Howard Flight is a former Shadow Chief Secretary to the Treasury and chairman of Flight & Partners Recovery Fund. He is the
author of the recent Centre for Policy Studies publication, From Boom
to Bust: a plain guide to the causes and implications of the banking
crisis. During the 2001-2005 Parliament Howard was one of the few people warning of the dangers of both the excessive increase in public spending and in consumer and mortgage borrowing and house prices. He also organised the James Review to cut out waste in public spending, many of whose savings Gordon Brown is now ironically intending to implement.
As the dust settles – or rather the debris starts to fall – a few major points are becoming clearer.
The first is that there is little the Government can do to sustain the economy on the tax front. The increase in the public sector deficit anyway over the next 2 years threatens the credit worthiness of the UK and will require tax increases in the future which, unless the bloated public sector is addressed, risks stifling economic recovery thereafter. Equally, it is apparent that tax stimulants are unlikely to have much effect.
The Government’s 2.5% reduction in VAT will do nothing more than alleviate the profitability and cash flow of retailers. If the inevitable reduction in consumption spending is to be slowed down a bit, this will be the result of retailers slashing prices by 20%. The main infrastructure investments which would make ‘double sense’ requiring legislation to cut through the planning delays, would be the necessary building of new nuclear power stations – but here, the financing would come from the private sector.
By contrast, there continues to be a failure of monetary policy. Slashing the Bank of England’s bank rate has limited effect if it cannot be translated into lower lending rates. To the extent banks need to finance themselves from the wholesale money markets – particularly to increase lending – it is the Libor rate that matters – the rate of interest at which banks borrow in the wholesale market, which remains well above bank rate.
Here lies the fundamental problem, the velocity of circulation of money
– the V of the MV which defines money supply – has fallen dramatically
as the result of the freeze up in inter-bank markets over the last
year, serving to reduce money supply even where the M element – however
defined, the stock of money – has increased.
Because of the continuing uncertain position of many banks, the banks
with cash surpluses are depositing these with the Bank of England: the
Bank of England, in turn, is not recycling these effectively into the
money markets. This has also been encouraged by the recent, wrong,
decision to pay interest on deposits with the Bank of England. Rather,
as did the Swiss central bank several years ago, it may become
appropriate for the Bank of England to charge negative interest on bank
deposits placed with it to encourage banks with cash surpluses to lend
these to other banks.
What has been needed for some time is a crisis management strategy by
the Bank of England to end or at least reduce the freeze up in
interbank markets. The necessary measures need to be taken which will
result in banks with cash surpluses lending them to other banks and for
periods of longer than overnight; and the Bank of England needs the
necessary Government guarantees to itself lend more readily into the
interbank market. There is not much point in reducing bank rate
further until these issues are addressed.
The second big point – and the disaster of Brown’s stewardship of the
UK economy over the last 7 years – is that if both citizens (consumers)
and the Government have borrowed too much, the painful economic
consequences of de-gearing cannot be avoided. People who criticised
Italy for the level of its Government borrowing, but Italian consumers
and the private sector in Italy are in major savings’ surplus.
In simple terms, you can have high levels of borrowing in the private
sector matched by healthy surpluses in the public sector, or vice
versa, but not high levels of borrowing at the same time by both.
Brown should have realised after 2001 that by encouraging consumer
borrowing to keep up economic growth, it would end in tears if at the
same time major increases in public spending pushed the public finances
into significant deficit.
Brown’s attempt to pretend that our problems are caused by overseas
factors is yet another of his attempted “cons”. While the Conservative
Party needs to focus on what measures are practical, affordable and
would work to alleviate the recession, we must get across to the
country that it has been Brown’s irresponsible and gross mismanagement
of the economy since 2001 which has largely caused the mess we are now
Here, the main mistake was a profligate increase in public spending
from 37% to 43% of national income – largely for political reasons –
and achieving little or nothing in terms of increased outcome and
reducing productivity in the public sector. The continuing squeeze on
the private sector, largely via stealth taxes led inevitably to
citizens borrowing more to keep up their standards of living – driving
down the savings rate to minus 1%. Now the bubble has burst a recovery
in the savings rate and economically, painful de-gearing in the private
sector are inevitable.
To return, full circle, there is a case for a major reduction in
Government spending now, but with all of the savings passed on to the
private sector via tax reductions. Citizens may use the money more
effectively than Government.
Others have reported the figures previously, highlighting the extent to
which the increase of one million people employed in the public sector
and the massive increase in the numbers of people receiving some form
of Brown introduced Government tax credits have constituted a ploy to
buy votes. This is where most of the higher spending has gone. But
Brown’s political ploy here has blown up on him as the consequences of
his mismanagement will cost many people their jobs.
In both a political and economic context the conclusion for an incoming
Conservative Government is clear. There will need to be a radical
reform of the public sector and public sector spending. The UK cannot
afford large pockets of welfare dependent citizens, harmful to their
real interests; the public sector is bloated with unnecessary
politically correct and highly paid officers who add nothing to the
national income. Local Government, too often, continues to operate in
a wasteful and inefficient fashion. There will be the urgent need to
release major resources from the public sector to the more productive
private sector, where high-tech and value added manufacturing now has a
great opportunity, worldwide, as the result of a cheaper pound.
As citizens are now realising, they have been deluded by Gordon Brown
that they can “have their cake and eat it”. People also now understand
that there has to be radical change for the UK economy to recover and
to be viable going forward.