Oral statement to Parliament

Denning Lecture 2010: Can we pay down the deficit and invest in growth?

Well you have a good example of speaker ‘inflation’ today. You booked the deputy leader of the Lib Dems, but you get a Secretary of State. Not…

Well you have a good example of speaker ‘inflation’ today. You booked the deputy leader of the Lib Dems, but you get a Secretary of State. Not an outcome many of us predicted, I have to say.

So suppose you might ask whether the message I might have delivered, “from the other side of the aisle” so to speak is different from the message I want to offer today as a Government Minister. I think I can honestly say that it is not.

A coalition government is obviously something of a novelty - or I would prefer to say, an innovation - in Britain. The new emphasis on cooperation and consensus can be, I believe, cathartic after the discrediting of parliamentary politics in the expenses scandal.

Lord Denning was a great lawyer, but I hope he would have excused me for choosing economics as my theme today. The theme I set for myself today is an important one - arguably the most important as far as the immediate prospects for the UK economy is concerned. Can we reduce the deficit while still investing in helping the economy grow?

Answering that question means being clear about where growth comes from. And clear about the role of government in helping create it.

The short answer is that it is not only possible to do both, but that it is necessary to do both. Recovery cannot be assured when the government is running such an unsustainable budget deficit. But without growth it is difficult to see how the deficit can be managed down since growth generates tax revenue and gets people off the dole.

So what I want to do today is to set out why this balance matters so much, and to say something about how we intend to strike it. It will be the inevitable balancing act at the centre of the emergency budget in two weeks time, and indeed of every budget that this coalition produces, as both the Chancellor and the Prime Minister have made clear.

It is also a challenge that is central to the whole mandate of my department, the Department for Business, Innovation and Skills, which has responsibility for business, regulatory reform, trade, further and higher education and science. A remit that, as I said in my first speech as Secretary of State last week, makes it a de facto ministry for growth.

I want to challenge the myth today that there is a not a constructive and progressive way to tackle the deficit. Indeed, I want to argue that this is precisely what a progressive government should be doing. Along the way I will have something to say about the use - and abuse - of Keynesian economics.

I think it is right to approach this task of cutting both deficit and debt with a degree of radicalism. It is a mistake to believe that a positive and productive role for the state has to involve the last ditch defence of the current level and patterns of public spending. My argument today is that have an important chance to rethink some of what government does from scratch.

But we have also rejected the idea that all we need for private sector growth is to cut back the public sector.

Fixing the imbalances in the economy will take time. Between manufacturing and finance. Between North and South. Between dependence on public sector jobs and new private enterprise.

Regions long dependent on public sector employment will not become silicon valleys of entrepreneurialism over night. Businesses are still reeling from recession and are reluctant to invest or unable to raise finance.

Households are nervously rebuilding their balance sheets. We hope that exports will lift the economy; but demand in some major markets, notably the Eurozone, is weak.

For all these reasons private sector demand will, only with difficulty, fill the space created by cuts in public sector demand.

And no less importantly, some of what gives us the capacity to grow the economy actually comes from what we spend collectively on things like education, infrastructure and science. To undermine these would be like a farmer consuming next years’ seed corn.This is a point I want to come back to at some length.

For all these reasons, we are rightly committed to advancing with care into a still uncertain economic future.

Escaping from deficit and debt

I warned tirelessly ‘from the other side of the aisle’ that we have for a long time been a dangerously leveraged economy.

Britain has a lethal combination of excessive household debt caused by high levels of lending against inflated property prices, an overleveraged - and now contracting - financial sector and a rapidly growing public sector debt generated by large budget deficits.

Following the collapse of the banking system and subsequent recession an extraordinary level of public borrowing at 12% of GDP, the largest of any significant economy. A recent McKinsey report found that combined British public and private debt levels are the highest in the world: 400 per cent of GDP. This is seriously dangerous economic territory.

