Warwick Lightfoot responds to the Labour Party Manifesto
Labour’s manifesto has an ambitious objective: to ‘rewrite the rules of a rigged system, so that our economy really works for the many, and not only the few’. It is expressly collectivist, claiming ‘Labour understands that the creation of wealth is a collective endeavour between worker, entrepreneurs, investors and government’.
Costing Labour’s programme
Eye-catching proposals range from abolishing university tuition fees, to increasing public sector pay, to a programme of extensive nationalisation. The centrepiece is a significant discretionary increase in public expenditure. If the programme were up and running, £48.8 billion would be added to current expenditure — around 2 percentage points of GDP. Labour proposes to spend £250 billion on capital investment over ten years, and has made it clear it would borrow to finance this. That would probably mean an annual increase in public-sector capital formation of around £25 billion, upping overall public expenditure by around a further 1 per cent or more as a ratio of GDP.
Realism about the reliability of revenue from tax increases
Increases in the recurrent programme of spending would be financed from discretionary increases in taxation. If this were to yield the cash scored in the document accompanying the manifesto, the tax burden would rise to just over 36 per cent of GDP — its highest level since the 1940s.
However, the tax measures that Labour claims would raise £37.9 billion would rely on the collection of additional revenue from sources that have often been unreliable. Marginal income tax rates above 40 per cent rate do not bring in significant extra money; tax avoidance measures rarely raise the cash that chancellors score in their budget Red Books; the international corporation tax base has become increasingly mobile. The extension of Stamp Duty Reserve Tax to derivatives, and the removal of the exemption of market makers from the tax is scored in the manifesto as being able to raise £5.6 billion. Yet the ‘Robin Hood tax’ in countries including France and Italy has been disappointing in terms of forecast revenue receipts.
Has the spending been comprehensively scored?
The level of expenditure that might have to be financed by borrowing to fund everything in this manifesto is probably greater than the costing offered. It is unclear if all the increases in the capital programme — such as higher hospital expenditure — would be contained within the £250 billion National Transformation Fund. The ending of council house sales would, for example, result in lower receipts from asset sales.
Neither is the financing of the proposed programme of nationalisation identified in terms of costs. Parts might be accomplished by franchises coming up for renewal, but the nationalisation of the water industry, for example, would involve a cost that is not identified (although it is worth noting that water companies have a total Regulated Capital Value of £69bn). Moreover, nationalised industries in the transport and utility sectors have voracious appetites for new capital investment, which would have to be added to the government’s capital programme.
Even if guidance were provided to the National Statistician on the accounting conventions to be used for scoring investment and borrowing in public corporations, it would not alter the fact that money would need to be spent — money coming immediately from taxpayers, or from delayed taxation in the form of government borrowing, financed by debt service charges on the public sector.
Eroding the supply performance of the economy
The manifesto includes a series of measures that, in the long term, would significantly erode the supply performance of the economy. Aside from a higher tax burden and higher marginal tax rates, a return to collective wage bargaining led by the trade unions is at its heart. Labour wants to end the UK labour market’s flexibility. A flexible labour market makes recruitment easy, and enables an economy to adjust to adverse shocks through price adjustments rather than quantity adjustments, which is why the UK weathered the Great Recession better than most other countries. However, the malign micro-economic consequences of Labour’s programme would only become apparent over many years, and would not be fully exposed until the economy suffered a severe adverse shock.
A world cast in aspic?
Much of Labour’s campaign and manifesto are couched in nostalgia, looking back to the 1970s and 1940s. Many of the party’s proposals represent an attempt to frustrate the visible effects of high-street change, which have arisen from wider alterations in banking, retailing, and lifestyle and leisure.
Labour wants to strengthen planning legislation to bolster local authorities with fuller powers, yet the planning system is the most obvious constraint on the supply performance of the UK. The party’s approach would not simply further constrain changes in land use and building, but would also contribute to communities exhibiting the appearance of their former economic purpose as though set in aspic.
Labour’s programme would not transform the economy or British society over the course of the next parliament; an additional three or four percentage points raising the share of public spending within GDP would not be transformative. Rather, it would raise taxes, and result in poorly-focused public expenditure initiatives, and awkward questions about rates of return on spending and the deadweight costs of the higher spending. In practice, it would not be much different from the discretionary increases in public spending programmes that Gordon Brown directed at the Treasury.
