New UK prime minister must be realistic about the economy

Realism and vision will both be needed as the new UK prime minister takes office this week and formulates his economic policy.

Realism is essential because the UK has limited time to negotiate an exit from the EU and its unbalanced economy requires a major reboot.

There needs to be a smooth evolution from current policy but Britain must approach Brexit as a great opportunity. Many challenges we face are seen across other western economies because of globalisation and technology. Brexit is disruptive but will allow us scope to play to our strengths.

Policy should initially focus on top-down levers that can be pulled and on shifting to a positive mindset. This approach requires a supply-side agenda and credible fiscal activism aided by consistent monetary policy and financial regulation.

The first priority will be to exit the EU in an orderly way. I expect this to happen if Boris Johnson, the likely prime minister, aims for a standstill transition period after the October 31 leaving date that allows time for a free trade deal with the EU to be negotiated. The Irish border issue can be settled with that agreement. Our terms of exit should not bind our hands on future domestic policy or trade deals with the rest of the world.

How initial conversations are framed is key. Pressure may be put on the EU by planning for no deal plus pushing trade talks with the US but we too may need to compromise to reach a deal.

If that cannot be agreed, expect the UK to leave the EU without a deal and the government — and many UK companies — to implement contingency plans. It is not clear whether enough has been done already, thus the new PM will have to ramp up preparations across Whitehall and encourage firms, especially smaller ones, to do so as well.

No deal, while ideally avoided, would be an economic shock but Britain can cope. Crucially, it would not be an end state.

Since the 2016 referendum, the UK economy has demonstrated its flexibility, adding 1m jobs, but it has seen low investment. Removing uncertainty is thus essential, as is addressing low pay.

It makes little sense to bring forward a Budget before October 31, but expect a mildly stimulative one immediately after — deal or no deal. With a no-deal, expect monetary easing also.

A supply-side agenda is vital to post-Brexit policy. The supply-side needs boosting to address below-trend growth and productivity and misplaced fears among some companies about post-Brexit Britain. There are many areas, such as easing regulations for small and medium sized firms, that could help. Radical options could be tried, too, such as establishing tariff-free ports.

More housing and better transport links are needed. Freeing up the private sector to build homes is vital.

The most contentious area may be fiscal policy. While there will be a desire for discipline, keeping financial markets onside, there is room for fiscal manoeuvre. Understandably, there will be an aim for more effective government spending. Yet, with low borrowing yields, the UK government can afford to borrow more to fund infrastructure. There is ample scope to attract more private money, especially in infrastructure projects with future revenue streams, and by channelling long-term savings into investment needs.

Economic success requires consistency between monetary and fiscal policy. It goes without saying that the Bank of England must ensure monetary and financial stability. But here, as elsewhere, the remit of the central bank needs revisiting. For instance, is a 2 per cent inflation target appropriate and what lessons can we learn from elsewhere?

We should promote London’s role as a world-leading financial centre but also ensure it serves the domestic real economy more. Monetary growth and bank lending to the private sector are too low. Capital requirements on banks need easing. The Financial Policy Committee ought to cut the extra capital that banks must hold as a counter cyclical buffer and seek to reduce capital to asset ratios.

Financial regulation has swung, like a pendulum, from one extreme of being too light-touch before the crisis, to the other extreme now. It needs revisiting, with a principles-based approach to allow it to settle in a more sustainable place.

After Brexit, economic policy must support the political aim of uniting the country, weathering any near-term disruption. Closing the pessimism gap and raising the level of economic ambition are paramount.

The writer is chief economic strategist at Netwealth

Letter in response to this article:

It may be better not to know how disorderly Brexit can be / From Prof Costas Milas, Management School, University of Liverpool, UK