“This week, the eyes of the world have been on the momentous events three thousand miles to the west of here.
In electing Barack Obama as their next President, the American people have written a new chapter in that country’s remarkable story.
The sight of people holding pictures of relatives who had been subjected to, and killed by, the most vicious racial segregation, going into town halls across America to cast their vote for a black President was truly one of the most extraordinary, and inspirational, things I’ve ever seen.
Today, I’m here to talk about the economy. But before that, I just want to say a few words about the election that happened sixty miles down the road.
Because of the result, the real battle in British politics has just started. We now know Labour’s leader – and strategy – for the next general election. And the British people will have a clear choice. Between more of the same under Labour and change with the Conservatives. And the arguments we will be making are clear.
After a decade of big taxing and big spending, yet with little improvement in our public services: that’s got to change. After a decade of rising anti-social behaviour, worklessness and family breakdown in our broken society: that’s got to change. After a decade in politics of the promise anything, deliver nothing, spin everything culture – manifested no better than by the return of Peter Mandelson: that’s got to change. But most important of all, after a decade of borrowing, with an economy built on the sand of debt and unprepared for the recession that lies ahead that has got to change.
Over the next few weeks, the Conservative Party will be setting out, clearly and specifically, what these economic changes should be.
To do that we need a clear understanding of what happened. So today, I want to debunk the myths that have been peddled for the past six months about this recession. Because if we don’t debunk the myths, we’ll make the same mistakes again.
First, there’s the myth that this recession came solely from America and was caused solely by international events.
Second, there’s the myth that we can spend our way out of recession.
And third, there’s the myth that there are no limits to borrowing.
And then I will set out the Conservative approach and show why our alternative of fiscal responsibility, financial responsibility, and a more balanced economy is not only the best way to deal with the recession today, but is the best way to prepare for a changed and better economy in the future.
LABOUR’S RECESSION
Let me begin with the first myth – the idea that this is purely and simply a “recession that came from America”. Of course there has been conflux of international events which have had a profound impact on our economy.
The now infamous collapse of the sub-prime lending market in America was the symptom of a much deeper cause which has had profound implications on the global economy. Over the past decade, two billion people – a third of the world’s population - entered the world economy. This pushed down prices for many goods and because they saved much of their new wealth, pushed down global interest rates.
The good times lasted for over a decade, and around the world many countries used the global boom to pay down debt and strengthen their economies. Sadly in Britain, our Government thought these good times would never end and that boom and bust really had been abolished, so they did not use the past decade to prepare, and we entered the downturn the least well prepared in the developed world.
That is not the fault of America, it is a failure of policy here at home.
Because we took away the Bank of England’s power to call time on debt, we built up more private debt than any other major country, ever. Because the government spent like there was no tomorrow, we built up the biggest budget deficit in the developed world.
And because we relied on just the engines of finance, housing, and public sector growth, we built up one of the most imbalanced economies in the developed world.
The consequence of this irresponsible failure to use the good times to prepare is that we are forecast to have the biggest recession of any major economy.
This week, first the European Commission said Britain’s recession would be worse than any other, with the exceptions of Latvia and Estonia. Then yesterday, the IMF confirmed that Britain’s recession will be deeper than any other. And the world markets have confirmed this picture with their response.
Britain has suffered the sharpest devaluation of sterling in our modern history, and the biggest fall of any major currency. These facts show how completely absurd it is to claim that we are well prepared for the economic storms that lie ahead.
And until we face up to this gloomy prognosis for the real economy, we will not be able to deal with it. Sadly, so far the Government’s response to the economic crisis – separate from the financial crisis in the City of London – is merely a political strategy, not an economic one.
And the strategy is simple. To give the impression that this recession was entirely caused by events overseas and with every international handshake the Prime Minister hopes to press this point home. Rather than admit the mistakes they have made, they take every opportunity to absolve themselves of any responsibility now things have gone bad.
But this will not work with people. They can see the facts.
Unemployment - in Britain - is increasing at its fastest rate for seventeen years.
Three hundred businesses - in Britain - are going bust every week.
Thousands of families – in Britain - are having their home repossessed.
But most important of all, this will not work for the future of our economy.
Put simply, we need to recognise the mistakes that have been made in the past decade, the debt we built up, the budget deficit we now have, the regulatory failures that happened if we are to give our economy the change it needs.
SPEND YOUR WAY OUT OF RECESSION
If the first myth we must debunk is about how we got into this recession - the second is concerned with how we will get out. In recent weeks, numerous people - Gordon Brown and Alistair Darling included - have speculated on a new Government spending splurge and encouraged the myth that we can spend our way out of recession.
I believe, with Brown and Darling, this is more a political strategy than an economic one. Beyond good headlines, their plans are alarmingly short of any detail or substance on the amount of money to be spent and on what projects.
