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«Economic policy in the UK under new Labour: the end of boom and bust? Malcolm Sawyer University of Leeds June 2006 Abstract: The paper first ...»

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Economic policy in the UK under new Labour: the end of boom and bust?

Malcolm Sawyer

University of Leeds

June 2006

Abstract: The paper first considers macroeconomic performance under the new Labour

government since 1997. It then considers the nature of fiscal and monetary policy since 1997

and the effects which those policies may have had on macroeconomic performance. The

performance in terms of unemployment and the distribution of income is then considered.

Finally, the question is asked as to whether Gordon Brown, Chancellor of the Exchequer throughout the period, has been a lucky chancellor in terms of whether the relatively good macroeconomic performance since 1997 can be ascribed to his policies or to the general national and global macroeconomic environment.

Key words: Labour government, monetary policy, fiscal policy

Address for correspondence :

Malcolm Sawyer, Economics Division, Leeds University Business School, The University of Leeds, Leeds LS2 9JT Email : mcs@lubs.leeds.ac.uk Economic policy in the UK under new Labour: the end of boom and bust?

Malcolm Sawyer

1. Introduction The Labour government elected in May 1997 came into office stressing that it was ‘new Labour’ and pursuing a ‘third way’. In macroeconomic terms, the emphasis was on the avoidance of ‘tax and spend’ policies and restraints on public expenditure along with the adoption of the so-called ‘golden rule’ of public finances (as discussed below). There was something akin to a disavowal of a Keynesian approach to macroeconomic policies and specifically the use of fiscal policy to help steer the economy. There was an emphasis on labour market reforms and flexibility, which would, in effect, lower the ‘non-accelerating rate of unemployment’ and thereby lower unemployment. Whereas previous Labour governments had pursued a range of industrial and regional development policies to stimulate economic growth and lower unemployment, there was a major shift from those policies to those of labour (and to some degree product) market ‘flexibility’.

This approach was reflected in New Labour’s belief in a ‘flexible labour market that serves employers and employees alike’ (Labour Party, 1997); also that ‘The more our welfare to work reforms allow the long-term unemployed to re-enter the active labour market, the more it will be possible to reduce unemployment without increasing inflationary pressures. And the more our tax and benefit reforms remove unnecessary barriers to work, and the more our structural reforms promote the skills for work, the more it is possible to envisage long-term increases in employment, without the fuelling of inflationary pressures’ (Brown, 1999, p.10).

Furthermore, ‘The sustainable rate of unemployment, or NAIRU, is believed to have risen in theUK during the 1970s and 1980s, but there is broad agreement that this increase has been partly reversed since the late 1980s. Although the magnitude of any fall is very difficult to estimate, most estimates of the current level of the NAIRU lie in the range of 6 to 8 per cent on the LFS measure of unemployment. However, considerably lower levels should be achievable in the long run through re-integrating the long-term unemployed back into the labour market, upgrading skills, and reforming the tax and benefit systems to promote work incentives (Treasury, 1997, p.82). However, ‘the idea of a fixed natural rate of unemployment consistent with stable inflation was discredited by the evidence of the 1980s, presumably on the grounds that unemployment and the estimates of the natural rate moved higher during the 1980s. In effect, ‘the new government has taken a decisively different approach to employment policy over the past two years aimed at reducing the NAIRU’ (Brown, 1999, p.10).

This paper seeks a preliminary evaluation of the effects of the macroeconomic policies, which emerged from the ‘third way’, and whether they have delivered growth and stability.

The focus of this paper is on macroeconomic policies. What may be deemed microeconomic policies and issues enter our discussion in a number of ways. First, microeconomic policies which have been intended to raise economic activity, reduce unemployment etc., have largely been labour market policies rather than industrial and/or regional policies. As reflected in some of the quotes given above, there was the notion that a more ‘flexible’ labour market would in itself (that is without the assistance of higher levels of demand etc.) raise the level of employment. Issues such as the location of industry and capacity, particularly in terms of their regional dimensions, were effectively ignored in contrast to the regional policies pursued by previous Labour (and other) governments.

