GOING FOR GROWTH
After the Virus A plan for restoring growth
BY THE RT HON SAJID JAVID MP AND THE CENTRE FOR POLICY STUDIES About this report ‘After the Virus’ was produced by a team of researchers at the Centre for Policy Studies, led by the Rt Hon Sajid Javid MP. The chief researcher on the project was James Heywood, working with Nick King, Tom Clougherty & Robert Colvile.
About the Centre for Policy Studies The Centre for Policy Studies was recently named by Conservative MPs polled by ComRes as the most influential think tank in Westminster. Its mission is to develop policies that widen enterprise, ownership and opportunity. This paper is the first in a major series, ‘Going for Growth’, devoted to rebuilding Britain’s prosperity in the wake of the coronavirus crisis.
Founded in 1974 by Sir Keith Joseph and Margaret Thatcher, the CPS has a world-class track record in turning ideas into practical policy. As well as developing the bulk of the Thatcher reform agenda, it has been responsible for proposing the raising of the personal allowance, the Enterprise Allowance, the ISA, transferable pensions, synthetic phonics, free ports, and many other successful policy innovations. The recent Conservative manifesto drew heavily on CPS proposals, in particular its flagship policies on tax and housing.
cps.org.uk 2 After the Virus Contents
Introduction 4
Chapter I: Surveying the Damage 7
Chapter 2: Principles for Recovery 21
Chapter 3: Tax, Spending and Borrowing 26
Chapter 4: Infrastructure and Investment 37
Chapter 5: Employment and Enterprise 49
Chapter 6: Monetary Policy 61
Conclusion 70
cps.org.uk 3 After the Virus Introduction
The Rt Hon Sajid Javid MP long-term damage to the economy is unavoidable, it is still within the Although the Covid-19 pandemic began as Government’s power to determine the a public health emergency, it has swiftly speed and scale of recovery. developed into the most extraordinary The purpose of this report is to support economic crisis of our time. the efforts of ministers to instigate the The threat posed to people’s livelihoods strongest possible recovery. It was written is superseded only by the threat to lives in response to a shortage of off-the-shelf themselves. solutions to a challenge quite unlike any other. As the Government puts together Because of its service-based economy, a stimulus package, it is essential that no the UK is more exposed than most. The stone is left unturned. Boldness, as well as Bank of England has suggested that the out-of-the-box thinking, is the order of the decrease in output this year could be day. as high at 14%, the most severe for three centuries. The fall in GDP during March In this spirit, this report sets out more than and April alone has already wiped out 18 60 specific recommendations, covering years of growth. As a result, 2.5 million everything from taxation to monetary people could lose their jobs by late policy. It draws on six years of personal summer. experience as the Secretary of State for five different Departments, as well as a 19- Given the scale of the challenge, the year career in business and finance. It also Treasury’s response has been deeply benefits from the experience and intellect impressive. The Chancellor acted of a team of researchers at the Centre for decisively to deploy the most significant Policy Studies. fiscal firepower since the Second World War with speed and scale. An elixir of I have no expectation that these job retention schemes, tax cuts and recommendations will be adopted government-backed loans has saved wholesale. Instead, they should be businesses up and down the country. thought of as a series of standalone measures - designed to inspire further However, as effective as they have thought and enhance an eventual been, the purpose of the Government’s recovery plan. But if you only have time interventions to date has been to contain to read one section, I recommend that the damage, not to find a cure. Soon, the you make it Chapter 2, ’Principles for focus must shift from safeguarding the Recovery’. Our free-enterprise, free- economy to rebuilding it. trade economic model has never looked The only way out of this crisis is growth. more open to challenge. A conservative And although early hopes for a V-shaped insistence on sound money and low recovery proved optimistic and some taxes is already coming under immense
cps.org.uk 4 After the Virus pressure. If we want to not just repair as a new commitment to investing in the economy but rebuild it on firmer infrastructure and levelling up every foundations, it is these established region of this country - that must form the principles of wealth creation - as well cornerstone of our recovery.
cps.org.uk 5 After the Virus Key Recommendations
New fiscal rules to gradually eliminate the current budget deficit after the economy recovers, balancing fiscal responsibility with the need to support recovery.
Bringing forward and enhancing plans for major investment in infrastructure and left-behind regions, both to increase economic activity now and to boost long-term productivity.
A revitalised devolution agenda to level-up the UK, with more City Deals and increasing the powers and capacity of devolved authorities to invest for growth.
A relentless focus on jobs, with significant temporary cuts to employer’s National Insurance and VAT.
Getting Britain building with major reforms to planning rules and a new generation of development corporations.
Pro-growth tax reform, shifting the burden of taxation away from income and investment in favour of fairer property taxes and tightening reliefs for high earners.
Signalling Britain is open for business by pushing ahead with free trade agreements and new measures to attract talent and investment from across the globe.
Cementing the focus on growth by considering nominal GDP targeting as part of a new 21st century monetary framework for the independent Bank of England.
cps.org.uk 6 After the Virus Chapter 1: Surveying the Damage
We are in the midst of one The combination of the public health crisis and the measures introduced to combat of the most extraordinary it have brought an unprecedented fiscal downturns in history. shock. Never before has a government instituted a deliberate shutdown of huge The coronavirus is an economic crisis swathes of the economy, with significant without precedent, which has left restrictions on movement and activity governments across the globe with no putting a temporary halt to many of our playbook, and no pre-existing package freedoms. Lives have been put on hold of measures suited to securing their and loved ones have been lost. recovery. Initially, many were hoping (based partly Ministers have acted with imagination and on the evidence of previous pandemics) decisiveness in coping with the economic for a ‘V-shaped’ recovery, with the consequences of the crisis - the swift Government’s interventions acting as a and successful implementation of the bridge across the economic crevice of the Coronavirus Jobs Retention Scheme being second quarter. Once the pandemic was a case in point. dealt with, the economic activities we had But over the next few months, they to drop on the floor in March could simply will be required to demonstrate equal be picked up and dusted off later in the resourcefulness and creativity to find a year. Indeed, the ‘reference scenario’ bespoke package of measures capable produced by the Office for Budget of rebuilding our economy - not just to Responsibility (OBR) to illustrate the restore growth, but to put it on a firmer economic and fiscal impact of the crisis, footing. published on April 14, showed a rubber- band rebound in which we experienced no The purpose of this paper is to suggest permanent loss of GDP and no increase in both broad principles and specific ideas structural public borrowing.1 which we believe can drive our long-term recovery. We believe they are in tune with Even at the time, those assumptions the Government’s existing agenda, and looked questionable - hence the OBR’s will help to drive it forward. We present insistence on referring to this work as a them not as a comprehensive package ‘scenario’ rather than a ‘forecast’. Today, of measures, but a series of ideas upon the outlook is far bleaker. In this section, which those in Government can draw. we will explore some of the big challenges which will mean lingering damage to our However, before we come to the economy and public finances - and which suggested treatment, we must start with any plan for recovery will need to address. the diagnosis. And on that front, the picture is grim indeed.
1 OBR, ‘Coronavirus analysis’, link cps.org.uk 7 After the Virus GDP damage to the economy. Social distancing is also likely to remain in place for a There is no doubt that there will be a sustained period in some form, and that will significant GDP contraction this year due have an impact not just on confidence but to the pandemic. The longer the country on productivity and efficiency – at a very remains under lockdown measures - and basic level, we just won’t be able to use the longer people choose to limit their space in shops, offices and factories in an activities, even after official restrictions are economically optimal way. relaxed - the deeper the recession will be. The National Institute of Economic and Estimates by the OECD suggest the initial Social Research (NIESR) has put together impact on the UK economy could amount a main-case scenario which factors in the to a 26 per cent fall in GDP for the period of lingering effects of the pandemic. While lockdown measures, and a drop in private the GDP trajectory shown in the graph consumption of as much as 37 per cent. below suggests a slightly higher growth For 2020 as a whole, the OBR model shows rate for the next few years after the initial a 13 per cent contraction in GDP, instead of hit from the virus (as the gradual ‘return the modest growth of 1.1 per cent forecast to normal’ boosts activity), this is far from at the March Budget. The Bank of England sufficient to make up for how far off modelling illustrates a similar contraction course the economy will have been blown. of 14 per cent. This would be the largest annual fall in output on record, exceeding both World Wars. Initial outturn data seems Figure 9. GDP forecast compared to be bearing out these predictions - the to pre-Covid 19 forecast Office for National Statistics (ONS) April GDP update showed GDP in April down by 25 per cent compared to February (the last ‘normal’ month).
These are not just numbers on a spreadsheet. We are talking about people’s livelihoods. Every job lost and every business closed means setbacks, lost dreams, financial worries and hardship.
As will be set out below, it would be complacent and naïve to assume that there will be a rapid and complete economic bounce-back - certainly one significant Source: NIESR. enough to make up for the growth we have lost. The reality is that bruised investor and consumer confidence as well as scarring effects from the deep recession will almost certainly cause stubborn and long-lasting
2 OECD, ‘Evaluation the initial impact of COVID-19 containment measures on economic activity’, link 3 Bank of England, ‘Monetary Policy Report: May 2020’, link 4 OBR, ‘Coronavirus analysis’, p8, link 5 ONS, ‘GDP Monthly Estimate: April 2020’, link cps.org.uk 8 After the Virus Even this scenario, says NIESR, is based had been supported through the scheme, on ‘optimistic conditioning assumptions’ helping 1.1 million employers cope with - it is entirely possible, they say, that the their wage bills and keep people on the road out of lockdown is even rockier. But payroll.8 The Business Impact of COVID-19 even under this scenario, they expect Survey, produced by the Office for National permanent scarring. Their conclusion is Statistics (ONS), suggests that the furlough that: ‘Over the next 10 years, this loss of scheme has been extremely successful, output cumulates to around £800 billion, with less than 1 per cent of employees or £11,000 per head. This is equivalent to being made redundant across firms.9 a loss of GDP of around 3½ per cent each However, it is important to note that these year over the next 10 years, though the figures relate only to businesses which economic cost is front-loaded’.6 still exist. Those who have lost their jobs Unemployment due to their companies folding are not captured in these figures - nor are those One of the Conservatives’ proudest who may operate as contractors or are achievements since 2010 is to have classed as self-employed workers, who achieved record high employment rates may have been let go without it formally and helped millions more people into being classed as redundancy. There may work. At one stage, as we emerged from also be large numbers of sole traders who, the financial crisis, Britain was creating despite the support for the self-employed more jobs than the rest of the European available, have either slipped through the Union put together - and this incredible cracks or will find it hard to maintain their performance has continued under a livelihoods once support is withdrawn. succession of Prime Ministers, even as the Government has significantly raised Real time PAYE data from HMRC suggests minimum wages.7 the number of employees on payroll fell by more than 600,000 between March and Sadly, this proud record is now in jeopardy. May,10 and figures from the Labour Force Indeed, it is the impact of the coronavirus Survey suggest a fall in the number of self- crisis on jobs and employment that could employed people of 300,000 by April.11 be its most pernicious consequence. Claims for Universal Credit and So far, the Government’s Job Retention Jobseeker’s Allowance certainly Scheme has performed a vital role in suggest that there has been a spike in maintaining employment levels while unemployment - while also showing the the country is in lockdown. By June 14, impact of the furlough scheme, announced according to HMRC, 9.1 million workers on March 23, in forestalling it.
6 Cyrille Lenoël and Garry Young, ‘Prospects for the UK economy’, link 7 Full Fact, ‘Has the UK created more jobs than the rest of the EU combined?’, link 8 HMRC, ‘Coronavirus statistics: Job Retention Scheme management information’, link 9 ONS, ‘Business Impact of Covid-19 Survey results’, link 10 ONS, ‘Labour Market Overview: 16 June 2020’, link 11 Tony Wilson, ‘Labour Market Statistics, June 2020: IES analysis’, link cps.org.uk 9 After the Virus New individual claims for Universal Credit each day, March 1 - June 9 2020
Lockdown announced
Source: DWP management information, UC declarations and advances, June 16 2020, link
In addition to the 2.3 million individual calmed down once the furlough scheme claims for UC between the lockdown was announced, the baseline for claims measures being announced on March 16 was still much higher. It is also highly and early May, there were 250,000 claims likely, given depressed demand and the for Jobseeker’s Allowance and 20,000 for restrictions imposed by social distancing, Employment and Support Allowance.12 that many of those currently furloughed will not have jobs or potentially even It is important to remember that not all companies to return to when support is claims for Universal Credit will be for out finally withdrawn - however smoothly the of work benefits, as it is also available transition out of lockdown is managed. The to workers on a low income. However, OBR, for example, expects employment to since the claims rate is vastly higher than bounce back much slower than output. usual and is correlated strongly with the lockdown, it is safe to assume most of This is why, as we outline later, the those claiming have either lost their jobs Government needs to make jobs its or had their hours reduced, meaning they core focus - not just to protect as many have avoided unemployment but are now as possible, but to make it as easy as underemployed. possible for them to be created and for people to move into them. There It is also unlikely that we have seen the is a great deal of economic literature last of this trend. While claims numbers
12 Thérèse Coffey, ‘DWP’s response to coronavirus (COVID-19)’, link cps.org.uk 10 After the Virus on the economic scarring caused by country’s already substantial regional unemployment. Work by the Resolution inequalities. Foundation, for example has shown As the Bank of England have pointed that those who left education during out, the more labour-intensive an the last recession have a lower rate of industry is, the harder it has been hit employment than the year groups above by the lockdown.15 This inevitably has a and below even today.13 geographical dimension. Those sectors Gaps in employment history, detachment which are more capital- or knowledge- from the labour market, the opportunity intensive have been more cushioned from cost of years which could be spent in a the crisis, not least because they are more trade – any period of unemployment has suitable for home working. They are also lasting damage for each individual and the disproportionately concentrated in London wider labour market. and the South East.
Those leaving education are particularly It is, therefore, the regions which were vulnerable, and may struggle to move into already suffering from low productivity, work in the first place. Indeed, we must low levels of capital intensification and remember that the rise in unemployment lack of investment which have been most will not only be from people losing their affected by the crisis. jobs but from fewer new jobs being created. ONS survey data shows that, as we By early May vacancies were down 60 per might expect, the sectors most able to cent compared to before the crisis.14 work from home are Information and Regional Impact Communication (86.6 per cent working remotely) and Professional, Scientific and One of the driving forces behind the Technical Activities (77.6 percent). Those current Government’s agenda is the need least able are, inevitably, in Hospitality (14.4 to spread wealth and opportunity more percent) - but areas such as Construction fairly. ‘Levelling up’ is not just a slogan, but (34.6 percent), Wholesale and Retail (35.7 a mission. percent) and Manufacturing (26.5 percent) are also substantially more affected by the Yet it is already clear that this crisis, like shutdown.16 so many before it, will exacerbate this
13 Kathleen Henehan, ‘Class of 2020: Education leavers in the current crisis’, link 14 IES, ‘Weekly vacancy analysis: Vacancy trends in week-ending 3 May 2020’, link 15 Bank of England, ‘Monetary Policy Report: May 2020’, p5, link 16 ONS, ‘BICS Survey dataset, 7 May 2020’, Sheet 20: Proportion Working Arrangements, link cps.org.uk 11 After the Virus The chart below from Professor Ben Ansell between GDP per capita and numbers of of Oxford University shows the correlation people still going to work.17
ReductionReduction in workplacein workplace activity activity vs. GDP vs.per GDPcapita, per by local capita, authority by local or county. authority or country.
Areas with low GDP per capita Areas with high GDP per capita and less social distancing and less social distancing -55% North East Lincolnshire Blaenau Gwent Herefordshire North Lincolnshire -60% Merthyr Tydfil Powys Peterborough
-65%
Luton
Warrington
Swindon -70% Inverclyde Slough Milton Keynes Aberdeen
Belfast -75% West Berkshire Surrey Reading
Percentage reduction in time at workplace (9 April 2020) at in time reduction Percentage Brighton and Hove Windsor and Maidenhead East Renfrewshire Greater London
Wokingham -80% Edinburgh
Areas with low GDP per capita Areas with high GDP per capita and more social distancing and more social distancing
£10,000 £20,000 £30,000 £40,000 £50,000 £60,000 GDP per capita
Source: Google Community Mibility Reports and ONS. Analysis by Ben Ansell for UK in a Changing Europe. Source: Google Community Mobility Reports and ONS. Analysis by Ben Ansell for UK in a Changing Europe.
17 Ben Ansell, ‘What explains differences in social distancing in the UK?’, link
cps.org.uk 12 After the Virus This illustrates not that the areas in the As a result, those regions with top-left are less affected by the pandemic, disproportionately high numbers of but that these are the areas where a people in higher-end, knowledge-intensive higher proportion of people are simply jobs are in the best place to weather the unable to undertake their work from home. storm. Another piece of research by the This is backed up by recent analysis from RSA concluded that ‘most of the less the RSA, which found a strong correlation vulnerable areas can be found either in between earnings and ability to continue London itself or in the city’s surrounding working from home.18 commuter belt’.19
While much of this impact will be We can see from the ONS data that London temporary, it seems likely that for a period and the South East have the highest of time working from home will become proportion of people working in the two much more prevalent and that some knowledge-intensive, high-value added of this will be a permanent shift. Many sectors (Professional Scientific & Technical workplaces may be affected by social and Information & Communication). These distancing for a while to come, and those two sectors combined make up 22.4 per less able to deal with this by working cent of all jobs in London compared to just remotely will be more likely to face higher 8.5 per cent in Wales and 9.5 per cent in the costs and need to shed staff. North East.
