Wake up, George and smell the green tea

Today the Office of Budgetary Responsibility (OBR) is expected to downgrade the UK growth forecast to less than 1%. This is bad news because if the UK economy does not grow, the major cuts in spending will not achieve their goal of reducing the deficit, and hence have caused much suffering -especially for the weakest elements of society - for nothing.  Cuts without growth don’t allow the deficit to fall because unemployment comes with a heavy cost to the public purse (e.g. unemployment benefits, loss of tax income, crime etc).

 

Britain’s sluggish growth, which preceded the Eurozone crisis, should not come as a surprise given that the strategy of the coalition government has been focused on appeasing bond markets via cuts, rather than focusing on growth via ‘smart’ investments. Bond markets worry about financial indicators like inflation and interest rates, rather than ‘real’ indicators of economic activity like investment, productivity, and employment. Is it really so great that George Osborne has made them happy? At what cost?

 

Osborne will attempt to address this problem, through the formal announcement on Tuesday of a £30 bn  infrastructure programme, for work on roads, rail, power stations, etc. This is to be funded partly through further cuts and tax rises (in the form of reductions in the working tax credit), as well as through a new £20bn plan for using private pension investments, which are guaranteed by the government, which in theory should not affect the UK’s AAA rating.

 

But the core problem is that there is still too much reliance on the private sector to kick start growth when actually the private sector is reluctant to spend – in fact currently hoarding around £75 billion. Business is not investing because it lacks the confidence to do so and due to the lack of demand for their goods and services. The latter has been affected by the squeeze in incomes and standards of living of British consumers who have been hit simultaneously with a rise in VAT, a freeze on public sector wages, cuts to services and benefits.

 

But there is another reason why the private sector is not investing and this is something that holds not only during recessionary periods. This has to do with the myth that growth is achieved by reducing the public sector, and increasing the private sector.  We are in a period of major transition, not just in terms of the Eurozone crisis but something more interesting: the decades of growth from the computer revolution are coming to maturity and the green tech revolution is about to take off. In such periods, bold courageous investments in the uncertain territory of a new technology have often been led not by the private sector but by the public sector. The lack of such investments in the UK has caused it to fall from 5th position in global investments in low carbon technology to 11th.  To regain position before it is too late the UK must today both produce a more certain ‘green’ business environment with clear signals—rather than the current confusion around feed-in tariffs—as well as undertake some of the most radical investments itself, and use procurement policy to introduce such innovations more generally. A lesson that has been learned by the leaders in the green tech race such as China, Germany, Finland and South Korea.

 

Another key point is about rebalancing. Much of the discussion right now in the UK is about the need to rebalance the economy away from a financial sector which is considered too large, moving more towards manufacturing. This debate is often misplaced because the real problem has not been so much the size of the financial sector but the short-termist principles on which it is based, which has badly affected all sectors, even manufacturing. Here what the government could do is to find ways to reward those businesses that produce evidence that they are investing in the long run. This could be in terms of tax benefits related to their human capital expenditures and their R&D expenditures. In fact, the much talked about ‘skills shortage’ is precisely a result of the fact that companies have little incentive to produce those skills. Skills don’t fall from the sky. They are invested in, both by the education and research infrastructure but also by companies themselves. Finding ways to support this is essential. 

 

A key lesson for Osborne is that the only countries in the developing world that have grown are those that have turned their backs on the neo-liberal agenda of financial markets (who predictably always ask for cuts, cuts, cuts) and produced the smart investments needed for growth.  And the fact that Sarkozy recently went begging to the door of Brazil and China, two such countries, to help the Eurozone is testament to the strange – and hypocritical - period in which we are living.