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French intellectuals agonise about national identity. Mundane British counterparts preferred to worry about our ailing economy, a pessimism more debilitating than the French because it’s a phallic failure not an anxiety: the once workshop of the world can`t make it. Yet today while French anxieties remain obsessive ours are gone. Prophets of economic doom are silent just as Britain is embarked on a series of economic gambles instead of attempting to build long-term economic strength as doomsters urged.
British economic pessimism has a long tradition. In the fifties Michael Shanks denounced the Stagnant Society, Andrew Schonfield its overvalued, imperial, currency. By the sixties we were deemed a failure with unions out of control, management incompetent, Britain ungovernable and Common Market membership proffered as the answer. It wasn’t. So the seventies brought the Ice Age, the eighties de-industrialisation, and by the nineties Finance was taking the helm with attendant instabilities, speculation, and credit bubbles. The City ruled: Not OK.
New Century New Dawn. Spectres are now banished from what’s proclaimed as a feast: a Golden Age, a Goldilocks Economy. Gordon Brown proclaims the triumph of prudence, though past problems are still with us compounded by the fact that we are living beyond our means in an economy run on gambling as a system of management. Britain is claimed to be leading the world to a new economy. No-one asks whether it’s a new future, or a bigger bubble inflated by debt and speculation.
The wealth of the nation has grown, its acquisitiveness even faster, but the productive base has not. A nation’s productive economy provides jobs, generates growth, pays the country’s way and boosts its living standards. To do all that successfully it must be competitive, a condition determined in the long term by productivity, scale, power, competitive and comparative advantage, but in the short by the exchange rate which translates domestic costs into prices on foreign markets, thus determining the success or failure of exports and imports. In The Economic Consequences of Mr. Churchill, Keynes described the disastrous consequences of Britain’s 1924 return to the Gold Standard at an overvalued exchange rate. We are now back in the same trap with an overvalued pound the instrument of economic management to please the same financial interests which once worshipped at the shrine of gold.
Nations which built or rebuilt powerful industrial bases post-war, from Germany to China, all started with a low exchange rate, boosting exports and penalising imports, to build powerful internationally traded sectors. All insisted on keeping that competitive edge despite persistent American pressure to revalue. Britain, on the other hand, started with a high exchange rate, devalued at long intervals, the last in 1992 when we were forced out of the ERM. Since then the pound has risen steadily to an unprecedented overvaluation. This is the result of oil, the homeward flow of dividends and profits from overseas investments and “confidence”, but it is also due to interest rates higher than anyone else’s. In the last decade these have been the consequence of Labour’s decision to hand control of interest rates to the Bank of England, the embodiment of the powerful financial interest which now dominates Britain’s economy. We have elevated the money lenders to the highest position in the land
Geoff Mulgan accuses Labour of being entranced by Cobbett`s “Thing” aka, the Establishment. We have certainly loved wealth and the wealthy and been excessively deferential to the interests of both but the more basic problem has been our subservience to a “Finance Thing” which is lopsidedly powerful. To win its confidence we made a Bank of England we’d nationalised in 1945 independent and gave it control of the basic levers of management, interest rates and the exchange rate influenced by them. Finance wants a high and stable exchange rate, the better to acquire assets overseas, and dear money sustained by high interest rates, the nation’s tribute to Finance. So overvaluation was institutionalised. The high pound became the crucial weapon against inflation by making imports cheap and forcing domestic producers to squeeze costs and labour, in a doomed effort to stay competitive.
A high pound pleases Finance and the City and keeps the electorate happy but is disastrous for manufacturing and domestic production, both already hard hit by the Thatcher deflation. In the 1970s many looked forward to oil wealth as an opportunity to invest and restructure as Norway did. In fact the Tories used it to underpin an orgy of destruction, closing huge swathes of production with no attempt to upgrade or move upmarket as economic sense might prescribe. This destroyed industrial networks, dissipated skills and experience, and undermined the industrial culture and its sustaining webs of training, suppliers, research, marketing and connectivity.
Instead of investing and upgrading British producers sacrificed jobs, training, investment and every weapon of success just to survive. All too many packed up and died, a sensible decision when sites and assets got a better return in the property boom than the dirty business of producing and selling things. A Thatcherite outward bound course, supposed to make manufacturing lean, hungry and competitive, did the opposite. It was followed not by a period of recuperation to allow industry to invest and rebuild for manufacturing’s brief, bright opportunity when Britain left the ERM, was quickly eroded by the remorseless rise of the pound. That forced our enfeebled manufacturing to run its competitive race with a ball and chain as well as crutches.