Proportion of the workforce in each industry sector, by UK region
Source: CPS Calculations based on ONS, Workforce jobs by region and industry, March 2020, link, calculated as a percentage of total jobs (smaller industry sectors such as Mining & Quarrying, Water & Sewerage and Electricity & Gas Supply have been aggregated under ‘Other’ for simplicity)
18 Fabian Wallace-Stephens and Will Grimond, ‘Low pay, lack of homeworking: why workers are suffering during lockdown’, link 19 Alan Lockey and Fabian Wallace-Stephens, ‘Which local areas are most at risk of impacts of coronavirus on employment?’, link cps.org.uk 13 After the Virus Just 2.1 per cent of jobs in London are lost to the crisis may be perfectly viable in manufacturing and 6 per cent in the companies without the temporary impact South East, compared to 11.9 per cent in of the shutdown. In the hospitality sector, the East Midlands and 10.8 per cent in for example, the only mistake many Yorkshire and the Humber. The South West managers have made is to choose to work has the highest proportion of people in in an industry that simply cannot operate accommodation and food services; the with all those involved standing two North West has the highest proportion of metres apart. people in wholesale and retail. Analysis by the Enterprise Research Analysis by KPMG of regional Gross Centre in April found that more than Value Added statistics backs up these 61,000 businesses folded between the conclusions. They find that London’s start of March and mid-April, and that for service-heavy economy will be the least March alone there was a 70 per cent rise affected, while the West Midlands is likely in businesses folding compared to the to be one of the hardest hit due to the same month last year and a fall in new preponderance of industries such as car start-ups of almost a quarter.22 manufacturing. They predict that as a In the ONS Business Impact Survey, result ‘the gap between performance in around half of respondents said turnover London and the rest of the UK will widen was down over the previous two weeks this year’.20 and almost a quarter said their turnover Within regions, analysis of bank account had been less than half the normal data by Chris Cook et al. for Tortoise Media level. More than two thirds of exporting suggests those smaller towns which were businesses say that their ability to export already suffering from low productivity and has been damaged by the pandemic.23 low investment are likely to be hit hard. This loss of firms is not easily reversed Council wards where sales are down the once the economy begins to recover. least seem to be those where the majority Firms benefit from institutional knowledge, of sales are to people who live within a and it can take years to grow from start-up radius of a mile or so, and these areas are to established firm. Connections between disproportionately in city centres.21 employers and employees, buyers and Businesses sellers, and the complex networks involved in modern supply chains can take years to While most of the disruption to economic develop. activity should be temporary, one of the most damaging long-term impacts could In other words, the best way to ensure that be the loss of firms that have been forced we have a thriving business population to fold. after the crisis is to protect those businesses we have today. The longer This is not a conventional recession, the shutdown and reduction in activity where we might expect some ‘creative continues, the more firms we will lose destruction’ from inefficient firms leaving and the greater the lasting damage will the market and allowing a more optimal be to the economy - and to the lives and allocation of resources. Many of the firms livelihoods of those involved.
20 Yael Selfin, ‘Chief Economist’s note: Levelling-up and COVID-19’ link 21 Chris Cook, Ella Hollowood and Chris Newell, ‘Corona shock’, link 22 ERC, ‘UK companies facing COVID-19 pincer movement, data shows’, link 23 ONS, ‘BICS Survey dataset, 7 May 2020’, link cps.org.uk 14 After the Virus The British Chambers of Commerce and how deep the recession will be Coronavirus Business Impacts Tracker has and what lasting impact the pandemic found that more than half of businesses could have on behaviour and policy. That have less than three months of cashflow means that businesses are likely to be in reserve.24 Small and family businesses far more hesitant to invest. This comes in particular will struggle if starved of cash on top of years in which some investment for too long, not having the reserves which may already have been put off due to many larger firms have to fall back on. the uncertainty surrounding Brexit - cruel timing given the widespread expectations We must also remember that we live in a of a ‘Brexit bounce’ following the highly integrated market economy where Conservatives’ convincing election victory. businesses, workers and consumers are interdependent across sectors. A As the OBR notes, one of the key ways in recent paper for the National Bureau of which the crisis could cause permanent Economic Research suggested there may scarring even if demand quickly recovers be a ‘business exit multiplier’ effect, as is from the temporary period of lower businesses closing stop buying from their investment causing a permanent loss to suppliers and paying their workers, and the capital stock and productivity.27 that mechanisms such as this can mean There is also consumer behaviour to a major supply shock like the one we are consider. In recent years economic growth currently experiencing can actually lead to has exceeded the gloomy forecasts made an even bigger demand shock.25 immediately after the 2016 Brexit vote Confidence in large part because consumers have continued spending and have reduced One of the most important but least saving. If people are worried about their certain factors in all of this will be incomes, they will be unwilling to spend, the extent to which the confidence of particularly on large purchases such as businesses, investors and consumers cars and white goods - and of course will remain low following the pandemic. lockdown has made it impossible for them Confidence - the willingness of consumers to spend even if they wanted to, with the to spend and firms to invest - is the fuel ONS estimating that 22 per cent of normal on which the economy runs. The longer household spending has been impossible it remains depressed, the worse the during lockdown.28 recession will be. Some may also be looking to replenish On this score, the early signs are not their savings after having depleted encouraging. The UK Manufacturing them during the height of the crisis. Purchasing Managers Index (PMI) fell Nearly a quarter of those reporting that to a record low in April of 32.6. The UK their finances have been affected by Services PMI Business Activity Index fell to coronavirus say they are having to use a depressing 12.3 in the same month.26 their savings to cover living costs, and nearly a third say they have not been Due to the completely unprecedented able to save as much as they are used to, nature of this crisis, there is a huge according to the Resolution Foundation.29 amount of uncertainty about how long
24 BCC, ‘Coronavirus Business Impact Tracker’, link 25 Veronica Guerrieri, Guido Lorenzoni, Ludwig Straub and Iván Werning, ‘Macroeconomic implications of COVID-19: Can negative supply shocks cause demand shortages?’, link 26 IHS Markit, ‘Record declines in UK manufacturing and service sector output as public health crisis continues’, link 27 OBR, ‘Coronavirus analysis’, paragraph 1.23, link 28 ONS, ‘More than one-fifth of usual household spending has been largely prevented during lockdown’, link 29 Jack Leslie and Charlie McCurdy, ‘The economic effects of coronavirus in the UK: Utilising timely economic indicators’, link cps.org.uk 15 After the Virus It is therefore highly likely that consumers pandemic - but that pandemic also risks will respond to the uncertainty and lack of undoing much of that hard and painful opportunities to spend by saving. NIESR work. suggest that the household savings ratio The Government has rightly responded to will shoot up from 6 per cent in 2019 to 17 the crisis with an unprecedented package per cent in 2020.30 of measures to mitigate the impact and Consumer confidence, and behaviour support businesses and incomes. Policies more generally, is something the such as the Job Retention Scheme and Government cannot control simply by the Self-Employment Income Support ending the lockdown. Even after official Scheme are among the most generous of restrictions have been lifted, a significant any country. minority of the population may still The result will be that public spending voluntarily choose to reduce their activity soars this year. The Centre for Policy and spending, sometimes subconsciously. Studies has estimated that the measures This is a natural human reaction – people already announced, coupled with the are understandably very concerned and impact of the recession on tax revenues scared for the safety of themselves and and welfare spending, will see borrowing those around them. surpassing £300 billion in 2020-21.32 The For both businesses and consumers, OBR estimates that the furlough scheme the uncertainty will not be helped by the alone could cost £54 billion this financial potential for a second wave of the virus year, more than the annual defence casting a shadow over the recovery. In budget.33 addition, people will now be acutely aware To give a sense of the scale of the of the risks of similar outbreaks. Just as burden being shouldered by the state, people underestimate the possibility of the collapse in economic activity and the ‘black swan’ events such as the COVID-19 decision by government to step in mean pandemic, for a period of time afterwards that the OBR expects total managed they tend to overestimate the likelihood expenditure to account for more than of them happening again. The Bank half (51.7 percent) of GDP in 2020-21. For of England’s Chief Economist, Andy example, with nine million workers on Haldane, has pointed out that behavioural furlough, more than a quarter of the labour psychology would suggest there may force are currently having their wages paid be a lingering ‘dread risk’ as demand by the Exchequer. remains depressed due to wariness by 31 consumers. This huge increase in borrowing will add substantially to public sector debt. The Public spending and debt OBR numbers show debt rising to 95 per Thanks to the tough decisions made by cent of GDP this year, 17 percentage points the Conservatives over the last decade, higher than predicted at the Budget. A and the hard work of the British people, we quirk of the way the ONS calculate debt- went into this crisis with a balanced current to-GDP ratios means this year’s downturn budget and a falling debt-to-GDP ratio. will actually make the official debt level for This put is in a far better position to tackle last year (2019-20) higher (by 13.3 per cent the consequences of the coronavirus of GDP, on OBR estimates). If the ratio was
30 Cyrille Lenoël and Garry Young, ‘Prospects for the UK economy’, link 31 Tim Wallace, ‘”Dread risk” of another virus outbreak could force UK into longer recession’, link 32 Caroline Elsom, ‘The Costs of Coronavirus’, link 33 OBR, Coronavirus Policy Monitoring Database: Live Tables, link cps.org.uk 16 After the Virus calculated based on financial year GDP, Other measures are in theory temporary according to the OBR’s numbers the debt but in reality will be very difficult to level for 2020-21 could be an eye-watering reverse. It is a lot easier for governments 112 per cent of GDP.34 to give than it is to take away again. It would be very difficult, for example, for While the OBR reference scenario shows the Government to cut Universal Credit borrowing returning quickly to where it allowances by £1,000 a year after having was expected to be before and debt raised them at the start of the crisis. It will stabilising, in reality the Chancellor will also be difficult to ask businesses to go face a number of difficulties in restoring back to paying their usual business rates the public finances to health. after many have been exempted for a year, Firstly, as set out above, a full recovery especially when some will also have tax is likely to take much longer than the bills which have been deferred rather than OBR’s model assumes, meaning lower tax written off and will come due in 2021. receipts and higher welfare spending. There has also been a large increase Secondly, the OBR cannot account for the in NHS funding on top of that already political reality the Government will face promised in the Conservative manifesto, when it comes to unwinding the measures to help it cope with the pandemic, and it has announced. Some of the increases in it seems likely that there will be calls for spending are likely to be permanent, or at higher spending still, alongside more least extremely difficult politically to unwind funding for social care. – for example, nearly a billion pounds of All of this means that we will face a additional spending on housing benefit. ballooning debt pile.
Public sector net borrowing, % of GDP
Source: CPS adjustment of OBR Public Finances Databank (link) to reflect OBR Coronavirus Reference Scenario, April 2020, link
34 OBR, ‘Coronavirus analysis’, Table 1.10, link cps.org.uk 17 After the Virus As the above graph shows, borrowing has are not predicting a significant change in been brought down steadily since 2010, inflation in the short term. However, the only to now shoot up again as a result of fact is we simply do not know what an the - entirely necessary - response to the economic shock of the scale and nature virus. When things have returned to some we are facing could do to prices. The Bank form of normality, fiscal conservatives may of England has also cut the bank rate have to win the argument all over again. and undertaken substantial open market operations, which we would expect to Sterling depreciation have some impact over the course of the and inflation coming months and years. The Bank will need to be vigilant and the Government In its quarterly report in May, the Bank will need to let them do their job. of England noted that sterling exchange Seemingly small fluctuations in consumer rates have been volatile since the crisis prices could have major repercussions, began. In March the trade-weighted especially if, for example, there is a period sterling exchange rate index was down of deflation. 9 percent compared to its value in the Bank’s January report, with a 12 percent Existing problems fall against the dollar, though it has recovered somewhat since then.35 The coronavirus crisis did not come out of a clear blue sky. The truth is that A drop in the value of sterling will increase even before the virus hit, there were the price of imports and raise costs for UK pressing economic challenges which the supply chains. Sterling has already been Government was determined to address - running at relative lows for a number of many of which have, as is always the way years, but its weakness against the dollar of these things, been exacerbated by the is now being exacerbated by the flight to impact of the pandemic. the dollar as a reserve currency during the economic storm caused by the pandemic. There are also areas which formed an important part of the Government’s policy There is debate among economists about agenda beforehand, and will need to what will happen to inflation, but it is likely be given due weight when developing that price fluctuations will be highly sector- a renewed agenda for the post-COVID specific (we have already seen evidence future. These include the Government’s of big price rises for some medicines). commitment to achieving net-zero The Institute for Fiscal Studies has noted greenhouse gas emissions by 2050, that the pandemic poses huge difficulties which will require substantial investment for official statisticians trying to estimate on research, infrastructure and incentive changes in the actual cost of living, whose schemes. indices are vital for calculating things like pensions, pay negotiations and benefits.36 There is not space here to carry out a full analysis of these issues. But it is worth It may be that different pandemic-related noting a few of the most pressing, which forces will put both upward and downward cannot be ignored when thinking about pressure on prices, and roughly cancel our path to recovery and growth. each other out. Certainly most forecasters
35 Bank of England, ‘Monetary Policy Report: May 2020’, link 36 Richard Blundell, Rachel Griffith, Peter Levell and Martin O’Connell, ‘Could coronavirus infect the Consumer Price Index?’, link cps.org.uk 18 After the Virus Productivity Incomes for those in the lower deciles have been supported by the introduction of the UK output per hour has barely grown in National Living Wage and generous real the last 12 years. Almost all of the UK’s terms increases in its rate each year. But GDP growth since the recession has employers will not be able to shoulder this been through strong employment growth. rising cost forever – at some point, wage Excepting Italy, the UK has had by far the rises will need to be supported by a more worst performance on productivity growth productive economy. There is also a need of all the G7 countries since the financial to address the intergenerational inequalities crisis.37 that have bedevilled the economy, not least in terms of home ownership. We already faced a significant uphill struggle to turn this around. But Levelling up productivity growth is the only way we can deliver sustainable economic growth and As mentioned above, the Government is rising real wages in the long-term. This is, committed to revitalising the economies of and will remain, the key challenge facing the regions which have been left behind the UK economy for the coming years. over the course of the last few decades, through significant investment and pro- Low levels of business growth policies. Too often, decisions about investment the lives of people in Britain’s regions are made in London by people who live and Levels of private sector investment have work in London and think the rest of the been historically low in the UK relative to country is like London. We need to level other advanced economies, even before up our regions and give them more control the impact of uncertainty over Brexit since over the decisions which affect them. 2016.38 Some have rightly warned against the A post-Brexit bounce had been hoped for tendency towards ‘now more than ever-ism’ given the greater political and economic when responding to the crisis, with people certainty that Britain offered, but the virus using it as an opportunity to advance has brought whole new uncertainties to their pre-existing agendas.40 But as set the investment landscape. Low levels of out earlier in this chapter, London and the investment have also been identified as a South East really are disproportionately key factor in the UK’s productivity puzzle. well placed to cope with the economic Living standards impact of the pandemic. There will be a need to focus efforts particularly on those Real wages have taken a decade to regions which may have suffered the most recover from the financial crisis. According and ensure the gap between them is not to the Resolution Foundation, for some simply left to grow even wider. groups incomes may still be lower now than in the mid-2000s.39
37 ONS, ‘International comparisons of productivity’, link 38 Carl Emmerson, Christine Farquharson and Paul Johnson, ‘The IFS Green Budget: October 2018’, Figure 2.6, link 39 Adam Corlett, Stephen Clarke, Charlie McCurdy, Fahmida Rahman and Matthew Whittaker, ‘The Living Standards Audit 2019’, link 40 Giles Wilkes, ‘Bailout for businesses after coronavirus’, link cps.org.uk 19 After the Virus Fiscal pressures areas of government - although there is always room for the state to be more Inevitably, there are always a blizzard of efficient in how it operates. But there competing demands on public spending. is equally little room to increase taxes: For any Chancellor, it is a delicate the tax burden as a proportion of GDP balancing act to respond to them while has not historically gone much higher maintaining fiscal discipline and keeping than where it now stands, which is why within the fiscal rules. the Conservatives committed in their manifesto not to raise rates of income Health and social care spending are tax, VAT and National Insurance, as well under increasing strain due to an ageing as increasing the National Insurance population, and social care in particular threshold to reward ordinary workers (as is long overdue reform of its funding recommended by the Centre for Policy framework. An older population also Studies). Significant tax increases would means more spending on the welfare state not only be unpopular but would be self- through the state pension system and defeating and choke off any recovery. pensioner benefits. Spending on disability benefits has also been rising noticeably in Taken together, the issues outlined in this recent years. chapter show just how severe the damage inflicted by the coronavirus threatens to be After 10 years of fiscal retrenchment there - and how ambitious any recovery agenda is a general feeling that there is little room will need to be. for further cuts in spending from other
cps.org.uk 20 After the Virus Chapter 2: Principles for Recovery
The bulk of this report is government spending in response to the virus, he failed to consider the objective devoted to making specific of the spending and its economic context. suggestions for recovery. In truth, our rapidly accumulating debt is swiftly turning into the best argument But just as we had to first establish against the long-term increases in spending the most pressing problems for the he himself proposed at the last election. Government to address, we also wanted to suggest some high-level principles that Meanwhile, the crisis has also been seized should inform that policy agenda. After on by protectionists, who have cited all, there is no point in setting out a list of the pandemic as proof that our global economic building blocks without having supply chains are overstretched and an idea of the kind of economy you want too interdependent. Their solution is to to use them to build. scale down our dependency on overseas production and manufacture more of what This task is all the more important we consume here. because the COVID-19 crisis has thrown so much up in the air. As the These concerns are not entirely without Government mounts market interventions merit. If the UK becomes overly reliant of unprecedented scope and scale, our on imports for key products, we leave approach to the economy has rarely ourselves vulnerable to supply-side looked more open to challenge. For shocks. Equally, if we become overly example, some have argued that if we dependent on one country’s exports, we are willing to borrow hundreds of billions grant them geopolitical leverage. But at to fight a virus, we should be prepared the same time, Britain’s prosperity has to do the same to tackle climate change. been built on an open economy. Similarly, they say, if it is good for The absence of off-the-shelf solutions government to pay people’s wages now, to the problems we face means that the why not in any future downturn? Treasury will have to design a recovery It is therefore worth restating some plan from first principles. And those fundamentals. A significant number principles should be straightforward, of commentators are leveraging the even if the task at hand is not: maximise crisis to call for a permanently larger growth, support businesses and role for the state. But their arguments employment, and create new jobs at are often predicated on a misreading speed to replace those that are lost. of the Treasury’s actions, as well as the That can best be done by embracing economic crisis itself. certain core values, which we believe will When Jeremy Corbyn claimed that he underpin the strongest possible recovery, has been proved ‘right’ by increased both on a short and long term basis.
