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Printing money and tax cuts aren’t enough. We need real investment

The government should create a a British Investment Bank with the power to raise money directly from

With less than a month to go until Budget day, doubts over the government's austerity programme are growing. The National Institute of Economic and Social Research has forecast that the British economy will shrink this year. The Office for National Statistics has announced that, on the broadest measure, more than 6.3 million Britons are underemployed – the highest number since records began, nearly 20 years ago.

Even Moody's, arbiters of global finance, is no longer confident that the coalition's current strategy is working: on 13 February, the agency changed its outlook on the UK's prized AAA credit rating to negative, citing uncertainty over whether the coalition government's strategy of fiscal consolidation will succeed in reducing the debt burden.

All these doubts ultimately derive from a single source. Cutting public spending is not by itself a growth policy. Considered in isolation, it is an anti-growth policy. If it is the only policy on offer, it will eventually defeat itself, by undermining the revenue on which the government depends to balance its books. This much is almost universally accepted across the political and analytical spectrum - and so, as a result, is the need for a "twin-track" policy mix: one that offsets the effects of government attempts to reduce its wasteful spending with measures to promote growth.

But it is here, on the question of what these complementary, growth-oriented policies should be, that agreement ends - and where the coalition government's policies to date have proved unfit for purpose.

Mix and match

There are two basic approaches available. The first - and the one favoured by the government until now - is what we might call the "indirect" approach. This is to use monetary policy as the offsetting device. As fiscal policy is tightened, monetary policy is loosened - in the hope that private businesses and individuals will respond to lower interest rates by increasing their spending.

The second approach is what we might call the "direct" approach. Rather than relying on loose monetary policy to counteract the drag of fiscal consolidation, the government takes action itself - by cutting taxes or by increasing its capital spending even as it reduces current spending.

Which policy mix is best? Quantitative easing (QE) - printing money - is a growth policy. The willingness to resort to QE around the world after 2008 is certainly what stopped the slide into another Great Depression. But QE is not enough. As a recovery policy, it suffers from two snags.

First, its effect on aggregate demand is weak and uncertain. It is not enough for the central bank to print money; the money has to be spent. The piling up of corporate cash balances - more than 5 per cent of GDP in the United Kingdom - shows that the new money is not translating into increased spending. Some argue that this is a reason to expand QE. Judging by its most recent £50bn injection, the Bank of England's Monetary Policy Committee seems to agree.

However, unless people expect QE to be permanent - in other words, that the gilts bought by the Bank will never be sold again and that part of the public debt will therefore be monetised - they may well go on piling up cash in order to cover expected future taxes. So there is a limit to how far QE can be pushed.

Second, QE does nothing to improve longer-term growth prospects. People have started to understand that the UK needs a more balanced economy - one in which financial services are a lower share of GNP, for example. In so far as it succeeds in raising aggregate demand alone, QE simply freezes the existing structure of the economy at a higher level of output.

Exactly the same objections apply to the tax cuts being proposed by business leaders and some Conservatives. These cuts will put more money into people's pockets - but their effect on spending is less certain. Unless they are expected to be permanent, a large part of the additional money will be saved. Likewise, tax cuts of the kind being proposed are unlikely to do much to improve the balance of the economy: they just put more spending power at the disposal of the structure that already exists.

They have one additional disadvantage. Unlike QE, tax cuts would increase the deficit and, therefore, to be consistent with the government's overall deficit reduction plan, they would have to be matched by spending reductions elsewhere - which would mean further cuts in public services.

Collateral benefits

The first two snags can be avoided by an enlarged and accelerated programme of capital investment. This would inject demand into the economy directly without having to rely on the vagaries of a private banking system that is still deep in repair mode, or on the uncertain willingness of businesses and households to spend the proceeds of tax cuts. And rebalancing public spending towards the capital budget - rather than away from it, as under the coalition's current austerity plans - would also have strong collateral benefits.

