Social democrats throughout Europe are being forced to confront the reality of limited resources. A return to expensive catalogues of public spending commitments is quite clearly impossible and is unlikely to win back trust in the centre-left’s economic credibility. In the UK, an economic model based on tax receipts from the financial sector that could then be spent on social programmes is no longer a viable or desirable option. A more fundamental rethink of Britain’s political economic model is therefore required.
As the legacy of the financial crisis casts doubt on the capacity of Britain’s political economic institutions to deliver economic and social objectives, now is the time for social democrats to recalibrate their thinking on how to overcome the institutional and macroeconomic imbalances in our economy. An important part of this debate is about the values that underpin our political economic institutions. But the debate about ‘responsible capitalism’ will need to work out what this means in terms of concrete institutional reforms.
One place to start, as many have recently contended, is by looking towards the German model. If British policy makers are serious about rebalancing the UK economy, then we need to think about the kind of institutions that support and foster innovation, patient capital lending and long-term growth, and here there are lessons to learn from Germany’s model of Rhineland capitalism. Whilst it would be folly to advocate the adoption of the German model wholesale, in establishing institutional answers to what ‘responsible capitalism’ means, the UK could learn valuable lessons from Germany. The emphasis on long-term planning and investment, vocational skills development and employee representation can feed into Labour’s thinking on how to adapt to the changing fiscal environment, promote institutional innovation and structural reform and support the development of a long-term business model that must all form part of a distinct social democratic vision of how to deliver long-term economic growth and social justice in straightened economic times.
Supporting business in the long-term
The debate about the nature of British corporate finance and the volatile short-termism it engenders is not unchartered territory. As early as 1930, John Maynard Keynes mocked the fickle disposition of British finance, claiming that, “If farming were to be organised like the stock market, the farmer would sell his farm in the morning when it is raining, only to buy it back in the afternoon when the sun came out”. Herein lies the fundamental problem: as companies draw on stock-based capital they become particularly vulnerable to economic downturns, and if the share price falls, investors can ‘exit’ their investment through the sale of their asset on the stock market.
This is what Will Hutton calls the “fetish of liquidity”. Companies are consequently under pressure to produce short-term financial returns to appear profitable and fend off the threat of hostile takeover. This bias inherent in our financial system drives company incentives to grow by acquisition and wealth-destroying mergers rather than through the investment that is vital for the growth and profitability of domestic industry. Market incentives for short-term gain are choking off prospects for long-term investment and innovation. As commercial banks increasingly turned their balance sheets over to more profitable investment strategies, the get-rich-quick-culture that pervades the financial sector infected the entire system.
We might better understand how to limit such nomadic patterns of investment by looking to Germany, where the institutional framework to a far greater extent favours long-term investment based on trust rather than short-term panic, and encourages banks to make long-term loans to industry. This is one of the principal points of divergence between the British and German banking systems. In Germany, strong local and regional banks are underwritten by local public authorities and supported by institutions at the regional and national levels. This allows the banks to lend cheaply to small and medium sized companies (SMEs), like those on which the UK is currently relying to kick-start its economy. In Germany over 400 public savings banks, known as Sparkassen, and 1,258 credit cooperatives operate according to local banking laws, which ensure that these banks satisfy the credit demands of local business and pursue a business strategy that serves a wider social agenda within the community they serve. In a recent article written for Policy Network Andrew Tarrant and Gregg McClymont highlight that in 2010, 43.4% of all loans to SMEs in Germany were provided by the Sparkassen, whereas in the UK over 90% of financial services supplied to SMEs were provided by the ‘Big Four’ banks, which, unlike German commercial banks, are particularly vulnerable to short-term quarterly profit margins.
In Britain banks are reneging on their responsibilities to lend to businesses. Whilst George Osborne’s Autumn Statement recognised this problem, by offering £40bn to small firms in a “credit easing” scheme, the policy serves merely to plaster over a deeper structural flaw. Instead, the creation of permanent regional development agencies and a state-owned national investment bank in the mould of the German Kreditanstalt für Wiederaufbau (KfW) would help provide the private sector with the necessary resources to finance large long-term infrastructure projects and high-tech start-ups, vital to the future growth prospects of the UK economy, and importantly the redevelopment of the manufacturing sector in the context of fierce global competition.