cps.org.uk 21 After the Virus Support free enterprise leaving them in place would only serve to frustrate economic growth. Overwhelmingly, scrutiny of the UK’s response to the pandemic has focussed Supporting free enterprise also means on the performance of government. reconsidering our approach to regulation. Whilst this is appropriate, we should also Indeed, not every post-pandemic measure recognise the contribution of business to was introduced with the intention of our country’s fight against COVID-19. putting the economy into hibernation. The Government actually demonstrated Over the past four months, private commendable flexibility to ensure that businesses have demonstrated their businesses, wherever possible, could ability to innovate and adapt, responding continue operating within the COVID-19 at pace to the request for ventilators regulations. and hand sanitiser and providing vital services for vulnerable citizens such as Removing red tape in order to allow pubs the home delivery of groceries. Their and restaurants to operate as takeaways successes have showcased the value of during the outbreak will have saved jobs free enterprise as a force for social good. and businesses. There is no reason why The actions of business saved lives, and relaxations such as these should not be significantly augmented our response to a retained on a permanent basis. crisis situation. Small and family firms are among the most Yet beyond its contribution to our initial vulnerable to the economic downturn, response, the true value of private business and historically have been the least able will be as the engine that drives our to deal even with existing levels of red economic recovery. The pandemic will tape. With a view to accelerating growth permanently alter some elements of our during our recovery, the Government economic landscape, but one principle should seek to relax regulations acting as that must survive unchanged is that a free a break on their activity and lessen their enterprise economy is the most effective administrative burden to allow them to way of generating wealth, creating jobs and focus on getting back to their feet. funding the public services we all rely on. This applies to COVID-19 regulations as It is therefore essential that well as existing requirements. The British unprecedented state intervention into public have demonstrated good sense the market is temporary. We must resist when keeping themselves and their calls for a continuation in peacetime communities safe throughout this crisis. of unaffordable - and often actively They can be trusted to continue doing counterproductive - measures, especially so. The restrictions we put in place for from those who believe that the pandemic businesses should be flexible so as to is an argument for a generally greater role allow business owners to use their own for the state. common sense, with clear minimum standards that must not be breached. There will come a time when the interventions that have supported our Keep Britain open economy through this crisis become the best way of ensuring we never recover. Protectionists have cited the pandemic as The majority of the measures implemented proof of a trade-off between globalisation by the Treasury were designed to keep and national resilience. They argued that the economy in stasis. It follows that our vulnerability was an unavoidable by-
cps.org.uk 22 After the Virus product of extensive trade routes and trade. As we become an independent economic links. trading nation once more, it is in all of our interests to take up the mantle as its Concerns about the resilience of our greatest champion once more, and set supply chains are understandable. about breaking down economic barriers However, as the crisis developed, with the rest of the world. it became increasingly clear how indispensable free and open trade is for But being open, and benefiting from everything from sourcing PPE to putting openness, is not just about trade. While food on the table. acknowledging legitimate public concerns about low-skilled immigration, and our When it comes to shared challenges, inability while European Union members globalisation is less the problem than to control our own borders, it is vital that it is the solution. Where goods and we ensure that Britain can attract the services are able to cross borders, entrepreneurs and wealth-creators of the so are knowledge and resources. future. International cooperation will be key to finding a vaccine and ensuring it is It is also about openness to outside swiftly distributed. Until that point, working capital. Last year, the UK outperformed with our partners will be essential for expectations to become the number reopening our economies and keeping one destination in Europe for inward them afloat. investment. The advantages that we enjoyed because of this - including Similarly, once the pandemic is over, we the creation of jobs, higher wages and will need to identify those strategically heightened competition - will only become critical weak points in our supply chains more crucial in the post-COVID economy. that need greater resilience. Yet it would be a huge mistake to reheat the old and As it orchestrates our recovery, the disastrous autarky agenda. Protectionism government must consider each of its has almost always proved short-sighted. interventions to ensure that none of the As Ronald Reagan said in 1985, it policies it introduces make our country ‘destroys jobs, weakens our industries, less attractive to overseas investors. The harms exports, costs billions of dollars exceptions to this should be on grounds to consumers, and damages our overall of national security and public health economy’.41 resilience. Where possible, we should seek out opportunities to signal our Free trade has been a significant driving openness to capital from overseas. force behind our economic growth over the past few decades. If recovering Champion sound money countries want to rapidly expand their economy at home, one of the places they and low taxes must look is overseas. Once the crisis In locking down the country, the state has passed, global supply chains will play has accepted a duty of care for an a critical role in an export-led recovery, immobilised economy and the livelihoods cutting costs, improving efficiency and that depend on it. Discharging this duty creating more high-value jobs at home. has required the Chancellor to deploy the most significant fiscal firepower since The United Kingdom has a proud heritage the Second World War with speed and as a global advocate for free and fair
41 Lou Cannon, Washington Post, 1985, link cps.org.uk 23 After the Virus scale. These interventions haven’t so at a significant advantage as we seek much steadied the economy as put it to mitigate the economic fallout of the into a medically induced coma. An elixir pandemic - just as it did in the wake of of job retention schemes, tax cuts and the 2008 crisis. Unlike the US, however, we government-backed loans has staved off do not have a reserve currency, meaning the demise of businesses up and down that we do not possess as much fiscal the country. flexibility to run a large cumulative deficit. Policymakers must ensure the credibility As mentioned above, this has come at of the pound. substantial cost. Politically, the easy option would be to accept a permanent increase First and foremost, that means maintaining in public sector borrowing for the rest of a stable monetary environment. In this parliament. Indeed, many on the Left particular, it would be deeply unwise for have chosen to frame the Government’s the Government to try and inflate its way fiscal response to the crisis not just out of an enlarged deficit. as vindication of a decade of calls for It also means being careful to maintain the increased spending, but a case study for credibility of our institutions, including the how it could be done. Bank of England and the Office for Budget In fact, the reverse is true. The only reason Responsibility. Similarly, confidence in our we have the fiscal flexibility to respond to currency is predicated on a strong and a crisis of this magnitude is because over respected finance ministry. It is essential the past decade consecutive Chancellors that the Treasury continues to be seen have made the decision to put the public as a check and a balance to Whitehall’s finances first, keep spending under desire to spend. control and balance the books. The fiscal Finally, much of the speculation about our rules set out in the Conservative manifesto post-crisis fiscal policy has focused on were written not only to preserve Britain’s taxation. One commonly cited argument readiness to respond to an economic contends that after a decade of austerity, shock, but with a break clause in balancing day to day spending will require anticipation of one. significant increases in tax, though there As we do not know when the next is little consensus on where the burden crisis may come, allowing debt to rise should fall. indefinitely is neither responsible nor Yet going into this crisis, the tax burden sustainable. Furthermore, burdening future as a percentage of GDP was already at generations with unserviceable levels of a 50-year high. While the Government debt would represent a failure to fulfil our has endeavoured to reduce the direct responsibilities. taxes levied on the poorest in our society, When we emerge from the downturn, research from the TaxPayers’ Alliance we must begin the process of bringing has shown that the burden still falls borrowing back under control. That means disproportionately on those who can least once more attempting to balance day to afford it.42 This is not a firm foundation for day spending, and close the deficit in a economic recovery. reasonable period of time. Yes, the Treasury will need to maximise In terms of monetary policy, having revenue - especially if it is to avoid control of our own currency has put us borrowing running out of control. But it
42 TPA, ‘The tax burden on households 2019’, link cps.org.uk 24 After the Virus must be especially careful not to pursue need to restore pre-crisis employment tax increases that weaken the businesses levels, this means that all elements of our that will drive our recovery. Trying to restore policy package must aggressively pursue the health of the Government’s accounts growth, powered by Britain’s businesses. by clawing back money from Britain’s SMEs Taxation is no exception. That is the only would take a scythe to any green shoots way to escape from the trap of higher and stymie economic growth. spending, higher borrowing and higher taxes. If we want to adequately fund our public services, first we must rebuild a In the following chapters, we will spell out sustainable tax base. Taken alongside the what that might mean in practice.
cps.org.uk 25 After the Virus Chapter 3: Tax, Spending and Borrowing
Our Recommendations
Reforming the fiscal rules Balance the current budget within three years of the economy returning to normality. The deficit should fall year on year. Once the current budget is balanced, the debt-to-GDP ratio should fall year on year. Postpone the planned Comprehensive Spending Review until 2021.
Tax and spending To avoid permanently higher borrowing, as many of the emergency spending measures as possible should be discontinued after April 2021. Consider replacing the emergency Universal Credit payment increases with a cut to the taper rate, so that in-work claimants keep more of their earnings. Take a fresh look at what sensible savings can be made from existing commitments, especially the running of government itself. Commission a system-wide review of the UK tax system, with a general shift away from taxing incomes and profits towards fairer, more progressive taxation of property and tightening reliefs which favour the wealthy. Avoid raising headline rates of income tax, VAT or National Insurance. A full council tax revaluation over this parliament, with revaluations every three years, and reforms to bands and rates. Consider switching from pension tax relief based on marginal rates to a flat rate bonus paid regardless of your tax code.
Financing the debt Maintain the target for interest spending as a proportion of receipts to not exceed 6 per cent, but suspend it this year to account for the temporary drop in receipts. Seek to further reduce the use of index-linked gilts. Increase average gilt maturities to lock in low rates and minimise refinancing risk, and continue to move towards super long-dated debt. Conclude the consultation on RPI as soon as possible and ensure the indexation of gilts is based on a fair reflection of UK inflation.
cps.org.uk 26 After the Virus Introduction it was going to be, then to some extent we will have to cut our coat according to Decisions on public spending are among our cloth - but not at the cost of stifling the most important a Government will the economic recovery via tax rises and take. spending cuts. David Cameron’s years in office were Reforming the fiscal rules largely defined by the hard decisions that he and George Osborne were forced Some have questioned the need for an to make to get the deficit under control administration to impose specific rules - which themselves were a response to on itself when it comes to borrowing and Gordon Brown’s failure to fix the fiscal spending, especially at a time like this. roof. Others have suggested the pandemic has ushered in a ‘new normal’ of consistently The rules established by the Johnson higher borrowing and turning a blind eye Government were designed to keep to debt levels. After all, if debt is soon taxes down, support the public services, set to be larger than the economy itself, and limit borrowing while making space what’s a few billion here and there? for a revolution in infrastructure - taking advantage of rock-bottom interest rates to But fiscal rules are vital, because they invest in increasing Britain’s productivity go to the heart of fiscal credibility. The and levelling up its economy. Resolution Foundation, hardly a bastion of right-wing fiscal hawks, said recently that At the same time, they acknowledged ‘While some have been quick to claim that that these rules could not apply in all the coronavirus outbreak has sounded circumstances - extraordinary times the death knell of fiscal rules, it actually require extraordinary measures. makes having a set of long-term fiscal Rishi Sunak duly announced at the objectives all the more important.’43 The March Budget that the Treasury would Institute for Government have stated that review the fiscal framework in light of ‘well-designed fiscal rules can provide prevailing macroeconomic circumstances. an important signal of the Government’s This section will set out how our fiscal plans and are a key part of responsible rules, and approach to fiscal policy, fiscal management’.44 could evolve to cope with the challenges At the most basic level, they are useful in of coronavirus, balancing fiscal the same way that you might set yourself responsibility with the need to support a target to go to the gym twice a week or the recovery. give up chocolate for Lent. Targets serve To that end, the Government’s first priority as a way to measure success and, when must be to get the economy moving again they are public, they are a way to be held and recover lost ground. The Chancellor to account. will have some incredibly difficult But they matter in other ways, too. We rely judgment calls to make. However, he on investors to buy our debts, and they are should be guided by the overriding need reassured if they see the Government is to prioritise growth. If the economy ends holding itself to a high standard of fiscal up permanently smaller than we thought
43 Richard Hughes, Jack Leslie, Charlie McCurdy, Cara Pacitti, James Smith and Daniel Tomlinson, ‘Doing more of what it takes’, p58, link 44 Thomas Pope, ‘Fiscal rules must not follow the chancellor out the door’, link cps.org.uk 27 After the Virus discipline. Performance against the fiscal budget deficit. The broad principle is that targets is assessed at regular intervals the Government, and the country, should by a respected independent body, the not be spending more than it earns, save OBR, ensuring a transparent and honest for productive investment in long-term account of the state of the finances. infrastructure.
And in terms of discussions and decisions But such a target relies on knowing where within Government, the need to keep you are in the business cycle - which the within the fiscal rules is a vital tool in pandemic has effectively scrambled. Nor explaining why the money they want is not would we want to choke off the recovery, available. for example by retrenching in the teeth of a recession. Fiscal rules, in other words, guard against those short-term temptations in the long- Our suggestion, then, would be that the term interests of taxpayers. Government should aim to balance the current budget within three years of the In their general election manifesto, the economy returning to normality. This Conservatives set out a clear fiscal should be calculated with reference not just framework: to the level of real GDP per capita getting • The current budget should be in balance back to the level seen before the crisis, by the third year of the forecast period. but growth rate being judged by the OBR to be sufficiently stable to accommodate • Spending on debt interest as a the withdrawal of support. The Chancellor proportion of revenue should not exceed should still ensure that the deficit falls 6 per cent. year on year until the current budget is balanced. • Public sector net investment should not average more than 3 per cent of GDP This would mean that if the recovery per year across the five-year forecast takes longer than the OBR and Bank of (see next chapter: ‘Infrastructure and England scenarios currently assume, then Investment’). the Government is not forced to either damage the fragile recovery through These were sensible rules and, because premature fiscal consolidation or lose they are rolling targets, they allowed credibility by abandoning its rules - while flexibility to respond to unexpected still moving in the right direction in terms changes in circumstances. However, of borrowing. this crisis is unprecedented. Sticking rigidly to the framework would not make After the deep recession of 2008-9, real sense. Those rules were designed as a GDP per capita took until 2014 to exceed responsible plan for the public finances 2008 levels.45 If this crisis ends up being in normal times – we are no longer in as damaging and long-lasting as that, normal times, nor will we be for some such a rule would give the Chancellor time. scope to respond.