Nevertheless Labour came in in 1997 to a great opportunity. The competitive boost from the 1992 devaluation was still there. A leaner business sector where the power of labour had been broken and inflation was low, had better prospects in an expanding world economy. Labour needed rapid economic growth to catch up lost ground, raise living standards and generate a surplus for a big boost to public spending. Manufacturing could have provided much of this, being quick to grow and recover, once given real competitiveness, and able to generate higher productivity gains than any other sector. An economy run for growth moves into a virtuous cycle of compounding growth, leading to new investment and improving productivity which grows with production. Tinkering with the tax system to bribe or push people into jobs or subsidise low pay is no substitute for a broad demand for workers and the sucking in of investment which come from running a competitive economy at full throttle.
That opportunity was thrown away. Growth required cheap money, a competitive exchange rate, a big boost to demand and higher government spending. Together all this would have boosted productivity, the best way to defeat inflation, rebooted the production base, and sucked investment into it because it was profitable. Instead, lacking confidence and any understanding of the role of the exchange rate, Labour, in awe of Finance, opted for “stability”, always the preference of Finance, and low growth, always less disruptive than fast.
The first great gamble was to rely on Finance, a friend neither of Labour nor the manufacturing base. It’s dominance meant an under-run economy, an invented “golden rule” on public borrowing to keep it low, the effective privatisation of both credit and demand management leading to a credit boom but public spending below levels in European economies, and making “fighting inflation” (by now a dead enemy) the top, and for the Bank only, priority. With the Bank controlling interest rates and the exchange rate they conditioned, dear money and interest rates around double the level best for growth were institutionalised. The consequence was a high and rising pound. Funny money flows got a rich return in London.
Public spending went up but not enough. It was concentrated on Education and Health so the pressing problems in Transport, Local Government and Housing (where a failure of supply helped generate the price spiral) weren’t tackled. Wealth accumulated. Production decayed. Manufacturing lost another million or more jobs, shrinking from a fifth of the economy to 12%. Britain was no longer able to pay its way in the world because a nation of producers became a clamour of consumers. Indeed we are now up with the world only in pharmaceuticals, perhaps chemicals, and an arms industry dependent on dirty deals.
The resulting balance of payments problem is less crucial with floating exchange rates than in the sixties when it was obsessive because of its threat to the exchange rate. International finance sustains massive deficits in America and Britain. Yet no nation can live beyond its means forever. Ultimately markets must bring the exchange rate down and stop the wastrel’s progress and newly dominant Finance can neither provide jobs on the necessary scale (342,000 in the Square Mile and Canary Wharf) nor pay the nation’s way. Indeed a flabby, overpaid, City is losing share of the world’s financial services market, just as manufacturing had done.
“No worries” said new thinkers who don’t live in the real world. But living on air is not a viable future if none of the alternatives to manufacturing can pay the rent and the trade deficit gapes. Until l982 the workshop of the world hadn’t had a trade deficit in manufacturing. By 2006 it was £60 billion, 4% of GNP, nearer 6% in 2007 and rising.
This deficit is the second gamble. It is financed by hot money, by turning London into a tax haven for the super-wealthy, and by a super-sale of British assets: property, utilities, companies, shares, land and football clubs, in an open take-over market where everything is for sale to anyone. This is billed as pure benefit, even a testimony to success, as Britain attracts more inward investment than any other country. In fact it is a testimony to the failure of domestic investment. Its long term consequence must be that profits are exported, along with research and design, that parts are imported, that big firms, like ICI, no longer serve the national interest and that when industries face difficulties, as volume car production is, British jobs are more likely to go. Workers at Ford and Peugeot can testify to the risk.
These risks are compounded by a change in company dynamics. Great British companies like ICI, BP, Unilever, Courtaulds or Barclays, once took pride in scale, export achievements, the loyalty and skills of their workers and in being national champions. Today`s biggest companies focus on financial engineering more than production becoming shells run by, and for, a financially motivated elite who use profit hype, creative accountancy and burden shedding to boost return to shareholders and, through share options, their own incomes. Profits are a more important test than power or performance and can be readily boosted by outsourcing, shedding obligations, from pension provision to training and safety (BP), and by reducing the social rent companies pay in taxes by channelling finance through tax havens (most of them British dependencies) via trusts and complex networks of subsidiaries. Financial engineering has replaced real engineering as a central company preoccupation.
