You have to assume that Osborne was gripped by a cold, clammy sweat when he stood to deliver his Autumn Statement yesterday, but as ever there are two types of bad news – political bad news, and real bad news.
This was the former. There was nothing in the OBR’s revised economic forecasting that moved beyond the consensus, and in reality the government is just catching up with the dominant view of the markets. The UK’s probability of dipping back into recession is now far greater than it was a year ago. But then it should be, given the shambles in the eurozone.
The result is that the Darling Plan has now been gentrified with an upper case ‘P’, and the debate about the scale and timings of the budget reductions has returned. But the difference between Plan A and the Darling Plan is actually a matter of degree rather than magnitude, despite attempts by both parties to imply otherwise.
Osborne’s cuts to the public sector imply a 0.5 per cent reduction in GDP growth per year across the economic cycle, with the hope of buying a more efficient and productive economy by the time we see a return to growth. I have no doubt he would welcome that extra half a percent buffer between the economy and recession but let’s not fool ourselves that the government has opened up a yawning chasm.
But if there is one lesson to be learned from watching the eurozone crisis unfold over the past six months it is that the threat of the bond markets is very real indeed. You do what they say, or you lose your house. That may not be nice, but it’s true. At the start of 2009, the UK’s government deficit was £159.2 billion. Of that, around £31 billion represented interest repayments. Moody’s at the time said that if interest repayments rose another percentage point of GDP then we risked a downgrade and £10 billion a year in repayments alone.
You only need to look to the parts of Europe that only easyJet can reach to see this is a state of affairs which has a horrible tendency to spiral into further downgrades and even higher repayments.
I therefore broadly support the strategy that Osborne took on government spending. It needed to be overzealous to appease a marketplace that is itself overzealous by nature. My concern with Plan A, and with yesterday’s statement, is that there seems to be no strategy of equal courage for the addressing the fundamental lack of growth.
The most important challenge for an economy like the UK in the modern world isn’t the fiscal deficit, it’s the trade deficit. Trade imbalances are the original sin of the western economies. They result in massive excesses of debt, a loss of manufacturing base, employment, tax receipts and ultimately economic growth.
The right prescription for the UK is to rebuild an export base built on our high innovation SMEs. These small businesses are the biggest exporters, biggest creators of intellectual property, and the only source of consistent job growth.
But to succeed they need access to funding across the economic cycle, and it is here that Osborne’s plan crumbles. His attempts to get bank lending moving with his credit easing scheme are laudable but doomed to failure for the simple reason that bank lending is inherently cyclical, and no amount of short term state subsidy can address that.
Instead the solution for economic growth has to be to support other, countercyclical forms of finance – to create an economic third wheel for those periods when bank lending dries up. Small businesses need equity rather than bank lending. Bank debt simply isn’t structured to absorb early stage risk, meaning SMEs often find themselves charged four or five times the normal lending rate for a loan even when those loans are available at all. That’s why Osborne is on firmer ground with his improvements to the venture capital environment, and with the simplification of VCTs and the creation of the new Seed Enterprise Investment Scheme in particular.
The problem is that these changes do not go nearly far enough. Even without the largely fictitious £30 billion in infrastructure spending Osborne has clearly carved out substantial funding for his growth review. He should have spent it on a fundamental restructuring of the funding environment for growth companies rather than another desperate attempt to subsidise a failed system.
I have a pipe dream of a nationwide equity bank. The high street banks have around 10,000 branches between them, which goes a long way to explain why they are such dominant and effective players in the SME funding market. But if we could establish an organisation able to make Dragon’s Den style investments in small businesses, with branches across the UK, I suspect we could achieve transformative change for our economic outlook.
On thing is absolutely for certain. We will not address the growth deficit without addressing the trade deficit, but we will address neither without putting in place a funding environment designed to support entrepreneurs rather than blue chips.
