Monday, 30 November 2009

Banking on a green industrial revolution

Idea of a national investment bank to steer economy towards low carbon future gains ground

Larry Elliott, Monday 30 November 2009
George Osborne is floating the idea of a green investment bank to get new technologies out of the lab and into new wealth-creating businesses. Vince Cable wants a national investment bank for infrastructure, financed with a blend of public and private money.
Both ideas are heartily welcome. Britain needs urgent remedial action to harness a wave of environmental technologies if it is to arrest long-term industrial decline. Billions will have to be spent on expensive capital projects – in the energy and transport sectors in particular – if the transition to a low-carbon economy is to be achieved.
Why, though, has it been left to the opposition parties rather than the Treasury to come up with these eminently sensible suggestions? The short answer is that there is one rule for the City and one rule for everybody else.
Desperately unbalanced
Alistair Darling would vehemently deny it, but there has been institutional capture of the Treasury by the financial sector, exemplified by the decision to ask a City grandee, Sir David Walker, to look at bankers' pay. That's a bit like asking David Beckham to lead a commission into whether footballers are paid too much or picking Jeremy Clarkson to head a top-level study into whether to cut the speed limit.
The dismal reality is as follows: Britain went into this slump with its economy in a desperately unbalanced state. As Richard Jeffrey, economist at Cazenove Capital Management, rightly noted: "One of the very clear early-warning signals that the UK was on an unsustainable growth path prior to the recession was the relentless expansion in the trade deficit."
Over the course of the decade, the gap between what Britain produced and what it consumed grew wider. It was considered a "good" month when the shortfall in manufactured goods dipped below £7bn. The government assured us that this did not matter because the City, the knowledge economy and the creative industries would help us pay our way. Britain was supposedly at the cutting edge of financial innovation and well placed to exploit its comparative advantage in hi-tech manufacturing. Total fantasy, the lot of it.
Somewhat surprisingly, Britain remains the sixth biggest manufacturing nation in the world, despite three severe industrial recessions in the past three decades. The trend is clear: output is lower than it was when Labour came to power in 1997. If things don't change, Britain will be a post-industrial nation.
The crisis was supposed to have led to a rethink, and to an extent it has. Mervyn King, the Bank of England governor, rarely wastes an opportunity to say that the shape of the UK should rely less on consumption and government spending and more on manufacturing, investment and exports. That was precisely what happened in the wake of the recession in the early 1990s, when in five out of the next six years domestic demand grew less quickly than overall economic output. A big fall in the exchange rate boosted exports and the current account improved steadily so Labour inherited a small surplus in 1997.
A similar period of adjustment is needed now and one of the key elements in rebalancing the economy – a weaker pound – is in place. Sterling has depreciated by about 25% since the financial crisis broke. Unfortunately, there is scant evidence of any beneficial effects from this depreciation. The breakdown of the latest set of growth figures – released by the Office for National Statistics last week – showed that net trade actually made a negative contribution of 0.2 percentage points to gross domestic product in the third quarter, because imports grew more strongly than exports. A key factor was the government's cash for clunkers scheme, which appeared to provide far more of a boost to foreign car manufacturers than producers at home. Investment – the other key component in rebalancing – has collapsed at an alarming rate over the last 18 months. Capital spending is down by a quarter, and the pace of decline has been even faster than it was during the industrial Armageddon unleashed by Margaret Thatcher in the early 1980s. Household spending has also been hit by the recession, but the impact has been softened by the deep cuts in bank rate, which have boosted personal cash flow and helped compensate for weak growth in earnings. The main effects of the downturn have shown up in plunging investment and savage de-stocking.
So you are the Treasury: how do you respond? Well, clearly, one option is to carry on as before. You assume, with the century-old Whitehall disdain, that manufacturing is the past, not the future, and that the only option is to get the financial sector back to rude health as quickly as possible. You pump £12.5bn into consumption through a cut in VAT, even though you know that a large chunk of the additional demand will leak overseas and that a recovery based on a fresh burst of consumer spending would be the opposite of what is actually needed. You recapitalise the banks with only the flimsiest of strings attached. You pump £200bn of electronic money into the economy through quantitative easing and wonder why asset prices rise but the real economy continues to flounder.
Alternatively, you say enough is enough. The "economy-as-a-hedge-fund" model is dead. The assumption that the economy could grow at an underlying rate of 2.75% a year was based on a financial bubble that put the entire banking system in jeopardy. Given the damage caused to productive capacity by the recession, the trend rate of non-inflationary growth is probably about 2%. Building it up again will take time, investment and imagination.
In this context, a green investment bank, a national infrastructure bank or a national investment bank all seem like ideas whose time has come. The traditional Treasury response – the days of "picking winners" are over – has been blown out of the water by the generosity of the "picking losers" scheme for banks. Nor is it true that demand for investment has been killed off by the recession. My colleague Victor Keegan, who specialises in the technology sector, says there are plenty of companies with good ideas out there.
Closed for business
As ever, though, the problem with the British economy is not a lack of good ideas but a dearth of long-term finance. The banks are closed for business and the venture capital industry demands a short-term pay-off that is inimical to the long-term growth of a business.
It is not difficult to see why the environmental sector has welcomed Osborne's willingness to look at a green investment bank. The Environmental Industries Commission has been lobbying tirelessly for years to get the government to recognise the potential of the move towards a cleaner, low-carbon economy. But it lacks the clout of the City. It hailed Osborne's speech as "revolutionary" and said the green bank would help to bridge the funding gap faced by firms trying to bring innovative products to market.
Whether the green bank would ever be delivered by a future Conservative government remains to be seen. But it is a good idea nonetheless, and Darling should not hesitate in nicking the idea for next week's pre-budget report.
There is no shame in that. The real shame is that the chancellor did not come up with the idea himself.