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How the UK Government Could Act to Support Growth

More QE is not the answer. The Chancellor should set out clear supply-side agenda...

TUESDAY'S UK GDP release showing 0.5% economic growth in the third quarter of 2011 is welcome. It was better than expectations. The UK economy is still growing – albeit less slowly than we would like, writes Andrew Sentance, former member of the Bank of England's Monetary Policy Committee.

The weakness of the recent GDP figures has put the spotlight on what the government or other official bodies (such as the Bank of England) can do to support growth. As I have made clear in earlier blogs, I don't support further demand stimulus through additional rounds of Quantitative Easing. Nor do I think that it is right for the government to back away from its deficit reduction plan.

Reverting to more monetary and fiscal stimulus involves pumping more demand into the economy. It was right to do this in 2008/9 when there were very negative demand trends. But we now face a problem of persistent inflation, alongside slow growth. Stimulatory demand policies in this environment risk making inflation worse without helping much on the growth front. Tempting though it is to go down this route, it is not the right approach in the current situation.

So what is the way forward if we want to support growth in the UK economy? Stimulating demand is a temporary fix. The way in which government can help support economic growth and employment on a longer-term basis is through supply-side policies, which aim to improve the environment in which business operates and help the functioning of market mechanisms which support economic growth – especially the operation of the labour market.

There are a wide array of policies which can be deployed to help supply-side performance of the economy. They tend to be more slow-burning than demand-side policies – with an impact over 5-10 years rather than 1-2 years. But effective supply-side policies can also help to boost business confidence, which is a major issue at the moment.

In his Autumn Statement, at the end of November, George Osborne has an opportunity to set out a much clearer and coherent supply-side agenda to support the growth of the UK economy. Here are three areas for him to focus his efforts.

1) Youth unemployment

We need a much stronger programme of measures to help younger unemployed workers get into work. Many companies have held onto their skilled and experienced workers through the recession – which is a good thing. But in the current uncertain economic environment, it also means they are reluctant to take on new recruits, particularly where they are lacking in skills and experience. 

While there are already a number of initiatives in this area, we need a bolder approach. Young people who have been unemployed for over 6 months should be able to take their benefit payments to an employer as a job subsidy. As long as the employer pays national insurance payments, they should not have to worry about wage costs. Over a period of time (12-24 months), the job subsidy would be phased out and an employer would be expected to pay the regular minimum wage or higher. But by using the benefit system to give young workers help in getting back into employment, we can reduce the risk that they become part of a persistent long-term unemployment problem in the future.

2) Tax reform

We have not had a serious tax-reforming Chancellor in the UK since Nigel Lawson, who left office over twenty years ago. The Institute of Fiscal Studies has recently published a radical tax-reforming agenda, based on a Review chaired by Nobel prize-winning economist Sir James Mirlees. 

Not all the recommendations of the Mirlees Review are politically feasible. But it should be a launch-pad for a new wave of UK tax reform, aimed at reducing tax rates and phasing out exemptions to spread the burden of tax more fairly. The aim should be to create a tax structure which is much more favourable to wealth creation because it spreads the burden of tax more widely and fairly across society – avoiding the need for high tax rates which discourage economic activity.

3) A bonfire of business regulation

Over the long period of growth from the mid-1990s until the onset of the financial crisis, it was very easy for government to add to the burden of regulation of business. The economy was buoyant, at home and abroad, so businesses tended to absorb the costs. These same regulations are now operating as an impediment to growth. The red tape surrounding taking on new workers and expanding business needs to be cut back urgently. The UK planning system is particularly cumbersome and there should be a fast-track planning procedure (maximum 6 weeks) for any business development proposal which will create more than 20 new jobs. The Business Secretary, Vince Cable, should be leading the charge in this area and challenging his Cabinet colleagues to cut back in the burden of regulation across government.

In the depths of the financial crisis, the main challenge for economic policy-making was to stabilise demand in the short-term. The challenge is now different – it is to provide confidence for medium-term growth prospects. Supply-side policies aimed at improving the business climate and supporting the flexibility of the economy are what is now needed. That should be the main focus for the Chancellor's Autumn Statement later this month.

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Now senior economic advisor to PricewaterhouseCoopers and part-time professor of sustainable economics at the University of Warwick in England, Andrew Sentance is a British business economist who from 2006 to 2011 served on the Bank of England's Monetary Policy Committee. Consistently calling for higher interest rates to combat rising inflation during his last 12 months in the role – and overwhelmingly outvoted each time – Dr. Sentance today shares his views on macroeconomic and monetary developments in his weekly blog, The Hawk Talks. His previous roles include senior economist at the Confederation of British Industry (CBI), chief economic advisor to the British Retail Consortium, and chief economist at British Airways.

See full archive of Andrew Sentance articles

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