Where should a UK growth strategy focus?

 

The Tory leadership race and Britain’s growth challenge

The life-sciences industry shows what embracing growth requires

Jul 21st 2022

And then there were two. On July 20th Tory MPs chose Rishi Sunak, a former chancellor of the exchequer, and Liz Truss, the foreign secretary, to battle it out to become their new leader and Britain’s next prime minister. The candidates, who will campaign for the votes of Conservative Party members over the coming weeks, agree on at least one thing: Britain sorely needs growth. The 15-year period between 2004 and 2019 was the weakest for growth in gdp per person since the one between 1919 and 1934—and that was before the shocks of Brexit and covid-19.

Boosting Britain’s feeble growth will require an honest assessment of what the country does well, not just where it lags behind. That may seem head-smackingly obvious. But it needs saying. The Tories won the 2019 election on the promise of a hard break with Britain’s largest trading partner. The big idea of Boris Johnson’s government has been levelling up, a scheme to reduce regional inequality that has often seemed more like an excuse to bash successful places. The financial-services industry, one of the country’s biggest assets, was an afterthought in Brexit negotiations. Brexit is a fact, and it will yield some opportunities. More should be done to improve the productivity of northern cities. However if the Tories are to be a party of growth again, they must play relentlessly to Britain’s strengths.

There is no better example of those strengths—which include scientific excellence, fine universities and a healthy startup culture—than the life-sciences industry. Britain hosts four of the top ten universities in the world in life sciences, all of them within the “golden triangle” of Oxford, Cambridge and London. Enterprise is flourishing. British life-sciences firms raised £4.5bn ($5.4bn) in 2021, compared with £261m in 2012.

In the National Health Service (nhs), the industry has a major asset: a large cradle-to-grave source of data for clinical trials and drug discovery. This ecosystem rose to the challenge of the pandemic. The Oxford-AstraZeneca vaccine saved more lives—6.3m of them—in the first year of its roll-out than any other jab. The recovery trial, the world’s largest trial for people hospitalised with covid-19, went from first protocol to first patient in nine days. British institutions sequenced more than a quarter of all sars-cov-2 genomes during the pandemic.

Yet the industry faces plenty of obstacles. In theory the nhs ought to be able to act as a centralised buyer of new medicines and products, giving startups a large market to test innovations. But it is often sluggish and stingy, and seldom cohesive. America’s competitive health-care market is swifter to adopt new technologies. The time from approval of a medicine to it being available to patients is 120 days in Germany, but 335 days in England. Lack of space is another constraint, particularly in the golden triangle: Cambridge had no available lab space in 2021, although property developers are now responding. Labour shortages are a worry: the industry says it will need 133,000 new staff by 2030.

Most important, there is not enough domestic growth capital available to young life-sciences and other technology firms. Investors often pull firms towards other markets, notably America, which has more large companies that can buy promising startups. The public markets in America are more hospitable, too. The London Stock Exchange accounts for less than 1% of the capital raised in global initial public offerings so far this year. Its biggest listing for a decade—a toothpaste-peddling spin-off from GlaxoSmithKline, one of two big pharma firms with headquarters in Britain, which took place on July 18th—is instructive. It raised no new money and involved no new technology.

There are technocratic answers to such problems. The gap in growth capital would close if pension funds and insurers were able to put more of their money into venture-capital funds; less than 1% of these assets is currently invested in unlisted equities. The government this week endorsed proposals to smooth public listings. Last year it added the job of lab technician to its “shortage occupation list”, making it easier for foreigners with the right experience to get a British work visa.

Real change requires political will. Getting the life-sciences industry, and the economy as a whole, to grow faster will require the new government to face some hard truths. The first concerns Brexit. Leaving the European Union (eu) does yield some opportunities to liberalise: Mr Sunak wants to streamline the approval process for clinical trials, for example. Yet Brexit throws an awful lot of sand in the gears, too. Britain’s medicines regulator is approving fewer new drugs than its peers in the eu, in part because firms are heading to the larger market first. A bill to override the bit of the eu withdrawal agreement about Northern Ireland threatens British participation in the world’s largest multinational scientific-funding programme. Until the Tories stop treating Brexit as a test of ideological purity, its economic costs will only grow.

Geography is another area where Tory thinking and economic logic collide. In 2021 the government released a plan it called the “Oxford-Cambridge Arc” to turbocharge connections between the two cities. That scheme was fundamentally wise—the fastest way to get between them by rail now is via London. But it was quietly dropped, in part because it was thought to conflict with levelling up, in part because the government is nervous of building anything that spoils the views from voters’ windows. It is reasonable to worry about governments picking winners; only in Britain has it been policy to pretend winners don’t exist.

