Reforming the UK's economy - the uphill task facing a Labour government .
As the election draws near, the reality of the problems facing a new Labour government are becoming increasingly difficult to ignore.
In a big year for global elections, the race for power in the UK is well underway despite no date having been fixed for when the country goes to the polls. With the Conservative party imploding amidst infighting and mutual recrimination, the outcome - a Labour victory - seems in little doubt. The question is now how big the Labour Party’s majority will be, and what this means in terms of a mandate to govern and to reform.
The UK’s economy shrank by 0.3% in Q4 2023, marking the second consecutive quarter of economic decline, thereby confirming a ‘technical’ recession1. In the context of the fumbling of Brexit and the cost of living crisis, the history of incumbent governments retaining power during and after economic crises is clear - they always get kicked out.
This happened after the sterling devaluation in 1967 (Labour lost in 1970), the 1973-4 inflation crisis (the Tories lost in 1974), the winter of discontent in 1978-9 (Labour lost in 1979), the ERM crisis in 1993 (the Tories lost in 1997) and the global financial crisis (Labour lost in 2010).
At some point later this year, we shall likely be saying goodbye to Prime Minister Rishi Sunak. Perhaps he can go back into finance, or make a living on the speaking circuit like so many other failed politicians. Perhaps he’ll end up sitting on a toadstool, a place he would likely look at home. In any case, the newspapers are now full of Labour’s economic plans - more precisely, how their grandiose plans are already being scaled back.
With the debacle of Liz Truss’s whirlwind premiership still fresh in politicians’ minds, the risk for Labour in pursuing unfunded spending plans, or spending plans which involve raising taxes aggressively at a time when corporate and income taxes are already at multi-decade highs, has already led to Labour’s green investment programme being drastically curtailed.
The original £28b per year spending pledge has been scaled back to £15b per annum, of which only £4.7b is new money2. The reason given is the Tory mismanagement of the economy constraining future government fiscal flexibility. This may well be true, and it is likely that most of Labour’s administration will be characterised by blaming economic failure on the previous government. If Labour ends up winning a second term, this excuse will start to wear thin, but not for a while yet.
Aside from dog-whistle policies like revoking the charitable status of private schools, Keir Starmer’s Labour party is at pains to emphasise how business-friendly it is. Clearly much lobbying is going on in the City of London right now, and in turn, business seems to be trying to curry favour with Labour, in part because the latter’s victory is a safe bet at this stage.
Shadow chancellor Rachel Reeves has already pledged not to raise corporation tax above the current 25% level in the hope of reassuring business with respect to the landscape for investment3. Yet it is another policy, that of raising the tax rate on carried interest for private equity firms, that seems to be causing consternation in the finance community.
Carried interest, the share of profits earned by partners in private equity (PE) and similar ventures, is currently taxed as a capital gain (at 28%) rather than at the higher 45% marginal income tax level. Ms Reeves is proposing to close this loophole, forcing private equity partners to pay the higher 45% rate4. Not many tears will be shed here, but the perceived risk is that the reform will discourage foreign direct investment (FDI) in the UK, harming jobs, growth and tax revenues.
If Labour is serious about turning the UK economy around, it clearly needs to focus on investment, infrastructure and related issues such as skill levels and education amongst the workforce. Fretting over keeping private equity partners pumping money into the economy may seem to be part of the investment element of the equation, but a brief assessment of recent PE deals perhaps reveals the real problem that is holding back productivity and growth in the UK’s economy.
A case in point is the British supermarket WM Morrisons, bought by US private equity firm Clayton, Dubilier & Rice (CD&R) for £7b in October 2021. The deal left £6.6b of debt on Morrisons’ balance sheet, helping the company to a £1.5b loss in the year after the deal was completed5.
While cash can be raised through sale-and-leasebacks of the supermarket’s real estate, and while the smart chaps at CD&R will doubtless find clever ways to cut costs and reduce overheads, it is hard to find a way to describe the takeover as anything more than an egregious example of extreme financial engineering based on the assumption that interests would stay low forever (which they didn’t). This is not the sort FDI the UK needs, yet it often seems to be the most common, or at least the most attention grabbing.
Elsewhere on the UK high street, Aurelius private equity’s short-lived ownership of the Body Shop has ended in the company heading into administration. The restructuring may end up benefitting Aurelius, but there will be many losers - both on the financing side but more importantly amongst employees who will doubtless be the victims of redundancy and rationalisation6.
If the Labour party is serious about improving the UK’s dire record of productivity and growth in the post-global financial crisis world, then emphasising quality not quantity in terms of FDI should surely be an area of focus. In part, the market is doing some of the work - higher interest rates mean a higher cost of capital, and this makes ill-conceived investments like the Morrisons takeover less tenable.
Yet the risk of taking a stand against the ‘forces of financialisation’ like private equity is that the UK would be perceived to be a less attractive place to invest. With the UK’s negative balance of payments, the level of the pound in the international markets and the corresponding cost of borrowing, both for the government and the private sector, will be the measure of the success or otherwise of a future Labour government’s policies.
If Keir Starmer is planning on being anything more than a one-term wonder, then a desire to overcome the inertia of the UK’s current reliance on financial sleight-of-hand has to manifest itself in a real push for productive, long-term investment, even if that involves ruffling some gilded feathers in the square mile. That would definitely be a mountain worth climbing.
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Elliot Smith, UK economy slipped into technical recession at the end of 2023, CNBC, 15/02/2024
Ben Quinn, How Labour ditched its flagship £28bn green investment pledge, The Guardian, 08/02/2024
Alistair Smout, UK’s Labour will cap corporation tax at 25% if it wins election, Reuters, 01/02/2024
Jim Pickard et al, Labour under pressure to water down proposed tax raid on private equity, Financial Times, 03/02/2024
Sahar Nazir, Morrisons posts £1.5b loss after being sold to CD&R, The Retail Gazette, 09/03/2023
Will Louch and Laura Onita, How The Body Shop unravelled in 3 months, Financial Times, 16/02/2024