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Charles Levy
Senior Economist
Charles  Levy

Targeted investment the only way forwards for Chancellor

Authors: Charles Levy Charles Levy

27 November 2012

In less than two weeks the Chancellor will have to deliver one of the most difficult economic speeches for years. While the latest GDP growth figure was positive he knows that this number was flattered by one-off events. The UK still faces a huge growth challenge and this is putting a large dent in his budget. Any momentum our economy gains could also easily be wiped out by changes in what continues to be a highly unstable European environment.

He is under pressure to maintain his own commitments for debt to fall in 2015/16 and to balance the budget within five years – given sluggish growth many now suggest he’ll have to cut spending and raise taxes faster than he previously thought. His own back benchers are pushing him to again postpone a fuel duty price rise. There are calls from big businesses for kinder tax treatment of investments and many more. There is a risk that amidst all this noise he may lose sight of what his single priority must be.

In our submission to the Autumn Statement, released today, we have urged the Chancellor to fully commit to supporting growth by setting out a credible growth strategy. We think that he must draw on the Heseltine Review recommendations and deliver a new industrial strategy, boost the regions and support investment in innovation and infrastructure. We have set out the various ways he should do this – increased spending on science and technology, bold action on the British Business Bank, changes to the Regional Growth Fund and additional support for Local Enterprise Partnerships. But, perhaps more important than the list, we need to see a shift in how we think about supporting growth in our economy.

We need greater focus. Until now, growth measures in all of the Chancellor’s Budget and Autumn Statements have been dominated by the broad. Cutting corporation tax will cost close to £4bn a year, and the decision to delay each of the 3p fuel duty increases costs approximately £1bn a year. These measures are broad in the sense that their benefit could spread to any businesses. The trouble is that these broad measures are very expensive and reflect an outdated view of how our economy renews itself.

These ‘little-bit-more’ measures slightly alter the payoff from alternative consumption and investment decisions. But it simply isn’t the case that businesses have a long shopping list of projects that they could pursue if only the options were, say, 2.1% more profitable.

This line of argument works in a world of perfect competition, with identical and unchanging products, where a slight edge makes all the difference. These policies may be highly effective for a traditional industry such as oil extraction, where precise models determine the viability of projects. But for most sectors the impact of these policies will be modest and the deadweight significant. In a modern knowledge economy like the UK growth will depend on our companies and entrepreneurs finding new ways to innovate, new ways to develop, deliver and sell new products and services. In these environments we’re talking about disruptive technologies, fundamentally different business models, huge risks and often a stark divide between corporate success and commercial failure. Tiny percentage nudges in this environment are less effective.

Instead, we need targeted investments with the potential to help build new markets, help to pull through and commercialise new technologies, or to catalyse a city or town to overcome the challenges they have been facing for decades.