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George Osborne: The British economy needs confidence and credit

A week ago, the Chancellor of the Exchequer stood here in this very room in the full expectation that by now we would be out of recession.

He said that "one set of data showing positive growth will not be enough".  Well one set of positive data would have been a lot better than what we got. 

Gordon Brown too got his predictions wrong.

He said Britain was "better placed" than other countries to weather the economic storms and - he said last month - the economy would be "now coming out of recession as a result of the actions that we have taken".

The GDP figures released on Friday demolished both claims.

Britain is now officially in the deepest and longest recession since the Second World War.

Our economy has contracted by 5.9%, equivalent to an annual loss of income of £1,500 for every man, woman and child in the country.

And far from being "better placed" than other economies, we find that Britain remains mired in recession while France, Germany and Japan have already enjoyed six months of recovery.

Indeed, last week came confirmation that the British economy was now smaller than Italy's.

There are two questions that must be asked.

Why has Britain faced a longer recession than most other countries?

And more importantly, what can we do about it? 

The deeply disappointing GDP figures, published just a couple of days after the equally disappointing figures from the Bank of England showing a continuing contraction in business lending, confirm that the British economy is lacking two crucial ingredients.

Confidence and credit.

The government's recession plan, put in place last autumn after the bank bailouts, has failed to provide either.

It has not helped Britain through the recession. 

It has left us there.

Let me explain:

What did the government's recession plan consist of - separate from the radical monetary action taken by the independent Bank of England, which we were urging and welcomed?

First, schemes that would, in the Prime Minister's words, help businesses and homeowners "get the credit they need." 

Second, again in his words, a "massive fiscal stimulus" to give confidence to consumers.

And finally, a bank rescue package, in his words "not to save the bankers, but to... make sure we have a banking system that can serve the people". 

Let us take each in turn.

First, the schemes.

These were announced in fanfare around a year ago, each one leading the BBC news and splashed across newspapers.

Their subsequent failure is one of the great unreported political scandals.

According to new parliamentary answers:

the Capital for Enterprise Fund has helped just five companies;

the Mortgage Rescue Scheme has helped just fifteen families instead of the 6,000 promised;

the Trade Credit Insurance Scheme, designed to provide £5 billion of credit insurance, has instead helped just fifty eight businesses with £13 million of insurance;

the Guarantee for Asset Backed Securities has provided not a single guarantee; and the latest figures show that the £2.3 billion Automotive Assistance Programme has issued not one pound of assistance.

Often announced with no detail and no delivery plan, these schemes have been a near total failure and have had no impact on our economy.

So what about the so-called "massive discretionary fiscal stimulus" that was supposed to be the answer to the collapse in demand?

It too does not live up to the hype.

According to the independent Institute for Fiscal Studies, a study of last week's public finance figures shows that the Government are currently on course to spend £10 billion less on public services than they claimed in the Budget - offsetting half of the £20 billion discretionary stimulus. 

So what is left of this "massive fiscal stimulus"?

A temporary VAT cut, which almost no retailer thinks has been effective, no other country considered copying, and which the Chief Economist of the IMF said with modest understatement "does not seem to me to be a good idea."

And what about the Government's banking package and the Prime Minister's promise that the era of the big bonus was over?

We supported the bank bailouts to get banks lending again, not to support bankers' bank accounts.

Yet here we are a year later, and the taxpayer subsidised profits are being used not to get lending going but to pay out massive bonuses again. 

As I heard repeatedly in Scotland, Cumbria, Cheshire and West Yorkshire last week, businesses can't get the working capital they need to operate or take people on.

Credit is being rationed and margins are still too high.

This is sapping demand from our economy, and fixing it should be our immediate priority.

The Asset Protection Scheme is still not operational, nine months after it was announced.

Credit is still too tight because the state owned banks are still on life support, capital is still too scarce, and there isn't enough competition in our banking system.

So the three planks of the Government's recession plan - the schemes to get credit flowing, the discretionary fiscal stimulus, and the banking package - are all broken.

We need a new approach. We need to provide those key missing ingredients which are present in other countries: credit and confidence.

First, credit.

We have argued since the start that this is a credit crunch and needs credit solutions to get lending going again to save existing jobs and create new jobs.

It was a year ago that we first proposed a National Loan Guarantee Scheme, that would have been far more effective that the host of government schemes that have helped pitifully few businesses.

And it was a year ago that I first warned that the money taxpayers provided to support bank lending must not be diverted into bonuses.

A year later, the banks are making billions in subsidized profits.

But instead of using these profits to lend more and get credit flowing again, the banks are threatening to pay out billions in cash bonuses instead. If this happens it will make the credit crunch worse.

I am not alone in expressing this concern - large institutional shareholders such as Hermes and Aviva argue in today's papers that subsidized profits should not be used to justify huge bonuses.

It is time for the Government to act - and act decisively.

We cannot wait for the Prime Minister's promised land of a new responsible bonus culture which looks more remote than ever.

