As George Osborne prepares his big speech for the Conservative party conference in 10 days time, the UK chancellor of the exchequer faces some momentous decisions. A year ago it seemed reasonable to hope for a brighter 2012, with the chance that next summer’s Olympic Games in London might mark a turning point on the way to sunny economic uplands in time for the general election in 2015.
Now it is clear that the growth assumptions on which his austerity package had been based were way too optimistic. So the budget numbers no longer add up, and there is a risk that British voters will go into the next election with years of falling living standards under their belts and not much benefit to show for them. The economic and social costs would be very serious. And Mr Osborne could be thinking about a new line of work.
He is a bold and ambitious politician. He cannot pretend that there are easy ways out. But nor can he accept that there is little he can do to change this gloomy picture, and that the best he can offer is a few more micro initiatives along the lines of the unmemorable growth plan launched by the coalition in the first half of the year, and then ask us to sit back for however long it takes for the storm to pass.
So what are his options?
What the economy needs now above all is a shot of entrepreneurial dynamism – a burst of activity from those small and medium-sized companies that are essential to job creation and innovation across the land. That will not come easily at a time when confidence is so low. But it has to be the objective that shapes policy for the short and medium term – and the driving force behind his message to the party faithful.
Step one is to emphasise that the austerity package is not quite as inflexible as was presented last year. Borrowing can rise above target if slow growth causes temporary shortfalls in tax revenues and rises in benefit payments. Policy will still be on track if the deficit does not close until a year later than originally promised. Debt financing costs will have been reduced by low interest rates and the savings could be used to fund badly-needed investment in the country’s infrastructure. Government assets could be sold for the same purpose – such as land or spectrum sales.
There is room for manoeuvre on the monetary side as well. Interest rates cannot be cut any further. But an increasingly strong case can be made for a further round of quantitative easing and this week’s minutes from the Bank of England’s monetary policy committee suggested that such a move was likely in the next couple of months.
All this will be helpful, but will not add up to a game changer. As Spencer Dale, the Bank’s chief economist, put it this week: “At the risk of stating the bleeding obvious, we need the banks to be working for our economy to grow and prosper.” And right now, they are not.
Net lending to businesses is still shrinking, and the interest rate on new facilities for smaller businesses is pushing over 5 per cent. This means the spread over the Bank rate has more than doubled since the end of 2008, in good part because the banks’ own funding costs have risen as tensions have spread across the eurozone. This financing problem is crushing the entrepreneurial spirit and Mr Osborne can address it in two ways.
First, he can make it clear that the job of the Bank’s new financial policy committee is to check excessive falls as well as rises in credit and debt. Lending to small businesses makes up only a tiny fraction of the big banks’ balance sheets and the capital cushion required to support such loans should be temporarily reduced.
Second, the chancellor should consider the case for a bolder approach to quantitative easing. Instead of restricting itself to buying government bonds, the Bank could be encouraged to inject finance directly into small company balance sheets, perhaps by investing in securitised bundles of loans to such businesses. This would call for a new kind of relationship between the Treasury and the Bank, which would not be able to take on such risks by itself. The need to protect the Bank’s independence should not be allowed to prevent closer collaboration between the monetary and fiscal authorities at this time of national need.
On top of these initiatives, Mr Osborne needs a big idea for the medium term. In his days in opposition, he used to emphasise his aim of turning Britain from a nation of consumers and borrowers into one of savers and investors, and that challenge is even more urgent today. The country languishes near the bottom of the global league tables of savings and investment as a share of national output and this just has to change if the economy is to be rebalanced on to a more sustainable base. Nothing can be done to fix the immediate problem, which is that with interest rates close to zero and inflation running at 5 per cent, savers today are getting a terrible deal.
But now is the time to start working on the big picture – practical steps towards a different and more prosperous future. And right on cue, the Institute for Fiscal Studies published this week the final report of the Mirrlees review of the UK’s chaotic tax system, spelling out the necessary reforms of a corporate tax system which today favours debt over equity finance, and showing how a radical overhaul of savings taxes could encourage the long-term savings that our society so badly needs.
This is the blueprint Mr Osborne can use to shape a different kind of economy for the future. Together with a better flow of credit for the short term, it provides a story not just to rally the party faithful but also to lift the animal spirits of industry. And that, more than anything, is what the country needs today.
The writer is former director-general of the CBI employers’ group and a former editor of the Financial Times