CAMBRIDGE – What is the government’s proper role in an advanced market economy? That is the fundamental question at the heart of the economic debacle in the United Kingdom. So far, the focus has been on Prime Minister Liz Truss’s disastrous macroeconomic judgment and the (entirely understandable) reaction of financial markets to her fiscal plan. But Truss and her Chancellor of the Exchequer, Kwasi Kwarteng, got one thing right: the UK’s core problem is that long-term growth has ground to a halt.
Few would disagree with Truss and Kwarteng’s diagnosis of the UK’s economic challenges. The current confluence of global crises has exposed the country’s chronically low growth rate and flat-lining productivity. But their proposed remedy – cutting taxes for the rich and undoing economic regulations, thereby unleashing innovation and investment – turned out to be a harder sell. Even financial-market traders (hardly statist left-wingers) do not believe in Truss’s vision of a twenty-first-century Hayekian utopia.
When courting rank-and-file Conservative Party members in the contest to replace Boris Johnson, Truss presented herself as Margaret Thatcher redux, copying not only the Iron Lady’s radical right-wing policies but many of her outfits and photo ops. But unlike Thatcher, who was elected in 1979 with a popular mandate and ample political capital, Truss became prime minister by winning over 81,326 Conservative Party members – just 21,000 votes more than her rival, Rishi Sunak. The wider British public remained on the sidelines.
Thatcher also commanded a vastly different economy than the one Truss was handed. Unlike the highly inefficient and relatively high-tax economy that Thatcher inherited, today’s UK economy is already relatively lightly taxed and regulated, limiting policymakers’ scope to cut taxes or deregulate. Moreover, there is no clear correlation across countries between the government’s share in the economy and GDP growth. Considering that the UK economy is still less productive than its peers after decades of tax cuts and deregulation, the idea that lowering tax for the wealthy would act as a supply-side stimulus struck most people as wishful thinking at best.
To reinvigorate the UK economy, Truss and her government must look to the future instead of mining the past. The character of advanced economies has changed significantly since the Thatcher era, following a steady worldwide shift toward services and knowledge work, the emergence of sophisticated supply chains that enable greater connectivity within and among economies, and the growing importance of intangible assets. Today’s weightless, globalized, high-skill economy requires a different kind of supply-side strategy, whereby governments would have to play a different role.
Some of the classic elements of the “minimal state” are essential to this transition, including the rule of law, contract enforcement, basic infrastructure, and, of course, education. Other widely accepted government functions, like publicly funded basic research and tax support for corporate research and development, are similarly crucial.
But the transition toward digital and green technologies requires governments to take a more active role in shaping markets. Digital markets, for example, must be competitive to encourage new entrants. Several reports in the UK, the European Union, and the United States have outlined steps regulators and competition authorities could take to make today’s winner-take-all markets more contestable.
Likewise, the use of data plays an important role in companies’ success. Research shows that data-equipped companies are more productive and profitable than other companies in their sectors and pay higher wages on average. This makes national data strategies – defining what should be open, setting the terms on which competitors should be able to access certain data, and establishing adequate safeguards and control for consumers – vitally important.
Lastly, governments today have a critical role to play in setting technical and regulatory standards for emerging technologies. And they must do so in a timely fashion to ensure that markets grow big enough to attract investors. Public procurement and advance-purchase commitments can be powerful tools to incentivize innovation and investment. This was the case with the development and production of COVID-19 vaccines, and it may be the case with clean-energy technologies or biomedical discoveries.
In short, an economy undergoing major structural shifts requires a forward-looking economic strategy. Just as the 1960s-era approach of subsidizing selected “winners” survived well past its expiration date, so has the tax-cutting and deregulatory approach of the past 40 years.
Today’s knowledge economy requires an innovative state to provide a long-term framework for investment and set the rules of the game. Unless Truss and Kwarteng stop living in the past, the prospects for the UK economy on their watch look bleak.
Diane Coyle, Professor of Public Policy at the University of Cambridge, is the author, most recently, of Cogs and Monsters: What Economics Is, and What It Should Be (Princeton University Press, 2021).
Copyright: Project Syndicate, 2022.