An attentive reading of the UK Chancellor's (finance minster's) latest speech to the City reveals the strain of ignoring what really limits Britain's ability to formulate a good response to its own double dip recession or to play a constructive role in the Eurozone crisis. In both cases, the root cause is the absence of true democratic legitimacy that pervades the Westminster/City nexus
George Osborne addresses 2 big issues in his Mansion House speech: the lack of investment in the British economy and the UK's disposition towards the tight Eurozone Union that is emerging. In both cases, dishonesty is the most striking feature. Especially the gulf between the implied analysis and the actual policies. At an economic level, if we want to understand the policy, we need to look well beyond the analysis offered by the Finance Minister. In the end, the speech raises the political question of why dishonesty has to be so deeply embedded in our political culture that a minister, talking to a friendly audience, can't even tell us how it really is.
Osborne is rightly worried about the lack of investment in the UK economy. It is basic accountancy that economic activity is the sum of consumption, investment, government spending, and net exports. Consumption and government spending are going nowhere; nor, realistically are net exports - the UK's external sector today is dominated by niche markets in which it is very strong and its products not very price sensitive, so it is hard for simple policies like devaluation to help there. That leaves investment as the only hope for reducing unemployment and reducing generalised malaise.
At this point, an attentive reader of the speech will start to wonder how Osborne is going to avoid the obvious solution to the dilemma - a bit of well-targeted public sector investment. After all, long term borrowing by the government costs under 2% - the lowest ever rates we've collectively been able to borrow at. It can't take much effort to find projects that will pay that back handsomely, especially when we factor-in their short term benefits for growth. Brad De Long and Larry Summers have outlined the basic case in a very persuasive model.
Funnily enough ... Osborne doesn't avoid the obvious solution. He says that this is exactly what he is doing:
That is not an excuse for doing nothing in the face of slower growth.
Far from it: the credibility we have enables us to do a great deal more than some other countries at present.
We can allow the automatic stabilisers to operate freely and we have already used the flexibility in our fiscal targets to extend the timetable of consolidation.
We have made further permanent reductions in current spending to pay for temporary increases in high quality capital spending.
We are today investing more in building new road and new rail, including Crossrail here in this City, than at the height of the spending boom – because that is a use of taxpayers’ money that gives a real economic return.
We’ve introduced the biggest back to work programme in this country’s history, including our new Youth Contract to get more young people into work.
Automatic stabilisers (ie welfare spending increases as the economy worsens); slowing down the rate at which the deficit is put onto sustainable path; high quality capital spending; infrastructure spending; back to work subsidies ... it all sounds like a thorough-going Keynesian program that Osborne is 'fessing up to. He's saying "Look! we're doing all of this already", as if the Keynesian remedies are all in place already.
Having pretended that he's already doing the Keynesian stuff - "let no one accuse me that I'm not increasing infrastructure spending ..." - he has prepared the ground for what he really wants to tell us about: he's going to get banks lending by promising them cheap funds conditional on them lending the funds out. This is sort of "performance enhanced QE". Instead of simply buying bonds (mainly from banks) to give them cheap cash, what we now have is cheap cash as long as they perform their function - to lend.
(The reason that he doesn't thoroughly implement the Keynesian policies that he is pretending to implement deserves an answer and article all of its own. Very briefly, the answer is that Osborne and the coalition - including the right of the Lib Dems - only really trust the private sector to pick investable projects. Ultimately, that means that if you want to have any investment done, you have to have it financed through the banking system. This is the essence of "Private sector Keynesianism" - the doctrine that actually has become the mainstream view of all the major parties. What one would hope for would be a little more attention at real alternatives to this: yes, state Keynesianism failed in the UK in the postwar; but so did the financial Keynesianism of the late 90s and noughties. We need to fix both finance and the state to find a better alternative...)
But back to Osborne's hopes to revive Square-Mile Keynesianism. If there were queues of projects out there stalled because banks weren't lending, Osborne would be on to something. It's true that banks are nursing their wounds, reducing their leverage and therefore in no great mood to lend. But even if the banks were willing, they'd find very few businesses asking to borrow. The problem right now is demand - investment looks very risky, whatever the interest rate. That's exactly why Osborne trumpets what demand enhancing projects he is involved in.
Why does Osborne persist with measures to enhance credit supply when the obvious thing to try next is more credit demand policies? Osborne does give us his own answer, but you have to be looking for it to see it as the key to the reality of his speech:
[Fiscal] consolidation is politically painful – I know that better than anyone.
So promises of consolidation tomorrow are not credible.
Here is the admission: if we were believed in our resolve to have honest finances one day, we could better economic policy today. But we're not believed, and this is the price of our untrustworthiness. And why aren't we believed? Because fiscal rectitude is politically hard ... politically too hard for Britain as its politics today works.
And why is that? Why is this, then, not the national priority - to give ourselves a politics that is sufficiently credible to allow us to have the right economic policy in a crisis? On that, George Osborne is silent.
Osborne - and the whole coalition - is motivated primarily by a single fear, the fear that was communicated in no uncertain terms to Clegg and Cameron in their immediate post-election meeting with Mervyn King, and it is expressed here by Osborne:
As we see all too clearly elsewhere, a banking sector balance sheet worth 500% of GDP – compared to just one fifth of that in the US - creates the very real risk of a destructive negative feedback loop between the sovereign and the financial sector. [...] Many countries with their own central banks have needed IMF bailouts – including our own country in 1976.
My conclusion from all this is that the balance of risks in the UK argues strongly in favour of credible deficit reduction.