Let me be clear, I supported the use of the public balance sheet to cushion the private economy from a deep recession, and to stabilize the banks. The policy of stimulus followed in this country and across the G20 had the effect of propping up demand and it was the right course to take. It prevented the world sinking into the depths of another Great Depression.

But the G20 is also right to warn that it cannot continue indefinitely, especially for countries like the UK with massive fiscal deficit. While we have to move carefully, we have almost certainly reached the limits of expansionary fiscal policy, not least because of growing worries over sovereign debt.

I have been criticised for apparently changing my position on a symbolically significant but, in practice, modest issue - the decision to make £6billion in savings this year.

But I have always maintained that the timing of fiscal consolidation is a judgment call. Nobody can afford to take a dogmatic approach to these matters.

What matters is to take a careful look at the actual conditions - here, in Europe and around the world. As do the OECD and the Bank of England. And they have warned, uncompromisingly, that there was no alternative to acting quickly in the increasingly febrile market conditions.

Defenders of a more relaxed approach sometimes argue: ‘the level of public debt is not unprecedented for the UK. There is no gilt strike. The markets are still lending us money. We can put of the tough decisions a little longer - maybe indefinitely’.

But the banking crisis should stand as a warning about this kind of complacency. We saw three years ago how rapidly sentiment can turn once confidence becomes a problem. And we are seeing it again as sovereign debt worries cloud the economic horizon in Europe.

Sovereign debt crises may not operate quite like these in wholesale capital markets for banks but a downgrade of the country’s credit rating - which has been a real risk - could change things very fast.

So there are risks on both sides. But I believe that by planning our public spending cuts carefully - which is exactly what we are doing - we can manage the impact on domestic demand and help maintain business confidence necessary for private sector recovery.

Early measures send a signal of the credibility of the government’s commitment to reduce the deficit quickly and sustainably: keeping down the cost of capital which is, in turn, necessary for recovery.

The last government sometimes seemed to present its record borrowing as an act of Keynesian heroism. In reality it was a short term expedient.

And in fact a substantial part of the deficit we have inherited was not a result of temporary stimulus or automatic stabilizers like unemployment assistance. It is structural. This means that even with returning growth, there would still be a fiscal hole to fill.

It is a long time since I studied and taught Keynes’ General Theory - the economists’ equivalent to the Bible - but I remember enough to feel extreme annoyance when Keynes’s name is used to justify high levels of public spending and persistent deficit financing.

Keynes was, in fact, an economic and political liberal. And he was addressing some specific problems in the inter war period which could have presented themselves in the current crises but haven’t, at least yet. The key point was the use of budget deficits when monetary policy fails to stop a downward deflationary spiral.

To be sure, Keynes would have approved of the highly expansionary monetary policy including quantitative easing that the UK has followed in this crisis so far. Helped by a big stimulus from devaluation.

And there is one other sense in which the so-called Keynesian critique of policy has force. Britain is part of a wider global economy. We have only 2% of global GDP and our exports in particular depend on developments elsewhere. If all major countries simultaneously embark on fiscal consolidation the cumulative effect on global demand is likely to be negative, and negative for Britain.

So there remains an obligation on countries with a stronger fiscal position to offset contraction elsewhere: Germany is the obvious case in Europe. But with our vulnerable fiscal position we are not in a strong position to preach from the bully pulpit.

However, having said that, Keynes would not have recognized much of what is now being called the Keynesian response to the recent and current crisis. In particular the structural element in the UK deficit which has nothing to do with Keynesian demand management and has to be dealt with.

What I mean by structural is this: the current level of public spending - and all the sense of entitlement built around it - is based on the revenues from an economy artificially boosted by a debt fuelled spending boom, an inflated housing market and a bloated banking sector. The position is unreal and unsustainable.

In the private sector the adjustment that deflated these bubbles was swift and brutal. The rapid contraction of retail - including the sudden disappearance of long-established names like Woolworths. The collapse of building many contractors.