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Allen Simpson is a speechwriter, policy adviser based in the City and a former parliamentary researcher to a Labour MP
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It’s all a bit sad reading this paper, especially as I’ve seen a lot of it before in a 50-year career.
There was once a “nationwide equity bank”. It was called Industrial and Commercial Finance Corporation (ICFC) and its shareholders were the clearing banks. It had regional offices lending little parcels of money and taking equity stakes in small businesses. It then outgrew its initial vocation (got too big for its boots), turned itself into 3i and went for the big time.
In those days, clearing bank branches had real managers, who knew their customers (and, even, had lunch with them). They seem all to have gone. They appear to be part of what one might call the vanished middle (not quite the squeezed middle), to be replaced by centralised computers making decisions and junior staff flogging ther infernal “products” in the branches.
The policy of the banks in recent years appears to have been to hoover up any spare cash from retail customers so as either to play the markets with it, or to do transactions that attract the maximum fee income, rather than lending margin. Essentially, short-term business.
With regard to the trade deficit and, indeed, the level of government borrowing, it is not surprising that these are high. In the circumstances that City influence has been, until very recently, such as to keep sterling high (as a matter of pride, perhaps) with interest rates higher than they ought to have been over the years.
This had the politically desirable consequence of keeping imports cheap, hence to keep the inflation rate down.
However, it had the other effect of wiping out a lot of British manufacturing industry. I remember, with some dismay, a Labour trade minister, about 10 years ago, saying that it was good we made things so tough for British industry because it meant that if businesses couldn’t become more efficient they wouldn’t survive.
I don’t think politicians realise that a lot of SMEs need real nannying to prosper. It is simply not good enough for banks to grade new (or old, for that matter) ventures on a scale and charge rates of interest according to perceived risk of failure on the scale. Doing that just indicates that they don’t care about the individuals running the business, or even the business itself, because they take all sorts of personal guarantees and people’s houses as security and then push the venture into open water. Sink or swim and we will take your house off you if you fail.
In my opinion, the best chance for a business to succeed is if there is some risk-sharing in the lending process. If we’re going to make progress with our SMEs, we need to get away from the confrontational approach and develop more of a partnership approach. If the banks which are closest to SMEs are unable to take a “business-angel” approach, they should retreat from doing any but the shortest-term lending and money transmission businesses and make space for those who can be business-angels.
A way to square this circle may be for depositors in banks to have the choice of either a deposit with the bank itself (which earns a low rate of interest) or what the Swiss banks used to call a “fiduciary” deposit. In the latter case, the depositor gets a slightly higher rate of interest, but is lending into a pool of money which is provided direct to businesses. The depositor has no call on the bank itself and would sustain a loss if the borrowers failed to repay. This is a form of business-angel/venture capital/securitisation managed by the bank and which would be off its balance sheet. Clearly, this requires, and gives scope for, the bank itself to act as mentor to the various underlying businesses.
Unfortunately, the legal framework for this to happen in Britain probably doesn’t exist, what with prospectus regulations and the whole drive to list companies on some sort of stock exchange.
I fear this all reflects the lack of trust in the system, which has led us to the present situation.
The politicians are, and have been, too inexperienced to do other than patch and mend as the financial crisis has unfolded, hoping that, before long, things could carry on as before. They were as much out of their depth as the bank directors who did not understand what was happening on the dealing desks of their traders before the banking crisis.
With the break-down in the inter-bank market that occurred in 2008, it could have been argued that each of the banks was trading insolvently (but for government assistance) and, therefore, under company law each of them ought to have ceased trading [note: if they don’t, directors become personally liable for the debts of the business].
The government at that time did not have the wit, or courage, to nationalise the lot of them and to conduct a process akin to the “pre-pack” receivership that has happened all too frequently in other sorts of business. A company closes one day and opens up the next day under new ownership and with a cleaned up balance sheet. Difficult though it might have been, it would have enabled the abuses of the banking system (eg excess salaries and bonuses, over-large balance sheets) to have been eliminated quickly, rather than for them to have continued much as before.