David Davis has today set out a competitive agenda for Britain’s economy in a speech to the Institute of Chartered Accountants in London.
David told the ICAEW:
There is one, single policy issue that dominates British politics today.
It is the economy.
It is the preeminent issue that determines the welfare of British citizens.
Whether they have a job, how well paid they are in that job, what taxes they have to pay, what healthcare and pensions they get, how good their children’s education will be – all of this depends on the health of the economy.
And the health of that economy is pretty dire.
We are making heavy weather of deficit reduction. The Government borrowed £3.4bn more in July than in the same month last year.
Growth prospects look poor.
Quite simply we are bumping along the bottom.
And I say that even though I suspect that the economic figures are slightly overstating the gloom at the moment, and that we are likely to get a correction. It does not matter whether the growth figures are minus half a percent, zero, or plus half a percent: they are all terrible.
Of course, the Chancellor can quite properly point to reasons beyond his control.
The spectacular debt overhang that he inherited from a fiscally incontinent Labour government.
The depression of our export market by the incompetent and futile policies of the Euro zone powers.
The devastating impact on our economy of the bank failures. He is right to point these out.
But an alibi is not a policy.
There is a risk that by focusing on parcelling out blame, we accept our circumstances with too much fatalism.
In economics, to understand should not be to excuse.
The parlous circumstances should not be an excuse for inaction, but rather a spur to dramatic action.
There are those who think that our comparative decline is inevitable.
That think that the rise of massive low cost competition from China, India, Brazil and the other emerging economies means an inevitable decline of the West in general, and Britain in particular.
That we face a future of low growth and poor prospects. That the West can no longer compete.
That this is the new normal.
This is fatalistic nonsense.
We have been here before, of course. In the 1970s the British Establishment was convinced that the job of the government was to manage our inevitable decline. To accept that the rise of the Eastern Tigers would eclipse us economically, and the rise of Soviet Union, believe it or not, would eclipse us politically!
All of that was swept away by the Thatcher government of 1979, who recognised that their job was to solve the problems, not simply to mitigate their consequences..
Today’s circumstances are difficult, but they are not impossible.
Let us take Switzerland as an example. Its economic dependence on banking was a third greater than ours, and its exports are predominantly to its Euro zone neighbours.
Yet, while our economy struggles, Switzerland’s is back up and running.
Whilst our growth rate is near zero Switzerland’s is 2%. Whilst our unemployment stands at 8%, their unemployment is a mere 3%. Whilst we expect to run a deficit of 6% of GDP for 2012/13, Switzerland expects a $1.5bn surplus.
So Britain’s problem cannot simply be attributed to bad banks at home and collapsing export markets abroad.
It is more fundamental than that, and demands more fundamental action.
Indeed, if we do not take a coherent and radical approach to galvanising our economy, there is a serious risk that we will face a decade, or even decades, in the doldrums.
So if we fear to act because we have anxieties that the alternative policies are too “risky”, we should start by facing up to the real risk. That inaction could deliver decades of decline and disappointment for a whole generation.
One in five recent graduates are out of work. A million youth unemployed. It is our moral duty to ensure that we do not allow the creation of a lost generation of young talent.
Just consider what happens when Governments are too risk adverse?
When nations are too fatalistic about their futures?
When as a result they refuse to grasp the nettle.
In 1990, the Japanese government, faced with a banking crisis, sought to save face rather than solve the problem.
The consequence? Two decades of disastrously low growth.
And bear in mind everything the Old school Keynesians are calling for, borrowing to increase domestic demand, increasing the expenditure on infrastructure projects, suppressing interest rates to zero has been done in spades by Japan for two decades.
And it didn’t work.
It is fashionable these days to talk about behavioural economics and the role of psychology in policy. I understand that Downing Street has a unit that specialises in “nudge policies”.
What I have in mind is rather more than a nudge.
The great economic transformations of history, the great recoveries, have always had a strong psychological component.
They have always had an appearance of risk, and of high drama.
When Hans Luther and Hjalmar Schacht stopped dead the hyperinflation of the Weimar Republic in the 1920’s, there were many important technical policy actions.
But the creation of the new Reichsmark, was an act of high drama designed to persuade the public and the markets that they meant action.