As Tarrant and McClymont highlight, in Germany over €28bn was made available to SMEs through the KfW in 2010, compared to just £500 million in the UK. Crucially, ‘patient capital’ loans are made at fixed interest rates with maturity of up to ten or even 20 years, allowing companies to look to the long term. According to eurostat, total R&D expenditure in Germany as a percentage of GDP is 2.54%, amongst the highest in the EU, compared to just 1.79% in the UK. Furthermore, between 2004 and 2006, Germany boasted the highest proportion of enterprises involved in innovation activities, with 63% compared to just 38% in the UK. In an era of austerity, only a productive and high-employment economy driven by long-term investment and innovation can deliver Labour’s social and economic goals. If Britain is to successfully rebalance its economy away from its over-reliance on the financial services sector, it must restore the link between finance and industry.
An economy that works for everyone
An institutional settlement key to the success of the German social model, and on which the British and Germans part company spectacularly, is the representation of workers and trade unions at the company level. The view that sees strong unions and employment regulations as barriers getting in the way of effective supply side reform of the labour market ignores the macroeconomic stabilising role that social partners can play in a market economy. In Germany, works councils and unions are represented at the company level by statute. This allows both employers and workers to collectively negotiate important decisions related to wages, jobs and company restructuring. During the financial crash in 2008 and subsequent downturn, German employment rates actually rose, as firms used long-standing links with trade unions to negotiate reduced working hours and wage freezes in order to protect jobs and boost productivity.
Active participation in the economy by well-organised and disciplined unions not only helps contain inflationary wage settlements and reduce income differentials within the economy; effective work life democracy is also essential to delivering social justice in an efficient market economy. Given that between 2004 and 2006 the UK lost nearly six times as many working days due to strike action than Germany, there are surely lessons to be learnt for Britain’s unions and employers. Germany’s experience presents a compelling argument for a role for government in facilitating more progressive industrial relations built on trust and reciprocity between capital and labour. Of course capital will pursue profit maximization, but sustainable, productive capitalism demands it does so within social boundaries that ensure a decent wage, employment and work-life democracy.
Towards a high-skill Britain
To ensure the regeneration of British industry, British companies need to be able to draw on a stable pool of skilled workers. However, the reality is that the market, without incentives, will not invest sufficiently in education and skills. Policy makers need to ask why it is that less than 25% of British engineering graduates went on to work in manufacturing [opens full report]? Despite increased investment in higher education over the last decade, Britain currently lacks the institutional support that aligns skills to sector-specific needs. When over 40% of firms in the automotive sector claimed they found it difficult to find skilled workers, it should not come as a surprise that since 1984 more than 4.5 million jobs have been lost in British manufacturing. As new patterns emerge of high-skilled ‘winners’ and low- and unskilled ‘losers’ in society, investment in high-quality vocational skills is vital if Britain is to diversify its economy, halt the pattern of economic decline in the old industrial regions, and stem rising inequalities.
In Germany, an emphasis on vocational training and apprenticeships has supported strong engineering and manufacturing sectors. Apprenticeships, supported by government and employers, offer a low-cost opportunity for employers, including SMEs, to gain access to skilled labour, and serve as an entry point for young workers into industry. The expansion of vocational colleges would increase access to high-quality skills, widen Britain’s skills base, strengthen its economic diversification and provide a productive alternative to would-be students who might otherwise pursue expensive university degrees that will do little for them in the job market. Investment in vocational skills can complement Britain’s comparative advantage in the so-called ‘knowledge economy’ and can ensure a more balanced, equitable and sustainable model.
Defining the future of Britain’s economy
Austerity is not working. As unemployment rose to a 17-year high, the Office for Budget Responsibility’s growth projections for 2012 were once again downgraded, from 2.5% to just 0.7% in the Chancellor’s Autumn Statement. The failure of George Osborne’s argument that deep and fast cuts would make way for the private sector should have presented Labour with an open goal, but this is not happening. Voters remain reluctant to trust Labour with the economy and continue to blame ‘Labour’s debts’ for the current state of the economy.
Labour cannot afford to simply shout from the sidelines, opposing all Tory cuts. Part of the argument should, and will, undoubtedly be about damaging and counterproductive cuts and, crucially, the unequal distribution of the impact of cuts. But as social democrats across Europe are forced to confront the reality of delivering economic growth and social justice on limited resources, more new thinking on political economy is required. Labour needs to have a debate around radical institutional reforms for long-term prosperity that support innovation, investment and equity. Beyond the current deficit question, Labour must present a positive vision that can define the future of the British economy.
Alex Keynes works as an assistant in the office of the President of the European Parliament and previously worked as a research assistant at Policy Network.