Oh Jeremy Corbyn 2.0: a more radical manifesto
Labour’s manifesto is no ‘revolution’, but radical enough to skew economic risks to the downside.
This time it really is ‘radical’
In our opinion Labour’s 2017 manifesto was not radical, despite the proclamations of Jeremy Corbyn’s acolytes. Populist? Sure. Leftist? Absolutely, although actually no more so than Neil Kinnock’s final manifesto in 1992. But radical? Not really. In fact, our cold-blooded analysis concluded that there was no one policy that alone should have made capital run for the hills, though we did worry that it might be a case of straws and camels’ backs.
As for the 2019 manifesto, there’s more nationalisation, the forced transfer of shares to workers, a promise to transition to a 32-hour working week with no loss of pay, and an enormous increase in spending and taxation. Although there is still no revolution of the way income, wealth and property are taxed, this year’s manifesto is undeniably radical.
We’ve tried very hard to suppress any political bias while writing this. Any analysis that doesn’t isn’t worth the paper it’s written on. In fact let’s summarise the manifesto via an economic production function: the idea that economic growth is a function of the quantity and quality of labour (also known as human capital), the stock of invested capital (everything from factories and tractors to broadband cables and computers), and the technological and organisational knowhow that interacts with them (what we call productivity). It doesn’t get much more sterile than that!
The good, the bad and the fanciful
There are no obvious plans to curb immigration, and there are big plans to upskill the adult population through adult education funds and apprenticeships. So far, so good (remember we’re talking purely about economic growth here!). There is huge investment in public infrastructure. That’s great too; in fact I even think it’s affordable, and empirical studies do not suggest that “crowding out” is a big risk.
But that increase in capital may be undone by a loss of private sector investment as a result of an overabundance of policies that are unfriendly to business. A loss of foreign direct investment (overseas investors putting cash into UK enterprises), would be troublesome for productivity growth, something that Labour is explicitly reliant on to sustain elements of its manifesto. A comprehensive programme to address the wide productivity gap between regions is welcome, as is a policy to lower energy costs and reduce waste with green technologies. Giving workers a more direct stake in company profits has been shown to increase productivity too. In fact Labour’s ambition here is admirable. But it is hugely optimistic.
Any economist will tell you how difficult productivity is to predict. We worry about the public sector’s ability to manage companies well, the implicit scope for regional procurement policies that stymie competition, and sector-based collective wage-setting. And even if everything goes swimmingly, productivity gains from Labour’s “green revolution” may take a very long time to come through. James Watt invented his steam engine in 1769, but it took almost 100 years before steam power made any outsized impact on productivity.
A clear tilt to the downside
Figure 1 below shows a best and worst case for the growth of human capital, invested capital and productivity relative to the status quo. We then weight them by how much each factor tends to feed through to economic growth and tot up the total effect. It’s not an especially scientific approach, but the uncertainty surrounding Labour policies is so great that anything sharper would achieve only spurious accuracy. It neatly indicates the large range of plausible outcomes, and the clear skew to the downside.
A hard-left case study
There is no UK precendent for a far-left government to provide an historical comparison. It’s hard even to find one anywhere in the advanced world over the past 30 years. But if we go back a little further, we find one potential case: in 1981 François Mitterrand came to power in France and enacted “110 Propositions”, an economic programme authored in collaboration with the communist party that included all those policies that stir fear in ardent capitalists: a wealth tax, significant expansion of the welfare state, a 10% uplift in the minimum wage, collective wage bargaining, and the nationalisation of an astonishing number of companies.
For markets, Mr Mitterrand’s campaign slogan of ‘La force tranquille’ certainly didn’t ring true. Yet higher yields and a cheaper currency did a good job of stemming the tide of capital flowing out of France, and money poured back in from 1982 onward – to buy the debt of the newly nationalised and ailing companies! The Franc and the stock market swung wildly, but staged a lasting recovery with Mr Mitterrand’s ‘tournant de la rigueur’ in 1983. The lesson here is that if, even after a period of folly, a Corbyn-led government jettisons its most left-wing reforms and courts private enterprises just a little, markets could recover very quickly.
You can read more about this case study in our blog Oh! Jeremy Corbyn: in search of a hard-left precedent, which raises interesting questions about how a Corbyn-led government would fare.
