Why Labour’s Plans Are Good for Economic Growth

The Labour party have said that if they win the election they will greatly increase public spending (spending by the Government and local councils), and that they will pay for this extra spending both by increasing government borrowing and by increasing taxes for the wealthiest people and corporations.

Some critics of the Labour Party have claimed that increasing public spending in this way would be bad for the economy. These critics often create the impression that we have to choose between having nice things (like more hospitals, better funded schools and full-fibre broadband) and having a strong economy.

However, in reality, the opposite is true. Labour’s spending plans would actually increase economic growth, while the plans of the Conservatives or the Liberal Democrats would keep it low.

In this post I will explain why this is the case. I will also explain why it is important. But first, let’s have a quick recap of some of the basics.

Quick recap – GDP and growth

My last post (What is Economic Growth?) was a detailed explanation of the concepts of GDP, economic growth, recession, and various other economic terms that you often hear in the news. If you aren’t sure what these terms mean, then I recommend reading that post before this one.

For those who have already read that post (or are already familiar with these terms), but want a quick reminder, here is a brief recap. Feel free to skip this part if you are already happy with this stuff.

GDP

GDP (gross domestic product) is a measure of the total amount of goods and services produced in a place (e.g. the UK) during a particular period of time (e.g. the year 2019).

GDP can also be thought of as a rough measure of the amount of goods and services that people are consuming in a country, and it can also be used as a rough measure of the size of a country’s economy.

GDP per capita

GDP per capita is the GDP of a country (or region) divided by its population. In other words, it gives a measure of the amount of goods and services produced per person.

GDP per capita is often taken as a measure of a country’s prosperity, however there are a lot of problems with this. For example, GDP per capita doesn’t tell us anything about how the goods and services are distributed once they are produced. For a more detailed explanation of why GDP per capita is not a good indicator of prosperity, see my previous post.

A better way to measure prosperity is to look at a range of different indicators (which could include GDP per capita).

Economic growth and recession

An increase in GDP per capita over time is called economic growth, and a decrease in GDP per capita over time is called recession.

(The terms ‘economic growth’ and ‘recession’ can also be used to refer to an increase or decrease in GDP rather than GDP per capita).

GDP per capita almost always increases from one year to the next. In other words, there is almost always economic growth. This is mainly due improvements in technology, and businesses accumulating the things they need to produce goods and services (like machines).

Although GDP per capita is usually increasing, the rate of increase varies from one year to the next. This rate of increase is called the growth rate. If there is a recession then the growth rate will be negative.

Why should we care about economic growth?

Given that GDP per capita is not, on its own, a very good measure of a country’s prosperity, it is a valid question to ask whether economic growth is even important. After all, shouldn’t we be focusing on improving people’s lives and protecting the environment, rather than trying to produce more stuff?

However, there are actually a few reasons why we should care about economic growth:

Having more goods and services can be a good thing

When we when think about economic growth we might sometimes picture a factory churning out greater and greater amounts of some useless plastic product while pumping out greenhouse gases and polluting the water supply.

While economic growth can involve that sort of thing, it doesn’t have to. And in fact there are many goods and services that we genuinely would benefit from having more of.

For example, a GP appointment is a service. In the UK we don’t have enough GP appointments, which is partly because public spending cuts have lead to a fall in the number of GPs. If more GPs were recruited and trained, and we invested more in keeping the GPs we already have, then there would be more GP appointments per year, which would mean a higher GDP per capita.

So economic growth can be a good thing, it is just that we also need to look at other things, like what kinds of goods and services we are producing more of, how those extra goods and services are being distributed, the impact of the extra production on the environment, and so on.

Economic growth creates jobs

Economic growth means that we are producing more goods and services. This means that more work is needed to produce those goods and services, which means that businesses will need to hire more workers. Also, it means there are more opportunities for people to start their own businesses.

Also, it means that there will be more hours of work available for people who already have jobs. In the UK we actually have quite a high rate of employment, however many of these people only have part-time work and don’t have enough hours of work to meet their needs. In other words, we have a high level of in-work poverty. A high growth rate could mean that many workers would have more hours.

Economic growth increases tax revenues

Tax revenues are the money that the Government and local councils get from taxes. When there is economic growth, tax revenues increase. This is because:

  • People are buying more goods and services, so more VAT is paid.
  • People’s incomes are higher, so more income tax and national insurance are paid.
  • Companies’ profits are higher so more corporation tax is paid.
  • More goods are produced, so more excise duties are paid (these are taxes paid on certain goods when they are produced – e.g. alcohol).

This means that there is more money available for public spending.

