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14 May 2024

The case for optimism

Britain can escape the age of economic anxiety if Labour is willing to ditch rules and embrace risk.

By Andy Haldane

We are living in an era of anxiety – or as Jonathan Haidt, the US social psychologist calls it in his latest book, a “generation of anxiety”. From the global financial crisis to the climate emergency, from Covid to the cost of living, from the war in Ukraine to the conflicts in Israel/Gaza: each of these global shocks has left deep scars – economic, societal and environmental. This has weakened the systems on which we rely for our security and prosperity: fiscal and monetary, social insurance and healthcare, education and learning, culture and community. We are facing a fragile world with weakened societal immunities.

Around half the global population goes to the polls this year. A fractious world adds to the chances of polarised or extreme political outcomes. Indeed, that has been the story of this century so far, with extremist and populist parties gaining ground and liberal democracy on the slide for 18 years straight. Larry Diamond, the US political scientist, has called this a “democratic recession”.

Geopolitically, the picture is no less fraught. More than 100 wars are currently being waged globally. Trade tensions continue to escalate, including along the key US-China axis. It is odds against that these geopolitical fractures will repair themselves quickly.

Fragilities in our politics are in part the result of the sluggishness in our economies. In the 20th century, global growth averaged over 3 per cent per year. That meant living standards doubled every generation. For the first time in history, generational progress became a social norm. Levels of poverty tumbled from more than three quarters to less than one quarter of the world’s population.

During the 21st century, growth has slowed in most countries. Over the past decade, growth per head in the G7 countries has averaged only 1 per cent. Doubling global living standards will, at this rate, take many generations. Rates of global poverty are no longer falling. And key growth engines of the past – China in the east, Germany in the west – have stalled. Nowhere is that stasis more pronounced than in people’s pay packets. Once we adjust for inflation, these have flat-lined in the UK for a decade and a half. In the US, they have been treading water for over half a century. The average UK worker is around 40 per cent – almost £14,000 per year – worse off than if pre-2008 crisis trends had continued, according to the Resolution Foundation.

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For the young, incomes have fallen furthest at the time when they should be rising fastest. This is the first generation for a century likely to be poorer than their parents, with levels of home ownership no better than their great-grandparents. The social norm of generational progress is at risk of being lost.

Most forecasters expect this growth recession to continue, driven by the weakness in global productivity, with some fearing the lowest-hanging technological fruit have already been picked. Factors also include our rapidly ageing societies, with 30 per cent of the European population projected to be over 65 by the end of this century, shrinking workforces and raising healthcare costs.

All of this comes at a time of mounting concern about nature and climate. Rising waters and temperatures are reshaping the lives of almost everyone. Avoiding environmental tipping points will only come with huge change and at significant cost.

These forces have ushered in our era of anxiety. Widening social divisions, a fraying social fabric and a scarring of our mental health are among the psychological costs. With justification, the US surgeon-general Vivek Murthy has called this a global psychological epidemic.

Not for nothing is economics known as the dismal science. But it is also known as a two-handed science. So let me now offer some reasons to be cautiously cheerful.

We may well be in a democratic recession. But we are also living in the first-ever century in human history where democracy is the dominant political regime globally. It currently covers around four billion people. Viewed from space, the world’s political systems would be seen as being just off the peak of a democratic boom, not in recession.

Things could, of course, worsen. Hard times increase voters’ willingness to experiment with political extremes. But contemplating, or experiencing, those extremes can often also encourage reversion to the political mean. We see this in the UK where the main parties will fight this year’s election on a small muddy patch around the centre circle.

Having lengthened and deepened in the second half of the 20th century, global supply chains have become shorter and more fragile in the 21st century. Yet we remain at or near the highest levels of integration of global trade and finance in a century. Even the recent pick-up in war and conflict comes against the backdrop of a lower incidence of large-scale war than at any point in history.

In the economy, the picture is not as gloomy as some portray. It is the level of income, not growth, that determines our living standards. Almost every part of the world is far richer than at any point in human history. And the slowing of growth has been sharpest in those countries that are already rich.