I suspect what is happening is they are dressing up what is inevitable, rising spending as unemployment and welfare bills go up, rising borrowing as tax receipts go down, as an economic strategy to fight the recession. This isn’t a plan – it’s merely extending an overdraft. But let’s just consider for a few moments whether it would actually be right to have a spending splurge over and above what is happening automatically – paid for out of additional discretionary borrowing.
In 1997, Gordon Brown was very clear. He said: “We have learned from past mistakes… you cannot spend your way out of recession.” And in 1999, a Treasury document gave a much more cogent argument, when it said: “loosening fiscal policy when the underlying structural fiscal position was poor could damage consumer and business confidence, thus having the opposite effect to that intended.”
I agree with that. All the evidence shows that trying to tackle a recession with a big spending program doesn’t work.
First, it’s extremely difficult to get the timing right. Big capital projects take years to get off the ground as plans need to be drawn up, compulsory purchase orders undertaken and permission granted.
Just take the Government’s existing plans for the first wave of school rebuilding projects. Thirteen – out of just seventeen – are behind schedule. This is of very little use to the small businesses, employers and families that need help to see them through Christmas.
Second, value for money is often very poor. It’s not just the impact such a splurge has on the public finances of today – and the tax rates of tomorrow. It’s also that the record of any Government in delivering capital projects on time and on budget leaves a lot to be desired.
Just think of the problems with The Millenium Dome and Holyrood in Edinburgh. And alongside the difficulties with timing and the poor value for money, there’s the danger of permanently damaging your public finances.
Japan is an example of all three. After years of stagnation, their Government tried to kick start their economy with a splurge in spending financed by borrowing. So between 1992 and 2002, Japanese government net debt grew by 58 per cent of GDP as a result of runaway spending. Over the same decade, the economy grew by only 9 per cent. They not only built white elephants, they permanently damaged their public finances. And that is linked to the third - and final – myth about this recession.
BORROW WITHOUT LIMIT
It’s the myth that to finance a spending splurge the government can borrow without limit. As I said three weeks ago, in a downturn, tax revenues will decrease and spending on benefits will increase – these are the so-called ‘automatic stabilisers’. They will help to counter deflationary pressures. And in the process, they will add to even further public sector borrowing – that is the inevitable consequence of recession.
Of course, this only re-enforces the point that we have consistently made that it was irresponsible for the Government to borrow so much when the economy was booming. But the fact that borrowing rises in a recession does not mean that the Government has a blank cheque to borrow without limit over and above whatever is automatic.
This is the irresponsible choice. And it’s irresponsible because it risks taking a road that could lead to economic ruin. More irresponsible borrowing now will saddle this generation and the next with a burden of debt that could take a decade or more to pay off. It means instead of building schools, equipping our hospitals with the latest technology and getting more police on the streets, spending priorities will have to shift to servicing our gargantuan debt.
We already spend more on paying the interest on our debt than we do on our entire defence budget. And it means more taxes on families and businesses in the years to come, putting a drag anchor on recovery. But the dangerous consequences of excessive borrowing now don’t just lie in the future – but also in the immediate present. We need to understand there are limits to borrowing – not political limits, but actual limits. As the IMF said yesterday, “"Fiscal stimulus can be effective if it is well targeted, supported by accommodative monetary policy, and implemented in countries that have fiscal space."
Sadly, unlike other countries, we don’t have much fiscal space. Indeed, as we borrow more, and our public finances deteriorate further, the question could well shift from being ‘how much more does the British government want to borrow from the markets?’ to ‘how much more are the markets prepared to lend?’
As the IMF says “increases in interest rate risks premium, as a result of debt concerns, can render fiscal multipliers negative, suggesting that discretionary stimulus may do more harm than good.”
Put in plain English that means that the Bank of England will have to encourage people to lend to our Government by keeping our own interest rates higher than otherwise, reducing the overall stimulus to the economy, not increasing it. This will bad for our recovery, because what homeowners and businesses need right now is a sustained reduction in interest rates. And, in extremis, international markets can simply pull the plug and refuse to give you any more money.
Only three countries entered the downturn with higher budget deficits than us. Two of them – Pakistan and Hungary – have reached the limits of borrowing and are now in the hands of the IMF. Those countries maybe emerging markets, but the cataclysmic events of recent weeks - not least the rapid decline in the value of our own currency – shows that we cannot, and should not, be as audacious to believe we are totally immune.
When you borrow without limits you get higher interest rates than necessary in the recession and higher taxes in the recovery. There is the simple – if painful – truth.
A truth that strong governments should not just acknowledge, but should be willing to make the argument for even in the teeth of the fiercest criticism. We cannot spend our way out of recession – and we cannot borrow without restraint.
OUR PLAN FOR CHANGE
We’ve consistently said there’s a different way. Not one based on the myths of excessive spending and unlimited borrowing, but the realities of sound money, sound finance and a balanced economy for the future. One based on responsibility – Conservative economic responsibility. And it’s rooted in the answers to three important questions.
