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George Osborne: A New British Economic Model

Thank you for inviting me, for the second time, to speak to your annual Conference.

Let me, on behalf of you all, thank your Director General Stephen Hadrill for all he has done in the last few tumultuous years to ensure the interests of the members of the ABI are fully and intelligently represented.

We all wish him good luck at the Financial Reporting Council.

For the past few weeks politics has pushed economics off the headlines.

We have had the scandal of the parliamentary expenses.

Now we have the Prime Minister fighting for survival.

The most damaging impact of the chaos now engulfing the Labour Party is that the Government has become incapable of looking beyond the next twenty four hours.

This leadership crisis is bad for the country and bad for the economy.

It's not just Gordon Brown's job that is at stake in this Labour civil war; the jobs of thousands of British people are at stake as confidence in the UK is damaged.

And so the challenge of the alternative government is now to provide the clarity, leadership and direction the country needs

To show that we have learnt the lessons of the last decade, and that we offer the country a new British economic model.

Today I want to explain what that new British economic model could look like, and the role that our financial services industry - including the insurance sector - could play in it.

Conservative economic policy in a new Government will be rooted in three priorities.

The immediate priority is to restore Britain's international credibility and preserve our credit rating with a clear plan to deal with the huge budget deficit - because we will all pay a heavy price if our country's credibility is lost.

The medium term priority is to make the transition from an economy built on excessive debt to one built on savings and investment - because when the recovery comes it must be sustainable.

And the long term priority is to re-focus our economy from the rush for short term gains to the pursuit of long term returns - because we need to end British short-termism if we are to raise our potential and our productivity.

If we follow these three priorities I believe we can do much more than simply survive this recession.

We can emerge from it with a stronger, more geographically balanced, and more broadly based economy in which more of the British people feel they are sharing in its success.

We should not be satisfied with turning back the clock to how things were before the crisis, or we risk simply pumping the bubble back up.

That would mean failing to understand a crucial insight that has become increasingly clear - that the model of economic growth pursued over the last ten years is fundamentally broken.

We can no longer rely on cheap borrowing from China and the rest of Asia to fund our standard of living.

The drivers of change we have depended on - housing, banking and rising Government consumption - cannot be relied upon to drive growth in the decades ahead.

In short, you cannot build lasting prosperity on a mountain of debt

Today I want to explain how a new British economic model can emerge from the wreckage of this recession.

Given the scale of Britain's public debt crisis, the immediate priority for the next government must be to restore Britain's international credibility.

Last month's warning from Standard & Poors made it clear that Britain's crucial triple-A credit rating is on probation.

If it is lost we will pay a heavy price in higher interest rates on government borrowing and even bigger increases in our national debt.

The credit rating agencies and international investors are looking beyond the next election to the potential next Conservative Government for reassurance that Britain will take the steps necessary to bring our surging national debt under control.

That is because we have consistently underpinned our economic policy with a firm commitment to fiscal responsibility.

Three years ago we made sound money our priority.

Last Autumn we opposed the temporary VAT because we thought it was an expensive mistake

And at this Budget we made it clear that the Government's spending plans do not constitute a credible plan for returning the public finances to balance.

The next Conservative Government is now far advanced in plans to create an independent Office for Budget Responsibility that will take over responsibility for publishing the Budget forecasts and will hold us to our commitment to return the government finances to current balance.

As a result, the Conservative Party's reputation for fiscal responsibility is already helping the recovery by shaping market expectations of the prospects for the cost of government borrowing and debt in twelve months time.

The markets are saying that Britain needs a Conservative Government with a working majority if we want to avoid the costs to the British people of the country's debts rising.

In other words re-electing this Labour Government is a risky choice for the British people and the British economy.

It means more instability, higher taxes, higher debt and higher debt interest costs, while a Conservative Government means stability, lower debt and lower debt interest costs.

The traditional political calculation has been turned on its head by the markets.

Re-electing the incumbent government is now the risky choice.

Electing a new Conservative Government is the safer choice for a strong recovery.

If restoring Britain's international credibility and safeguarding our credit rating is the immediate priority, the medium term priority is to make the transition from an economy built on debt to one built on savings and investment.

The story of the British economy over the last decade can be broadly characterised as too much consumption paid for by too much debt.

The evidence was there in our persistent current account deficit, as we borrowed from abroad to fund our spending.

It was there in our banks, which became amongst the most indebted, most leveraged in the world, with tangible assets thirty nine times tangible equity compared to seventeen times in US banks.