In theory you could stop inflation of the old currency. In practice the political theatre, of trading in a trillion old Marks for a new Reichsmark was vital to shock the nation into the mindset necessary to solve their problems.
When Margaret Thatcher’s government stopped the steady decline of the British economy, a decline that was thought to be so inevitable, we forget some of the enormous risks she apparently took.
The ferociously unpopular but effective 1981 budget.
The liberalisation of exchange controls, which was thought at the time to be a dangerous economic leap in the dark.
Reform of the Labour markets by a Conservative Party who, only a few years earlier we were being confidently told “could not deal with the unions”.
Indeed the most confident thing about those years were the certainties of the critics who proclaimed it was destined to fail.
Of course, if we had not taken those risks we would have continued with the comfortable certainty of continuous long term decline.
Today what is needed is a modern shock therapy for our economy, to jolt it out of its torpor. When one of the possible futures facing us is decades in the economic doldrums, what looks risky may in fact be the safest course.
This isn’t just history. Look at the example of Germany in 2003, only 9 years ago.
A time when they were not the confidently dominant economy they are now.
With growing unemployment, soaring national debts, and struggling to compete, they were entering an economic quagmire. Gerhard Schroder’s Social Democratic government, took firm and resolute action, most notably with radical labour market and welfare reforms.
The results are clear.
Today Germany is the productive powerhouse of Europe. People give credit for their success to the level of the Euro, and the comparative competitiveness of the German economy against the Southern Europeans.
But that competitive advantage was created by decisive Government actions in 2003.
These parables exemplify the fact that there is nothing inevitable about a nation’s fate in today’s global economy.
Resolute, determined and radical action works.
But what action?
What is it that works?
Well the first thing to understand is that we must earn our way out of this problem, not spend our way out of it.
The recommendations of the Opposition front bench will not do it.
I doubt that Keynesian demand management ever lived up to its billing. But I am quite sure that it would be disastrous in an economy as open as ours.
It is not a good idea to borrow money from foreigners that we cannot afford to borrow, to spend it on buying goods that we cannot afford to buy from those same foreigners.
That sounds too likely to leave future generations in hock paying off the nation’s debts.
The Chancellor is right when he says the answer to too much borrowing cannot be more borrowing.
So when I talk about a growth policy, be clear that I am not talking about an exercise in Keynesian demand management.
But a policy for growth is at the heart of what I am speaking to today.
Apart from its obvious benefits to the welfare of the nation, growth is also essential to the deficit reduction policy.
This graph shows the effect of a persistent change in growth rates.
The effect is enormous.
But the impact of losing 1% growth for just one year worsens the deficit by almost three quarters of a percent of GDP for all time. Over £9bn a year.
If you have continuing poor growth you get the sort of figures you see here. And if you got the sort of result that Japan got, with a permanent 3% loss, you would be off the scale and could kiss any deficit reduction programme goodbye.
Those, by the way, are the numbers using the Office of Budget Responsibilities ready reckoner.
I think the dynamic effects are much fiercer in the medium term
Cutting the Public Sector
So growth is fundamental to the deficit reduction strategy, just as deficit reduction is fundamental to the growth strategy.
Indeed my only criticism of the deficit reduction policy is not that it is too fierce, but that if anything it is too little too late. My colleague John Redwood has expounded this better than I can on his blog over the last year.
It has suited both major political parties to exaggerate the ferocity of the cuts; Labour for domestic political reasons, and the Conservatives to keep the financial markets onside.
The raw truth is that we are still spending £125 billion more than we raise in taxes every year. And government spending amounts to just short of half the GDP.
Those who argue for a fiscal stimulus first have to explain why a fiscal stimulus of this size is not already making our economy grow.
So the chancellor is right to attempt to correct the fiscal imbalance. But of itself it is not enough.
The idea that the private sector would simply expand to fill the space vacated by the State was attractive, but in our over regulated, over burdened, over taxed economy it was simply never going to happen fast enough.
So we need to take strong action to spur that expansion of the private sector.
That action must liberate individuals and companies from the impediments that are undermining their confidence and limiting their freedom of action.
The simple truth is that the state is too large, too intrusive, too complex, too powerful and too expensive for the good that it does.
I am not a believer in a minimal state, but I am a believer in an optimal state, a state that can deliver the demands of their citizens without so burdening the whole nation so much that it cannot compete. We are far beyond that point.