In the short run, it doesn't matter whether the increase in aggregate demand takes the form of employing people to dig holes and fill them up again, giving every household a time-limited spending voucher or building a new railway. All that matters is that the overall level of spending in the economy is maintained - so that unemployment stops rising and, with any luck, begins to fall again. But from any longer-term point of view, increasing aggregate demand by capital investment is better, because it creates identifiable future assets that promise to fund themselves and improve growth potential.

Yet it does not overcome the third disadvantage, which is that it will increase government borrowing at a time when the markets are demanding that the government reduce its debt. So, like tax cuts, it will have to be matched by cuts elsewhere - and again at the expense of the public services.

That is why we have argued for a British Investment Bank with the power to raise money directly from the private sector, and which therefore does not add significantly to the government's deficit. The government's commitment would be limited to capitalising it: the bank's lending would be funded from the private capital markets. It would charge lower interest rates for its loans than ordinary commercial banks; while the long-term returns that it would offer investors - being higher than those obtainable from gilts - would meet the desperate need for higher yields by pension funds.

A further advantage of such an autonomous set-up would be to shield the investment programme from the so-called boondoggle effect - building, at political behest, roads and railways that lead nowhere and therefore have no passengers or freight. Although there would be an implicit state guarantee of returns, the record of public investment banks in other countries - such as the European Investment Bank, the Nordic Investment Bank and the German Kreditanstalt für Wiederaufbau - shows that if an institution is well run, these guarantees are never, or rarely, called upon.

A final question might be: if these investment projects are worth doing, why isn't the private sector already doing them? A complete answer would take us deep into the theory of "market failure".

Here, it is important to make only one central point: the uncertain prospects for recovery as well as the impaired balance sheets of banks and firms have generated a massive "flight to liquidity", with savings stuck in bills and gilts while the riskier projects on which growth depends go wanting.

A British Investment Bank operating on the principles above, with a cogent and adequately funded investment strategy embedded in its mandate, would be an ideal vehicle for attracting "frozen" savings into the mar­-ket. It would help address the current deficit of confidence and certainty about demand directly, rather than just praying for spontaneous reignition.

In particular, a national infrastructure programme would not only make Britain a more efficient place to do business but could also contribute greatly to the rebalancing of the economy away from excessive reliance on the City of London and financial services.

Simple solution

In sum, while QE and tax cuts should not be excluded from the recovery policy mix, the main driver needs to be a programme of long-term capital investment. The simplest way to do this would be to use the government's balance sheet to bear some of the risk. But this will not happen under the current government. Fortunately, there is an alternative way of achieving the same objective.

On 21 March, George Osborne, in his Budget speech, should announce that he is transforming the Green Investment Bank into an institution that can make a macroeconomically significant - and direct - contribution to recovery and growth.

Robert Skidelsky is professor emeritus of political economy at the University of Warwick and author of "Keynes: the Return of the Master".

Felix Martin is a macroeconomist and bond investor, whose book "Money: the Unauthorised Biography" will be published in 2013

This article first appeared in the 05 March 2012 issue of the New Statesman, The last Tsar

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How can Labour break the Osborne supremacy?

The Conservative hegemony is deeply embedded - but it can be broken, says Ken Spours.

The Conservative Party commands a majority not just in the House of Commons, but also in the wider political landscape. It holds the political loyalty of expanding and powerful voting constituencies, such as the retired population and private sector businesses and their workers. It is dominant in English politics outside the largest urban centres, and it has ambitions to consolidate its position in the South West and to move into the “Northern Powerhouse”. Most ambitiously, it aims to detach irreversibly the skilled working classes from allegiance to the Labour Party, something that was attempted by Thatcher in the 1980s. Its goal is the building of new political hegemonic bloc that might be termed the Osborne supremacy, after its chief strategist.

The new Conservative hegemony is not simply based on stealing Labour’s political clothes or co-opting the odd political figure, such as Andrew Adonis; it runs much deeper and has been more than a decade the making. While leading conservative thinkers have not seriously engaged with the work of Antonio Gramsci, they act as if they have done. They do this instinctively, although they also work hard at enacting political domination.

