Squaring the Circle

There are no good elections to lose – but some are better than others to win. Yesterday demonstrated both sides of the equation.

In his Mansion House speech, the Chancellor announced new fiscal rules designed to bind the hands of governments to deliver surpluses ‘in normal times’. This Andrew Lilico article describes why reducing debt/GDP levels matters, while the chart in this piece demonstrates just how rare annual surpluses are in reality. The real impact will be political though: governments are able to set baselines like this and dare oppositions to deviate from them.

On the other side of the equation, some detail began to emerge on how the Government intends to deliver a £12 billion reduction in welfare spending. On Newsnight Allegra Stratton suggested that savings will be sought through cuts to tax credits – but the problem is how to square this with a One Nation message and its emphasis on working people.

Damian Green suggested that one way of squaring the circle would be to encourage more companies to pay the living wage. But there are two problems with this. The first is whether the government has the mechanisms, beyond exhortation, to increase take-up of the living wage enough to fill in the gap. The second is that the living wage itself is calculated assuming that people take up tax credits. If tax credits are cut, the level of the living wage would need to rise even higher, making it harder for companies to meet.

In the long-run the answer lies in another part of the Chancellor’s speech last night: productivity. Ultimately, this is what creates the room for wage rises and the revenue for tax cuts or fiscal transfers. As the Resolution Foundation have shown, if productivity rises in line with the OBR’s optimistic scenarios (rather than their central projection) the government could actually eliminate the deficit without the need for dramatic spending reductions.

This is easier said than done, however. The Chancellor diagnosed a list of problems holding productivity back. As he put it ‘We don’t export enough; we don’t train enough; we don’t save enough; we don’t invest enough; we don’t manufacture enough; we certainly don’t build enough, and far too much of the economic activity in our nation is concentrated here in the centre of London.’

In truth, no-one knows for sure how to solve the productivity puzzle, but we have some ideas. They include more and better apprenticeships, better access to finance for business, further and faster devolution, and more creative ways to generate investment in infrastructure. Demos is working on all of these things – and the Government is producing its own productivity plan in the next month. This is the real key to living standards in the future. In the meantime, the Government has some difficult decisions to make.