For example, one cornerstone of This might sound at odds with the Conservative economic policy, and approach taken by the Conservatives in economic thinking, has been to target government after 2010, but the measure the structural (i.e. cyclically adjusted) being targeted in 2010 was actually the
45 OBR, ‘Economic and Fiscal Outlook, March 2020’, Supplementary Economy Table 1.5, link cps.org.uk 28 After the Virus cyclically adjusted current budget deficit, trend. The approach was gradual, and the meaning the intention was to target only current budget was not actually brought structural borrowing which would have been into balance until a few years after per there even if the economy was growing at capita output had recovered, as can be seen from the chart below. Path of borrowing (left axis) and GDP (right axis) after 2008
Source: OBR Databank, Aggregates (per cent of GDP), link; OBR Economic and Fiscal Outlook, Supplementary Economy Table 1.5, March 2020, link
Note that this is about eliminating the deficit the risk that we eventually hit a spike in on day-to-day spending. As long as our financing costs. The corollary of the rule costs of borrowing remain manageable, it set out above is that once the recovery is is reasonable for the Government to borrow secure, public sector net debt would start to fund investments in infrastructure which to fall year on year. This strikes a balance will provide a return. The same basic laws between allowing us to borrow while we of finance that applied before the virus will nurture the economy back to health while apply after it. If we can return to growth and ensuring debt does not rise indefinitely. balance the current budget, we can deliver A balanced current budget should be a gradual fall in debt relative to output while sufficient to deliver this target if we have also borrowing to invest in future growth. moderate growth and capital spending is We discuss this in more depth in the next not excessive. chapter. Just as the fiscal rules should At the same time, we must not allow debt accommodate the current uncertainty, to spiral out of control. As set out below, a so should our spending plans. We larger debt burden increases our exposure therefore suggest that the Chancellor to rising debt interest - and the longer we postpones the planned Comprehensive maintain a high level of debt the greater Spending Review until 2021, when he will
cps.org.uk 29 After the Virus have a better idea of how the coronavirus In those areas where it is politically has affected the public finances and impractical to unwind additional spending, economy. Instead, he should conduct a we must ensure that it is targeted as one-year spending round (as happened effectively as possible. For example, on in 2019). welfare, the Government should explore the idea of shifting that extra support from Tax and spending a flat increase to benefits to improving work incentives within Universal Credit. While the OBR has said that borrowing This would reflect the need to shift the could return to pre-virus levels relatively policy response from supporting incomes quickly, that does not factor in the lasting during the lockdown to encouraging impact of scarring on the economy, nor economic activity for the recovery. can the OBR take account of the likely This could take the form of a cut to the political situation. taper rate, so that in-work claimants Besides the impact of lower GDP, the keep more of every extra pound they public finances could remain in a much earn – effectively a tax cut for the lowest paid. worse state than the official forecasts suggest because the OBR ‘reference In terms of public spending more broadly, scenario’ is founded on an assumption polls suggest that the country is not ready that all of the policy response will be for a repeat of the austerity measures temporary. In their scenario, ‘the rise in we saw during the David Cameron era - the deficit is only temporary’ and this necessary though they were. However, ‘contrasts with the financial crisis, after voters have also decisively rejected the which a large structural deficit persisted Labour Party’s approach, which calls for and debt continued to rise as a share of significantly higher public spending on GDP’.46 the basis that it will be an investment in economic growth. The reality is there will be huge political pressure for some of the measures to be Spending in and of itself does not retained. It would require tough decisions provide a sustainable boost to our growth and political resolve to roll back some of potential. Too often the calls from the the major spending changes. left for ‘investment’ have been calls for increases in day-to-day spending For example, the £20 per week increase on things like abolishing tuition fees, in the Universal Credit standard allowance increasing benefits, public sector wages was a desirable temporary measure and services in general. More spending on because the need to incentivise earning some of these things may sometimes be a a wage relative to claiming benefits is very good thing, but it is disingenuous to irrelevant during this crisis. But when say it will ‘pay for itself’. things go back to normal, it will be hard to return that amount to its original total. To avoid permanently higher borrowing, The increased generosity in welfare alone as many of the emergency spending has added £8 billion to expenditure, and measures as possible should be if unemployment remains stubbornly high discontinued after April 2021. The for some years the cost of making these Government should be clear that such changes permanent would be even higher. measures are temporary.
46 OBR, ‘Coronavirus analysis’, p13, link cps.org.uk 30 After the Virus We should also take a fresh look at really matters is not raising a few extra billion what sensible savings can be made in the next couple of years but the long-term from existing commitments, especially revenue potential of our tax structure. the running of government itself. For example, there has long been talk of The Government should commission a merging some government departments, system-wide review of the UK tax system. in addition to the recent combination of This should be done with a view to DfID and the FCO. The Centre for Policy delivering a moderate increase in revenue over the medium-term through improved Studies has also highlighted the savings incentives and higher growth. There should if non-unitary local authority areas across be a general shift away from taxing incomes England adopted a unitary model, which and profits towards fairer, more progressive government could incentivise. The reforms taxation of property and tightening tax to childcare proposed later in this report, reliefs which unduly favour the wealthy.47 while primarily targeted at reducing the cost of living and encouraging parents The Government should avoid raising to return to work, could also rein in the headline rates of income tax, VAT or Government’s multi-billion-pound childcare National Insurance - indeed, we point bill. The CPS has also long been critical of out later that temporary cuts in VAT the ‘triple lock’ on pensions, although we and Employer’s National Insurance are recognise that this is a politically sensitive extremely good candidates for stimulus area and the Government will be reluctant spending, as are reforms to our business to set aside its manifesto commitments. investment regime. If increases in headline rates of those three taxes are judged In terms of taxation, reports are already necessary over the long term, they should widespread that the Treasury are not take effect within this Parliament. considering additional revenue raising measures for next year to try to close The tax review should also look at cutting the gap in the finances. We believe that, distortionary taxes such as Stamp Duty wherever possible, the state should Land Tax for primary residences - the minimise the amount it is taking out of Centre for Policy Studies has done work people’s hard-earned pay-packets. on the galvanising effect this would have on the housing market, for a surprisingly low In particular, the Conservative election cost. manifesto pledged not to raise headline rates of income tax, National Insurance Ultimately, the only way to square the fiscal and VAT. This promise will come under circle is to drive up growth - generating the intense pressure - not least as there will be tax revenue to pay for public services while pressure on Government to look at simple keeping taxes low. Tax rises should always solutions to raise revenue. There will also be a last resort. But if the Government be some who call for increased taxes on does need to raise revenue, there are two business - even though it is the private areas where it could do so while ironing sector that will drive any recovery. out existing injustices - and, indeed, where it would be sensible to act even if the The best approach, we suggest, is for results were revenue-neutral. the Government to consider how we can reform the tax system to improve incentives, The first is council tax. The current system minimise distortions and also raise more is highly regressive, not least because it is revenue without increasing tax rates. What
47 A good place to start would be the principles set out in the seminal Mirrlees Review (though we would not necessarily endorse every one of its recommendations). See: James Mirrlees, Stuart Adam, Tim Besley, Richard Blundell, Stephen Bond, Robert Chote, Malcolm Gammie, Paul Johnson, Gareth Myles and James M. Poterba, ‘Tax by design’, link cps.org.uk 31 After the Virus based on property values nearly 30 years taxpayer’s marginal rate of tax, to account ago. The result is that when a newly built for the fact that tax will be due when property is valued for council tax, a bizarre income is drawn in retirement. But the cost process takes place in which an estimate of the relief far outweighs the tax paid by has to be made of the value the property retirees on pension payouts. Even after would have had on April 1, 1991. taxes paid in retirement are netted off, the cost of the various reliefs currently available This means the system undercharges comes to a huge £35 billion a year.50 wealthy homeowners in London and the South-East, who have seen the value of Using marginal rates to calculate relief their homes soar relative to the rest of the also means the vast majority of this money country in recent decades, at the expense only benefits higher earners, while low of those in the North and Midlands. In fact, earners who pay no tax get no benefit. the average council tax bill in London is The last time a breakdown by income was roughly the same as in the West Midlands, released, it showed nearly 60 per cent despite Londoners having higher average of relief being paid to the richest income incomes and much greater housing decile alone and 75 per cent to the top wealth.48 This is not the only discriminatory quintile, while only 8 per cent goes to the consequence: council tax bills for the entire poorer half of the population.51 lowest income decile are almost 10 per We suggest switching from pension tax cent of average household income, or relief based on marginal rates to a flat around 4 per cent on average once council rate bonus paid on contributions up to a tax support is factored in, compared to generous annual allowance, regardless less than 2 per cent for the richest decile.49 of your tax code. This would significantly The Government should consider carrying increase the incentive to save for low out a full council tax revaluation over this earners and the self-employed while also parliament, with revaluations every three potentially bringing substantial savings years, and reform bands and rates to for the Exchequer. Previous CPS research make council tax bills more proportional has suggested combining such a flat-rate to today’s property values. savings bonus with a broader shift to an ISA-style pension system, which we urge Reform of how pension contributions are the Government to consider. taxed is another example of low-hanging fruit. The Centre for Policy Studies has Financing the debt argued in favour of comprehensive reforms to encourage saving, but Governments As part of its fiscal rules, the Government have consistently baulked at the prospect included a ceiling on debt interest of meaningful reform and instead sought spending. This was about recognising that to make savings through tweaks to the when we have been targeting falling debt existing system, which has ultimately created levels in the past, it was on the basis that controversial distortions such as the effect of high debt is unsustainable if the costs of annual allowance changes on doctors. servicing it become excessive.
The principle behind the current system The good news is that so far, the gilt is that relief on contributions is paid at a market has held up relatively well and
48 Stuart Adam, Louis Hodge, David Phillips and Xiaowei Xu, ‘Revaluation and reform: bringing council tax in England into the 21st century’, Figure 2.2, link 49 Stuart Adam, Louis Hodge, David Phillips and Xiaowei Xu, ‘Revaluation and reform: bringing council tax in England into the 21st century’, Figure 2.7, link 50 HM Revenue and Customs, ‘Registered pension schemes costs of tax relief’, link 51 Pensions Policy Institute, ‘Pension facts: private pensions’, Table 29, link cps.org.uk 32 After the Virus the Treasury has been able to issue very In fact, despite the jump in debt this year substantial amounts of new debt without due to increased borrowing, the OBR investors demanding a premium. Yields are expects spending on debt interest will very low, partly due to the side effects of actually be lower than it forecast before the Bank of England’s latest quantitative the pandemic, as shown in the chart below. easing programme and rate reduction, and partly due to the search for security at a time of great uncertainty and low yields across most asset classes.
Public sector net debt and interest payments before and after the impact of Covid-19, 2020-21
Source: OBR, Coronavirus Reference Scenario, Charts and Tables, Tables 1.5 and 1.8, April 2020 link. Debt interest is given net of the Asset Purchase Facility.
However, there will be a limit to this. The borrow at real interest rates which are Treasury has already found it necessary to comfortably negative, most of the wider request an extension of the Ways and Means causes of that phenomenon are not Facility, meaning that the Bank of England desirable over the long-term. has been directly providing it with cash so As the OBR itself has pointed out, a that gilt issuance can be spread across a significant increase in the stock of public longer timeframe. Some people have already debt also increases the potential volatility talked of allowing this to evolve into direct of the public finances.52 More debt means monetary financing, with the Bank creating that spending on debt servicing, and by new money to fund fiscal policy. As we argue extension the overall budget deficit, is in the final chapter of this report, that would more exposed to changes in interest rates be completely irresponsible – we cannot and inflation (due to the link between print our way out of this crisis. gilts and RPI). Small fluctuations in these And while it is fortunate in the present variables will make a substantial difference circumstances that the Government can to spending.
52 OBR, ‘Coronavirus analysis’, p20, link cps.org.uk 33 After the Virus Direct impact on spending if different variables were 1 percentage point higher across the forecast
Source: OBR, Fiscal Risks Report, July 2019, spending ready reckoners, link
As an illustration of the level of exposure not lose out because we are having to the public finances already had to spend tens of billions every year in debt variations in debt servicing costs, in interest. Indeed, one of the reasons the December 2014 the OBR forecast that finances remained in good shape at in 2019-20 interest spending would be the March Budget was that a £7.4 billion around £60 billion, but due to consistent upwards revision in the OBR’s spending falls in interest rates this figure ended up expectations was fully offset by a £7.4 coming in around £25 billion lower at just billion downwards revision in interest £35.8 billion.53 In other words, the deficit spending – the less we spend on interest, could have been 50 per cent higher last the more we can spend elsewhere, or year if not for the fall in interest rates. What return to the public via tax cuts.54 goes down can go up again just as easily, This is more important to remember than and with a much bigger debt pile after the ever now that we have little choice but to pandemic the risk posed by a sudden rise accept a rising debt-to-GDP ratio in the in interest spending will be acute. short-term. The graph below shows that, More importantly, every pound we have to despite rising debt, interest spending as spend on servicing our debts is a pound a proportion of receipts has been falling in the pocket of a bondholder instead consistently and is comfortably below the of a pound to spend on our schools and 6 per cent ceiling set last year. hospitals. Our public services should
53 Carl Emmerson and Isabel Stockton, ‘For sale: £45 billion of gilts’, link; OBR, ‘Data: Public finances databank’, link 54 OBR, ‘Economic and Fiscal Outlook, March 2020’, Section 1.28, link cps.org.uk 34 After the Virus Spending on debt interest, 1976-2025
Source: OBR, Economic and Fiscal Outlook, March 2020, Charts and Tables: Chapter 4, link. Figures post-2019-20 are forecasts.
While the debt will be significantly higher is likely to occur due to Covid-19, we than when that rule was set, the cost of recommend that the Government seeks borrowing has also fallen as set out above. to further reduce its reliance on index- The Government should therefore maintain linked gilts. the target for interest spending as a We can also use longer debt maturity proportion of receipts to not exceed 6 per to lock in record low rates and reduce cent, but this should be suspended for the exposure to refinancing risk. We are lucky current financial year to account for the that the UK already has comfortably the necessity of a temporary drop in receipts. longest dated government debt in the The proportion of our debt which is OECD on average, and the DMO has been inflation index-linked is high by international steadily lengthening maturities in recent standards and has doubled since 2005 from years.56 There is a well-established market 14 per cent to 28 per cent.55 The Treasury for long-dated UK gilts which we can take has recently become aware of its increased advantage of. The Treasury should ask exposure to price level fluctuation and asked the DMO to further increase average the Debt Management Office (DMO) to look gilt maturities to lock in low rates and at reducing the amount of index-linked debt minimise refinancing risk, and continue being issued. In light of the substantial to move towards super long-dated debt increase in public sector net debt which issuance such as ‘century bonds’.
55 HM Treasury, ‘Debt management report 2020-21’, link 56 OECD, ‘Sovereign Borrowing Outlook for OECD Countries 2020’, link cps.org.uk 35 After the Virus Furthermore, there is an ongoing same time, some have made the case consultation on the future of the Retail that since the RPI appears to systemically Price Index (RPI). It is widely recognised overestimate inflation, the use of RPI for that RPI in its current form is not an index-linked gilts may mean the Exchequer appropriate measure of changes in UK is overpaying. The OBR estimated last retail prices, but the use of RPI is also year that correcting the RPI methodology embedded in many areas of our economy. would reduce interest spending by £4.4 The Government recently announced a billion annually after a few years.58 Since consultation on proposals from the UK the exposure of the public finances to Statistics Authority to reform the RPI.57 inflation levels will be increased by rising This consultation has now been delayed debt, the Treasury should seek to conclude due to the pandemic. The longer this the consultation on RPI as soon as possible process is drawn out, the longer there and ensure the indexation of gilts is based will be uncertainty for gilt investors. At the on a fair reflection of UK inflation.
57 UK Statistics Authority, ‘UK Statistics Authority Statement on the future of the RPI’, link 58 OBR, ‘Fiscal risks report: July 2019’, Box 7.1, link cps.org.uk 36 After the Virus Chapter 4: Infrastructure and Investment
Our Recommendations
Exploiting cheap borrowing Protect investment in cash terms by basing investment rules on pre-pandemic GDP forecasts. Look to increase planned investment, temporarily relaxing the 3 per cent average investment ceiling.
Improving public investment Ask the National Infrastructure Commission (NIC) to urgently evaluate which projects could be commenced quickly to boost GDP and employment during the recovery. Local Project Facilitation Funds should be made available to local authorities through a bidding process. Revise the Treasury ‘Green Book’ to specifically prioritise ‘levelling up’. Beef-up the NIC into a cross-government coordinating body, established on a statutory basis. Ask the strengthened NIC to review the UK’s complex system of infrastructure responsibilities to improve strategic coordination. Establish a British Infrastructure Bank, based outside London, with seed capital to fund infrastructure and leverage private capital. A ‘Future Growth Fund’, with a specific remit for strategic investment in growth sectors.
Levelling up Change road improvement plans to bring spending forward to 2020. Set out a fully funded path full fibre and gigabit-capable networks in every part of the country by 2025. Target increased R&D spending on new opportunities outside the South East.
cps.org.uk 37 After the Virus Pushing forward devolution A renewed agenda for English devolution with the promised White Paper published as soon as possible this year. Devolve more powers to unitary authorities and extend the reach and coverage of devolved mayoralties and combined authorities. Integrate the roles of new devolved bodies with both the new British Infrastructure Bank and newly strengthened National Infrastructure Commission. Provide dedicated funding for combined authorities to expand their capacity to assess potential investments, present business cases, and deliver projects. Extend the borrowing powers of combined authorities and allow them to use ‘tax increment financing’. ‘Earn back’ arrangements should become the norm in all city deals.
