UK economic performance under Labour.

Corry, Dan ; Valero, Anna ; Van Reenen, John 等

It is right that vigorous debates are going on about what Labour's economic policy should be going forward towards the next election. These debates have two dimensions: on the one hand, what is right from an economic point of view; and on the other, what has any chance of working electorally. Ideally the two come together--but life is not always like that.

Naturally, in looking at these issues, commentators end up basing their approach on what they think happened in the New Labour years. Therefore it is crucial that in thinking about the future, we establish what actually happened during those years, so that the right policies for the future can be formulated. At present there is a danger that the way the economy has evolved since the financial crisis in 2008 has deeply and erroneously coloured the view of what actually happened, what did and did not work, and where we go from here. In this article we look beyond the hype and the heat to focus on the numbers and analyse the economic facts.

What did happen under Labour?

A common view is that the performance of the UK economy between 1997 and 2010 under Labour was weak and based on an artificial bubble. According to this view, the UK's current economic problems are a consequence of poor policies in this period. The question is whether the data back this up or not.

We focus on measures of business performance, especially productivity growth. This is a key economic indicator as, in the long run, productivity determines material wellbeing--wages and consumption. Productivity determines the size of the 'economic pie' available to the citizens of a country. Of course it is by no means everything, and we are leaving out key issues like equality and environmental sustainability, as well as jobs and long term unemployment. The relationship between economic growth and concepts of happiness or wellbeing are much debated, but productivity is still crucial for understanding what was happening in the Labour years. We remain strongly of the view that the growth of national output per person is, all else equal, a desirable thing.

The big picture

There is an argument for focusing our analysis of the Labour period only up to 2008--that is, before the Great Recession, since the financial crisis was essentially a global shock and it seems tough to 'blame' it all on Labour. However a sterner test is to look across the whole period in which Labour was in government right through to 2010. Since we know that the UK was hit harder than most other nations by the Great Recession we would expect the record to be poorer when including the later years. In what follows, where the data allow it, we look at the longer period.

We begin by looking at the UK's performance relative to some key comparator countries, namely the US, Japan and the three largest EU economies, Germany, France and Italy. In Table 1 the first three columns examine the 1997-2010 period and the last three columns the 1997-2007 period. The first column of each section looks at GDP itself and shows that in both periods the UK comes in a close second to the US in terms of average annual GDP growth.

Table 1: Growth of GDP, GDP per person and GDP per adult, 1997-2010

              1997-2010 (whole      1997-2007 (up until
           period of New Labour)    the Great Recession)

          GDP   GDP per  GDP per   GDP   GDP per  GDP per
                 capita   capita          capita   capita
               (person)  (adult)        (person)  (adult)

UK       1.93      1.42     1.22  2.89      2.43     2.20
US       2.22      1.22     0.99  3.00      1.96     1.64
Germany  1.24      1.26     1.01  1.67      1.64     1.35
France   1.66      1.04     0.92  2.31      1.66     1.51
Japan    0.59      0.52     0.31  1.15      1.02     0.79
Italy    0.69      0.22     0.19  1.45      1.01     0.99

(Sources: Cumulative annual growth rates (in per cent). Analysis based
on OECD data (extracted on 28 Oct 2011 from OECD. Stat). GDP is US$,
constant prices, constant PPPs, OECD base year (2005) from GDP
database. Adult' refers to 'working age adults', obtained from US
Bureau of Labour Force Statistics, and includes the civilian
population aged over 16. Data for Unified Germany from 1991)

Of course, absolute economic growth is not as important for welfare as national income per person as this will ultimately determine wages and consumption. The second column therefore looks at the growth of GDP per capita (in terms of the total population). It shows that the UK outperformed every other country in the period 1997--2010 (growing at an average annual rate of 1.42 per cent a year compared to 1.22 per cent in the US and as low as 0.22 per cent in Italy).