First, what was the cause of our problems? This recession was triggered by a credit crunch and it’s now vital that we unblock credit and get money flowing through the veins of our economy, back to families and businesses. Just as the recession has a monetary cause, so the most important solution is a monetary stimulus and fiscal policy must support that stimulus not try to replace it.
I welcome yesterday’s large cut in interest rates by the Bank of England. But the monetary stimulus that we need is not just about lowering the Bank’s official interest rate – important though that is. It is about making sure that rate cut gets passed on to families and businesses and that we get lending going again.
We supported the bank recapitalisation plan not just to save the banking system – but because only by saving the banks could we save the wider economy. If the cuts in interest rates do not reach families and businesses then other monetary measures may be required. We all agree with the end of getting the rate cuts to families and businesses – the question is: how do we make that happen?
Today, we’ve made two proposals.
At the root of the problem is the price at which banks can borrow in order to lend to us. The whole point of the bank rescue package was to reduce this price, but the price of the guarantees set by the Government are now too high. We need to revisit this.
We should also ask why banks are now paid interest when they lend to the Bank of England, when they used not to be. That encourages them to leave cash they do have at the Bank of England instead of lending it to customers. And because monetary policy is the best response to the cause of this recession we must do nothing that gets in the way of as radical a monetary stimulus that may be necessary. That means being fiscally responsible.
So on fiscal policy, while we will allow the automatic stabilisers do their job, we will understand there are limits to borrowing and we will pave the way to the permanently lower interest rates that families and businesses need now and the lower taxes our economy demands in the future. And we would enforce this with a new Office of Budget Responsibility that will hold every Government to account to make sure it lives within its means.
The second question we need to answer is why were we – here in Britain - hit so badly? It’s because the levels of debt in our economy – both public and private - spiralled out of control.
Because the Government never put anything aside during the good years, they can offer no relief in the bad – which makes it all the more important to have an Office of Budget Responsibility. But more than that, because households and banks did the same, when the boom did turn to bust and the value of assets fell our financial system was hit harder than most.
We need a return to financial responsibility.
So we will reverse the fundamental mistake made a decade ago and restore the Bank of England’s role in regulating the level of debt in the economy by introducing a new Debt Responsibility Mechanism to ensure that debt and asset prices never again get so out of control.
And the third question we need to answer is how do we strengthen our economy for the future?
We need to move away from an economy that relies too heavily on the narrow shoulders of finance and housing to drive growth to one that includes more science, more hi-tech services, more green technologies, more engineering and more high-value manufacturing and one that draws upon a much wider range of industries, markets, people, towns and cities.
That’s the right way to become more resilient. But this won’t happen overnight - we need a radical plan. We need economic decentralisation.
So we will introduce a simpler and more competitive tax system, cut the headline rate of tax for businesses, and tackle red tape so more people with new ideas are empowered to set up their businesses. And we need to help businesses in the downturn to keep Britain working by reducing national insurance for the smallest companies and helping companies with their cashflow by delaying their VAT bills. These are fully funded policies that could be introduced today.
What’s more, we will radically reform our education system, giving local communities the chance to set up local schools and train local children with the skills they need to succeed. And we will introduce a high speed rail system that will link cities across Britain and transform the geography of our economy.
And this economic decentralisation, needs to be backed by a political one.
More Mayors in our big cities, who can champion enterprise and ingenuity – and be judged at the ballot box. More power to community groups - to set up social enterprises in their local area and transform the aspirations of their neighbours.
And real devolution too. I want to see Scottish people take more control of their lives.
This isn’t just about more powers at Holyrood, it’s about more people owning their own homes, running their own businesses, investing in their local communities.
CONCLUSION
This week is the week that the American people came together chose the bold, but necessary, path of change. Bold because it was brave – it’s always easier to stick with what you know. But necessary because it was right –because a changed, and confident, America means a changed, and confident, world.
When the election is called here, the British people will have the same opportunity.
And in the weeks and months that lie in between, it will be the Conservative Party – in the arguments that we make, the policies we develop and the vision we have – that will offer the people of this country the change they want – and the change they need.
Change in our public services, in our society and in our politics. And change in our economy. It’s a change that will acknowledge, and act upon, the domestic economic failures of the past ten years – not airbrush them out of history to save political skins.
It’s a change that will understand the lessons of history – and not subscribe to, and crumble before, the failed dogma of spending your way out of recession.
It’s a change that will recognise the limits of borrowing – and not saddle today’s families with higher interests, and future generations with higher taxes.
Ultimately, it’s a change that will be built around the cornerstone of a new economic responsibility.
A responsible fiscal policy, so we can keep interest rates and taxes down.
A responsible financial policy, so people never become so indebted again.
And a responsible attitude to economic development, that fosters more balanced economic growth.
That’s the economic change we need and that’s the economic change that only a new Conservative government can bring.”