Mirages of economic growth

Government departments and think-tanks in Westminster, Edinburgh, etc want to offer some magic recipe for restoring economic growth. The reason is obvious: without faster economic growth the UK faces extreme fiscal constraints and social unrest because all policy choices involve redistribution from one group to another that is likely to be resisted. For those with a short memory it will be 2010s austerity redux, while for the ancient it may appear like a rerun of the 1970s.

The problem with all the pontificating is that the self-appointed experts seem to know little economics and even less economic history. The current fashionable theme is that the UK needs to build more infrastructure more quickly. This might be good for construction firms and civil engineering firms but what does it do for economic growth? Of course, it would provide a temporary boost to employment in construction and industries supplying related capital goods. But the cost must be financed in some way, so if we hold total borrowing constant the money must be found by reducing other spending and employment.

If the UK were to build more infrastructure, would this really increase productivity and economic growth? As it happens, I ran a research project at the World Bank during the 1990s which examined the historical relationship between investment in infrastructure and economic growth. Superficially, the answer was positive. Large infrastructure investments were associated with higher economic growth in subsequent 5-year periods.

But, but … the details are hugely important. It is agreed by everyone that the development of the US inter-state highway network in the 1950s made a significant contribution to economic growth in the 1960s, but later investments in roads had a much smaller impact. Going from a very limited road network to a relatively good one is a huge bonus. Upgrading or extending a reasonable road network yields a much smaller boost to economic growth. The results suggested that the biggest boost to economic growth in the late 20^th century came from investment in telecommunications, not transport.

The UK has a reasonable road network, even though a failure to invest has left it in worse condition and more over-crowded than many road users would prefer. Still, travelling on specific roads is a matter of choice, a function of locational and other decisions. Many businesses can mitigate the impact of congestion by moving away from the worst-affected locations. If businesses choose not to move, then the benefits of locating in cities or other congested locations must outweigh the costs that they incur. On this basis it is hard to make a case that investing in better roads or other transport infrastructure will have a significant impact on economic growth.

Most of the complaints about road infrastructure are about the distribution of gross value-added, not its aggregate. Workers prefer to live in pleasant locations subject to limits on the amount of time and money they spend travelling to work. Historically, investments in transport infrastructure that have lowered travel costs have led workers to travel longer distances from home to work. If travel costs increase again because roads and other transport infrastructure becomes congested, those workers may feel aggrieved and are likely to argue that they would be more productive if there were less congestion. Sadly for them, that argument is wrong because it is their consumption rather than their output which is affected by the increase in transport costs.

What about telecoms infrastructure? Again, this is not like the expansion of the telephone network in the second half of the 20^th century or providing broadband services in the 2000s. Businesses in the UK have had access to reasonable telecoms infrastructure, including fibre, for 15 or more years in most of the country. Rural areas were neglected but that has improved, and alternatives were always available.

In economic terms, most investments in new transport and telecoms infrastructure in the UK enhance consumption rather than contribute to economic growth. It is not my intention to downplay the consumption benefits of such improvements, but we should be clear that they will not show up in either gross value-added or public revenues. The arguments made by lobbyists are largely special pleading rather than serious economic analysis.

The dividing line between output and consumption is particularly important when considering the huge program of investment in energy infrastructure, especially to produce and transport electricity. For at least 30 years the UK has had sufficient energy infrastructure to meet a level of demand that is considerably higher than actual demand today. All that was needed was to ensure that infrastructure was properly maintained and assets were replaced when they reached the end of their economic lives. The replacement cycle would automatically improve both labour and capital productivity since new generating plants tend to be more efficient than those they replace, while new transmission and distribution assets tend to reduce network losses.

However, deliberate choices were made by successive governments to pursue targets affecting how energy was produced and used. Initially, the focus was on the share of renewables in total energy consumption; more recently, on the decarbonisation of energy use in sectors like transport and heating. None of these targets change the services provided by energy production and use – the power used by business and residential users, warm offices and houses, miles travelled. In those terms the outputs of energy use have not changed. What has changed is that greatly higher inputs of capital and, probably, labour are being deployed to produce the same outputs.

By any standard this change has reduced what economists call total factor productivity. The resources that might otherwise have been used to increase output and living standards – i.e. economic growth – are instead being diverted to underwrite the consumption choices mandated by the luxury beliefs of the political elite.

To be clear, this is clear political choice to favour certain forms of consumption - relying on renewables and some (but not all) low carbon forms of energy use. The politicians who lament the absence of economic growth should look in the mirror and ask themselves what their responsibility is for the choice to consume more and thereby sacrifice future increases in economic welfare.

