By Josh Ryan-Collins

After a decade of austerity and the trauma of a two-year long pandemic, the UK’s public sector workers deserved some respite come 2022. Instead, they are now enduring the largest real wage cuts in recent history.

Average settlements on offer to public sector workers are currently around 3% with inflation at 10%. This 7% cut in real wages amounts to almost a month’s salary not being paid. Furthermore, the private sector is enjoying wage deals more than twice as high at around 7% as shown in Figure 1.

Under such conditions, the withdrawing of labour is an entirely rational response. It is even more understandable when you consider the wider macroeconomic policy regime that appears rigged against the public sector.

The argument being repeatedly made by both the government and the independent Bank of England is that paying public sector workers close to or above the current rate of inflation would be self-defeating because it would lead to higher prices. This is due to the so called ‘wage-price spiral’ where higher prices lead to calls for higher wages which then feed through to higher prices and so on.

There are four reasons this argument is flawed.

Firstly, in capitalist market economies the public sector does not set prices, firms do. So the wage-price spiral can only apply to the private sector in as far as it is a direct relationship between wages and consumer prices.

The only way the government could finance additional wages for the public sector would be raise taxes or borrow more. Taxing directly removes money from the economy so it is difficult to see how this could be inflationary.

Borrowing involves investors spending money buying government debt instead of other assets. Bank of England governor Andrew Bailey has stated this would affect “overall demand in the economy” and force the Bank to raise interest rates, further adding to the cost-of-living crisis facing low paid workers.

There is evidence that bond financed fiscal deficits are associated with higher inflation. But this relationship is almost exclusively found in developing countries with weaker institutions and tax raising powers, not in high income economies like Britain.

Second, current inflation in the UK is mainly driven by supply-side factors, in particular rising energy prices caused by the Ukraine war feeding through to other sectors. There is evidence that rising energy costs have led firms to raise their prices and evidence that other firms have exploited the situation of rising prices to use their market power to raise prices above inflation, generating excess profits. If anything, there is more evidence of a ‘profit-price spiral’. None of this has anything to do with what public sector workers are paid.

Thirdly, public sector workers make up only around 17% of the workforce. Thus inflation-linked wages to help public sector workers catch up with years of real wage cuts would have much less impact on total demand in the economy than they would in the private sector.

Finally, the public sector is suffering from a serious shortage of labour caused by the COVID pandemic and difficulty recruiting workers from the EU post-Brexit. In particular the healthcare sector is in crisis, making up 13% of all jobs advertised in the UK last month.

Keeping wages well below those available in the private sector — which they have been over most of the past eight years (Figure 1) — will make the situation worse as employees are more tempted to leave. In turn, this will require even larger pay increases down the line to bring workers back.

Given flatlining growth, fears about excess demand and entrenched inflation have to be tempered with the risk of rising unemployment and even more individuals leaving the workforce, worsening an already extremely weak macroeconomic environment.

Striking public sector workers have the support of the majority of the public. They seem to recognise, better than the politicians and policy makers in charge of our economy, that a strong public sector is the building block for sustainable economic growth. Let us hope that those taking industrial action succeed in pushing through higher wages for all our sakes.

This blog was first published on 14th February 2023 on the official blog of the UCL Institute for Innovation and Public Purpose | Rethinking how public value is created, nurtured and evaluated | Director @MazzucatoM | https://www.ucl.ac.uk/bartlett/public-purpose/

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This week the UK Chancellor Rishi Sunak delivered the 2021 Autumn Budget in the House of Commons. The Budget confirms that this government has accepted a permanently larger role for the state in the economy. Spending will grow in real terms by 3.8% across government, amounting to a £111bn annual increase by 2024–25. Analysis by the Office of Budget Responsibility (OBR) shows total public spending levelling out around 42% of GDP once the huge rises associated with the pandemic wear off. This is not high by European standards. However given the figure averaged around 37% in the 30 years preceding the Great Financial Crisis it marks a step change, in particular for the Conservative party.

But Rishi Sunak and the Treasury remain fiscal conservatives. The Chancellor has created a new ‘fiscal rule’ (the fifteenth since 1997) which requires balancing day-to-day spending, excluding investment, within three years and keeping public sector investment from averaging more than 3% of GDP. Instead of achieving this through spending cuts, the Chancellor is embarking on major tax rises. Post-budget analysis by the Resolution Foundation finds that by 2026–27, tax revenue as a share of the economy will be at its highest level since 1950 (36.2%), amounting to an increase per household since Boris Johnson became Prime Minister of around £3,000.

The fiscal rule itself is arbitrary and appears to be more driven by politics than economics. With interest rates on long-dated government debt remaining at record lows, there is no obvious reason to balance the budget over the short-term when the economy faces longer-term ‘scarring’ effects from the pandemic, which the OBR estimates will be around 2% of GDP.

More generally, the Budget lacks any real vision for how to achieve the ‘high skill, high productivity, high wage’ economy that Boris Johnson spoke about in his party conference speech.