In this drive to liberate the wealth creating and employment creating energies of our nation,
in this push to liberate the animal spirits that make any vigorous economy work, we should understand that incrementalism is not enough.
For our policies to work in the timetable available, they have to be simple enough to be understood by everybody.
Big and bold enough to seize the imagination of the would be entrepreneurs whose energies we want to galvanise.
And not just headline grabbing trivia of the kind that has bloated the Budgets of the past 15 years.
Focus of Concern: Small and Medium Sized Businesses
So where are we going to find the paragons of virtue to drive the recovery?
The natural instinct for politicians is to look at the biggest companies. The opening of a new factory or signing of a new contract on a Prime Ministerial foreign trip makes for the biggest headlines.
But the real action is in the 4.5 million small and medium sized companies that create the vast majority of employment in this country.
In my time working for a FTSE 100 company, we always increased the revenues and the profits.
Most of the time we were actually employing fewer people as a result of the permanent drive for efficiency.
Nothing wrong with that. It protects jobs, by improving competitiveness, it just does not create them.
The virtue of small businesses is they create jobs and wealth.
They are nimble and innovative. The problem is they are also much more fragile than the big companies.
When they succeed their growth rates are astronomical. But the very small ones can be killed off by a single employment tribunal case, or a single accounting error leapt on by a pig headed tax inspector.
It is not an accident that most insolvencies are precipitated by the Revenue.
Jump starting the economy will above all else involve liberating this sector to do what it does best, create jobs and wealth.
Regulation, Welfare and the Labour Market
The biggest growth killer in modern economies is regulation. Much of the most harmful regulation cripples the labour market, and it very often combines with perverse welfare rules.
Last week the Institute of Directors published a survey of over a thousand business leaders to see how they scored Government’s actions on competitiveness.
Reducing tax complexity minus 62%
Reducing business regulation minus 60%
Simplifying employment law minus 51%
And the Institute of Chartered Accountants own report shows that less than half of businesses thought the UK was “business-friendly”.
Amongst the vitally important medium-sized businesses, just over a third viewed the UK as a good place to do business, both figures significantly worse than the year before.
When the German government launched its growth strategy in 2003, the labour market was the centre of the reform program.
Special exemptions from employment law for small companies, easing of laws governing dismissals and redundancies, protection of companies from vexatious employee lawsuits, were combined with reform of the welfare system to improve incentives to work.
And it worked.
Similarly in Switzerland, it is easier to hire and fire than in Britain, and the welfare system encourages the work ethic rather more effectively than ours does.
I have had more than one constituency case where a company employing four or five people has shut down not as a result of going to an employment tribunal, but by the mere prospect of going to an employment tribunal. The result? Three or four people lost their jobs, without the rights or wrongs of the case ever being decided, simply to protect the rights of one person.
I am a believer in justice in the workplace.
We have got to decide what we prioritise – rights for the employed, or the right for the unemployed to have the best chance to find work.
Neither Switzerland or Germany are barbaric in their treatment of workers. They are both viewed as rather civilised. The German reforms were introduced by a Social Democratic government with strong union links.
Britain must learn from these success stories.
We need to transform our labour market to make it more employment friendly, particularly for smaller companies in the critical employment creation band of 5 to 500 employees.
Hand in hand with labour market reform must go policies which give people an incentive to work.
Iain Duncan Smith’s welfare reforms are a clear step in the right direction, making benefits fairer and making work pay by ensuring that jobless households cannot take home more than the average working household earns.
But Iain’s reforms to make people want to work must be matched by labour law reforms that mean they are able to work.
There is no reason why we cannot replicate the German Agenda 2010, which freed up the labour market, cut bureaucracy for small business and increased incentives to work.
In effect we need a bonfire of regulations.
Starting with employment law.
After over regulation, over taxation is the biggest enemy of growth and the biggest killer of jobs.
Yet since 2010, inherited tax hikes from the Labour government and front-loaded tax increases from the deficit reduction plan have squeezed the private sector.
We’ve seen the continuation of a higher band of additional income tax.
An increase in employers’ National Insurance Contributions – a tax on jobs.
A VAT hike from 17.5% to 20%.
Increases in stamp duty, fuel duty and air passenger duty.
