Labour must grasp markets, incentives and the Government’s part in our economic malaise
Daily Telegraph 17/05/26
This week promises to be a significant one, both politically and economically. The news and political sections of just about all the media are, of course, dominated by the wranglings over who, if anyone, will succeed Sir Keir Starmer as Prime Minister. But this subject has come to dominate the economics and business pages as markets try to assess the significance of the various candidates for economic and market performance.
The truth of the matter is that there is probably not a cigarette paper to be put between them. On what we have heard so far, their different posturings correspond to rearranging the deckchairs on the Titanic.
The fundamental reason is that all of the leading candidates for the top job are, unsurprisingly, shot through with Labour’s basic ideology, namely that fairness and the distribution of income are the main issues before us. And state-led action through taxes, regulation and the law presents the way forward to addressing these.
Fairness is a legitimate concern, yet the predominant problem facing this country today is surely that, over the last six years, the economy has grown hardly at all per capita. In these circumstances, it is not surprising that average real incomes have stagnated.
This is not a story of rapacious businesses and exploitative employers. The share of profits in the economy has been declining since 2020. Workers’ disposable incomes are static because of weak productivity growth and the ongoing rise in the tax take. These are the two key issues that the Government, whoever is leading it, needs to address.
There is an awful lot wrong with the subject of economics. But it has given us some key insights. One of the most important is that people respond to incentives. Good intentions, fine words, resolutions and even laws are of no importance if the incentives point in the opposite direction. The Labour Party has lost sight of this wisdom. It doesn’t believe in markets and does not understand them. This is the central failing underlying so much of what has gone wrong under this Labour Government, not helped by ministers’ complete lack of business experience.
There are umpteen examples. If you increase the burdens on landlords, fewer properties will be offered for rent. The consequence of this is higher rents.
If you push up minimum wages and increase employers’ National Insurance contributions, the result will be fewer jobs. If you increase the benefits available to welfare claimants relative to the returns from work, then you will have more welfare claimants and fewer workers.
If you increase taxes, you will end up with fewer taxpayers, and in some cases, lower tax receipts. In this country, we have become unusually dependent on the enormous tax contributions of a comparatively small part of the population. The top 1pc of taxpayers contribute more than 25pc of total tax receipts, the top 5pc contribute almost 50pc, and the top 10pc contribute almost 60pc. This makes us particularly vulnerable to the exodus of high-earning individuals, which has already occurred on a large scale.
When it comes to the bond markets, there seems to be a peculiar lack of understanding among most Labour MPs. Andy Burnham has complained that we should not be “in hock” to the bond markets. This is a very strange expression to use. The fact is that we are in hock to the bond markets because the UK Government owes almost £3tn.
When bond markets react adversely to a government statement or action, there are usually cries of anger, derision, or both from the Left, as if bond markets should “support” government policy. Yet why should the bond investors who have lent all this money to the Government not react this way?
The power of incentives operates beyond the narrowly economic. Why is the public sector plagued by poor productivity? In part, it is derived from excessive rates of working from home and high sickness absence rates. Yet why does this occur? The predominant reason is that many public sector workers realise that they can get away with it without suffering any penalty, and there is no incentive to work a full week.
Similarly with crime. Shoplifting is now rampant. There should be no mystery about this. Retail stores and the police have apparently both decided to take little or no action against this practice, and, unsurprisingly, realising that the perpetrators face virtually no potential penalties for shoplifting, the practice has dramatically increased.
The consequences of allowing shoplifting to go unchallenged and unpunished are serious. When normal, law-abiding citizens see the state’s attitude to this behaviour, it corrodes their faith in the system and risks affecting their own behaviour.
Meanwhile, over recent months, retailers have come in for a good deal of stick for raising prices, thereby pushing inflation higher. In that regard, this week could bring some relief as the latest inflation data, out on Wednesday, may show a drop in the Consumer Price Index (CPI) inflation rate from 3.3pc to about 3pc.
But this will be wholly misleading as an indicator of current inflationary pressures in the economy. The fall in the rate, despite higher oil prices, is being driven by the dropping out of the annual comparison of last year’s large increases in regulated prices in March, the fall in the Ofgem price cap and the early timing of Easter this year. Don’t be deceived, inflation is set to rise pretty smartly later this year, probably reaching something like 4.3pc early in 2027.
On past form, the Labour government’s response to this inflationary pressure may be to attempt to control specific prices or to again berate private-sector companies for raising them, or both.
A Labour leader who understands markets, the power of incentives and the Government’s own role in worsening our current economic malaise would deserve support.
Roger Bootle is senior independent adviser to Capital Economics and a senior fellow at Policy Exchange. roger.bootle@capitaleconomics.com
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