Government: Convergence Programme

Lord Davies of Oldham Excerpts

Thursday 12th May 2011 Lords Chamber

[Lord Davies of Oldham]

My Lords, this has been a most interesting debate, not least because of its focus on the valuable documents before us—those provided by the Treasury, by the Office for Budget Responsibility and, of course, the extensive work done by the European Union Committee of this House. I congratulate the noble Baroness, Lady O’Cathain, on her work in the committee, to which tribute has been paid during the course of the debate, and on her contribution this afternoon.

It is also a timely debate, for while the situation of the UK economy at the turn of the year was grave, today it is worse. In the first half of 2010, it should be recognised that under the recovery strategy put in place by my right honourable friend Alistair Darling the economy grew at an annual rate in excess of 2 per cent, with a beneficial effect on tax revenues that led to welcome reductions in the deficit that were substantially in excess of what the forecasts had predicted. Now the economy has effectively ground to a halt and there has been no growth at all since the third quarter of last year. Indeed, the National Institute for Economic and Social Research said last week that the performance of the UK had deteriorated markedly since the autumn, that economic output would grow by just 1.4 per cent and that the weak recovery would feed through to lower tax revenues. That meant that even if the spending plans are met over the next four years, the public sector deficit will substantially exceed the Government’s professed target. Yesterday, the Bank of England downgraded its growth forecasts and added in the extra spice of a predicted rise in inflation in the not-too-distant future to 5 per cent. This is a new coalition of low growth and high inflation.

As this debate is set in a European context, what of convergence? How are our major European partners doing on the road to recovery and in the face of rising commodity prices that we also confront? Germany has growth at around 3 per cent, with inflation at 2.6 per cent. That is almost double UK growth and half our predicted inflation rate. France has growth at 2 per cent with inflation at 2 per cent—higher growth and lower inflation. Italy has growth at 1.5 per cent with inflation at 2.5 per cent. Growth is about the same as ours, but with much lower inflation.

Indeed, despite all the financial problems in the eurozone, the eurozone as a whole is forecast to grow just as fast as the UK this year, with less than half the UK’s rate of inflation. The new UK coalition of low growth and high inflation is just like another coalition that I can think of—it tends to bring out the worst elements in each partner. Low growth undermines productivity, stoking the fires of inflation. High inflation not only cuts growth of demand by cutting real income, it also means that Britain becomes less competitive at home and abroad. Inflation is likely to erode all the advantage that we obtained, particularly in our manufacturing industry, from the devaluation a couple of years ago.

I referred to the Treasury documents. They are indeed valuable, because they contain clear, succinct statements of the Government’s economic strategy. It is particularly well put in paragraph 2.10 of the 2010-11 Convergence Programme for the United Kingdom, which states that the policy has four components: cutting the deficit to promote confidence; monetary policy to secure price stability—it is pretty obvious how well that is working—reform of financial regulation; and microeconomic policies to make the UK the best place in Europe to start, finance and grow a business. Underpinning all that is the deficit reduction programme and the rate at which the Government want to see that programme completed. The link that the Government make between deficit reduction and growth is very clear. On page 7, we are told:

“Tackling the deficit is essential as it will: reduce the UK’s vulnerability to further shocks or a loss of market confidence, which could force a much sharper correction; underpin private sector confidence, supporting growth and job creation over the medium term”.

That is what serious economists, such as the Nobel prize-winning economist Paul Krugman, call the confidence fairy theory of growth, where the confidence fairy is like the tooth fairy, but with a bit less credibility. Sad to say, the confidence fairy does not seem to have sprinkled much stardust on the UK economy. Not only has consumer confidence plummeted over the past six months, the recently updated survey by the Institute of Chartered Accountants reveals that,

“business confidence has fallen sharply over the past three quarters”.

The chief executive of the Chartered Institute of Purchasing and Supply stated last month that in the construction industry:

“Confidence remains at a historically low level as the number of jobs continues to drop”.

We have rising inflation and falling confidence. No wonder that in April, the UK's manufacturing sector grew at the slowest pace for months. On page 8 of Convergence Programme for the United Kingdom, there is a valuable table. It compares the impact on the deficit of what is called the policy inherited by the Government—in other words, Alistair Darling's strategy to halve the deficit in four years—with the Government's policy of eliminating the deficit in four years, the clear implication being that Labour's policy was just a timid version of that of the present Government.

That is a quite incorrect implication. The thinking behind Labour's policy was and is entirely different from the policy stance of this Government. The coalition argues that cutting the deficit is the prerequisite of growth, whether via the confidence fairy or microeconomic measures—something that I will talk about in a moment. Labour argues that the only way to secure a sustainable reduction in the deficit is for the economy to grow. Preserving, as far as possible, a steady rate of demand is the key to securing growth. That is exactly what was happening in the first half of last year. Exactly the opposite is happening now.

It is only fair to ask whether the fourth element in the coalition's economic plan, the microeconomic measures, will achieve what seems to be beyond even the confidence fairy's magic wand. Of course, there are some sensible sounding measures; and I would be the first to recognise them. There is a focus on science and research and development, on apprenticeships and on tax incentives for entrepreneurs. Sadly, when we look more closely, the actual measures are either too small or badly targeted. Research and development tax changes sound good until one realises that they benefit just 7,000 of the 4.8 million small firms in this country. The entrepreneurs’ relief sounds good until one realises that the benefit will go to just a few hundred people. The idea that higher education is being put on a “sustainable financial footing”, when this week David Willetts, the Member of Parliament and Minister, has produced another dimension of uncertainty with regard to higher education, indicates that the Government’s funding projection for higher education is beyond a joke.

However, of even more concern is the idea that at the heart of the growth strategy is a policy to,

“create the most competitive tax system in the G20”.

The Minister emphasised the extent to which corporation tax was going to be reduced. As we all know, the problem with corporation tax is that it is an extraordinarily efficient device for enhancing capacity for tax avoidance. Of course, there is nothing wrong with lowering taxes to create the right climate for business when it is part of a wider growth strategy that includes finance for industry, increased investment in research and higher education, and the maintenance of growing demand, which is the key motivation to invest. However, when cutting taxes and deregulation are central to the strategy, there is a risk of a race to the bottom—a risk that we will be involved in competitive tax-cutting, which has the effect of draining the Government of the funding they need for vital investment in infrastructure and other foundations of competitive success. Will low growth, weak regulation and low taxes build a manufacturing industry in this country to compete with Germany? I think that the answer is clear.

However, we can leave to the Office for Budget Responsibility the final verdict on the Government’s so-called growth strategy, which is at the heart of this debate in relationship to our perspective on Europe. Considering the growth measures in the recent Budget, the OBR concluded that the impact on growth would be “minimal”. No wonder. Without the prospect of growth, there is no incentive to invest, however low taxes might be.

Of course, we all recognise that economic forecasting is a hazardous activity, indulged in when projections over 10 to 15 years enable one to avoid some of the harsh realities of the immediate and clear future. Why do we need the crystal ball when the book is open before us? Under the coalition Government, the recovery has stopped in its tracks, with no growth since the third quarter of 2010. The previous Government’s strategy of supporting the growth of demand in the recovery process has been replaced by the economics of low growth allied with high inflation—a coalition perfectly designed to reduce confidence, discourage investment, postpone recovery and, as the national institute has argued, reduce tax revenues in due course and therefore make the deficit problem more acute. This is the world of the Government’s economics, and the Minister will no doubt set out to defend them once again.