket from 1.5% to 2.0%. Ditto electricity. When you speculate about its role in the consumption of everything else, the problem of expensive energy looms larger and larger. A thesis of this book, while wacky at times, cannot be ignored: look out how energy improvements stopped.

The biggest story is a dog that didn’t bark. For the industrial era, prosperity has been driven by the constant improvement in price of big, important physical items. Cars got invented, and became a combination of cheaper and better, for decade after decade. We spent more on them (unlike “Audiovisual”), but we got much more back. Lots of physical goods were like this. Clothes. Mod-cons. Computers. The whole of modernity got created and cheaper.

But not so much, since 2008. Look at this ugly table. It compares the cash price improvement in a bunch of items for the years 1992-2008, and then the 15 years after.

They make up around a fifth of the consumption basket. Every item here stopped improving at the same pace (apart from “Other Financial Services”)- including the really incredible smartphone-era technologies at the top. Clothing, which fell in half in cash terms over the previous 16 years, started rising in price again. New cars just stopped improving. Look at air travel! The years up to 2008 were wonderful. Afterwards, just like anything else.

Why did this happen (or not happen)? There will be a lot of answers. The one that strikes me mostis a reflection on how we trade a lot of these items. For a long time, Western Consuming countries passively enjoyed the benefit of falling prices that stemmed from the incorporation of the East into our trading networks, and the constant improvement that their factories achieved. That came to an end. Maybe it had a natural limit. The Financial Crisis will not have helped. Rising Chinese wages likewise. The collapse in the pound from $2.00 to $1.20.

In particular, I think it is a real and important mystery that the explosion of network technology, the incredible GPT that is the smartphone, has not seemingly improved the productivity of other industries. Our ability to gain knowledge and promulgate it has skyrocketted. Why hasn’t that had real, physical consequences? This unbarking dog is one reason I remain sceptical, for now, about artificial intelligence transforming real growth. We still need to demonstrate how to make the last technological marvel do that.

For all that this post is already overlong, it just scratches the surface of the topic, and hides a lot. It doesn’t solve the problem of UK productivity, or even characterise it. Had the UK been a ‘better’ economy, selling for high prices a lot of valuable goods and services that the world really wants, our incomes would be higher, the pound stronger, and all these numbers would look different. What we choose to consume would not have constrained us.

But I find in all this data further confirmation that in a big, connected world full of mostly exogenous technological trends, our future prosperity is, unavoidably, to a large extent out of our hands. Each generation has tended to be more prosperous than the one before because of phenomena like factory managers organising production better, somewhere a long way away. Hairdressers, lawyers, politicians and teachers are better off because of exogenous changes they are not directly responsible for. Economic progress is largely a game of free-riding. It is humbling.

*Overall, I pulled in about 90% of the consumption basket for this

The Myth of “No Austerity”

If you attend to enough right-wing commentary on the dismal state of the UK, at some point you will hear or read some version of the following: “But they never even cut public spending! We haven’t been Conservative at all! This is SOCIALISM”.

The marvellous Liz Truss event at the Institute for Government provided the most recent example (see my epic threads or watch it here). Truss has a consistent thesis: Conservatism hasn’t failed, it wasn’t even tried – instead we have a “corporatist social democracy”. In case it doesn’t feel that way to you, she has some evidence, and it is the usual: state spending is massive, higher than since the 1970s, and rising like in no other country. Slam dunk!

And is it true? Well, yes…..ish. Go to the PESA tables and this is what is officially the case:

You can see how in the hands of the unscrupulous (not, I will admit, Truss) those figures can be made to seem even worse – “in the year 2000 we spent less than £400bn, now we are on course to spend £1.1 TRILLION” etc.

Then at the same time we all also know something: that public services are under enormous strain. NHS waiting lists are through the roof.

Schools are crumbling, local councils are keeling over, and everyone is on strike because they have suffered realterms wage cuts for years.

Look at the IFG Performance Tracker for more.

So how do you reconcile this? First and most important point: the austerity is not a fiction! You can easily check this yourself by going to the PESA public spending tables, found here. Now, first a few caveats. I have chucked in data from 2008-ish to 2019 or so, before covid, and doing this runs into all sorts of risks. Education spending, for example, has moved around with different departments. The Scottish and Welsh Governments gained control of some revenues in 2015 or 2016 and therefore caused all sorts of ructions in the division between Departmental Spending and other types. This sort of thing is very annoying indeed. But you end up getting numbers like these:

Ignore the weird pandemic years for now, and remember these are cash figures. Between 2010 and 2019, inflation will have eroded figures by a sixth or more in real terms. (Personally, I think a higher deflator is needed because resource spending is really about spending on people.) If you run those figures through, and compare 2009-10 to 2018-19, say, this is what you get:

These are really large numbers! I am sure there is going to be mistakes and misleading aspects to them – DFE’s figures surprised me, until I realised that they had picked up the BIS spending on HE and FE, for example. But this really is austerity. The biggest cash-terms winner here, the NHS, clearly did not get enough to keep pace with healthcare demands.