Second, the distribution and re-distribution of income (and wealth) has to be considered.

There has been some re-structuring of the tax system, notably the introduction of working tax credits, with the avowed intention of modifying the distribution of income. Further, ‘the government has a quantified Public Service Agreement (PSA) target for child poverty in 2004–05 to be a quarter lower than its level in 1998–99, using a poverty line of 60% of median income’ (Brewer, Goodman, Shaw and Shephard, 2005, p.19). The introduction of a national minimum wage was also an early policy of the incoming Labour government. Within the overall fiscal system there have been attempts (evaluated below) to re-distribute income, particularly at the bottom of the income distribution.





The paper first considers (rather briefly) macroeconomic performance under the Labour government since 1997. It then considers the nature of fiscal and monetary policy since 1997 and the effects which those policies may have had on macroeconomic performance. The following two sections consider the performance in terms of unemployment and the distribution of income. The final main section considers the question of whether Gordon Brown, Chancellor of the Exchequer throughout the period, has been a lucky chancellor in terms of whether the relatively good macroeconomic performance since 1997 can be ascribed to his policies or to the general national and global macroeconomic environment.

2. Recent macroeconomic performance Table 1 summarises some of the aspects of recent macroeconomic performance. In growth terms, GDP has grown at an average annual rate of 2.8 per cent over the period 1997-2005, slightly above the presumed trend rate of growth. In the preceding seven years it had been

2.05 per cent, but that included the recession years of 1990/91 (not included in Table 1); over the previous five years of 1992 to 1997 the average growth rate was 2.9 per cent. Growth has been relatively stable, and in particular there has been no period of negative growth, whereas in the preceding quarter of a century there had been three recessions (1974/75,1980/1,1990/1). Inflation has remained low and consistently met the Chancellor’s target of 2 per cent plus or minus 1 per cent.1 Unemployment fell continuously from 1993 until 2005, but has been rising over the past 15 months to reach a 4 year high in May 2006.

Table 1 near here Figures such as those in Table 1 are used to support the view that macroeconomic performance in the past decade or so has been rather good – in the phrase used by the governor of the Bank of England, Meryvn King, the ‘NICE’ decade – ‘Non-Inflationary Continuous Expansion’. The government and Chancellor, amongst others, have strongly promoted the idea that macroeconomic performance, in terms of the level (e.g. of inflation, growth) and variability (‘stability’), has been particularly good. Recent endorsements have

come from the OECD and IMF. For example, in their report on the UK, the OECD write that:

‘Macroeconomic performance over the last decade has been a paragon of stability: GDP growth has remained closer to potential than for almost any other OECD country; the unemployment rate has fallen to its lowest level and has been the least volatile since the 1970s; and inflation has remained stable and close to the official target. Perhaps most surprisingly, in the period since the current monetary and fiscal framework has been in place, not only has the effective exchange rate been more stable than at any time since the Bretton Woods period, but it is also among the most stable in the OECD and more stable than for the major euro area countries.’ This performance is ascribed ‘to the strength of the institutional arrangements for setting monetary and fiscal policy … as well as to the flexibility of labour and product markets’ (OECD, 2005, p.24). It is, thus, argued that ‘Flexible labour and product markets have underpinned the recent impressive macroeconomic performance.

Moreover, sectoral policies have not attempted to foster “national champions”. The United Kingdom is among the leading countries in the OECD in terms of liberal product market regulation (OECD, 2005b) and ranks highly in most aspects of labour market flexibility.

Recent OECD work, which constructed a composite policy indicator of flexibility ranked the United Kingdom the highest among all OECD countries. It also found cross-country evidence that this flexibility is important in facilitating growth in the service sector (Kongsrud and This refers to the current target set in terms of the HICP to which the figures in Table 1 refer. For much of the time the target was set in terms of the RPI and used the figure of 2.5 per cent.