While plateauing in some countries, global life expectancies and health outcomes have never been higher. Despite the global population never having been older, it has more years left to live than ever in human history. Even the worrying deterioration in mental health, especially among young people, has been greatest in those countries that are richest.

We are doing too little, too late to tackle the climate and nature emergencies: unless we catch up, as the astronomer royal Martin Rees has pointed out, there is a non-trivial chance this could be humanity’s final century. The qualified good news, though, is that there is now at least widespread international agreement on what is needed to address these crises. This was unthinkable a generation ago. The climate, of opinion at least, has shifted. And it is already unleashing a technological wave.

For all its fractures, viewed through a long lens, the world is in most respects a far better place to live than ever previously. After a long period of stasis, the world broke free of its Hobbesian chains a century or so ago: most people’s lives are no longer nasty, short and brutish. Today is a comma, not a full stop.

What of the future? A historian would have good source material to write a fatalistic next chapter to our unfolding story: high and rising inequalities (between people, places); AI and technology (devouring our jobs and agency); rapid ageing (shrinking our workforces and increasing care costs); and the climate-cum-nature crises.

But as well as being the challenges of the century, these forces also represent opportunities. With the right steps taken, they could become potent drivers of a new period of rapid progress, a new Enlightenment.

Inequality matters for two distinct reasons. The first is social justice or fairness. The second is that inequality signals inefficiency. Tackling it boosts the size of the pie, as well as how it is sliced. Inequality means that people and places are not fulfilling their potential. It means opportunities are being lost, lives unfulfilled, resources under-utilised. It is not just morally wrong but economically inefficient for people’s destinies to be dictated by their histories (the problem of social immobility) or their geographies (the problem of levelling up).

Tackling inequality unlocks a latent energy in people and places. Those untapped energy reserves, evidence suggests, could be vast. Much the same can be said of ageing. If our longer lives are lived healthily and productively, as Andrew Scott at the London Business School has set out in his upcoming book The Longevity Imperative, this could boost growth by more than 1 per cent each year and levels of well-being by much more. And on the climate challenge, Nick Stern at the London School of Economics (author of the 2006 Stern Review, on the economic consequences of climate change) believes that, with large-scale investment, global growth could be boosted by 2 per cent per year while averting planetary threat.

Finally on artificial intelligence (AI), there has been much doom-mongering about its threat to our jobs and agency. That threat is real. Yet the evidence so far points in a different direction. As during the first three industrial revolutions, most AI so far appears to have been a job creator and enhancer, not a killer and inhibitor. Even if more AI means we work fewer hours, this does not necessarily mean less pay. It is productivity, not hours, that drives pay, and AI is the ultimate productivity-enhancer. Indeed, it could speed us on our passage to what, almost 100 years ago, John Maynard Keynes called the economic possibilities for our grandchildren – a 15-hour working week.

Whether the mega-trends of the 21st century – inequality, ageing, climate and AI – prove to be for societal good or ill depends, ultimately, on us.

Left unattended, anxiety is self-fulfilling. Fearfulness about what lies ahead heightens our aversion to risk and reduces our horizons for planning. Investment relies on optimism about the future, and innovation, to reshape it. If we are to harvest the opportunities (and avoid the threats) of technology, ageing, inequality and net zero, we require what the economist Joseph Schumpeter called “creative destruction”.

One piece of good news is that unemployment, the scourge of labour markets in the 1980s and 1990s, appears largely to have been purged from our economies. The less good news is that two different labour market scourges have emerged in its place. In the UK, around one in five adults of working age are not in work or training and are not seeking it. That is around nine million people who are “economically inactive”.

A market with more than 20 per cent of its resources unused, and more people exiting than entering, is not a dynamic one. It worsens inequalities of opportunity and outcome. And while most acute among those over 50, inactivity is rising fastest among those under 25. This risks constraining lifelong opportunities for millions of workers.