We need to take emergency steps to support bank lending and move the economy forward this winter.

The banks have to understand that we are all in this together.

I am today calling on the Treasury and the FSA to combine forces and stop retail banks - in other words the banks that lend directly to businesses and families - paying out profits in significant cash bonuses. Full stop.

That includes their investment banking arms.

Then the cash that would have been paid out should be put onto banks' balance sheets explicitly to support new lending.

This should be a condition of continuing to receive taxpayer guarantees and liquidity support.

I am not, of course, referring here to the small cash pay outs to the staff in the branches and the call centres.

Nor am I insensitive to the need of Britain's banks to remain competitive and retain their most talented staff.

So where banks do want to pay bonuses this year to those senior staff who have earned them, those bonuses should take the form of new equity capital - shares in the business.

This equity capital will strengthen the balance sheet and support new lending.

To those who say that Britain should not act alone, I say we would not be.

The Obama administration's new policy will see the cash remuneration of the top bankers cut by 90%, and banks have been told to pay out in shares instead.

America is acting.  Britain at the moment is not.

We are a Party that believes in enterprise and a competitive economy.

We know financial services have a huge role to play in Britain's future.

The politics of envy will play no part in our plans.

But we do need the politics of common sense. 

There can be no justification for using taxpayer support and guarantees to pay cash into the bank accounts of bankers when the rest of the economy is in such desperate need of that cash.

Cash for the economy - not cash for the bonuses.

We are all in this together.

Accelerating the recapitalisation of the banking sector to increase lending capacity must go hand in hand with greater competition to help bring down margins. 

The best way to increase competition is to encourage new entrants and limit the ability of the largest banks to dominate the market.

We need more smaller banks, competing with the bigger banks to serve families and businesses in a responsible way.

That will encourage more lending and bring down margins throughout the industry. 

If restoring credit is the first part of a plan for the recovery, the second part is restoring confidence: 

  • confidence in the way our financial system is regulated.
  • confidence that as a country we can pay our way in the world.
  • confidence that Britain is open for business, that growth is sustainable, and that we won't just pump the bubble back up again.

In short, Britain needs a banking plan, a fiscal plan, and a growth plan. 

Let's start with the reform of financial regulation.

As Mervyn King said last week, despite all of the rhetoric there has been "little real reform".

He blamed an "inadequately designed regulatory system" for helping to unleash a "financial firestorm".

Well, a crucial lesson from this crisis is that the central bank and lender of last resort should also be responsible for supervising the banks themselves.

Since we published our White Paper on regulatory reform in July, this argument has been gaining ground internationally.

As well as President Obama's proposals to give new powers to the Federal Reserve, the Bundesbank in Germany has now voted to take control of bank regulation.

And Jacques de Larosiere, the architect of the new European regulatory structure, has said that he agrees with our proposals because "in our present world it's good to have the central bank in charge of supervision". 

We are now working on the transitional arrangements that ensure a smooth transfer takes place.

I spoke with the FSA's senior staff last week, and we are in regular contact with the other parts of the tripartite system.

Of course reforming our system of regulation alone will not be enough, we also need to reform the structure of the banking system itself.

Mervyn King is right that we now have a banking system that is more concentrated and more risky than before the crisis.

We cannot afford to let it remain that way.

So this is what real leadership on banking could achieve - a healthier, better regulated and more competitive banking system where profits are used to support lending not big bonuses.

The second area where confidence is lacking and must be restored is the debt crisis. 

What we need urgently is a credible plan to restore domestic and international confidence in our economy.

As Harvard Professor and former IMF Chief Economist Kenneth Rogoff put it last month, "There's no question that the most significant vulnerability as we emerge from recession is the soaring government debt. It's very likely that will trigger the next crisis as governments have been stretched so wide."

Nowhere is that warning more relevant than the UK - with the largest budget deficit in the G20 and without the security of a reserve currency like the dollar.

Analysts at global Japanese bank Nomura have said that "the prospect of a UK fiscal crisis is a clear and present danger." 

Alistair Darling said last week that getting to grips with spending would put the recovery at risk.

I say the greatest single risk to the recovery would be failing to provide a credible plan to deal with Britain's deficit.

It is the soaring national debt that sits like a vulture poised to swoop on a sustainable British recovery.

Already, international markets and rating agencies are questioning Britain's creditworthiness.

The consequences of a loss of international confidence for a debt-laden economy like the UK would be truly devastating.
Higher interest rates would choke off the recovery and lead to soaring unemployment. 

Our debt interest bill - already set to be bigger than the defence budget - would become the largest item of government spending.

Whoever was in Government would be forced to implement even bigger cuts in public spending or tax increases in order to reassure nervous international investors.

So restoring confidence by setting out a credible plan now to bring the deficit down over the next few years is a pre-requisite for recovery. 

The Government have so far failed to do that - as the CBI said in their recent submission to the Chancellor:

"The 2009 Budget shows current budget balance being achieved by 2017-18. This is too long a time horizon to underpin the credibility of the government's public finance management and risks destabilising financial markets." 

