Boris Johnson says “we need to grow our economy out of these problems” caused by high energy costs, perhaps by cutting taxes and red tape. There’s just one problem with this: it can’t be done.
“You can’t reform your way to rapid growth” says Dietrich Vollrath University of Houston. This is because the size of our economy depends, ultimately, upon our capital stock, labour, skills and technologies. Yes, low aggregate demand or mismatches between supply and demand can cause output to be below the limit set by these, but in the long-run it is these that determine economic activity.
But they are slow to change: as Abhijit Banerjee and Esther Duflo point out in Good Economics for Hard Times, economies are sticky. Companies are slow to invest, expand or make best use of new technologies and slow to move into new markets, while it takes time for workers to learn new skills. All of which means that even if the government can increase potential output by cutting taxes or red tape, it will take years for this potential to be reached.
Let’s assume that tax cuts and deregulation could raise potential output by 10 per cent; there’s little evidence for this, but let’s be optimistic. Then Vollrath’s maths imply that this would raise annual GDP growth by only around 0.2 percentage points. To get a bigger impact you need either a bigger rise in potential output, or faster convergence to the higher potential. Both are unlikely.
One big fact tells us this. John Landon-Lane and Peter Robertson have pointed out that over long periods developed economies tend to grow at much the same rates as each other. This, they say, suggests that national policies can do little to raise long-term growth. It is instead determined more by global factors such as technical change.
Which brings us to our problem. Although 0.2 percentage points is not nothing, it is small compared with the size of the energy price shock. The Bank of England estimates that by the end of this year the share of household incomes spent on energy will have risen by more than two percentage points (from 5 per cent to almost 8 per cent). We’ll need more than a decade of extra growth to offset that.
But can’t we grow faster by encouraging new, dynamic industries?
Not really. The problem with such industries is that they are by definition small and so do little to raise aggregate output. If 1 per cent of the economy were to triple in size in the next 10 years without taking resources from the rest of the economy, it would add only around 0.2 percentage points to annual growth. This is why growth was slow at the start of the industrial revolution: the industries that would eventually change the world started small.
So no, we cannot grow our way out of the energy crisis. In claiming that we can, Johnson is betraying an ignorance of how economies work. Our fundamental problem is that oil and gap producers are seizing a bigger share of the economic pie, which means somebody must get a smaller share. In pretending he can increase the size of the pie, Johnson is trying to hide the fact that sometimes in economics there are simply conflicts of interest.
