In 2010, the coalition government inherited a budget deficit of over 10% of national income and adopted a strategy that would have been familiar to finance ministers throughout the ages. It cut expenditure (a lot) and raised taxes (a bit) to get the budget back into balance. Alongside austerity it pursued broadly conventional supply side policies. It reduced the burden of regulation on business and kept marginal rates of direct taxation low to incentivise investment and effort. Meanwhile, the Bank of England pursued a monetary policy that was anything but conventional. With negative real interest rates and quantitative easing, the Bank resorted to everything short of dropping parcels of money down people’s chimneys in an effort to maintain demand.
This deliberate blend of unorthodox monetary policy and orthodox fiscal and supply-side policies stabilised the financial markets and allowed confidence to seep back into the system. A truly phenomenal record of job creation has been the result. The UK’s unemployment rate has fallen to its lowest level since the 1970s. In September 2017, over three quarters of people aged between 16 and 64 were in work, the highest rate since records began – and a rate higher than in any other advanced economy.
But other aspects of our performance give us less to boast about. Average wages have hardly enjoyed any growth in real terms since 2005. Different analysts study different figures (averages and medians, wages and household incomes) and make different assumptions about inflation (RPI, CPI) but there is no getting away from a central fact: the incomes received by most working people in our country have stagnated for most of the past 12 years. At best, they have only just returned to their pre-2008 peak (2). Overall compensation (including pension contributions) has done better but the introduction of pension auto-enrolment has dragged down take-home pay.
Behind the averages and the medians lies a worrying divergence in experience between different age groups and different parts of the country. The Institute for Fiscal Studies found that “By 2015–16, median income for those aged 60 and over was 10% higher than it was in 2007–08, but for adults aged 22–30 it was still 4% lower. Real earnings for this group were still 12% lower in 2015–16 than before the recession (and still 9% lower by 2016–17, according to more recent data from the Labour Force Survey)” (3). Make no mistake about it, Britain’s workforce is suffering an economic injustice and is understandably resentful.
The variations are regional too. By 2015 output per head had exceeded its 2007 level only in London and the South East. In Scotland, the South West and the East Midlands it had just about regained its 2007 level. In all other regions, including the North West, the North East, Yorkshire and Humber, the West Midlands and the East of England, output per head was still well short of its 2007 level (4).
Underpinning the poor growth in wages has been a continuation of the UK’s poor record on productivity (the value of the output produced for each hour worked.) In 2015 British output per hour was 16% below the average for the G7 group of richest countries, 27% below Germany, 23% below France and 22% below the US (although interestingly 1% above Canada and 11% above Japan) (5). To make matters worse, in common with the United States and most other advanced economies, since 2008 we have not seen the growth in productivity that would normally follow a recession.
Austerity has worked. It has brought the British economy back from the brink of disaster. It has allowed a flood of new jobs. But, seven years on, our version of 21st century capitalism is not delivering the goods for ordinary working people. It is now time for the government to shift gear. It should use the fiscal flexibility secured by austerity and focus on improving productivity and real wages for most people in work. As Theodore Roosevelt understood, nothing is more important for society’s wellbeing than this: “We stand for a living wage…enough to secure the elements of a normal standard of living – a standard high enough to make morality possible, to provide for education and recreation, to care for immature members of the family, to maintain the family during periods of sickness, and to permit a reasonable saving for our old age” (6). We should aim for no less.
The best way to improve productivity is to increase investment – so that the amount of capital employed for every worker goes up. The Office for Budget Responsibility estimates that the budget deficit for 2016/17 will amount to 2.6% of GDP. The government is currently planning to reduce that to roughly 1% of GDP in 2021/22. It plans a surplus sometime after the 2022 general election. This ambition is no longer appropriate. We should drop the surplus target and not seek further cuts in the deficit below its current level. This would allow us to increase public investment by a dramatic amount. By maintaining tight control on the government’s current spending, we should be able to push public-sector net investment up from 1.8% of GDP in 2015/16 to over 3% of GDP – and maybe even double it (7). This would help bring total investment up from 17% of GDP in 2015 closer to the level in Germany (19%) or the United States (20%).
Deficit hawks will denounce this as profligacy. It is nothing of the kind, if the money is being devoted to investment rather than current spending. What matters for the long-term creditworthiness of a country is how much it owes relative to how much it makes. We can maintain fiscal discipline by retaining the target for public sector net debt as a percentage of GDP and slowly reducing it from 2017/18 onwards. Nothing would bring this crucial measure down more quickly than the sustained growth in productivity that should result from a programme of public and private investment.
