Productivity is everything, here's how we boost it

The Chancellor decided not to exercise his traditional right to present the budget alongside a stiff drink. That’s a surprise, because today’s OBR GDP Growth projections would have any reasonable person reaching for the bottle. The stubborn refusal of productivity growth to return to its pre-crisis levels has led the OBR to predict that growth will be a sluggish 1.5% for the next five years. By contrast, the US is currently growing at twice that rate.

Forget the gimmicks, the jokes and the tweaks to the tax system, this should be the big the story out of the budget. And if the OBR’s forecasts are correct, we should expect voters to be even more likely to risk it all on a radical socialist agenda.

Hammond understands the problem. It’s welcome to see him commit to boosting R&D spending and recognise the importance of sorting out the housing crisis so people can move to the high-paying jobs of the future. But frankly, the measures announced in the budget won’t do enough to really move the needle.

If the government wants to get a grip on productivity, here’s what they need to do.

Housing

As my colleague Sam Bowman persuasively argues the housing crisis is a key driver of the productivity crisis. Nobel Prize Winner Ed Prescott found that wages in the US would be 12.4% higher if planning regulations were relaxed in the most productive cities. It’s likely that the problem is even worse in the UK.

Hammond is right that housing has become increasingly unaffordable because we’re not building enough. Indeed, if rumours are true he understood the need to build on the Green Belt but was blocked by the PM. Still if the government are truly committed to ending the housing crisis they need to be bolder and focus less on distractions like second homes and land banks, and more on fixing the broken planning system.

• They should revise green belt rules so that land within a short walk of an existing railway station is made available for development – 3.7% of London’s green belt made available in this way would give us land for one million new homes. If they auction off the planning permission for this land, they could raise billions to pay down the deficit, fund local services and replace intensively farmed land with lush parks and forests.
• They should make it easier to build up as well as out. They should grant permitted development rights within cities to allow anyone to add two extra floors (or match the tallest building on their street). That would allow our cities to densify gradually. Furthermore, they should scrap outdated protected views that allow people in Richmond to block development in Stratford.
• The public sector is sitting on bundles of land that could be developed for real estate. We charge public bodies for using the radio spectrum, maybe we should replicate that for land use. If government bodies were forced to pay rent on the land they used and could auction it off with permission attached, we could raise billions to fund tax cuts or better public services.
• Scrap stamp duty altogether to allow households to downsize. Stamp duty is the worst tax on the books destroying more wealth for every penny raised than any other tax. Taxing transactions gums up a market and causes people to stay put when they’d be happier in smaller properties. Scrapping it altogether and adding extra council tax bands to compensate would make it much easier for home owners to move to where the jobs are.

Investment

The UK has one of the lowest levels of business investment in the EU. Only Greece and Portugal invest less as a share of GDP. Part of that is down to a tax system that encourages consumption at the expense of long-term investment. Corporations are able to deduct day-to-day expenses (e.g. stationary) from their annual taxable income, but they can only deduct long-term productivity boosting investments in new machinery gradually as the investment depreciates. But a £100 tax benefit is worth much less if I don’t get it in full until ten years down the line. Worse still, even as corporation tax has fallen (a good thing) the cuts were funded in part by lengthening capital allowances and for industrial buildings scrapping them altogether.

• Boost investment by letting firms deduct capital costs from their taxable income in full, up front. Research from Oxford University by Giorgia Maffini, Jing Xing and Michael Devereux found that when firms qualified for additional investment allowances that they boosted capital expenditures substantially. Firms upped investment by 11% on average. Further research, this time from the US by Eric Ohrn, found that US states that brought in this measure saw investment increase by 17% leading to a 2.5% increase in wages.

Infrastructure

Cheaper off-peak rail travel is a nice perk, but it’s no substitute for ensuring that Britain’s towns are well-connected to growing cities and ensuring everyone has a fast connection to the web.

• Devolve the money that is going to be spent HS2 and let Manchester and Birmingham decide on the best way to spend it on transport. The Eddington Review found that the biggest transport projects often delivered the smallest returns. Money could probably be better spent in adding services across the North through rail electrification. I suspect Manchester and Birmingham's mayors could put the money to better use.
• Use existing infrastructure more efficiently by bringing real road pricing. Congestion is a nightmare and imposes substantial costs on the UK’s economy. By bringing in dynamic road pricing we could reduce congestion and boost speeds on UK roads and motorways.
• Rural broadband speeds are a constant complaint, but deregulation after Brexit is the real solution. Rather than waste taxpayers money on outdated broadband projects, the government should repeal the EU’s Net Neutrality rules to incentivise firms to invest and grow their customer bases. When similar rules were brought in stateside, investment levels fell by 5.6%.

Since Thatcher, the fundamental debate between Labour and the Conservatives has been about whether it’s better to grow the pie (the Conservative way) or slice the pie more evenly (the Labour way). If the Conservatives can’t deliver the real growth, voters will desert them for a less dynamic but more egalitarian Labour government. Put simply, if the OBR’s forecasts come to pass then this government is toast. But we shouldn’t be fatalists, we know the policies that can kickstart growth across Britain, we just need a government with the guts to implement them.