Osborne speech in full
Read George Osborne’s full speech to the Spectator’s ‘Paths Back to Prosperity’ conference this morning.
Today I want to set out the Conservative strategy for the recovery.
I want to argue that we must draw the correct conclusions from the last two years if we are to design the right policies for the future.
And, just as the Conservatives have comprehensively won the spending argument by forcing the Labour Party to admit that cuts are necessary and inevitable, we must now win the next argument about what kind of recovery we want.
How do we get a recovery that is strong and enduring?
How do we get borrowing under control so we can keep interest rates lower for longer?
Do we want to pump up the bubble again and repeat all the economic mistakes that got Britain into this economic mess?
Or do we want to build a truly sustainable recovery by gradually rebalancing our economy away from debt and towards saving and long term investment?
After the experience of the last few years I know which of these options the British people would choose – real growth, not a temporary illusion.
And I know the right policies to achieve it, because they are the same policies that David Cameron and I have been arguing for since the beginning of this crisis – monetary activism, fiscal responsibility, and supply side reform.
Monetary activism to keep interest rates low and stimulate the economy.
Fiscal responsibility to restore confidence and rebuild our battered public finances.
And supply side reform to build a new British economic model, with more investment in long term productive assets to equip our economy for the opportunities that any global recovery will bring.
The starting point for any discussion of economic policy in the recovery must be a proper understanding of what has happened over the last two years and what is driving the gradual improvement in leading economic indicators that we are currently seeing.
The Labour claim is that their policies have seen us through the recession.
It is not clear what they mean by ‘seen us through’.
Other major economies including France, Germany and Japan emerged from recession in the second quarter of this year, while the UK economy continued to shrink by -0.7%.
The UK is now the only major economy for which the OECD is predicting no growth at all this calendar year, although we hope they are wrong.
And unemployment has risen faster here than in Germany, France, Japan and 16 other OECD countries.
If that is Labour’s idea of seeing us through a recession then it’s not really anything to boast about.
Of course, there is no question that the global outlook is improving.
Partly this is a result of factors beyond the control of policy makers – inventories cannot be run down forever, and the catastrophic impact of the financial crisis last autumn on the machinery of global trade and finance is lessening over time.
But we also need to understand which parts of the policy response have had the biggest impact.
Gordon Brown emphasises the role of what he now calls his “massive fiscal stimulus”.
Let us be absolutely clear – the Conservatives have consistently argued that, in those countries that could afford it because of the budget surpluses or small deficits with which they began the crisis, a well targeted fiscal stimulus could be a sensible part of the policy response to the recession.
You fix the roof when the sun is shining so that it can protect you when it rains.
But sadly the UK went into the recession with the largest budget deficit of any major economy.
Even that understated our precarious position – our public finances were particularly dependent on the boom in housing and financial services, with the result that according to the IMF the automatic deterioration in Britain’s public finances as a result of the crisis has also been the largest of any major economy.
No wonder we now face the prospect of the largest budget deficit of any G20 country – by far the largest in our peacetime history.
In other words, we couldn’t afford a further, discretionary, fiscal stimulus.
Britain’s fiscal stimulus also failed the other test – it was not well targeted.
But by far the largest part of the UK’s discretionary fiscal stimulus was the temporary reduction in VAT – accounting for well over half of the total cost at £12.5 billion.
The Conservatives stood by our principles and opposed this ill-conceived and expensive policy, despite the short term political cost, and I believe that difficult judgement has been vindicated.
Nobody – and, judging by the fact that they now barely mention it, this includes many members of the Government – believes that the VAT cut has been a good use of taxpayers money.
A PWC survey last month concluded that “the reduction in the rate of VAT from 17.5% to 15% late last year has had little or no impact on consumer spending”.
That shouldn’t be a surprise.
The Chief Economist at the IMF, Olivier Blanchard, said at the time that a temporary cut in VAT “does not seem to me to be a good idea.”
And the major retailers united in saying it had made no impact.
So if Britain’s fiscal stimulus has been a failure, which part of the policy response has had an impact?
Around the world, but particularly in the UK, it has been the unprecedented monetary stimulus.
As Mervyn King said in his Mansion House speech: “perhaps most important is the enormous policy stimulus that has been injected into the economy. Bank Rate was cut by four percentage points in four months.”
For an economy like the UK – with the largest private sector debt burden of any major economy in history – lower interest costs are by far the most powerful tool we have to stimulate demand, prevent defaults, and help households and businesses to start paying down debt.
Bank of England rate cuts are saving British households more than £30 billion a year in interest payments.