There will be others who argue that we should not increase spending on public investment while overall public spending remains at 39% of GDP. They hold that we should pay for any increase with further cuts in current spending on other government programmes (8). I disagree. It was absolutely right to bring public spending down from a wholly unsustainable 46% of GDP in 2009/10 to below 40% today. But if, as a country, we want to provide the high quality healthcare that people need, if we want young people to stay in full-time education until the age of 18, if we want the low-paid and disabled to receive a reasonable income from benefits and tax credits, if we want pensioners to receive a decent income in their old age, if we want to maintain our defence and meet our commitment to helping the poorest people in the world, then it is pure fantasy to believe that we can cut public expenditure much below 39% of GDP.
Britain’s new quest
“Productivity isn’t everything, but in the long run it is almost everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker” (9). Paul Krugman’s dictum should be a daily mantra for government ministers. Ever since 2012 when I devoted a Tory Reform Group lecture to the subject of Britain’s productivity problem, it has been clear to me that productivity growth is the holy grail of economic policy-making. If you have it, everything else becomes easier. If you don’t, all other achievements quickly sour.
While it is easy to get economists to agree that productivity is the be-all-and-end-all, it is much harder to get consensus on any of the big questions about British productivity that we face today. Why is it substantially lower than that of most of our competitors? Why hasn’t it been growing in the last few years as one would expect after a recession? And, most importantly of all, what should government do to boost productivity growth?
After reading a seemingly endless series of reports on Britain’s productivity crisis, and finding them rich in information but short on insight, I have reached a rough and ready conclusion. Productivity in the UK will increase if we have better transport and communications infrastructure (especially outside London), if we increase dramatically the number of people with technical and management skills, if we do a lot more scientific research, and if employers invest a lot more in automation and other capital equipment. It is impossible to know exactly which of these will have the biggest impact on productivity. So we need to do them all and, as a rule of thumb, spend at least 50% more on each of them than we are currently doing.
We should use this surge in public investment to transform our economic culture. The Government should set up a Productivity Commission with an independent status similar to that of the Office of Budget Responsibility. It should be given the task of assessing every department’s policies and budgets for their likely impact on productivity. It should also be asked to produce policy recommendations that might contribute to productivity growth. We need to recruit businesses to join this campaign to increase investment – through tax changes and co-investment schemes.
When it leaves the European Union, Britain needs to be a place where we invest more than our competitors, because we believe in ourselves, are optimistic about our future and want to capture the full potential of the British people. As the age of austerity closes, let the age of investment begin.
Real wage growth at the bottom and middle
One of the boldest moves of David Cameron’s government was to introduce the National Living Wage for workers of 25 and over. I was involved in the gestation of the policy, and its implementation. Both inside government and out, people were concerned that it would lead to significant job losses in sectors characterised by low pay. The most recent unemployment figures show this fear to have been misplaced (although it was far from irrational.) For once, government timed its intervention just right and millions of low-paid people have benefited from a real increase in their wages as a result.
There are two potential points of equilibrium for the labour market – one with lower wages and lower investment, one with higher wages and higher investment. Supermarkets provide a good example. In France, where labour costs are much higher, supermarkets have long operated digital price tags which can be changed by one person at a desktop. In the UK, most supermarkets still use physically printed price tags, that have to be laboriously changed by hand. By introducing the National Living Wage and announcing a plan to increase it to 60% of average earnings, we are signalling to employers that it will be worth their while to make the investments in automation that will increase the productivity of their workers and justify higher wages.
We should now go further. We must put the commitment to growing real wages at the heart of our economic strategy. The Chancellor should give the Treasury a new target for economic policy: that of achieving a real increase in average wages of at least 1% a year and otherwise in line with the average increase in output per hour. It would send a powerful message to businesses small and large if the department responsible for managing the economy put improving productivity and increasing working people’s wages at the centre of its governing mission.
Incentives for wage restraint at the top
Increasing the average wages that most working people receive should be the government’s top priority. But we cannot ignore the evidence that senior executives’ salaries have spiralled upwards at a rate which bears no relation to the profitability or value of the organisations that employ them. Government should not be indifferent to greed, particularly when it is not justified by performance.