Of course, there are plenty of clever sophists among people with a smattering of economic jargon without any deep knowledge. The argument in this case is that greenhouse gas emissions are an externality that is not taken into account when we measure total output or income. The (very small) nugget of truth in that argument is that it implies we should apply a consistent levy on emissions of greenhouse gases from all sources but no other interventions. The levy should reflect the amount that collectively – and globally - we are willing to pay to reduce greenhouse gas emissions.

The difficulty, of course, is that it is easy to bias estimates how large that levy – the social cost of carbon - should be by making absurd assumptions that are inconsistent with other decisions made by public and private bodies.[1] If we insist on consistency, then the levy would be relatively small – of the order of $10-$20 per tonne of CO2-equivalent at current prices. Existing taxes on fuel consumption and carbon emissions have long exceeded that level without taking any account of other interventions.

Unfortunately, the contribution of policies to promote renewable energy and decarbonisation to reducing economic growth is only the latest phase in a lengthy tale of woe. Even at the end of the 19^th century it was widely argued that innovation and investment in new industries, the main drivers of economic growth, were lagging far behind Germany and the US. Blame was placed on a preference for rentier investments, especially abroad, as well as the claimed aristocratic disdain for commerce.

These arguments rumbled on during the inter-war and post-war periods up to the 1970s with recurring claims about the priority given to financial over industrial interests, poor industrial management and an aversion to innovation. The final straw was the economic shift that occurred in the late 1970s and early 1980s. While mythology blames Mrs Thatcher, reality was rather different. Tight monetary policy was s part of the story, but this was hardly unreasonable given high inflation at the time.

The rise in inflation was linked to a sharp increase in oil prices following the outbreak of the Iran-Iraq war. Critically this was when North Sea oil and gas production was rising, so the UK suffered from an acute episode of the resource curse by which high commodity prices and increasing output pushes up the exchange rate to the detriment of other industries producing traded goods. The ratchet was made worse in the mid- and late-1980s by a flood of money into the financial sector, because of deregulation both in the UK and elsewhere. This sequence of economic shocks transmitted by an increase in the real exchange rate was the last straw for industries that had been weakened by adverse economic conditions during the 1970s.

Over the longer term, both before and after 1980 the consistent weakness of the UK economy has been the low level of investment in productive sectors. The North Sea oil boom was associated with high investment in oil and gas production but little in other sectors. Investment in infrastructure will achieve little unless it is matched by complementary investment in productive assets.

Not only is net investment – i.e. capital expenditures which exceed the replacement of existing assets – low as a share of GDP but it is disproportionately focused on property and especially housing. Those who lament the high cost of housing, especially in London and the South-East, may object to the suggestion that the UK invests too much in housing. The underlying problem is that UK net investment is far too low in aggregate.

The priority given to housing means that the capital expenditures required to sustain and increase economic growth are squeezed. To meet its goals the current government would have to (a) increase both savings and investment, and (b) ensure that all or most of the increase in capital spending goes to productive assets which underpin economic growth. There is no sign that the government either understands the issue or is willing to contemplate the policy measures that might achieve such an outcome.

The get-out-jail card waved by governments over the last two decades has been innovation that is supposed to flow from public expenditures on research and development. Anyone who has had to deal with the UK research bureaucracy can only respond to that logic with hollow laughter. The multiplicity of schemes is a bureaucratic nightmare, while expenditure priorities change frequently with the latest political fashion. As I have pointed out in another article, tax incentives for R&D spending by companies were deliberately reduced or eliminated the moment they seemed to become too popular.

More seriously, the argument rests upon a political fiction. Innovation does not, for the most part, translate to economic growth without substantial investment in productive assets – not just infrastructure but buildings, machinery, and the software required to operate them. That is the unacknowledged story behind the complaints that the UK is good at invention but poor at turning inventions into innovation and economic growth. This is largely a consequence of low levels of investment combined with strong financial and other incentives to invest in property and housing.

Which, if any, of the measures announced by the current government are likely to stimulate the necessary shifts (a) from consumption to savings, and (b) from investment in property to investment in innovation and associated productive assets? In broad terms – none. What we have is a government which for ideological reasons and under severe fiscal pressure is committed to go in the opposite direction. It is hardly surprising that independent forecasts of future UK economic growth are so depressing.

[1] See, for example, my colleague Jonathan Lesser’s discussion of the huge jump in the EPA’s estimates of the social cost of carbon - https://energyanalytics.org/wp-content/uploads/2025/04/2025-04-NCEA-Social-Cost-of-Carbon-Lesser.pdf.