Reforming planning Planning rules should focus on minimum housing supply, broad land uses, basic design codes, and guidance on significant alterations to existing properties. Review permitted development rights to allow more work to be carried out without going through the planning process. Covid-related adaptations to increase capacity for social distancing should be fast- tracked for planning permission, with a specific grant made available. Encourage a new generation of development corporations and give them the powers of a local planning authority. Establish more new towns and garden cities. Fast-track reclassification of green belt where it is both necessary and popular.
cps.org.uk 38 After the Virus Introduction The benefits of such a programme of public investment are twofold. There is One of the real difficulties in deciding on an immediate economic benefit from spending priorities is that the areas where the investment spending itself and the there is most political pressure to increase associated multiplier effect, and then spending rarely overlap neatly with the there is the long-term benefit of the things which will boost growth. These assets, such as improved connectivity competing priorities have sometimes from road and rail investments. led governments to neglect long-term investments. With the urgent need to recover from the economic shock of the pandemic, the When the Conservatives came into case for such spending has strengthened. government in 2010, for example, they failed to reverse the sharp reductions in capital Exploiting cheap borrowing spending pencilled in by Labour. That allowed them to protect public services - As we set out in the previous section, the but in the long term, the best and only way cost of borrowing for the Government was to pay for increased spending on those already incredibly low before the crisis, services is through a growing economy. and is now even lower. Investor demand for a secure long-term asset class has meant The Johnson Government switched tack, the UK can borrow at real interest rates taking advantage of the low cost of capital well below zero. Some recent academic to fund infrastructure investments. It work has theorised that this could be a argued that these boosted connectivity long-term trend.59 and productivity, thereby driving up growth in the long run, as well as spreading it more evenly across the country.
Source: DMO, Debt management report 2020-21, link
59 Bank of England, ‘Eight centuries of global real interest rates, R-G, and the supra-secular decline, 1311–2018’, link
cps.org.uk 39 After the Virus Even relatively recently, negative real rates Before the crisis, the Government put were such an unexpected concept that in place a fiscal rule that allowed it to the Treasury models for assessing returns substantially increase public investment to capital did not even take account of while limiting it to no more than 3 per them as a possibility. Yet now, investors cent of GDP on average over the forecast are effectively paying for the privilege of horizon, in order to ensure the UK could lending to us. get debt stable or falling slightly while still borrowing to invest.
Public sector net investment, 1976-2025
Source: OBR Databank, aggregates (per cent of GDP), link
With the current crisis, we have accepted There is a strong case, indeed, that the that debt will have to rise in the short-term Government should not only maintain but to allow fiscal policy to nurse the economy increase its planned investment in the through the downturn and back to health. light of the coronavirus crisis, particularly At the same time, the Government can where there is a solid case that doing now benefit from an even lower cost so will drive long-term growth. The 3 per of borrowing than before. But if GDP is cent average investment ceiling should expected to be substantially lower than therefore be relaxed temporarily, to allow forecast in March, the logic of the current the Government to fund additional projects rules would imply investment spending that can support jobs and growth during should be cut. This is clearly wrong. The the recovery and represent value for money. Government should therefore protect its They can do this without jeopardising our capital budget in cash terms by basing long-term financial health as the historically the calculation of its investment rules on low cost of borrowing means that interest the OBR’s pre-pandemic GDP forecasts in spending is comfortably below the 6 per March. cent ceiling, and likely to remain so.
cps.org.uk 40 After the Virus We do not want to pretend that increasing We sincerely hope that the Government infrastructure spending is as simple as has already commissioned the National increasing a number on a spreadsheet. In Infrastructure Commission to assess which March, when factoring in the increases in projects are the most ‘shovel-ready’. If not, capital spending already announced, the it should ask the NIC to urgently evaluate OBR stated that they assume 20 per cent which projects could be commenced of the money allocated would end up going quickly, taking into account the potential unspent, which reflects the difficulty previous benefits on GDP and employment during governments have had with ramping up the recovery. This should be used to capital spending over a short timeframe.60 inform the National Infrastructure Strategy In the wake of the coronavirus, we need to due to be published later in the year, to bring forward shovel-ready projects - but we ensure the Strategy takes account of the also have to look at the fundamentals of how changed economic circumstances and decisions will be made and how we get the the need to support recovery. biggest bang for our buck. To facilitate this work on the ground, Improving public investment local leadership should be involved in identifying valuable projects. Local This new infrastructure programme should authorities and LEPs have already, have at its heart three key objectives: reportedly, been asked to identify shovel- ready projects in their area which could be • To support the immediate need for off the ground this year. We recommend economic recovery and a return to the Government puts additional funding growth. into dedicated Local Project Facilitation • To increase the UK’s long-term growth Funds, which would be made available potential through productivity gains. to local authorities and local enterprise partnerships through a bidding process • To level up areas with relatively low either via central government or levels of well-paid employment and combined authorities. The process used productivity. to implement the Housing Infrastructure Public investment can play a major role Fund would be a good template. not just in boosting productivity in the The Treasury has already begun work on long-term but in supporting economic reforming the ‘Green Book’ - the way in activity and employment as we steer a which it conducts cost-benefit analyses course out of the coronavirus crisis. Capital and signs off on infrastructure decisions. expenditure has a higher multiplier effect This currently tends to favour areas which than current spending and that effect is already have high levels of gross value likely to be even higher in an environment added, i.e. London and the South East. where the economy is operating well The Treasury should revise the Green Book below capacity and investment levels are as quickly as possible to better account depressed, because spending is less likely for the dynamic effects of infrastructure to crowd out the private sector. It may investment and to specifically prioritise therefore end up being fortunate that the ‘levelling up’ by making economic benefits planned National Infrastructure Strategy in left-behind regions and localities a key was delayed in March - because we now factor when assessing projects. need to put it at the heart of the recovery.
60 OBR, ‘Economic and Fiscal Outlook, March 2020’, p14, link cps.org.uk 41 After the Virus The way decisions on infrastructure are and leverage private investment. Some of made in Whitehall is also disjointed. the work already done to replace the role According to the Institute for Government, of the European Investment Bank would there are 26 different ministers with some prove useful. The model could be similar responsibility for infrastructure, stretching to the Green Investment Bank, which across eight departments.61 At a sub- was set up in 2012 and proved a success national level there is a hodgepodge of for funding green infrastructure projects different local and regional bodies, and by leveraging in third party investment, the overall framework can be complex and attracting £3 of private capital for every £1 confused. it invested.62
We need to improve and simplify the way There is increasing talk of the potential infrastructure is planned and delivered, benefits of a sovereign wealth fund in both to speed up decisions and to ensure the UK. Such entities tend to be set up all efforts are directed towards the National by countries that are running budget Infrastructure Strategy. The decision to surpluses and have low levels of public actually develop and publish a National debt, often with large natural resource Infrastructure Strategy is a good start. reserves such as oil. We are not such a country, so we remain unconvinced of the However, we recommend that the feasibilility of a sovereign wealth fund on Government beefs-up the National the model of a country like Norway. Infrastructure Commission into a cross- government coordinating body with However, one part of this programme of responsibility for ensuring all parts of the public investment could be a dedicated public sector are working towards the fund to provide the super-patient capital vision set out in the Strategy. This could which is sometimes lacking for projects involve establishing it on a statutory which can have major long-term economic basis, with regular reporting on progress benefits. The Government could put some in the same way that the OBR publishes additional capital funding into creating a updates on fiscal policy. The first job ‘Future Growth Fund’, with a specific remit of this strengthened institution should for strategic investment in growth sectors be to conduct a review of the current and projects which will drive productivity complex framework of responsibilities growth and innovation. across the public sector and produce This entity would be led not by civil recommendations for how to simplify the servants but by a board of investment system and improve strategic coordination. experts from a wide range of sectoral and To complement this, we need a new geographic backgrounds. One model for institution which can work alongside this is the Ireland Strategic Investment public sector bodies to direct some of Fund (ISIF), which has a statutory mandate the increased public investment and to support domestic economic activity facilitate the necessary links between the and employment, and is designed to public and private sectors for delivering provide long-term capital in areas where major projects. The Government should investment is lacking, rather than simply establish a British Infrastructure Bank, crowding out private investors in search of based outside London, with seed capital fund growth.63 to fund infrastructure across UK regions
61 Daniel Slade and Nick Davies, ‘How to design an infrastructure strategy for the UK’, link 62 Department for Business, Energy and Industrial Strategy and UK Green Investment Bank, ‘Green Investment Bank to boost support for low carbon projects as government confirms sale to Macquarie’, link 63 Ireland Strategic Investment Fund, ‘How we invest’, link cps.org.uk 42 After the Virus Levelling up should be able to benefit from a thriving private sector, good jobs, higher wages As we set out in Chapter 1 of this report, and inward investment. the impact of the Covid-19 outbreak is likely to exacerbate the regional disparities Part of the reason London is able to which the Government committed to garner significant agglomeration benefits tackling in its manifesto last December. is because it is so well connected, both within the city itself and with other regions. Those regions which have lost out in the More intra-regional rail journeys were taken economic game over recent decades in London in 2018-19 than within all the other regions of the UK combined. Rail journeys in 2018-19 by UK region
Source: Office of Rail and Road, Regional Rail Usage, Annual Data Tables, Table 15.13, link
It is striking that the other great cities do not use trains regularly and road travel and towns of the UK are significantly less tends to dominate. Some have argued that productive than comparable conurbations there has been too much focus on railways in other advanced economies. One familiar in the levelling up debate, and to an extent statistic is that GVA per worker is 30 per we agree with that assessment: given that cent lower in Birmingham than in Lyon.64 most train journeys are taken by a minority Improving the transport infrastructure of people who are disproportionately mix for travel to, from and perhaps most affluent and disproportionately South- crucially within those urban areas is key to Eastern, levelling up cannot just be about improving their economic performance. big new railway lines.
Of course, the graph above also reflects However, at the same time, it’s important to the fact that outside London most people remember that in a way what we actually
64 Centre for Cities, ‘City factsheet: Birmingham’, link cps.org.uk 43 After the Virus want is for more people in the regions that this is a false economy as it often means to resemble the affluent commuters of roads need to be closed for emergency the South East. Successful regions tend repairs. There is an opportunity to frontload to have reliable rail transport options for the £500 million per year Potholes Fund people to commute to high-end jobs and announced at the Budget to take advantage meet with other thriving businesses and of lower traffic levels while social distancing people, so rail investment has to be part of and widespread working from home are the answer for levelling up. still in place. Full road resurfacing is also preferable to simply filling potholes when it It shouldn’t be an either/or debate, comes to long-term resilience, and such work and neither is it about saying ‘Let’s just can be organised relatively quickly compared build everything!’. What we need is a to other infrastructure decisions. We complementary mixture of transport recommend that the Government changes solutions, thinking intelligently about what its road improvement plans to bring forward works for individual places and people, as much spending as possible to 2020. and crucially also about how different parts of the infrastructure network interact. Cities like Birmingham, Manchester and Leeds need investment in roads and bus For example, some who have suggested the services both to improve existing routes money spent on HS2 would be better spent and increase capacity, and to connect more on connecting our northern towns and cities people with the city. They should also be through the proposed Northern Powerhouse able to benefit from the level and quality Rail programme seem not to appreciate that of intra- and inter-city rail connectivity, plus those plans are contingent on the completion light-rail and trams where appropriate, that of HS2. The whole point of Northern the citizens of the most successful and Powerhouse Rail is to connect the new HS2 productive cities in the developed world hubs with as many places across the North have been enjoying for decades. as possible to maximise the benefits – it is intended to complement HS2, not as an When a town or city does not have adequate alternative to it. Indeed, ensuring that plans for transport connections, its size is effectively wider investment in the Midlands and North reduced. Tom Forth of the Open Data are complementary to the HS2 project is Institute has used data on bus journeys in the main purpose of the Integrated Rail Plan Birmingham to estimate that, if we define the currently being developed.65 size of the city as the number of people who can reliably get to the city centre within 30 Yet even after a significant expansion of rail minutes during peak time, then Birmingham provision, regular rail travel still isn’t going is really only a city of 0.9 million rather to be an option for many. While only 28 per than its official population of more than cent of Londoners drive to work, 80 per twice that.67 We are wasting the potential cent of people in the West Midlands do and of our urban areas by not enabling the 76 per cent in the North West.66 One of the agglomeration effects which lead to higher easiest wins for public investment, therefore, productivity. The chart on the following page, is a major programme to improve our roads. shows there is a clear correlation between The NIC has pointed out that our roads have the average distance people in different been neglected, with six per cent of urban regions travel to work and output per head. A roads in poor or very poor condition, and
65 Department for Transport, ‘Terms of reference for an integrated rail plan for the north and midlands’, link 66 Department for Transport, ‘Modal comparisons (TSGB01): Usual method of travel to work by region of residence’, link 67 Productivity Insights Network, ‘Real Journey Time, Real City Size, and the disappearing productivity puzzle’, link cps.org.uk 44 After the Virus Correlation between distance travelled to work and GVA per head by UK region
Source: ONS, Regional gross value added (balanced) per head and income components, 2018 data, link; UK Data Service, Total and average distance travelled to place of work - Local Authority and above, 2011 Census Data, link
There is a crucial point to be made from coverage of full fibre and gigabit-capable this. The levelling up agenda is not simply networks in every part of the country by about a more ‘just’ distribution of prosperity 2025. We should also set an ambition to between regions - it is a vital part of solving have a full fibre national network by the the UK’s productivity puzzle. It’s not just a end of the decade. Other large nations, case of choosing to redirect investment such as Japan and Spain, are far ahead of outside the South East for the sake of us on digital connectivity - we need to put fairness or for some political agenda that right as quickly as possible. around the former ‘Red Wall’. Levelling Another regional imbalance which must be up is an economic decision based on addressed is on research and development. recognising that we have towns and cities Recent analysis from Nesta has shown with massive untapped potential which that public spending on R&D is actually are underperforming compared to their more concentrated in the South-East than European counterparts due to lack of private sector R&D spending. In particular, investment. London, Oxford and Cambridge account This is also not just about transport. for 46 per cent of public R&D spend but The pandemic has shown how modern just 31 per cent of business R&D spend.68 technology can enable new modes of The commitment at the Budget to increase working and that good digital connectivity R&D spending to £22 billion a year by 2025 is vital for economic resilience. For our left- is welcome but this should be seen as an behind regions to thrive we need to invest opportunity to level the playing field. The in world-leading digital infrastructure. The Government should target increased public National Infrastructure Strategy should R&D investment on new geographies and set out a fully funded path for achieving new opportunities, rather than entrenching the manifesto commitment of full existing spending disparities.
68 Tom Forth and Richard A.L. Jones, ‘The Missing £4 billion: Making R&D work for the whole UK’, link cps.org.uk 45 After the Virus Pushing forward devolution coverage of devolved mayoralties and combined authorities. The best people to make decisions about the right mix of infrastructure investment As part of this, the Government should in our cities and regions - and about many ensure that the influence and powers of other issues too - are those closest to local areas and metro mayors specifically them. We have seen some major changes relating to capital expenditure decisions in the UK in recent years, with moves are a priority consideration. There should towards business rates retention for be a clear plan for how to integrate local authorities and the development of the roles of new devolved bodies with combined authorities and eventually metro both the new British Infrastructure mayors empowered by City Deals. This has Bank and newly strengthened National been a huge success, with mayors such Infrastructure Commission. Currently only as Andy Street in the West Midlands and 36 per cent of investment spending is Ben Houchen in Tees Valley leading the managed by sub-national bodies in the way in a new generation of enhanced local UK, compared to 51 per cent on average 70 leadership. across OECD countries.
