Oh! Jeremy Corbyn: Labour’s manifesto - Bolshevik or bluster?

While former French President Francois Mitterrand’s 110 Propositions provide the best precedent for what a hard-left government might look like, the latest Labour manifesto is nowhere near as radical. As with any manifesto, actual policy is likely to differ. But this is the only costed and all-inclusive policy document currently available for an objective analysis of what a Labour government would mean for the economy.

In the final two blogs in this Oh! Jeremy Corbyn series, we will take a look in more detail at some of the key features of Labour’s manifesto, beginning with minimum wages and taxes. In the final blog, we’ll take a closer look at Labour’s plans for renationalisation and infrastructure spending, and provide an overall assessment of the potential impact on the UK economy.

Minimum wages: Who would benefit?

Both Labour and the Conservatives have committed to large and rapid increases in minimum wages, and both propose reaching a minimum wage in 2020 higher than that in most comparable countries. The UK’s minimum wage is now effectively the National Living Wage (NLW). Labour promises to increase it to £10 per hour by 2020, more than the £8.75 promised by the Conservative government (which would still be a record high relative to average earnings). Labour’s increase would put the UK on a par with France. That might make you gasp, but growth in business investment was no lower in France than in the UK over the 10 years to 2016.

Someone, somewhere along the chain must pay for higher minimum wages. Either domestic firms make less profit, cut jobs (or other benefits) or pass on the increased labour cost to households in the form of higher prices. In practice, there’s precious little evidence that firms cut jobs as a result of higher minimum wages. However, this may be because historic rises in the minimum wage almost invariably started from a relatively low base – often zero. Theoretically, there must be a point beyond which higher minimum wages lower employment, but that point is unknown. The higher the NLW rises, the greater the risk things go bump in the night.

We estimate Labour’s plans would knock half a percentage point off the average FTSE 250 company’s profit margin, which is 14%. Firms are unlikely to wear all of that loss in profit, but it can probably be managed by some combination of lower profits, lower non-wage benefits and pass-through pricing without resorting to the firing squad.

So what would Labour’s plan for the NLW do to inflation? We approximate that it adds £17.5 billion, or 1%, to household disposable income in 2020 after accounting for spill-over effects and income taxes. An increase in the disposable income of low-to-mid income households is likely to generate some inflation due to their higher-than-average marginal propensity to consume, but 1% is not enough firepower to induce a wincingly high rate of inflation.

A stagflationary episode reminiscent of the 1970s is also unlikely because Labour do not propose indexing the NLW. The death spiral of high inflation and high unemployment was in part caused by the succession of inflation-indexed annual wage increases achieved by many (unionised) workers. Without indexation, it is highly unlikely that inflation spirals upward while growth spirals downward. After the NLW reaches £10, any negative effect on growth or employment will quickly produce subsequent deflationary pressures.

Spending and taxes: are fiscal rules made to be broken?

Labour promises to more or less maintain borrowing for everyday expenditure at current levels, so proposes to offset a very large increase in state spending with a very large increase in taxation. The Institute for Fiscal Studies has questioned whether Labour’s tax measures would raise anything like the £49 billion required, when taking into consideration things like the usual overly optimistic reliance on tax avoidance measures (which the Conservatives also use similarly fancifully), the lack of concessions for behavioural responses (e.g. giving more to charity or setting up tax-free trusts) and the potential for higher taxes to weaken economic growth and lower tax receipts.

Any shortfall of receipts is more likely to be made up by higher taxes than more debt thanks to Shadow Chancellor John McDonnell’s own version of a ‘fiscal rule’ – taxes must cover current spending within five years. This part is not too dissimilar to former Chancellor George Osborne’s rule, which he regularly failed to meet with no penalty whatsoever from bond investors – we should take a peculiar solace from this.

Corporate and financial taxes: More reasons to relocate?

Higher corporation tax is a key feature of Labour’s fiscal plan.. Labour plans to increase the corporate rate to 26% in 2020 from 19% today; we believe such an increase is highly likely put a kink in the path of wages and investment. The academic literature tells us that economic growth is far more sensitive to changes in corporation tax than it is to taxes on personal income, consumption or property. However the impact would likely be greater in the short term and it may be less harmful to long-term growth than some fear.

A paper by HM Treasury modelled the long-run impact of the eight percentage point reduction in the corporate tax rate between 2010 and 2015, the biggest percentage point cut in any single parliament since the 1980s. Their modelling work suggests that GDP would be just 0.6% to 0.8% higher after 20 years. That’s not very much! The short-run effect is likely larger, and the model probably underestimates the impact on foreign direct investment, but it still tells us that Labour’s seven percentage point increase may not be quite as distortionary over the longer term as some fear.

Compared to other developed nations, Labour’s plans wouldn’t make the economy’s tax burden particularly onerous – in fact it would be the third lowest among the G-7 group of seven largest developed economies. That said, higher taxes could provide a further nudge to international companies already considering relocation because of Brexit. Sure, the UK currently has a corporate tax rate lower than all of the original 15 EU member states apart from Ireland’s 12.5%. But it is now more important than ever to remain competitive versus Ireland. Furthermore, the 26% tax rate is still 4% below the 30% tax rate in affect from 1999-2008, when the economy and business investment grew strongly.

In our next blog in this series, we’ll conclude our look at the Labour Manifesto and what it can tell us about the potential economic impact of a Jeremy Corbyn-led government. Meanwhile, you can read our full report, Oh! Jeremy Corbyn on our website, or request a copy from your sales representative.