June 19, 2017    7 minute read

Corbynomics And Britain’s Economy: A Recipe For Disaster

Ideologies Clash    June 19, 2017    7 minute read

Corbynomics And Britain’s Economy: A Recipe For Disaster

In the recent UK General Election, we saw the return of socialism. Jeremy Corbyn and his new hard-left Labour party had largely run a successful campaign where they enjoyed a net gain of 30 seats, which included the massive shock of winning the Kensington seat for the first time. Corbyn seems to have brought socialism back into fashion. This article makes an effort to explore and explain why socialism is and has always been a bad idea for Britain’s economy and the potential impacts of a Corbyn premiership if Theresa May is unable to lead a stable government.

Drawbacks of Socialism

Socialism always appears as an attractive option initially but in the long-run its deep flaws are eventually unveiled. This is primarily due to the fact the ideology is inconsistent with a fundamental principle of human behaviour: incentives. Despite capitalism having its own flaws, incentives play a major role, whereas socialism is inconsistent with human nature, making it destined for failure.

Private property rights, ideas of profit and loss in accounting and prices set by market forces result in a fair and efficient system of incentives to guide economic behaviour. Of course, economic levers are available and how and when they are used is always debatable. With the absence of incentives there is no mechanism to direct economic behaviour in socialism.

Although in the short-run, socialism can work towards equalising society, its deep flaws result in inefficiency, a stifling of innovation and an inhibition of economic growth, resulting in greater inequality in the long-run. Historical evidence has always proved that capitalism is the greatest wealth-producing economic system. One only has to see which is the better of the two evils.

The term creative destruction was popularised by Joseph Schumpeter, one of the most influential economists in the 20th century. It describes the process whereby there is constant product and process innovation through which outdated production methods and units are replaced by new ones. Socialism slows down, or even prevents, the process of creative destruction from occurring. Creative destruction is one of the main ways in which GDP per capita grows within an economy. Average GDP per capita is often a good proxy for the wealth of individuals within a nation.

A paper published by MIT had the following quote: “Over the long run, the process of creative destruction accounts for over 50 percent of productivity growth…Obstacles to the process of creative destruction can have severe short- and long-run macroeconomic consequences”

Nationalisation

One of the key features of the Labour manifesto was the nationalisation of mail, rail and energy firms. A key factor that requires to be considered is that nationalisation comes with massive inefficiency and mismanagement. The competitive pressures, need for innovation and tighter budget constraints push private operators towards effective cost management, higher productivity, investment and innovation. These factors are all profoundly impacted when companies are nationalised. One only needs to compare the case of privately-owned Jet Airways in India which is massively outperforming the government owned counterpart, Air India, in terms of operational efficiency.

Of course, privatisation comes with its inherent drawbacks. If consumer exploitation due to natural monopolies is really the issue then one solution is through tighter regulation. Another potential solution, instead of than nationalising the whole company, is for the government to buy a stake in the business and have a government representative on the company’s board.

Financial Services Sector & Taxes

It would be an understatement to say that the financial services sector plays a critical role in the UK economy. A briefing paper from the House of Commons library regarding the role of financial and insurance sectors in the UK economy outlines that it employs more than a million people which is 3.1% of all UK jobs contributing  £124.2bn in Gross Value Added (GVA), 7.2% of the UK’s total GVA. The sector generates £24.4bn of revenue, in the form of tax receipts for the government.

One of the tax policy reforms suggested was to increase the tax rate for those earning above £80,000. The majority of these high earners work in the banking and insurance sector in the City of London, Mayfair and Canary Wharf. The shadow chancellor, John McDonnell, proposed having a separate higher tax rate for bonuses, clearly aimed at the employees of the banking sector. The Labour manifesto also outlined plans for a ‘Robin Hood’ tax, a tax imposed on financial transactions.

London’s status as the global financial centre is already at threat due to Brexit with many jobs set to move to Paris and Frankfurt. At this time it is in the nation’s interest for its politicians to work to preserve jobs within the financial services sector in the UK. In an attempt to punish those working in the banking sector, further increasing the already heavy tax burden on the sector will drive many financial services firms and jobs out of London resulting in a significant negative GDP shock and higher levels of unemployment due to the size of the sector in the UK. If many financial service firms decide to move out of London, the government tax revenue from the sector can actually decrease. It’s worth remembering that sometimes a smaller piece of a large pie is still more than a large piece of a small pie.

Anti-Austerity Stance

David Cameron and George Osborne placed a large emphasis on getting the budget deficit under control and through their austerity policies they were largely successful in doing so. In turn, this kept the economic credibility of the UK intact and prevented the economy from experiencing higher interest rates on borrowing.

Labour’s campaign took an anti-austerity stance during the election campaign through increased spending plans and its plan to scrap university tuition fees. The increased borrowing as a result will destroy all previous efforts to bring the budget deficit under control. The resulting effect is rising interest rates having a direct impact on investment and stifling economic growth – the exact opposite of what Jeremy Corbyn intends to do. The devalued sterling has already contributed to a rising cost of input prices which has feed through to consumer prices in turn leading to higher inflation – which was reported to have risen to 2.9% last week. With business and consumer confidence already low, it is important to keep in mind that fiscal responsibility is of paramount importance and it is vital to keep a long-term approach to managing economic growth

National Investment Bank

Corbyn also proposed the idea of a National Investment Bank that invests in infrastructure projects, funded through cutting “reliefs and subsidies on offer to the corporate sector”.

The issue with this is that cutting corporate welfare harms private sector investment, as according to economists at HMRC, “for every £1 spent on R&D tax credits, British companies boost their R&D by £1.53-£2.35”. R&D is crucial to the process of creative destruction outlined above and R&D plays a critical role in technical and technological progress underpinning the long-run growth of all economies.

People’s Quantitative Easing

The most disturbing policy unveiled by Jeremy Corbyn was his plan to implement ‘People’s Quantitative Easing’. It largely works the same way as traditional Quantitative Easing, except the Bank of England uses the artificially created money to buy bonds issued by the National Investment Bank instead of the government’s bonds.

The Bank of England was made an independent public organisation in 1998 due to issues of credibility and to safeguard its independence. The Bank of England sets inflation targets and uses levers like interest rates to influence inflation and hence keep them in check. However, the credibility of the institution setting inflation targets is critical. If quantitative easing is used to fund public investment, it will result in the Bank of England losing credibility leading to higher inflation forcing interest rates upwards and choking investment spending – once again, the exact opposite of what Jeremy Corbyn intends to do.

Looking Ahead

The issue with the policies of Jeremy Corbyn is that they have all been influenced by ideology. Although ideology plays a role in policy-making decisions, a sensible and pragmatic politician would design and construct policies based on empirical evidence, from home and abroad. All policy decisions taken now will flow through the chain and the impact will be experienced by future generations. What legacy would Corbyn like to leave and how will history judge him? Will he have a bust installed in the company of former politicians in the Houses of Parliament?

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