The Tory leadership debate about growth has so far focused on tax cuts. Ms Truss thinks an unfunded giveaway would pep up the economy; Mr Sunak argues, rightly, that it would fuel inflation. In making these arguments, both lay claim to the mantle of Margaret Thatcher. But Thatcher was defined above all by her character, not her policies. Hauling the British economy out of a deep rut took steel and stamina. These qualities are needed again today. It is easy enough to talk about the need for growth, much harder to embrace its consequences: difficult compromises with the eu, more money for already-wealthy areas and unpopular planning decisions taken in the teeth of local objections. The fortunate thing is that Britain boasts world-class strengths. It should play to them.

Where are the reserves for FX intervention in Asia coming from?

 

How Asian governments are starting to use companies' foreign exchange reserves to intervene to support their currencies:

Oct 27th 2022 | SINGAPORE

Taiwan’s life insurers and Japan’s Government Pension Investment Fund (gpif) sound like sleepy organisations—hardly the sort to play a role in international markets. But over the past decade they have become vast institutions. They now look after hoards of foreign assets as big as national foreign-exchange reserves (see chart). In the middle of this year, the gpif alone held more than $700bn in foreign bonds and stocks

As the dollar strengthens, policymakers are looking covetously at these foreign assets. The greenback is up by 16% in 2022 against a basket of currencies. Outside America, depreciation is raising import costs. Japan and South Korea have followed the conventional path of selling their own foreign-exchange reserves to shore up their currencies. Japanese officials do not say when they do so, but a sudden strengthening of the yen on October 21st bore telltale signs of intervention. Analysts reckon 5.5trn yen ($37bn) has been spent on such manoeuvres this month.

Will domestic financial institutions be enlisted to the fight? China is not shy of doing so. It tweaks foreign-reserve requirements on commercial banks to manage the yuan, and majority state-owned lenders sometimes intervene on the central bank’s behalf. Things are not so easy in countries with more open capital accounts and less high-handed governments.

In the early 2000s, the last time the dollar was as strong, the question of intervention by financial institutions did not arise, simply because the funds were much smaller. As recently as 2010, South Korea’s pension fund was a third of its current size. Since then, populations have aged and sought higher returns—and portfolios have ballooned. The firms’ sales of domestic currencies to buy foreign assets has kept the yen, won and Taiwanese dollar weak, which was welcome until recently.

The level of influence that officials can exert over institutions varies. The Bank of Korea and the country’s pension fund entered a $10bn currency-swap deal last month. The fund agreed to borrow dollars from the central bank in exchange for won, rather than selling the currency on the open market, relieving a potential source of pressure on its market value.

Taiwanese life insurers, unlike South Korea’s pension fund, are private firms. Even so, they can be prodded in the right direction. Taiwan’s central bank now allows life insurers to remit $100m-150m a day to the country, according to Reuters, a news agency. When the local currency was stronger, the central bank had been reluctant to allow such transfers.

Japan’s gpif has not been recruited to combat the weakening yen, but that has not stopped speculation that it might be eventually. The fund could hedge more of its assets in yen, which could have the effect of strengthening the currency, says Brad Setser of the Council on Foreign Relations, a think-tank. “On pure financial-management grounds, there’s a question of whether the gpif should have such a large share of its foreign-currency holdings held on an unhedged basis,” he adds.

Although the dollar has slipped a little in recent days, that does not change the picture for Asian officials, who are still dealing with far weaker currencies than they would like. They will probably continue intervening. And they may be tempted to bring outside assets into play.

Are higher taxes here to stay?

 

PAUL JOHNSON | COMMENT

We can live with higher taxes but only if we secure serious reforms

Paul Johnson

Monday November 21 2022, 12.01am, The Times

It is always dangerous to announce that we have entered a new normal. Those who thought that near-zero interest rates would last forever have been badly stung. The claim in the early 2000s, made by many who should have known better, that boom and bust had been abolished, was soon made to look foolish. I am nevertheless going to make a prediction of a new normal and it is not even one that we have yet fully entered.

Among the many striking economic statistics presented by the Office for Budget Responsibility last week was this: having hovered around the 33 per cent mark for decades, tax as a percentage of national income is on a path to rise above 37 per cent by the late 2020s, its highest ever.

So here is my prediction: higher taxes are the new normal. The tax take will not return to 33 per cent in my lifetime. For reference, I can reasonably expect still to be around in the 2050s.