That’s almost three times as big as the VAT cut, and at no long term cost to the taxpayer.
This response – “radical monetary activism” in the words of David Cameron – is the prescription that the Conservatives have consistently called for during this recession.
As I said in a speech at the beginning of this year, “it is monetary policy, and specifically action on credit, that will be the most effective way of reducing the length and severity of this recession.”
That is why it was so important to prevent the collapse of the banking system last year, and why the Conservatives supported the package of capital injections, guarantees and liquidity operations that is still propping up our banks.
So this is the correct analysis of the last two years: around the world it is first and foremost monetary activism that has been the most effective tool in countering the severity of the recession.
What can this tell us about the right policies for the future?
The answer depends on the kind of recovery that we want.
It is increasingly clear that the Labour Party is either unable or unwilling to learn the lessons of the last decade.
Their strategy for the recovery is to try and pump the bubble back up with more government spending and debt-fuelled consumption.
As with our failed system of financial regulation, or our broken politics, they seem to think we can carry on much as before, with a few tweaks here and there.
That is not just the wrong conclusion, it is a dangerous fantasy.
Government spending and debt-fuelled consumption were the principal drivers of growth during the boom – indeed the rapid growth of government spending accounted for two thirds of all net job creation.
But that growth turned out to be an unsustainable illusion when the boom turned to bust.
Any recovery built on the same foundations will be just as unsustainable.
As I have argued before, “the model of economic growth pursued over the last ten years is fundamentally broken. you cannot build lasting prosperity on a mountain of debt”.
A sustainable recovery needs new drivers of growth that will start to rebalance our economy from one built on debt to one built on savings and investment.
If we cannot rely on government spending and debt-fuelled consumption, a simple process of elimination leads to the inescapable conclusion that a sustainable recovery must be led by private sector investment and export growth.
Our aim must therefore be nothing less than a new British economic model: an economy with a structurally higher rate of national saving, a more competitive export sector, and higher rates of private investment in long term productive assets.
That will require fundamental change across the whole spectrum of economic policy, including taxation, infrastructure, skills, housing and financial regulation.
But most importantly, it means that the combination of monetary activism and fiscal responsibility that we have called for throughout the recession is also the right prescription for the recovery.
Both economic theory and international evidence tell us that the policy mix most likely to support a vigorous and sustainable recovery, led by private sector investment and exports, is low interest rates and tight fiscal policy.
And by combining these with a new programme of supply side reform to improve our competitiveness we will be best placed to benefit from the exciting opportunities that a global recovery will bring.
So these are the three components of the Conservative strategy for the recovery – monetary activism, fiscal responsibility, and supply side reform.
Let me explain each in turn.
First, monetary activism.
The most important reason why the Labour argument for ever more spending is simplistic and wrong is that it assumes that fiscal policy operates in isolation.
In fact, just as it should have been during the recession, the main focus of economic policy during the recovery should be on keeping down the interest rates paid on our enormous private and public debt burden.
That means not only the short term policy rates set by the Bank of England, but also the medium and longer term market interest rates that determine the cost of mortgages and business loans.
One of the first conversations any new Chancellor would want to have is with the Governor of the Bank of England.
The independent Monetary Policy Committee is responsible for setting interest rates.
They must remain focused on that goal, and eventually on managing an exit strategy that avoids both excessive inflation and deflation.
But as the Governor has made clear on many occasions, in doing that they take into account what the Government is doing with fiscal policy.
That is why tight fiscal policy will allow the independent MPC to keep interest rates as low as possible for as long as possible while keeping inflation and inflation expectations securely anchored.
That must be combined with a proper system of financial supervision and so called macro-prudential regulation to prevent the excesses of the last decade from returning.
And it also means ensuring that what is known as the ‘monetary policy transmission mechanism’ is functioning properly – in other words making sure that reductions in short term policy interest rates are ultimately passed through to households and businesses in lower borrowing costs.
That is why it is so important for our recovery that we have a healthy banking system.
If the banking system remains undercapitalised – with so called ‘zombie banks’ – then the monetary transmission mechanism will be broken.
As happened in Japan, lower policy rates will be absorbed by the banks in the form of higher margins and profits in order to rebuild their balance sheets, instead of being passed on to households and businesses.
Monitoring bank margins and the extent to which lower interest rates are passed through to consumers should be a key focus of economic policy.
That means ensuring that the banks remain adequately capitalised – Moody’s reported yesterday that British banks may be less than half way through recognising the true scale of the losses on their balance sheets.