On the spending front, the biggest increases will go towards the NHS, social care and pensioners. With an ageing population and technological advances in healthcare, such increases are inevitable. They should arguably be higher, in particular for social care, which ultimately could help reduce costs on the NHS in the long run.

Disappointment

The biggest disappointment, ahead of the UK’s hosting of the COP26 summit next week in Glasgow, is the lack of any new plans to support a green transition. Keeping public sector investment to below 3% suggests the Chancellor is not yet taking seriously the massive transformation of our energy, housing and transport infrastructure required to meet the UK’s net Zero 2050 targets. The Treasury appears unable to see the potential of policies such as a national home insulation program to reduce carbon emissions, create good quality jobs and reduce the cost of living for those many poorer households in leaky homes. The announcement of a tax break on short haul flights — which are already significantly cheaper for equivalent journeys than trains in this country — confirms the Treasury’s myopic views on the net zero transition.

Sunak made much of the announcement of reduction of the rate at which universal credit is taxed for those who are in work. How the remaining four million or so households on universal credit who haven’t found work are supposed to survive the £1,050 per year reduction in their incomes from the reversal of the £20 uplift remains to be seen.

But the broader point here is that if the Treasury was genuinely interested in ‘making work pay’ as Sunak emphasised in his speech, they would be taxing wealth and not wages. A recent analysis found that the Treasury could raise £16bn a year if shares and property were taxed at the same rate as salaries. Currently, the richest 1% of the population take 13% of their income in the form of capital gains.

Given that the bulk of new spending announced in the budget will mainly support older, wealthier people, the case for a gradual shift towards taxing some of the assets they have built up over their lifetimes rather than the income of the wider population seems strong. This should also encourage more private investment into productive activities rather than property. But, just as with climate change, this kind of broader strategic vision seems missing from the Chancellor and the Treasury’s thinking.

Originally published on the UCL Institute for Innovation and Public Policy blog.

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Jan Toporowski

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Robert Skidelsky

Will Hutton

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This week’s budget appeared at first to be seismic shift away from conservative economic orthodoxy by the government. Alongside a further major expansion in borrowing to support jobs and incomes over the next six months, the chancellor adopted the previous left-wing Labour party’s policy of a major rise in corporation tax (from 19% to 25% of profits) to close a record peacetime budget deficit.

But as the dust has settled and the numbers interrogated, the budget looks rather less radical.

Firstly, it cannot be described as a rejection of austerity. The budget contained no explicit additional resources beyond the coming financial year for public services to deal with the legacy of the pandemic. Rather, as pointed out by the government’s own spending watchdog, the Office of Budget Responsibility (OBR), it involved an additional £4bn spending cut, alongside £11bn previously announced, beyond next year. For the most vulnerable, the proposed £20 cut in universal credit remains, even if pushed back to September. The freezing of income tax thresholds will also hurt lower paid workers, assuming wages do rise.

Annual revaccinations, ongoing test and trace capacity, a huge NHS catch up program on thousands of missed operations, and rising unemployment bills will all be somehow funded on pre-pandemic spending plans. Meanwhile, NHS workers can look forward to a miserly 1% pay rise in return for their heroic pandemic efforts.

Secondly, the budget was singularly lacking in ambition when it came to the government’s role in creating a sustainable, inclusive and investment-led recovery.

There was no mention of investment in social care, a sector that is badly organised, extremely low paid and clearly vital in improving the resilience of an ageing population and economy to future pandemic-type shocks.

There was no new green stimulus despite the UK facing a £100bn funding gap to reach its net-zero by 2050 target and despite its hosting of the global COP26 climate change summit this November. Neither was there any major program to help young people find work. Both the latter two challenges could have been tackled with green jobs and apprenticeships program focused on renewable energy and environmental conservation.

Meanwhile, the new National Infrastructure Bank will be capitalised with just £12bn (equivalent to just 0.5% of GDP) and again, be heavily reliant on private sector co-investment.

Indeed, it appears the government may have abandoned industrial policy altogether, shutting down the Industrial Strategy Council lead by Andy Haldane and moving industrial policy out of BEIS and in to HMT.

Reverting to economic orthodoxy

Instead, the Treasury is reverting to free-market economic orthodoxy, relying on business and the housing market to do the heavy lifting.

A 130% ‘super deduction’ tax break for capital investment by businesses in machinery and plant was the key pro-growth policy announcement. Whilst it makes sense to reduce tax on productive investment, it is highly questionable whether the majority of British firms believe there is sufficient demand in the economy for major new capital investment outlays. The OBR is predicting not, forecasting a return to anaemic growth of just 1.7% in 2023, following a boom in 2022.

“The Treasury is reverting to free-market economic orthodoxy, relying on business and the housing market to do the heavy lifting.”

The policy may bring forward some existing planned capital spending but is unlikely to create the structural shift in investment the economy needs. The exception may be those firms already doing rather well in pandemic conditions. Amazon, for example, has racked up record profits over the past nine months as physical retail has collapsed and may use the supertax break to wipe out its UK tax bill completely.

