Written evidence submitted by Christine Berry (PEG0267)

Introduction

This is a response to the general call for evidence on post-pandemic economic growth, focussing in particular on the following questions posed by the committee:

• What core/guiding principles should the Government adopt/prioritise in its recovery package, and why?
• What measures and support will businesses need to rebuild consumer confidence and stimulate growth that is sustainable, both economically and environmentally?
• What opportunities does this provide to reset the economy to drive forward progress on broader Government priorities, including (but not limited to) Net Zero, the UK outside of the EU and the ‘levelling up’ agenda?
• What lessons should the Government learn from the pandemic about actions required to improve the UK’s resilience to future external shocks (including – but not limited to – health, financial, domestic and global supply chains and climate crises)?

I am an independent researcher and writer based in Manchester. My recent work has focussed on the economic impacts of the pandemic and the prospects for a sustainable recovery, and I am a regular contributor to the debate in national print and broadcast media. I am a Senior Fellow of the Finance Innovation Lab, a Fellow of The Democracy Collaborative, a Trustee of Rethinking Economics and a Contributing Editor of the political journal Renewal. This response is written in a personal capacity but draws on my research for various organisations including the Institute for Public Policy Research, The Democracy Collaborative and the New Economics Foundation.

Summary of key points

• The UK’s pre-pandemic economic model was highly dependent on asset-price inflation and debt-driven consumer spending, as opposed to productive investment. Early signs suggest that the government is seeking to revive this model rather than take the opportunity to transition to a new one.
• In some cases, this will simply not be possible. For instance, the shift to working from home is likely to permanently disrupt a city-centre development model based on high commercial property values (i.e. office blocks and shopping centres). Rather than seeking to resuscitate this model, policymakers should be seeking to adapt – taking the opportunity to pivot to a development model that spreads prosperity more widely and supports local communities.
• In other cases, government action has been somewhat successful in reviving the pre-pandemic model – for instance, the effect of QE and stamp duty holidays in propping up asset prices – but it is far from clear that this is really desirable. Such measures risk creating a ‘K-shaped recovery’ in which we see a growing disconnect between capital markets and real living standards for the majority of people.
• A better approach would be to invest in job-creating activities in sectors which the pandemic has exposed as chronically in need of investment – from care to renewable energy to affordable housing. This could be achieved through a mix of direct public job creation and state-backed investment by institutions such as a National Investment Bank.
• This must go hand in hand with measures to ensure that private lending supports the economy – learning from the failures of the Coronavirus Business Interruption Loan Scheme, which exposed the dangers of over-dependence on a small number of large commercial banks, whose business models are simply not designed for local relationship-based lending to small businesses. This could include regulation, but should also encompass structural reforms – such as support for new co-operative or public retail banking institutions, and a rethink of the role of state-owned RBS.
• Finally, the pandemic is exacerbating existing inequalities between those who own assets and those who do not. This is worsening the UK’s private debt problem, as low-income households and businesses weighed down by the costs of the crisis become increasingly over-indebted. Without action to rebalance the burden, the UK risks becoming trapped in a ‘debt-deflation’ spiral, where over-indebtedness reduces demand, leading to more job losses and a slower recovery, which in turn will worsen over-indebtedness. Calls for debt relief and wealth taxes should be seen in this context: not simply as a matter of social justice but as an urgent economic necessity.

