This post is part 2 in a two-part series. The first can be found here

It’s been a conventional wisdom for many decades now that the UK economy has a structural weakness (or feature) in that not enough investment makes its way into capital formation, rather than either capital export or else into the property sector. This goes back at least as far as the Royal Commission on the 1870s depression. The most common version of this criticism is that the “gentlemanly capitalists” of the City were uninterested in industry or in operational management. There are others - imperialists complained that they routed far too much capital into the United States rather than the UK or the colonies, socialists suspected that the whole thing was a racket.

Repeated efforts have been made to change it up to the 1980s, when the Thatcher government took essentially the opposite view. Rather than the financial sector failing to allocate capital in the British economy, the problem was that the British economy wasn’t worth the capital. It was entirely rational for the City to move its investors’ money out of the UK.

The Thatcherites weren’t entirely consistent in this - Thatcher herself originally seems to have had the idea that the (feminised, feckless, irresponsible) Labour governments of the 1970s had scared investors into buying government bonds, and that the point was to restore their confidence by a display of toughness, so they would move their capital back into industry. Why investors worried by the government’s finances would choose to buy government bonds was never explained. (In this sense, George Osborne and the expansionary contractors are far more Thatcherite than the original Thatcherites.)

Also, they weren’t averse to deliberately trying to reallocate capital themselves - their efforts to restructure the housing market and to drum up foreign direct investment are evidence of this. But then, political choices always involve real resources. Of course, the chase after FDI was an indirect acknowledgement that there was indeed a problem with finance for industry.

So, why all this rambling? John van Reenen of LSE has a fascinating paper about the UK economy in the New Labour years. It demands that we think differently about this problem.

For a start, the rhetoric of economic moralising - austerity, purge, slimming - is even more misleading than usual. Even if you include the financial crisis years 2007-2010, per capita GDP growth was still higher than that of Japan, Germany, France, or the United States. Labour productivity was lower than that of Germany in 1997 - it is now higher, and in 2007 it was getting close to that of France, although some of that will have been illusory. Even the investment issue was tackled to some extent - spending on research and development as a percentage of GDP increased between 1997 and 2007, although not by much. (It fell sharply between 1987 and 1997, while it was rising everywhere else.)

Labour should be much louder in defending its record and in (as Margaret Thatcher would have said) banging the drum for Britain all over the world. There is nothing to apologise for here. Further, we should be much more confident in fighting the battle of the demand side. If labour productivity is actually higher than in Germany, there is absolutely no reason to think that capacity utilisation, GDP, and wages cannot be higher.

But, as the Dunc points out, the politics of productivity are not enough by themselves. Van Reenen argues that the barriers to growth are more structural, and their solutions will be more radical, than that. Notably, he argues that a major drag on productivity growth is the persistence of hereditary management. Whose kid are you?

Another is the impact of oligopoly on competition. Further, although the UK has improved its education system, van Reenen argues that it’s done very well at the graduate level but left behind a long tail of poor children, rather as the French economy is split between the high tech, TGVs and nukes CAC 40 sector, and a low productivity small business sector. We’re still not spending enough on science. And the worst oligopoly of all is that of the banks, which is a constant menace of financial crisis.

This implies a seriously radical critique of the British economy, although it’s possible that van Reenen doesn’t realise it. If he’s right, we desperately need to break up the banks and to create new channels for investment to reach industry. We also need to take a much harder line on competition, oligopoly, and restrictive practices. We need to hike inheritance tax and generally attack inherited fortunes. Cutting back the numbers of student visas is insane. And the very last thing we should think of doing is anything that keeps poor kids from staying on in the sixth form. Stick that in your EMA and smoke it!

Of course, this is an LSE document. So the only actual suggestion for tougher competition policy refers to hospitals:

Evidence from hospitals, for example, shows that increased competition between trusts helps improve management and save patient lives.

He doesn’t cite any of this evidence. But let that pass. Is it likely that the coalition plans for the NHS will actually create more competition, or will it just allow the creation of an all-new oligopoly run by US health-maintenance organisation firms, hardly a world benchmark for efficiency, operating in the interests of the too-big-to-fail banks?