The economic record of the coalition government: introduction.

Portes, Jonathan

As we approach the 2015 UK General Election, this Review assesses the economic record of the 2010-15 Coalition government. While we cannot hope to be comprehensive, the papers included here cover not just an overview of developments in macroeconomic policy, growth and productivity, but also two of the key areas for medium-term policy reform: education and the welfare system.

First, some context. The 1970s and 1980s were an era of both political polarisation and sharp controversy over economic policy, both macroeconomic and microeconomic. But they were followed, in the UK as elsewhere in most developed economies, by a long period of stability in the general approach to economic management. From 1992 to 2007 there was a remarkable degree of consensus across the political spectrum on economic issues.

As in most advanced economies, monetary policy was taken out of direct political control and assigned to an independent central bank, which was responsible for achieving an inflation target. Fiscal policy, while still macroeconomically significant and occasionally politically controversial at the margin, was not seen as a useful tool for short-term demand management, and was therefore seen as primarily relevant to long-term sustainability.

Microeconomic, or supply-side, policies were directed at improving the workings of markets, either by policy liberalisation (for example, through reducing labour market regulation, the development of the Single Market, or liberalising immigration policy) or by correcting market failures (for example, congestion charging in London). The existing boundaries between the public and private sector remained (so health and compulsory education remained free at the point of use and provided by the state) but various quasi-market mechanisms were introduced to, it was hoped, spur greater efficiency within monopoly providers. In education, greater autonomy was given to schools, and some of the burden of financing higher education was shifted to students.

Within this framework, what dispute there was among the major parties and most economic commentators was not about'positive' economic issues (the basic framework or the efficacy of these policies) but rather (and properly) about normative questions--the appropriate level of taxation and spending on public services and the degree of redistribution implied by the tax and benefit systems.

This consensus was sustained by what appeared to be relatively good results. Particularly in areas where these ideas were applied clearly and consistently, with significant input from economic research and evidence --competition policy, labour markets, welfare reform, and immigration are prominent examples--significant progress was made and the economic benefits are generally recognised. UK growth and productivity performance in the 1979-2007 period was at least reasonable in absolute terms, and better than our major competitors (Corry, Valero and Van Reenen, 2011). Meanwhile, the considerably greater degree of redistribution embodied in the tax and benefit policies implemented by the 1997-2010 Labour government meant that inequality, which rose very sharply between 1979 and the mid-1990s, at least stabilised, while child poverty was substantially reduced (Portes, 2011).

The Great Recession and its aftermath provided a huge shock to this consensus. While the economy had bottomed in March 2009, and recovery appeared to have taken hold, this was after the largest fall in output in living memory. Interest rates were stuck at zero; already, quantitative easing had blurred the separation between monetary and fiscal policy, and between the politicians at the Treasury and the 'technocrats' at the Bank of England. And, most immediately, the incoming Coalition government faced a fiscal deficit unprecedented in peacetime. Meanwhile, the glaring and manifest failure of the 'light-touch' approach to financial sector regulation at the very least caused many economists (including this author) and politicians to question the 'market failure' approach to microeconomic policymaking (Turner, 2010).

So, arguably, the new government faced both a challenge and an opportunity--broad continuity in policy was no longer the obvious default option. Certainly, in sharp contrast to the debate pre-2008 (when the Conservatives pledged to match Labour's spending plans, and the then Shadow Chancellor, George Osborne, criticised excessive financial regulation), the initial rhetoric was of a radical break. The Prime Minister's first major economic speech, in May 2010, claimed the country faced an existential choice:

"Today, Britain is at a turning point. The decisions we make now will live with us for decades to come. For many years we have been heading in the wrong direction. Our economy has become more and more unbalanced, with our fortunes hitched to a few industries in one corner of the country, while we let other sectors like manufacturing slide.

It has become over-reliant on welfare, with mass worklessness accepted as a fact of life and around five million people now on out-of-work benefits. It has become increasingly hostile to enterprise, with business investment in the past decade growing at around one per cent each year--only a quarter of what it was the decade before. It has become far too dependent on the public sector, with over half of all jobs created in the last ten years associated in some way with public spending.

