Speech to the Centre for Policy Studies
"In the 1970s the Centre for Policy Studies began a revolution in Conservative thinking that transformed the Party and then our country. Now the CPS, under the leadership of Ruth Lea and Norman Blackwell, is again taking a leading role in stimulating debate on the future of the Party - a debate which I hope, in time, will also change our country.
This evening I want to contribute to that debate by talking to you about economic policy. These days that is a little unfashionable. Many of the speeches we have heard from Conservatives recently have focused on social policy - how we create a stronger society; how we tackle problems like drug abuse, failing schools, low aspirations and family breakdown. It is refreshing and exciting to hear Conservatives talking about these issues with passion and confidence.
This is very different from thirty years ago. Then the debate was primarily about economic policy. If you want to know why, come to my office. I've just hung up on the walls a set of brilliant political cartoons from that period lent to me by the House of Commons. One shows Harold Wilson unveiling a car show room called "Austerity". Another depicts Dennis Healey in a balloon called "Hyper Inflation" trying to avoid a mountain called "Unemployment". The most telling has the three party leaders at the time -Wilson, Heath and Thorpe - dropping their Manifestoes as they are engulfed by an avalanche called "Inflation".
That we don't see such political cartoons in the papers today is in large part due to the revolution in economic thinking that took place here at the CPS. But they remind us of something that is as true now as it was then: that without a strong and stable economy, the social promises of politicians are worthless. A strong society depends on a strong economy.
We as Conservatives need to remember that we still lag a long way behind the Labour Party when it comes to public confidence in our ability to manage the economy. However interesting our social policies may be, we will not have the chance to implement them until we gain public confidence in our economic policies. To be blunt: unless we come to be trusted to run the economy we will not be trusted to run the country.
In this speech I hope to map out a route to earning that trust by avoiding short-term populism and engaging instead in the long-term economic challenges this country faces from globalisation. And I hope to show how we can meet those long-term challenges by pursuing an economic policy based on four key objectives: macro economic stability; increased productivity; reduced long term demands on the state; and lower taxes.
The Story So Far
Back in the late 1970s, those Conservatives thinking about economic policy, here in the CPS and beyond, achieved a desperately needed breakthrough. In the preceding decades, the prevailing wisdom was to use microeconomic policy to target inflation - through the prices and incomes policies - and to use macroeconomic policy to target growth, by using monetary and fiscal policy in a number of aborted attempts to 'dash for growth'.
By the late 1970s, it was clear that this approach had failed. The architects of Conservative economic policy realised that we had to perform an about-turn in economic strategy. Microeconomic policies were used to target unemployment and underlying trend growth, and macroeconomic policies were used to target inflation. That change, most eloquently set out by Nigel Lawson in his landmark Mais lecture in 1984, represented a one hundred and eighty degree reversal of previous policy.
In our microeconomic, supply side, reforms, we were enormously successful. We had a broad economic policy that: freed us from exchange and price controls; challenged the power of the trade unions; enhanced competition; privatized unproductive industry; and reformed the labour market so that firms were freer to create jobs and prosperity.
Our macroeconomic policy brought more success to the job of beating inflation. We developed a series of monetary policy tools to fight inflation - first monetary targeting, then exchange rate targeting, and the exchange rate mechanism. But it was only after the exit from the ERM in 1992 that the best tool came to the fore: inflation targeting. Before then inflation targeting was an idea whose time had not yet come.
It is a supreme irony that the moment the Conservative Party lost its reputation for economic competence was the moment that we implemented the most successful macroeconomic strategy in modern times. Inflation targeting since 1992 has so far delivered 51 quarters of uninterrupted economic growth, low inflation, and gradually falling unemployment - the first nineteen of which, I constantly have to remind the Chancellor, happened under a Conservative Government.
What lessons did Labour take from all this?
For over a decade they stuck their heads in the sand. But by the mid 1990s, Tony Blair and Gordon Brown at last came to terms with the Thatcher revolution. So they pledged to stick to Conservative spending plans, promised not to raise income tax rates and accepted that the main trade unions reforms and privatizations were irreversible.
By establishing economic credibility, Labour persuaded the public that they could actually deliver on their promises of social justice as well. Economic efficiency and social justice looked plausible. They went from the politics of 'or' to the politics of 'and'.
Now, after what will be at least twelve years of a Labour Government, we too have to come to terms with the changes that have happened.
In economic policy, Labour immediately made the Bank of England independent and gave it a symmetric inflation target. They formalised the principles that by then governed Conservative fiscal policy, and communicated them in two bite sized rules: the 'golden rule' and the 'sustainable investment rule'. And they rigidly stuck to Conservative spending plans. In other words, they took the next steps in the building on the successful economic framework they inherited from the Conservatives.