For most of the past half century, barring a dip in the 1990s, the tax take has been in a remarkably narrow band between 32 per cent and 34 per cent of national income. I remember it being almost an object of faith among some senior colleagues when I worked at the Treasury that it could not be sustained at a level much above that. The British, it was believed, would not wear it.

That stability was made possible in part because we funded increasing spending on the welfare state — the NHS, pensions, benefits — by cutting defence spending. The state also withdrew from activities such as building houses, running nationalised industries and, latterly, paying for university tuition. More recently low interest rates kept the cost of servicing the national debt down. We have not needed to raise taxes.

Things are now changing, and rather suddenly. The tax take was at 33 per cent of GDP in 2020, exactly where it was in 2000. It has already gone up by a couple of percentage points since then and will go up another couple during the next four years. To give you a sense of scale, an additional 4 per cent of GDP is about £100 billion, or enough to pay most of the bill for the state pension.

Why the sudden change? Spiralling debt interest payments, inflation pushing up spending on pensions and benefits and an NHS growing like Topsy, provide much of the explanation. Without higher taxes we would not be able to afford even the none-too-generous levels of public spending that are planned.

Having gone up, it is hard to see how we get spending, and hence taxes, down. International commitments mean that cutting defence spending is not a trick we are likely to be able to pull again. There is no housing or nationalised industry to cut and we surely cannot push student fees much higher. After a decade of cuts there is not much fat left on the bones of the rest of the welfare state. Population ageing is upon us. The baby boomers are in their early seventies. Our demand for healthcare appears insatiable.

We absolutely need to improve efficiency in state provision — we can all see how badly run the NHS is — but getting tax back down to 33 per cent of national income would require more than improving efficiency; it would mean taking decisions that at present are way beyond public or political appetites. Means-test the state pension? Force higher earners to get private health insurance? Dramatically cut working-age benefits?

There are those who do not believe that this is a “real” Conservative government. If only they were serious about it, they could find tens of billions of cuts ready to be made. I have yet to hear a credible proposal for what those cuts would look like. George Osborne was serious about cutting spending. I believe Rishi Sunak when he says he wants lower taxes. These guys are not closet socialists.

For most of the years since Margaret Thatcher led Britain the tax take has been between 32 and 34 per cent

ALAMY

We will notice a higher tax burden. Six years of freezing income tax allowances and thresholds will bring millions into the income tax system and mean more tax taken from all of us who pay it. The number of higher-rate taxpayers is likely to hit 8 million in the late 2020s, a virtual doubling within a decade. The numbers paying at 60 per cent (with incomes between £100,000 and £125,000), because of a so-called tax trap, and at 45 per cent (those with incomes over £125,140) will approach 2 million, more than the number of 40 per cent taxpayers back in 1990. Meanwhile, the increase in the rate of corporation tax will probably mean record payments by companies. Our corporation tax system will pull in a bigger slice of corporate profits than that in most other comparable countries.

If tax is to stay high it is more important than ever that the tax system is both equitable and efficient.

Yet raising income tax by holding down allowances bears heaviest on lower earners. Pushing up council tax means increasing a tax that is based on 1991 house values and is regressive with respect to the value of the home. Raising the main rate of corporation tax without fixing the base on which the tax is levied is not efficient: it will unnecessarily deter investment.

The other tax measures in the autumn statement were a hodgepodge of the good, the bad and the ugly. What united them — the vehicle excise duty on electric cars, the reduction in the capital gains tax allowance, the rise in stamp duty, the cuts to business rates — was a lack of any strategy, sense of direction or apparent interest in reform.

If I am right and high taxes are the new normal, then we must do better. We absolutely can live with higher taxes than we have been used to but without serious reform the price we will pay for them will be much more than it need be.

Read this for balance on the UK growth debate

 

Don’t blame Brexit for our economic woes

On a range of metrics - from trade to inflation and the financial sector - the downsides of leaving the EU have been vastly overstated

JULIAN JESSOPGRAHAM GUDGIN21 November 2022 • 6:00am

The sixth anniversary of the Brexit referendum prompted another wave of warnings about the economic costs. Indeed, if you believe the latest headlines, leaving the EU has been an economic disaster and is one of the main reasons why the public finances are in such a mess.

The aim seems to be to persuade us that the UK cannot prosper outside the EU and should at least rejoin the Single Market, either formally, or following the Swiss model of ad hoc agreements that could amount to the same thing.

Several of the usual suspects in the media are involved. However, one of the low points was the claim by the former Bank of England governor, Mark Carney, that the UK economy had shrunk from 90 per cent of the size of the Germany economy to less than 70 per cent since 2016.