Of course, as I said in my conference speech, "the pace of fiscal tightening has to be determined in co-ordination with the independent Bank of England and monetary policy."

We have never proposed a tightening of fiscal policy in this financial year, and we are not proposing to eliminate a £90 billion structural deficit overnight.

What we call for is a credible plan to eliminate the deficit that commands international and domestic confidence, and that moves more quickly and decisively than the government to deal with the deficit.

For tightening fiscal policy as the recovery gathers pace will help prolong the low interest rates that are doing so much to cushion the impact of the recession and bring about a recovery

So the arguments clearly favour early action.

When Goran Persson - the Finance Minister and then Prime Minister who successfully closed Sweden's record budget deficit while the economy was recovering from a banking crisis and a deep recession - spoke at the Institute for Government in September, he was very clear on this point.

As he put it, fiscal consolidation "is a risky process of course. But, on the other hand, not doing it is probably even more dangerous... perhaps you can wait half a year, a year, I don't know, but it is a very high risk to take."

I will not take that very high risk with the economy.

That is why I have been honest with the British public about some of the difficult choices the country faces, whoever wins the election.

Achieving a fiscal consolidation on such a massive scale requires a mandate to take difficult decisions.

Gordon Brown and Alistair Darling may think it is acceptable to fight the next election on a false prospectus - and to pretend that we can go on spending without limit. 

That was certainly the message from their Party Conference - The Prime Minister announced random new spending commitments when he can't even afford the existing spending. 

But I think they take the British people for fools.

The public knows there are difficult choices. 

Especially after all that has happened in Parliament this year, they want politicians to level with them.

This is what I did at our Party Conference earlier this month.

Some thought I was taking a big risk in detailing - on top of the broader public sector efficiencies that are needed - the case for a pay freeze, a restriction of middle class benefits, and an earlier increase in the state pension age.

But let me tell you - in the current climate the real risk lies with a party that gets itself elected and then finds it doesn't have the confidence of the public to govern.

The next government will need a clear mandate from the British people to deal with the debt crisis.

So to restore confidence, we need a plan for real reform of our banks and a plan to deal with the debt crisis.

There is one final thing Britain needs as well.

We need a credible plan for growth and jobs.

The cumulative impact of a decade of higher and more complex taxes, more red tape and unbalanced growth has destroyed Britain's reputation as a place to invest.

That needs to change, fast, and we need to send the signal loud and clear that Britain is once again open for business.

At our Party Conference in Manchester, we launched our plan to Get Britain Working.

It will create thousands of high quality training places and new entrepreneurial opportunities.

We will let anyone with a passion for giving children the best start in life set up a new school.

That will increase competition, raise standards and make sure it's our children who have the education they need to succeed.

Our plans for a technical school in our twelve biggest cities and 200,000 new apprenticeships mean we will develop the engineering and technological skills of the future.

And we will overhaul the welfare system so the unemployed get the tailored support they need to get back into work - not just those who recently have lost their job, but the millions who have never had a lasting job and have been left behind on out-of-work benefits.

Of course it's not just about getting people ready for work, it's also about developing the environment for enterprise so the jobs are created here.

We have asked Sir James Dyson - one of our most successful entrepreneurs - to lead a taskforce looking at how we can make Britain the leading exporter of high tech products in Europe.

For I am clear.  We have to rebalance this economy to make it less wholly dependent on the success of financial services.

We need active government support for manufacturing, low carbon energy, pharmaceuticals, aerospace, the creative industries and the other sectors Britain should be excelling in.

We need a financial system that enables more long term investment in productive assets and infrastructure.

And to encourage the creation of new businesses in the recovery, we will abolish all tax on the first ten jobs they create during the first two years of a Conservative Government. 

Existing businesses will benefit from our plans to create a much simpler corporation tax regime with a lower headline rate.

Removing complexity will enable us to cut the corporation tax rate by 3 pence to start with.  And I hope we can go much further in that direction.

Recently Britain overtook India as the country with the longest business tax code in the world.

That is a huge drag on enterprise and we will create, as part of the tax law making process, a permanent drive to simplification. 

Everything we do will be directed towards sending the message out loud and clear that if you want to set up a business, make an investment, employ new people, then we are on your side.

And in doing this we should show the world that we can deal not just with the immediate challenge of dragging Britain out of recession - but that we can also address the country's long term problems, ignored for too long, that stand in the path of lasting recovery.

Our economy built on excessive debt must become an economy built on savings and real investment.

Our economy, overly dependent on financial services, must be rebalanced to become an economy that grows other sectors as well.

Our economy where too much of the activity is focused here in the south east must become a national economy where there is strong private sector growth in every region of the country.

Our economy that has left millions behind trapped in poverty must give opportunities to all. 

Yes, our priority is to get through the recession.

But not by pumping up an overheated debt bubble again.

We need a new economic model for our country.

And the confidence to go out and build it.

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