It is an irony that these have been their most successful areas of policy - areas where they have stood back and stopped themselves from interfering. But we must recognise that these developments have improved the macroeconomic management of the UK economy.
Simply acknowledging what the rest of the country knows to be true gives credibility to Conservatives to criticize the Government where they have made real mistakes. And there have been plenty of mistakes.
For Labour's success on macroeconomic policy has obscured a microeconomic policy that has been damaging to the functioning of the economy in the long run.
The Chancellor has raised taxes on business and individuals. The CBI estimate that taxes on business has risen by £43 billion since 1997. Taxes on individuals have risen as a proportion of income.
The Chancellor has interfered with business, not through ownership as Labour once did, but through intrusive regulation. Sir David Arculus estimates that the cost of regulation is now a staggering £150 billion, of which one third is administration costs.
The Chancellor has extended a dependency culture and increased the long term demands placed on the State. The slice of national spending made by the state has risen from 37% to 42%.
It's one of the reasons why our productivity growth rate has fallen to half that of the United States, and recently fell again. It's one of the reasons that we have fallen from 4th to 11th in the league table for world competitiveness.
So let's be clear. Gordon Brown has not been the worst Chancellor this country has ever seen. Since 1992 we have had economic growth, low inflation and falling unemployment. But he is spending too much, wasting too much, taxing too much, regulating too much and interfering and meddling too much. These are exactly the opposite of what Britain needs to do to compete in the modern world.
Gordon Brown is failing the economic challenge posed by globalization. China is producing two million graduates a year. India has 1300 engineering colleges. It costs eight times more to train an engineer in Britain as it does in Slovakia. Where once we lost low skill, low paid jobs abroad, we now risk losing the high skill, high paid jobs.
We need an economic strategy that enables Britain to compete in the world and keep those high skill jobs. But the Chancellor's microeconomic policies are taking us in exactly the wrong direction.
Given Labour's failure to meet these long-term challenges what has the Conservative response been?
For far too long the Party has had good ideas, but lacked consistency and clarity.
We have correctly put forward the case for lower taxes, but failed to set that in the context of a broader economic strategy. A taxation policy does not equal an economic policy.
We laid the foundation for the macroeconomic stability that Britain has enjoyed, but we lost credit for it by voting against Bank independence.
We have talked about reform of public services, but we voted against the creation of foundation hospitals. It's good news that we are now supporting City Academies.
We have made theoretical arguments in favour of a smaller state, but in practice we voted against tuition fees.
We have consistently opposed strikes yet tacitly supported the fuel protestors who brought England to a virtual stand still.
Too often we have sacrificed long term credibility for the prospect of winning the support of an aggrieved section of the population or the possibility of winning a vote in the House of Commons. By disagreeing with the Prime Minister when he attempts to do the right thing, we undermine our credibility when we criticize him for doing the wrong thing.
Short termism has hampered attempts to develop a long term economic policy.
I am not looking for any scapegoats. As someone involved in the Opposition since 1997 I blame myself as much as anyone else. But I've learnt my lesson.
We must not fall into the same trap this Parliament. We must never again confuse populism with popularity.
Britain today desperately needs an opposition with a broad, credible, economic policy. That policy must have one over-arching ambition: to achieve rising living standards.
That is not easy in a fiercely competitive world where businesses, wealth creators and capital can increasingly move anywhere.
It means Britain cannot be satisfied with second best. We need an economic policy that provides stability, that improves the productivity of our workforce, that makes sure the state is efficient and effective in the money it spends, and that reduces long term demands on the taxpayer so we can have lower taxes.
Those must be the objectives of a Conservative economic policy primed to meet the challenges of the twenty first century. Let me look at each in turn.
Four Objectives of Conservative Economic Policy
(i) Reinforce macroeconomic stability.
First, all our economic policies must reinforce macroeconomic stability.
Economic stability cannot be guaranteed by the Government. But bad government policy can guarantee economic instability. So nothing we do should endanger the macroeconomic stability that we have enjoyed since 1992. This first objective is paramount, and trumps any other objective as a guide to our economic policy.
Reinforcing stability means that we must always be fiscally responsible - unlike the current Chancellor. He has a structural deficit, no room for fiscal manoeuvre within the golden rule, he's coming up against the ceiling of his sustainable investment rule, and he is presiding over an economy growing below trend that needs tax cuts, not tax rises.
Instead of gambling on the economic cycle, as Gordon Brown is now doing, we should be strengthening macroeconomic stability. We must maintain the independence of the Bank of England, which has excelled thus far in its job of managing monetary policy.