Could some of these patterns be driven simply by different demographic trends? For instance some countries had growing proportions of those too young or too old to work? To partially control for this, the third column of Table 1 presents GDP per adult (and this is the main measure of overall economic performance that we use in this paper). This does change some of the rankings and levels, but here again, the UK outperformed all the other advanced nations including the US and Germany.

We conclude that relative to other major industrialised countries, the UK's performance was good after 1997, even more so if we end the analysis before the Great Recession in 2008.

Just a continuation of trends established under Thatcher?

In order to try to appraise Labour's impact on the economy, we also compare the UK's performance over 1997-2010 not only to its most relevant peers, but also its performance over the preceding years. For this purpose, it makes most sense to consider the period 1979-1997, which corresponds to the Thatcher-Major led Conservative governments.

The results for GDP per capita are contained in Figure 1. We base each series in 1997 to show the cumulative performance of the UK and other countries before and after the 1997 election, so the slope of the line can be interpreted as growth rates. In the post-1997 period, the fact that the darker, dashed UK line ends up above all other countries shows in graphical form what was already revealed in the numbers in Table 1. In addition the fall in GDP per capita in the Great Recession is evident in all countries, but appears particularly large in the UK.

Going back to 1979, Figure 1 shows that the UK grew faster than its peers in the 1979-1997 period. Under the Conservative period, UK per capita GDP growth was similar to the US and significantly stronger than French growth.

[FIGURE 1 OMITTED]

The UK's strong productivity performance relative to other countries in the New Labour years can therefore be seen as a continuation of the trends during the earlier period of Conservative government from 1979. This broke a pattern of relative economic decline stretching back a century or more (Crafts, 2011). UK GDP per person fell relative to the US, Germany and France from 1870 to 1979, but over the next three decades this trend reversed. UK GDP per capita was about 23 per cent above the US in 1870 whereas the US was 43 per cent ahead of the UK in 1979. By 2007, the UK still lagged behind the US, but the gap had closed to 33 per cent. During the past thirty years, the UK has had a faster catch-up of GDP per capita with the US under Labour than under the Conservatives, although there was a slower rate of relative improvement over France (Corry et al, 2011).

What drove the good GDP performance in the Labour years?

We can go further in trying to discover what drove this good GDP performance over 1997-2010. GDP per capita can be decomposed into productivity growth and labour market performance since mathematically, GDP per capita = GDP per worker (that is, productivity) x workers per capita (that is, the employment rate).

Figure 2 presents the decomposition using GDP per worker as a measure of productivity. Panel A (the top panel) shows that the UK's GDP per worker growth was as fast as that in the US between 1997 and 2008, which is impressive as these are the years of the US 'productivity miracle' (Jorgenson, 2001). So the UK managed to hold the tail of the US tiger. Since the Great Recession engulfed the developed world, US productivity has outstripped that in the UK, which reflects the much more aggressive job shedding in the US in response to the downturn. UK productivity growth was better than continental Europe, however. Again, the UK productivity performance was also strong in the pre-1997 period--in fact, during the 1979-1997 period UK GDP per worker grew faster than both the US and France.

[FIGURE 2 OMITTED]

Panel B (the bottom panel) of Figure 2 shows employment rates. Over the period 1997-2007, the growth of the employment rate in the UK was similar to that in France and Germany. The US, by contrast, had a very poor jobs performance, with the employment rate falling by nearly 5 per cent by 2008, before plummeting in the Great Recession. This is reflected in the fact that US unemployment rates rose from 5 per cent to almost 10 per cent whereas in the UK the increase in unemployment was more modest at least until recently despite a larger fall in GDP. In Germany, unemployment has hardly risen at all. The UK's employment rate was similar at the beginning and at the end of the Conservative period, not rising like in the US, but not falling like in France. What is most striking is how volatile the jobs market was in the Conservative era, with a huge boom in the late 1980s and busts in the early 1980s and early 1990s. If we repeat the analysis for productivity measured in hours, instead of workers, it shows broadly similar trends.