We could get all of these benefits without economic growth

It is important to note that we could have these things without economic growth. For example, we could redirect our resources to produce more of the goods and services that are most important to us, without actually increasing the total amount produced. We could create more jobs by sharing out the existing work between more people (e.g. by introducing a four-day working week). And we could increase tax revenues by making changes to the tax system (e.g. by increasing corporation tax).

So I am not saying that we should only be focusing on trying to increase the growth rate. However a higher growth rate can genuinely be beneficial, so it is worth looking at the ways that different parties’ policies would affect it.

Before we look at what the options are today, it will be useful to look at what has been happening for the last ten years or so.

The Great Recession and its consequences

In 2007 and 2008 there was a global financial crash, which caused the UK’s economy to go into recession. The graph below shows the UK’s GDP per capita from 2004 to 2013 (hover or press on a data point to see the year and value; the values are in US dollars based on the value of a dollar in 2010). As you can see, there was a big drop from 2007 to 2008 and an even bigger drop from 2008 to 2009. This recession, which occurred in many countries, was named The Great Recession.

The Great Recession was a big problem for two reasons. Firstly, it had a massive impact on people’s lives, as jobs were lost and standards of living went down. Secondly, it meant that tax revenues went down, so the Government had less money coming in. In other words, the problems of a recession are the opposite of the benefits of growth.

The fall in tax revenues meant that the Government had to rely more on borrowing in order to maintain the same level of public spending.

Every year, the Government and local councils receive a certain amount of money from tax (and from other revenues, such as fines and the profits of publicly owned businesses).

The Government and local councils also spend a certain amount of money, which is called public spending.

If the amount of money raised through tax and other revenues is not enough to cover the public spending for that year, then the Government has to get the extra money by borrowing (see my post Government Borrowing can be a Good Idea). When this happens, the amount of money that has to be borrowed is called the ‘deficit’ for that year. Because the Government borrows money, the amount of government debt goes up.

On the other hand, if the amount that is raised through tax and other revenues is more than the public spending for that year, then the amount of leftover revenue is called the ‘surplus’ for that year. This surplus can be used to pay off government debt, meaning that the amount of government debt goes down.

It is quite normal for there to be a deficit. After all, as I explain in one of my other posts, government borrowing can be (and often is) an investment that leaves the Government with more money in the long run. In fact, the UK has only had a surplus for 12 out of the last 70 years, as shown in the following chart where a yellow (upwards) bar is a surplus and blue (downwards) bar is a deficit.

Chart showing that the UK has had a deficit almost every year since 1948.

The recession caused the deficit to go up a lot, which meant that the total amount of government debt increased by a lot more than it had done in previous years.

What is austerity?

In 2010 (two years after the recession first hit) there was general election. None of the parties won enough seats to form a government on their own, so a coalition government was formed between the Conservatives and the Liberal Democrats (with Conservative David Cameron as Prime Minister and Liberal Democrat Nick Clegg as Deputy Prime Minister).

The coalition government argued that the deficit was too high. In other words, they said that the Government was borrowing too much money and that we needed to reduce the amount of borrowing. Government policies that are designed to reduce the deficit are called ‘austerity’ policies.

There are two main ways to reduce the deficit. One is to increases taxes so that government revenue goes up and less borrowing is needed. The other is to reduce public spending.

The coalition government decided to focus mostly on cutting public spending rather than increasing taxes. In fact, one of the first things they did when they came to power was to decrease the top rate of income tax.

This form of austerity (cutting public spending) has been continued by the Conservative governments that we have had since the coalition government ended in 2015.

It is important to note that while technically the term ‘austerity’ can be used to refer to either tax increases or public spending cuts, when people use the term in the UK at the moment they are usually referring to the public spending cuts that have been carried out by governments that we have had since 2010. In this article, and on the rest of this website, that is what I mean by ‘austerity’.

Austerity has been bad for growth

These cuts to public spending have had a devastating effect on millions of people in the UK. Public services have been underfunded, many people have been driven into poverty, and levels of homelessness and food-bank use have risen massively.

The Conservatives and Liberal Democrats have argued that this was all necessary in order to fix the economy. However, if we look at the growth rate over the last ten years, we can see that it has not been working.

The graph below shows the UK’s GDP per capita every year from 1996 to 2018.

We can see that although there has been positive growth every year apart from the two years of the Great Recession (2008 and 2009), the rate of growth (how steeply the graph goes up) has been lower since austerity was introduced than it was before the recession (when public spending was high).

As Oxford University economics professor Simon Wren-Lewis pointed out in a recent article, the average growth rate for the ten years before the global financial crisis (1997 to 2007), when public spending was high, was over 2.5%, whereas the average growth rate for 2010 to 2018, when we have had austerity, has been under 1.2%.

Earlier this year, over a decade since the crisis first hit, and after almost ten years of austerity, the UK economy almost slipped back into recession.