Growth of what? Restoring versus rethinking the UK’s development model

1. When asking what policy measures would best support post-pandemic economic growth, we need to be specific about what it is we are seeking to grow. In particular, there is an important distinction between reviving asset prices, reviving socially useful productive activity, and reviving living standards: the policy measures required to achieve these differing objectives are very different and may even be diametrically opposed. A simple focus on GDP growth does not capture these nuances, and is unlikely to give a sufficient picture of the extent to which the UK economy is really ‘recovering’ in a meaningful way over the coming months and years.
2. The pre-pandemic UK economy was unusually dependent on asset price inflation (particularly house price inflation) and debt-fuelled consumer spending, rather than on investment in the ‘real’ (productive) economy. Research has extensively documented the links between this growth model and many of our economic problems, including financial instability, low productivity growth, regional imbalances and high levels of wealth and income inequality.[1] For instance, economists from Mariana Mazzucato to John Kay have emphasised the distinction between value extraction (i.e. zero sum activity which comes at the expense of others in the economy) and value creation.[2] As academic Brett Christophers shows, an economy built on expectations of rising asset prices incentivises people to ‘sweat’ existing assets (i.e. extract rent from them at others’ expense) rather than invest in creating new ones.[3] It also magnifies inequalities between those who own assets and those who do not – and especially those who owe debts to asset owners. In turn, rising indebtedness contributes to financial fragility by making the economy vulnerable to shocks which render people unable to service their debts.[4]
3. The pandemic has disrupted both the real economy and the financial markets, and creates an opportunity to ‘reset’ the UK’s economic model by focussing government support on investing in sustainable, socially useful productive activity. However, there are concerning signs that the government is instead simply taking the UK’s pre-pandemic growth model as a ‘given’, and seeking to revive it. For instance, in introducing his mini-budget, Chancellor Rishi Sunak noted that “our economy relies on consumption”.[5] This thinking underpins schemes such as ‘Eat Out to Help Out’, which have focussed on getting consumers spending again (a dubious approach even on its own terms, given that the fundamental problem is a lack of confidence rather than a lack of financial incentives to spend).
4. Likewise, measures such as the stamp duty holiday are clearly designed to pump up a housing market that was already overvalued – and appear to have been successful in doing so. Central bank interventions such as the expansion of QE and the Covid Corporate Financing Facility also appear to have been successful in shoring up capital markets. However, the premature end of the furlough scheme – and the lack of a coherent strategy to counteract the resulting job losses through strategic public investment and job creation – means that employment levels are highly unlikely to be protected as successfully.
5. All of this means that, as some commentators have observed, asset prices are likely to recover far more swiftly and more strongly from the crisis than wages and employment levels.[6] In turn, this will act as a drag on the recovery of the ‘real’ economy, by suppressing consumer demand and economic confidence.
6. The government’s approach to the recovery also reflects a wider lack of ambition for the UK’s post-pandemic economy. The proposed ‘bonfire of the planning rules’ is indicative here. The implication is that we are so desperate to encourage private developers to build, we can no longer afford to exert any democratic oversight over what they might build or where.[7] This might help to revive short-term economic growth, and it will certainly help to support developers’ profitability. But this prosperity is unlikely to be widely shared – indeed, to the extent that this approach will exacerbate the lack of affordable housing, it could actively worsen living standards and suppress discretionary spending for those currently stuck in the private rental sector. Once again, it will tend to support value extraction rather than genuine value creation. It may also present an obstacle to local economic development strategies which seek to protect and nurture local high streets. This is to say nothing of the impact on housing quality: the lockdown has exposed the effects of lack of space and outdoor access, and we know that future developments must be energy-efficient in order to meet our climate change targets. This is the opposite of an aspiration to ‘build back better’. It is, quite literally, an invitation to developers to ‘build back worse’.

Principles for supporting a sustainable recovery

7. A better approach would be to support the real economy through mission-oriented industrial strategy.[8] This would use public investment – both directly in public sector job creation, and indirectly via public investment institutions – to support sectors and activities that are critical to the wellbeing of society. In doing so, it would reorient the UK’s economic model away from dependence on asset-price inflation and towards real economic activity in support of human needs. For example, in relation to housing, the government would do better to enable local authorities to invest directly in expanding the supply of affordable housing, rather than shoring up the price of existing houses and stripping away planning rules.
8. As Laurie Macfarlane and I have previously suggested – building on significant work by the Institute for Innovation in Public Policy – the UK could use a National Investment Bank (NIB) to support commercially viable economic activity that is critical to social goals, such as decarbonisation or regional rebalancing.[9] This approach would emulate best practice from successful economies like Germany, Brazil and China. It would also have the advantage of supporting the economy by investing in return-generating assets, rather than simply by incurring liabilities for the taxpayer (the approach taken by most government measures so far, including the Bounce-Back Loan Scheme and the Kickstart Jobs Fund). Although the proposed NIB would be an independent entity, this more prudent approach would indirectly help to support the public finances.
9. The pandemic has also exposed the chronic need for investment in job-rich sectors such as social care and childcare. For instance, the already financially fragile childcare sector is on the brink of crisis, with 1 in 4 providers fearing closure.[10] This has knock-on impacts on the ability of parents (and overwhelmingly of women) to work. As has been proposed by the Women’s Budget Group[11] and the New Economics Foundation,[12] the government could act to support these critical sectors via direct public investment in a ‘care-led recovery’. This approach (i.e. public spending rather than publicly-backed lending) is more appropriate for providing public goods which may not meet commercial investment criteria. Its wider economic and social benefits nonetheless make it a sound investment from the point of view of the public purse.

