The British Empire provides lessons on spending and taxes
According to the historian JR Seeley, the British Empire was acquired “in a fit of absence of mind”. It certainly wasn’t carefully considered, let alone planned. Something similar often happens in economic policy. An idea appears, spreads throughout the commentariat and insidiously inserts itself among policymakers as the “inevitable” way forward.
Last month’s astonishing general election result has led to a re-assessment of the shape of economic policy. According to some commentators, unless the Conservatives abandon the attempt to bring the deficit down, they will now have to implement significant tax rises.
Apparently the voters are simply fed up with “austerity” and won’t wear any more of it. That would be a momentous conclusion to emerge from the election – if it were justified. But it isn’t.
Quite what the voters will put up with – and indeed vote for – cannot be gleaned from the election result, not least because a coherent economic offering from the Government was conspicuous by its absence.
Austerity is now widely taken to mean the constant squeeze on the quantity and quality of public services. Yet, except in relation to the 1pc pay rise cap, across broad swathes of the public sector there has been no austerity.
Indeed, over the last five years, overall public spending has been roughly flat in real terms.
What the voters are just as likely to be fed up with is the squeeze on their living standards imposed by several years of low pay growth and the constant battle to afford a decent place to live, whether owner-occupied or rented.
Except with regard to the 1pc cap, these things have nothing to do with austerity, narrowly interpreted, and everything to do with the overall performance of the British economy. But first, the facts about the public finances. The public deficit is running at about 2.5pc of GDP, down from 10pc at the peak.
The ratio of government debt, that is the accumulation of past deficits, currently stands at about 87pc of GDP. This is very far from being a comfortable position.
To put it into context, Gordon Brown’s fiscal rules stipulated that this ratio should be less than 40pc, while the Maastricht treaty put down the figure of 60pc to govern eligibility to join the euro.
We are not yet close to it, but there is a point at which the debt ratio can explode out of control as debt interest payments rise faster than the economy’s ability to grow. So the ratio is a cause for concern and we need to get it down.
That said, there is no need to panic. We have twice before in our history had public debt ratios in excess of 240pc of GDP and we have worked the ratio down again – first after the war against Napoleon (interrupted by another upward spike at the time of the First World War), and then again after the Second World War against Hitler.
The ratio now looks likely to peak at 88pc this year, and to fall back gradually thereafter.
The most important thing is sustained economic growth, which will tend to keep the deficit down and reduce the debt ratio by increasing GDP.
Nevertheless, we should still operate a tight fiscal policy that brings the deficit down, and not only because of the future dangers posed by a ballooning debt ratio.
Other things equal, the tighter fiscal policy is, then the looser monetary policy can be.
This is particularly important for rebalancing the economy towards net exports and investment since lower interest rates will tend to keep the pound competitive.
Yet, except in selected areas where higher taxes can be justified on grounds of efficiency or fairness, we should definitely not be trying to reduce the deficit by increasing tax rates.
Indeed, lower tax rates are important to the prospects for economic growth – and not just for all the usual reasons to do with incentives.
Although the prospects for postbrexit Britain are good, they will be better the more we embrace lower taxes. For all those companies and individuals that are worried about tariffs or “exclusion” from the single market there needs to be something to keep them focused on the UK’S attractions.
If the British Government put taxes up at just the time that the UK was negotiating its way out of the EU, that would give exactly the opposite message.
So the Government should be doing its best to continue the squeeze on public spending, with the twin objectives of reducing the deficit and bringing taxes down.
It may have been acquired absentmindedly, but the Empire provides lessons for us, including with regard to public spending and tax rates.
I have just read a fascinating new book called Architect of Prosperity by Neil Monnery.
It is about the role of Sir John Cowperthwaite, financial secretary of Hong Kong from 1961 to 1971, in setting the colony on the road to prosperity.
It is an astonishing story. After the war, on a standard international (PPP) comparison, Hong Kong had a per capita GDP some 70pc lower than the UK’S.
Now the figure is 30pc higher than the UK’S. This certainly wasn’t because Hong Kong benefited from huge endowments of natural resources. It didn’t have any.
Its success derived from brilliant economic policymaking that involved reliance on market forces and minimising the role of the state.
Interestingly, another Asian city state, also a former British colony, namely Singapore, has also enjoyed stellar economic success. Its government has been much more interventionist than Hong Kong’s and in many ways its model of economic development has been quite different. Strikingly, though, in both countries the share of government spending in GDP and hence tax rates have been kept very low.
You might think that, given the economic record, Britain’s establishment, including the serried ranks of mandarins and their political masters, might feel that they have a good deal to learn.
They have. They should read Monnery’s book.
Roger Bootle is chairman of Capital Economics roger.bootle@capitaleconomics.com
‘The ratio of government debt stands at about 87pc of GDP. That is far from being a comfortable position’