A country cannot tax its way to prosperity.
Income taxes, employment taxes, capital taxes, sales taxes, are all too high and too complex.
We need to cut taxes and we need to take a sharp knife to the Gordian Knot of the British Tax Code.
Keynes once said that practical men are usually the slaves of some long dead economist. The modern equivalent is that practical politicians are often the slaves of long dead sound bites.
The Chancellor at one stage became very fond of using the phrase “no unfunded tax cuts”.
It sounds terribly responsible, is no doubt intended to impress the financial markets, but it is of course meaningless.
Taxes are not like double entry bookkeeping, with a change in one column leading inexorably to an identical change in another column.
Whenever you increase a tax rate you can be sure that you will collect less tax than you expect.
Why? Because people will do less of the activity that you are taxing, be it working, employing people, investing, saving or spending.
So you get less tax.
They will also expend more effort in avoiding your tax, and in some cases evading it.
So you get even less tax.
And finally the effect of high taxes is to bend the decision making mechanisms in the economy out of shape, making the whole economy work less well.
So you get even less tax again.
And the harm you do is much greater than you think. Not for nothing is the power to tax called the power to destroy.
The corollary is that when you lower taxes you still raise more than you expected. And far, far more often than you think, when you cut tax rates, you actually increase the tax take.
This happened most spectacularly when Lawson cut the top rate of tax, and dramatically increased the tax raised from top rate taxpayers, but it also happens across the whole economy when tax rates are cut.
So what should we do about it?
Let’s start with the easy part – there must be no new taxes. Yes, I’m talking to you, Mr Clegg.
You have to make a decision, you either punish the rich or you harness their energy, their talent and their resources to benefit all of society. We cannot do both.
Punishing the rich is politically profitable but can be economically disastrous.
I yield to no one in my wish to see the least well off in British society have the best chances, best opportunities and the best public services to support them.
Abraham Lincoln once said “you can’t make the poor rich by making the rich poor.”
We should also cut or eliminate those taxes that deter all that we want to encourage.
Income tax, which drives wealth creators away.
Employers national insurance, which prevents entrepreneurs creating new jobs.
Capital gains tax which discourages savings and which skews investment decisions.
And we should scrap the policies that impose marginal tax rates of over 60% on middle and low income families.
But these are just stepping stones.
The government needs a coherent long term strategy for a genuinely lower flatter tax.
There is no need to reinvent the wheel here.
There was a brilliant exposition of what is necessary published by the Tax Payers Alliance only a few months ago.
This strategy would eliminate the vast complexity of our tax, destroying the chance of tax evasion as well as reducing the problems the government are currently having with avoidance.
Most critically it would cut down the economic distortions and the handicaps to growth that that creates.
It will take 10 years to deliver but we should start now.
The result of this tax cutting and simplification strategy will be to raise money not to lose it.
Look back at that deficit chart, at what happens when we unleash the ability of the economy to grow.
The whole system turns into a virtuous circle. And that is why low tax Switzerland is going to run a surplus this year.
Our energy policies have also become the enemy of competitiveness and growth.
In July of this year a government report warned that, by the end of the decade, UK green taxes will be double the EU average and dozens of times higher than in the US.
Costs for consumers have been pushed skywards by misguided energy policies like huge subsidies for unreliable, ineffective and uncompetitive renewable technologies.
But for British business, the worst is yet to come.
In April 2013, the Government will introduce a carbon price floor, a levy on every tonne of carbon emitted.
For Britain’s energy intensive industries, which employ 600,000 workers and contribute £50 billion a year to our economy, this will be hugely damaging.
For these companies energy is always a major part of their expense and sometimes a majority of their costs.
According to the Government’s own figures, energy intensive businesses – like steel and ceramics producers – could see electricity costs rise by up to 52% by 2020.
Worse still, the carbon price floor is a unilateral measure – a green tax that British businesses will have to bear, and that other EU businesses will avoid.
Last year Tata Steel slashed 1500 UK jobs and Rio Tinto another 500.
Both blamed excessive green taxes for rising costs.
To add insult to injury, the carbon price floor will not even bring any environmental benefits. Every tonne of carbon priced out of the UK will be emitted more cheaply elsewhere in the world.