Investing in recovery: the role of banks

10. In addition to these various forms of public investment, we also need to ensure that private lending supports the post-pandemic recovery. The crisis has exposed the limits of the UK’s banking system when it comes to supporting the real economy, and particularly small businesses, through a recession. The early failures of the CBILS reflected that fact that large commercial banks simply no longer have the capacity or the appetite for local relationship-based lending to small businesses. They lacked staff with the skills to assess applicants’ creditworthiness, instead relying on centralised credit-scoring algorithms. Their business models now overwhelmingly focus on collateralised real-estate lending (i.e. mortgages) – once again doing more to inflate the price of existing assets than to help invest in developing new ones.[13]
11. In April, the CEO of the London Chamber of Commerce and Industry (LCCI) wrote, “Banks have whittled away at their capacity to engage effectively with small and medium enterprise … SMEs are being offered loans with outrageous interest rates and demands for security from every possible source… In the end, banks are simply not stepping up to the plate.”[14] The ultimate effect of this behaviour was to force the government to increase loan guarantees to 100% for the smallest businesses in order to get credit flowing. That this was necessary reflects the UK’s extreme dependence – unusual by international standards – on a very small number of very large commercial banks. Twelve years on from the financial crisis, this over-dependence remains a significant risk to the UK’s economic resilience.[15]
12. Although it is too early to make an international comparison of how different banking systems have responded to this crisis, we can look at how they have fared in previous crises. Evidence from the aftermath of the 2008 crash showed that ‘stakeholder banks’ – including public savings banks such as the German Sparkassen and Swiss cantonal banks, as well as co-operative banks – kept lending to businesses through the downturn at a much higher rate than large shareholder-owned banks.[16] The relative absence of such banks in the UK may help to explain the relatively slow pace of its recovery.
13. More generally, academic studies consistently show that stakeholder banks behave in a less pro-cyclical way, are more stable and less risky, lend proportionately more to the ‘real’ economy, and contribute more to regional rebalancing than large shareholder-owned banks.[17] This may be explained by the lack of imperatives to maximise shareholder returns, by their public interest mandates, or by the fact that they tend to be structured as local networks with deeper knowledge of local economies and business creditworthiness. Most likely, it is some combination of all three. If the UK wants to build a sustainable recovery – one which is based on investment in socially useful productive activity, which contributes to ‘levelling up’ and improves our resilience to future shocks – it is imperative that we do something about our top-heavy and dysfunctional banking system.
14. There are a number of ways this could be approached. One would be to support efforts to rebuild a network of co-operative banks in the UK, such as those being spearheaded by the Community Savings Bank Association. Another would be to seek to fill the gap directly through a new network of public retail banks modelled on the German Sparkassen or on the ‘Post Banks’ of other major economies (Laurie Macfarlane and I developed a detailed proposal for how this could be done under the auspices of the Post Office).[18] We noted that an ecosystem of banks prepared to support small businesses across the country is essential to the success of any future National Investment Bank – at least to the degree that such a bank intends to operate via ‘on-lending’ (using existing retail banks as intermediaries) rather than direct lending. This is the key lesson of the CBILS: the government was effectively forced to rely on existing shareholder-owned banks as intermediaries for ‘on-lending’, channelling government-backed support to small businesses, and they failed disastrously. The lessons of this failure must be learnt, ensuring that the UK has a banking ecosystem capable of supporting the real economy – both in normal times and in times of crisis.
15. In the absence of such measures, as the LCCI concluded, serious consideration will need to be given to large commercial banks’ “social license to operate”. In other words, if there is no political appetite to create or nurture competitors that are capable of supporting sustainable real-economy lending, then there must be a regulatory strategy to ensure that existing incumbent banks do this more effectively. This could include various forms of ‘credit guidance’ and changes to macroprudential regulation.[19]
16. Finally, the government should reconsider the potential role of RBS, which remains in public ownership following the 2008 financial crisis and was the single largest provider of loans under the CBILS in its early weeks.[20] At time of writing, RBS shares are trading at 106p; the National Audit Office has calculated the ‘break-even’ price on any reprivatisation at 625p.[21] There is no realistic near-term prospect of the bank being reprivatized successfully. The government should therefore accept that it will remain in public hands for the foreseeable future, and should develop a positive strategy for maximising its contribution to the UK economy and to the government’s industrial strategy. In theory, RBS is run independently at arms-length from government by UK Government Investments (formerly UKFI) – but the Parliamentary Commission on Banking Standards described this as “a fig leaf to disguise the reality of direct Government control.”[22] In this context, it would be far preferable for the government’s strategy for RBS to be transparent and democratically accountable.

