Labour is about to get very lucky indeed

Sir Keir Starmer
Sir Keir Starmer's party is already preparing to claim credit for any improvement in Britain's economic fortunes - Aaron Chown

More than anything else, the perceived success or failure of an incoming Labour government will depend on the economic weather. Luckily for Labour, after a decade and a half of international economic turbulence, the outlook seems set fair. The reappearance of low inflation and subdued interest rates will allow incomes, both earned and unearned, to grow in real terms. This in turn will boost consumer demand, the mainstay of aggregate demand.

The OBR forecasts that GDP growth will run at a respectable rate of just below 2pc per year throughout the next parliament. Reasonable doubts surround OBR forecasts, and indeed most forecasts, but the modelling of myself and colleagues at Cambridge suggests something similar, with growth a little above 2pc per year. Unlike the OBR, however, we also expect the near-stagnation in productivity to end, allowing living standards to grow faster.

Like many economists, the OBR has only a tenuous understanding of why productivity growth has been so slow since the banking crisis of 2008/9. The so-called productivity puzzle might be better termed the employment puzzle, since what has happened since 2008/09 has been surprisingly buoyant job creation despite muted growth in GDP, with most of these jobs filled by people born outside the UK.

Slow growth in productivity since 2008 has coincided with low interest rates and the coincidence is not accidental. Firstly, low borrowing costs have stimulated a boom in the formation of new businesses. An extra half a million businesses have created perhaps half of the four million new jobs in the private sector since 2008. In addition, reduced interest payments by commercial firms are likely to have lessened the financial pressures on companies to maximise efficiency by laying off, or not recruiting, staff.

Since we expect interest rates to remain relatively high in future, a predicted consequence will be slower job creation and slightly higher unemployment. But productivity will accelerate as a result. This will wrongfoot the OBR, whose forecasts depend on projections of productive capacity underpinned by assumptions on productivity, which is assumed to continue expanding at recently observed low rates.

The OBR was caught out badly when it was first formed in 2010 since it wrongly expected productivity to continue expanding at the rapid rates preceding the banking crisis. The same will happen again as productivity accelerates and the slow-moving OBR fails to predict it.

Labour will of course claim credit for any pick-up in growth even if this was likely to happen anyway. Their manifesto almost outdoes Liz Truss in its devotion to economic growth, but equally it promises financial stability to avoid the turbulence that accompanied Kwasi Kwarteng’s mini-Budget fiasco.

There is little evidence that the Truss plan of raising growth rates through lower taxes would have worked to any significant extent, and Labour expects to achieve faster growth without tax cuts. The main planks in its plan are financial stability (which we already possess), planning reform, and further devolution to elected mayors.

Planning reform aims to achieve a target of 300,000 extra houses a year compared to the 200,000 recent levels.

But if, as expected, interest rates remain well above the minimal levels of the recent past, mortgage lending will be constrained.

Unless much of the heavy lifting comes from the public sector, achieving Labour’s housebuilding target will be difficult. Any additional availability of homes would be welcomed by the young, especially if migration is kept low, but the boost to the economy would not be large.

Devolution to local mayors will have even less impact and is a triumph of hope over experience. Those behind the current craze of devolving powers to mayors fail to recognise that regional devolution has done little to accelerate growth in Scotland, Wales or Northern Ireland.

More useful would be a reform of commercial regulations. The constraints on building nuclear power stations are, for instance, draconian, leading to construction costs in the UK four times those in South Korea and well above Finland or France. There is no need to spend years re-examining designs already approved by the Americans or French, nor do we need a 10-year lead-up before construction starts. We have made nuclear construction far too expensive and slowed both economic growth and the achievement of net zero carbon emissions.

Labour’s deregulation is mainly about housebuilding. Beyond this, the party promises a business-friendly industrial strategy. Not a bad thing in itself, but all governments have an industrial strategy, whether or not they use this name. As the Americans and the EU head down this route, there is little option but to follow.

Industrial strategy focuses on subsidies

Labour’s industrial strategy consists mostly of subsidies for ports, battery giga-factories, green energy and steel. But the scale of subsidies is not large and much smaller than the extra tax relief for businesses in the spring 2023 Budget. Again the impact on GDP will be small.

Labour needs us to believe that future economic growth would have been slow without their own plans. Writing in the Times, Lord Mandelson recently rolled the pitch for this story. He did not use Labour’s silly “14 years of Tory chaos” rhetoric but conceded that the global banking crisis, Covid and the Ukraine war have left a difficult inheritance for Labour. Being who he is, he could not resist adding, without evidence, that Brexit and Truss exert permanent handicaps. The Brexit claim is untrue and the long-term Truss impact was political rather than economic.

Now the banking crisis and Covid are in the past. Without global shocks of similar size, the future looks much brighter and it is important we should expect this and not be persuaded that limited new Labour policies are responsible for an improved economic performance.

Graham Gudgin is honorary research associate at the Centre for Business Research, Judge Business School, University of Cambridge