And let us be clear we are not just talking about exporting our industry to Shanghai or Mumbai but to Frankfurt, Rotterdam, Milan and Marseille.
Global emissions will not be reduced; just outsourced.
This is both environmental madness and economic suicide.
If we believe this is a global problem there is no policy sense whatsoever in choosing to sacrifice British jobs just so that the same pollution is emitted somewhere else in the world.
If we want low carbon power then we should certainly accelerate plans for next generation nuclear power stations.
In the meantime we should scrap green policies which inflate business’ energy costs today, and drop plans for new policies which could do so tomorrow.
Most immediately the carbon price we start in 2013.
In future environmental policy should be screened to ensure that it actually reduces global pollution rather than simply move it around the world.
If it cannot pass that test it should not make it into law.
Germany is one of the greenest of countries – often hailed by environmental activists as an example for Britain to follow – and even it exempts energy-intensive industry from 98.5% of the renewables tax paid by other businesses.
We should do no less.
In hard times, many a government has spent money it does not have on infrastructure projects it does not need.
Japan has spent trillions since 1990 on projects including an art museum with no paintings, an airport so empty it offers passengers money to use it, and a $70 million bridge to an almost deserted island.
At its peak, Japan spent more per year on public infrastructure than was spent building the entire Panama Canal.
And as you can see from the graph, it did not work.
We should be incredibly cautious about embarking on large taxpayer-funded infrastructure projects.
But there is a non-Keynesian, market based rationale for infrastructure investment during recession.
Whether we like it or not, large parts of our infrastructure are either provided by the state or by massively dominant monopolies that exist hand in glove with state regulators.
During recession the state can take advantage of the fact that capital investment can be done cheaply. However, this perspective demands that public infrastructure projects meet three requirements.
First, they must be short-term projects completed during the period of economic difficulty.
Second, each project must be designed to deliver a major, long-term economic boost.
Third, where possible these projects should be done at arm’s length from the state: facilitated rather than executed by government.
The Government’s flagship infrastructure scheme, High Speed 2, fails all these tests.
A £30 billion, 25 year long prestige project is precisely the sort of white elephant we must avoid.
To make infrastructure spending work for taxpayers in a recession, the money should be spent on smaller projects with a quicker return.
On the railways, that means improving existing lines, clearing bottlenecks, and building more conventional lines in congested areas.
And if you really want to give Britain a competitive advantage, then perhaps we should focus on a modern technology that has been handicapped by the lack of a real competitive market in its provision, namely our digital infrastructure.
With tiny fraction of what we would spend on HS2, we could create a broadband network which puts Britain ahead of the world in its digital infrastructure.
By 2013 South Korea will have one Gigabit broadband direct to every home – ten times the speed of the most ambitious British plans.
As it stands only 0.2% of UK households have a super-fast broadband connection.
Similar arguments could be used for unclogging the choke points on our roads, again with significant more private sector involvement.
The government has been thinking out loud about that. I would suggest that they stop musing and start acting, because if it is ever necessary, it is necessary now.
As for airports, well I will leave that to Boris.
But let us be clear, spending money that we don’t have for its own sake is a bad idea, sometimes promoted by businessmen with a vested interest of their own.
If the project does not stand up on its own economic benefits it should not happen.
One of the continual refrains from small and medium sized business is the shortage of finance to allow them to expand, or even continue operations. I have some sympathy with this complaint.
Whilst it is undoubtedly true that some of the drop in bank lending to business has been as a result of reduction in demand, much of it is a structural defect in the banking system itself.
There is a quandary, of course. In the current climate, lending to small business is risky. We do not want our banks to lose money and put themselves, and thence the whole economy, at risk.
How do you increase the lending, without increasing the risk?
The trite answer is, make better judgements.
Those used to be the sort of trading judgements that British bankers were brilliant at.
They still are, when it comes to the huge businesses that have been floated on the London Stock Exchange in the last couple of decades.
The financial skills of the City of London are still there.
Or at least they are for the big decisions.
The problem is that we have lost those skills for the hundreds of thousands of lending decisions that need to be taken up and down our country every month, the decisions that decide the future of our entire SME sector, and hence decide the employment prospects of large parts of our population.
Some decades ago those decisions were taken by the managers of local banks.
Some years ago I coined the expression Captain Mainwaring banking. It may be dull but it is incredibly useful.