Growth where? ‘Levelling up’ and regional rebalancing

17. The government’s approach of seeking to revive the UK’s pre-pandemic economic model, rather than seeking to pivot to a new one, will also limit its ability to deliver on its promises of ‘levelling up’. The pandemic is already severely disrupting the UK’s economic geography, and thus creates an opportunity to rethink this in ways that spread prosperity more evenly around the country. However, this opportunity is in danger of being missed, with the result that the pandemic could instead exacerbate regional inequalities (for instance, if the impacts of unemployment are felt unevenly across the country).
18. A case in point is the government’s determination to encourage people back to work in offices to support commuter spending (and, perhaps more to the point, the city-centre commercial property values that depend on such spending). This approach makes limited economic sense even on its own terms: people working from home can still spend money on lunch if they choose to, but they will be spending it in their own neighbourhoods, thus contributing to ‘levelling up’ prosperity outside major urban centres and supporting local high streets. But, once again, this also reflects a desire to revive the pre-pandemic economic model – in this case, one which may be gone for good whether we like it or not – rather than adapting to a post-pandemic future.
19. The widespread shift to working from home is disrupting a city-centre development model predicated on high values for land and commercial property (i.e. office blocks and shopping centres). There is growing evidence that this shift will outlast the pandemic, as more and more employers offer flexible working as standard: many employees appreciate the ability to cut their commute and spend more time with their family or on leisure activities.[23] It seems highly unlikely that things will go ‘back to normal’ in this respect. This shift could have positive as well as negative economic impacts. As well as supporting employee wellbeing, it could help to distribute economic activity more evenly across the country – both nationally (as jobs previously concentrated in London become doable elsewhere) and locally (as spending in city centres is displaced to local high streets). National and local government alike must adapt their development strategies to this shifting landscape, seeking to maximise the positive impacts and cushion the negative impacts: they cannot simply wish it away.
20. At a minimum, this should mean rethinking commitments of significant capital spending to development projects predicated on the pre-pandemic model, which may no longer be viable in the future. Unfortunately, the government’s current recovery plans incentivise precisely the opposite of this. For instance, the £900m ‘Getting Building Fund’ required local authorities to submit ‘shovel ready’ projects to create jobs and growth. By definition, this often meant projects that had been developed and costed according to pre-crisis assumptions. The fund has therefore been used to support a number of large investments in city-centre office developments.[24] These may or may not be viable in the post-pandemic context, and in any case are unlikely to be the best use of funds in terms of supporting jobs and living standards for the majority in these localities (as opposed to supporting city-centre asset prices).
21. Once again, the scramble to ‘get growth going again’ at any cost appears to have come at the expense of serious thought about what we want to grow and how. Once again, this not only misses the opportunity to ‘build back better’ – by failing to reckon with the changes being wrought by the pandemic, it also risks failing on its own terms, producing expensive white elephants rather than sustainable investment prospects. A better approach would be to learn from community wealth building and asset-based development strategies, which seek to build on local assets to meet local needs – such as those pioneered by the Centre for Local Economic Strategies (CLES) and the much-vaunted ‘Preston Model’.[25] At the same time, we may need a deeper rethink of the role of city centres and high streets – perhaps taking advantage of falling commercial property values to bring spaces into public or community ownership, redesigning the public realm around parks, community spaces and outdoor markets rather than office blocks. This is a necessary part of a wider shift to an economic model based on good jobs, thriving communities and socially valuable activity, rather than on pumping up asset prices and consumer spending in urban centres.