Despite employment rates being high, wage rises for those in work have stalled. A lack of dynamism in the UK jobs market is one of the key reasons for this stasis in pay because one of the fastest and most effective routes to a pay rise is by moving jobs. And the rates of job transition have fallen in the UK since the global financial crisis, by around 50 per cent. This is likely to have reflected heightened anxieties among workers, putting job security over job moves.

This is mirrored in the behaviour of business. Productivity in the UK has stalled over the past 15 years and the gap with our international competitors, such as the US and Germany, has risen to between 10-30 per cent. There has been too little creative destruction. Schumpeter lies slumped.

The UK’s best-performing businesses, however, are more productive than international counterparts. This fits with the narrative of the UK having a fertile research and innovation sector, with more tech unicorns – companies worth more than $1bn – than Germany and France combined. The UK does the “creative” well, and the “destructive” poorly.

But despite the pipeline of research start-ups, many promising UK companies are lost in the journey from start-up to scale-up – the “valley of despair”. They are unable to find funding, or can only do so by selling to overseas investors. The foreign sale and listing of Arm Holdings, one of the technological jewels in the UK’s crown, is a case in point.

This has left the UK without the equivalent of the German “Mittelstand” – energetic, medium-sized businesses driving productivity and growth. And such absence has in turn contributed to ossification at the upper end of the UK corporate sector. The average age of the ten largest US companies is 50 years. Two were formed this century. Big US business is a combination of sprightly middle-aged and energetic adolescent. The average age of the top ten UK companies is 150 years. They are, by comparison, bed-bound geriatrics.

[See also: Joseph Stiglitz: the UK’s tax system is “inexcusable”]

This risk-averse behaviour is shared by financial companies. The risk capital allocated by banks to support risky ventures has been in retreat for several decades. This has siphoned off the financial fuel needed to power companies from start-up to scale-up and help them escape the valley of despair. As a fraction of their balance sheets, bank-lending to UK businesses currently sits at less than 10 per cent, down from levels of around a quarter in the 1980s. For pension funds, the fraction of their assets invested in UK businesses currently stands at 1.5 per cent, down from a third in 1992.

This culture of private-sector risk-aversion is mirrored in the public sector. Many governments have over recent years supported sectors facing adversity – the banks during the global financial crisis, companies and households during the Covid and cost-of-living crises. This has ratcheted up government debt among the G7 to its highest levels in half a century.

With debts and deficits high, many governments are now fearful about using their balance sheets to invest, especially when undertaking large, long-term, transformational projects. UK public investment has been weak by historical and international standards for several decades and is projected to remain well below the levels of other OECD countries.

These risk-averse responses, public and private, are self-defeating. As Keynes articulated in the 1930s, the paradox of thrift is that it can turn an individual virtue into a collective vice. In an era of anxiety, people’s search for safety and security stymies the very risk-taking and investment needed to solve security and prosperity problems.

These features are not unique to economies. The richest ecosystems, such as tropical rainforests, have dynamism as well as fragility. By contrast, ultra-stable ecosystems, such as deserts and savannahs, have no such richness. We are facing the economic equivalent of desertification – too much stability, too little dynamism. What is needed to shift us from desert to rainforest? First, our social systems need stronger “floors”, to protect individuals and communities from the risks they face, and to catch people when they fall. But we also need taller “ladders” to enable the same people to climb and fulfil their potential.

Reducing anxiety at source is at the heart of the “securonomics” agenda developed by the shadow chancellor Rachel Reeves. This strategy makes perfect sense. In an insecure world, it adds resilience to economies and psychologies. This is the case for stronger floors, and it is a necessary ingredient of success. But it is not a sufficient one. Realising the potential of people and places requires longer, stronger ladders, especially for those on the lowest rungs. That ladder creates and enables a shift in risk-taking culture, inspires investment in the future and leads to aspiration trumping anxiety in a self-fulfilling loop.

Viewed through the prism of floors and ladders, we can see how different countries have positioned themselves and the success and failures this has delivered. A pure free-market model caps neither downside nor upside – a long ladder with no floor. This increases the incentives to climb, but at the expense of vertiginous falls for those who fail. The US perhaps comes closest to this model. State insurance for unemployment or healthcare problems is weak, but investment and innovation, job and business churn are high. The result is high growth, but with high inequality and precarity.