This analysis gives a fairly clear story of Britain's performance under Labour. GDP per capita outstripped the other major economies because the UK did well in terms of both productivity (only a little worse than the US and better than EU) and the labour market (better than the US and only a little worse than the EU). This was an impressive performance, contrary to what general discussion about the period suggests. However, it is also true that the UK also did well in terms of productivity in the Conservative years of 1979-1997, so the UK performance is part of a continuation of a post 1979 trend rather than a sharp break with the past. However, at the same time as continuing the productivity trend, Labour is generally regarded as having done better than the earlier period in areas like equality and jobs (Brewer et al, 2010).

But wasn't it all a bubble?

We now turn to the exercise of accounting for what lies beneath these aggregate trends in UK productivity. Rigorous and comparable cross-national data at the industry level is not currently available after 2008, so we first focus on the period up until the Great Recession (1).

We consider two ways to decompose growth. First, we look at the contributions of the 'factor inputs' to growth--that is, the quantity and quality of capital and labour. Second, we examine the contributions of various industries to the aggregate productivity performance of the UK and its key comparators.

On the first decomposition we find that during Labour's period, overall labour productivity growth was similar to that in the previous Conservative period while its composition changed--human capital and ICT (information and communication technologies) accounted for more of the growth. Low tech capital became less important and overall efficiency growth (called 'Total Factor Productivity' or TFP) remained at about 1 per cent throughout.

When we come to the contribution of different sectors to aggregate productivity growth, the first thing to say is that we can always split up the total economy into the 'market economy', and the 'non-market economy' which contains hard-to-measure industries, in particular those in the public sector (and areas like education and health). In fact over the period public sector productivity was a drag on total productivity growth which is both interesting and important in itself but also important in how we think about the overall productivity figures.

Estimates of public sector productivity are never going to be very reliable because output is extremely hard to measure (Timmer et al, 2010) with productivity growth assumed to be zero in most sectors and in most countries. Nevertheless taking this for a moment at face value, we find that UK output growth in the non-market sectors was greater in the Labour period than under the Conservatives, but that labour productivity growth fell from 0.6 per cent pa to zero. Other EU countries also experienced a decline (but not the US).

This is consistent with the story that the large increase in public services expenditures outstripped the ability of the system to produce more so that measured productivity fell in these sectors. For example, even after improvements in measurement following the Atkinson Review (2005), NHS productivity appears to be at best flat. Undoubtedly, low productivity in the public sector is a major problem and there is much debate over what effect Labour's reforms to public services had on efficiency. Evidence suggests for instance that some attempts to bring in competition did work well but much depends on the particular circumstance and the way that quasi-markets are implemented and regulated. For example, the decision to remove price competition from the current Health Bill was correct, as otherwise competition could reduce clinical quality as it did in the 'internal market' period (Propper et al, 2008).

In fact we show elsewhere that the growth in the public sector, finance and real estate sectors between the Conservative and the Labour periods has been less than often imagined (Corry et al, 2011). Financial intermediation is about 6 per cent of aggregate value added in both periods and the public sector (public administration, health and education) also remains constant at 18 per cent of value added. Real estate activities have grown, but only from 5 per cent to 8 per cent. But the key point is that even including (measured) public services, aggregate productivity performance of the UK was second only to the US since 1997.

For a more detailed analysis of the contribution of different sectors to productivity growth, we exclude the public sector (and real estate) and focus on the better measured market economy. A sector's contribution to overall market economy productivity growth depends on both its productivity growth and its size. Overall productivity growth can increase either because a sector increases productivity ('within effect') or a high productivity sector grows in size at the expense of a low productivity sector ('between effect'). The Figure 3 shows the breakdown by broad sector, calculated by multiplying the average productivity growth of a sector by its average share in gross valued added (GVA) over the corresponding period.

The key finding here is that in the period 1997-2007, under Labour, financial intermediation was responsible for only 0.4 percentage points of the 2.8 percentage points average annual growth in productivity. Another way of putting this is that financial intermediation accounted for just 14 per cent (= 100 x 0.4/2.8) of productivity growth, leaving 86 per cent of aggregate market economy growth due to other sectors. With only 9 per cent of the market economy value added, this is no small achievement, but to put it in perspective, as the top part of the very first column in Figures 3 shows, this sector already accounted for 0.2 percentage points of the growth under the Conservatives (when it constituted 8 per cent of market economy value added).