Growth for whom? Inequality and over-indebtedness

22. As I and others warned in a report for IPPR, the economic impact of the pandemic has been extremely uneven. Many wealthier households have seen their cash balances enhanced, as they continue to work from home but have had to cut discretionary spending on holidays and going out, and are saving on commuting. Meanwhile, for many of those at the bottom of the income distribution – who have less disposable income for such activities to begin with – the negative impact of the pandemic on their income has outweighed any reductions in spending. This includes those on furlough who have lost 20% of their salary, as well as those who have lost work altogether. Many of these households were already struggling to make ends meet and are now being pushed further into debt; others are experiencing problem debt for the first time.
23. Our analysis suggested that households in the second highest income decile who were working from home could be saving an extra £189 a week, while households in the second lowest income decile who were furloughed could be in debt by an extra £11 a week.[26] Aggregate figures are thus likely to give an increasingly poor picture of whether and how the recovery is being felt by different people in different places. Rather, we are likely to see a widening gap between those who have been largely shielded from the effects of the crisis and those who have borne the brunt of its effects.
24. Subsequent research has confirmed our analysis. The IFS[27] and Bank of England[28] have documented the uneven impact of the pandemic on households in different income deciles, reinforcing our own findings. Citizens Advice estimate that 6 million adults have fallen behind on their bills due to the pandemic.[29] As they note, this has wider implications for the economic recovery, especially if the government is relying on a revival of consumer spending: “every pound spent on debt repayments is a pound not spent consuming goods and services”.
25. As noted above, the design of government interventions has also widened pre-existing inequalities between those with assets and those without. Even interventions like the furlough scheme and Coronavirus Business Interruption Loan Scheme (CBILS) indirectly helped to shield asset owners from the effects of the pandemic, whilst leaving low-income workers and small businesses bearing considerable financial risks.[30] We found that 45% of the government money spent on the furlough scheme would end up being passed on to banks and landlords in the form of rent and debt repayments.
26. UK households and businesses were already over-indebted before the onset of the pandemic, but many of the steps taken to help them weather the crisis relied on them taking on even more private debt: for households, via ‘holidays’ on mortgages and personal debt (accruing added interest), and for businesses, via state-backed loans. Meanwhile, creditors themselves have been entitled to continue claiming full repayments (even if these payments are deferred). To the extent that we should be worried about debt levels dragging back the economic recovery, it is overwhelmingly private debt and not public debt that should be our concern. While there is no realistic prospect of the government being unable to service its debts, the same cannot be said of businesses and households – and this represents a very real economic danger.
27. It is important to note that the CBILS amounts to an implicit subsidy for banks (not small businesses), since it pays out 80% of the value of the loan in the event of default, while the borrower still becomes insolvent. The Bounce-Back Loan Scheme extends this to a 100% guarantee. Unlike the comparable Swiss scheme, which set interests rates at 0.5%, this scheme allows banks to charge 2% interest. This is despite the state assuming all the credit risk and the ability of banks themselves to borrow at virtually zero interest. This scheme thus represents a transfer of wealth from the taxpayer and small businesses to banks and commercial lenders. To the extent that this results in more business failures over the medium term, it could also dampen the recovery.
28. Going forward, the government could increasingly look to replace these loan schemes with direct grants – in other words, it should pay businesses directly to keep them alive, rather than paying banks when they fold. Another approach would be to set up a public holding company to buy up distressed SMEs with a view to refloating them when the economy recovers, perhaps under employee ownership to help spread the benefits of recovery more widely. This has been proposed by the think tank Common Wealth and is currently being considered by the Welsh Government.[31]
29. Taking the household and business picture together, the UK risks getting trapped in a spiral of ‘debt-deflation’ - where over-indebtedness dampens demand, which results in a slower recovery, more job losses and more over-indebtedness. Those at the bottom of the income distribution are likely to spend a greater proportion of their incomes, so a hit to their living standards represents a significant contraction of economic demand. Conversely, wealthier households and asset owners are building up savings which are less likely to be spent. If these savings are not reinvested in productive activity (as opposed to e.g. bidding up the price of existing assets through the purchase of second homes and buy-to-let properties), then this will also act as a drag on recovery.
30. These inequalities therefore matter not simply from a social justice point of view, but also from an economic point of view. Household debt levels risk becoming unsustainable and acting as a significant drag on recovery. Sooner or later, many of these debts will simply become unpayable. Whether planned or not, some form of debt relief or debt write-downs may well become inevitable. Policymakers should therefore consider such measures proactively with a view to rebalancing the burden of the crisis and minimising the associated economic and social damage.
31. Meanwhile, proposals to increase taxes on capital gains and other forms of wealth should also be seen in this context. It is true that raising income taxes for low and middle income workers, or taxes on consumption, would likely act as a brake on recovery by weakening already subdued domestic demand. However, the same is not necessarily true for income taxes on high-income workers (who, as we have seen, have on average built up significant cash balances during the pandemic), or on accumulated wealth. On the contrary, if the money raised is reinvested in job-creating activity or used to support those in problem debt, it could positively enhance the recovery. The oft-repeated mantra that “you don’t raise taxes in a recession” is thus an over-simplification of the reality.
32. A similar argument can be made about corporate profits in sectors that have done well during the pandemic. Conventional supply-side economics would argue that leaving these companies to reinvest their own profits will be the most efficient spur to further economic activity. However, this assumption is extremely debatable in a context where (a) economy-wide demand is severely depressed, and (b) structural incentives for productive investment, as opposed to asset-price speculation or cash-hoarding, are weak. This is part of the argument for a windfall tax, or excess profits tax, on the pandemic’s ‘winners’ – for instance, outsourcing firms like Serco, supermarkets and online retailers – which polls show would enjoy broad popular support.[32] As we noted in our IPPR report, this approach has historical precedent during systemic crises in which specific actors benefit while large swathes of the economy struggle.

September 2020