Figure 1. Summarising the impact of Labour's manifesto with a production function approach
*each + or - is a guide to the degree of deviation from the long-term trend rate of growth for the UK economy
Beware the economic quacks
While Labour’s 2019 manifesto is not as radical as Mitterand’s 110 Propositions, it contains many programmes designed to redistribute income, wealth, prospects and power away from the very top. Many are sold on the promise that they will also enhance Britain’s ailing economic productivity: some have a chance of doing so, but there are many more nostrums.
Britain’s inequalities are high and some are still rising. There is an unrelenting stream of evidence that associates high inequality with worsened economic performance. The line-up at the Peterson Institute’s recent conference on the subject reads like the Who’s Who of economics, with former advisers to both left and right-leaning governments concurring. In short, high inequality reduces economic opportunities for the lower and middle classes, and fosters monopolistic rents for the very wealthy, all to the detriment of human capital and productivity. Still, fixing inequality isn’t straightforward. Many solutions can end up encouraging worse behaviours. Too many pages of Labour’s manifesto can be summed up as: good intentions, iffy design.
Think twice before you invest
Furthermore, the manifesto gives businesses an awful lot of reasons to think twice before increasing investment or headcount in the UK – especially overseas ones, which might not need to be here. A pervasive loss of business confidence is a big risk. It could lead to lower economy-wide investment (despite the extra public investment) and inhibit the productivity gains that would otherwise come from improved infrastructure.
Summing it up
Our full report dives deeper into the merits and pitfalls of some of the manifesto’s more controversial elements. But here are the headlines.
Labour would push up day-to-day spending by £83 billion in 2023–24, an almost 10% increase on what is currently planned. It estimates that its tax-raising measures would bring in a similar sum which, if delivered, would push the tax burden well above levels sustained by Britain since World War II. While this is a radical change for the UK economy, there are other developed economies – in Scandinavia for example – with similar tax burdens. Moreover, there has been no correlation between the size of a country’s tax burden and its economic performance over the last few decades. And the ultra long-run evidence shows a very clear association: larger tax programmes are accompanied by higher rates of economic growth. In the early industrial revolution, British counties which provided more poor relief saw greater political stability and more technological innovation. That’s not to say that the structure of taxation (who, where, or how) isn’t important. Changes in taxes often lower growth in the short- to-medium term. But the long-run effects on productive potential are less clear.
The additional 45% rate on personal income tax would apply from £80,000 and a new 50% rate would apply on income above £125,000. Corporation tax would rise from 19% to 26%. And capital gains above the 10-year gilt interest rate would be taxed at the same rate as income. Clearly this last change falls on the shoulders of you, our client. Thinking dispassionately, however, there is scant evidence that lighter taxes on capital incentivise more investment in business.
Labour promises to take on corporate short-termism, and amend the Companies Act accordingly, requiring companies to prioritise long-term growth while strengthening protections of stakeholders, including pension funds. The intentions chime with our own advocacy of responsible capitalism. We also want to ensure that profits today aren’t made at the expense of profits tomorrow – we’re long-term investors after all. There is an abundance of evidence to suggest that firms have become more short-termist and that the worst offenders deliver poor performance for long-term shareholders. Although the tide is turning, the market failure has been well documented and some intervention appears necessary. But there is a risk that Labour’s hand will be too heavy, and that some policies, such as putting workers on company boards, may be more curse than cure. It could lead employees to demand too much pay today, threatening the long-term viability of businesses in the process.
Here are our views in brief on the most controversial elements of Labour’s manifesto (as noted above you can read more on these in the full report):
- The four-day work week
Plenty of firm-specific studies report positive effects from shorter hours. But here’s the problem: a large proportion of these studies suggest working hours need to be well above 32 per week to be counter-productive.
- Increasing the minimum wage
For firms, the effects of a rapid increase in wages could probably be managed by some combination of lower profits, lower non-wage benefits and price hikes, without cutting jobs. Past experience suggests a larger role for price hikes, but 1970s-style stagflation is very unlikely.
- Transferring power to workers
Labour wants to give workers seats on boards and force companies to transfer shares to workers. Dilution is never good for existing shareholders, but it also happens, for example, through exorbitant executive pay. The glaring flaw is that it would also be a big disincentive to locate in the UK.