To understand why austerity has been so bad for the economy we need to look at why public spending is so important for growth.

Why public spending increases growth

There are two main reasons why government spending increases growth. One is extremely straightforward. The other takes a little bit more explaining, but is still pretty uncomplicated. Let’s start with the really easy one.

A lot of government spending is on goods and services

A lot of what the Government spends money on is goods and services. For example, the National Health Service is a service (or, really, a set of services). The Government pays hospitals, clinics and surgeries to provide us with services like GP appointments, X-rays and operations. All of this counts towards GDP. The Government also pays for the goods used by the NHS, like medicines and cleaning products. So more funding for the NHS means more spending on goods and services, which means a higher GDP.

If you think about all of the things that the Government spends money on – health, education, parks, libraries, transport, and so on – then you can see that a lot of this money is being spent on goods and services.

Government spending transfers money to poorer people (who will spend it)

How rich or poor a person is has a big effect on what proportion of their income they will spend on goods and services.

If someone is living in poverty – meaning that they don’t have enough money to pay for their basic needs – then they will probably spend a large proportion of their income on goods and services. This is because they need to use the money they have coming in to provide for their needs.

Someone a little bit wealthier, who has enough income to live comfortably, will be likely to set some of their income aside as savings. This means that they spend a lower proportion of their income on goods and services than the person living in poverty.

Someone who is very rich is likely to put a large proportion of their income aside as savings, since they have no need to spend the large amount of money they have coming in. This means that they will spend only a small proportion of their income on goods and services.

The obvious conclusion from this is that if we want to increase economic growth, we should transfer money from the rich to the poor. In other words, take money that is sitting in savings accounts and give it to people who will spend it on goods and services.

This is exactly what government spending does.

One of the sources of money for government spending is government borrowing. As I explain in my post on government borrowing, the Government borrows money by selling bonds to people who having savings that they want to invest. By buying government bonds, these people are lending their savings to the Government.

This means that when the Government borrows, the money they are receiving is money that would otherwise have been sitting in savings accounts, rather than being spent.

The other main source of government money is tax. Since a large amount of tax revenue comes from wealthy people, a lot of this money is also money that would otherwise have been saved rather than spent.

When the Government spends, a lot of this money goes to people with relatively low incomes and low wealth. There are three ways in which this happens:

Firstly, some of the money is directly transferred in the form of benefits payments (for unemployed people, people with disabilities and so on).

Secondly, some of the money is used to pay public sector workers. While there are some senior doctors, headteachers and so on who are relatively wealthy, most public sector workers (including nurses, junior doctors, teaching assistants, teachers, road sweepers, park keepers and so on) have low enough incomes that they spend a large proportion of what they are paid on goods and services.

Finally, some of the money is used to buy goods and services from private companies, which means that some of that money is passed on to the people who work for those companies as their wages or salaries. Many of these people will have low enough incomes that a large proportion is spent on goods and services.

By taking money that would otherwise not have been spent and transferring it to people who will spend it on goods and services, public spending boosts economic growth.

These two factors work together

These two ways in which government spending boosts growth actually work together. For example, think about what happens when the Government pays a road sweeper. Firstly, the Government is paying the road sweeper for a service (sweeping the road), so there is a direct boost to GDP there. Then, the road sweeper spends some of their pay on goods and services, which boosts GDP again. Some of the recipients of that money will then spend it on goods and services again. So the money is spent multiple times, which is why public spending can be so good for growth.

Austerity was a terrible idea

The massive cuts to public spending that we have had since 2010 have limited the ability of the economy to recover from the effects of the global financial crisis. Just as we started to come out of recession, the Government introduced austerity, and growth has been slow ever since.

Public spending fuels economic growth. In the aftermath of the crisis, public spending was needed more than ever to get the economy moving again. However, just when public spending was most needed, the Government massively reduced it.

Instead of increasing borrowing and taxation to invest in the country and get the economy moving, the Governments that we have had since 2010 have been obsessed with reducing the deficit. There is no reason to focus on reducing borrowing if borrowing is the thing that will allow you to grow the economy in the long run.

As professor Wren-Lewis points out in his article, “Deficits always rise in recessions, and it is basic economic wisdom that the last thing you do in that situation is cut spending, because you will choke off the recovery”.

Professor Joseph Stiglitz, former chief economist at the World Bank and a Nobel Prize winner, has also made this point. In a recent talk he referred to the fact that when companies borrow money they don’t just look at how much debt they are in (their ‘liabilities’), but they also look at how much their assets have increased as a result of that borrowing.

As he points out (at 19m 45s in the video), “We talk a lot about government debt – everybody focuses on debt. No company would ever talk about just their debt. Your debt is your liabilities side of your balance sheet, but there’s another side called your assets. And if you look at just the liabilities of course things look terrible.”

