The two main parties’ policies on tax and spending have had plenty of attention in this election campaign. Yet few have commented on quite why there is such a difference between their plans.
Labour has a huge number of proposals to increase current spending. The party is promising to abolish tuition fees and to put more money into schools and early-years education, the health service, local government, social care, universal credit and public sector pay. These will be paid for by higher taxes on higher earners and companies.
In addition, Labour plans a very large increase in public investment, including building more houses and “greening” the economy, paid for by additional borrowing. Finally there is also a one-off rebate for female pensioners hit by the increase in the pension age.
The Conservatives’ plans, by contrast, offer very little change – inaction that the Institute for Fiscal Studies describes as remarkable. At first sight, the absence of tax cuts from their manifesto, beyond a change in the national insurance threshold, is surprising given earlier promises by the prime minister. But the likely reason is straightforward: Brexit.
Just as this has been called the Brexit election, Brexit is also central to how we evaluate the economic plans of Labour and the Conservatives. Under a Labour government Brexit is unlikely to happen, partly because the Conservatives could boycott any referendum involving a soft Brexit. Under a Conservative government we will either get no deal (if Boris Johnson keeps to his word about not allowing more than a year to negotiate a trade deal with the EU) or a hard Brexit. A hard Brexit would be very damaging to the economy over the medium term, and a no-deal Brexit even worse, with possible short-term disruption thrown in as well.
The importance of Brexit is shown in one chart from the final analysis of the plans by the IFS. This shows its best guess of how government debt, as a percentage of GDP, will move over the next five years. Labour’s additional investment would lead to a rise in borrowing, but this is dwarfed by an increase in borrowing that would follow from a no-deal Brexit, so great would be the economic damage. We can now see why the Conservative manifesto contains so few giveaways: under a no-deal or hard Brexit the UK just cannot afford them.
The IFS’s analysis of the fiscal impact of a no-deal Brexit is not out of line with the consensus of estimates among mainstream economists. Nor is it particularly new: during the 2016 referendum, economists at the London School of Economics, the National Institute of Social and Economic Research and elsewhere wrote about the severe economic costs of a no-deal Brexit. Developments since the referendum have been consistent with this analysis. The potential impact of a Johnson free-trade agreement with the EU is more difficult to assess without the details, but it would still imply a large increase in borrowing either just below or just above Labour’s plans.
What the IFS analysis does not do is discuss in detail the impact each party’s plans might have on the macro-economy: growth, inflation and so on. There is no doubt that Labour’s plans would imply a large increase in demand, mainly from the public sector. The impact that would have would depend on the degree of spare capacity in the economy and the extent to which firms short of capacity would put up prices or increase investment and productivity when demand rises.
The consensus among economists is that little spare capacity exists and higher demand would therefore lead to a small increase in GDP but a significant increase in short-term interest rates as the Bank of England offsets the additional inflationary pressure. However, a significant minority of economists think the rise in GDP would be bigger than that, with little or no increase in interest rates. The National Institute has calculated that with enough spare capacity, GDP over the next five years might be on average 2% higher each year under Labour than under the Conservatives.
Many on the right warn that if Labour wins the election, capital would take flight, and sterling would collapse as a result. Two factors make that unlikely. First, if either interest rates or GDP rise, that makes sterling more attractive. Second, under a Labour government we would avoid a hard or no-deal Brexit, and that would lead to an appreciation, effectively reversing much of the depreciation that has taken place since the referendum vote. The one area in which Labour is not radical is monetary policy and fiscal rules, so there is nothing to frighten investors.
The IFS has suggested that some of Labour’s plans, particularly on the investment side, are too ambitious to be achieved in a five-year term. That may well be true, but it is hard to see it as a criticism as long as a Labour government takes the time to invest wisely.
The IFS has also said that some of Labour’s higher taxes on companies might influence real wages, but empirical evidence of the extent of this is very unclear. What is clear is that these tax increases redistribute income away from the top.
After nine years of stagnation, and with low interest rates on borrowing, now is the time to invest in the economy and to start addressing some of the problems that led to the 2016 referendum. For the economy, this election represents a fork in the road: do we take the path of stagnation and insularity with Brexit or do we invest and redistribute to become more like other European economies? The cruel irony of our electoral system is that while a majority of our political parties want the latter, we may end up going down the Brexit path.
• Simon Wren-Lewis is emeritus professor of economics and fellow of Merton College, Oxford. He blogs at Mainly Macro
