How Osborne's Budget can increase confidence

The state must have more faith in its own power to tame recession.

The state must have more faith in its own power to tame recession.

This week's Budget will reflect whether George Osborne's team has learned some economics over the last few months. If not, here is a last minute crash course, focusing on the need to increase "confidence" (the government's buzz word). But whose confidence?

1. Market confidence

Low interest rates in the UK aren't a reflection of "market" confidence, but of the fact that the economy is not growing. As in most stagnant economies, interest rates remain low - as does also inflation, which is only rising due to international commodity prices. The fact that the UK has its own currency, with an active central bank, partly explains why the bond markets are not fearful of a default and why Britain's AAA credit rating has not been downgraded, yet.

But the increasingly low growth forecasts for the UK, and the recent warnings by ratings agencies (including Fitch last week), show that the markets know that one of the world's most "austere" nations is in trouble because austerity does not generate growth.

Lesson: In your speech, don't use the "market'"and low interest rates as the reason that you need to continue austerity. Remember that savers are punished by low interest rates and life insurers - an important UK industry and a source of finance for recovery - could be seriously undermined by them. And if you think that the fixed rate on 100 year bonds is the solution, this will only make markets less confident. It demonstrates that you think rates of return will remain very low for an extended period. If not, it's unclear why anyone would invest in these.

2. Business confidence

Private business investment is not driven by tweaks in taxes, but by expectations about future technological and market opportunities. This is what Keynes meant by investment being driven by "animal spirits" and is the reason why there is too little investment in downturns and too much in booms.. It is also the reason why even in booms, there is little investment in countries, or particular regions, with low future growth opportunities. Weak private business investment in the UK and the fact that various companies are picking up and leaving (Pfizer, GSK, Sanofi) , is not due to their high taxes, but the lack of positive expectations about future growth in the UK.

Lesson: Don't try to increase investment by decreasing corporate taxes. Evidence is that these "savings" will not be reinvested back into production. Likewise reduction of the 50p rate will not "trickle down" to the rest of the economy, it will only increase inequality as all such measures, especially in the USA and the UK, have in the last decades. To increase investment, government must invest in those areas that create high expectations about technological and market growth: education, research in emerging technologies, modern infrastructure, and constructing a financial system that can nurture long-run, innovative investments.

3. Confidence in competition

When competition is strong, businesses feel the need to differentiate themselves to increase market share, whether via advertising or innovation. This is why there is rarely dynamism in sectors where competition is lacking. Competition policy should nurture those types of businesses that are most interested in growing via new products, processes, or new markets for existing products -- and in so doing create jobs. One way to invest in such opportunities is to properly fund the whole 'eco-system' of innovation, promoting broad technological areas rather than trying to pick winners within them.

In doing so it is important not to mythologise some of the actors, especially those with strong lobbies (e.g. small/medium enterprises, venture capital). It is not true, for example, that the SME sector as a whole is being starved of funds. Indeed UK SMEs get somewhere between £7-8 billion pounds a year in direct and indirect government support - more than either universities or the police. It is the high-growth, innovative SMEs (about 6 per cent of the total) that need support, which must be tailored towards their precise needs. And it is not true that the problem in the UK is commercialisation, the target of the new Catapult Centres. The lower amount of market relevant research is the UK's the problem; so setting up Catapult Centres, without investing in public R&D and stimulating business to do the same, is like pushing on a string. The UK's R&D/GDP ratio is 1.3 per cent, compared to 2.6 per cent in Germany and the USA. Unlike Britain, the former has increased its spending since the crisis.

Lesson: Invest in measures that can help generate the company strategies and structures that enable UK companies to produce products and services that the world wants to buy. Only in this way will UK companies win procurement contracts in their own country (it is hardly surprising that Siemens' won the Thameslink train deal, with its very high R&D spending, and investment in green technology). And don't focus so much on new vehicles like Catapult Centres, which will have all the force of a pea-shooter if the research base remains underfunded.

4. Bank confidence

Quantitative easing (QE) by the Bank of England has not resulted in higher growth because this injection of money has simply ended up in the coffers and bonus pools of banks, which are not lending. They are scared because they, like business, do not believe there are growth opportunities in a country that has problems with both demand (consumer spending) and supply (new business output). Banks' complaint that they are not receiving enough demand for new loans highlights the slump in demand afflicting the economy. Thus ironically, post-crisis QE has benefited only the actors that have been most responsible for the crisis, letting them recapitalise on the cheap without reducing business finance costs.

Lesson: To increase lending, the government should create a National Investment Bank that could offer the kind of "patient capital" needed by businesses investing for the long run. As private investment banking will not be viable on the past scale after banking reforms, this could be constructed from the skeleton of RBS. At present there is £500 billion of net financial surplus hoarded in the UK (and $1.1. trillion in the USA), mainly in pension funds; government can play a greater role in releasing these funds, which also have a public dimension, in particular directions like "green" investments with high future returns (see Nick Stern's recommendations).

5. Consumer confidence

Four types of demand drive GDP. Demand by government, by private business investment, by consumers and by what other nations demand from us (exports) minus what we demand from them (imports). Of these, consumer demand is the largest, and the most stable component, about 65 per cent of our GDP. It is much more predictable than private investment, as it is largely a function of disposable income. Thus even if you get all the policies above right, if you cut down on disposable income during a recession, you'll turn it into a depression. This is indeed the real current risk. And falling household incomes (from the rise in VAT, freeze in public sector pay, cuts to fundamental social services, and general downturn of the economy) will be made only worse with the further cuts that will be needed as a consequence of the 50p rate reduction.