As he goes on to explain (25m 35s), when the financial crisis hit, “Some governments… focused on only the liabilities side. They said deficits matter. GDP was going down, so tax revenues were going down, and the response to that was austerity, cut back expenditures. Now any reasonable economic analysis (which does not exist in all countries), would say cutting back on expenditures – austerity – is going to decrease GDP even more and won’t lead to recovery, and its going to have a negative effect on tax revenue.”.

What need a big increase in public spending

We need to massively increase public spending in order to repair the damage caused by austerity, to invest in the future of the country, and to boost the rate of economic growth.

Out of the three main parties – Labour, the Conservatives and the Liberal Democrats – only the Labour party are proposing the big increases to public spending needed. They are planning to fund this spending by increasing taxes for the wealthiest people and corporations, and by increasing government borrowing – which is a sensible investment.

The Conservative Party are promising much smaller increases in public spending – effectively just reversing a bit of the austerity that they have unnecessarily imposed for the last nine years. And they have no plans to increase taxes. In fact they were planning to decrease corporation tax (we already have the lowest rate in Europe) until this became so embarrassing that they “shelved” the plan (meaning they are saving it for later, when there isn’t an election happening). They have claimed that Labour’s plans would be a reckless spending spree.

The Liberal Democrats are promising even less spending than the Conservatives. In addition, they have said that they would only borrow money to pay for ‘capital investment projects’ – which means building things like hospitals and roads – but they would not borrow money for spending on providing public services (like paying nurses or buying equipment for schools). They have claimed that even the Conservatives’ plans for a moderate spending increase are reckless.

The Conservatives and the Liberal Democrats are claiming that Labour’s spending plans are extreme and reckless, while what they are proposing is much more sensible. In fact, the opposite is true. Labour’s plans are completely a normal and sensible way to manage an economy, and are actually very similar to what already happens in many other countries. What the Conservatives, and even more so the Liberal Democrats, are proposing is in fact reckless and extreme.

The graph below shows the amount of public spending in several different EU countries. Each country’s public spending is expressed as a percentage of its GDP (if you aren’t sure why public spending would be expressed this way, see my post on GDP).

Bar showing that the UK's public spending is 40.4% of GDP, lower than most EU countries.

The UK’s level of public spending, at 40.4% of GDP is one of the lowest in the EU. Even the increases in public spending that Labour are proposing would be unlikely to put us as high as countries like France (on 56.8%), Finland (on 56.6%) or Belgium (on 54.5%).

(If you want to look at how we compare in other groups of countries, or when looking at amount spent per person, have a look at the interactive chart from the OECD.)

Of course, the aim isn’t necessarily to have the highest level of public spending. The point is just that what Labour are proposing is very much within the realms of what is normal for other countries.

Given the damage that austerity has caused and is continuing to cause, the desperate need to invest in our infrastructure, and the importance of boosting our economy – which came dangerously close to slipping into recession this year – Labour’s spending increases are totally necessary.

Meanwhile the Conservatives and the Liberal Democrats’ plans for low public spending would continue to make us all worse off while also starving the economy of the money that it needs to grow.

Although the Liberal Democrats have not been in power since 2015, and were only in power as part of a coalition before that, it is important to note that they have consistently voted for and argued for austerity. Even to this day they still argue that it was and is necessary.

In fact, Jo Swinson, the leader of the Liberal Democrats has consistently voted with the Conservatives on austerity and in June she told the BBC’s Andrew Marr, “we did need to constrain spending because of the deficit”.

Just in case you need a reminder, here’s that quote from Nobel-prize winning former World Bank Chief Economist Joseph Stiglitz again:

Any reasonable economic analysis (which does not exist in all countries), would say cutting back on expenditures – austerity – is going to decrease GDP even more and won’t lead to recovery, and its going to have a negative effect on tax revenue.”

The Liberal Democrats portray themselves as the party that would be strong on the economy, when in reality the policies that they are proposing, and the ones they have supported for the last nine years, go against basic economic principles.

Their plan to never borrow money for day-to-day spending is dangerous and should be seen as an extreme break from what is considered sensible by economists and governments around the world. It ignores the fact that all public spending is an investment. Spending on health now prevents people’s medical problems from getting worse, which would cost us more money later. Spending on education gives people the skills they need to succeed economically, which boosts growth, which increases future tax revenues.

Borrowing money to fund day-to-day spending is standard practice for governments. What the Liberal Democrats are proposing would be considered extreme even for the Conservatives.

Labour’s plans for increased taxation, increased borrowing and increased public spending are completely in line with what is already standard practice for many successful European countries. They are also completely necessary.

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