Furthermore, as the other sections of Figure 3 show, the contribution of finance also increased in other economies: its contribution more than doubled in the US over the same periods (from 0.2 to 0.5) and doubled in the EU as a whole (0.1 to 0.2). So the idea that all of the productivity growth in the UK relative to others was due to a bubble in finance does not seem to square with this evidence. Furthermore, if we exclude the effect of finance altogether, productivity growth in the UK would have been broadly constant at around 2.5 per cent per annum in the pre- and post-1997 periods.

[FIGURE 3 OMITTED]

So the answer to the question of whether the growth in productivity was due to 'unsustainable bubbles' in sectors such as finance, property, the public sector and oil, is an emphatic 'no'. As we have seen, the financial sector contributed only about 0.4 per cent of the 2.8 per cent annual growth in the UK market economy between 1997 and 2007. The expansion of the public sector and property both actually held back measured aggregate productivity. Productivity in energy extraction (included within 'other goods producing industries' also declined in the post 1997 period) (2). Our analysis shows that the biggest contributors to productivity increases were the business services and distribution sectors, and they were generated through the increased importance of skills and new technologies.

There is a proviso we should pick up on. Although the productivity growth performance does not seem directly attributable to the 'bubble' sectors of finance, property and the public sector, there could conceivably be some other indirect mechanism. Could productivity in business services, for example, all be driven by the demands from financial services? This seems somewhat unlikely, as many parts of business services (for example, consultancy and legal) are serving primarily non-financial firms.

A more subtle argument is that the financial bubble created a kind of unsustainable excess consumption demand that was propping up fundamentally inefficient companies. However, Chris Giles shows that the data does not support the assertion that there was a great consumer boom before the financial crisis (Giles, 2011). In fact, there was a drop in household consumption as a share of national income, from 63.3 per cent in 2002 to 61.3 per cent in 2007. Furthermore, even if this consumption bubble story were true, it is unlikely that this would artificially inflate productivity. A general bubble would increase output and employment hours (temporarily) above their sustainable levels. But it is unclear why this would flatter the productivity numbers. In fact, if generally unproductive activities were being drawn in, this would be more likely to lower measured productivity.

Although the UK's overall productivity growth has been strong, we note that productivity levels still lag behind Germany, France and the US; despite a narrowing of the gap since the early 1990s.

Analysis of other indicators of business performance such as foreign direct investment, innovation, entrepreneurship and skills, supports the view that the gains in productivity were largely real rather than a statistical artefact (Corry et al, 2011). This evidence points to a more positive reading of the supply side of the economy than the current consensus. Although the UK still has some long-standing issues in terms of lower investment relative to other G6 economies (especially in R&D and vocational skills), things clearly improved over the Labour years.

Did Labour's policies have any positive influence?

We have seen that the productivity growth in the Labour years was of the same order as in the previous period. Some have therefore argued that Labour simply enjoyed a 'free ride' on the radicalism of Mrs Thatcher. Most analysis suggests that freeing up the labour market through breaking union militancy, removing subsidies for 'lame ducks' and implementing privatisation, lower marginal tax rates and cuts in some benefits all boosted productivity performance after 1979. On this line of argument the best that could be said is that at least Labour did not return to the failed policies of the 1970s.

But in fact the 'at least Labour didn't mess it up' argument does not stand up. It is hard to believe that the reforms in the Conservative years permanently kept productivity growth higher for the next fifteen years. The anti-union policies may have raised output, for example, but it stretches credulity to think they kept the UK on a permanently better productivity growth path (Menezes-Filho and Van Reenen, 2003).