Lesson: Consider reducing VAT, and releasing the public sector pay freeze, both of which are damaging to demand. While marginal rates have little effect on top earners they do deter effort and initiative at very low rates of pay (see Mirrlees Report). So what is needed is to decrease the marginal rate on very low earners - sometimes 100 per cent or more - not worrying about a 50 per cent rate at the top. Do whatever you can to steer councils away from spending cuts in areas that sustain the social fabric, including after-school clubs that allow women to work more and youth clubs that allow young people to feel valued members of society.

Perhaps the biggest lesson around confidence is that government must be more confident of its own powers. It should use the ability to tame recessions through monetary and fiscal policy, and invest in the future by funding the knowledge base that is the source of new waves of growth. The new green revolution is just beginning and, like all technological revolutions, will not happen without government playing a lead role, absorbing most of the uncertainty before the private sector dares to enter. This entrepreneurial role must lead the vision in next week's Budget if the UK is to play a meaningful role in the world economy.

Mariana Mazzucato is Professor of Economics and RM Phillips Chair in Science and Technology Policy at the University of Sussex. She is the author of The Entrepreneurial State.

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Is defeat in Stoke the beginning of the end for Paul Nuttall?

The Ukip leader was his party's unity candidate. But after his defeat in Stoke, the old divisions are beginning to show again

In a speech to Ukip’s spring conference in Bolton on February 17, the party’s once and probably future leader Nigel Farage laid down the gauntlet for his successor, Paul Nuttall. Stoke’s by-election was “fundamental” to the future of the party – and Nuttall had to win.
 
One week on, Nuttall has failed that test miserably and thrown the fundamental questions hanging over Ukip’s future into harsh relief. 

For all his bullish talk of supplanting Labour in its industrial heartlands, the Ukip leader only managed to increase the party’s vote share by 2.2 percentage points on 2015. This paltry increase came despite Stoke’s 70 per cent Brexit majority, and a media narrative that was, until the revelations around Nuttall and Hillsborough, talking the party’s chances up.
 
So what now for Nuttall? There is, for the time being, little chance of him resigning – and, in truth, few inside Ukip expected him to win. Nuttall was relying on two well-rehearsed lines as get-out-of-jail free cards very early on in the campaign. 

The first was that the seat was a lowly 72 on Ukip’s target list. The second was that he had been leader of party whose image had been tarnished by infighting both figurative and literal for all of 12 weeks – the real work of his project had yet to begin. 

The chances of that project ever succeeding were modest at the very best. After yesterday’s defeat, it looks even more unlikely. Nuttall had originally stated his intention to run in the likely by-election in Leigh, Greater Manchester, when Andy Burnham wins the Greater Manchester metro mayoralty as is expected in May (Wigan, the borough of which Leigh is part, voted 64 per cent for Brexit).

If he goes ahead and stands – which he may well do – he will have to overturn a Labour majority of over 14,000. That, even before the unedifying row over the veracity of his Hillsborough recollections, was always going to be a big challenge. If he goes for it and loses, his leadership – predicated as it is on his supposed ability to win votes in the north - will be dead in the water. 

Nuttall is not entirely to blame, but he is a big part of Ukip’s problem. I visited Stoke the day before The Guardian published its initial report on Nuttall’s Hillsborough claims, and even then Nuttall’s campaign manager admitted that he was unlikely to convince the “hard core” of Conservative voters to back him. 

There are manifold reasons for this, but chief among them is that Nuttall, despite his newfound love of tweed, is no Nigel Farage. Not only does he lack his name recognition and box office appeal, but the sad truth is that the Tory voters Ukip need to attract are much less likely to vote for a party led by a Scouser whose platform consists of reassuring working-class voters their NHS and benefits are safe.
 
It is Farage and his allies – most notably the party’s main donor Arron Banks – who hold the most power over Nuttall’s future. Banks, who Nuttall publicly disowned as a non-member after he said he was “sick to death” of people “milking” the Hillsborough disaster, said on the eve of the Stoke poll that Ukip had to “remain radical” if it wanted to keep receiving his money. Farage himself has said the party’s campaign ought to have been “clearer” on immigration. 

Senior party figures are already briefing against Nuttall and his team in the Telegraph, whose proprietors are chummy with the beer-swilling Farage-Banks axis. They deride him for his efforts to turn Ukip into “NiceKip” or “Nukip” in order to appeal to more women voters, and for the heavy-handedness of his pitch to Labour voters (“There were times when I wondered whether I’ve got a purple rosette or a red one on”, one told the paper). 

It is Nuttall’s policy advisers - the anti-Farage awkward squad of Suzanne Evans, MEP Patrick O’Flynn (who famously branded Farage "snarling, thin-skinned and aggressive") and former leadership candidate Lisa Duffy – come in for the harshest criticism. Herein lies the leader's almost impossible task. Despite having pitched to members as a unity candidate, the two sides’ visions for Ukip are irreconcilable – one urges him to emulate Trump (who Nuttall says he would not have voted for), and the other urges a more moderate tack. 

Endorsing his leader on Question Time last night, Ukip’s sole MP Douglas Carswell blamed the legacy of the party’s Tea Party-inspired 2015 general election campaign, which saw Farage complain about foreigners with HIV using the NHS in ITV’s leaders debate, for the party’s poor performance in Stoke. Others, such as MEP Bill Etheridge, say precisely the opposite – that Nuttall must be more like Farage. 

Neither side has yet called for Nuttall’s head. He insists he is “not going anywhere”. With his febrile party no stranger to abortive coup and counter-coup, he is unlikely to be the one who has the final say.