And, of course, as a country we have become indebted on an unprecedented scale. Our huge deficit and rapidly growing public debt are the clearest manifestations of our economic mistakes--the glaring warning sign overhead telling us we have taken the wrong route. We have been sleepwalking our way to an economy that is unsustainable, unstable, unfair and, frankly, uninspiring.

Now that this country is waking up to it, the people of Britain--the people of the world--want to know: can we turn this around? Can we rebalance economic power across our regions, across different industries, so that more people have a stake in our success? Can we end the inevitability of millions on long-term welfare and bring hope to those unemployed? Can we inject new life into the private sector, so that enterprise can drive not just our recovery but the re-building beyond it? Can we go from an economy built on debt and borrowing to one built on saving and investment? Can we re-open Britain for business?" (1)

So, nearly five years on, what does the balance sheet look like? The most prominent and controversial economic policy debate has focused on the Coalition's approach to fiscal policy, and the first article in this issue, by Simon Wren-Lewis, examines the macroeconomic record. He draws a clear distinction between structural and institutional change--the establishment of the Office of Budget Responsibility (OBR) and its remit to judge whether government policy is consistent with its stated fiscal mandate--and the conduct of macroeconomic, especially fiscal, policy. The former has clearly been a success, and he suggests possible further extensions of the OBR's role; the latter largely a failure, in economic if not political terms, albeit mitigated by a partial change of course in 2012.

He argues that accelerated fiscal consolidation in 2010 was, at best, an unnecessary risk. It was a risk because, even though recovery appeared to be underway, interest rates remained at the zero lower bound, while both domestically and internationally there were obvious downside risks--several of which duly materialised. It was unnecessary because, as subsequent theoretical work and empirical evidence have established beyond doubt, the UK (unlike the eurozone) never faced any solvency issues relating to the funding of the deficit (De Grauwe, 2011). While the record is flattered by the fact that eurozone policymakers have made very similar, but larger, more persistent, and hence more damaging mistakes, the damage was nevertheless significant. He concludes:

"The delay in the UK recovery over the first part of the coalition government's term is at least in part a result of the government's fiscal decisions. I have argued that these decisions were a mistake not just in hindsight but when they were taken. It will be many years before we can settle on a figure for the total cost of that mistake, but measured against the scale of how much governments can influence the welfare of its citizens in peace time, it is likely to be a large cost."

Nick Crafts' complementary paper also attempts to understand and explain the UK's poor growth performance, but primarily from a supply-side perspective. He concludes that, for better or worse, and in contrast to the rhetoric above (set out, in much greater length in the Coalition's Plan for Growth), policy has not deviated significantly from the pre-crisis path. Sensible policies have largely been continued and in some places extended (for example, competition and innovation policies, and education). In some areas there have been much-needed improvements (land-use)--although still not matching either the rhetoric or the scale of the problem. On the downside, infrastructure policy (both in terms of institutional structures, and of actual outcomes) remains disappointing, while immigration policy has become more restrictive. He describes the attempt to re-invent 'industrial strategy' as a "quite modest repositioning of industrial policy which is most unlikely to re-balance the economy in the direction of a larger share of GDP originating in manufacturing". Overall, he concludes, "changes in policy under the Coalition government are unlikely to have made a big difference to growth potential. On the one hand, this means opportunities for radical reform have been ignored; on the other hand, there has been no repeat of the 1930s' debacle."

If, as Crafts argues, there has been no major structural break in either supply-side policy or growth potential, what explains the unprecedented weakness in productivity since the onset of the crisis? Vicky Pryce examines the potential explanations for the UK's 'productivity puzzle' and concludes that while it remains just that--a puzzle--most of the explanations point to the demand side, broadly defined.

In particular, she points to an increase in risk aversion, both by businesses reluctant to invest and workers reluctant to seek higher pay or take the risk of moving jobs. This in turn is the result both of the international environment (in particular the problems of the eurozone) and of domestic policy. While Pryce is slightly more negative than Crafts about the government's record, they broadly agree on the appropriate direction for policy on the supply side, in particular on the importance of a stable framework which would allow an increase in growth-enhancing capital investment, and hence in productivity and real wages; she also identifies the importance of innovation and government support for research and development.

