George Osborne must ignore the siren calls – and take steps to raise potential growth

The CPS' Ryan Bourne gives its hitlist for the 2013 budget.

Over the past few weeks, we’ve heard from advocates of more government spending to attempt to stimulate the economy, advocates of shock-and-awe tax cuts to stimulate the economy, people suggesting the Government needs more interventionist long-term planning for the economy, and calls from back-bench Conservative MPs that this should be a‘cost-of-living’ budget.

Following more than £500 billion of deficit spending, £375 billion of QE, interest rates at their lowest level in the history of the Bank of England, a sharp fall in sterling, and with inflation continuously above target, it is difficult not to agree with Sir Mervyn King that most of our economic problems are structural. Years of a stagnant economy despite extraordinary monetary and fiscal policies suggest that in the wake of the crisis we are now suffering from a sustained fall in potential growth on unchanged supply-side policies – which, even if you do believe that stimulus spending policies work, cannot be solved by more short-term borrowing or money printing. Those convinced the economy just needs a kick-start to push it into a new equilibrium of self-sustaining recovery should look at Japan’s recent economic history.

Nor would increasing the structural deficit by borrowing significantly more for tax cuts be sensible. With public sector net borrowing still over 8% of GDP and debts already above the level known to permanently retard growth for two decades, adding to the deficit significantly, two years before the uncertainty of another general election, poses significant risks in bond markets (and even if we print to hold yields down, merely transfers to a problem for sterling).

The Budget then needs to recognise that the UK has a medium-term growth problem. It should therefore contain policies to raise our medium-term growth rate. This is the main insight which drives the 20 recommendations which we set out in Take the Long View, ahead of next week’s Budget. We suggest a three-pronged approach addressing fiscal strategy, supply-side reform and a robust pro-competition agenda in certain oligopolistic industries.

Support is waning for the Government’s fiscal agenda, but in truth cuts to investment expenditure and tax hikes were front-loaded and cuts to current expenditure were back-loaded. For a developed country like the UK, evidence suggests that cutting the latter not only has a far smaller impact on short-term growth, but also enhances medium-term growth. Abandoning the overall plan now, just as it about to start cutting in the right areas, would be madness. In fact, if anything the level of current spending cuts are inadequate. Because of ring-fencing of several large items, current spending overall is actually forecast to increase in real-terms over the course of this Parliament by 0.7%. But this assumes growth will generate large increases in tax revenues to close the deficit. As we mentioned above, we do not believe this will happen on unchanged policies. So further cuts to current spending, in part used for enterprise inducing tax cuts, should be implemented to enhance the economy’s medium-term growth rate.

To decide where these cuts fall the next spending review should examine all spending without any ring-fencing, particularly focusing on areas which have the smallest effects on short-term growth, like pensioner benefits, retirement ages, and eligibility for a host of other transfers. A failure to re-open spending in this way risks some budgets being savaged to protect areas of which have seen significant largesse over the past decade.

On the tax side, the spending review should be supplemented by better resourcing of the Office for Tax Simplification and giving it a more strategic role over efforts to simplify and restore trust in our tax system. Substantial pro-growth tax reform, along the lines of broadening bases and lowering rates, is an area which the Coalition has so far done little.

On the supply-side, the key aim is to raise the productive potential of the economy. A Small Business Incentive Scheme, which includes significant exemptions from regulation for small businesses, should be introduced. Though less sexy, a framework for ‘sunset clauses’ for new regulations should be rolled out and Michael Fallon’s ambitions for deregulation utilised by widening the scope of the ‘One-in, Two-out’ framework further. And the Government should look again at the case for abolishing national pay bargaining, which could substantially enhance public sector efficiency and counter regional inequalities in the medium-term.

Finally, the only sustainable way to address rising living costs for the UK public requires an aggressive pro-market agenda in many oligopolistic industries to enhance innovation and productivity, and to lower costs. Banking, energy, water, rail and education are all necessity industries or state run services where there is scope for much more competition, and there would be much more beneficial long-term effects of removing barriers to entry for new providers, and providing a level playing field for existing market participants, in these than dealing with the symptoms of our current cost-of-living problems through fiddling with changes to certain taxes or subsidies.