But the public sector carried on growing. For a while, it could afford to. And in part that was based on an economic calculation that the public sector had to support the economy temporarily. Which it did.

But this could never last forever, and now the right thing is for it to plan an orderly return to solvency, rather than run the risk of a “Woolworths moment” in the public finances.

Deficit and debt reduction as a progressive aim

So in the UK tackling the deficit is a massive, unavoidable challenge. Even the last government began to recognize this, although for too long they denied that this would add up to the need for spending restraint.

The public, I think, understand the need for tight measures. But there is resistance in some parts of the country with strong folk memories that associate public spending cuts with an anti-government ideology and the sink or swim economic worldview of the 80s.

I believe that the case for tough fiscal measures has to be made from the standpoint of those who are committed to public services and effective government.

There is a simple, common-sense argument. Having a structural deficit is a little like using an overdraft to run expensive cars and dining out several times a week. And the overdraft has to be serviced. The public sector cannot be run in this basis. Either we need to earn more, or we change our spending levels and patterns.

We also have to recognise something that is generally true about the public sector. It has a tendency to grow through accretion rather than by design. A quango tacked on here. A program extended there.

It is a sobering fact that no government in the last thirty years has ever left behind it a state smaller as a proportion of GDP than it inherited, even if it has cut public spending in real terms for short periods.

It is not in any way to devalue the public sector or those who work in it to say that this is not a rational or wise way to run our country. We now have a window of opportunity for a genuine public debate about what government does - and just as importantly how it does it. We should not waste it.

This is exactly what I have asked my officials to do at the Department of Business. You can call it zero-based budgeting. So we don’t just try to find savings by slicing away at existing structures.

And certainly not by simply cutting services at the point of delivery like reducing the quality of further and university education or our capacity for scientific research.

Instead, we ask: if we were designing this system from scratch, how would we do it? As a small step in this direction I have already identified more than £800million in savings at the Department of Business. I have set out plans to reduce the number of BIS quangos by a third over this parliament.

This is the same approach that Canada took in the 1990s, successfully turning a fiscal basket case into an economy that weathered the financial storm better than any other developed nation. And it didn’t descend into anarchy or sacrifice its strong social model.

It means rejecting an ideological attitude to cutting back the state for a more pragmatic argument about what we want government to do and how.

It means asking if the private or voluntary sector could not do things as well. It means insisting that we don’t defend the role of government by defending the size of government.

Of course at a human level we have to acknowledge that cutting public spending is going to mean people losing jobs in both private and public sector.

That is not an argument against doing it. It is an argument for making sure that those people are equipped to find new jobs in a revitalized private sector, and that that private sector has the capacity to grow to employ them.

The growth effect of public spending

And that brings me to the crux of my argument. I have already noted that cuts in public sector demand have to be matched by rises in private sector demand and supply if we want to keep the economy growing. Otherwise the people who lose their jobs will simply swell welfare roles, which is like moving them from one part of the public payroll to another - and a lot worse for them.

It is also naive to believe that cutting public spending automatically produces private sector growth. Certainly in current conditions the public sector is not “crowding out” the private sector.

Indeed, the contribution of public spending to growth is not just in its effect on aggregate demand. It also provides things that the private sector needs and exploits.

They include universal high quality education. Infrastructure networks. Science and research up to the stage of innovation. Even healthcare has an impact on productivity and growth, for the obvious reason that you can’t work when you’re seriously sick. And these are very often things that the market won’t provide on its own.

So we need to recognise that the links between public spending and growth are subtle and not necessarily in conflict. When we do it right, some of the money we spend on these capabilities - even in areas we might label ‘social spending’ - ultimately pays for itself, often many times over, in higher productivity. And often in ways a purely free market will not replicate. So as we cut, we need to have this at the front of our minds.

Growth policy on a tight budget

What might this mean in practice for a growth policy designed to live with much tighter budgets? Well, obviously it will be for the Chancellor and the Treasury to set out a budget in detail in two weeks’ time and I have no intention of stepping on his toes - that’s the ballroom dancer in me. But I would make a few points.