So how come, then, we have this narrative of endless further splurges? Well, it is a combination.

  • Money illusion Some people are simply fooled by how numbers rise with inflation. Between 2010 and 2020, Total Managed Expenditure rose 24% from £721bn to £891bn on OBR figures, or less if you go off PESA figures (don’t ask. It’s about OBR backdating adjustments etc I think). People find that really impressive
  • Winners and losers. I use “winners” advisedly here, but within those big numbers different totals will have risen and fallen at different rates. People think about Austerity often with regard to departmental spending, as I have here. Departmental resource (i.e. not capital) spending is about 42-46% of the total. Other items HAVE risen a lot – like Debt Interest! £34bn in 2008/9, £72bn in 2021/2. Aid.
  • Welfare? Well, ish. Go to the OBR Historical Forecast database and you find that the welfare within the “cap”, the stuff the Conservatives want to control hard, has risen from just £113bn in 2010/11 to £123bn in 2021/2. Not much at all – a big cut in inflation-adjusted terms. But the TOTAL welfare bill has risen from £197bn to £244bn, so other stuff – pensions? – has gone up much more impressively, from £84bn to £121bn, ish.

Ultimately, this chart below is the final truth of the matter when it comes to departmental spending up to the eve of the pandemic. Take out the NHS, FCO/DfID and devolved administrations*, and the picture is clear. Yes, there was austerity.

*I do this simply because the transfers between AME and DEL in the devolved administrations just confuses things. They had austerity too …

Ted Lasso versus the Triangle of Crapness

About six months ago, we passed the point at which bad news for the economy was good news for Labour.  Thanks to Liz Truss, the Conservatives have lost their reputation for economic competence. High mortgage rates will be associated with this government, come what may. Labour are now around 90% likely to be in power in 2025. They don’t want a basket case.

And let’s be clear about it – Labour governments need times to be good. Parties that believe in the power of the state to improve things have a much harder time when funds are tight; look at the stress caused by the two-child benefits policy. We can all celebrate the achievements of the Attlee government but it wasn’t an easy time for the country, and it left Labour exhausted. Not having a financial crisis would have been good.

If better times are needed, it is difficult after the last 15 years to believe they are around the corner.  As well as being a master at producing endless growth charts pointing down and to the right, I read and follow the wrong people: Tim and the OBR on the fiscal situation, Peter Foster and Rafael Behr on Brexit, Dieter Vollrath and Tim on the prospects for growth, Bagehot and Tim on the prospects for cost-free public sector reform. You know: pessimists. Together they generate what I might poetically call the Triangle of Crapness:

Hence a slew of articles setting out Labour’s crappy inheritance.  As you might expect, Chris Giles’s is the most comprehensive, covering all three points of the triangle: no more room for spending (according to the fiscal rules); much less low-hanging fruit to improve growth; and public services start from a perilous position.

Also, remember that the OBR is if anything a little optimistic. Including its forecasts out to 2027, the period from 2010 has seen real growth average at 1.6% a year, whereas the OBR thinks (as of March) that we will manage 1.8, 2.5, 2.1 and 1.9 in the years ahead. In nominal GDP terms, the trend has been terrible for three decades:

That shift from 5.5% in the years up to 2010 to 3.5% ever since is why I still think the Financial Crisis is the most significant event of the millennium so far, more than Brexit, Trump, Covid or Ukraine. It changed everything. By the power of compounding, this is what those shrinking forecasts did to our expected nominal GDP in 2027

We have an economy some £800bn smaller in cash terms than you might have forecast 15 years ago. Compared to late 2015, before Brexit gut-punched the recovering economy, we still have £200bn less. And though these are cash figures, remember that inflation has turned out higher than forecast.  Cash isn’t going any further. Think about this the next time someone tells you GDP isn’t the point. Only if you clearly have enough of it. We don’t.

What makes it worse is that the points of the Triangle interrelate, in a bad way. Bad public services undermine the economy – through poor health outcomes, sclerotic planning procedures, etc.  The weak economy damages the fiscal situation, obviously, and then the services get worse again … Put a “circling the drain” gif into that Triangle.

Objectively, if that is a thing, this gloom is justified.  Given the ageing economy, the shortage of workers, the threat of energy shortages, higher interest rates and deglobalization, it would be irresponsible for forecasting bodies like the OBR and BOE simply to assume things will pick up. Their independence is designed around avoiding just that kind of bias. And while I am no political strategist, I fully understand why Reeves and Starmer (and Hunt and Sunak, for that matter) are going with the pessimism in devising their pre-election strategies. Memories of Truss are too vivid. I suspect the British public associate boosterish optimism with recklessness and insincerity, to a greater degree than ever before, thanks to three years of Johnson and six weeks of his successor. And raising growth is hard work. There isn’t one simple trick (read my Nesta blog). Growth isn’t just “unleashed” any more: see my other blog, and read everything by Dieter Vollrath. There is just too much already there: £4.5tn of capital, 33m workers, a vast amount of inertia, a gradual shift towards more services, Baumol’s cost disease. Your policy ideas are small in comparison.  You need frankly amazing estimates for how much a tax cut or capital increase can raise production to believe otherwise.