We should avoid a heavy-handed regulatory approach. We want business executives to focus their energies on growing their businesses and investing in innovation not on compliance with clunky new rules about board representation or shareholder votes. What is missing is a simple but powerful incentive for the people who own businesses to impose restraint on the pay packets of those who manage them. We should adopt a version of an idea that was proposed to the California state legislature in 2014 (10), and which features in former US Labor Secretary Robert Reich’s book Saving Capitalism.
The UK’s corporation tax rate is currently set at 19% for the 2017/18 financial year. This is due to fall to 17% in the 2020/21 financial year. The government should announce that the additional 2% cut will only be made available to businesses which can demonstrate that the they are not paying their highest paid executive more than a maximum multiple of the average amount they pay their UK employees. On average the ratio between top pay and average pay in FTSE 100 companies has gone from 48:1 in 1995 to 128:1 in 2015 (11).
Offering the 17% tax rate to businesses paying their highest paid executive no more than 75 times the average employee seems a reasonable place to start but of course the government would want to consult widely before settling on a precise number. The target multiple should be reviewed every five years. Shareholders would then have a clear choice: if they really believe that paying their most senior executives more than 75 times their average employee will deliver a crucial competitive advantage and therefore increased profitability, they will be free to decide that is worth paying an additional 2% of corporation tax. But if they value the additional 2% of profits more, they can insist that the board recruits senior executives who are willing to work at the sanctioned rate – or increase the average employee’s pay accordingly.
Introducing a simple tax incentive rather than a fiddly set of board procedures has several advantages. It will apply to all employers paying corporation tax, so privately-owned companies will not be exempt. Its compliance cost will be small, as employers already submit full details of most aspects of employees’ compensation to HMRC for PAYE purposes. Most importantly, it preserves the central principle that in our free society we should avoid telling business people how to run their businesses, set a few simple rules and let them get on with it.
Levelling the playing field for corporate tax
One of the things that most undermines people’s confidence in the fairness of our economic system is the justified sense that there is one set of rules for big international corporations and another for ordinary local businesses. Companies like Google, Apple and Facebook exploit international taxation treaties to pay derisory amounts of corporation tax despite earning massive revenues from British consumers. If we are to rehabilitate the reputation of the free market and ensure that the Treasury can rely on a secure stream of revenues to fund high quality public services, we need to make the tax system fairer, and introduce new, more dependable sources of revenue. Over the next five years we should raise more tax from multinational corporations, and use the proceeds to cut taxes on the modest profits of small and medium-sized businesses.
Raising more money from global corporations is hard. Despite the welcome introduction of the ‘diverted profits tax’ (or Google tax) in 2015, the amount of tax paid by Google, Amazon, Facebook and Apple in the UK remains tiny as a percentage of their revenues from UK consumers. The best idea for redressing the balance was floated by Jonathan Ford in the Financial Times (12). It involves borrowing some of the features of the old Advance Corporation Tax and charging companies a new levy that can be offset against corporation tax. The levy would be set as a percentage of UK sales. This means that there would be no increase in the tax paid by the vast majority of companies who book a reasonable profit margin on their UK sales and pay corporation tax on it. But extra money would be raised from international companies who use transfer pricing and other tricks of the trade to keep taxable profits to a minimum. Charging global corporations like Google and Facebook a sales levy of 4% and leaving it to them to decide whether to adjust their arrangements so that they book enough profits to offset it, would reassure their customers and their competitors that every business making money out of Britain is also making a fair contribution to its wellbeing. The proceeds of this new levy should be used to double the annual investment allowance from £500,000 to £1 million so that small and medium-sized businesses can join in Britain’s investment boom.
In this chapter, I have proposed new targets for the Treasury and new incentives for business so the government can shift economic policy from its current focus on austerity and job creation to a new pair of priorities: productivity and wage growth. But as important as any policy initiative will be the attitude we take towards business and the language we use about it.
As we leave the European Union, it would be fatal for Britain to adopt the mindset of the far left and treat business with suspicion or disdain. We need to call out those who break the law and abuse positions of power. Politicians should not cower or fawn when confronted with men who have evaded minimum wage laws or subverted a company pension fund. But our criticism should be targeted and contained. Targeted at those few who abuse our economic freedoms. And contained so it does not harden into the anti-capitalist’s reflex of distaste for business in general.
We must applaud people who achieve success in business, especially when that success is shared with customers, employees and the wider community. The UK has seen the biggest increase in the number of new firms created from 2007 and 2016 of any country in the OECD (13). That is a huge source of strength. Our economy is confronting a storm of disruption from automation, robots and artificial intelligence with a lively spirit of enterprise and optimism. It is essential that this spreads throughout the country. We need to encourage young people to think positively about a career in business, to get excited about the adventure of setting up their own businesses and to embrace the values of entrepreneurs.