 Adaptiveness through a conservative ‘double shuffle’

A major source of the new Conservative hegemony has been its fundamental intellectual political thinking and its adaptive nature. The intellectual foundations were laid in the decades of Keysianism when free market thinkers, notably Hayak and Friedman, pioneered neo-liberal thinking that would burst onto the political scene in Reagan/Thatcher era.  Despite setbacks, following the exhaustion of the Thatcherite political project in the 1990s, it has sprung back to life again in a more malleable form. Its strengths lie not only in its roots in a neo-liberal economy and state, but in a conservative ‘double shuffle’: the combining of neo-Thatcherite economics and social and civil liberalism, represented by a highly flexible and cordial relationship between Osborne and Cameron.  

 Right intellectual and political resources

The Conservative Party has also mobilised an integrated set of highly effective political and intellectual resources that are constantly seeking new avenues of economic, technological, political and social development, able to appropriate the language of the Left and to summon and frame popular common sense. These include well-resourced Right think tanks such as Policy Exchange; campaigning attack organisations, notably, the Taxpayers Alliance; a stratum of websites (e.g. ConservativeHome) and bloggers linked to the more established rightwing press that provide easy outlets for key ideas and stories. Moreover, a modernized Conservative Parliamentary Party provides essential political leadership and is highly receptive to new ideas.

 Very Machiavellian - conservative coercion and consensus

No longer restrained by the Liberal Democrats, the Conservatives have also opted for a strategy of coercion to erode the remaining political bastions of the Left with proposed legislation against trade unions, attacks on charities with social missions, reform of the Human Rights Act, and measures to make it more difficult for trade unionists to affiliate to the Labour Party. Coupled with proposed boundary changes and English Votes for English Laws (Evel) in the House of Commons, these are aimed at crippling the organisational capacity of Labour and the wider Left.  It is these twin strategies of consensus and coercion that they anticipate will cohere and expand the Conservative political bloc – a set of economic, political and social alliances underpinned by new institutional ‘facts on the ground’ that aims to irrevocably shift the centre of political gravity.

The strengths and limits of the Conservative political bloc

In 2015 the conservative political bloc constitutes an extensive and well-organised array of ‘ramparts and earthworks’ geared to fighting successful political and ideological ‘wars of position’ and occasional “wars of manoeuvre”. This contrasts sharply with the ramshackle political and ideological trenches of Labour and the Left, which could be characterised as fragmented and in a state of serious disrepair.

The terrain of the Conservative bloc is not impregnable, however, having potential fault lines and weaknesses that might be exploited by a committed and skillful adversary. These include an ideological approach to austerity and shrinking the state that will hit their voting blocs; Europe; a social ‘holding pattern’ and dependence on the older voter that fails to tap into the dynamism of a younger and increasingly estranged generation and, crucially, vulnerability to a new economic crisis because the underlying systemic issues remain unresolved.

 Is the Left capable of building an alternative political bloc?

The answer is not straightforward.  On the one hand, Corbynism is focused on building and energizing a committed core and historically may be recognized as having saved the Labour Party from collapse after a catastrophic defeat in May. The Core may be the foundation of an effective counter bloc, but cannot represent it.  A counter-hegemony will need to be built by reaching out around new vision of a productive economy; a more democratic state that balances national leadership and local discretion (a more democratic version of the Northern Powerhouse); a new social alliance that really articulates the idea of ‘one nation’ and an ability to represent these ideas and visions in everyday, common-sense language. 

 If the Conservatives instinctively understand political hegemony Labour politicians, with one or two notable exceptions, behave as though they have little or no understanding of what is actually going on.  If they hope to win in future this has to change and a good start would be a collective sober analysis of the Conservative’s political and ideological achievements.

This is an extract from The Osborne Supremacy, a new pamphlet by Compass.

Ken Spours is a Professor at the IoE and was Convener of the Compass Education Inquiry. The final report of the Compass Education Inquiry, Big Education can be downloaded here.