We should establish an independent National Statistical service to enhance the credibility of government data. Failing to include PFI liabilities as government debt is a clear affront to the transparency of government and the credibility of the sustainable investment rule.
We should establish independence in fiscal forecasts through a Fiscal Projections Committee that will give real force to the golden rule. Gordon Brown thought this was a good idea when in opposition: in 1995 he called for a 'panel of independent forecasters' to judge the golden rule. But in Government he ditched the idea and now changes the fiscal goal posts in the middle of the game. We need an independent referee to make sure that there's no cheating.
We need policies that help to safeguard stability, for without stability everything else is at risk. So the first overriding objective of Conservative economic policy is to reinforce macroeconomic stability.
(ii) Increase the productivity of the economy
Achieving that helps us achieve the second objective of a twenty first century economic policy - increasing the productivity of the economy.
Gordon Brown was right when he said that 'productivity is a fundamental yardstick of economic performance'. Only by constantly adding value can we hope to compete against economies where wages are lower. By improving productivity, we can improve our competitiveness - for boosting productivity is the only way to improve competitiveness without cutting wages.
That's why it is particularly disappointing that over the past eight years Britain's productivity growth rate has stalled, and is now just 1.3% - down from an average of 2.1% over the last eight years under the Conservatives. By contrast, America's productivity growth has increased and is now more than double ours.
The Chancellor must bear a heavy responsibility. His micromanagement of the economy, with excessive regulation and higher taxes, have contributed to this fall in productivity growth.
We can tackle poor productivity in a number of ways. I have set out elsewhere how we should tackle regulation, and how we need to do much more to improve the skills of our workforce. I have also argued that we must encourage technological progress and scientific advance, embracing change instead of becoming latter-day Luddites. I will talk later in this speech about the need for a modern transport infrastructure. All these must be part of a modern economic policy because all help improve productivity.
But tackling the growth of the public sector is also a crucial part of improving productivity.
Public sector employment has risen by over half a million. Those people are now not available to work in the private sector, so inhibiting businesses' ability to grow. Public sector growth has been crowding out the rest of the economy. In some parts of the country, like the North East and the Midlands, private sector employment has actually fallen under Labour.
In an age of unprecedented international competition, and with a stable macroeconomic background since 1992, the private sector cannot bid up the price of these resources, as it used to, in an inflationary spiral. Instead, we miss opportunities to expand productive capacity and create wealth.
So unless those extra public sector resources are used well, and better than they would have been by companies in the private sector, the economy counts the cost. We have all paid a heavy economic price, as well as a social price, for the poor value for money and low productivity that has characterized this Government's mismanagement of public services.
That is why public service reform is so important.
I reject absolutely Gordon Brown's view that there should be a state monopoly in providing health care or schooling. It is important that health and education are publicly funded - that is a principle the British people are rightly very attached to - but that does not mean every doctor, teacher and nurse needs to be employed by the government.
Gordon Brown has been the roadblock to reform in this Government. But where a little diversity of provision has been forced upon the Chancellor, such as NHS Treatment Centres, we are already seeing the benefits with big increases in productivity.
We need to go much further than Tony Blair has been willing or able to go. For reform is the key to improving not just the productivity of the public sector but also the productivity of the whole economy - that second objective of a modern economic policy.
(iii) Reduce the long tern demands on the state
This leads naturally to a third objective of Conservative economic policy: to reduce long-term demands on the State.
We should ask whether, as well as how, the Government can solve problems. Often, the answer to this question will be 'yes'.
Conservatives have tended to sound as if we're limited in our aspirations for government: as if we think that government is so much a part of the problem that it can't really offer any positive solutions to anything.
At a time when people are crying out for change, they see only false choices. On the one side a Labour Party that is not sufficiently aware of the limitations of government, and on the other, a Conservative Party which is too limited in its aspirations for government.
I believe that it is right that government should ensure all children regardless of their background or ability have access to a good school. It's not only critical to sustaining Britain's continued economic growth and to rising in living standards, but it's the moral thing to do.
I believe that it is right that government should ensure everyone has access to first class health care.
I believe that it is right that government should help families with childcare. We cannot as a society expect people to have dynamic, productive careers and at the same time be good parents without offering support.
It is clearly right, as last week's events so tragically demonstrated, that we should do as much as is possible to enhance our security.
And it is right that government should provide a safety net below which none can fall.
But we cannot be satisfied with a situation where the public sector takes an ever-increasing share of our national income. It damages economic dynamism and undermines the civic society that underpins our freedom.