20 recommendations for the budget

On fiscal strategy

  1. Announce the remit of the 2013/14 spending review. This should include:
    • plans to cut government current expenditure substantially over the next five years with no ring-fences;
    • a programme of reducing entitlement eligibility;
    • a plan to raise retirement ages more rapidly than currently planned.
  2. Widen the remit of the Office for Tax Simplification to establish tax reforms for the rest of this Parliament along the principles of base-broadening and lowering rates.
  3. Pledge no new taxes or further net tax rate rises for the 2013/14 spending review period.
  4. Set out a path to raise the threshold for the basic rate of Income Tax to the equivalent of the gross income of a full-time earner on the minimum wage.
  5. Cut Capital Gains Tax immediately, as it is above the revenue maximising rate.
  6. Commit to further reductions in Corporation Tax.
  7. Re-open negotiations on public sector pensions.
  8. Supply-side reform
    Announce a Small Business Incentive Scheme to include a package of exemptions from regulations for very small businesses. This should include exemptions from: minimum wage legislation for those under 21; requests for time off for training; and pension auto-enrolment.
  9. Adopt sunset clauses for all regulations with a post-implementation audit three years after enactment of each regulation; and bring more regulation into the scope of 'One-In Two-Out'.
  10. Adopt a Consolidated Planning Act and repeal all existing legislation with a single rationalised Act.
  11. Encourage neighbouring local councils to co-operate in identifying sites for new Garden Cities.
  12. Abolish national pay bargaining in the public sector.
  13. Ensure that the recommendations of the Davies Review of airport capacity can be implemented swiftly.
  14. An agenda for competition
    Adopt the "Fair Shares" scheme for the re-privatisation of Lloyds and RBS.
  15. Reduce the regulatory burden on new banks.
  16. Give the Financial Conduct Authority a competition mandate.
  17. Require the legal separation of retail and supply arms of water companies, paving the way for the extension of retail competition.
  18. Encourage far greater competition between operators on the rail network.
  19. Lift the bar on profit-making companies running academies and free schools.
  20. Abandon the planned unilateral carbon price floor and phase out subsidies for renewable energies.
Photograph: Getty Images

Ryan Bourne is the head of economic research at the Centre for Policy Studies.

Getty Images.
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John McDonnell interview: "We’re going to destroy Osborne’s credibility"

The shadow chancellor on the Spending Review, Jeremy Corbyn's leadership and why trade unions will have to break the law. 

When I interviewed John McDonnell in March, before the general election, he predicted that Labour would be the largest party and confessed to a “sneaking feeling that we could win a small majority – because I think the Tory vote is really soft”. As the long-standing chair of the Socialist Campaign Group, McDonnell anticipated leading the resistance inside Labour to any spending cuts made by Ed Miliband. Eight months later, he is indeed campaigning against austerity – but as shadow chancellor against a Conservative majority government.

I meet McDonnell in his new Westminster office in Norman Shaw South, a short walk down the corridor from that of his close friend and greatest ally, Jeremy Corbyn. The day before George Osborne delivers his Spending Review and Autumn Statement, his desk is cluttered with economic papers in preparation for his response.

“The message we’re trying to get across is that this concept of the Tories’ having a ‘long-term economic plan’ is an absolute myth and they’re in chaos, really in chaos on many fronts,” he tells me. McDonnell points to the revolt against cuts to tax credits and policing, and the social care crisis, as evidence that Osborne’s programme is unravelling. On health, he says: “He’s trying to dig out money as best as he can for the NHS, he’s announced the frontloading of some of it, but that simply covers the deficits that there are. Behind that, he’s looking for £22bn of savings, so this winter the NHS is going to be in crisis again.”

Asked what Labour’s equivalent is to the Tories’ undeniably effective “long-term economic plan” message, he said: “I don’t think we’re going to get into one-liners in that way. We’ll be more sophisticated in the way that we communicate. We’re going to have an intelligent and a mature economic debate. If I hear again that they’re going to ‘fix the roof while the sun shines’ I will throw up. It’s nauseating, isn’t it? It reduces debate, intellectual debate, economic debate, to the lowest level of a slogan. That’s why we’re in the mess we are.”

Having abandoned his original support for the Chancellor’s fiscal charter, which mandated a budget surplus by 2020, McDonnell makes an unashamed case for borrowing to invest. “The biggest failure of the last five years under Osborne is the failure to invest,” he says. “Borrowing at the moment is at its cheapest level, but in addition to that I’m not even sure we’ll need to borrow great amounts, because we can get more efficient spending in terms of government spending. If we can address the tax cuts that have gone ahead, particularly around corporation tax, that will give us the resources to actually start paying again in terms of investment.”

He promises a “line-by-line budget review” when I ask whether there are any areas in which he believes spending should be reduced. “My background is hard-nosed bureaucrat . . . we’ll be looking at where we can shift expenditure into more productive areas.”

From 1982 until 1985, John McDonnell, who is 64, was chair of finance at the Greater London Council under Ken Livingstone. After vowing to defy the Thatcher government’s rate-capping policy he was sacked by Livingstone, who accused him of manipulating figures for political purposes. “We’re going to look like the biggest fucking liars since Goebbels,” the future mayor of London told him. McDonnell, who later described Livingstone’s account as “complete fiction”, has since resolved his differences with the man now co-chairing Labour’s defence review.