All this boosts profits and enriches top management but weakens the nation and the company’s ability to sustain or contribute to it. Companies become more footloose (big British companies, such as Barclays, BP and Shell have even threatened to move HQs elsewhere). They are more vulnerable to takeover by foreign competitors or Private Equity vultures moving in to boost returns, by slimming down (a.k.a. asset stripping) firing and selling off assets like scrap dealers. The company sector becomes less effective as national provider and Britain more peripheral, in a globalised production system.
Unlike President Sarkozy and many US Democrats, our leaders assure us that globalisation is wholly beneficial. They may be right if the economy were a powerful producer, but because we are not that, openness becomes another gamble and immigration a source of cheap labour. As long as Britain has a booming consumer market it will be attractive to foreign investment, but in the long run those who don’t produce can be relegated, becoming an irrelevant periphery, supplied from the EU, with little to offer big multinationals who from Singer onwards have come here to supply a rich domestic and imperial market.
Instead of rebuilding a strong national economy to provide for its people, Britain has been offered up to foreign producers like a business Wimbledon: good court to play on, well situated in the time zones, with glittering prizes (in easy profits) but no British champions. Selling off family silver has been wonderful business for a City earning fat fees from the sale of British companies and assets, while soft regulation attracted funny money and curious companies. While the money flowed in, Finance, ever more interested in the world than in Britain, took the opportunity of the overvalued exchange rate to buy up foreign assets. This helped push the pound up because British investments overseas produced higher returns than foreign investment here. The City interpreted this as a testimony to its investment skills though it was really due to overvaluation which made it less profitable to produce in Britain. Either way Britain was becoming a rentier economy run like an international hedge fund with all the risks inherent in the genre. Yet another gamble.
Far from being a powerful productive sector taking on the world and winning for Britain, British enterprise retreated into a business welfare state created by Labour, there to be propped up by the state through privatisations, PFI and PPP contracts (often sold on for profit), by outsourcing of public services, by subsidy to low wages via tax credits, and by a lucrative consultancy market charging billions to advise a government which lost faith in its public service. The Fat Four Accountancy houses in their shimmering monoliths replaced the Dark Satanic Mills as Britain’s front line, though unlike the mill owners they are headquartered in tax havens and provide far fewer jobs. Leaching on the public sector, and globalisation are both interpreted as benefits but both make our increasingly dependant economy reliant on the whims of wealth and the fickleness of funny money. Finance, always the great generator of instability, is far freer and less regulated than in the US. The great increase in financial manipulation and inventive practices has been largely uncontrolled.
Ministers who proclaim their faith in markets never allow for the possibility that markets will bring down a pound which has remained high, indeed, higher than the “Black Wednesday” level which produced the 1992 crisis. Rather they argue that the high pound is an indication of confidence in them. It certainly pleases both the City and the Electorate, who get cheap imports, holidays and villas abroad. Yet it can’t be sustained if the shrinking production base cann’t pay the nation’s way and the pound must to come down if that base is to expand.
This points another gamble. If (or rather, when) markets bring the pound down (as the dollar is falling) Bank of England Independence could be a Doomsday Machine. Bankers assume that any fall in the exchange rate is an inflationary threat to be countered by an increase in interest rates. Not true for previous devaluations, in 1949, 1967 and 1992, all of which boosted the economy without substantial inflationary consequences, just as the falling dollar is boosting American production now. Yet the folk wisdom of bankers ignores reality and a stream of lugubrious warnings from our inflation hawk Governor make it clear that the fear of inflation is obsessive. So the Bank is likely to resist any fall with higher rates, rather than the benign neglect of the Fed.
Though Britain blithely defied all the rules of building national strength, the economy still grew, unemployment fell and Gordon Brown certainly did a better job than any predecessor with growth every quarter. Neither the growth nor the unemployment level were as good as the best post-war years but both looked better than competitors, mainly because Europe’s performance was so bad. Yet these successes conceal another gamble: Where will the jobs come from now?
Originally they came because we inherited the growth from the 1992 devaluation, boosted further by employment in the public sector, financed by higher public spending and by the growth of the consumption and service economy, stimulated by the consumer boom. Headlines in Northern towns told the story. Laments for hundreds of jobs lost in manufacturing were usually followed by announcements of new jobs in call centres or supermarkets: at lower pay rates. Later came the loss of call centre jobs to Bangalore.