It also means that increased competition – whether through new entrants, the expansion of existing smaller players, or divestments by dominant groups – is vital in order to achieve a better deal for customers and put downwards pressure on margins.
The importance of a healthy banking system for the broader economy also explains why the concern about bankers’ bonuses and remuneration is grounded in serious economic analysis.
Let me be clear: a Conservative Government will want financial services to succeed, compete and innovate. Making London the premier home of global finance will be a key objective of policy and we will resist ill-designed European regulation that threatens that objective.
But the entire banking system – not just the banks with government stakes – remains dependent for its survival on a vast range of taxpayer support, from inter-bank guarantees to the Bank of England’s ongoing liquidity operations.
The profits that the banks are making are therefore not simply the results of success, they are subsidised profits.
What we have at the moment is a free option not a free market.
And it is important to remember that we are underwriting these profits for a purpose – to help recapitalise the banks and support the broader economy, not so that they can be paid out as huge bonuses or distributed as excess returns to shareholders.
Indeed, if banks pay out huge bonuses on the back of taxpayer support instead of using profits to rebuild their balance sheets, that is not only bad for the broader economy, it is bad for the City itself.
It is not in the interests of the financial services sector as a whole to have a small number of government-subsidised players distorting competition by using taxpayer support to bid up remuneration levels.
So the first component of the Conservative strategy for the recovery is monetary activism – keeping the interest rates charged on our huge private and public debt burden down for as long as possible while continuing to ensure that lower rates are passed on by the banks.
This helps to explain the second component – fiscal responsibility – because irresponsible fiscal policy puts low interest rates at risk.
Let me take a step back and reflect on what is taking place in British politics this very day.
Gordon Brown is on the eve of a complete capitulation.
Whether he hoists the white flag today at the TUC, or later at his Conference, or when Parliament returns, we will see. But hoist that white flag he will. For he and his style of politics have been comprehensively defeated.
And it is the Conservatives who have made the right judgement about the biggest economic question that faces this country.
We could have let it go. We could have taken the easy route, ducked telling the public the truth, and avoided a pitched battle with our opponents on the same terrain on which our party had lost so often.
Or we could have the courage to say it as we saw it; to warn our country of the looming debt crisis; to tell the truth that spending will have to be cut whoever wins the election.
That is the hard path we chose. For months we endured the onslaught of Gordon Brown and Labour Cabinet Ministers as they spoke in apocalyptic terms about what would happen if you cut spending.
Time and again this summer in the House of Commons, David Cameron fought back across the Dispatch Box and challenged the Prime Minister to tell the truth.
When people ask: are the Conservatives up to it? I say, look how David Cameron and our party told the truth about the national debt, told the truth about public spending and won the biggest economic argument of the day.
We have shown in the way we have conducted ourselves that we now command the centre of British politics, and we have the character, the judgement and the courage to take this country through the difficult times ahead.
I hope that we can now move on to the next stage of the debate.
A strong Labour leader would go to the TUC Conference today and tell them the whole truth: a decade of uncontrolled spending has left Britain with unsustainable debts, and the people who will suffer the most are our nurses and teachers and low paid public sector workers if we don’t deal with it.
Instead, we have a weak and desperate Labour Leader who is putting fixing the finances of his party ahead of fixing the finances of the country.
Favours not fairness is what Gordon Brown is promising the trade unions – and it is the British people who will pay the high price for this grubby bargain.
And now we know: if by some chance Gordon Brown is re-elected, our national debt will spiral still further out of control.
That will lead to higher long term interest rates, damaging the recovery and destroying jobs.
And in the end a Labour Government will be forced by a combination of mounting interest bills at home, and a loss of international confidence abroad, to hike up taxes and impose across the board cuts in frontline public services.
We have been there before with Labour in the 1970s. We will be there again with Labour if, by some chance, they cling on.
The tragedy is that Gordon Brown himself used to warn against exactly this danger.
He said in 2000 that he rejected the “vicious circle” of “rising debt, higher long term interest rates, higher debt repayment costs, lower growth, higher unemployment and enforced cuts in public spending, the old boom and bust.”
This is why a credible commitment to cut spending and get to grips with our record budget deficit is so vital.
The problem is not just the size of our debt relative to our national income, it is the worrying speed with which it is rising and the size of the fiscal adjustment needed to get it under control.
And while other countries have also seen increases in national debt as a result of the crisis, the UK is almost uniquely vulnerable amongst the major economies – we have the largest budget deficit in the G20, and unlike the US we do not have the luxury of a reserve currency.