What can go wrong will go wrong
Labour also underestimates what can go wrong. It is not clear that the manifesto fully scores the whole of its capital programme, and the borrowing involved. Yet the country’s tax receipts are vulnerable. Labour is proposing a big increase in public spending when the economy is in the mature phase of the economic cycle, and has little spare capacity; the trend rate of growth is significantly lower than the 2.75 per cent figure the last Labour government mistakenly relied on in its economic forecast; and the UK economy has a large balance of payments deficit, which has to be financed through the capital account.
A Labour Chancellor implementing this programme might have more difficulty in retaining the confidence of international rentiers than any since Denis Healey. There are two macro-economic challenges that would arise. The first relates to how its proposals represent a discretionary fiscal stimulus to an economy operating with little or no spare capacity. Unemployment is at a forty-two year low of 4.6 per cent, and the economy is exhibiting some domestic price pressures over and above the pass through from the lower exchange rate. A further fiscal expansion would aggravate the UK’s balance of payments challenge, and increased capital spending would inevitably boost specific imports necessary for the investment programmes involved.
The second challenge relates to the government’s funding programme, which has to finance a large stock of public debt. Interest rates are at very low levels, but at some stage will rise. Given the inverse relationship between bond prices and interest rates, there is potential for significant capital losses on bond portfolios when rates do eventually rise. There is appetite for gilts and long-term gilts, in particular, from insurance companies and pension funds. Recent changes to prudential banking regulation effectively require banks to hold greater amounts of capital than before. The Bank for International Settlements points out that this is one of the reasons why bond yields remain so low — because banks have to buy government debt. But a chancellor in a Corbyn administration would be unwise to rely on that.
There is already something of a bond-market price bubble. The authorities own £465 billion of gilts through the Bank of England’s Asset Purchase Facility, as a consequence of the programme of quantitative easing. Whether the Bank ultimately sells these gilts back into the market or holds them to maturity, this casts a shadow over institutional gilt portfolios. This year, the Government is expecting to run a deficit of around 2.7 per cent of GDP. In cash terms, it will be £58 billion, but the Debt Management Office will have to issue around £105 billion of gilts, because inter alia with complex transactions in the public accounts, some £79 billion of gilts are maturing.
How does this this manifesto compare with 1983?
The manifesto of Jeremy Corbyn’s radical Labour leadership invites obvious comparison with Michael Foot’s from 1983. They share rhetoric, and a collectivist agenda; both documents draw heavily on trade union policy proposals and analysis. There are, however, two significant differences. The first is that in 1983 Labour proposed leaving the EEC, and was convinced that departure would enable the Common Agricultural Policy to be replaced with a more targeted deficiency payment system. Contrastingly, the 2017 manifesto implies a form of continuity with the EU, and refrains from offering suggestions about reforms on farming, fishing, or EU funding.
Realism about the controls and financial repression required to manage a socialised economy
The other big difference is the thought that the then Shadow Chancellor Peter Shore afforded to the vulnerability of Labour’s proposed economic programme. He identified two challenges: a potential collapse of confidence in the financial markets, and issues presented by the balance of payments. As a former Secretary of State for Trade, he was fully seized of the vulnerability of the external account. His remedy was the reintroduction of exchange controls; controls on prices, wages, and dividends; and controls on imports to protect the balance of payments. His proposed fiscal stimulus was to be financed by borrowing from UK financial institutions, and supported by a monetary policy ensuring interest rates did not rise. In 2017, Labour is proposing an increase in spending of around 4.5 per cent of GDP, at a point in the economic cycle when there is little or no spare capacity. In 1983, the £11 billion programme represented about 3 per cent of GDP, and the economy had an output gap of around 2.7 per cent.
The contrast is striking. Labour’s current socialist programme — while audacious in its rhetoric — offers little or no attention to the policies and controls needed to sustain it. Whether those controls — and resultant losses of economic welfare — would be welcome is a separate matter. Paradoxically, the programme would fail to deliver the radical rhetoric employed by the Labour leader, and would be awkward to finance. Moreover, the changes to labour and product markets would do significant long-term damage to the supply performance of the economy.