The Government has rightly recognised If devolved bodies are to play their part that we should build on this success in delivering the National Infrastructure and devolve deeper and wider. In the Strategy and driving the return to growth, Conservative manifesto we committed to they also need to be able to rely on the publishing an English Devolution White same level of expert advice and evidence Paper in 2020, but with the disruption of base which central government can. The the pandemic this risks being delayed. Government should provide dedicated It can take years to develop the detailed funding for combined authorities plans involved when transferring to expand their capacity to assess responsibilities to entirely new institutions. the economic benefits of potential Local leadership should play a major role investments, present reliable business in the expanded programme of public cases, and actually deliver projects. This investment, and there should therefore be could include plugging them into the as much haste as possible in developing roles of the existing Infrastructure and a renewed agenda for English devolution; Projects Authority and the Major Projects the promised White Paper must be Leadership Academy. published as soon as possible this year. Part of the role of devolved bodies will be This should focus both on increasing the to make the case to central government powers of existing devolved authorities for projects in their area, as will already and expanding those models which have happen with the new intra-city transport proved successful to more areas. Even settlements announced at the Budget. But taking account of the West Yorkshire City this cannot just be about Whitehall waving Deal signed in March, nearly 60 per cent its wallet over the heads of metro mayors of the population of England are still not and seeing who can jump highest and going to be benefitting from a devolution shout loudest. Local bodies should also be deal.69 We need to make sure we have the able to both raise funds themselves and to right powers at the right level, for example borrow against future revenue streams, just by devolving more powers to unitary as Transport for London can. authorities and extending the reach and
69 Akash Paun, James Wilson and Elspeth Nicholson, ‘English devolution: combined authorities and metro mayors’, link 70 Andrew Bailey, Richard Hughes, Lindsay Judge and Cara Pacitti, ‘Euston, we have a problem: Is Britain ready for an infrastructure revolution?’, link cps.org.uk 46 After the Virus There are already examples of success Reform planning we can draw on from outside London. The Greater Manchester Combined Our planning system is holding back Authority (GMCA) set up Transport for housing supply and contributing to low Greater Manchester (TfGM) to bring productivity and declining rates of home together local transport responsibilities ownership. under a single strategic body. As part of Building more and better homes is an their funding settlements with TfGM, the absolutely vital part of the economic GMCA have used their borrowing powers jigsaw. That is why it is so encouraging to finance extensions to the Metrolink, that the Government is reportedly treating and a portion of the revenue stream from this issue as a priority. The Planning White running the Metrolink is then allocated to Paper that is due to be published should covering the financing costs associated now be seen as an opportunity to increase with the investment.71 The Government housebuilding to boost the economic could extend the borrowing powers of recovery and to massively simplify and combined authorities by lifting borrowing rationalise the planning system. limits and allowing them to use ‘tax increment financing’ to borrow against Our view is that national and local future revenues. It could also explore planning regulations should focus innovative ways for central government on minimum housing supply, broad to allow sub-national bodies to benefit land uses and associated transport from the record low borrowing costs it infrastructure, basic design codes, and currently enjoys. guidance on significant alterations to existing properties (where these affect Greater Manchester also benefits from neighbours). An overhauled system should an ‘earn back’ arrangement. Central also be as rule-based as possible, limiting government provides an ongoing the discretionary powers of councils and revenue stream of grant funding for policymakers – and thus bringing us into Greater Manchester based on additional line with most other countries. tax revenues generated from previous infrastructure investments. This provides Businesses will need to make adaptations a ‘revolving infrastructure fund’ for to their premises and potentially construct reinvesting revenues in future projects, extensions to allow them to operate as well as giving GMCA an incentive to with social distancing measures. We choose the most economically beneficial should take this opportunity to bring investments. This was how the Trafford more flexibility into our planning system, Park extension of the Metrolink was both to help cope with the current funded. ‘Earn back’ arrangements should crisis and to allow greater freedom for become the norm in all city deals. improvements in the future. Permitted development rights allow improvements Devolved authorities could also be given or extensions to be made without the more opportunities to capture some of need to seek planning permission. We the value uplift resulting from projects, recommend the Government reviews by giving them more flexibility with how permitted development rights with a they can levy precepts on local rates, view to broadening the scope of these as suggested in the NIC’s National rights to allow more work to be carried Infrastructure Assessment in 2018.72
71 Transport for Greater Manchester, Greater Manchester Combined Authority and Greater Manchester Local Enterprise Partnership, ‘Greater Manchester Transport Strategy 2040: Draft Delivery Plan (2020-2025)’, p80, link 72 NIC, ‘National Infrastructure Assessment 2018’, p121, link cps.org.uk 47 After the Virus out without the burden of going through The housing crisis cannot be solved by the planning process. Ministers should be piecemeal additions here and there. We prepared to speedily amend the legislation also need to think imaginatively about to facilitate this. In addition to this, Covid- new towns and garden cities. related adaptations to increase capacity for social distancing should be fast- Our approach to the green belt also needs tracked for planning permission, and the to change. It is right that some areas are Government should provide a specific protected and we should maintain the grant for small businesses to adapt their existing protections for green belt land. properties in this way. But in many areas land that is classified as green belt is of very poor quality or The Government is currently consulting on is inaccessible. Work by the London reforming our approach to development Chambers of Commerce and Industry corporations.73 A development corporation found that London’s metropolitan green can be an excellent model for delivering belt contains derelict and unused land regeneration and new housing supply, equivalent to 500 football pitches, capable combining long-term public sector of accommodating 20,000 homes.74 commitment and powers with private sector involvement, expertise and Nobody wants to see the green belt investment. Legislation now allows concreted over or protections removed - combined authorities to set up their own but local authorities and local communities development corporations, which Tees currently find it almost impossible to get Valley has already done. green belt plots reclassified even when there is an overwhelming case for doing We recommend the Government so and strong local support. The current encourages a new generation of process is arduous and long, involving a development corporations by developing requirement to review green belt for the a template model for their creation and entire area - and even then can simply be giving greater autonomy to local areas quashed by the Secretary of State. So to and combined authorities to allow them fast-track reclassification of green belt to do so. All development corporations where it is both necessary and popular, should be given the powers of a local the Government should allow reviews of planning authority to coordinate planning specific plots without the need to review and manage development. They should the entire area. MHCLG should publish be able to capture value from planning clear guidance defining the criteria for uplift through Section 106 payments and reclassification to give local authorities Community Infrastructure Levies and confidence that the process is worthwhile, reinvest this in local development. and should commit to significantly shortening the average time from application to resolution.
73 p42, after sentence “The Government is currently consulting…”, insert reference 73 Ministry of Housing, Communities and Local Government, ‘Development corporation reform: technical consultation’, link 74 p42, after “20,000 homes” insert reference 74 London Chamber of Commerce and Industry, ‘Building on poor quality green belt would help solve housing crisis says business survey’, link cps.org.uk 48 After the Virus Chapter 5: Employment and Enterprise
Our Recommendations
A drive for better data The Treasury and BEIS should urgently form a joint Covid-19 Data Taskforce to coordinate between policymakers and statisticians. The DWP and HMRC should conduct an assessment of what real-time data from their systems could reasonably be collated and published to help monitor economic trends during the recovery.
Jobs Substantial temporary reductions in Employer’s National Insurance – we set out a range of options for how this could be done. A one-year reduction in VAT.
Business investment Introduce full expensing in the UK through an unlimited Annual Investment Allowance. Let companies immediately ‘cash out’ any accumulated tax credits or deductions. Tighten limits on interest deductibility and reduce companies’ ability to carry forward interest expenses. Improvements to business premises, or construction of new ones, should be disregarded in business rates valuations. Working with the Bank of England, the Government should consider introducing a ‘bad bank’ scheme.
cps.org.uk 49 After the Virus Regulation A moratorium on all new non-urgent regulation on business, and a cross-government review of which regulatory measures could be delayed or waived. Regulators should help pave the way for innovations to be brought to market through regulatory support for firms and automatic updating to accommodate new technologies and concepts. Reform Britain’s bankruptcy rules, making it easier for firms to restructure, keep paying workers and prevent creditors from forcing a premature shutdown with layoffs. Relax regulations on childcare provision in order to allow the flexibilities, and much lower costs, which are the norm in most other European countries.
Skills The types of training which qualify under the apprenticeship levy should be broadened, perhaps evolving it into a ‘skills levy’. A time-limited labour market programme focused on young people living in unemployment hotspots.
A green recovery A major programme of incentives for households to replace older boilers. A car scrappage scheme, with a discount on new electric or hybrid cars if the purchaser is replacing a diesel or older petrol car. Bring forward existing commitments to significantly increase coverage of electric charging points.
Openness A visa scheme to automatically allow recent graduates from the top 50 academic institutions globally into the UK for work and research. Any restrictions on overseas investment must be strictly related to national security and/or public health needs. A time-limited, tax-efficient investment vehicle to give people a strong incentive to bring money into the UK from overseas. Seek to agree the widest possible trade deals with the United States and other countries to increase trade volumes and open up new markets for UK exports.
cps.org.uk 50 After the Virus Introduction A drive for better data
Infrastructure investment from government The first crucial point to understand is that is important - but its purpose and value is we are in completely uncharted waters. in providing the best possible environment This is an economic crisis the likes of which for businesses to create jobs, to invest, to we have never seen before. We simply do innovate. One of the fundamental principles not know what the ultimate impact of the of this report, and any plan for recovery, is lockdown measures will have been on the that it is only the enterprise and innovation economy, nor do we know the extent to of the private sector which can lift us out of which behaviours such as social distancing this crisis and deliver the growth we need. will persist even after measures are eased and how this will affect businesses. But for that to happen, we need to make sure that the tax and regulatory That means that monitoring the recovery environment is geared towards growth. and collecting as much immediate and detailed data as possible should be an Low-tax Conservatives are not just averse absolute priority. The ONS has been doing to taking money from people who have some excellent work on this already with worked hard for it, much as that instinct its fortnightly Business Impact of COVID-19 is strong. They recognise that if we are to Survey and other rapid response surveys,75 compete in the modern, global economy, as well as developing new indicators we need to be a country which attracts such as using data from online job search investment and rewards hard work and website Adzuna to estimate vacancy enterprise. We also need to give businesses rates.76 The Resolution Foundation has the flexibility and freedom to participate also carried out work designed to ‘plug the efficiently in competitive markets – for it is gap’ left by traditional economic indicators only by harnessing the power of markets which are not timely enough to be of any that we will rebuild our economy. use to policymakers during the fast-moving Britain has millions of businesses of crisis.77 all shapes and sizes. They are the Good data is vital for forming opinions and backbone of our economy. Many are now developing policy. Even in normal times, struggling through a period of severe and there are sometimes surprising gaps in unexpected shock, in which economic our evidence base, which places limits activity has been deliberately limited in on government’s ability to make informed response to the public health crisis. decisions. Often the best indicators are not As we saw in Chapter 1, and we are seeing available for some time, so that decisions every day in the data, a modern economy are being made in 2020 based on cannot simply shut down for half a year statistics which may only reach up to 2018. and then return to how things were before. Given there has been so much sudden, As businesses fold, jobs are lost and dramatic and unpredictable change in the investments are cancelled, permanent last few months, it will be more important damage is done. This section will set out than ever to have reliable and up-to-date how the Government should be looking data. It is notable, for example, that we to galvanise the private sector, ensuring businesses can not just survive but thrive.
75 ONS, ‘Coronavirus and the latest indicators for the UK economy and society: 4 June 2020’, link 76 ONS, ‘Using Adzuna data to derive an indicator of weekly vacancies: experimental statistics’, link 77 Jack Leslie and Charlie McCurdy, ‘The economic effects of coronavirus in the UK: Utilising timely economic indicators’, link
cps.org.uk 51 After the Virus spent the first few months of the lockdown The Department for Work and Pensions having little clue of what was really (DWP) has already been publishing some happening to unemployment because ad-hoc UC management statistics during of the time lag on the official statistics; the lockdown to illustrate the increase the Resolution Foundation used Google in claims.78 HMRC have also recently search term data to give an indication of published experimental statistics using job losses. RTI from the Pay As You Earn system.79 The DWP and HMRC should conduct The Treasury and the Department an assessment of what real-time data for Business, Energy and Industrial from their systems on claims, earnings, Strategy (BEIS) should urgently form employment status and other areas a joint Covid-19 Data Taskforce to could reasonably be collated and coordinate between policymakers and published and be useful for monitoring statisticians. This would be designed to economic trends during the recession allow officials, advisers and ministers to and recovery. quickly communicate what information they need to inform policy responses Jobs and ensure policy is based on the best With the unemployment rate already possible evidence. This could involve having risen rapidly, and with many more commissioning new experimental statistics jobs at risk once the Job Retention and exploring how to disaggregate Scheme is wound down, we could be existing indicators to give a more detailed facing a joblessness crisis which blights a picture of geographic, demographic and generation. We have to do everything we sectoral variations. The Taskforce would can to support employment - but we are also consider how best to engage with also now at the stage where we need to be actors on the ground to gather qualitative shifting from simply maintaining the labour evidence, and share information and market as it was pre-pandemic towards lessons learnt with industry to quickly allowing it to evolve. disseminate best practice. That means we need to strike a delicate We are fortunate to have the Universal balance, making sure firms are given Credit system in place. It is perhaps the every possible opportunity to keep people most advanced digital benefit system on while they work through this period in the world, and its use of real time of difficulty, while reducing the extent to information (RTI) is invaluable for a number which the Government is actively paying of reasons. First, it allows the payment wage bills, ultimately to zero. We want as system to respond quickly to falls in a many people as possible to keep their claimant’s income, where the legacy tax jobs, but some churn in the jobs market is credit system would not have picked up also necessary for the economy to adjust those changes until next year. Second, the to a changed world - so we should also be system has coped admirably with the flood encouraging firms in healthier sectors to of claims. Third, the speed and detail with get hiring and quickly soak up those who which the UC system collects data can be have lost their jobs. a crucial tool for monitoring the economic impact of the pandemic and planning for In the context of the pandemic, tax the recovery. measures are an attractive policy tool
78 Department for Work and Pensions, ‘Universal Credit declarations (claims) and advances: management information’, link 79 HMRC and ONS, ‘Earnings and employment statistics from Pay As You Earn (PAYE) Real Time Information (Experimental Statistics)’, link cps.org.uk 52 After the Virus because they are much quicker and billion using the current rules, although the easier to implement than creating new Government could also consider widening bureaucratic government schemes. eligibility to larger employers as well. They are also a way of rapidly increasing Another option would be to temporarily demand. raise the threshold above which employers If we want to support and stimulate pay NICs from the current £8,788 per year employment, then axiomatically the to £12,500, in line with the income tax best option is to cut the payroll tax personal allowance. The annualised cost of - Employer’s National Insurance. Tax this would be roughly £13 billion, but could employment less, and all other things make a big difference as a temporary being equal you will end up with more of it. measure, reducing the cost of employing any full-time employee by more than £500.82 There is plenty of academic literature to support the positive impact on employment In other countries, such as the rates of reducing non-wage labour costs, of Netherlands, the equivalent of our JRS which employer NICs make up a significant support has been based on looking at proportion in the UK.80 The biggest bang how much a firm’s revenue has fallen measure we could take would be to since the outbreak of Covid-19.83 Another eliminate them altogether - but given that option, targeted particularly at firms in Employer’s National Insurance contributes sectors such as hospitality and tourism, approximately £80 billion to the Exchequer would be to offer a complete NICs holiday every year, this is impractical.81 until April 2021 to firms with fewer than 250 employees who have seen a fall in There are however a range of measures to quarterly revenue of more than 25 per choose from (including significantly raising cent. This would strike a balance between the threshold or simply cutting the rate), helping firms with labour costs in the short and we urge the Treasury to evaluate term while trying to ensure employers are which will do most to maintain and only retaining jobs they believe will still be stimulate employment. viable once measures have been eased. For example, some firms may want to It is also imperative that new jobs are keep staff on because they are confident being created as fast as possible and business will return, but are going to there are opportunities for those people struggle with costs in the meantime, who have lost their jobs to find new work. especially when the furlough scheme is This could be encouraged via a two-year withdrawn. The Government has already complete employer NICs holiday for all increased the Employment Allowance, net new hires, effective immediately. This which gives businesses a discount on would give employers an incentive to take their NICs bill, from £3,000 to £4,000. The on new staff by lifting all newly created Chancellor could bring in a substantial jobs out of employer NICs. To prevent increase to this allowance for SMEs to, employers laying off and rehiring, it should say, £20,000 to massively reduce the tax only apply to net job creation, with rehires bills associated with keeping people in of employees not qualifying. Obviously employment. This would cost around £7 the cost would depend on how many new
80 Raul Ramos, Enrique López-Bazo, Carlos Vacas, Vicente Royuela, Rosina Moreno, Christian Dreger, John Hurley and Jordi Suriñach, ‘Employment effects of reduced non-wage labour costs’, link 81 OBR, ‘Economic and Fiscal Outlook, March 2020: supplementary fiscal tables – receipts and other’, Table 2.4, link 82 Cost of Employment Allowance increase based on policy costing of the £1,000 increase in the Employment Allowance announced at Budget 2020; cost of increasing the employer NICs threshold based on Treasury ready reckoners, link 83 Netherlands Enterprise Agency, ‘Corona crisis: temporary emergency bridging measure NOW’, link cps.org.uk 53 After the Virus jobs are created, but given the employer Business investment NICs bill for a worker on average wages is around £3,000 per year, a rough estimate In the last chapter, we focused on the need would be £3 billion per million jobs.84 to increase public sector investment - but one of the UK’s other great economic Finally, supporting employment is also problems is its relatively low levels of private about ensuring businesses remain viable, sector investment. While this has been which will require supporting consumer exacerbated by Brexit uncertainty in recent demand at a time when many will be years, the phenomenon is not new. It is also, cautious about spending. To provide a for many economists, a key explanation of temporary boost to consumer spending the UK’s equally disappointing productivity and support economic activity and performance. employment, the Government should consider a one-year reduction in VAT, as The chart below shows that between 1997 happened in the wake of the financial and 2017 levels of spending on gross crisis. A cut from, say, 20 per cent to 17 per fixed capital formation (a measure of net cent would cost around £21 billion, but as investment) by the private sector were lower a one-off fiscal hit to give consumers more in the UK than in any other G7 economy. And bang for their buck, it could be a vital tool the present incredible uncertainty about the for ensuring businesses can weather the future, thanks to the pandemic, will weigh on storm and retain staff.85 investment decisions even more.