The surge in consumption which produced the consumer jobs in restaurants and shops was stimulated by the credit explosion. Borrowing soared, underpinned by house price inflation. Loose credit and the steady increase in the number of households, coupled with lavish City bonuses and the influx of the wealthy claiming tax haven status all boosted demand for houses at a time when build, both private and public, was at its lowest levels since the l920s. There was no spending to spare for public rented housing, and too much of that was directed to financing purchase schemes for large scale “voluntary” transfers to the private sector to increasingly unaffordable “affordable” housing and to Pathfinder renewal schemes. This failure of housing supply contributed to the house price spiral, which, even though house prices are not part of its inflation rubric, obsesses the Bank of England, so it punishes manufacturing by higher interest rates to check an asset inflation government itself has created.
Now the two drivers which have boosted the economy so far, public spending and consumer demand, are weakening. Public spending has plateaued and consumers are mired in debt. A housing drive could replace them but would have to be big and publicly financed because the great need now is for public rented housing for the increasing proportion who can`t get on the ladder. Even then it does not obviate the risk that the housing price boom can easily turn sour. OECD studies indicate that soft landings in house price booms are the exception. The higher interest rates the Bank looks to to reduce demand will have a disproportionate impact on people who are so over-extended, so to prick the bubble is to risk the negative equity and repossessions that ended the Lawson boom.
The biggest gamble is on the future. Britain’s economic success has been lavishly praised by the government which proffers it as an example to the world. It is true that we have done better than most over the ten years but the economy has no firm base. We defy the common sense nostrums: “what goes up must come down”, “bubbles burst”, “boom leads to bust”, and the adage that if something can’t go on forever it probably won’t. We have not done that which we ought to have done. We have over-done what we ought not to have done, and sooner or later a price must be paid by a nation which has done so little to build a production base to sustain it as the oil prop, which underpinned the locust years, weakens and eventually fails.
Unlike Norway we have squandered the oil. There is much brave talk about cultural industries, educating the world at Oxbridge and the public schools (and overcharging them in the process), exporting services, living on intellectual property rights, building the “knowledge economy” and IT industries, or developing indigenous Green technology but no indication that any or all of this can pay the rent. If it doesn`t we are training and educating the younger generation for industries and production we haven`t got.
Those who produce less must consume less. So long term Britain faces a more serious problem than competitors. The ten good years haven`t been used to build a production base from which to face the future. As an unter economy maintaining the attitudes and life style of an uber, even a super, economy, we will find increasing difficulty.
America has opted for the same dynamics with similar consequences but far less damaging in a powerful continental economy with its mighty multi-nationals and reserve currency status allows it to borrow in dollars. So its debt burden falls as the dollar comes down to restore competitiveness, as happened in the 1980s with the substantial devaluation of the Reagan years. Britain borrows in foreign currency and is reliant on hot money flows which can quickly reverse. So the debt burden increases if the currency becomes more competitive.
The contrast with other economies is even more depressing. Germany has grown only slowly over the decade but massive spending, much of it public, has gone into integrating the East and its skilled labour force while companies have invested, modernized and slimmed down Germany`s powerful industry. Britain has lost a quarter of its manufacturing jobs, Germany only 5% of its bigger total. Its re-powered economy has been able to grow through the deflation caused by an increase in VAT and its manufacturing is poised to dominate European markets. By contrast, in Britain the huge credit explosion went into asset price inflation and speculation as companies bought back their own shares, lavished share options on their leaders and indulged in an orgy of takeovers.
Competing economies did not run down their manufacturing in the belief that phoenixes rise from ashes. Nor did they allow a credit explosion on the same scale. Most have trade surpluses while some, like China and Japan, have built up massive reserves. Nor has any become as dependent on fickle finance. As well as manufacturing the French, the Americans, the Brazilians, Chinese and Indians have powerful agricultural sectors while we are net agricultural importers. Others, like Russia, Australia and Canada have oil reserves and extractive industries where we have exhausted both and are left with a population of 58 million (and still growing) bred for manufacturing which no longer exists.
If the growth our people crave and the living standards they want can`t be kept up we become less attractive to investment in a British consumer market which will become a backwater in the world economy instead of a pace-setter. Indeed, the long term consequences of prevailing trends must be that Britain becomes less significant in the world economy, our average standard of living falls in comparison with the rest, our society becomes more unequal and less competitive, our market less attractive and investment here less likely because we can`t pay our way and the economy doesn`t rest on a powerful, competitive base. The weak can`t inherit the Earth.
Government has long congratulated itself on the growth, as if it had been the result of its economic management. In fact there was very little of that. Apart from tax reductions for companies, and incentives to invest, Government gave up management to hand the two crucial levers, interest rates and the exchange rate, to the bankers. There and everywhere we did what business wanted. The results are widening wealth gaps, a bubble economy, and a huge credit expansion where demand management is privatized.