After his election as the MP for Hayes and Harlington in 1997, McDonnell achieved renown as one of New Labour’s most vociferous opponents, rebelling with a frequency rivalled only by Corbyn. His appointment as shadow chancellor was the most divisive of the Labour leader’s reshuffle. “People like Jeremy even if they don’t agree with him. People don’t like John,” one MP told me at the time. Mindful of this, McDonnell has sought to transform his image. He has apologised for his past praise of the IRA and for joking about assassinating Margaret Thatcher, rebranding himself as a “boring bank manager”. But there are moments when his more radical side surfaces.

He told me that he supports workers breaking the law if the trade union bill, which would limit the right to strike, is passed. “It’s inevitable, I think it’s inevitable. If the bill is introduced in its existing form and is used against any particular trade unionist or trade union, I think it’s inevitable that people will resist. We established our rights by campaigning against unjust laws and taking the risk if necessary. I think that’s inevitable and I’ll support them.”

“Chaos” might be how McDonnell describes Osborne’s position but the same term is now daily applied to Labour. The party is riven over air strikes in Syria and the renewal of Trident and MPs are ever more scornful of Corbyn’s leadership.

While Corbyn has so far refused to offer Labour MPs a free vote on Syria, McDonnell says that he favours one and would oppose military action. “My position on wars has always been that it’s a moral issue and therefore I veer towards free votes . . . We’re waiting for Cameron’s statement; we’ll analyse that, there’ll be a discussion in shadow cabinet and in the PLP [Parliamentary Labour Party] and then we’ll make a decision. I’m still in a situation where I’ve expressed the view that I’m opposed to the bombing campaign or engagement. I think the history of the UK involvement in the Middle East has been a disaster, to say the least . . .This isn’t like the Second World War where you have a military campaign – you defeat the enemy, you sign a peace agreement and that’s it – this is asymmetric warfare. In addition to the risks that are in the battlefield there’s a risk in every community in our land as a result of it.”

Would he want any of the 14 former shadow cabinet members who refused to serve under Corbyn to return? “All of them, we’re trying to get them all back. We’ve got Yvette [Cooper] helping us on a review we’re doing about the economy and women . . . It’s an open door policy, I’m trying to meet them all over these next few weeks.”

Livingstone, a member of Labour’s National Executive Committee, recently called for Simon Danczuk, who revealed details of a private meeting with Corbyn in the Mail on Sunday, and Frank Field, who told me that MPs should run as independents if deselected, to be disciplined. But McDonnell takes a more conciliatory line. “With Simon [Danczuk] in particular and the others, it’s just a matter of saying look at the long-term interests of the party. People don’t vote for a divided party. They’ll accept, though, that within a party you can have democratic debate. As I said time and time again, don’t mistake democracy for division. It’s the way in which you express those different views that are important. All I’m saying is let people express their views, let’s have democratic engagement but please don’t personalise this. I think there’s a reaction within the community, not just the party, against personalised politics. It’s not Jeremy’s style, he never responds in that way. It’s unfortunate but we’ll get through it. It’s just minor elements of it, that’s all.”

McDonnell disavows moves by some in Momentum, the Corbyn-aligned group, to deselect critical MPs. “What we’re not into is deselecting people, what we want to try and do is make sure that everyone’s involved in a democratic engagement process, simple as that.

“So I’ve said time and time again, this isn’t about deselection or whatever. But at the same what we’re trying to say to everybody is even if you disagree, treat each other with respect. At the height of the debates around tuition fees and the Iraq war, even though we had heated disagreements we always treated each other with mutual respect and I think we’ve got to adhere to that. Anyone who’s not doing that just lets themselves down, that’s not the culture of the Labour Party.”

In private, the 90 per cent of MPs who did not support Corbyn’s leadership bid speak often of how and when he could be removed. One point of debate is whether, under the current rules, the Labour leader would automatically make the ballot if challenged or be forced to re-seek nominations. McDonnell is emphatic that the former is the case: “Oh yeah, that’s the rule, yeah.”

McDonnell’s recent media performances have been praised by MPs, and he is spoken of by some on the left as a possible replacement if Corbyn is removed or stands down before 2020. His speech to the PLP on 23 November was described to me by one shadow minister as a “leadership bid”. But McDonnell rules out standing in any future contest. “No, no, I’ve tried twice [in 2007 and 2010], I’m not going to try again, there’s no way I would.”

Despite opinion polls showing Labour as much as 15 points behind the Conservatives, McDonnell insists that the party can win in 2020. “Oh definitely, yeah, you’ll see that. I think this next year’s going to be pivotal for us. We’re going to destroy Osborne’s credibility over the next six months. But more importantly than that, we can’t just be a negative party . . . we’re going to present a positive view of what Labour’s future will be and the future of the economy.

“Over the next 18 months, we’ll be in a situation where we’ve destroyed the Tories’ economic reputation and we’ve built up our own but we’ll do it in a visionary way that presents people with a real alternative.”  

George Eaton is political editor of the New Statesman.