9 July 2015

Britain versus the world


Will the budget really deliver a high-productivity high-wage economy?

George Osborne has a dream. It is a dream of an economy in which the market pays – one in which the workforce is productive, capable of earning enough to live a life independent of government handouts. He looks ahead to a Britain in which it is no longer necessary to subsidise low paid dead-end jobs with government welfare. He looks ahead to a faster growing Britain. His plan is to shift the economy away from what he sees as a low wage, high benefit, high tax path to the very opposite: a high wage, low benefit, low tax economy.

As might be expected from the first Conservative Party budget for almost twenty years, Osborne’s budget is radical, something which he hopes will place the economy on his new trajectory. Not only is it a budget of the already much talked about benefit cuts, it is also a budget which offers workers a “national living wage”.With this and other measures, Osborne hopes to encourage the market to deliver greater rewards for the workforce (whether by force or by choice), rather than expecting government to top-up low pay. It is a budget that not only pulls back the tentacles of the state but that also redirects them. It is neither a budget of Thatcher nor a budget of Blair.

The extent to which Osborne’s budget proves capable of turning his dream into a reality will hang on that most crucial of all economic variables: productivity growth. For too long, the British economy has been struggling to deliver higher productivity and, with it, increasing pay. In terms of investment rates and R&D spending, Britain lags behind many other major economies, including the US and Germany. With stagnant productivity has come stagnant pay. Whilst the last few months have seen healthy growth in real disposable incomes (partly helped by falling prices), without continued growth in productivity this up-tick will prove to be unsustainable.

The big question is, therefore, whether Osborne’s policy changes will be enough to place the economy on the desired path towards higher productivity growth. If they are, the associated market rewards that productivity growth brings could have the power to offset any cuts to benefits in the longer term and to make the national living wage affordable for firms. However, if productivity remains a problem, the living wage risks pricing the lowest paid out of work whilst the budget as a whole risks exacerbating that hot potato that is inequality.

Looking to history, there is, on the face of it, reason to be optimistic. Higher wage economies turn into more productive economies. Here, the new national living wage could beneficial. When Britain began its rise from backwater to the world’s leading economy at the time of the Industrial Revolution, it was not a low wage but a high wage economy. According to the historian Robert Allen, these high wages helped to provide employers with an incentive to mechanise: to search for and to adopt machines and technologies that substituted for labour, leading to higher productivity and sustained growth. Higher wages and higher productivity became mutually reinforcing: higher wages led to higher productivity, which fed back to support the higher wage growth.

By the end of the nineteenth century, the US economy was overtaking Britain, and there was one clear difference between the two: the US had even higher wages than Britain. These higher wages encouraged an even more mechanised production process than in Britain (the advent of “mass production”) and helped to deliver productivity levels in US manufacturing that were double those of Britain. The US economy has remained the leading economy ever since.

History is clear: it was not the lower wage parts of the world that rose to become global economic powers, but those with higher wages. The relationship between wages and productivity is not one-way, it is two-way, providing snowball effects for those who can break into the virtuous circle – and a life of economic stagnation for those economies who cannot. If the national living wage encourages firms to raise productivity, it can only be a good thing.

However, there is one force that is working in the opposite direction to Osborne – and it is a far greater force. It is the growing pool of cheap labour outside of the West. Through outsourcing and immigration, this cheap labour has become increasingly accessible to Western businesses in the course of globalisation. With it, wage growth at home has suffered and so therefore has the incentive for domestic businesses to employ production processes which raise productivity. In fact, labour productivity growth has been falling relatively consistently since at least 1970 throughout the developed world. Globalisation has put an end – at least for now – to the high wage growth and high productivity growth equilibrium in the West, leaving us in our current state. The explanation is simple: why invest in technology and mechanisation – in raising productivity – if you can instead rely on cheap labour? Productivity growth, economic growth, investment rates and wage growth have all suffered as a result. Inequality has widened. Whilst the Chancellor’s aims for the economy are admirable and whilst the living wage might help, Britain does not have the power to tackle what is really a global problem: a world awash with people.

You could be forgiven for thinking that part of the solution to this bigger “problem” is to take action against immigration, something that is proving popular in political circles, including those of the present government. With a smaller and flatter world, it is not surprising that the gaping differences in pay between rich and poor countries has meant people from poorer parts of the world risking their lives on arduous journeys by boat across the Mediterranean Sea into Europe or by foot across the hot Mexican desert into the US. Across the world, rich economies are using all kinds of regulations to try to resist this seemingly ever-growing force. However, in reality, to fight immigration in this way is to fight a losing battle – the market incentives driving such movements are so strong that they will override any regulations that a single government can put in place. Market forces will exert themselves in the end – with such large differences in pay between the West and the rest, we will not be capable of stemming the flows of people across borders – that is, until wages start to rise in the poorest parts of the world. The national living wage will only serve to exacerbate the flows.

As I have argued elsewhere, if we really want to return Britain to the type of economic performance seen in the past, and if we truly want to tackle the weakening power of labour which has resulted in low pay and increased inequality at home, we instead need to employ measures in the global sphere which act to raise wages in poorer countries. Here, history provides a clear answer as to how this can be done: empowering women in a way that gives them control over their own baby-making capacity.

In too many parts of the world, poverty means that young girls are seen as a financial burden, to be married off at a young age. In India, the average age at which young women are married is 17 – or 15 for the poorest groups. With little in the way of financial independence, girls have no power to stand up to their parents and delay marriage. Once married, they then have little power to take charge of their baby-making capacity. The result is a life of poverty: of a large family living in slum conditions, with knock on effects not only for their own economy but also for the West.

What we need is for women across the world to have the freedom to be able to make their own choices about work and family – choices which, if you believe in the invisible hand, will work to the betterment of the wider economy. Educational and work opportunities provide young women with the financial independence they need to take charge of their lives: to stand up to early marriage, and to possess the bargaining power needed within the home to be in control of their own fertility. The result: smaller families – families who can therefore better afford to invest in their children – lower population pressure and, with it, higher wages, with positive knock-on effects on the West. Give women across the world freedom to pursue what is in their own best interest and not only will their own family and home economy benefit, but so will the global economy. Along the way, the “problem” of immigration will naturally resolve itself.

If Osborne really wants to achieve his dream, he needs to do more, much more. He needs to go further than introducing the living wage, cutting benefits and offering tax cuts. In a global world, and one where productivity growth has been suffering throughout the West, he needs to look for solutions to today’s economic problems that go beyond Britain. Unless he does so, the measures taken at home risk being half-baked – they risk leaving the poorer parts of our society with neither market rewards in the form of increasing wages nor government-supported rewards in the form of income supplements. For “One Nation Conservatism” to succeed we also need to think in terms of “One World”.

Dr Victoria Bateman, Economic Historian and Fellow in Economics, Gonville & Caius College, Cambridge, and Fellow of the Legatum Institute, London. Her other article for CapX can be found here.