The coalition's core business strategy is wrong. If there's money to be made investors won't worry about regulation
Following the news that Britain has entered the dreaded double-dip recession, those who support the coalition's austerity policy say that this is just a "technical" recession, as growth is bound to happen in the next quarter.
However, even if does – which is by no means certain – we are still faced with the grim fact that this current recovery is proving to be the slowest in history – slower even than the one that followed the 1929 Great Depression.
The main reason is, simply put, that Britain's economic model – based on an inflated housing market, ever rising consumer debts and freewheeling financial services – is broken. It is unable to re-generate growth even four years after the financial crash, and is unlikely to do so for at least another couple of years.
The bankruptcy of the existing model has prompted talk of "rebalancing" the economy through the revival of the manufacturing sector. Even the chancellor, George Osborne – not known for his love of industry – talks of the need for a "march of the makers". Unfortunately, after three decades of relentless de-industrialisation, Britain's manufacturing base is hopelessly weakened, and its revival is going to be a long, hard slog.
Some people have found solace in the fact – brought to attention by Peter Mandelson – that Britain is still the sixth largest manufacturer in the world. But this is essentially on account of Britain having one of the largest populations among the rich countries. In terms of per capita manufacturing output, a more accurate indicator of a country's prowess, Britain ranks only about 20th – behind even Luxembourg and Iceland, not to mention South Korea and Taiwan.
The weakness of British manufacturing is most clearly illustrated by the inability of the country to generate trade surplus despite the large devaluation of sterling since the 2008 crisis. Compared to the peak in 2007, the pound has lost 15% against the euro, 20% against the US dollar, and a whopping 40% against the Japanese yen. In other countries, devaluation of this magnitude would have generated a massive manufacturing export boom; but in Britain there simply isn't a big enough manufacturing base that can take advantage.
Despite all this, the government's approach to renewing the sector is to repeat the same old, failed strategy of cutting (personal and corporate) taxes and "red tape". The theory behind it is that wealthy people and corporations need to be given more incentives to invest and create jobs by making it easier for them to do business (deregulation) and to keep more of the income they generate through their businesses (tax cuts). If only it were that simple.
Those who think taxes are hindrances to business do not realise that taxes do not just take but also give resources to the potential investors. With taxes, the government can (and does) provide benefits that all businesses need but are unable to provide individually, except at prohibitive costs – infrastructure, skilled workers, basic research and development, export marketing (for smaller firms) and so on. The fact that "wealth creators" do not rush to open business in Jamaica, with its 5% top personal income tax rate, or Albania, with a 10% corporate tax rate, shows that the crucial question is how a government spends its taxes, not how much it taxes.
Would-be red tape cutters believe that the more regulations there are, the less investment there will be. However, regulation is only a minor factor in investment decisions. Things like growth prospects, technological progress, quality of labour force and infrastructure are far more important. The truth is that, if there is money to be made, businessmen will invest regardless of the level of regulations. This is why the 299 permits that were needed to open a factory in South Korea in the early 1990s did not prevent the country from investing 35% of its income and growing at 10% per year at the time.
More importantly, many regulations are there to help business as a whole by restricting what individual firms can do. For example, in the 19th century regulation on child labour may have harmed those firms that used it, but benefited British business as a whole by ultimately making the labour force healthier and more educated. Likewise, regulations on environmental pollution or on excessive bank lending have long-term collective benefits, even if they may hurt individual firms or banks in the short run.
Instead of cutting taxes and regulation and hoping for the best, Britain needs a coherent industrial strategy, covering areas such as infrastructural development, support for research and development, skills and training, government procurement, and help for small- and medium-sized enterprises. In the British context, the strategy also has to involve reform of the City of London. Ways have to be found to reduce the short-termism prevalent in the City and enable more investments oriented to the long term, vital for the revival of manufacturing. Pay restraint in the City is also necessary, not simply for the sake of equality but also to prevent the financial sector from depriving the manufacturing sector of talented scientists and engineers.
Without completely rebuilding its economic model, the future of the British economy is bleak. The coalition government has to face up to that fact.
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