If our huge bank-sector liabilities came to be seen as likely to become public sector debts, our borrowing costs would multiply many-fold. Why? Because of the likelihood that we, taxpayers, would not agree to service them. The likelihood, in other words, that our politics would become Greek. And consider for a moment the politics of this for the coalition: which is worse, 7% interest rates that eventually lead to a doubling of the average middle class mortgage payment, or a few more points on unemployment and some hardship for the worst off on welfare. A political strategist would call this one a no-brainer.
So what we see is a correct, if brutal fundamental analysis of the crisis is implicit in Osborne's speech: we should stimulate demand; we can't, because the risks are too high; and the risks are too high because politically, we probably wouldn't stand behind our banks. However much we might like to, we just can't do the right thing.
And just a note to point out that it is not impossible to be credible over long term debt and fiscal rectitude. Switzerland's bank balance sheet is even higher than the UK's as a proportion of GDP - it stands at 800% - and yet its interest rates are at similar rock-bottom levels to ours. The simple fact is that investors believe that whatever happens, the Swiss population really is behind its banking sector. Were great sacrifices required to make good unwise promises, Swiss citizens would deliver. I think that's true - but more importantly, the reason that it is true is that the Swiss banks exist in a context of legitimate democracy. Citizens know that if they wanted to make the environment unfriendly for global banking giants, they could. Indeed, there are indications that they may be doing this to the hedge fund industry that has been flooding into the country.
In other words, a properly functioning democracy delivers a sense of responsibility for outcomes. You may like or dislike the choices the Swiss have made in respect of their banking industry, but at least they have been citizen choices. The fact that ours were not lies at the core of Osborne's predicament.
If we really don't want to find ourselves here once again, what we need, beyond Vickers, is democratic reform.
The second half of Osborne's speech is devoted to his European negotiation. Here again, we can read his structural inability to speak straight. After some "I told you so" throat clearing (hey ... I understand ... I've done a bit of that myself) and his now habitual request that the Eurozone form a tighter political union, Osborne lays out the position for Britain:
it’s not in our interests to stand in the way of the further integration amongst the eurozone countries that any successful solution will require.
That includes proposals for a banking union – in other words, a union that stands behind the stability of eurozone banks and their deposits in return for common financial supervision.
But a banking union is not a natural consequence of a single market.
The same level of integration and common supervision is not considered necessary in other areas of the single market like energy.
So we are clear that Britain will not take part in this banking union.
British taxpayers will not stand behind eurozone banks, and British voters want the British authorities to be in charge of supervising our own banks, especially in a crisis.
The telling falsehood is the analogy with energy markets. The single market in energy - which has been extremely hard to bring about, by the way, and is far from complete - has developed according to the model of basic access rules for European energy companies into each others' markets (hence the arrival of many German and French utilities here in the UK) and national regulation of those markets. The reason national regulation does not threaten the "energy union" is that neither I nor anyone else in the UK can choose to buy a unit of energy that is regulated, say, in Finland. We have regulation at the point of trade, and the point of trade is constrained by where the wires are.
Not so with finance. A company seeking a loan can look cross-border. Indeed, it was a very large part of the particularly acute Hungarian economic crisis that so many households and firms had borrowed in Euros in Vienna rather than Forints in Budapest. Capital is liquid and mobile within the single market in a way that most other products are not.
Why does Osborne have to use an analogy with energy that he and his speech writers know is essentially misleading? We get to the answer soon, and it has nothing to do with the risk of British taxpayers standing behind Eurozone banks ... (Osborne might feel rather relieved of the converse - Eurozone taxpayers standing behind British banks, given the difficulty he has already expressed in the speech, of going to sleep at night knowing that if our banks went under, we'd have public debts of 600% of GDP to worry about). the British taxpayers play their usual role in this speech of populist sop.
No. The reason for the dishonesty - the thing that needs to remain covered - comes later, while he is apparently on the subject of how voting will work in the EU when the Eurozone does form an inner core:
... the argument for safeguards that we were making last year is becoming more relevant than ever.
And getting the right solutions for the financial services sector must be a vital part of that.
Osborne is referring here to Cameron's December 2011 decision to veto the Treaty extensions, forcing the fiscal stability pact to be a separate multi-lateral treaty amongst the "twenty seven minus one".
My first reaction to that decision was, between gritted teeth, to approve it. I now think of that as a mistaken reaction of anger and frustration of the moment.
It is getting clearer every day why the motivation for the decision - to make sure that the City not be regulated commonly with the rest of Europe's financial sector - is going to make a resolution of the EU crisis extremely difficult, if not impossible. And the reason why is in Osborne's speech. Britain wants two basically incompatible things: first, for the Eurozone to form a tight union; and second, for that tight union not to impact on the single market in financial products - that really would harm the City, after all. But that is like saying: "we really want these two teams to play football; and if this other team on the sidelines comes in and plays rugby with the same ball and on the same pitch, don't worry. Keep playing."
You can't have a tight political union that does not keep control of its financial sector. That is precisely what the Euro crisis has been teaching us. And you can't have tight control of finance under a single market in financial services that does not overlap with the political union. Yet that is exactly what Osborne is saying that Britain will continue to veto, and all, it turns out, for what Osborne tries to express as a polite aside to his financier hosts of the evening, "the right solution for the financial services sector."
In the end, we have the same buried unsayable in the second half of Osborne's speech as in the first: the interests of the City determine economic and European policy, but this can't be expressed honestly, because the City does not have democratic legitimacy.
Fixing the root of the problem - creating true democratic support for the institution (it is possible for people to really want this - look at Swiss banking and finance) - is in the end not a project that the Treasury, or Westminster generally, seems likely to be willing to engage in.