This is not the first government to attempt a modern supply side strategy to get growth. Both Truss-Kwarteng and Sunak-Hunt tried it, the latter more successfully than the former. For success to materialise before the decade is up, Labour will have to dissuade the fiscal watchdog against caution, or better yet – simply prove them wrong.
Having spent a fair amount of time in the weeds of Labour’s economic worldview, putting together our recent report on the subject, I feel confident in claiming that the new government is trying to pursue a “modern supply-side” strategy. That means boosting investment and labour market participation and productivity so as to increase the country’s economic capacity. The trouble is that this isn’t the first government in recent years to have that aim. Indeed, reviewing the recent history of supply side economics highlights some of the challenges facing the current administration in boosting growth, but also getting political credit for it.
Liz Truss, who Rachel Reeves has sought define herself in opposition to, also saw herself as a supply sider. It is easily forgotten that Truss’ government promised a suite of supply side growth measures including changes to the planning system, business regulations, childcare, immigration, agricultural productivity and digital infrastructure – many of the same areas that Labour are or will be looking at as part of their economic project. Truss never got that far because of the fallout from the disastrous ‘mini budget’. A cynic would say that reflects Truss’ ultimate reversion to more traditional supply side economics in the Thatcher or Reagan mould, prioritising tax cuts above all else.
However, the collapse of Truss also reflected an inability to square her approach with economic institutions, and in particular, the Office for Budget Responsibility. She subsequently said that she never realised the “sheer level of power” that the OBR has. It wasn’t just the scale of unfunded borrowing that did it for Truss, but her efforts to sidestep the OBR, and prevent it from forecasting the impact of the mini-Budget.
Why did she do that? Because she thinks the OBR is too “orthodox” in its thinking, and so wouldn’t recognise the potential of her policies to boost growth. It would be too pessimistic about her economic worldview, and undermine her argument to the markets and the public, torpedoing her reforms.
The OBR, of course, came out on top. Yet what is often missed is the fact that Jeremy Hunt, who on the face of it had to repudiate so much of what Truss stands for, then went on to produce one of the most effective supply side budgets in recent memory in March 2023. Truss was all mouth and no trousers, while Hunt quietly delivered, but – in keeping with the Sunak government – failed to explain the extent of his achievements.
At the heart of the March 2023 Budget were two key policies: full expensing (tax relief to incentivise business investment), and the expansion of free childcare entitlements (making it easier for parents to work). Both measures expand the supply side of the economy. But what’s more, Hunt managed the thing that Truss didn’t even attempt: he convinced the OBR that his supply side reforms are good for growth. The OBR’s modelling estimated that the 110,000 people drawn into the workforce by Hunt’s childcare reforms and other changes to benefits would increase national income by 0.2% – “the largest upward revision we have made to potential output within our five-year forecasts as a result of fiscal policy decisions taken by a Government in any of our forecasts since 2010”. Full expensing was expected to add a further 0.2%, though that was treated as a temporary measure at the time (it has since been retained by Labour).
The new Labour government has hugged the OBR close, in an effort to distinguish itself from the recklessness of the Truss era. Yet in this week’s Budget it has found it harder to find supply side reforms that meet with the OBR’s favour. In part, this may be because Hunt nabbed some of the more promising ones that take effect quickly (before the Budget childcare was shaping up to be the party’s flagship priority in education). Labour’s proposed increase in public investment is expected eventually to increase GDP by 0.3%, but most of the gains won’t be felt until the 2030s, according to the OBR. You will notice that is after the next election, which poses some political challenges, to say the least. That 0.3% figure assumes that the benefit of public investment is cancelled out by some ‘crowding out’ of private investment as borrowing costs go up; already sympathetic think tanks are arguing that the growth effect will be bigger because of ‘crowding in’ as the private sector invests to take advantage of the opportunities from better public infrastructure.
In terms of other supply side reforms the government is pinning its hopes on, the OBR admits planning reform could increase productivity, though it has held fire for the time being until sees more detail. In any case, the worry again is that the economic benefits won’t arrive until the next parliament. The government has also ambitious plans to get more people into work by improving job quality, having pledged to raise the employment rate to 80%. Yet the OBR sees the national insurance increase as destroying jobs, and suggests that its employment rights package “could pose downside risks”.
Having put so much stock in the OBR’s word, it is challenging for the government to prosecute its growth narrative without arguing back, for fear of looking too ‘Liz Truss’. Better, perhaps, to get its head down and try to persuade the country’s fiscal watchdog that this time, it really is being too cautious.
Over the last few weeks, the assumption within Westminster has been that this Budget would be a defining moment for the new government. Yet in terms of supply side growth reforms, it is apparent that much of the action is still to come – in the detail of planning reform, in the effectiveness of the forthcoming Plan to Get Britain Working, and the impact of pension reforms. For the country’s sake, we had better hope they are successful enough to prove the OBR wrong.
