Never Mind Benefits – The Problem Is UK Productivity

For a statement initially viewed as “inconsequential” and “one to forget”, the political shockwaves from George Osborne’s mid-March budget continue to reverberate.

The rumblings over the planned £1.3bn-a-year “cut” to disability benefits, specifically Personal Independence Payments, started early. I use inverted commas because the Chancellor actually proposed a reduction in the planned increase in spending on PIPs – made to adults with long-term disabilities that restrict mobility and the completion of daily tasks.

PIPs expenditure is still set to rise, the budget documents show, from £16.2bn this year to £18.2bn in 2019. And the cost of the benefit has anyway already spiralled. As recently as 2013, the Office for Budget Responsibility put the PIPs bill for 2019 at around £14bn. Yet Osborne just allocated over £4bn more for PIPs spending that year in his latest budget.

Such details are irrelevant, of course. For even this hefty cash increase could result in a real-terms reduction under certain inflation scenarios. And making such “cuts” while also “lowering taxes for the rich” – trimming the higher-rate threshold and reducing corporation tax – was always going to be tough if the press chose to make the link.

Iain Duncan Smith’s resignation made sure they did. At a stroke, Osborne’s post-budget tremor escalated into a full-blown political earthquake. Denouncing Osborne’s disability benefits as “indefensible”, the Work and Pensions Secretary quit within 48 hours of the budget. That happened even though the government was already retreating from the PIP changes – and has since scrapped them altogether.

The new Work and Pensions Secretary, the youthful Stephen Crabb, not only reversed the PIPs changes in fact, but ruled-out further reductions in welfare spending between now and 2020. I don’t believe him for one moment. The form of words the youthful Crabb used – “no plans to make welfare savings” – bring to mind Michael Heseltine’s infamous claim to have “no plans” to challenge Margaret Thatcher as Conservative leader just months before he did.

The political fall-out from Osborne’s eighth budget, and the government’s reaction to it, must be seen through the prism of the upcoming referendum on the UK’s European Union membership that is now just 12 weeks away. The main aim of Osborne’s budget was to avoid annoying anyone – so as to draw support for Remain from as wide a spectrum as possible.

With the majority of Conservative voters likely to back Leave, the government badly needs the backing of Labour, Lib Dem and SNP supporters who might be tempted to use their referendum vote as a way to kick a Tory government. That’s why, at a stroke, Downing Street responded to Duncan Smith’s resignation, and the then inevitable disability benefits furore, by blurting out a entirely irresponsible and ultimately meaningless pledge to make no further attempt to rein-in this country’s huge welfare bill. That’s despite a budget deficit still beyond 5pc of GDP and the very real danger of now failing to achieve even a single annual budget surplus after 10 years of Conservative rule.

It’s also why Number Ten sought to close down a potentially explosive Commons rebellion over VAT on women’s sanitary products and solar panels. Instigated by an unlikely alliance of Eurosceptic Tory MPs, and various opposition backbenchers, the row could have become a rallying call for the Brexit camp, highlighting Brussels’ on-going control over the UK’s indirect tax rates.

To head off trouble, and keep anti-EU headlines to a minimum, the government held its collective nose and took the highly unusual (and politically rather demeaning) step of accepting, effectively uncontested, two Labour amendments to the finance bill implementing Osborne’s flagship budget-day measures.

Duncan Smith’s resignation, I would say, was partly about his long-term frustration with Osborne’s Treasury – this time manifest in changes to disability benefit that went further than he envisaged – but partly about his long-term backing for Brexit. Rid of government responsibility, he’s now free to campaign even more passionately for the UK to quit the EU. And the government’s “hands up, we’re the good guys” response to Duncan Smith’s departure, abandoning not just the PIP changes but any pretence of fiscal discipline, was entirely about the upcoming EU vote.

The Tories, in the run up to 23rd June, are desperate to be loved, or at least not despised. Expect increasingly bizarre behaviour over the coming weeks – with Cameron cosying-up to the Lib Dems, and Osborne wooing Labour. We’re in for a close Yes-No referendum, which could easily go to the wire. Every vote will count. With another migrant crisis looming and continued fall-out from last week’s terrorist atrocities in Brussels, the government needs all the support for Remain it can muster – and doesn’t care where it comes from.

While this will be remembered as a pre-referendum budget, it may also been seen in retrospect as the budget when the UK’s “productivity problem” really came to the fore. While Osborne didn’t mention productivity much, the concept was at the heart of detailed analysis conducted by the OBR’s independent analysis.

For UK productivity – broadly defined as value generated per hour worked – has recently plunged. Between 1994 and the start of 2008, UK productivity grew by 1.9pc a year, driving up real wages and broader economic growth. Since the financial crisis, though, the OBR calculates productivity is up just 0.1pc per annum, with a sharp deterioration over the last six months.

This is a problem. Our weak productivity performance hits incomes and profits, undermining consumer spending and investment, translating into lower growth and tax receipts. Poor productivity growth explains the OBR’s heavy down-grading of the UK’s growth forecasts, rather than “turbulence from abroad” – a blame-shifting phrase Osborne now uses frequently, as did his Labour predecessor Gordon Brown. Poor productivity growth explains the unravelling of the Chancellor’s fiscal forecasts.

Why is UK productivity so weak? The usual reasons cited include our relatively poor vocational education and training and the need for a wholesale infrastructure upgrade – particularly transport and power generation. More generally, as manufacturing has fallen from around a third of the British economy 40 years ago to just a tenth today, with services expanding, the scope for productivity gains in a “post-industrial” nation like the UK are simply lower.

I recognise some truth in all of these explanations.
Since the financial crisis, though, other factors have driven the productivity plunge that are barely acknowledged – seeing as they involve our all-powerful banking sector.

A major reason why productivity growth has dropped since 2008 is that ultra-low interest rates mean banks have no incentive to lend to the innovative firms – particularly small-and-medium-sized enterprises – that have traditionally been the seedbeds of so much UK productivity growth. UK banks today are typically only interested in secured lending, such as property. Given that base rates are nailed to the floor, and effectively negative in real terms, banks can secure a perfectly profitable 4pc spread on low-yielding deals.

If base rates were “normalized” – back at 4pc-6pc, as they’ve typically been in recent decades – then banks would need to search for a critical mass of higher-return investments to make a decent margin, which would often involve productivity-boosting activities including the development of new and innovative products.

Yes, finance can sometimes be found elsewhere beyond the banks. And, yes, we’ve seen the emergence of crowd-funding. But let us not kid ourselves. The UK economy isn’t growing properly, and our public finances remain precarious, because productivity is weak. And a key reason for that weakness is our still deeply irregular monetary policy and the on-going fragility of a highly-impaired UK banking sector

Follow Liam on Twitter @liamhalligan

http://www.telegraph.co.uk/business/2016/03/26/never-mind-benefits-the-problem-is-uk-productivity/