Even economists who are known to be sceptical about Brexit denounced this as ‘nonsense’, but Carney followed up by implausibly blaming the latest increase in interest rates on Brexit. In his view the departure from the EU had "slowed the pace at which the [UK] economy can grow".

It was to examine, and where necessary correct, such claims that we recently published a detailed report on the BriefingsforBritain website. This carefully describes the evidence and methods used in a range of studies and articles and shows how the UK compares with other countries for changes since 2016 in GDP, trade, inflation, exchange rates and the financial sector.

The hard evidence is that leaving the EU has had remarkably little impact on the UK economy. Between the first quarter of 2016 (the quarter before the referendum) and the third quarter of 2022, OECD data show that the UK economy grew by a total of 6.7pc. This was a little behind France (7.4pc), but ahead of Spain (6.6pc), Germany (6.2pc) and Italy (4.9pc). UK exports to the EU have recovered to long-term trend levels and the City of London has been little impacted.

This, of course, contradicts the Carney claim, which was based on data at prevailing market exchange rates and therefore reflected the fall in the pound since 2015. But the net effect of a weaker currency on the economy is uncertain and it is wrong anyway to assume that sterling would not have weakened regardless of the outcome of the referendum. Sterling already looked overvalued in 2015 – with the UK running a huge current account deficit – and the retreat in the effective exchange rate in 2016 was only to a little below the average for 2009 to 2013.

Another persistent belief is that the vote to leave the EU prompted a collapse in investment which has left it far below its trend rate. The studies that make this claim are mostly based on a simple extrapolation of the growth in investment between 2009 and 2016 and the implausible assumption that this growth would have persisted indefinitely. In fact the growth in investment during these years was a strong, but inevitably temporary, rebound in investment from the depths of the global
financial crisis.

Taking a longer view, UK business investment is only a little below its historic trend, and some of the gap can be explained by lower investment in North Sea oil and gas which is clearly unrelated to Brexit.

Foreign direct investment (FDI) into the UK has also held up well since 2016, in contrast to predictions that it would slump. In particular, greenfield FDI into the UK rose by a third between 2016 and 2021 and was the highest of any large European economy in every year in this period. 

There is little evidence either that Brexit has contributed to labour shortages (at least, not permanently). UK employment has failed to recover to pre-Covid levels and this helps to explain the relatively weak growth of the UK economy since 2019. But this mainly reflects an increase in long-term sickness. The failure of many EU migrants to return to the UK can be attributed to the pandemic too, which has had a similar impact on the migrant workforce in other European countries, notably Germany, where vacancy rates are similar.

This leaves two other channels by which Brexit might have ‘wrecked’ the UK economy. One is inflation. However, UK inflation has been similar to that in the US and EU, including food price inflation. The other is trade. Far from collapsing as some claim, UK trade with the EU has fully recovered after some initial disruption.

The views of the Office for Budget Responsibility (OBR) have been widely cited here. It would be odd to deny that the increase in trade frictions between the UK and EU has had any negative impact. However, it is not clear that there has been a significant drop in trade intensity, at least in the latest data, or that the drop that has happened is primarily due to Brexit. It is certainly a huge leap to assume, as the OBR does, that this is a permanent hit which will reduce the long-term productivity of the UK by as much as 4 per cent.

In particular, there has not been a big difference between the performance of UK exports to the EU and those to the rest of the world. What’s more, until the energy crisis, the UK’s trade balance with the EU was actually improving as exports held up better than imports.

It is worth noting too that the OBR’s 4pc assumption is based on an average of outside studies, rather than original work. The evidence for a strong link between changes in trade intensity and in productivity in an economy like the UK, which is already relatively open and developed, is also weak.

The lack of evidence of significant economic harms from Brexit is particularly important because it was always likely that most costs would be upfront and relatively visible. In contrast, the main upside of Brexit was always the increased freedom to develop distinctive economic policies, whose benefits would take longer to come through.

Success or failure will depend on how effective these policies prove to be. But it would be wrong to backtrack now on the basis of an anti-Brexit campaign built on such flimsy foundations. 

 

Dr Graham Gudgin, is Research Associate at the CBR, University of Cambridge and Julian Jessop is a Fellow at the Institute of Economic Affairs

Autumn Statement analysed:

 Some nuggets about industrial policy (there isn't one) and policy flip flops - there are several:

COMMENT

Autumn statement: Ministers must decide what industry needs, set out a strategy and stick to it

Dominic O’Connell

Saturday November 19 2022, 12.01am, The Times

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The day before the autumn statement I whiled away a few minutes playing buzzword bingo: coming up with the words or phrases that might be used, a point for every one I got right. Not for the statement itself; that would be far too easy. Instead I tried to predict what business lobby groups would say in response to the chancellor.

