Labour wants Bidenomics for Britain

So, how do the parties compare? According to opinion polls, the Labour Party is set to form the next UK government with a comfortable majority. The poor showing of the Conservatives in the May local elections also adds weight to the argument that opposition leader, Keir Starmer, is set to become the seventh Labour Prime Minister, a century after James Ramsay MacDonald became the first Labour Prime Minister on 22 January 1924.

No doubt, investors will be trying to figure out what a Labour government might mean for UK financial markets. Politics matters when it comes to valuing UK equities. For instance, UK stocks suffered a material de-rating in the lead up to and after Brexit, including the political paralysis in the Commons under Prime Minister Theresa May‘s minority Conservative government. During that time, the UK’s stock market’s limited exposure to the rallying technology sector has also contributed to its unloved status with investors.

To get an idea of the potential impact from a prospective Labour government we need to understand the party’s economic agenda. A good starting point is Shadow Chancellor Rachel Reeves’ speech at the annual Mais lecture in March. It largely focused on delivering “broad-based and resilient growth” through greater state involvement in the economy and has some differences from the approach taken under the current Conservative government. The bottom line is that the Labour party wants to raise the growth potential of the UK economy through its economic agenda, which can be largely summarised in two key parts:

Stability and investment: Reeves argues that businesses need economic and political stability to create the conditions to invest with confidence through a policy she’s coined as “Securonomics”. Labour believes that by improving the information flow to firms through “partnership” with the government, as well as providing strategic direction and selective policy intervention, firms will be encouraged to invest their capital. This tailored economic approach for Britain is similar to “Bidenomics” - the flagship policies of President Joe Biden’s administration.

In short, Labour wants to direct business investment to areas where it believes the UK will have a strategic competitive advantage (e.g., green technology); commonly known as modern supply side economics. This is different to the traditional supply side economics championed by former Prime Minister Margaret Thatcher more than 40 years ago where regulations were cut to allow free markets to determine where private investment goes (think of the privatisations of British Telecom and British Gas in the 1980s).

Reforms: Reeves also made clear “the single greatest obstacle to our economic success” is the planning system. She argues that it creates barriers for opportunity, growth and home ownership and Labour will put “planning reform at the very centre of our economic and our political argument.”

Labour intends to address planning obstacles by streamlining applications with off-the-peg processes. Importantly, to address local opposition to planning proposals, Labour wants to devolve power away from the central government. The idea is that regions and local governments are assumed to have better knowledge of their respective areas and are better placed to fast-track high-value applications. While Labour’s policy is akin to the current government’s approach, Reeves wants to make even more progress on devolution. For instance, on planning reform, Labour intends to reintroduce mandatary local housing targets, employ more people to tackle backlogs and bring forward the next generation of “New Towns.”

Labour also wants to reform the labour market by strengthening workers’ rights. This includes banning zero hours contacts, repealing anti-union laws and ending “fire and rehire”. This will be unveiled in an employment bill within the Labour administration’s first 100 days. At this stage, it is unclear what impact labour reforms will have on the employment outlook.

A new Labour government would face a vastly different backdrop compared to the last one under Prime Minister Tony Blair in 1997 when government debt and the budget deficit were much lower. It’s likely that a Labour government will need to make spending cuts and/or raise tax over the next parliament to stay within current fiscal rules.

Certainly, Labour will be wary that breaking fiscal rules could lead to financial market turmoil: the short premiership of Liz Truss in 2022, when gilt yields soared to leave her economic agenda in tatters is a case in point. So, this will mean that fiscal policy could be a drag on growth and impact the independent Office for Budget Responsibility’s average real GDP growth expectation of 1.6% per annum over the next five years.¹

Labour aims to raise economic growth to offset the downside to output from bringing in the deficit. This will largely be dependent on encouraging firms to invest their shareholder’s funds in government-directed strategic areas by providing a favourable and stable environment through “Securonomics”.

Labour also expects its planning reforms and decentralisation to help raise workers’ productivity. However, this will be difficult to do when whole economy productivity (defined as output per hour worked) is already so low. It has increased by just 0.6% since 2009, after the end of the Global Financial Crisis (GFC).¹ Austerity, financial sector deleveraging, competition from imports affecting the manufacturing sector and the rising proportion of the workforce on long-term sickness leave are already contributing factors to the UK’s poor productivity. For comparison, productivity rose at an annualised pace of 2.3% from 1971 (when the data starts) to the end of 2006, the year before the GFC started.¹

There is plenty of uncertainty over whether a Labour government delivers on its rhetoric and whether their policies work to support growth, company earnings and valuations. So, we use scenario analysis to assess the impact on our expectations for the long-term returns of UK equities.

Our Head of Quantitative Strategy, Krishna Nehra, estimates a base case of 5.6% (nominal, annualised returns) for UK equities over the next 10 years. This is based on future real GDP growth, valuations and dividend yields. Under a bullish scenario, where Labour lift the UK’s potential growth rate and valuations expand, that would rise to 7%, while a bear case would produce returns of 4.9% per year.²

Ultimately, what will probably drive UK equity returns is whether a Labour government can improve the investment landscape for UK companies.  In the Mais lecture, Reeves recognised that unlocking private investment requires institutional reform to encourage UK financial companies to invest in productive assets domestically. This will be crucial, as the scrapping of the dividend tax credit by Chancellor Gordon Brown in 1997 led to the share of UK equities owned by pension and insurance companies to fall from around 46% to just 4% currently.³

If Labour wins the election, only time will tell if their policies succeed in lifting the economy’s growth rate. However, given the poor state of the UK government’s finances and subdued productivity, it will be a hard task for the next government to achieve.

[1] LSEG Refinitiv/Evelyn Partners

[2] Evelyn Partners