In the last Parliament we focused on ways to improve the efficiency of Government, reduce the headcount of the civil service and rationalize the plethora of government quangos. The James Report is a powerful indictment of waste in government and an important tool in delivering value for money.
But clearly it was not enough. Perhaps that is because politicians always talk about reducing bureaucracy and red tape.
I believe we need to make a number of significant, real and credible reductions in the long-term demands on the state. That way, we can concentrate valuable resources on those who really need them.
We should start by taking a long, hard look at Gordon Brown's tax credit system, as we have been doing this afternoon in the House of Commons. Supporting people in low paid jobs is vital to helping them move from welfare into work. Conservatives recognized that when we introduced Family Credit.
But we should ask ourselves whether taxpayers earning incomes of say £15,000 should really be providing means-tested benefits to people earning up to £66,000 a year.
Another area where we must reduce future demand for the state is public sector pensions. This huge government liability, currently estimated to cost between £500bn and £690bn, lies hidden from the government's books. At a time when life expectancy has increased, and when millions of people in the private sector have seen their pensions reduced and their final salary schemes closed, how can we justify making them pay taxes to support generous, unfunded public sector pensions? Most people are being asked to contribute more to their pensions. Is it right that many civil servants contribute 3.5 per cent of their salary to their pensions when most people are being asked to contribute at least 6 per cent?
The Labour Government proposed public sector pension reform last autumn and then backtracked in the face of opposition from their public sector union paymasters. We should show more resolve than they do.
We should look at other ways of reducing demands on the state while at the same time improving the services that the government does provide.
We desperately need to update Britain's crumbling transport infrastructure. And in the case of roads we can do that by paying for new roads through tolling. The toll road around Birmingham has been an enormous success, decreasing journey times, both for those who pay on the new road, and for those who stick to the old. And it was built without increasing the burden on the taxpayer at all. Instead, it operates on the principle that those who use it pay.
Only by reducing long term demands on the state will we reverse the ever-increasing proportion of national income consumed by the government, and the ever-increasing taxes that must inevitably follow.
That's why reducing long-term demands should be the third objective of a modern Conservative economic policy.
(iv) Lower Taxes
It leads naturally to a fourth objective of Conservative economic policy: sustainable lower taxes.
This objective is not about cutting taxes for the sake of it. Taxes are only one part of a broader economic policy.
I saw in Estonia a fortnight ago how a low and simple tax system helps individuals and businesses.
Simpler taxes save everyone time and money. They remove the need for people to waste their lives trying to find loop holes, and for others to have to plug them. Britain's economy would be more productive if those involved in the war of attrition between tax planners and taxmen spent their lives building businesses and creating wealth.
But to compete in the increasingly competitive global environment, where businesses can locate anywhere and wealth creators can move anywhere, simplicity is not enough. We need lower taxes - particularly lower business taxes.
Most developed countries are cutting their business tax rates in order to compete with the emerging economies of east and southern Asia and the flat tax systems of eastern Europe. The United States has cut taxes on dividends and investment. Germany is planning to cut its federal corporate tax rates. Ireland has pioneered low business taxes and reaped the reward in foreign direct investment.
Britain is being left behind under Gordon Brown. Far from looking at ways to reduce taxes, independent experts believe the Chancellor will almost certainly have to raise them to pay for his fiscal mismanagement.
Conservatives need to strike out in a different direction. We need to make not just the moral case for lower taxation, powerful as that is, but also the economic case. The global economy will not tolerate high tax systems of the kind Gordon Brown is building.
So the fourth objective of our economic policy is lower and simpler taxes - and we need to make the case from lower and simpler taxes from the beginning of the Parliament, not in the last weeks before polling day.
Following these four objectives of economic policy - macroeconomic stability, increased productivity, reduced demand on the state, and lower taxes - gives the Conservatives a story to tell about the new challenges facing the British economy and how we would meet them.
We must reinforce macroeconomic stability, as stability is crucial to everything else we want to achieve. Hence our first objective.
That stability is at risk because of the Chancellor's excessive spending. His solution is to raise taxes. The other, better, solution is to increase productivity and reduce demand on the state in the long term, by changing how the government does what it does - our second and third objectives.
Only by doing these things can we achieve sustainable lower taxes - our fourth and final objective.
All these objectives support our wider goal for economic policy: to enable rising living standards in a competitive world.
As I said at the beginning, the foundation of a strong society is a strong economy.
We need to establish our credibility with the public as people who can be trusted to run the economy.
We need to show how we are better placed than our opponents to meet the challenges of intense global competition and exploit the enormous opportunities of new global markets.
To do that we should never sacrifice long-term credibility for short-term opportunity.
The founders of the CPS understood that thirty years ago. We must understand it again today."