The risk is that this level of sensible conservativism leads to fatalism – if every government has to confront this Triangle of Crapness then what is the point of voting? But to escape it you need something better than a vacuous Ted Lasso theory of change, in which you can take over an establishment, no matter how rubbish, and transform its performance simply through a change in the management and some positive thinking.

So here are a few reasons I think the Labour inheritance might end up being better than currently feared. In no particular order:

  • That there is definitely a negative feedback loop within the Triangle points unavoidably to there being a positive one as well. Improve the economy, make public services more efficient, sort out the public finances and you can get a virtuous circle going too.
  • The miracle of compounding.  Too many people look at this chart and treat it as our future:

But what I see is how relatively small starting conditions build over time, if nothing at all is done about them. It suggests that we might end up with a debt/GDP ratio of 150% in 2050, in about 25 Budgets’ time. But that many Budgets ago, the world economy was beginning to do so well that Alan Greenspan fretted before Congress about the prospect of endless fiscal surpluses, oh woe. Small improvements now – or avoiding mistakes like those Greenspan-era tax cuts – make a huge difference.  Focus on now, not 2073.

  • The inflation problem is going to resolve itself, and not necessarily in a bad way.  As Tim points out, sometimes it serves to boost revenues and lighten the deficit.
  • And one of the reasons that inflation has proven stubborn is that the widely predicted UK recession has still not arrived.  For the next few months we may enjoy something of a Goldilocks period – falling producer prices, the beginning of some real wage increases, a renewed sense that interest rates are near or at their peak
  • Furthermore the shift, finally, out of a zero interest rate world isn’t all bad, either. Sure, it is worse for the indebted government, but negative real rates were a miserable signal for the economy. Pension schemes will be more solvent now.  Above all …
  • … it may be easier to eke out productivity gains in an economy closer to running “hot” than one bumping along in deflationary conditions.  Trying to raise productivity in a cold economy is much harder, like trying to float a boat off the rocks when the tide is low. For individuals and businesses, the incentive to do it isn’t there as much when conditions are slack. What motivates investment, training, innovation and all those productivity-boosting good things is the press of business, the actual experience of not having enough capacity to serve what is coming through your door. We have finally stumbled upon how to run the economy hot-ish
  • The pessimism about public sector reform is a bit overdone.  I can see why the Economist’s Bagehot columnist goes after the “reform fairy”: in politician-speak, it has supplanted “efficiencies” as the magic balancing item. There is no doubt that some key reforms need upfront investment, such as spending more on the planning system and NHS capital.  And some injustices just demand money – like the two child benefits limit. But, having reviewed a nice book about public sector reforms a couple of years ago – How Should a Government Be? The New Levers of State Power by Jaideep Prabhu – I refuse to believe we have exhausted all possibilities. The excellent Dutch “Buurtzorg” social care system, for example, is simply a better way of arranging care. It does not have to cost more.  Countries like Vietnam manage to improve their education system without oodles of money.  So has the UK!
  • It is also too glib to conclude that just because Reeves is trying to sound as close to Hunt as possible, there are going to be no fiscal recourses available. There are tax-breaks and allowances for business riddled through our fiscal system – look at the OECD examination – that amount to quite a few billions. And the business bungs are small compared to those aimed at individuals – see these figures:

On this topic, I also subscribe to a little Ted Lasso-style thinking. Simply removing the pressure of the Conservative backbenchers with their constant clamour for unfunded tax cuts is a fiscal plus. It hasn’t generated extra growth or more sustainable public finances.

  • Fundamentally, there is an optimistic way of responding to how badly the UK has done this last fifteen years. We have fallen ever further away from the productivity frontier. That is a huge pity, but it also means growing is less about performing achingly high-tech, best-in-class actions. You just need to catch up to what is possible elsewhere. Don’t have such a centralized government, don’t have such a sclerotic planning system, stick to the same investment incentives for more than a year at a time, improve your deal with Europe. You don’t need to host the world’s first quantum computer or fusion reactor (though by all means go for it)
  • And significant chunks of the UK are pretty close to the frontier already (see Tyler Cowen on south England). So there is nothing fundamentally prosperity-repelling about the UK’s laws and customs. We just need the whole country to be closer to that level.  

I feel weird projecting any kind of optimism about this discombobulated country of ours. Brexit in particular still has the capacity to depress me – read Peter Foster on the negative ratchet it has put between us and the EU. I never stop worrying about Ukraine. But if we have learned anything about the last 15 years it is that the future course is never set. Sometimes things can get better.