At the other end of the spectrum are countries with heavy state intervention, capping both floor and ceiling, such as models of communism and state socialism. The result is lower dynamism and growth but greater levels of security and lower degrees of inequality. The twin imposters of “creation” and “destruction” are treated just the same.

The UK is neither as dynamic as the US nor as precarious for its workers and businesses. Perhaps the most interesting cases, though, are those countries that combine fast-growing economies with strong social safety nets: the Scandinavian countries, Singapore and Korea.

This begs the question of whether the UK could strike a different balance. Could our social systems be reconfigured in ways that add dynamism without precarity?

Almost a century ago, facing deep anxieties during the Great Depression, Keynes proposed a radical shift in policy. This involved the state acting entrepreneurially, shouldering more risk through improved insurance (stronger floors) and greater investment through public works (longer ladders). This package was mirrored in President Roosevelt’s New Deal in the US. Both were, in time, a success: anxiety was replaced with aspiration, thrift with investment, depression with dynamism. All boats were lifted, especially the smallest ones.

Although today’s conditions are different, this logic remains strong. Government is the agent in society with the longest time horizon. It is best-placed to make transformational investment, and to take calculated risks that yield benefits in the future. Government is society’s anchor venture capitalist. Or should be.

This anchoring role is especially important when risk-taking and investment are too low. The best way of government demonstrating optimism about the future is by investing in it, putting its money where its mouth is. Yet the opposite is happening. UK investment, at around 17 per cent of GDP, is five percentage points below the G7 average and over 10 percentage points behind high-growth economies. Worse still, the government’s projections for investment put it on a downward path.

The reason is simple: the UK’s fiscal rules. Fiscal rules have the sensible aim of curbing excessive spending by governments. They limit fiscal risk and the tax burden on future generations. Whether they achieve these objectives hinges, however, on their design.

One of the UK’s rules, which would also be adopted if Labour came to power, is to require debt to be on a falling path at the end of five years. This is a binding constraint on fiscal choices, and explains the falling projections for UK investment and the weak medium-term growth. Breaking free of these constraints would allow greater long-termism and dynamism in decision-making.

The thin-slicing and eventual scrapping of the northern leg of the high-speed rail line HS2 was one casualty of these rules under the current government. The thin-slicing and near-scrapping of Labour’s green prosperity plan is another. In sticking to the rules, some of the opportunities of our lifetime were lost.

Rules in the private sector are similarly designed to curb risk-taking and protect citizens, but inadvertently have the opposite effect. This compliance culture was evident last year in the row over “de-banking” Nigel Farage. (Around 140,000 companies had their bank accounts closed in 2023.) Somewhat to my surprise, last year I discovered I was a “Nigel” too. I tried opening a bank account and was rejected because I was “politically connected” due to my working for the Bank of England. This was odd. First, I did not work for the Bank of England. Second, the Bank is by statute independent of politics. And third, the Bank was also their regulator! The mistake was soon corrected, apologetically. As in Little Britain, it was apparently the computer that had said no. But the consequences of compliance culture make doing business and taking reasonable risks harder work and more costly. Redesigning these rules could encourage risk-taking, strengthen ladders of investment and reignite growth.

The game of life is a game of snakes and ladders. Our era of anxiety has generated a phobia of snakes and an acute mistrust of the ladders. Both are understandable but both are self-defeating. Suppressing the snakes and repairing the ladders is needed to switch us, culturally and economically, into an age of aspiration.

And if we are to shift to a new age of aspiration, we will need an environment where risk and uncertainty are seen as opportunity not threat, where the culture is one of optimism not fatalism, and where investment is everywhere and for everyone.

Andy Haldane is CEO of the Royal Society of Arts. This is an edited and abridged version of his Chief Executive’s Lecture delivered on 8 May.

[See also: Marx and Keynes can free Labour from its budget bind]

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