And it was there in our households, which became the most indebted of any major economy, more even than America's, with debt to income standing at 175% for the average British family compared to 140% for the average American family.

But it wasn't just British households and British banks borrowed to pump up the bubble.

The contribution to the last decade's unsustainable boom of Government consumption is not as well understood as it should be.

General Government Consumption, which excludes benefit spending and capital investment, was less than 18% of GDP in 1998 but is now set to break through 24% of GDP - the highest level since the war.

In the Eurozone over the same period it has hovered steadily around 20% of GDP.

We used to think of the continental model as a byword for excessive government spending - Britain has now overtaken it.

The tragedy is that, despite the rhetoric, this government spending boom was mainly in consumption, not in investment, leaving us with little to show for it except the largest budget deficit in the G20 and in our peacetime history.

Sustainable growth over the next decade cannot rely on another debt-fuelled consumption boom, whether by households or Government.

Instead we are going to need investment in infrastructure and new technologies to drive growth in the years ahead.

When I met him last month in Washington it was clear that Treasury Secretary Tim Geithner understands that this is true in the US as it is in the UK.

As he said a week ago in Beijing, "after a long period of falling saving and substantial growth in household borrowing relative to GDP, consumer spending in the United States will be restrained for some time relative to what is typically the case in recoveries. These are necessary adjustments. They will entail a longer, slower process of recovery, with a very different pattern of future growth across countries than we have seen in the past several recoveries."

In Britain we need investment to improve our persistently poor productivity and to create the assets that can begin to offset the debts on our nation's balance sheet.

Yes, we want to attract investment from abroad.

But for too long we have relied on an unsustainable flow of cheap foreign savings from Asia and the Middle East to fund investment.

We need to start building a pool of domestic savings to drive our growth - that means a structural increase in the amount we save.

As Mervyn King said recently, "as part of a longer-run rebalancing of the UK economy, an increase in our national saving rate, both private and public, is necessary."

For Government that means tackling the debt crisis and putting the public finances back on a sustainable path.

For companies it means reducing the reliance on debt and leverage to increase returns - assisted by reducing the bias in our corporate tax system against equity and towards debt financing.

And for households it means nurturing a culture of saving that has been so damaged over the last decade.

That damage has come from many directions, including a widespread belief that rising house prices would pay for our retirement.

But most of all it has been inflicted by persistent attacks on our savings and pensions industry through the tax system and new regulations.

Encouraging saving through the tax system will be a central task for the next Conservative Government.

We can start by avoiding the uncertainty and damage caused by unpredictable and rushed changes to the tax system.

The U-turns on ASPs and pension term assurance, the changes to accumulation and maintenance trusts, and the surprise restriction of higher rate tax relief in the Budget are only the most recent examples of the instability that has persistently undermined confidence in the certainty of the tax system over the last twelve years.

I don't want a Conservative Government to make the same mistakes. That's why I have said we will adopt the key proposals of a report I commissioned from Lord Howe on reforming the way we make tax law.

Those include a new requirement that all technical changes will have to be published at the Pre-Budget Report ahead of the Budget, with proper Parliamentary scrutiny able to take evidence from outside experts.

We will also make use of the expertise available in the tax professions with secondees working together with officials in a new Office for Tax Simplification whose remit will be the systematic simplification of the existing tax code.

Reducing uncertainty is one important step towards rebuilding our savings culture.

We also proposed at the Budget the abolition of basic rate tax on savings income.

We are committed to raising the Inheritance Tax threshold to £1 million so that only millionaires pay tax on what they have saved to pass on to their children.

We want to abolish compulsory annuitisation at 75, conditional on having sufficient income in retirement to avoid means-tested benefits.

And we want to resolve the Equitable Life debacle in a way that is fair to policy holders and restores broader confidence in the industry.

We will produce more proposals in due course, but I hope that the savings and pensions industry will play its part in re-building our savings culture by providing products that are transparent, reliable and competitive.

I want to work with you to make sure we have a regulatory system that allows you to do that.

The introduction of Personal Accounts is the biggest immediate challenge in this area.

It would be a disaster if Personal Accounts were to end up undermining saving even further instead of encouraging it.

We have made it very clear that we have grave concerns about the potential for mis-selling to people who risk losing means-tested benefits by saving, the operating costs of the new system - which the Government now admits will be much higher than originally claimed - and the risk of employers 'levelling down' the generosity of their pension provision.