Wanner, 2005).’ However, ‘one area where macroeconomic policy does, however, require attention is fiscal policy’ (OECD 2005 p. 34), and we return to this below.

The IMF write that ‘Macroeconomic stability in the United Kingdom remains remarkable.

Over the past decade, the growth of real GDP per capita has been strong and stable.

Unemployment and inflation have been low, and the current account deficit has been moderate. This impressive record owes much to good macroeconomic, financial, and structural policies, underpinned by sound policy frameworks and supported by a generally favorable external environment’ (United Kingdom—2005 Article IV Consultation Concluding Statement of the IMF Mission p.1, emphasis in original).2 The rest of the paper attempts to evaluate the contribution of macroeconomic policy to this performance, and specifically whether the policy regime introduced by the incoming Labour government in 1997 has made a major contribution.

3. Fiscal policy The Chancellor’s Budget of March 2006 provides a recent summary of government’s objectives and policy instruments. ‘This Budget describes the next steps the Government is

taking to enhance its long term goals of:

• maintaining macroeconomic stability, ensuring the fiscal rules are met and that inflation remains low;

• raising the sustainable rate of productivity growth, through reforms that promote enterprise and competition, enhance flexibility and promote science, innovation and skills;

• providing employment opportunity for all, by promoting a flexible labour market which sustains a higher proportion of people in employment than ever before;

• ensuring fairness, by providing security for people when they need it, tackling child and pensioner poverty, providing opportunity for all children and young people and delivering security for all in retirement;

• delivering world-class public services, with extra investment alongside efficiency, reform and results; and

• addressing environmental challenges, such as climate change and the need for energy efficiency in response to rising oil prices.’ (Treasury 2006, p.3, emphasis in original) The six goals highlighted here provide a good summary of the objectives of the government as they see them, and in this paper we pay particular attention to the first, third and fourth ones listed.

http://www.imf.org/external/np/ms/2005/121905.htm : accessed 23.12.2005 It boosts that this [world] slowdown, the Government’s macroeconomic framework ‘despite has continued to deliver the UK’s longest period of sustained and stable economic growth since records began fifty years ago. UK GDP has now expanded for 53 consecutive quarters.

Moreover, the current economic expansion has now persisted for well over twice as long as the duration of the previous period of unbroken growth.’ (Treasury, 2005, p.3), and now 54 quarters (Treasury, 2006, p.4). The operation of fiscal policy has been subject throughout the

period to the operation of:

‘the golden rule - on average over the economic cycle, the Government will borrow only to invest and not to fund current spending; and,

- the sustainable investment rule – the public sector net debt as a proportion of GDP will be held over the economic cycle at a stable and prudent level’ (Treasury, 1999, p. 19).

‘The Government's primary objective for fiscal policy is to ensure sound public finances in the medium term. This means maintaining public sector net debt at a low and sustainable level. To meet the sustainable investment rule with confidence, net debt will be maintained below 40 per cent of GDP in each and every year of the current economic cycle.’ (Treasury, 2005). This refers to public sector net debt: the figure calculated according to the Maastricht Treaty rules is around 6 to 7 per cent of GDP higher than 40 per cent.

In the ‘golden rule’ itself nothing is said on the extent of public investment and hence of the extent of borrowing). But it is well-known that an overall budget deficit to GDP ratio (d) would lead to debt to GDP ratio (b) stabilising at: b = d/g, where g is the nominal growth rate. Hence with a nominal growth rate of around 5 per cent (real growth of 2.5 per cent, inflation of 2.5 per cent say), a 40 per cent debt to GDP ratio would be consistent with a 2 per cent average budget deficit.

These fiscal rules are significantly less restrictive than those imposed on euro area governments by the Stability and Growth Pact (SGP). An overall budget deficit of the order of 2 per cent of GDP as compared with the balanced budget or small surplus envisaged in the SGP. Further there is no upper limit placed on the size of budget deficit during a recession.



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