The biggest risk to the economy is not government cuts, says John Redwood, but lack of credit. There’s plenty ministers can do to get companies, and people, borrowing again
This time it is different. Normally the UK economy bounces back from a downturn, and we have several years of rising prosperity. Today there are many experts who fear another downturn hard on the heels of the big recession we have just lived through. I welcome the government’s decision this week to write about the funding gap for business, and to float ideas including more banking competition. They will need to move quickly and purposefully from consultation to remedies to fuel the recovery.
To understand why some peddle fears of another fall in output — a ‘double dip’ — we need to know why we are here. People in the UK are used to rising living standards. Both Margaret Thatcher and Tony Blair presided over a decade of higher average incomes. Each allowed or encouraged a rise of a bit more than one quarter in our national income per head. John Major did his bit with a 13 per cent rise over seven years. Only Gordon Brown stands in the record book as presiding over a decline, of more than 5 per cent.
Both Margaret Thatcher’s and John Major’s period in power started with downturns. Margaret Thatcher’s was inherited from Labour’s excess spending, inflating and borrowing in the 1970s. John Major’s came from membership of a European currency system which went wrong, which he himself had signed up for as Chancellor. Recovery from each was quite swift and sustained, leading to those overall solid advances in most people’s spending power.
The pattern was the same in 1981 and 1991. Cut public spending, curb state borrowing and allow enough money to circulate in the private sector to pick up the slack. It worked, with many new jobs coming as companies expanded. Cutting public borrowing allowed the authorities to keep interest rates sufficiently low to foster credit for worthwhile investments. Each time we were told that cutting public spending would stifle recovery: each time the critics were wrong.
The growth in income and spending which we enjoyed in the years prior to 2008 was fool’s gold, based on excess borrowing. It was fun while you could spend, but then the bill came in for the interest charges and the repayments. You might feel sorry for Gordon Brown taking over at the peak of the boom and having to wrestle with the inherited debts, if he hadn’t been Chancellor at the time. As it was he reaped what he sowed.
There was too much debt in three main areas. The government borrowed too much to spend it foolishly. While we needed and got some extra nurses, teachers and doctors, more of the money went on administrators, regulators, large pay and pensions awards, IT projects and endless glossy brochures. Lots of new projects were bought on the never never, called public/private partnerships. As the Conservatives endlessly jibed, Gordon Brown did not mend the roof when the sun was shining. Instead of reining in borrowing as the tax revenue grew and grew, he just kept borrowing more.
Some individuals and companies borrowed too much in the private sector. Too many took out large mortgages on homes which were already expensively valued. The venture capital industry required their companies to borrow on a huge scale, while many investment funds also joined in the borrowing binge.
Above all, the banks went on their own borrowing bonanza to finance all the rest. The government’s regulators allowed banks to lend more and more in more and more exotic ways. Some large banks had 35 times as much at risk as their share capital and retained profits, compared to the more normal 20 times of the prudent 1980s and 1990s. The Bank of England stoked the fires of debt and inflation by keeping interest rates too low for too long.
This time round we still need new lending to the people and companies who did not overdo it before. We need money loaned to those with good ideas for new projects and new jobs. The paradox is that you need to let some people borrow more — to help correct the excesses of the past. That way you generate more tax revenue and more business profit from the extra activity. The government are right to see that they need to rein in public spending and cut the rate of extra borrowing. That is essential to free resources for private sector recovery, to avoid more upward pressure on interest rates, and to obtain the efficiency improvements in the public sector we are used to in the private sector. It is above all necessary to avoid a worse crisis. We are close to national embarrassment by the scale of our collective debt. We do not wish to go the way of Greece or Ireland, forced by the world’s money lenders into larger public spending cuts as they decline to lend the state more money on reasonable terms.
For the strategy to work there needs to be a steady flow of new bank credit to the private sector to pick up the slack. We need new power stations, new roads, new railways, more fuel efficient homes and vehicles. Most of this investment has to be made with private money. We need to make more of the things we currently import. That requires more investment in factories, stocks and products.
The current state of the banks makes it less likely. British banks have cut their lending to UK business by a massive £60 billion between January 2009 and May 2010. RBS and Lloyds, partially state-owned, have been sent on a mission to rebuild their balance sheets — which means lending less than they would normally. The growth of money in the economy has been subdued, going up by less than inflation. M4, a much-ignored indicator of money supply, rose by just 3 per cent in the year to June. Lending to business is in freefall.
So what needs to be done to see off a double dip? The government needs to tell its regulators the banks are now strong enough. There is no need for the large banks to cut their lending down any more. They do have sufficient cash and capital to be able to turn their minds to lending more for decent projects and worthwhile businesses.
One way to help British banking is for the government to sell off some of the banking brands and banks which it owns. The banks could raise extra money in the process, so they have more to lend. Ministers can also help the private sector create the two million extra jobs we need to make a go of this by cutting out more regulatory cost through Nick Clegg’s Freedom Bill. Future budgets can be used to cut the tax burden on savers, investors and companies.
We must remember that it’s a highly competitive world out there. The Asian competition is working harder and smarter with every month that passes. The UK needs better infrastructure, more skilled people and a better climate for business. Government can make a difference in all those areas. Asia will end up eating our lunch if we do not understand soon that we cannot go on borrowing to pay for it. We have to invest and work as hard as they do to earn it.
The debate between those who favour a fiscal stimulus and those who favour a monetary one is easily answered. Fiscal stimulus means spending and borrowing more in the state sector. It has not worked in the past and is not a wise course now. Even Labour admits we need to be cutting the deficit, not increasing it. Past recoveries have started with spending cuts.
You do need some growth in money and credit to finance productive investment to get the economy moving again. We cannot and must not repeat the credit excesses of the state, property and banking sectors of 2006-07. There is a danger credit and money growth stays too low, and too little is available for business expansion. That’s why the government has to fix the banks to foil the double dip — what I read they are now planning to do.
John Redwood is Conservative MP for Wokingham and chairman of the Conservative Economic Affairs Committee.
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