When a young man or woman came to them for business finance, the bank manager would bring a lot of knowledge to bear.
Of course they would know the numbers. But they would also often know the individual’s reputation. They would know his character, his energy, his determination, his thriftiness, his imagination.
If it was a local business, they might know the market, the competition, the prospective customers.
Today, most of those local banks do not exist.
The massive concentration of market share in the big banks led inevitably to a massive centralisation and “rationalisation” of branch networks.
In many small towns the local banks have been replaced by ATMs.
Those once local commercial decisions are now made hundreds of miles away, on nothing more than a business plan, probably written by some local government agency.
As a result, they base a major part of the lending decision on the collateral available, and little else. That is why over 80% of small business lending is essentially a secured property loan. It looks safe from an office in Leeds and London.
But as the Spaniards have demonstrated, this approach is anything but risk free.
And it does not do the fundamental job of banking in a modern economy, funding the working capital, and reinforcing and scaling up the successes of the small business sector.
The answer to this problem is radical but it is not fast. And it is not, by the way, a whole new slew of ineffective regulations.
It is structural, not regulatory.
We need to make it easier not harder to start a new bank.
We need to tear down the barriers to entry in banking, and reverse the policy of the last decade which has effectively excluded banking from competition law, in a sad misunderstanding of the role of the financial sector in the modern state.
Not so much Glass Steagall, as Glass Steagall squared.
These ideas are illustrative rather than prescriptive, or indeed exhaustive.
What is fundamentally important is that we attack the problem of low growth in the British economy before once again our nation gets used to the idea of perpetualdecline.
Whilst the actions necessary will prove painful in the short term, the longer we wait before we start, the harder the task becomes.
It was the indecisive decade of the 70’s that made the early 80’s so traumatic.
Precisely because our economy is bumping along the bottom, to shock it into activity, the government needs to be strategically bold with radical reforms such as
excluding small businesses from large amounts of regulation,
cutting taxes; most importantly the employment killers like Capital Gains Tax, employers National Insurance and corporation tax,
abandoning the carbon price floor
and radical reform of our domestic banking system.
More than this the government should layout a long term vision of a tax and regulatory structure which will encourage enterprise and favour employment creation in the private sector.
It should make clear to the people of Britain that there is a competitive future.
We believe that Britain can compete in the global markets of tomorrow, if the government is willing to liberate Britain’s energy, enterprise and creative genius.
There is one final political consideration.
Conventional wisdom has it that supply side reforms take two years or more to work, meaning a government would suffer political pain today and lose the election tomorrow, handing the benefits to a successor.
Indeed the opponents of these ideas would reasonably point out the number of governments that have lost power in the last few years whilst struggling with these problems, and that Gerhard Schroder lost office after starting his reforms.
Put to one side that the national interest should pre-empt political interest. Perhaps that is too idealistic a view for modern politics.
In my view the conventional wisdom is just plain wrong.
In most of those cases the electorate sacked their governments because they thought that those governments were simply cleaning up a mess of their own making.
In Britain it is still just apparent that these painful proposals are necessary because of the predecessor government.
I believe that the electorate would decide, as they did with Mrs Thatcher, that this government was simply administering a necessary medicine as a result of what they inherited.
The British electorate are a lot smarter than their leaders sometimes give them credit for!
We are not quite out of time. But it is the eleventh hour, if not yet the 59th minute. The Chancellor is a clever and resourceful man. He should take the opportunity of the Autumn Statement in a few weeks time, and lay out a plan to reinvigorate Britain.
A plan that offers the prospect of growth, not just austerity.
A plan that will put Britain and its citizens on a path to greater competitiveness, and hence more job opportunities, better pay, lower taxes, more effective public services.
Thirty years ago we demonstrated to the world that this was possible.
Now other countries like Switzerland and Germany, and those further afield such as Australia, are showing us that it can still be done
It is said amongst Westminster glitterati that Number 10 and Number 11 Downing Street both retain an admiration for Tony Blair as Prime Minister.
It may be true, or it may be one of those urban myths that infest Westminster.
If it is true, I have one, and only one, quote from him that I would commend to them at this moment in time.
It is – “we are at our best, when we are at our boldest.”
If we must learn a lesson from Blair, let it be that one.