A successful economy is a prerequisite for sustaining a progressive agenda. It provides the means to achieve prosperity for all: raising living standards, increasing opportunity, reducing poverty and improving people’s quality of life. And it is the key to Labour winning a third term in government, and hence pursuing its broader progressive aims.
Rightly, Labour’s central economic objective is to achieve high and stable levels of growth and employment. So far, the government has managed the economy well. But it has yet to improve the economy’s long-term performance.
GDP growth has averaged 2.6 percent since 1997. That is a significant achievement, but not an outstanding one. Over the same period, GDP growth averaged 2.4 percent in the European Union and 3.2 percent in the United States. GDP growth also averaged 2.6 percent in the last term of the Major government (1992-6). Britain’s productivity performance is also still weak. In 2002, GDP per hour worked – the hourly output of the typical British worker – was not only eighteen percent less than the productivity of the typical American. It was also less than in twelve of the fifteen EU countries.
Closing the productivity gap, and hence increasing wages, living standards and the ability to fund public spending, requires a combination of three things: improving workers’ skills, higher capital investment and greater innovation. The government has already gone a long way to improving workers’ skills by increasing access to universities, for instance, as well as through its education reforms. But much more effort is needed, notably in improving vocational and technical skills.
Crucial to improving Britain’s productivity performance is higher capital investment. The British economy must do more than match investment rates in continental Europe and the US: it must exceed them. Yet private business investment in the UK was only fifteen percent of GDP in 2001, the lowest rate in the EU. Moreover, despite the government’s commitment to make good for decades of under-investment, public investment in Britain is still half the EU average. Britain’s poor infrastructure – notably our third-rate rail and road network – is now arguably as big a drag on growth as Germany’s outdated labour and product market regulations are on its economy.
Faster innovation is largely a matter for the private sector. But the government can do its bit to help. It can do more to encourage research and development. It can enforce tougher measures to increase competition – the granting of independence to the Competition Commission and the toughening of competition law are big steps in the right direction.
Most importantly, the government can encourage foreign direct investment. Foreign-owned companies account for 40 percent of our manufacturing investment. They benefit the economy as a whole because the new technologies and skills they bring spill over to other firms and they increase the competitive pressures on domestic firms. A third of recent productivity growth, on which companies’ ability to pay higher wages depends, has come from foreign investment.
Britain has many attractions as a location for foreign investment, among them a favourable business climate, the English language, and EU membership. But set against those advantages are our poor infrastructure and self-exclusion from the euro. Since the euro’s launch, Britain’s share of foreign investment in the EU has collapsed – from 28 percent in 1998 to eight percent in 2002, according to the latest OECD figures.
Signing up to Europe’s common currency would go a long way to boosting Britain’s poor productivity performance. According to the Treasury’s own (conservative) estimates, joining the euro could boost economic growth by 0.3 percentage points a year for 30 years. There is nothing in economic theory to suggest that such gains from increased trade are conditional on Britain’s economy having converged with the eurozone’s – and so Britain is missing out on a tantalising prize by delaying its euro entry.
These weaknesses jeopardise the government’s ability to sustain its progressive agenda. Without faster growth, higher public spending will require politically painful tax hikes. Poverty reduction will have to rely more on potentially problematic redistribution than on a general rise in living standards. Improving the economy’s long-term performance is a priority. It is a precondition for achieving the government’s wider social aims.