Responsible economics, affordable Britain: a whole-economy approach to affordability

Sixty years ago, on a chilly November evening, an eminent Labour economist took to the stage. It was just months after an historic election victory, and a Labour Government were slumping in the polls. ‘One of the basic economic facts which has increasingly entered into national consciousness is the relatively slow rate of economic growth of Britain’, was how Nicholas Kaldor put it.¹ He went on to set out his laws of growth: that higher spending and investment leads to a nation producing more, which in turn leads to even more spending and investment, and so on. 

We would do well to heed Kaldor’s words today: in the face of the Iran crisis, higher spending and investment can get growth rising and inflation falling, with the added benefit of our debt burden falling in the process.  

I have written elsewhere (and often) about specific policy interventions needed to get living standards rising. But the scale of the affordability crisis we face today also requires a ‘whole-economy’ approach. We have two structural problems that have reduced living standards – a fossil fuel-based economy has left inflation too high, and a failure to listen to Nicholas Kaldor has left growth too low. Both have led to an unacceptable rise in our debt burden, making it harder to use government spending to raise living standards. 

We can fix this with a whole-economy approach that improves living standards by raising growth and getting inflation down, which in turn will reduce our debt burden. To do this, we implement pro-growth and anti-inflation investments in clean energy and social housing, alongside windfall tax-funded affordability payments that are consistent with fiscal rules. With fiscal responsibility at its core, this is the whole-economy approach this government will take to make life affordable again. 

Why did living standards fall – the ‘whole-economy’ view

Living standards fell over the past 14 years because George Osborne’s cuts to both spending and investment led to lower growth and the highest inflation in the G7.

Osborne’s cuts meant the economy ran at less than capacity, and this damaged both growth and living standards. Some examples are helpful here: imagine what happens when we stop using a building for years on end. The damp starts building, the weeds start growing – leaving it derelict makes it more difficult to use it in the future. There is a permanent scarring effect.  

When you add up all the buildings, and people, and machines that aren’t being used to full capacity, you get an economy-wide scarring effect. Productivity is lower because investments that could’ve been made were put off, workers that could’ve been working were instead unemployed and losing their skills, businesses that could’ve been bigger were instead smaller and less efficient. Similar to the post-Thatcher economy, austerity led to long-term scarring effects. Today, we still have an economy that is operating below capacity, with post-industrial areas and non-graduates still not fully employed. That means less growth, lower wages, and lower living standards.

The second great sin of austerity left us with an economy that has structurally higher prices. Osborne and Nick Clegg famously blocked both nuclear and onshore wind projects. This, in turn, has left us dependent on natural gas, with the highest domestic and industrial inflation in the developed world as a result. That now means lower living standards directly, through higher prices, and indirectly through lower growth.

Put together, lower growth and higher inflation also mean a higher debt burden. A nation’s debt burden is much like your debt burden. What matters is not your total debt, but your debt relative to your income. If I owe £100,000 and my income is only £10,000, I have a high debt burden. If I owe £100,000 but my income is £1,000,000 then I have a low debt burden.

For a country, our debt burden is measured as total debt (interest payments) relative to total GDP. The higher the ratio of total debt to GDP, the less affordable interest payments are. Cuts that reduce growth (and so GDP) are irresponsible as they lead to a higher debt burden. Similarly, cuts to clean energy that led to higher prices were also deeply irresponsible as they drove up interest payments. Even worse, as much of our debt is inflation-linked, so that higher prices today lead to automatically higher debt repayments. Osborne’s cuts were highly irresponsible, and we’re still paying the price. 

What this means today – the Iran problem

The crisis in Iran means it is even more important to build a responsible whole-economy approach. As people spend more on energy bills and less on local services, this means an economy that is operating even further under capacity with lower growth and wages. Money that would have been spent down the shops is instead going to fossil fuel producers around the world. Similarly, as inflation rises, this means lower incomes and a higher national debt burden². Those who say we should do little risk repeating the same irresponsible mistakes of the Osborne era.

Responsible economics today

The Government can use its budgetary powers – our tax, spending, and borrowing – to maximise growth and reduce inflation, especially in this new post-Iran era.

Maximising growth is important for living standards, both now and in the future. More growth today means higher total wages and higher employment. And as Kaldor pointed out on that cold November night, higher growth today gets us higher productivity in the future. It prevents the damaging scarring we saw under Osborne, and it gives businesses the revenue they need to invest in more efficient production. We use up today’s spare capacity to grow, and we build new capacity through higher productivity in the future. Growth reduces our debt burden today, and by even more in the future.

At this moment, to run the economy at capacity in a responsible manner, the Government can (and already does) borrow in a time-limited manner to invest in higher growth and lower inflation. This can (and is) being done consistently with the current fiscal rules, by ending extra borrowing before the third year of the forecast i.e. when the fiscal rules bite. 

Investments in the clean energy economy or building social homes that get prices down are both examples of short-term borrowing that leads to long-term benefits through greater growth, lower inflation, and so a lower debt burden. As these do not constitute ongoing expenditure, they set out a credible and responsible path for bond market traders. Expanding these programs gets growth rising and the debt burden down, which in turn helps us meet the fiscal rules.

Aside from borrowing, there are more subtle ways to get growth rising. For any given level of taxation and expenditure, we can redistribute from the wealthiest households to low- and middle-income households. As poorer households spend more of their income, this both raises affordability directly for them, and raises growth in our economy.

Let us start with tax. Our economy has become increasingly dominated by wealth, which has doubled relative to national income, but we keep taxing the income of workers. When we have shifted taxation toward the income from wealth and away from income from work, that means more spending by workers and higher growth. 

Similarly, we can allocate more spending to people and places that are more deprived to raise both affordability and growth. People with lower incomes spend more of their income leading to a further rise in living standards for others, while spending in more deprived areas has a greater impact on growth because there is more unused capacity.

Directly, we can allocate this spending in clever ways that directly reduce inflation. This is what the energy bill reduction at the Autumn Budget did. Those payments directly reduced inflation by almost half a percentage point, helping to lower the interest rate payments, and then lower the cost of our debt burden. 

The purest and most effective form of wealth-funded affordability payments that have raised growth and reduced inflation were the energy bill reductions, funded by a windfall tax on energy companies. 

There is another added benefit of directly lowering inflation through affordability bill reductions – lower interest rates. The Government has no direct control over interest rates, but the Bank of England is far more likely to cut these rates when inflation is closer to target. The Bank of England is given ‘space’ to cut rates, which leads to lower financing costs to households, businesses, and government. It leads to higher growth, lower inflation, and higher living standards.

We can create a responsible whole-economy policy that delivers growth, lower inflation and a lower debt burden. Taken together, this will help to raise living standards across the country. This is more, not less, important in this period following Iran. To do this we can invest more in short-term capital projects that raise growth and lower inflation. We can also fund direct payments to households in a way that gets inflation down, paid for by taxes on windfall profits as we’ve already done with energy profits. All of this adds up to rising living standards built upon responsible economics.

Jeevun Sandher has been the Labour MP for Loughborough since 2024

 Notes

1. Nicholas Kaldor, Causes of the Slow Rate of Economic Growth of the United Kingdom, Cambridge University Press, 1966. 
2. Because a quarter of our debt is index-linked, higher inflation makes it more difficult to ‘inflate away’ our debt stock.