The consequences of a loss of international confidence for a debt-laden economy like the UK would be truly devastating.
Just because these risks have not yet materialised does not mean that they are not very real, and the lesson of the last two years is that facing up to problems in advance is much better than trying to clean up the mess when things go wrong.
International experience suggests that the moment of greatest danger may come precisely when growth returns and investors begin to re-assess the long term sustainability of the public finances.
For example the Swedish Government only realised the urgency of the need to control spending after the country was severely affected by the bond crisis of 1994.
There is a further reason for our Government’s current complacency about the size of our fiscal problem.
One side effect of the Bank of England’s programme of quantitative easing is that it is currently providing false comfort on the sustainability of our record levels of government borrowing.
At the moment the Bank is purchasing more debt than the Government is issuing: £143 billion so far compared to the £96 billion of gilts issued by the DMO over the same period.
But when it judges that it has bought enough we will have to rely on international investors to fund our borrowing.
At that point we will start to discover the true market appetite for UK government debt.
As Labour MP Frank Field put it at the weekend, “when the Government is unable to print any more new money to buy its own debt, the market will insist on higher long-term interest rates. This will not only make it more difficult to sustain an economic recovery, but it will increase the cost of servicing this debt.”
Or as Michael Saunders, Chief UK Economist at Citigroup, wrote last week, “gilts remain highly vulnerable if and when the Bank of England’s huge gilt buying programme ends.”
He argues that Conservative plans to cut spending and set up an independent Office for Budget Responsibility to hold politicians to their commitments would “lock in a return to fiscal sustainability” and therefore “help to extend the period of low Bank of England rates and limit upside risks in gilt yields”.
So early action on spending is crucial to maintain market confidence and keep market interest rates down.
But what about the argument that cutting spending risks undermining the recovery by reducing demand in the economy?
Not only does this argument ignore the risks of a loss of confidence and higher interest rates, it is also too simplistic.
It ignores the impact of fiscal policy on the exchange rate in an open economy like the UK.
Ben Broadbent, Chief UK Economist at Goldman Sachs, wrote recently that fiscal tightening in an open economy “has little appreciable impact on aggregate output” because it tends to rebalance demand away from non-traded goods and services and towards the traded sector.
In other words, what you lose in government spending, you gain in exports.
Similarly, research presented to the IMF earlier this summer by Professor Carlos Vegh and colleagues finds that “fiscal policy is more or less powerless to affect output” in open economies.
Gordon Brown appeared to understand this when he told the Labour Party conference in 1997 that “we have learned from past mistakes. you cannot spend your way out of recession.”
Indeed the early 1990s is a good historical example of the way that tight fiscal policy can support a sustainable recovery: real government spending did not grow for four years but exports and investment recovered strongly, resulting in growth of well over 3 per cent a year.
So fiscal responsibility – in the form of early action to control spending, reform public services and reduce the deficit – is the second component of the Conservative strategy for recovery.
It is crucial for maintaining market confidence and helping to keep interest rates low, and the evidence shows that in an open economy it does not undermine recovery by reducing aggregate demand.
The final component of the Conservative strategy for the recovery is a comprehensive programme of supply side reform to equip our economy for the opportunities that any global recovery will bring.
No single policy can achieve this on its own, but we have begun to set out a programme of reform no less radical than the one that restored the UK’s economic competitiveness in the 1980s and 1990s.
Lower corporation tax rates and a simpler tax system.
Radical school reform, welfare reform and better skills.
More private investment in infrastructure and other long term productive assets such as high speed rail and smart energy networks.
The transition to a low carbon economy.
Regulatory reform to create a financial system that serves the long term interests of the economy, not its own short term interests.
We need to build nothing short of a new British economic model that saves more, invests more for the long term, and is greener and more sustainable.
Some of these changes will take time before their full effects are felt, but together they will send out a powerful signal that Britain is once again open for business.
Because we don’t know how quickly the global recovery will come or exactly where it will come from, but we must make sure that we are well placed to benefit from the exciting opportunities for investment and new markets that it will offer.
Despite the financial crisis and the recession, there are still billions of people in the developing world eager to join the global economy as consumers.
And scientists and engineers around the world are still developing the next generation of technologies that will enable them to achieve that aspiration.
With the right combination of monetary activism, fiscal responsibility and supply side reform we can restore confidence in the British economy and take full advantage of these opportunities.
This is the Conservative strategy for the recovery.
It is the only sustainable route from austerity to prosperity.
Because a recovery built on debt is just like an economic boom built on debt – it is living on borrowed time.