Freeing corporate cash the key to UK recovery

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Britain’s monetary and fiscal policy appears increasingly impotent after four years of flat-lining growth and stubborn inflation. To end its economic malaise the UK requires radical supply-side reforms that create the conditions for business to thrive, not further stimulus. Ross Walker, Senior UK Economist at RBS explains.

Ross Walker, Senior UK Economist at RBS
The fallacy at the heart of the current policy debate is that there exists a quick, pain-free fix: another round of quantitative easing, one more dose of fiscal expansion or a weaker pound to encourage exports.

Such demand-orientated thinking blithely ignores the massive stimulus already unleashed: 500 basis points of rate cuts, QE gilt purchases equivalent to a quarter of national income, a substantial depreciation in sterling and persistent fiscal deficits. The QE experiment was entirely justifiable given the severity of the financial crash, but it is hard to argue that monetary policy has been overly restrictive and the problem could be rectified by another say, GBP125 billion of QE.

Nor can ‘austerity’ be blamed as the principal cause of Britain’s stagnant growth. The deficit is being lowered at pedestrian pace – 1 per cent of GDP a year. In any case, the chancellor has very little leeway to offer significant fiscal easing in the Budget without prompting bond and currency markets to balk.

Unprecedented stimulus has offered dismal returns so far. Inflation has averaged 2.7 per cent since QE began, while real GDP has flat-lined.

No, a lack of fiscal discipline and a reckless credit bubble are the real causes of stagnant growth – not least because they disguised the rot that was eroding Britain’s economic foundations. What the UK needs now is a long overdue programme of reforms that lower barriers to production: addressing regulations, taxes, infrastructure and public services which are holding back a business-led recovery.

The key point is that a revival in private sector investment would provide the biggest single fillip to the economy. British firms hold roughly GBP670 billion in cash and also have ready access to cheap money on capital markets, yet they are holding back – uncertain over future demand and pessimistic about returns. Measures such as a cut in corporation tax could help to start unleashing that money.

The private sector first needs to see a commitment by the state to improve Britain’s infrastructure. The upgrading of the UK’s road, rail and air infrastructure must be a priority in that. Accelerating the planning process and expanding the role private firms play in financing and running infrastructure would get things rolling and have the added benefit of allowing the chancellor to stick to spending targets. London in particular urgently needs more airport capacity, either at Heathrow or a new hub. That would not only ease the strain on crammed airports but also improve Britain’s links to fast-growing emerging markets with which the UK has depressingly little trade at present.

The UK’s energy policy needs urgent attention too. The regulator, Ofgem, has warned that a ‘near crisis’ in energy supply is approaching. Despite becoming increasingly reliant on gas, Britain’s gas storage capacity is woefully inadequate. The UK should urgently focus on improving that capacity and bringing on stream greater and cheaper supplies.

The government needs to look for ways to lift anaemic rates of residential and commercial construction by reducing local opposition and a tortuously slow planning process. A bill smoothing the planning process will hopefully raise the number of housing starts (currently at multi-decade lows). If it does, the economy will feel the benefit - both in direct GDP and also in giving a whole swathe of the population access to the housing market for the first time.

There is a need to address regulation right across the economy. Deregulation is not exactly de rigueur at present, given the recent experience in financial markets. But bureaucratic obstacles for small and medium-sized enterprises in particular could be lowered and the tax system simplified with lower, flatter taxes paid for by abolishing a plethora of allowances and reliefs.

That is not to argue for unfettered capitalism. There are questions over whether Britain’s competition policy is sufficiently active with sectors such as supermarkets and broadband operators dominated by just a few players. Encouraging competition by lowering barriers to entry should be given greater attention.

The prospects for many of these, and other, supply-side reforms do not appear good. Even though the UK economy has not seen serious supply-side reforms since the 1980s, a lack of political consensus and their unpopularity in the near term invariably stifles the reform agenda. The bad news from history, specifically the 1970s, is that things have to get far worse before the public’s attitude shifts and policymakers take action.

Is the UK therefore condemned to suffer years of weak growth? Yes, if it continues on the current path and pretends another wave of QE, even larger fiscal deficits or currency debasement offer a sustainable solution. If the debate changes to one about creating an environment that provides incentives for wealth creation, then there is hope. 

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