I have set up two businesses, and devoted fifteen years of my life to nurturing them. There are few greater thrills than winning a new customer or a big order, few better feelings than the pride of being part of a team that delivers a massive project or meets daunting targets, few places where you will feel more stimulated and stretched than at a company that prizes innovation and invests in research. In the new age of investment, Britain’s businesses must lead the way.
When banging the drum for British business we should distinguish between the fleet-of-foot enterprises that operate in competitive customer-driven markets, and the corporate bureaucracies that shelter behind barriers in cosy cartels. If a large number of markets are dominated by a few big players and consumers are paying higher prices and receiving worse service as a result, as was suggested by a recent report by the Social Market Foundation (14), government needs to push the competition authorities and industry regulators for more robust action and legislate to give them sharper teeth if necessary. The authorities should avoid crude measures like price caps and focus instead on breaking up excessive concentrations of market power.
The Square Deal will be judged by its impact on the consumer and the small producer. Theodore Roosevelt’s words should guide us: “we wish to shape conditions so that a greater number of the small men in business–the decent, respectable, industrious, and energetic men who conduct small businesses, who are retail traders, who run small stores and shops–shall be able to succeed, and so that the big man who is dishonest, shall not be allowed to succeed at all” (15).
(1) Office of National Statistics. 2017 Analysis of real earnings: October 2017. Available at: https://www.ons.gov.uk/employmentandlabourmarket/peopleinwork/earningsandworkinghours/articles/supplementaryanalysisofaverageweeklyearnings/latest
(2) Resolution Foundation. 2017. Living Standards 2017: the past, present and possible future of UK incomes – Resolution Foundation. Available at: http://www.resolutionfoundation.org/publications/living-standards-2017-the-past-present-and-possible-future-of-uk-incomes/
(3) Institute for Fiscal Studies. 2017. Living standards, poverty and inequality in the UK: 2017. Availabe at: https://www.ifs.org.uk/uploads/publications/comms/R129%20-%20HBAI%20report%202017.pdf
(4) Haldane A. Bank of England. 2016. Whose Recovery? Available at: http://www.bankofengland.co.uk/publications/Documents/speeches/2016/speech916.pdf
(5) Office of National Statistics. 2017. International comparisons of UK productivity (ICP), final estimates: 2015. Available at:
(6) Roosevelt T. 1912. Speech to Progressive Party convention. Available at: http://theodorerooseveltcenter.org/Research/Digital-Library/Record.aspx?libID=o284876
(7) Mor F. House of Commons Library. 2017. Infrastructure Policies and Investment, Briefing Paper Number 6594. Available at: http://researchbriefings.parliament.uk/ResearchBriefing/Summary/SN06594#fullreport
(8) Emmerson C. Institute for Fiscal Studies. 2017. Two Parliaments of Pain: the UK public finances 2010 to 2017, Briefing Note (BN199). Available at: https://www.ifs.org.uk/publications/9180
(9) Krugman P. The Age of Diminishing Expectations. 1994
(10) Kohn G, Capital and Main. Overcompensation: Tying Corporate Taxes to CEO Pay. 2014. Available at: https://capitalandmain.com/overcompensation-tying-corporate-taxes-to-ceo-pay
(11) CIPD and High Pay Centre. Corporate governance reform 2017. Available at: http://highpaycentre.org/files/CIPD_and_HPC_response_to_BEIS_Green_Paper_on_Corporate_Governance_%281%29.pdf
(12) Ford J, Financial Times. Don’t get mad at Google – get even. 2016. Available at: https://www.ft.com/content/589c9972-c81d-11e5-be0b-b7ece4e953a0
(13) OECD. Entrepreneurship at a Glance 2017. 2017. Available at: http://www.oecd.org/std/business-stats/entrepreneurship-at-a-glance-22266941.htm
(14) Corfe S and Gicheva N, Social Market Foundation. Concentration not competition: the state of UK consumer markets. 2017. Available at: http://www.smf.co.uk/wp-content/uploads/2017/10/Concentration-not-competition.pdf
(15) Roosevelt, T. The Farmer and the Business Man. 1912. Available at: https://www.historyonthenet.com/authentichistory/1898-1913/2-progressivism/5-wilson/19120800_The_Farmer_And_The_Business_Man-Theodore_Roosevelt-lyrics.html