The state of things to come

9 Jan 09
PETER RIDDELL | Is big government on the way back? Next to the length and depth of the recession, the central question in British politics this year will be about the role of the state.

Is big government on the way back? Next to the length and depth of the recession, the central question in British politics this year will be about the role of the state. 

The immediate response to the collapse of confidence in the global financial system in mid-September was government intervention on a huge scale to provide guarantees and to shore up banks. This was followed by sizeable fiscal boosts through a mix of tax cuts and additional public spending, including a new instalment last week from the previously cautious German administration.

To some on the Left, these events represent a turning point: the ignominious end of 25 years dominance of free market, neo-liberal economics, accepted as much by New Labour since 1997 as by the previous Conservative administration.

But the waving of the red flag is premature. There has certainly been a shift by the government since last summer, but it has been as much in rhetoric as in substance. Prime Minister Gordon Brown has tried to create a dividing line with the Conservatives: allegedly between an active government looking after hard-working families and homebuyers, and an inactive and passive opposition.

This distinction is greatly overblown. The Conservatives backed the bank rescue last autumn and have urged its extension through guarantees of bank lending.

Admittedly, differences have emerged over the role of fiscal policy. Brown has argued that monetary policy is insufficient at present. Therefore an expansionary fiscal policy has to play a greater role via tax cuts, notably the temporary reduction in VAT, even if it boosts borrowing in the short term. By contrast, the Tories maintain that, since debt is already too high, it would be wrong to increase it further, so any tax cuts should be offset by savings in public expenditure.

This ideological divide has been highlighted since the new year by the contrast between Brown’s pledge to create 100,000 new jobs and Cameron’s proposal to cut taxes on savings for basic rate taxpayers and pensioners, financed by a slower growth in spending next year.

But this is really about the medium-term outlook for borrowing, spending and taxation when the economy is recovering. The main parties accept that the longer-term rate of growth of public spending will be much, much slower than it has been for over a decade, at or little more than 1% or so in real terms.

Paradoxically, this spending squeeze is being planned at a time when the state is considering guarantees and help worth tens of billions of pounds: £50bn alone so far to recapitalise the banking system.

The pressing questions are therefore different: how much more will the government have to intervene in the face of a deepening recession, and what form should this intervention take?

The form of the help is crucial. The government is wary of repeating the errors of the 1970s and providing large-scale loans or injecting equity into failing manufacturing companies such as British Leyland.

The business view, as recently expressed by Richard Lambert, director-general of the CBI, is that the current difficulties of British industry are essentially about the availability of credit. This shortage is what is now threatening not only retailers but also big manufacturing companies and the construction industry. Small and medium-sized companies are finding it hard to secure the trade credit insurance cover which is vital for their survival.

In most cases, these are efficient companies with good long-term futures, not the inefficient giants that were propped up in the 1970s. So the need is not for bail-outs on the 1970s’ pattern, but, rather, for extensions of credit and loan guarantees. But should they be paid directly to the affected sectors, as may apply for mortgage finance, or by guaranteeing bank loans to business? This would involve the government taking the underlying risk, while leaving the banks, mortgage lenders and credit insurers to deal with specific customers.

The test for future interventions will be whether they are temporary or lead to longer-term commitments. The dilemma is underlined by UK Financial Investments, which is managing the government’s large equity stakes in the banks on an arm’s-length basis from a small office in the Treasury. The stated intention is to sell off the stakes as soon as practicable. However, there is a conflict between this goal and the government’s frustration about the inadequate levels of bank lending — in part a result of the terms of the state investment.

So is this increased government activism largely a short-lived response to a deep recession, or does it represent a shift in the balance between the state and the markets? The signs so far are that the government has not lost its belief in markets and competition in the era of globalisation, but the state will in future be more active as a regulator and guarantor.

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