Our Shadow Work and Pensions Secretary Theresa May will continue to press these concerns with the Government.

So the immediate priority for Conservative economic policy is to restore Britain's international credibility, and our medium term priority is to make the transition from an economy built on debt to one built on savings and investment.

Together these will help to ensure a sustainable recovery.

But if we are to build a truly new British economic model we need to address some persistent and deep rooted weaknesses.

That is why our long term priority is to re-focus our economy from short term gains to long term returns.

The charge of short-termism and underinvestment in long term productive assets has frequently been aimed at Britain's economic model, and with some good reasons.

We have lower levels of physical capital per worker than our main competitors, and research by the OECD and the National Institute of Economic and Social Research has shown that in key sectors this is an important part of the explanation for our long-standing productivity gap with countries such as France and Germany.

Our physical infrastructure is older and far more congested than the average for OECD countries, particularly our transport and energy networks.

And our levels of investment in R&D and innovation are significantly lower than the US, Japan, Germany and France.

Will Hutton, now the Chief Executive of the Work Foundation has set out a powerful critique of an approach to economic management that encourages short term rent-seeking and undervalues long term investment in productive assets.

As he wrote recently, "my generation's opportunity seriously to reform the way Britain does capitalism... - and with it the living standards of millions - has been squandered."

A similar argument from a very different view point has been put forward in recent years by Sir John Rose, the Chief Executive of Rolls Royce, one of our most successful high tech engineering businesses.

Sir John sits with other external members on the Conservative Economic Recovery Committee which is chaired by David Cameron and meets every fortnight.

As I have seen on visits to their plants in Lancashire and Derby, Rolls Royce cannot afford to think short term.

They compete in a global industry where product life-cycles - from R&D, production and service to obsolescence - may be as long as sixty years.

Yet they survive despite Britain's economic model, not because of it, and we cannot take it for granted that they will continue to invest in new R&D and production facilities at home when their workforce is increasingly global.

As John Rose himself has said, "the credit crunch could provide the impetus we need to answer a question that has defeated policymakers for more than 50 years: how can manufacturing be encouraged to create wealth as part of a competitive, high-value British economy?"

The solution to this systemic problem is not to go back to the bad old days of picking winners or national champions.

Nor should we ever abandon the huge benefits of vibrant competition and free trade that have helped to liberate our economy over the last thirty years.

But Britain should be taking a longer term and more strategic attitude to investment in infrastructure, skills and new technologies.

That's why we are developing detailed plans for the next Conservative Government to invest in a new high speed rail network, for a smart electricity grid, and for investment in carbon capture and storage technology.

These investments have the potential to generate hundreds of thousands of high quality jobs while simultaneously reducing our carbon emissions.

But in a period where government capital budgets are likely to be constrained, we need to prioritise public funds and develop new ways of financing long term investments like this.

The role of Government will vary according to the nature of the investments.

In some cases, such as nuclear power, government needs to act as a facilitator, setting long term price signals that make private investment less risky and ensuring that planning costs are not prohibitive.

In others, such as smart grids, it needs to make sure that the regulatory incentives are correctly aligned.

And in those cases where government ultimately needs to provide some of the funding, such as high speed rail, we are working on reforms to the discredited PFI model that are transparently accounted for and genuinely shift risk to the private sector.

At the heart of all of this must be a financial system that is able to channel affordable finance into investments that may not pay off for decades, whether they are large infrastructure projects or a small company investing in cutting edge new technology.

The City has long been accused of short-termism.

Its critics have often ignored the huge contribution it makes to our economy, but the events of the last two years make the charge of short-termism harder to refute.

An excessive focus on short term profits that often turned out to be illusory has damaged not only the financial sector but the whole economy.

It's clear that we need to reform our system of financial regulation to reduce the risks the financial sector poses to the rest of the economy.

Let me be clear that I don't want to tar the whole financial services sector with the same brush.

I know that many of you are frustrated that our public debate often fails to differentiate between the insurance sector and banking.

You are right to argue that most insurers did not contribute to the crisis in the same way as the banks, although of course AIG and the monolines were at the very heart of the credit crunch.

Indeed in some respects insurance offers a model for what a more responsible City could look like.

Yours is a long term business that does not depend on being leveraged up to the hilt.

As a result your industry has so far survived the crisis with no need for government bail outs.

And I know that the ABI is now leading the way on reform in a number of areas including transparency, consumer protection and risk management.

