The Budget: it’ll take more than deregulation to stimulate growth

George Osborne made it clear very early on in his Budget speech that it would be “fiscally neutral”. This meant there were no large-scale tax cuts or any rises in public spending.

You see the key points here. I don’t really want to concentrate on the details: wading through the nitty-gritty can be left to the professionals, thank you very much. Instead, I’d rather focus on the tone of this budget.

As you’d expect from this coalition government, it’s dedicated to a free-market, neo-liberal economic model. Following up from Cameron’s “Enemies of Enterprise” speech, which talked of wanting to cut red tape, plans were laid out to cut taxes and regulation for businesses. Sadly, such an approach is misguided.

Labour keep on saying that the Tories are taking us “back to the 1980s”. One way in which they are doing this is in creating 21 new “Enterprise Zones”. This announcement was no big shock – such a plan was leaked to the Evening Standard as far back as January, and Osborne talked about creating these zones in a speech made only a few weeks ago.

Essentially, Enterprise Zones are specific areas which “will include tax breaks, deregulation and relaxing of planning rules to ten areas across the UK, costing the government £100m over four years”. Margaret Thatcher and John Major created 38 of these areas in the 1980s and early 1990s. Cutting red tape to stimulate growth sounds very sensible, but these schemes have not been very successful in practice.

Last month The Work Foundation planning published a report on Enterprise Zones. It found that their success across various countries had been “ambiguous at best”, and often had a “resoundingly negative” impact. (p6)

In Britain, Enterprise Zones had created 63, 300 jobs by 1987, but only 13, 000 were “new jobs”. The other 80% of these jobs were merely displaced from other areas. A government report put the cost at £45, 000 per new job created in the Enterprise Zone.

All this deregulation also didn’t seem to attract companies to the Enterprise Zone. Surveys suggested that only one-quarter of new jobs could be seen to have arisen from this deregulation, with site characteristics and market access seen as being more important reasons for them to invest. (pp5-6)

The one main success story of the Enterprise Zones was the emergence of Canary Wharf as a thriving employment hub. However, that can be attributed to the government investment in the Dockland Light Railway, rather than the deregulation present in the Enterprise Zone. Most jobs were created in the area after the area lost its “Enterprise Zone” status. (p7)

The whole ethos behind this budget and the creation of the Enterprise Zones is to create a “flexible labour market”. David Cameron has been banging on about this since the start of this year: in January he talked about plans to make it easier to sack workers who had worked for a company for less than two years.

That implies that it’s good to have a lightly-regulated, flexible labour market. However, such a market can have just as much inefficiencies as a labour market which has buckets of regulation. Ha-Joon Chang writes about one illuminating example in 23 Things They Don’t Tell You About Capitalism.

South Korea has one of the most lightly-regulated labour markets in the world, with the result that many South Koreans end up in very insecure, temporary jobs. Around 60% of workers are on a temporary contract. Workers in their 40s and 50s are often “shunted out” to make way for younger workers: a chilling prospect given Korea’s meagre welfare state. Because of this, most young South Koreans are trying to become doctors if they have a science degree, or lawyers if they are humanities-inclined, because there is (slightly) more job security in these areas than in engineering, say.

80% of top-performing graduates say they want to study medicine. It is harder to get into South Korea’s 27th-best medical school than the country’s top engineering department. All this is despite the fact that now doctors’ wages are falling, in relative terms, because of the over-supply in doctors in South Korea. Summing up, Chang concludes that “one of the freest labour markets in the rich world…is spectacularly failing to allocate talent in the most efficient manner. The reason? Heightened job insecurity.” (pp222-224, at p224)

There are a couple of elephants in the room with the Coalition’s attack on regulations on business. The first is that some regulation is necessary. Very lightly-regulated economies that sought to encourage business (especially financial businesses) such as Iceland, Ireland and Britain are amongst those who were hit hardest by the crash: an unsustainable boom caused a long and gloomy period of economic insecurity afterwards.

Regulations might impinge on short-term growth, but they can then lay the foundations for longer-term, stable growth. Back to 23 Things again (p197):

(R)egulating the intensity of fish farming may reduce the profits of individual fish farms but help the fish-farming industry as a whole by preserving the quality of water that all the fish farms have to use.

It’s not as if regulation is incompatible with economic growth. Per capita income growth in the developing world was 3% per annum in the 1960s and 1970s. From 1980-2009, after the free-market reforms were introduced, the rate of growth fell to 2.6%. That figure is inflated by the fact that it includes the performance of India and China, neither of whom embraced neo-liberal policies. (23 Things, p73)

Going back to South Korea again, businessmen in the early 1990s needed to collect 299 different permits from a number of different government agencies in order to set up a factory. Despite this, its economy had grown at 6% in per capita terms since 1960. (p196)

The important thing is not to have no regulation, but the right regulation.

That’s what Osborne’s budget misses. Instead, we have indiscriminate deregulation and lowering of corporation tax. This benefits wealthy businessmen whilst stripping workers of basic rights, such as maternity leave and health and safety laws which could protect them. It’s only going to perpetuate inequality.

Also, and oddly for a budget meant to deliver growth by stripping red tape, the rate of growth was downgraded. The Office for Budget Responsibility revised its growth forecasts for 2011 and 2012 (1.7% and 2.5%, down from 2.1% and 2.6% in November). What’s more, these figures seem optimistic compared to other forecasts (see the Blanchflower article I linked to for these).

That’s not the only forecast that’s more grim than was predicted:

The deficit increase of £11.8bn in February was almost double the £6.9bn expected by the market. Also unexpected was the increase in the Consumer Prices Index (CPI) rate of inflation to 4.4 per cent, with core inflation jumping to 3.4 per cent. This has increased the pressure on the Bank of England’s Monetary Policy Committee (MPC) to raise rates, which would be disastrous for growth.

I can think of no better way to round off this blog than to paraphrase Paul Krugman from a few months ago: George Osborne’s plan is bold, but he’s boldly going in the wrong direction.

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3 Responses to The Budget: it’ll take more than deregulation to stimulate growth

  1. Eamon says:

    Good summing up of the budget, Cory. Growth forecasts are down, inflation forecast are up, unemployment is up and as David Blanchflower said in his article, the deficit for February was twice the level that was predicted. This time last year, any discussion of the economy was accompanied by manic calls for a reduction in the budget deficit. But what those people who called for spending cuts forgot, was cuts in spending would be followed by falls in consumer confidence and therefore demand in the economy.

    Any plans to cut the deficit needed a plan for growth, sadly the Conservative led Government’s need to eliminate the entire structural deficit in five years has led demand being sucked out of the economy and growth forecasts being downgaded time after time. How long before we hear the Thatcher mantra of ‘There is No Alternative’?.

  2. WH says:

    One little point, you mention

    “Going back to South Korea again, businessmen in the early 1990s needed to collect 299 different permits from a number of different government agencies in order to set up a factory. Despite this…”

    But isn’t this a reason why the South Korean economy is dominated by massive conglomerates — the chaebol? Having to find hundreds or thousands of permits isn’t much of a burden if you can afford to have your own legal team, but it’d be prohibitive for small firms.

    In fact, if you are Samsung or LG or whoever then the more rules the better: keeps out the competition.

    There’s surely an extent to which regulation favours incumbent and large players and stifles the emergence of new ones.

    • Yes that’s a good point I hadn’t thought of. I think a point that Chang makes repeatedly is that it isn’t so much that regulation that’s the problem but the type of regulation. It would be nice to not have regulation that placed such burdens on small businesses, but I think the example still shows that regulation isn’t necessarily incompatible with economic growth.

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