David Cameron and George Osborne have still not developed a full-throated industrial policy that would encourage companies to spend money on investment and innovation
Silent panic and a disastrous fatalism now define British economic policy. There is no vision of what kind of economy Britain should develop, too little willingness to fashion new tools that might produce it and no leadership that might get us there. Instead, there is a stifling acceptance that nothing game-changing can or should be attempted to correct the worst economic performance for more than 100 years.
The facts of the situation can be briefly stated. The production of goods and services in Britain is still below the levels of four years ago and will not recover to those levels for another two – a recession deeper and very much longer than even 1929 to 1933. Measures that stimulated the economy after past big recessions, such as the imperial preference of the 1930s, which promoted trade within the British empire, or the bonfire of controls on the banking system in the 1980s, are not remotely possible. What is required is purposive intervention – and it precisely this that is lacking.
Meanwhile, the cumulative stock of private debt built up by individuals, home buyers, banks and companies over the last 20 years to levels proportionally higher than anywhere else in the world is suffocating economic activity. British companies are running a cash surplus of some 6% of GDP, again the largest in the world, but are refusing to spend that cash on investment or innovation, preferring to hoard it, preserve profit margins or buy back their own shares. Business investment as a share of GDP is thus the lowest among large industrialised countries. Banks, still vastly overstretched, are cutting their new lending to smaller and medium-sized businesses despite their promises otherwise.
Thus, while Britain possesses a highly efficient labour market in which people search for jobs ultra-aggressively because their miserly benefits are dependent on their doing so, unemployment is climbing inexorably towards 3 million. There is one overwhelming reason: lack of demand. Companies and banks are standing on the economic sidelines while the government is cutting its spending, a process that is only just beginning.
This conjunction of circumstances is neither God-given nor unavoidable. It is a matter of policy choice – of prioritising rapid public debt reduction over any other goal, oblivious to the conditions that have laid the economy low. Too many are still blindly trusting in the imagined dynamism of Britain's business sector to come to the rescue. It will not. A desperate business secretary, Vince Cable, last week wrote publicly to the prime minister and deputy prime minister pleading for the government to develop a vision of what Britain should become economically, backed by a full-throated industrial policy. Mr Cameron and Mr Osborne say some of the right words. What must gall Cable is that they back it with no decisive action, vision or willingness to challenge the interests that gain so enormously from the current position.
One of their problems, as it would be for any other government, is that it is not just a legacy of private debt and long-standing neglect of productive enterprise that is dragging the economy down. It is the incentives and attitudes of much of our business and financial leadership built up over the last 20 years interacting with the devastating impact of a still overvalued exchange rate.
An important paper by City economist Andrew Smithers, "Britain Needs a Weaker Pound and Lower Profits", makes the point that one of the chief reasons why companies are hoarding cash and refusing to build up productive capacity is that this is a rational course of action if the aim is to sustain a high share price. Too much of directors' pay comes in annual bonuses paid as share options, he argues, so that their overwhelming preoccupation is to do whatever it takes to keep the share price up – which is personally enriching – rather than grow the company. The way it works is that new capacity would reduce profit margins, hitting rates of return and share price. Bonuses paid in shares, writes Smithers, have until now been seen as a social problem. In fact, they are an economic problem – a perverse incentive that is producing a collective economic failure.
Smithers is right. Only American company directors are paid more than the British, but once you adjust for size of company turnover many British directors are the highest paid in the world, yet they preside over companies uniquely unwilling to invest and innovate. Part of the problem is that they don't want to back a stagnant British economy where the prospective financial returns are so low, in part because the still high exchange rate makes our relative wage costs high and in part because growth prospects are so poor. But this state of affairs is reinforced by their own collective decision not to invest, so conserving, as they imagine, their individual share price.
But imagine the reaction if the government were to take action on annual bonuses paid in shares by, say, proposing very high bonus taxes (except if directors were to "earn back" part of their base pay by performance). If relieving Fred Goodwin of his knighthood was portrayed as anti-business playing to the gallery, to try to eliminate annual bonuses paid in shares would be seen as positively Bolshevik, even though it is obvious that they are now a major factor holding back corporate investment. Mr Cable's instincts on this matter are right; Mr Cameron's wrong.
It is hard not to be pessimistic: the governor of the Bank of England urges patience as once again he embarks on another round of quantitative easing, but obstinately refrains from finding direct ways for the £50bn of printed cash to help the economy. We could, for example, buy foreign assets, so lowering the exchange rate. Or we could invent mechanisms, such as demanding the Treasury indemnify securities, made up of new loans to small and medium-sized enterprises, so that the cash could end up fast where it is most needed. This is inactivity disguised as activity. As an exercise in avoiding blame, it is masterly. As a contribution to solve our problems, it is close to useless.
Meanwhile, depressing signals of decline and depression abound. To get beyond the years of slow growth and austerity ahead requires a shared vision by our political, financial and business leadership and then the willingness to make common cause and take the risks to achieve it. The silent panic at the heart of government is more than justified. This is too brittle and fragile a condition to hold. Increasingly, the only issue is how and when it will break.