“Wealth creation” seemed a good bet (bingo! Federation of Small Businesses). I thought “caution” would be everywhere, but struck out. My banker, though, was “detailed plan for growth” (back of the net! The first line of the CBI response talks about a “clear plan for growth”.)

That was a bit of a cheat, because trade groups and ministers are always talking about clear plans for growth and rarely arriving at one. The autumn statement, however, was clear, if only by omission. When Jeremy Hunt talked about the future engines of the economy, he listed five areas worthy of attention: digital, life sciences, green technology, financial services and advanced manufacturing. His model, and that of Rishi Sunak, he said, was Silicon Valley.

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If you have a car plant in the UK — or any other type of traditional manufacturing business — you would definitely feel unloved. Manufacturing has been in retreat in Britain since the late 1970s but is still not, despite high energy costs, high carbon costs, a disinterested stock market and the myriad hassles caused by Brexit, dead and buried. Nor, though, is it worthy of direct government attention.

Make UK, the main trade body for manufacturers, caught the mood. It praised several items in the budget, including the business rates revamp and the abolition of some import tariffs, but it ended on a plaintive note: “There is little scope for growth and instead it is clear we are operating in survival mode.”

There have been many comparisons between this autumn statement and George Osborne’s 2010 budget. Both involved squeezes on public spending (a stealthy one this time round, with cash allocations flat and inflation left to do the dirty work) and a big fall in household incomes. Osborne, though, believed that a revival in manufacturing was vital to future growth. He ended his budget with the vision of “a Britain carried aloft by the march of the makers”.

The march never quite materialised and, although the makers have not gone into full retreat, several big sectors face an uncertain future. I wrote last month about the plight of traditional steel mills. Negotiations between the Scunthorpe-based, Chinese-owned British Steel about financial support have not concluded and Tata Steel, the Indian owner of Port Talbot in Wales, is still waiting to hear if ministers will help it to move to a green form of steelmaking.

Automotive, too, is beginning to slide. The calamity threatened by Brexit was staved off with a trade deal that gave car companies free access to and from the European Union but the recovery from the pandemic has been uneven. As my colleague Simon Nixon pointed out on these pages on Thursday, there is a worrying lack of progress on the battery factories needed if UK car plants are to have a decent chance of staying here after the transition to electric vehicles.

Nor is there much encouragement for smaller companies. One of the few specific business measures concerned tax relief for research and development by small and medium-sized enterprises. It has been made much less generous and Hunt made it clear that the Treasury was concerned about fraud. An investigation by this newspaper has revealed abuses of the scheme. Rather than tackle the fraudsters, however, the incentive has been made much less valuable, a move that the Federation of Small Businesses said would crush innovation. “This doom loop makes a mockery of plans for growth.” “Doom loop” was not one of my guesses in buzzword bingo.

What of Hunt’s Silicon Valley vision? This might be more inspiring had it not been trotted out by previous administrations and if there were not already detailed analyses of why the conditions that created the West Coast crucible of technology and investment do not exist here. That is not to say that the UK tech sector has to be inferior, but it will prosper by concentrating on its own strengths rather than copying others.

On Times Radio yesterday I spoke to Joni Rautavuori, chief executive of Tharsus, a robotics company in Blythe, Northumberland. Ministers often cite Scandinavia and Singapore as examples for industry and Rautavuori has worked in both. Their secret, he said, was consistency, their governments setting a strategy and adhering to it.

Britain has in the past had a formal industrial strategy, which waxed and waned in importance in sync with the political profile of whoever was business secretary. Last year, however, it was scrapped by Kwasi Kwarteng, then business secretary, and folded into the “plan for growth” overseen by Sunak, then chancellor. Rather than dream about Silicon Valley, it might be an idea for Hunt and Sunak to decide what is important for industry, set out a strategy and stick to it.

PS
An example of flip-flopping on industrial policy comes in the oil and gas windfall tax. Ministers were extremely cool on North Sea development on climate-change grounds and licensing rounds were suspended three years ago. Then came the Ukraine invasion and suddenly it was good again. Then came a windfall tax (which falls mainly on domestic production), then a big new North Sea licensing round and now an extended windfall tax. Chris Wheaton, oil and gas analyst at Stifel, had a succinct verdict. “Assuming the lights are still on, will the last energy companies to leave the North Sea please turn them off.”