The first is that there is a wide range of things the government can do to encourage growth that actually cost nothing at all. We can keep the tax system enterprise-friendly. We can keep our borders open to goods and services and the highly skilled. We can maintain an activist competition regime. Market discipline ultimately makes companies more competitive and more productive and that boosts our growth.

One of the great risks with government when it can’t spend is that it tries to look as if it is doing something by regulating instead. But the regulatory burden is a check on business growth and everything we can do to lighten it will help.

This is especially true of the impediments to starting up and running small companies. Rules governing accounting standards, for example, are as demanding for micro businesses as for multinationals - which makes no sense to me. I will take the same tough line on new and existing regulation as the Chancellor will be taking on spending.

We are also making sure that the banks are lending to small business. Access to credit is a prerequisite for growth and potentially a very serious constraint. So we will be looking again at how we can get real results out of the lending agreements agreed by the last government. And we have wider plans for shaking up the banking and credit system to ensure it serves the wider economy well.

But there are other areas where we do have to recognize that some forms of public investment are key to rising productivity and growth.

One of the realities of globalisation is that the UK cannot compete internationally without high levels of private and public on high levels of public and private investment in sophisticated skills, knowledge, technology and innovation.

One of the problems with the growth pattern in the UK economy over the last decade is that instead of being built on business investment, rising skills, rising entrepreneurship and strong exports it was built on consumption, asset price rises and a rapid expansion of the financial services sector. Banks made hay while manufacturing declined.

If we want to avoid this mistake again, we will need to ensure that we have the kinds of skills that are needed by sectors like low carbon and advanced manufacturing. We will need to ensure that tax and regulation do not disincentivise the kinds of productive activity that we want to encourage.

Of course sectors like Higher and Further education and science and research cannot escape their share of deficit reduction. But when we design it right, the way we fund higher and adult learning and our science and research base is a direct contributor to our growth capability. And we must not put this capability at risk.

An early signal of this is my decision to redirect savings within the department to strengthen, rather than reduce, both investment in FE colleges and to create 50000 new apprenticeships.

Conclusion: two sides of the same coin

So, let me sum up. I’ve argued today that reducing the deficit is a progressive goal, and can be done by progressive means. I’ve argued that the coalition government is right to tackle this quickly and with a clear sense of direction.

Failing to deal with it takes huge risks with our economy, and puts all our goals at risk. By addressing the deficit problem with conviction we create space to achieve genuinely progressive aims such as lifting low income earners out of the tax system altogether.

However the real questions we face are not about if or even when we cut the deficit but how. The burden must be spread between spending cuts - the majority - and tax rises.

It bears saying clearly that is a mistake to believe the public sector or public spending in its entirety is a ‘cost centre’ in the economy, sucking away resources that could be better employed in private hands. Sometimes this is true.

But private markets alone actually tend to produce suboptimal growth, because some of what the private sector leverages into growth actually starts with the collective investments we make as a society. Investments markets alone won’t always make. In things like education and science. In the support we provide for small businesses and adult education.

So over the next few months as we reflect on policy on regional development, science, higher education and innovation the imperative will be the same. Not just to cut: but to reduce spending in a way that keeps the growth potential of this investment intact.

We come back to the point we started with. Which is the argument that it is both possible and necessary to both cut the deficit and invest in growth. Not least because they are in fact in an important sense the same thing. This is the basic argument that I want to put at the heart of the agenda of the Department for Business, Innovation and Skills.

For all the talk of an age of austerity I want to end on a note of real optimism. This is a brilliantly inventive country, full of enterprise and aspiration. It has immense potential and we are committed to seeing it fulfil that. We’ve taken some wrong steps as a country. But we can put that right.

This is going to be a long and in some respects painful process for the UK. But it will not be a re-run of the 80s. It can and should be something from which Britain emerges stronger, fairer and better equipped for its economic future.

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