The other two papers focus on two key areas of public service reform: education and welfare. Rebecca Allen notes that while education reform was very much seen as conceived and driven by one single individual--Michael Gove--there were nevertheless two important, and still unresolved, contradictions at its (and, implicitly, his) heart. The first was that between a desire to pursue a "well-evidenced and moderate approach to reforming the education system" (in large part representing, as Gove has acknowledged, an intensification rather than a reversal of the previous government's approach) and an attitude to those who actually deliver education (teachers and the broader education system) she describes as "publicly humiliating". The second was between a market-oriented approach to educational improvement (competition, choice, exit and entry) and the centralising tendencies exemplified in a desire to impose a 'traditional' curriculum. She concludes that while the broad direction of structural reform is likely to continue, some elements of planning--in particular, in respect of school places and the teacher workforce--will have to be reintroduced or reinvented.

Finally, Declan Gaffney examines another set of reforms that were also largely driven by one Secretary of State. Although Iain Duncan Smith's programme is often perceived as a seamless whole, Gaffney distinguishes between several strands or objectives: continuity (in respect of lone parent and disability benefits, where the key changes were either planned by the previous government or obvious developments of the existing policy direction); retrenchment, largely driven by Treasury requirements for expenditure reductions; and reform, in particular Universal Credit.

The 'continuity' strand has yielded two very contrasting outcomes. The extension of worksearch obligations to single parents with youngest children aged five has resulted in increased employment and lower numbers on benefits, and is hence likely to have saved money; it has also been largely uncontroversial. By contrast the reassessment of incapacity benefit claimants has been an unmitigated disaster, both for claimants and taxpayers (Portes, 2014a). Meanwhile, while aggregate spending has not fallen, due both to exogenous factors and policy errors, there have been significant reductions in some areas--further cuts will be harder. Finally, Universal Credit faced and failed to meet a formidable technical challenge, but there are prior questions. Most of its objectives could have been met with much less ambitious modifications to the existing system. In retrospect, the debacle was not only predictable but unnecessary.

More broadly, it is also worth noting that there is no evidence suggesting that the surprising strength of employment growth has to any significant extent been driven by recent changes in welfare policy, as opposed to the more long-run changes in the structure and operation of the UK labour market over the past three decades. The reduction in JSA claims has been driven by a fall in inflows rather than by more people moving from benefits to work, so is difficult to relate to the functioning of the welfare system. Indeed, in some respects government policy appears to have resulted in a reduction in labour supply: the mismanagement of incapacity benefits has actually led to a reversal in the long-standing trend for the number on these benefits to fall. This failure, as well as the well-publicised problems with the implementation of Universal Credit, will pose significant challenges to the next government, both in fiscal and human terms (Portes, 2014b).

Inevitably, as I noted above, this is only a partial account of the government's economic record. In particular, we have not attempted to address in this issue the regulation of the financial sector (arguably the biggest economic failure of the previous administration); nor have we covered the most politically salient and expensive public service, health. Nor have we addressed what will be perhaps the single most important economic issue of the next Parliament--the UK's relationship with the European Union. So I will not attempt any definitive summing up. It is clear, however, that the Prime Minister was wrong: 2010 was not a turning point, but merely another twist in a long and winding road.

REFERENCES

Corry, D., Valero, A. and Van Reenen, J. (2011), 'UK economic performance since 1997: growth, productivity and jobs', CEP Special Papers 24, Centre for Economic Performance, LSE.

De Grauwe, P. (2011), 'The European Central Bank as a lender of last resort', VoxEU 18/08/11.

Portes, J. (2011), 'Poverty and inequality: introduction', National Institute Economic Review, October.

--(2014a), 'Welfare reform and the jobs miracle', NIESR blogpost, July.

--(2014b), 'Universal credit is a tale of failure', The Guardian, October.

Turner, A. (2010), 'After the crises: assessing the costs and benefits of financial liberalisation', speech to the Reserve Bank of India, February.

NOTE

(1) "Transforming the UK economy: Coalition strategy for economic growth", Prime Minister's speech, 28 May 2010: http:// webarchive.nationalarchives.gov.uk/20130109092234/http:// number10.gov.uk/news/transforming-the-british-economy-coalition-strategy-for-economic-growth/

Jonathan Portes, National Institute of Economic and Social Research. E-mail: j.portes@niesr.ac.uk.