It is therefore much more likely that the policies of the Labour government drove at least some of the productivity improvement. In particular, the strengthening of competition policy, open markets, the support for innovation, the expansion of university education and smart regulation in labour markets, telecoms and elsewhere played a positive role. It is possible too that immigration may have also played a positive role. Establishing the magnitude of the causal impact of these policies is extremely difficult, and the need for proper quantitative policy evaluation remains as strong as ever. Nevertheless, it is reasonable to assume that Labour's policies in these areas had some positive impact.

What about Labour's failures?

There are a number of stories that try to link the problems of the UK economy now to what happened in the Labour period. These tend to get mixed up and it is important to distinguish and analyse them separately.

One is that the 1997-2007 productivity improvements were a statistical illusion, mainly froth, driven by a finance and real estate bubble. Thus, when the crash happened, the mask was removed and the UK was revealed to have a much lower trend rate of growth and productivity than had been previously maintained. Potential output was lower than we had thought and so despite a massive fall-off in output now compared to what it would have been if trend had been maintained, the UK has virtually no gap between potential and actual output. As we have seen, this argument does not stack up, as the financial sector only contributed about 0.4 per cent of the 2.8 per cent annual growth in the UK market economy, which excludes the public sector and real estate, both of which held back aggregate productivity. We also saw that productivity increases were mainly based in business services and distribution and generated through the increased importance of human capital and ICT (compared to low-tech capital). It is difficult to see why such activities could be solely generated by an artificial financial or property bubble.

Another argument is that the Great Recession itself was due to Labour's policies. One reason for this is the weak regulation of the financial sector which clearly had a role to play in causing the financial crisis. However, this 'light touch' regulation began before Labour came into power with things like Big Bang in the Thatcher/Major era; continued strongly under the Labour government but they were being urged to go further by the Conservative Opposition, and it was a global phenomenon with the catalyst for the crisis being in the US and not the UK. So although the global financial liberalisation in the 1990s and 2000s was generally supported by Labour, it is likely that broadly the same policies would have been pursued by the Conservatives. It is extremely hard therefore to blame the global crash on UK policies.

The third argument is that the wrong things were done once the crash occurred. However, as our work shows, the record even through to 2010 was not that bad. If anything, the vigorous countercyclical and interventionist actions that were taken, and which had real and confidence effects from 2008, meant that output and employment did not fall nearly as much as it could have. Recapitalising banks and maintaining demand through fiscal policies were common throughout the OECD and indicated that policy lessons had been learned from the Great Depression. Productivity fell, but primarily because employment stayed much higher than would be expected compared to previous recessions (Gregg and Wadsworth, 2011). Real wages have fallen substantially since the Great Recession, and this has been an important factor in keeping unemployment much lower than we would expect at least up until the Coalition policies began to bite - certainly from the second half of 2011. Additionally, the effectiveness of the Employment Service is greater than in previous recessions.

The strongest challenge is that the UK economy was particularly vulnerable to a downturn because of policy mistakes made by Labour, mainly to do with financial regulation and public debt.

Financial market regulation clearly failed. The 'light touch' regulation helped the development of the financial services industry, delivering some benefits for a time in terms of access to credit and creating large amounts of tax revenue and high paying jobs. But it was clear this went too far (although nowhere nearly as bad as in the US sub-prime fiasco). It drew a lot of talented people in the UK towards this sector, and out of other industries, that would be more favourable to long-term growth. And because the UK has a larger financial sector than other countries, it took a harder hit in the downturn.

In retrospect, a major problem was 'too big to fail' - equity and bondholders of financial institutions were given too many implicit and explicit guarantees of protection if they got into trouble. This encouraged banks to take excessive risks and disguise these risks by creating exotic and opaque financial instruments. When the crisis hit, the state had little choice but to bail out the failing institutions.

But during the good times, and with hindsight, it is clear that regulatory policy should have been more vigilant in all countries in (a) creating a mechanism for the orderly break-up of failing banks (such as so called 'living wills'); (b) demanding higher capital requirement to prevent the excessive leveraging of debt (a la Basel 3); (c) keeping a greater separation between the 'casino' (investment) and 'utility' (retail) part of banking; (d) controlling the exposure of utility banking to raising finance in the wholesale market (Northern Rock's problem) and (e) paying more attention to asset bubbles (such as in housing).