Average non-government spend on Gross Fixed Capital Formation, 1997-2017
Source: ONS, An international comparison of gross fixed capital formation, November 2017, Table 2, link
84 Based on average weekly earnings of £585 per week; ONS, ‘Employee earnings in the UK: 2019’, link 85 HM Revenue and Customs, ‘Direct effects of illustrative tax changes’, link cps.org.uk 54 After the Virus Again, the tax system is the best way will necessarily be on an unprecedented to solve this problem, and give firms a scale to bridge the economy through the reason to invest again. That is particularly pandemic. important because the UK has one of the Calculations by the Centre for Policy least investment-friendly regimes of any Studies show that an unlimited AIA would major economy when it comes to the way under normal circumstances cost the our corporate tax system treats investment Treasury around £10 billion of revenue in spending by firms.86 the year after it was introduced - but this Capital allowances can have a much more would fall to approximately £1.5 billion a positive impact on growth than a simple year, which does not include the benefit of cut in corporation tax rates because they the increase in economic activity it would specifically incentivise investment spending. generate.88 Bringing in this reform at a time The US-based Tax Foundation has found when economic activity is depressed due that, per dollar of forgone revenue, full to COVID-19 would also be substantially expensing for capital expenditure can have cheaper than when the economy is firing a growth effect double that of cutting the on all cylinders. However, this should headline corporate tax rate. A UK study in not be just a temporary post-Covid 2016 from the Oxford University Centre for measure, but a permanent reform to boost Business Taxation found that access to investment levels (and thus productivity) more generous capital allowances for SMEs over the long term. At a bare minimum, pre-2008-09 increased the investment rate the £1 million AIA should be made by 11 per cent.87 permanent.
Under our current regime, the Annual One way to boost businesses now, Investment Allowance (AIA) allows firms to while also smoothing the transition to write-off a certain amount of investment a corporate tax system based on full spending on plant and machinery each expensing, would be to let companies year for tax purposes. The AIA is currently immediately ‘cash out’ any accumulated set at a temporarily high level of £1 million tax credits or deductions that they could but is due to fall back to £200,000 at the otherwise use in future years.89 Instead of, end of this year. say, rolling forward losses for several years, or gradually deducting past investments The potential benefits of more generous through the existing system of capital capital allowances are so great that, allowances, businesses would be able to given our need for radical policies to opt for an immediate payment equivalent turbocharge investment and growth, we to 19 percent of the accumulated total recommend introducing full expensing (reflecting the corporation tax rate). The in the UK through an unlimited AIA. up-front cost of such a policy could be The initial costs of this to the Exchequer significant, and the government may would be high, as you would effectively want to put a cap on how much can be be bringing forward tax allowances from claimed. But, importantly, you would only future years. However, the costs diminish be bringing future tax deductions forward significantly over time - and this should to the present day – this proposal does be considered in the context of having not affect the government’s long-term already accepted borrowing this year
86 Elke Asen, ‘UK Taxes: Potential for Growth’, link 87 Giorgia Maffini, Jing Xing, Michael Devereux, ‘The impact of investment incentives: evidence from UK corporation tax returns’, link 88 Centre for Policy Studies, ‘A Budget for No Deal’, link. Estimates have been amended to reflect the decision to maintain the corporation tax rate at 19 per cent. 89 For more on this idea (in the US context) see Scott A. Hodge et al., ‘Tax Policy After Coronavirus: Clearing a Path to Economic Recovery’, Tax Foundation (April 2020), link cps.org.uk 55 After the Virus fiscal position in any meaningful way. There dramatically increased capital since the is precedent for this, as a similar principle 2007-8 financial crisis, it was not surprising already exists for claiming R&D tax credits that the report concluded that the UK for expenditure on intangible assets.90 banking sector is stable and resilient, and can withstand this economic shock. We To complement these reforms and to need banks, however, to be more than offset some of the costs, we should tighten stable. To support the economic recovery the rules on tax deductibility of interest we need a banking sector that is proactively for companies. Companies can currently lending to businesses, without government reduce their tax bills by offsetting profits guarantees. Given the losses that banks against debt financing costs, and this are expecting on their existing portfolios, encourages companies to take on debt in it is unlikely that banks will adopt such a the UK while offshoring profits to minimise proactive position soon. Therefore, working tax liability.91 The Government should with the Bank of England, the Government tighten limits on interest deductibility should consider introducing a “bad bank” (currently set at 30 percent of earnings scheme. Such a scheme would offer banks before interest, tax, depreciation and support with loans that have become non- amortisation or EBITDA) and reduce performing as a direct result of the lockdown companies’ ability to carry forward interest in exchange for increased bank lending to expenses. business, especially privately owned non- This combination of measures would be financial enterprises. designed to shift incentives in favour of greater equity-financed investment in jobs Regulation and growth in the UK. When firms are struggling through an Businesses should also be encouraged to unprecedented situation like this, the last invest in their premises. Considering social thing they need is new red tape. We need distancing may require some firms to build to ensure that the regulatory burden on extensions or find other ways to increase business is as limited as possible while the the capacity of their premises, we suggest economy gets back on its feet. We also that any improvement of business need to get better at how we do regulation premises, or construction of new ones, in this country, creating a pro-business, pro- should be disregarded for the purposes innovation environment for the long-term. of business rates valuation. While this Some of the measures already announced policy could be limited to the immediate by the Government are very welcome, recovery period after coronavirus, it such as deferring the introduction of new would ideally prepare the ground for IR35 reporting requirements until next year. much broader reform of the business However, we need to go further: there rates system as part of the Government’s should be a moratorium on all new non- upcoming review. urgent regulation on business. In addition, Bank lending is another crucial component we suggest that BEIS lead a cross- of business growth. The Bank of England’s government review both of what scheduled Financial Policy Committee published an new measures affecting businesses could interim Financial Stability Report to assess be delayed to 2022, and what existing rules the risks to UK financial stability from the could be temporarily waived. pandemic.92 Given that UK banks have
90 Forrest-Brown, ‘Intangible assets and R&D tax credits’, link 91 HM Revenue and Customs, ‘Corporation Tax: tax deductibility of corporate interest expense’, link 92 Bank of England, ‘Monetary Policy Report and Interim Financial Stability Report - May 2020’, link cps.org.uk 56 After the Virus In the longer term, the UK’s regulatory more breathing space. The Government regime needs to be geared towards has already announced some relaxations accommodating innovation and change. to waive the ‘wrongful trading rule’ under The UK has the opportunity to be a which directors can be prosecuted if they world leader in a number of high-growth know the business is insolvent but choose technology sectors such as artificial to continue trading. We welcome this but intelligence and life sciences, but innovative think there is scope to go further. We need new products and services can pose to reform Britain’s bankruptcy rules with challenges for regulatory regimes. a US-style Chapter 11 provision, making it easier for large firms to restructure, keep Firms need to know how their innovations paying workers and prevent creditors will fit into the regulatory environment and from forcing a premature shutdown with that they will not be held back by out-of- layoffs.95 Trading would still take place date rules. The Financial Conduct Authority under the supervision of the court, and (FCA) have been doing some great work firms would have greater opportunity to in recent years on helping innovative firms reorganise and make themselves viable. bring products to market through advice We should also strengthen the concept of and ‘regulatory sandboxes’, which allow ‘debtor in possession’. firms to test new concepts and products in a controlled environment with supervision Some of our regulations are also increasing and advice from the regulator. To build on the cost of living for households by good work such as this, the Department for restricting supply or imposing overly strict Business, Energy and Industrial Strategy standards requirements. For example, should help pave the way for innovations regulations on childcare are unnecessarily to be brought to market through regulatory inflating costs for working families through support for firms and automatic updating restrictions on how many children each of regulations to accommodate new carer can legally be responsible for and technologies and concepts. This could be excessively high qualification requirements. done directly through a cross-regulatory A Government review in 2016 concluded ‘single entry point’ for innovators, as that ‘the rigid application of the ratios and proposed by Nesta, or via sectoral regulatory – depending on qualifications – who, and bodies. We need regulators to channel their who isn’t able to be counted within the inner Gromit, constantly laying down the new ratios is having a negative impact on the track in front of it to allow the innovation train potential growth and flexibility in the sector’, to speed onwards, embedding a system- but previous plans to relax the rules were wide ‘anticipatory regulation approach’.93 dropped after opposition from the sector.96 This initiative could also bring together the We would support relaxing regulations various regulatory sandboxes under one roof on staff to child ratios in childcare, and and host the sort of digital sandbox currently reviewing qualifications guidelines, in order being piloted by the FCA.94 to allow the flexibilities, and much lower costs, which are the norm in most other The UK’s insolvency laws are also not European countries. This would also make it ideal in the current circumstances, and we easier for parents to return to the workforce, should consider relaxing the rules to reduce further strengthening the recovery. the power of creditors and give firms
93 Nesta, ‘Renewing regulation: “Anticipatory regulation” in an age of disruption’, link 94 FCA, ‘Digital sandbox – coronavirus (Covid-19) pilot’, link 95 Jones Day, ‘Comparison of Chapter 11 of the United States Bankruptcy Code and the System of Administration in the United Kingdom’, link 96 HM Government, ‘Cutting Red Tape: Review of childcare’, link cps.org.uk 57 After the Virus Skills A green recovery
There will undoubtedly be a long-term It is not an exaggeration to say that we impact from the pandemic on the nature of are effectively going to be rebuilding our work and the labour market. The rapid shift economy after this crisis. With that in mind, to remote working and learning, and even it makes sense to build back in a way greater focus on sectors such as digital and that prepares us for the future, and that software, will change the skills people need means building a greener economy. The to succeed in the labour market. Employers Conservatives are committed to Net Zero will also want to ensure they can bring their greenhouse gas emissions by 2050 - and existing workforce along with these new while they hope to achieve this in ways that trends through training and development. maximise the economic and environmental benefits, they have also recognised there The current operation of the apprenticeship will be costs involved in the transition, levy is not working as it should. Employers in particular in terms of infrastructure are paying billions every year into their investment. apprenticeship levy accounts but only around 10 per cent of the funds are actually The economic recovery therefore being drawn on for apprenticeships, provides an opportunity to use the need because the restrictions on what the money for investment and transition to greener can be used for prevent many firms from technologies to drive growth and create being able to use the funds.97 To give jobs. A recent CPS report, for example, employers more flexibility to re-skill their focused on the potential of hydrogen both workforces after this crisis, the types as a way to decarbonise heavy vehicles and of training which can qualify under the as a potential source of jobs and growth. apprenticeship levy should be broadened One of the major areas where we need to substantially, perhaps even reforming the reduce emissions is domestic heating - and levy into a broader ‘skills levy’. one of the major obstacles to reducing There also needs to be a strong focus household emissions is the upfront capital on youth unemployment. Recessions are cost of installing a new boiler. Newer, more always worst for those who are new to efficient boilers and heat pumps can the labour market, who find their careers substantially reduce energy usage, saving permanently scarred. Coronavirus makes consumers money while also saving the this that much worse as the sectors that planet. The Government could establish are worst affected, such as hospitality, tend a major programme of incentives for to be those where many young people get households to replace older boilers. their start. We need to make it as easy as This could take the form of generous possible for them to find work. It is reported interest-free finance to cover new boilers that the Prime Minister has ambitious or heat pumps and their installation, with plans on this score, but we would certainly repayments based on the savings the support a time-limited labour market household enjoys going forward. programme focused on young people living in unemployment hotspots.
97 House of Commons Library, ‘Apprenticeships and skills policy in England’, link cps.org.uk 58 After the Virus This might also be a good opportunity to We also want to maintain our reputation as move more people to greener vehicles by a safe and attractive place for individuals providing incentives to buy a new electric and companies to invest. This means that or ULEV car. The Government could work any restrictions on overseas investment with the automotive industry to develop a must be strictly related to national car scrappage scheme, offering a discount security and/or public health needs, rather of perhaps £3,000 on any new electric or than extending the concept of ‘strategic hybrid cars if the purchaser is replacing a industries’ from areas such as vaccine diesel or older petrol vehicle. The discount or PPE production to manufacturing or would be funded jointly by government yoghurt-making. We also want to ensure and industry, similar to the car scrappage that individual investors are encouraged scheme of 2009-10, and should be a to come to the UK, and use their assets to welcome boost to car manufacturers. invest in our prosperity. The Government should consider setting up a time-limited, To support this, the Government should tax-efficient investment vehicle that bring forward its commitment to would give people a strong incentive to significantly increase coverage of electric bring money into the UK from overseas, charging points across the UK. This is while also ensuring that investment was the sort of infrastructure investment which directed towards productive ends rather can be brought forward relatively easily than property speculation. compared to major projects, and could support economic activity. Nothing is more important to an open economy than free trade. There is a debate Openness underway about whether to reduce trade barriers with other countries in post-Brexit Our economy should be open to the world trade deals or maintain tariffs and strict for investment and trade. Not only does that standards to protect domestic producers. benefit businesses, consumers and workers We are firmly in the former camp. Freer here in the UK, it also means more tax trade is a win-win situation. Globalisation revenue for the Exchequer. has benefited both the poorest in the We absolutely do not want to return to the world and consumers in developed bad old days of unrestricted immigration - countries. Trade deals can increase particularly at a time of high unemployment. consumer choice and reduce the cost But in order to help create those jobs, of living through cheaper imports and we need to remain open to the best and increased competition, which is also a brightest from around the world. To attract good thing for the long-term efficiency and elite talent and skills from across the world, competitiveness of our domestic industries. we recommend the Government introduces A world-leading standards regime a visa scheme to automatically allow those can facilitate more trade and help UK who have graduated from one of the top exporters if used as a way to decrease 50 academic institutions globally within trade friction across borders, not to shield the last five years into the UK for work and domestic producers from legitimate research. This would be aimed at facilitating competition.98 We should absolutely greater interaction between UK industry and maintain good food safety and animal institutions and the cream of global talent in welfare standards, but these should not science and technology. be a tool for protectionism. Deliberately
98 Centre for Economics and Business Research, ‘The Economic Contribution of Standards to the UK Economy’, link cps.org.uk 59 After the Virus increasing prices and restricting choice increase trade volumes and open up new for consumers and businesses to protect markets for UK exports. We should also uncompetitive producers is exactly what explore the possibility of Britain joining we should be leaving behind when we the Comprehensive and Progressive leave the EU. We should look to agree Agreement for Trans-Pacific Partnership, the widest possible trade deals with the successor agreement to the Trans- the United States and other countries to Pacific Partnership.
cps.org.uk 60 After the Virus Chapter 6: Monetary Policy
Our Recommendations
The Bank of England’s remit Conduct a review of the framework within which the Bank of England operates, while maintaining the commitment to full operational independence. As part of the review of the Bank of England’s remit, strong consideration should be given to the idea of nominal GDP targeting.
cps.org.uk 61 After the Virus Introduction the markets and ensures that politicians cannot drive the economy to overheat One of the strangest aspects of the simply because there is an election economic debate in Britain is the way in looming. which so many in politics and the media Likewise, while the Treasury has found ignore the vital importance of monetary it necessary to request an extension of policy. the Ways and Means Facility, we cannot allow this to evolve into direct monetary A relatively small tax tweak can dominate financing, with the Bank creating new the headlines for weeks, while the money to fund fiscal policy on an ongoing purchase of hundreds of billions in bonds basis. We cannot print our way out of this by the Bank of England passes almost crisis or any future ones – and resorting unnoticed. to the magical money tree would result in The coronavirus crisis has shown, yet us reaping the bitterest of fruit. Wringing again, how important monetary policy inflation out of the economy was a actually is. Throughout the crisis, the hard-fought process, but has delivered Treasury and the Bank of England have incalculable economic benefits. To let it rip worked closely together to mitigate the once again would be to voluntarily expose economic effects – even to the point, as ourselves to a crippling and debilitating mentioned above, of the Bank directly economic disease. assisting with the financing of Government This is why any temptation to inflate operations. away the debts we have incurred from This chapter, however, will not contain a coronavirus must be resisted. Such an long list of recommendations – because approach would be like the swingeing the most important thing we can do in one-off taxes on wealth that many on the terms of monetary policy is to follow the Left would like to see – not a responsible old medical maximum of ‘First, do no harvest, but a pulling up of the crop harm’. by the roots which would leave us far poorer in the long term. Sound money The unfortunate truth is that many of the has been, and must be, a cornerstone of ideas proposed for reform of monetary Conservative economic doctrine. policy in the UK are very bad ones. That is because they mostly come from those So what can we do - beyond ensuring that on the Left who want to find a pretext for monetary policy is as accommodative as massively increasing state spending – possible during the recovery? without owning up to the huge tax rises on One suggestion is that, while the Bank ordinary Britons that such a programme of England’s operational independence would require. must be maintained, it may well be time For example, while it is absolutely right to review the framework within which the that the Treasury and the Bank of England Bank of England operates. This is very much have worked closely together during a matter for Parliament and the Government this crisis, it would be a huge mistake if to consider – especially because that this led to any long-term change in the framework has remained essentially status of the Bank of England, making it unchanged since Bank of England completely subordinate to the economic independence was introduced in 1997. policies of the government of the day. In recent years, an alternative to inflation The Bank’s operational independence is targeting, based on nominal GDP growth, critical - it lends it invaluable credibility in
cps.org.uk 62 After the Virus has been gaining support in academic or barriers to trade increase. Tightening and policymaking circles. Because this monetary policy to bring inflation down is such a big idea, we want to take the would choke the economy when it was time to explore the argument more fully already weakened by other factors. than elsewhere in this paper – although In some ways, then, inflation targeting any change should only be made after is already a polite fiction. Under a strict extensive review, with the full engagement interpretation of its remit, the Bank of of the Treasury and the Bank. England would have tightened monetary The inflation targeting regime policy in response to a no-deal Brexit, on the grounds that inflation would spike as We have been targeting inflation since imports got more expensive. This would the early 1990s, and in many ways that have triggered a sharp economic downturn regime has been a success. It has certainly at the worst possible moment. In reality, increased transparency and boosted just as the Bank sensibly responded to the confidence in the financial markets. Most Brexit vote by loosening monetary policy, importantly, it has kept inflation low and it most likely would have done the same in stable. It is easy to take that for granted the event of no deal. now, but it was definitely not the case in the 1970s and 1980s. The Bank of England, in other words, frequently ‘looks through’ short-term The Bank of England currently targets a inflation figures in its efforts to get monetary 2% annual rate of CPI inflation. If inflation policy right – and its remit explicitly departs from that target, the governor of the recognises that economic shocks can Bank of England has to write a letter to the knock inflation off target. Chancellor explaining what has gone wrong, and how the Monetary Policy Committee The trouble is that it isn’t always clear in real intends to get things back on track. time what is causing inflation to rise and fall. And making the wrong judgement – as Yet since the financial crisis, it has become arguably happened before the financial increasingly clear that inflation is not crisis and in its early stages – can have very always the best guide to what monetary serious consequences. policymakers should do at any given moment in time. There are two further problems. Firstly, a monetary policy regime that requires the The big problem is that inflation can change Bank of England to effectively ignore its for reasons that don’t actually require a central target on a regular basis is bound to monetary response. For example, if cheaper lose credibility over time. Secondly, a target imports or rising productivity cause prices that tends to point in the wrong direction in to fall, the Bank of England should not times of crisis is bound to inhibit monetary loosen monetary policy to bring prices policymakers from responding as rapidly them back up, as it would risk building and as dramatically to unfolding events as up unsustainable bubbles or causing the the circumstances may require. economy to overheat. Some people argue that this is precisely what happened in the We certainly should not cast aside inflation run-up to the financial crisis. targeting without a second thought. But given its apparent weaknesses – which Conversely, inflation sometimes rises appear to be becoming more pronounced above target because commodities like over time – it is right we ask whether we oil become more expensive, taxes go up, can improve on the current regime.