The corporate tax profits hike is a sensible policy. However, its timing — not being introduced to 2023 — is suspect and will likely mean it is subject to ferocious counter lobbying if the economy improves. If businesses are to be taxed, a more sensible approach would have been a phased in rise in corporate tax starting immediately, accompanied by a windfall tax on those companies — like Big Tech, Private Equity and the Supermarkets — that have done so well out of the pandemic.

On housing, the budget was an opportunity to push forward a big capital investment in public housing and retrofit of existing stock and rethink the country’s highly regressive property taxation system. Reducing property tax for the poorest would be a fair way of stimulating stagnating demand.

Instead, the government extended the stamp duty tax cut on home purchase into the summer and announced it will guarantee 95% mortgages. These are expensive policies that reveal the Treasury remains fixated on the idea that ever-rising house prices are the best way to stimulate the economy and private sector house building. This debt- and consumption-lead economic growth model is inefficient, leads to greater financial fragility as well as increasing inequality as more people are priced out of the housing market.

Meanwhile, there was no sign of any reform of property taxation, nor even a commitment to raise capital gains and remove exclusions as had been rumoured.

In summary, whilst the extension of government support to the Autumn should be welcomed and will help the country avoid a much more severe recession, this Budget was not the economic reset the country needed. It will do little to stimulate a sustainable recovery and help Britain on to a more progressive economic trajectory. Now was surely the perfect time to shift the focus of taxation on to economic rents and away from labour. Instead, it is a budget that mainly favours the rentier sectors already doing well — Big Tech, banks, developers, homeowners — at the expense of the public sector, lower paid workers and renters.UCL IIPP Blog

This blog first appeared on the blog for the UCL Institute for Innovation and Public Purpose

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In his spending review this week, the Chancellor made clear the scale of the economic crisis facing the UK. Much discussion has followed as to the sustainability of the current spending commitments and public sector debt. Announcements of public sector pay freezes and cuts to foreign aid have been met with dismay.  

Might there be a better way of dealing with the longer-term economic costs of the pandemic? In a new report for the UCL Institute for Innovation and Public Purpose, we argue that the government should consider taking equity stakes in firms at risk of collapse to boost a sustainable recovery. Not only would this be preferential to piling up more publicly guaranteed debt on already highly indebted firms, but, once the economic situation has improved, it could generate a fiscal return.

The advantage of equity investment is that the state and taxpayers can recovery their money when an ailing firm gets back on its feet and is either sold off; or, in other cases, the state can make a longer-term investment, hopefully attracting in other forms of finance to support firms that private investors are not yet prepared to invest in. This avoids the socialisation of losses and privatisation of risk problem that has often occurred during financial and economic crisis.

Widespread government equity ownership in hundreds of thousands of small firms is neither desirable nor practically possible. But well-targeted state investments could help pull economies out of the recession and support longer term policy objectives at the same time. 

However, how to govern public assets to generate value has received little attention compared to the vociferous debate over whether or not to nationalise or privatise. If poorly managed, public equity bailouts risk damaging growth prospects.

Reviewing the evidence on state-owned enterprises across many countries, we find that they can be run effectively providing that the government ownership is institutionalized according to the highest standards of corporate governance and structured as ‘public wealth funds’ (PWFs) that combine arms-length independence from day-to-day politics with active and competent public governance.

The report argues for the creation of five different specialised PWFs: a National Wealth Fund in charge of mature assets such as airlines or energy companies; ‘mission-driven’ venture capital funds focused on innovation, climate transition and regional growth; and regional Urban Wealth Funds to support housing and urban renewal.

Successful examples of PWFs include Singapore which used these vehicles to help turn themselves from an economic backwater to one of the world’s richest countries in the space of a few decades from the 1970s onwards anda number of cities, such as Copenhagen’s City & Port Company and Hamburg’s HafenCity.

The costs of financing PWFs would be low. Even assuming that the suggested equity investments lose their value, the direct fiscal cost of investing in the above-mentioned funds would be small, only around 0.1 percentage points of GDP per year. Moreover, over time some of these investments would likely turn a profit. Historically, the yield on equity has been around 6 percent.

Managing public assets more professionally would also incentivise a wider rethink of public sector accounting, which is currently too focused on debt and short-term cash measures, and largely neglects public sector assets. A better approach for public sector accounting would be to focus on net worth (assets less liabilities) as the most comprehensive fiscal measure using accrual-based accounting. This takes into account both sides of the balance sheet and, when linked to the budget, would incentivise public sector investments.

As the IMF argued in report published last year, if the entire portfolio of public assets were properly accounted for and professionally managed, they could potentially generate some 3% of GDP in additional revenues to government budgets.

The holy grail of public asset management is an institutional arrangement that both removes governance from a government´s direct responsibilities, but at the same time encourages active commercial governance of public assets with the aim of generating value for the public and a dividend that can benefit society as a whole.

This blog was first posted on the IIPP web site

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