In retrospect too, it is clear that public debt levels were too high for the stage of the cycle in 2008 in the UK (alongside many other countries like the US, Ireland and Spain). This reflected the large increase in public spending after 2000 with what we now can see were insufficient increases in tax to fully pay for this, which meant that the budget deficits were running up debt. The debt position has exacerbated the pain of recession. However, this can be overstated - and is regularly! The 'structural' element of the deficit, excluding investment spending, that was not related to cycle, was only about 1 per cent of GDP in 2008 (Portes, 2011). Over the next two years this jumped to 5 per cent because of the crisis - the poor state of the public finances was a consequence of the recession, not a cause of it.

A sense of perspective is also required: the UK debt and deficit position is not in any way catastrophic in an historical context. In 2010 national debt stood at 52 per cent of GDP, high in comparison to the 1980s and 1990s (see OECD Economic Outlook Database, 2010), but lower than much of the twentieth century (between 1750 and 1850 debt exceeded 100 per cent of GDP). Compared to other countries the maturity of UK sovereign debt is very long which means that the Chancellor does not have to raise finance frequently (like Italy). The UK is not Greece.

Labour left office with a plan to eliminate the structural deficit in eight years. In July 2010, the Coalition replaced this with a plan to eliminate the structural deficit in four years. Thus there is and was a cross-party consensus over the medium term plan to reduce the deficit: the question is more to do with its pace and timing - perhaps a second order issue, but a crucial one nevertheless.

Does the Great Recession change everything?

Does the experience of the recession since 2008 show that the productivity improvements to the supply side since 1997 were illusory? We have argued 'no' as the 1997-2010 improvements were real and not due to the bubble sectors of finance, property and oil.

But how much did the financial crisis permanently reduce the rate and level of productivity growth? The extreme version of the 'supply-side pessimism' argument is that because the recession was caused by a banking crisis, the fall in potential output has been severe, the UK's output gap (the difference between actual and potential GDP) is now close to zero, with productivity growth permanently lower for the foreseeable future. Pessimists point to the 7 per cent fall in GDP and slower growth from the trough of the 2009 recession.

It is likely that the recession has caused some permanent fall in output compared with what it would have been without such a deep downturn. But we think there is huge uncertainty over the size of the output gap. An alternative explanation to a supply shock that had permanently reduced the level and growth rate of potential output is that global demand is muted. Several elements point in this more optimistic direction. First, the pre-2008 productivity growth rate suggests that the supply side made real improvements before the crisis. Second, the fall in productivity from 2008 to 2011 is broad-based, and not all due to specific sectors such as finance and oil (just as the 1997-2008 productivity growth rates were not dominated by these sectors). Third, we look at the evidence put forward by the pessimists on inflation, jobs, capacity utilisation surveys and trade performance, and find that this does not make a compelling case that the output gap is tiny.

We worry that policies based on an excessively pessimistic view of potential output can lead to needlessly slow economic growth. Indeed, the pessimism over the state of the supply side can become self-fulfilling, as ever-larger austerity programmes cause excess scrapping of human and physical capital. This type of view has been put forward by the IMF, and more recently, the credit ratings agencies have acknowledged that excessive fiscal austerity alone can be self-fulfilling (3).

The current 'Plan A' for the UK economy is a period of very strong fiscal consolidation - spending cuts and tax rises to eliminate the structural public sector deficit in the life of this Parliament; though, due to insufficient growth, this timeline has been extended in the 2011 Autumn Statement. An alternative Plan B would be to slow down the pace of the fiscal consolidation. If the output gap was near zero, then a Plan B would simply increase inflation, so the fact that we think there is a good chance of a substantial output gap implies the possibility of a Plan B.

