Nobel Prize winners’ message is clear: Excessive taxation inhibits growth
This year’s economics Nobel Prize winners make it clear that the UK’s path of high taxation will destroy growth, writes Paul Ormerod
This year’s award for the Nobel Prize in economics, announced a couple of weeks ago, has not attracted much media attention.
But the recipients have a lot to say about the central aim of the government’s economic policy. Namely, how to make the UK more innovative and generate economic growth.
Joel Mokyr, an economic historian at Northwestern and Tel Aviv universities, received his share for “having identified the prerequisites for sustained growth through technological progress”.
The other two recipients, the American Peter Howitt and the French economist currently based at LSE, Phillipe Aghion, got theirs for “the theory of sustained growth through creative destruction”.
Although the word “theory” is mentioned in the citations, the work of all three is replete with empirical evidence and examples. There is a lot which can help to steer practical policy on how to generate growth.
Entrepreneurs hold up the economy
Aghion and a couple of collaborators published a book, The Power of Creative Destruction, in 2021 which contains many of the key points. There are lots of diagrams, some of them quite technical, but otherwise it is all in English. No maths to deter readers.
The essential message is set out in two points which the authors make in the opening chapter.
First, innovation and the diffusion of knowledge are at the heart of the growth process. Second, that innovation itself relies on incentives.
We can usefully expand on these rather terse, condensed statements.
A big chunk of total economic growth is generated by young start-up companies which successfully turn a new idea into practice and move into the phase of scaling-up, of becoming much bigger.
At one stage, the current big tech companies which dominate the economic landscape were themselves tiny. In a short space of time, well within the living memory of most, they became giants.
A heavily cited academic analysis of US Census Bureau data in the Longitudinal Business Database showed that in a typical year new firms created more than 100 per cent of all the net new jobs in the United States. In other words, the older companies as a whole in net terms saw their employment shrink. The expansion came from new ones.
This finding has been reinforced by a project using data based on the underlying US Census Bureau Business Register, known as the Comprehensive Start-up Panel (CSP).
Innovation needs incentives
The study shows show how strikingly important entrepreneurship is for the economy.
On average, each annual cohort of start-ups employs a total of 2.6m workers five years later. The authors calculate that without the contribution of start-ups, job creation by all other businesses would be negative in most years.
But entrepreneurs need to be incentivised.
Incentives can be more than simple monetary ones. For example, the regulatory environment around the hiring and firing of workers. Existing companies have already made their views known that extending full rights to people on the first day of a job is a deterrent to hiring.
Aghion discusses in some detail the link between innovation and tax policy, citing a wide range of studies.
His conclusion is clear: “excessive taxation can discourage innovation and consequently inhibit growth”. Whether it is high marginal rates of personal tax or high corporate taxes, the incentive to innovate is reduced.
Tony Blair has recently called for a reduction in the top rate of income tax. Along with Harold Wilson, he is by far the most successful Labour leader in the entire history of the party.
Blair presided over many years of strong economic growth. He understands instinctively, in a way which the current Labour leadership appears not to, how a successful and innovative market economy operates. Rachel Reeves would do well to heed his words.
Paul Ormerod is an honorary professor at the Alliance Business School at the University of Manchester and an economist at Volterra Partners LLP