cps.org.uk 63 After the Virus Targeting nominal GDP commercial bank reserves (the base rate) and/or buying more assets (quantitative Many outstanding economists and central easing). If total spending grew too fast, the bankers have been putting forward different opposite would occur – the Bank would views of how monetary policy should work tighten monetary policy by selling assets or going forward. But we are most persuaded raising the base rate (or some combination by the idea of nominal GDP targeting as a of the two). potential alternative – not least because of the difficult economic situation we currently Since nominal GDP is effectively composed find ourselves in. of real growth and inflation, keeping it on a stable growth path implies lower inflation For those who are unfamiliar with the when the economy grows strongly, and concept, nominal GDP growth is a measure somewhat higher inflation when it grows that combines real economic growth (the slowly, or even shrinks. This is actually numbers we are used to seeing) and one of the great advantages of targeting inflation. So if you had 2% growth and 2% nominal GDP: it ensures that monetary inflation, your nominal GDP growth rate policy is automatically countercyclical, would be 4%. Another way to look at this is keeping the economy from overheating in to say that nominal GDP is equivalent to the good times but also stimulating demand total level of spending in the economy over when times are tough. And as with the a given period. current inflation targeting regime, it never lets the inflation genie out of the bottle. It makes sense for the Bank of England to target nominal GDP, because this total Targeting nominal GDP – or total spending spending is a vitally important variable – has a number of other advantages: in the modern economy. It basically determines how much money is available to 1) A nominal GDP target combines the pay wages, honour debts and meet other Bank of England’s primary objective financial obligations. Pretty much every (controlling inflation) with its secondary contract out there is implicitly based on objective (supporting the Government’s certain expectations of future spending economic policy) in a single, growth, so if total spending is suddenly independently verifiable metric. By lower than expected, there won’t be focusing on a target that encapsulates enough money to go around. The result different aspects of the Bank’s remit, is that workers will lose their jobs, debts we would increase its transparency and will go unpaid, and companies will fall into accountability, while also preserving its bankruptcy. operational independence.
On a micro level, this happens all the 2) Total spending is a nominal variable, time – it is part of the cut and thrust of a which means that the Bank can influence dynamic, competitive economy. But when it quickly and directly by controlling such a spending shortfall happens at a the supply of and demand for base national level, the result is recessions, and money. By contrast, inflation is a real sometimes even depressions. variable that can come about for all sorts of reasons. It makes sense for the Nominal GDP targeting, then, means setting Bank to focus on a target that it almost monetary policy so that total spending always has the power to determine. grows at a stable, predetermined rate. If Though it is important to note here total spending fell below expectations, the that the composition of nominal GDP – Bank of England would loosen monetary how much inflation and how much real policy to bring it back up to target, by growth – will always be determined by reducing the interest rate it pays on real economic factors. cps.org.uk 64 After the Virus 3) Nominal GDP targeting is a very effective inflation during a downturn means that tool for ensuring that unemployment the real burden of debt falls, never rises too far above its ‘natural’ so borrowers are more easily able level. Generally, when total spending to keep up with repayments. At the in the economy falls, employers find same time, the lender makes a lower they don’t have enough money to real return. In a sense, then, nominal meet wage demands. So you get mass GDP targeting shares the risk of an unemployment and the downward economic downturn between the economic spiral that entails. If wages borrower and the lender. could quickly adjust to changed economic conditions, this mass The same thing happens, but in reverse, unemployment would not occur. But when the economy booms. Rapid that doesn’t happen because wages economic growth would usually mean are ‘sticky’ – employers seem to prefer windfall gains for borrowers. However, making redundancies to cutting pay, and if inflation is unexpectedly low during employees find it hard to accept falling a boom – as would be the case with wages because their biggest expenses nominal GDP targeting – real debt (like rent or the mortgage) are fixed. payments would effectively rise. This would mean that the gains from a With nominal GDP targeting, the growing economy would be shared moderately higher inflation you would between the borrower and the lender – get during a downturn would mean that just as the losses were in the previous most businesses would still have enough example. cash coming in to pay existing wages. Real (i.e. inflation-adjusted) wages would Another way to put this is to say that be falling to reflect lower real output, but nominal GDP targeting would, because you wouldn’t get economy-wide layoffs. of its counter-cyclicity, make debt function a lot more like equity, with both We need to stress here that nothing the upside rewards and downside risks Bank of England does can save every shared between both parties. Nominal job or protect every business. That’s GDP targeting would therefore make not how markets work – the economy the financial economy significantly more will always have to adapt to changed resilient to wider economic shocks. That circumstances and sometimes that can only be a good thing. adjustment can be painful. The point of nominal GDP targeting is to avoid 5) Nominal GDP targeting offers a path a generalised slump and ensure that towards monetary policy normalisation in workers who are laid off are able to find the medium term. work fairly quickly elsewhere. It’s also Ever since the financial crisis, we have worth pointing out that nominal GDP become used to extraordinary monetary targeting could help to boost real wages policy, with interest rates at or close when the economy grows strongly, by to zero, and central banks making keeping inflation lower than the existing wave after wave of large-scale asset 2% CPI target. purchases. For the most part, this has 4) Nominal GDP targeting is also a very been entirely necessary – but that good way of ensuring financial stability doesn’t mean it isn’t an unhealthy state throughout the economic cycle.99 Higher of affairs over the long run.
99 For a good explanation of this idea, as well as references to recent academic work on the topic, see David Beckworth, ‘Facts, Fears, and Functionality of NGDP Level Targeting: A Guide to a Popular Framework for Monetary Policy’, Mercatus Center, p14, link cps.org.uk 65 After the Virus Raising total spending to hit a nominal The targeting transition GDP target would not change this in the short run: in times like these, it would Before any change in the monetary mean more quantitative easing and framework took place, we would need to maintaining a low Bank of England base work out how to make such a transition at a rate. But over time, so long as the Bank’s time of major economic upheaval. commitment to keep nominal GDP on a Clearly, there would be no sense in stable growth path was seen as credible the Bank of England trying to produce, and binding, market expectations for say, 4% nominal GDP growth this year. inflation and total spending would start The coronavirus pandemic has led to a to rise, pushing up nominal interest rates. massive fall in real output and the inflation In turn, this would allow the Bank to necessary to hit that 4% nominal GDP raise the base rate away from the zero target would be hugely distortionary. lower bound and reduce its reliance on quantitative easing. It could also let its Similarly, given how much economic activity stock of government and commercial has been suppressed this year, you would debt dwindle as it matured, or sell assets both want and expect much faster ‘bounce- back into the market if spending growth back’ growth in 2021. took off. In other words, a nominal GDP target could eventually help to shrink the But a properly designed targeting system Bank’s balance sheet and get interest would accommodate such exceptions - rates back to historically ‘normal’ levels. because the best way to do nominal GDP targeting is not by simply aiming for an Incidentally, this also explains why we annual growth rate, but instead by targeting should avoid the siren call of those a predetermined path for total spending who say we can reduce government over the years ahead. If you deviate from debt by simply having the Bank of that path in year 1, you should try to make England write-off gilts it has acquired up the difference in subsequent years, so through quantitative easing. Such a that total spending gets back on track. step would, of course, amount to direct This is an idea that economists call ‘level monetary financing on a massive scale targeting’. – abolishing the all-important distinction between fiscal and monetary policy, One of the big advantages of level undermining Britain’s reputation as a targeting is that it offers strong ‘forward responsible borrower, and potentially guidance’ to financial markets and helps causing long-run inflation expectations to shape expectations in a positive way. to get out of control. But it would also, And because level targeting requires crucially, deprive the Bank of the tools the central bank to make up for past it needs to manage the money supply problems or mistakes, you don’t get the in future. Monetary policy should never slippage in market expectations over be seen as a one-way street, on which time that occurs with the current inflation- ‘expansion’ is the only direction of travel. targeting regime. At some point, economic conditions Our suggestion for implementing nominal will dictate a different approach, and GDP targeting, then, would be as follows. the Bank will want to sell assets to First, take an average of market forecasts tighten the money supply. Cancelling of nominal GDP growth in 2020, 2021 and government debt held by the Bank 2022 from before the coronavirus pandemic would undermine that possibility. hit. Second, use those forecasts to plot
cps.org.uk 66 After the Virus an expected path for nominal GDP over The graph below gives an indication of how the same years. Third, charge the Bank of this might work. The blue line represents the England with getting our actual nominal path of a nominal GDP index as professional GDP numbers to converge with that pre- forecasters expected it to look before the crisis path by the end of 2022. The Bank current crisis. The orange line shows how should pledge to do whatever it takes to the Bank currently expects nominal GDP meet this objective. to develop, based on its latest forecasts.
The Nominal GDP Gap100
The initial goal of the new monetary regime inflation expectations and trend growth would be to make these two lines converge rates that would make a lot of sense. before the end of the forecast period, Ultimately, though, the exact number setting whatever base rate and conducting matters a lot less than the commitment to whatever open market operations as might hit some credible target and to make up be necessary to do so. If this results in for any inevitable deviations from the target inflation being slightly higher than would path in future years. otherwise have been the case, so be Of course, we do not want to make it it – but once we commit to getting total sound like nominal GDP targeting is some spending back on track after lockdown kind of panacea. It is obviously only part is over, we will give the private sector the of the solution to our current economic confidence it needs to generate more real problems – an improvement over the growth as well. status quo, but not a silver bullet. We also Looking further ahead, you would want want to be clear that there is plenty of the Government to set a clear target for room for discussion here. Nominal GDP the future path of nominal GDP growth. targeting has been an increasingly popular Four per cent annual growth is the number idea among monetary economists over usually suggested and given current the last decade or so. Leading British
100 For a detailed exploration of this concept, see David Beckworth, ‘The Stance of Monetary Policy: The NGDP Gap’, Mercatus Center, link cps.org.uk 67 After the Virus thinkers such as Lord O’Neill and Gerard most part this is a feature rather than Lyons have endorsed it in recent weeks.101 a bug, since it makes monetary policy And we are persuaded by its benefits. under nominal GDP targeting strongly But before making any decision of such countercyclical. Research from the US enormous consequence, we need to have suggests that nominal GDP targeting open and honest debate about its merits. would not lead to wild swings in inflation.103 But we would need to conduct our own In particular, we think there are three detailed analysis on this issue before fears about nominal GDP targeting that its making any definitive shift away from advocates are going to have to address. inflation targeting. Firstly, we know that our existing GDP data Finally, and arguably most importantly, can be unreliable and subject to frequent there is the issue of public understanding. (and sometimes significant) revisions. This Whatever its flaws, inflation targeting is could pose practical problems for a central at least well understood by the British bank relying on nominal GDP to make people. That helps the Bank to anchor monetary policy decisions. This is another our expectations and helps us to hold reason why, as outlined above, we need to the Bank to account. By contrast, nominal use technology to improve the speed and GDP is a widely discussed concept accuracy with which we gather economic among economists, but quite obscure to data. the general public. This should not stop Another possibility is that the Bank us adopting nominal GDP targeting if of England could focus on surveys it is the right thing to do. But we would of professional forecasts and market need to work hard to educate the public, expectations when making its policy developing accessible ways of presenting decisions, rather than relying on outturn and talking about the relevant economic data. This is what Scott Sumner, the data so that people understand what economist who popularised nominal GDP is happening and why. Transparency targeting after the financial crisis, favours. and clear communication from both the As well as helping to overcome the data Treasury and the Bank of England would problem, he says that ‘targeting the be essential to making any change to our forecast’ would make the Bank’s decisions monetary framework a success. more forward-looking and proactive.102 Ultimately, whatever changes we might Secondly, people worry that nominal GDP make to monetary policy, we need to be targeting might cause inflation to be more absolutely clear about the fact that no volatile than we have become used to in central bank can, by itself, generate real the last 20 years. Unexpected inflation growth or long-run improvements in living always has economic costs, making it standards. Only a dynamic, free market harder for individuals and businesses to economy, supported by an efficient and plan for the future, so this is a concern that effective government, can guarantee that. we ought to take very seriously. What monetary policy can do, however, Some variability in inflation is inherent is create the macroeconomic conditions to nominal GDP targeting. And for the in which a competitive private sector is
101 Jim O’Neill, ‘It’s Time to Target Nominal GDP’, Project Syndicate, link; Gerard Lyons, Warwick Lightfoot, and Jan Zeber, ‘A Pro-Growth Economic Strategy’, Policy Exchange, pp27–28, link 102 See Scott Sumner, ‘The Case for Nominal GDP Targeting: Lessons from the Great Recession’, Adam Smith Institute, link 103 David Beckworth, ‘Facts, Fears, and Functionality of NGDP Level Targeting: A Guide to a Popular Framework for Monetary Policy’, Mercatus Center, p20, link cps.org.uk 68 After the Virus able to thrive. And in our view, adopting it would require the Bank of England to nominal GDP level targeting could be keep total, economy-wide spending on a the best possible way to ensure that stable growth path, and make up for any such a macroeconomic environment deviations from that path in subsequent prevails in the years ahead. We therefore years. Yet monetary policymakers do not urge the Treasury, in consultation with the have it within their power to determine how Bank of England, to start thinking about that spending breaks down between real and planning for a hypothetical transition, output and inflation. It would still be up to while taking the public – and the financial the government to maximise real growth by markets – with them every step of the pursuing the kind of policies we have way. outlined elsewhere in this report – policies If we did adopt nominal GDP level that boost investment, promote enterprise, targeting as our new monetary framework, and advance prosperity.
cps.org.uk 69 After the Virus Conclusion
The Rt Hon Sajid Javid MP More important than the specific details, however, is the spirit which animates The coronavirus crisis represents an them - and which should be central to any extraordinary economic challenge for recovery agenda, especially one overseen governments across the Western world, by a Conservative Government. Britain’s included. Coping with the This relies on a recognition that flexibility consequences will require a blend of is needed to cope with the consequences agility, flexibility, imagination and bravery. of the crisis - that we should not rush The early talk of a V-shaped recovery may to raise taxes or slash spending if it will have died away. It is clear already that the choke off the recovery. But we need to impact of the crisis, the need to maintain remain committed in the medium and long forms of social distancing, and the blow to term to those vital values of sound money, consumer and business confidence, are balanced budgets, low borrowing and low going to represent formidable headwinds taxes. And to those we need to add a new to renewed economic growth. commitment to invest in infrastructure in order to drive growth across every region But it is still within Government’s power to of this great country. determine much of the speed and scale of recovery. Indeed, this is - alongside Growth, indeed, is the only thing that containing the pandemic itself - the single will get us out of this crisis. And that most important task facing my former growth can only be driven by a robust colleagues in the Cabinet. private sector, supported by world-class infrastructure and incentivised to hire and This report contains dozens of invest. If we get it right, we can not only recommendations. I have no expectation rebuild the economy but put it on even that they will be adopted wholesale. firmer foundations than before. Instead I, and my co-authors from the Centre for Policy Studies, offer them to the Government as the best measures we can think of at this time to promote recovery.
cps.org.uk 70 After the Virus © Centre for Policy Studies 57 Tufton Street, London, SW1P 3QL June 2020 ISBN 978-1-910627-84-6