The desirability of a Plan B would be muted if monetary policy was sufficient, if fiscal policy was ineffective in an open economy like the UK, if any increase in public spending or tax cuts was irreversible, or if markets would panic at any retreat from Plan A. We consider these problems, but do not find them overwhelming objections. We argue that we do indeed need a medium-term plan for debt reduction but this does not have to be done at the current speed when the world economy is so fragile. This is also true for Northern eurozone countries and the US. Thus we need a short-term stimulus ('Plan B') and a long term growth strategy ('Plan V' - see Valero and Van Reenen, 2011).

Lessons for the future

Whatever view is taken on shorter-term policies, all sides agree on the need to focus on longer-term growth. What are the lessons from the Labour years then?

First, the general policies of the Labour government over the period 1997-2010 largely seem to have been successful (Corry, 2011). That is important in that it gives us some sense of what works and what does not. It does not suggest that the approaches used over 1997-2010 now need to be dumped by the left - far from it.

The structural improvement in the UK's relative performance in the Labour years (and since 1979) contain the lesson that getting the market environment right is key: strong product market competition, openness to foreign investment, flexible labour markets, a robust welfare-to-work system, and smart regulation, are major factors in promoting growth. Government has a role in all of this, setting the rules, and it also needs to be pro-active in building human capital and infrastructure, and supporting innovation.

As Anna Valero and John Van Reenen argue elsewhere, this requires the state and civil society to scan the global economy for potential growth in demand, and then hone in on areas where the UK has actual or latent comparative advantage (Valero and Van Reenen, 2011). Within this space there has to be relentless scrutiny of where the state is hindering and where it could help. A specific example is higher education where foreign students are an export industry of global growth and where the UK has very successful elite science. Restricting high skilled immigration is hugely damaging to this sector. More generally, growth policies could include supporting sector-specific skills, access to credit for small enterprises and subsidising innovation in key industries like green technologies, software and health-care.

Second, our look at the Labour years also tells us something about the policies urged from the right especially with respect to areas like labour market regulation and tax.

Labour regulation increased after 1997: there were more rights for trade unions (employers have to grant recognition if a majority of workers vote for it), more opportunities for flexible work and maternity/paternity leave, the first National Minimum Wage and a shorter time period before employees qualified for unfair dismissal. Productivity growth did not seem to falter in the face of these, and the (small) empirical literature examining these does not seem to have uncovered large negative productivity effects (Draca et al, 2011) even if one could argue that productivity would have been higher if the UK had not brought them in. The main point, however, is that intelligent regulation, that brought in protection for and investment in workers, still left the UK with one of the most flexible labour markets in the EU as opposed to a return to the heavily regulated labour market of the 1970s with militant trade unions.

There is also little evidence that the changes in tax rates have much impact on underlying performance. As the Mirrlees Review argues, the critical thing is not the level of the rates of marginal taxation which has been the obsession of debate in the media and political circles (Mirrlees et al, 2011). Around the marginal rates that exist in the UK and most OECD countries, the loss of output from disincentive effects is relatively minor. The real problem with the tax system is its complexity and instability. Changes are made piecemeal without much regard to how different parts of the tax system interrelate, and how the tax system interacts closely with the benefit system (for example housing benefits). Furthermore, much could be gained from removing the bias towards financing investment though debt instead of equity.

The most important lesson, then, is to try and get the policy environment right in terms of the physical and human capital infrastructure. Beyond this, however, there is a case for a more pro-active growth strategy. The starting point of this is to examine areas where global growth is likely to come from and where the UK has some comparative advantage. The intersection of these is where attention should be focused on removing barriers and fostering development (in the form of local public goods). Such a modern 'industrial policy' is not about picking winners, but rather a way of thinking about growth that is much better than the current confusion.

References

Atkinson, A. B. (2005) The Atkinson Review: Final Report. Measurement of Government Output and Productivity for the National Accounts, Houndmills, Pagrave MacMillan.

