The big state won’t save our post-Covid world

6 March 2021

6:58 PM

6 March 2021

6:58 PM

The big state is back. The Budget puts Britain on a path to having the highest tax levels since the 1950s, and a state that controls as much of our GDP as it did in the days when it still owned carmakers, phone lines and travel agents. Despite Rishi Sunak’s best efforts to contain spending, the figures are likely to go higher still, as the bills for the NHS, social care, and disrupted education continue to rise.

But it’s not just about the numbers. Even before the pandemic, the political winds were blowing towards larger government, with Boris Johnson embracing a more muscular, state-led industrial strategy. But the pandemic has put that on steroids.

The largest disruption to our lives since the second world war has been matched by a return of the wartime spirit — the feeling that we’re all in it together, that it’s the government’s job not just to get us through the crisis but to carry the economy forward after it. The Tories talk about ‘building back better’ by investing in hand-picked schemes and sectors. While Keir Starmer often invokes the legacy of Attlee, talking repeatedly about the need for the government to step up to the plate and deliver fundamental social and economic change.

Yet the mythology of the post-war years is just that — a myth. The evidence, in fact, suggests the exact opposite: if we want to increase growth and safeguard the long-term prosperity of the country, drawing inspiration from Britain’s post-war policies would be a fatal mistake.

Of course, the comparison between the pandemic and the war is hardly exact. While the pandemic has exacted a truly horrific death toll, in contrast to 1945, there are no bomb craters, destroyed cities, or ruined transport links littering Europe.

But just as the wartime government grew enormously, not only in size but in scope and intrusiveness, so, too, our economy has been transformed. Even rationing has returned in a form, only this time people have been deprived of social contact and pints down the pub rather than food and consumer goods. And just as in 1945, we will have to go through a significant economic adjustment once the pandemic ends.

So what lessons can we learn from that previous upheaval? The precedents are far from encouraging: some may look back on the post-war period as a golden age for the UK, however in terms of economic growth it was anything but. The almost three and a half decades after the war saw the UK stagnate from an international perspective, culminating in the truly dire decade of the 1970s.

Right from the end of the war, the UK economy did significantly worse than its peers. Over the period 1949–1959, the Wirtschaftswunder in West Germany gave them an average growth rate of 6.3 per cent. Italy managed similarly impressive growth of 5.5 per cent. Yet the UK lagged far behind, managing only a miserly 2.1 per cent. Even France, which is generally seen as being economically weak during this period, still did a lot better than Britain with a growth rate of 3.6 per cent.

While these other nations closed the gap on the much wealthier US, the UK fell further behind. In 1950, the UK had GDP per capita about 72 per cent as high as that in the US, which made it by far the richest nation after America. But over the next 20 years, we stagnated, hitting 68 per cent of the American level by 1970. By contrast, West Germany went from just under 45 per cent of the US level to 82.5 per cent. Japan did even better, going from 22.3 per cent in 1950 to 65.4 per cent in 1970.

In explaining Britain’s colossal under-performance, there are plenty of explanations people reach for: Japan and West Germany were rebuilding after the devastation of the war, so could buy new and more productive machinery. They were helped by American aid. Britain had to bear the crippling costs of wartime debt and pay the price for dismantling its empire.

But if you actually look at the data, none of these explanations stack up. It’s true that it was always likely that countries such as West Germany or France would grow more quickly than Britain — not so much because of the devastation of war (in fact their industrial bases remained surprisingly intact despite the carnage) but because they still had far more people working in the fields, who rapidly found better jobs in the factories. But even when other factors are accounted for, the UK’s growth rate was still between 0.75 and 1 per cent a year lower than it could — and should — have been.

The explanation for this? Bad economics. Countries such as West Germany, Japan and America shrunk the size of the state, dismantled most wartime interventions in the economy and introduced lower, more business-friendly tax regimes. The UK went down a very different path, keeping many wartime restrictions such as rationing, and embracing a larger state which spent, taxed, and intruded more into the economy.

Ludwig Erhard spent the 1960s abolishing wartime controls in West Germany and reforming the tax system by lowering marginal rates and offering generous investment tax credits to encourage work and investment. Attlee, by contrast, was nationalising large swathes of the British economy and running a horrifically designed tax system with punitively high marginal rates, which did all it could to deter wealth creation.

This wasn’t just about a few specific policy choices, but a general attitude. In Britain, the importance of the state was emphasised over the private sector. At the same time as countries like America went back to relying on entrepreneurs to generate growth and jobs, post-war policy in the UK revolved around government management and investment as being crucial to securing prosperity.

Key to this was the need for the government to protect and support domestic industry. In West Germany and Japan, they demanded that firms became competitive by cutting off wartime support, running tight monetary policy and in the case of West Germany opening their markets up to international competition.

Britain, which had invented free trade, instead clung to protection — coddling and shielding British firms and thereby dooming industry to a long, slow, painful decline as our companies gradually became ever less competitive.

Perhaps the most instructive example is what happened in America. It’s often claimed that it was Franklin Roosevelt who resurrected the American economy, either via the New Deal or the wartime command economy — and again, there have been voices calling for a Rooseveltian approach in post-pandemic Britain. But, in fact, all the evidence suggests that it’s the much more business-friendly figure of Roosevelt’s successor, Harry S. Truman, who the government should copy.

Under Roosevelt, business investment and consumer confidence were strikingly low. There was a genuine fear — not so bizarre given what was happening elsewhere in the world — that America was turning its back on capitalism, and even on democracy. The White House became packed with central planners, with FDR delivering fiery speeches condemning the fat cats.

That began to change during the war years, as businesses retooled with spectacular success to arm the Allies — and the process was completed when Truman took over, and business confidence surged. Truman slashed government spending — which fell from 55 per cent of GNP to 16 per cent between 1944 and 1947 — ended price and production controls, lowered the corporate tax rate, abolished the wartime excess profits tax, and generally took government out of the way of business.

The results were miraculous: when you adjust for wartime inflation, the data shows that the real boom in consumption and investment came after the war, not during it. Despite 20 million people (a full third of the American workforce at the time) losing their job at the end of hostilities as the army massively downsized and wartime industries shifted back to making consumer goods, unemployment rose only very slightly. By stepping back and slimming down, the government made room for the private sector to rapidly adjust to the post-war world.

Much like in 1945, the government today faces a fork in the road. It can emulate the UK’s post-war governments with a larger more interventionist state. Or it can take the other route that America, West Germany, and Japan took, and reject an ever larger, more interventionist government; reform taxation to improve work and investment incentives, and generally get out of the way of the private sector.

The former risks confining the UK to a repeat of the stagnation we experienced after the war. The latter offers the opportunity to not only rapidly recover from the damage of the pandemic, but to put in place the foundations of robust growth for decades to come.

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