- The infrastructure card
Labour’s plans for increased infrastructure spending could be very positive, by raising the productive capacity of the economy. But the high target for investment could lead to waste and misallocation.
Labour’s nationalisation agenda has grown bolder since its 2017 manifesto, but also less justifiable. Claims that this would be ‘costless’, alongside promises to cut bills, are not credible. Although, controversially, we do actually think the plans are “affordable”. Loss of business confidence and higher risk premiums for UK stocks would be likely.
Could this actually happen?
The betting markets suggest just a 3% chance of a Labour majority, and there is still a 14-point gap between Labour and the Conservatives in the average of the last five polls. But the Conservatives had a 17-point lead at this point before the 2017 election, and in the end the Conservatives didn’t get a majority.
Mr Corbyn is incredibly unpopular. According to the pollsters Ipsos-MORI, just a few months ago he had the lowest leadership rating of any opposition leader since they started conducting surveys in 1977. But don’t mistake his personal unpopularity for the unpopularity of his policies.
There isn’t a single age cohort in which more people view “capitalism” favourably than unfavourably, while only the over-65s have a net unfavourability rating on “socialism”. Fewer than one in 20 voters want taxes and spending to fall – a huge shift from 2010. The British Election Study finds that seven in 10 people say “private companies running public services has gone too far or much too far”. Last year, the Legatum Institute found that when you present voters with a range of paired statements they leaned toward a populist left disposition: protectionist; supporting capping executive pay; wanting more regulation of business; believing that some businesses are making so much profit that it can no longer be justified; and that companies have a responsibility to put their workers on company boards.
When real wages are still below pre-crisis levels all the way up to and including the 99th percentile of the income distribution; when more than 20% of households with an income over £75,000 a year report difficulty paying the rent or the mortgage; when Brexit has alienated some voters from traditional party allegiances: a surprising result is entirely plausible. Especially when an unusually high proportion of voters intend to vote tactically. In October, the Electoral Reform Society found 24% of people would vote for the person best placed to keep out a candidate they didn’t like.
Still, the route to a Labour majority is difficult to see, especially now that the Brexit Party won’t split the “leave” vote in seats already held by Conservatives. Of the 22 seats the Conservatives won in 2017 with a majority of less than 3%, 18 voted to leave the EU. In fact, compelling analysis by stockbroker Redburn suggests the Conservatives could pick up quite a few seats from Labour. But this may be more than offset by losses to the Liberal Democrats and the SNP in “remainer” boroughs.
In other words, a Labour-led minority government (most likely a “confidence and supply” coalition) is a very plausible outcome. Coalitions tend to impede policymaking. According to the Institute for Government, fewer than 60% of the Conservatives’ manifesto pledges from 2010 were fulfilled by the coalition government. If the coalition required the Liberal Democrats we could expect some of the most radical propositions to fall by the wayside.
Financial markets are not sending a clear signal about Labour’s chances. The pound has rallied strongly over the last month as the Conservatives’ lead extended, but the historical correlation is non-existent and the rally is unlikely to have been driven by the polls. Indeed, although the rally coincided with the Brexit extension granted by the EU, the rally can actually be explained largely by the return of “risk-on” sentiment in global financial markets across the board– in other words Brexit news was not the major driving force.
Where would the pound trade if Mr Corbyn were to get the keys to No. 10? We are highly sceptical of any short-term currency forecasts, especially when they involve unprecedented political scenarios. But the way to approach it involves first adjusting the exchange rate up for the near guarantee of either a customs union Brexit or no Brexit at all. Using our Behavioural Equilibrium framework, our target is around $1.55 in the case of the former, 20c higher still in the case of the latter. Only then should we adjust it back down for the risks to business confidence, investment and the long-term effects on Britain’s productivity and savings profile.
We suspect the market will place more emphasis on the downside risks. This could takes us back to around $1.00-$1.25. Of course, currency markets have a tendency to overreact, but the downside in the event of a Labour minority government aided by the Lib Dems may not be much at all. Remember that the French franc staged a 25% rally in 1983 when Mr Mitterrand moderated his policies just a little.