Brewer, M, Brown, J, Muriel, A, Phillips, D, and Sibieta, L. (2010) 'Labour's tax and benefit increases prevent rapid rise in income inequality', Institute for Fiscal Studies, 7.04.2010; available at http://www.ifs.org.uk/publications/4806.

Corry, D. (2011) 'Labour and the economy, 1997-2010: more than a Faustian pact', in Diamond, P. and Kenny, M. (eds) Reassessing New Labour: Market, State and Society under Blair and Brown, Oxford, Blackwell.

Corry, D., Valero, A., and Van Reenen, J. (2011) UK Economic Performance Since 1997: Growth, Productivity And Jobs, Centre For Economic Performance, London School Of Economics, November 15th.

Crafts, N. (2011) 'British Relative Economic Decline Revisited: The Role of Competition', CEPR Discussion Paper Series, Centre for Economic Policy Research; available at www.cepr.org/pubs/dps/DP8384.asp.

Draca, M., Machin, S. and Van Reenen, J. (2011) 'Minimum Wages and Firm Profitability', American Economic Journal: Applied Economics 3 (1): 129-151.

Giles, C. (2011) 'Busting the myths on the economy', Financial Times 25.10.2011. Gregg, P. and Wadsworth, J. (2011) 'Jobs in the recession', Centrepiece, summer issue.

Jorgenson, D. W. (2001) 'Information Technology and the US Economy', American Economic Review 91 (1): 1-32.

Menezes-Filho, N. and Van Reenen, J. (2003) 'Unions and innovation: a survey of the theory and empirical evidence', in Addison, J. and Schnabel, C. (eds.) International Handbook Of Trade Unions, Cheltenham, Edward Elgar.

Mirrlees, J. et al (2011) Tax By Design: The Mirrlees Review, London / Oxford, Institute for Fiscal Studies / Oxford University Press.

Portes, J. (2011) 'The Coalition's Confidence Trick', New Statesman 24.08.2011.

Propper, C., Burgess, S. and Gossage, D. (2008) 'Competition and quality: evidence from the NHS internal market 1991-9', Economic Journal 118 (525): 138-170.

Standard and Poor's (2012) 'Credit FAQ: Factors Behind Our Rating Actions On Eurozone Sovereign Governments', 13.01.2012; available at http://www.standardandpoors.com/ratings/articles/en/us/?articleType=HTML&assetID=1245327305715

Timmer, M. P., Inklaar, R., O'Mahony, M. and Van Ark, B. (2010) Economic Growth in Europe: A Comparative Industry Perspective, Cambridge, Cambridge University Press.

Valero, A. and Van Reenen, J. (2011) 'Slow Growth Does Not Have To Be Our "New Normal"'; LSE British Politics and Policy Blog, 2.08.2011; available at http://blogs.lse.ac.uk/politicsandpolicy/2011/08/02/slow-growth-not-new-normal/

This paper draws heavily on a longer paper by Dan Corry, Anna Valero and John Van Reenen, 'UK Economic Performance since 1997: Growth, Productivity and Jobs', Centre for Economic Performance, London School of Economics, 15.11.2011; available at http://cep.lse.ac.uk/conference_papers/15b_11_2011/CEP_Report_UK_Business_15112011.pdf

Notes

(1.) For these purposes we use the KLEMS database (Timmer, 2007), which is the best avail-able source of harmonised productivity data (at the time of the research, October 2011) for the major countries that we want to look at.

(2.) Productivity in energy extraction rose rapidly from the late 1980s to mid 1990s. This was not the case during the post 1997 years, when productivity declined. In our analysis, energy extraction is included within 'mining and quarrying', within 'other goods producing industries'.

(3.) '[A] reform process based on a pillar of fiscal austerity alone risks becoming self-defeating' (Standard and Poor's, 2012).

Dan Corry is a Visiting Fellow at Southampton University and was a Downing Street, Treasury, Education and DTI adviser between 1997 and 2010. Anna Valero is at the Centre for Economic Performance, London School of Economics. John Van Reenen is Director of the Centre for Economic Performance, and a Professor of Economics at the London School of Economics.