Without solid building the deficit gaped/ As a result the economy was colonized because beggars can`t be choosers. Or regulators. The deficit was financed by attracting wealth and non-domiciled residents to a tax haven, by selling off assets and companies, and by attracting foreign investment. Company taxation was kept low and regulation weak to attract business. No Sarbanes Oxley, though the practices which sank Enron and WorldCom were the norm here. No tough financial regulation because the weak FSA had neither the powers nor the will of the SEC. No restriction on the powers and profits of the Big Four who were prosecuted for selling tax avoidance schemes in the US but advised government on the issue here. No regulation of Hedge Funds or the massive risks they posed. Indeed Britain was at the forefront in resisting EU regulation and made no stipulations on reserve ratios. So they clustered here and invented ever more profitable risk vehicles such as bundled debt sold on by lenders of all kinds. Since that is less saleable than shares, the result in August 2007 was a liquidity crisis as the herd instincts of the funds led them to attempt to sell the unsaleable.
Finance ruled. Not OK. The City has never been much interested in investment in Britain or sustaining in British production. Its interests are international and because Finance is speculative it has become an increasing source of risk. So as the power of Finance grew, Britain becomes ever more exposed. The American sub prime crisis, compounded by the lax lending here by de-mutualised building societies now called banks, such as Northern Rock, to British sub primers. The Bank of England`s response was higher interest rates to damp the frenzy and sermons about Moral Hazard while the Fed and the Euro Bank had reduced interest rates and pumped out liquidity. Until government, unable to face the prospect that Saatchi queues outside bust banks and a big lender going under, forced action.
The end result of our gambler`s progress and all the risks government has taken is that Britain`s brittle prosperity is less secure. Congratulating ourselves on taking tough decisions, we have gone for easy options and “hands off” management and neglect of the national interest has relegated us to a future bobbing on stormy seas of globalization. Our gambles don`t together constitute or accumulate or bet. That could pay off big. They are an accumulator risk in which one failure can compound others and the fall of one domino knocks down more.
a shock coming in from outside could burst the bubble. Too strong a check to rising house prices could produce a collapse in consumer demand and mass repossessions. Then the currency won`t be sustained by “confidence” and a flight of hot money will make everything worse. Banks and building societies, who have taken too many risks in sub prime lending here and in the US, will face a swelling burden of bad debts and draw in their horns. Credit will tighten as it now is, weakening companies and undermining borrowers. In a failing British market foreign investors will think again about investment here and the damage could stop the hot money flow. So many interlocking risks in an economy with no strong productive base mean small setbacks can have big consequences, all of which will be magnified by fickle, unregulated, Finance.
Economic predictions don`t necessarily work out. Probabilities aren`t certainties. But the risks are real. The gambles can continue as long as growth goes on and government will certainly continue to downplay reality and play up statistics. Politically the strategy works well. Finance, the dominant national interest, loves it. Oppositions can`t offer doom, gloom and despair or any alternative, the Left has none and is unfashionable anyway, while Euro-enthusiasts offer “more Europe” as their answer to everything. The new economics please the comfortable, rising house prices benefit the majority who are owners, and a high pound means cheap holidays and imports. So the majority go along happily.
Viewed from the bottom the view isn`t quite as good. High wages have gone with manufacturing, take-home pay isn`t growing and living standards are squeezed by rising utility and local government charges and higher interest rates, while everything, particularly labour, is sweated, pushed harder and squeezed by cheap immigrant alternatives or outsourcing. So Labour`s people aren`t gibberingly grateful though hostility is inchoate and instinctive, though a set-back to the jolly wagon could turn it nasty.
Bubble economics and live-now-pay-later both mean that problems are all in the future. Yet it is still surprising that the warnings have been few and mainly moralistic rather than economic. Economists, so prompt with warnings when the potential for disaster was less, have fallen silent. The only warning shots fired by Elliot and Atkinson in Fantasy Island concentrate, like most other critics, on failures to tackle global warming not the failure to build a strong healthy economy. Just as Mrs. Thatcher did so much to clean up Britain`s rivers by closing down the factories which polluted them so now environmentalists tend to see growth and economic strength as undesirable. Both are out of fashion. Which may be why no one argues for more.
Yet the longer we gamble instead of building, the less powerful the economy becomes and the faster and more forcefully downward trends can emerge. It is appropriate that super casinos are offered as a means of urban regeneration in such a bubble economy. Yet surprising that the Jeremiahs of yesteryear are silent now we really need them so who, now, will show the way to a more certain future. What, short of disaster, will lead government to implement it?
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