But I want to argue that as institutional shareholders you too have a crucial role to play in building a new British economic model that truly values long term wealth creation.

Better financial regulation means at the very least new rules for capital and liquidity, better micro and macro prudential regulation of risk, and fundamental reform of the failed tripartite system of regulation created in 1997.

Over the next few months we will be setting out our proposals in more detail, following the interim report that I commissioned from Sir James Sassoon.

I want those proposals to recognise the special needs of the insurance industry, so I hope you will continue to engage with me, James, Mark Hoban and the rest of my team to help us get them right.

While better regulation is clearly necessary, together we must ensure that badly designed new regulation and uncompetitive tax rates do not needlessly undermine London's competitive advantage.

That would just force more industries offshore, following in the footsteps of the reinsurance industry and companies like Amlin and Hiscox.

The proposed draft directive on alternative investment fund managers is a classic example of badly thought through regulation that could do real damage to our economy.

And I know that your industry has been concerned about the Government's failure to represent British interests over Solvency 2.

European regulation in particular is going to be crucial, yet the evidence is that Treasury ministers are currently absent from the European debate.

A Conservative Treasury and our large group of MEPs will actively engage with Europe to make sure that any new regulations meet the needs of our economy.

But as well as better regulation, we also need to bring about a deeper change in order to embed a culture of long term investment at the heart of our financial system.

We need a financial system that measures returns over many years and decades, not just quarters.

Part of the solution must be reforming a system of remuneration that emphasised short term gains over long term returns.

Some banks are now making big profits again from higher margins, underpinned by taxpayer guarantees.

It would be a huge mistake if they pay out huge bonuses this year end on the back of these government-supported profits.

The City should remember that the inter-bank guarantees, the liquidity operations, the insurance schemes and the large equity stakes exist to protect the wider economy.

The banks should be using their profits to rebuild their balance sheets, not to hand out huge bonuses while the rest of the economy picks up the pieces for the follies of finance.

But the change of culture needs to go far deeper than bonuses.

Partly that means ensuring that we have a truly competitive banking industry to improve the supply of long term credit to British businesses, particularly SMEs.

I don't believe that we should be comfortable with a banking industry that is becoming more concentrated than ever - we should use the disposal of government stakes to strategic effect and in the interests of the wider economy.

But we also need to embed a new culture in new institutions that value investment in long term assets and technologies.

Such institutions have worked well in the past. After all it was a Conservative Government that formed Investors in Industry - which became today's 3i - out of the Industrial and Commercial Finance Corporation

The ICFC successfully provided long term debt financing to large swathes of British industry, and in particular the small and medium sized businesses that were not always well served by the banks.

I believe we should examine the case for creating such institutions today, particularly now that our banking industry is more concentrated than ever before.

In particular we need to encourage long term equity investments in the entrepreneurs and success stories of tomorrow.

One of the most damaging impacts of the credit boom was that real venture capital in exciting new businesses was squeezed out by highly leveraged private equity.

Figures from the British Venture Capital Association show that early-stage investments have slumped from 11 per cent of total equity value invested in 2000 to less than 4 per cent in 2007.

You might think that the middle of a recession is not the time to be investing in the businesses and entrepreneurs of the future, but you couldn't be more wrong.  It's actually exactly the right time.

Half of the top 50 US companies in the Fortune 500 were incorporated during a recession, including seven out of the top ten.  Even in this savage downturn, new markets and business opportunities are emerging all the time, and if we don't seize them someone else will.

It is start-ups and new technology, not bail outs, that will drive our recovery

Ultimately, however, it is large institutional shareholders - including members of the ABI - that have the most power to change incentives for the better throughout our economy.

What may seem like small changes to structures and incentives could go a long way to improving our corporate governance and building a new culture of long term investment.

I welcome the signs that institutional investors are becoming more assertive in holding management to account, particularly when it comes to remuneration.

And I welcome last week's proposals from the Institutional Shareholders Committee for improved engagement by investors.

But there is still much further to go. I look forward to working with the ABI and other investors to bring about a new culture of long term investment.

So these will be the three priorities for Conservative economic policy.

Restoring Britain's international credibility and preserving our credit rating.

Making the transition from an economy built on debt to one built on savings and investment.

And re-focusing our economy from the rush for short term gains to the pursuit of long term returns.

This economic crisis offers the opportunity to build a new British economic model.

That is the alternative vision that we will offer at the next election.

I look forward to working with you to make it a reality.

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