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“UK business activity fell for the first time in more than a year, according to a closely watched survey, as the private sector warned that confidence in the Labor government had been hit hard by last month's Budget.” This was the opening of the the story which appeared in the FT on November 22 2024. It raises the important question of whether “confidence” is an important factor for economic performance.
To answer it, one must separate the concept of confidence from the direct impact of policy. So, in this story, S&P Global's Chris Williamson is quoted as saying that “companies are clearly giving the 'thumbs up' to the policies announced in the Budget (due 30 October 2024), particularly the proposed increase in employers' national insurance contributions . “.
Yet this may not have anything to do with any loss of confidence. It could mean that companies were convinced that higher employment taxes would lead to higher costs, higher prices, lower employment and lower profits and, if so, they were sure to be lowered, in the absence of a stronger tariff. Another payoff may be lower borrowing costs as taxes rise. In practice, as the Office for Budget Responsibility noted at the timeborrowers are increasing. Not surprisingly, the yield on 10-year gilts rose by 26.8 points from before the Budget to December 19, the biggest increase of any member of the G7, except the US.
But confidence can be important. Indeed, it certainly does. After all, as Nobel laureates George Akerlof and Robert Shiller explained in their 2009 book. Animal Spiritshumans are not intelligent calculating machines. We have deep feelings.
Often, however, we can still analyze the economy as if it is not a problem. A sophisticated analysis of the tax hike – as in the Autumn Budget – can do enough. However there are important conditions. These occur at any time “great uncertainty“, the title of the 2020 book by two British economists, John Kay and Mervyn King, becomes the main issue. Moreover, there are two situations where such uncertainty has dominated in determining what will happen: the first one is one of great macroeconomic instability, such as a financial crisis; the second is long-term weak growth.
In both cases, the important variable is what John Maynard Keynes called “the propensity to invest”. Investing is where “animal spirits” should come in. After all, any investment decision is a bet on an uncertain long-term future. The past twenty years have shown how unpredictable the future can be. It rarely seems so unlikely today. Just think of what could happen politically, geographically, strategically, economically or environmentally.
Moreover, as Keynes emphasized, investment can be depressed for years if the economy ever falls into a slump. That is why, in my view, the lack of money after the financial crisis was a mistake. We are part of the reason why growth in the UK and most other European economies has weakened since then.
At the moment, above all in the UK, where, as I said November 25, the remaining investment is very low, the depressed animal spirits threaten the investment on which future economic growth depends. Unfortunately, the data shows that confidence is low. An important example is the “economic confidence index” published by the Institute of Directors earlier this month, showing business confidence at levels close to those of 2020, at the height of the Covid pandemic, or immediately after a full-scale Russian invasion of Ukraine in 2022. Not unlike, the Confederation of British Industry reported on December 2 2024 that “Private sector firms expect employment to decline in the three months to February 2025. . . This marks the first time this year that growth is expected to be negative.”
The danger, then, is that the measures taken by the government to raise taxes and tighten regulation, especially in the labor market, will not only increase uncertainty about the future, but, worse, actually increase the certainty that the economy will continue. Both of these outcomes should undermine trust in the future. That risks starting a vicious decline, where confidence undermines morale, weakens investment, slows demand, undermines innovation, and thus slows the growth of productive forces.
At the level of discourse, the government emphasizes the priority of economic growth. It is worth doing so. Nothing will work without it. But it needs to understand that growth depends on business confidence in that growth. This is the confidence that can encourage a business to take risky opportunities. Therefore, in every decision, the government must ask itself this question: will it make the business believe more in a better future, or not?
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This article has been amended to reflect the fact that yields on 10-year gilts rose by 26.8 basis points from before the Budget to 19 December.