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Why Economic Growth Is Faltering and What We Can Do About It

Government’s mistake is to misunderstand the scale of de-industrialisation

The Government wants economic growth as much as anyone. Why isn’t it happening? A new report from Civitas argues that growth is faltering because the Government has been solving the wrong problems. The Coalition thinks that the national debt and global warming are the biggest challenges we face, but according to A Strategy For Economic Growth, our main problem is de-industrialisation. The report suggests ten things the Government could do.

Our economic capacity has been ‘hollowed out’

The Government has been hoping that controlling public sector spending, combined with some supply-side measures like deregulation and cutting company taxation, will lead to a private sector revival. But it has been making the unspoken assumption that there is spare capacity in the private sector, or at least capacity that can be rapidly deployed.

Unfortunately, the hollowing out of manufacturing in the last 30 years means that such capacity is no longer there. This reality was acknowledged by the Bank of England’s Monetary Policy Committee in April 2011, when it said it was ‘possible that UK firms in some industries lacked the plant or capacity to expand production rapidly in response to the past depreciation of sterling and it would take time for them to install it’.

The Government’s expectations about the potential for private sector growth seem to have been forged in an earlier era when Britain had more manufacturing industry. It comprised 20% of GDP as recently as 1997, but now it is 11% and hopes for a rapid private-sector led resurgence of growth are over-optimistic.

Urgent policy changes to create jobs

We need a national strategy to rebuild our productive infrastructure and create jobs. To achieve a revival of manufacturing the Government needs urgently to do two things:

  • Establish an industry bank charged with making investment decisions on commercial grounds.
  • Establish an exchange rate target to give confidence to investors.

The industry bank – Economists worried about the state ‘picking winners’ can relax

The banks are not lending at a pace consistent with rapid recovery. The most rapid solution is to establish an industry bank and to finance it by allocating £10 billion from the £75 billion recently added to the money supply by the Bank of England.

The model being proposed is a blend of America’s Small Business Administration and Germany’s state development bank, KfW. Germany has found KfW crucial to ending its recession. When private bank lending fell during the recession, KfW lent record sums: €30bn in 2010 alone, creating 66,000 jobs.

America’s Small Business Administration (SBA) also increased funding during the recession. America defines any company with fewer than 500 employees as ‘small’, which covers over 29 million small businesses in the US (99% of companies), employing over half of the American workforce. Since the Second World War the SBA has supplied 20 million small businesses with financial help by supporting them when commercial banks would not. It does not makes loans directly, but guarantees private loans against default, a subsidy that vastly increases the availability of private finance. At present, the SBA has roughly 219,000 loans worth around $45 billion, making it the largest investor in US businesses.

If it’s OK for capitalist America to subsidise business investment, it should be OK for us.

The exchange rate

Often competitive margins in manufacturing are very small and easily overwhelmed by exchange rate fluctuations. A company might strain every sinew to gain a 5% price advantage and find it eradicated by a sudden lurch in the exchange rate. As a result, companies are not likely to spend months building a new factory if the competitive advantage it would bring might be lost before the building work was completed.

A stable exchange rate over the lifecycle of typical investments in productive capacity will encourage efforts to gain advantages through genuine improvements in productivity. It will also alter the attractiveness of investment in productive enterprise compared with money making through arbitrage. Utility banking will be better rewarded by comparison with casino banking.

To avoid inflation, monetary policy should focus less on the interest rate and more on quantitative measures.

‘Green’ policies should not be allowed to destroy jobs

Policies being pursued to combat global warming are weakening the manufacturing sector, undermining our economic recovery and destroying jobs. Paradoxically, they also fail in their own terms. Imposing costs on high-energy users will drive them overseas where they will continue to produce carbon emissions.

The global-warming debate provokes strong feelings. But both sides should be able to agree that reducing carbon emissions should not take priority over job creation.

Manufacturing – it’s about hard-headed productivity not the romance of ‘making things’

Contrary to the arguments of some critics, we need to re-industrialise not because of a romantic attachment to ‘making things’ but because the key to prosperity is raising productivity and manufacturing provides better opportunities for productivity gains than services. The nations that expanded their GDP rapidly in the post-war years all based their strategy on manufacturing, including Germany, Japan, Taiwan, Korea and today China. They knew what they were doing. Services do not provide the same scope for rapid increases in productivity.

Ten things the Government could do

  1. Reduce the cost of electricity for businesses by scrapping plans to build over-priced wind turbines.
  2. Develop ‘retainable’ industries through an industry bank.
  3. Set an exchange rate target, even at the risk of higher inflation.
  4. Support industries engaging in import substitution.
  5. Convert RBS branches into outposts of the industry bank.
  6. Reduce corporation tax to 15%.
  7. Replace employment tribunals with arbitration to eliminate avaricious no-win no-fee lawyers.
  8. Cut personal taxation to encourage investment and entrepreneurship.
  9. Provide more support for exporters.
  10. Make the most of EU state aid rules by using the same loopholes as our competitors.

For more information contact:

David Green, Director 020 7799 6677

David Merlin-Jones, Research Fellow 020 7799 6677

Notes for Editors

i. A Strategy For Economic Growth by David Green and David Merlin-Jones is available online below.

ii. Civitas is an independent social policy think tank. It has no links to any political party and its research programme receives no state funding.

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