Take on the City with a 'people's budget'

Alistair Darling has a chance to start tackling the deep structural problems of the economy

Larry Elliott
The Guardian, Monday 22 March 2010 01.34 GMT

Budget day has its own ritual. The battered old red box, the photo call in Downing Street, the tension in the Commons as MPs wait for the chancellor to pull a rabbit out of the hat – all are part of a peculiarly British occasion. It was never quite the same when the Conservatives moved it to autumn in the 1990s, and a relief when Gordon Brown moved it back to its proper place in the calendar.
Tradition and pageantry can deceive. The budget box may give the impression of enduring solidity but the economy is weak and the public finances are shot to pieces. More worrying, perhaps, is that plans for attacking the deep structural problems of the economy remain inchoate as the third anniversary of the financial crisis approaches.
Alistair Darling said yesterday that this week's speech would flesh out the government's plans for growth. There would be no giveaways, he told Andrew Marr, no pre-election sweeteners. He thinks voters would be more impressed by a budget that he promises will be "sensible and workmanlike".
But this is what chancellors always say. You would struggle to find a second lord of the Treasury who promised a flashy and opportunistic budget. To be truly "sensible and workmanlike", the budget needs to contain five elements.
Firstly, it should facilitate, rather than impede, economic recovery. Darling will rightly reject George Osborne's calls for immediate tax rises or cuts in public spending to reduce the budget deficit but he should consider filching the shadow chancellor's proposal for an Office of Budget Responsibility, only with a different mandate from that proposed by the Conservatives. The Opposition would like an independent OBR to produce forecasts for the public finances ahead of the budget, assess their long-term sustainability and suggest steps to hit the fiscal objectives.
But this, as a forthcoming paper from the Progressive Economics Panel rightly notes, is putting the cart before the horse. In the current circumstances, with a marked risk of a double-dip recession, the strength of the recovery should take precedence. "Certainly," the paper argues, "a credible strategy is needed to address the budget deficit but this strategy must be flexible and based on the strength of the recovery and not on rigid timelines and/or ideological opposition to budget deficits."
Secondly, the budget should lay the foundations for structural reform. As Britain has discovered to its cost all too often in the past 40 years, the nature of the recovery matters and pumping up consumer demand through a booming housing market is no long-term solution. The government's challenge is to create a supply-side environment that will rebalance the economy towards production and exports.
Baby steps
There is now all-party agreement that the City will have to pay more to the exchequer, either through a financial transaction tax or through an insurance levy. The Conservatives and the Liberal Democrats say this can be done unilaterally; Darling insists that a go-it-alone strategy would put the competitiveness of the UK financial sector in jeopardy.
But since the aim is to reduce the economy's dependency on the City as a source of growth, it makes sense to use the money raised from the City to fund the rebalancing through a national investment bank and a system of German-style job subsidies to protect skilled labour during downturns. Britain's competitors have better educated workforces, more predictable flows of capital to industry, and stronger supply chains.
Thirdly, the budget should recognise that Britain is falling behind in the race to develop the low-carbon industrial sectors of the future. Darling has hinted that he will announce a £2bn green infrastructure fund on Wednesday, but this is a baby step when giant leaps are needed. Recessions inevitably result in the environment slipping down the political agenda but the long-term challenges of climate change and more expensive fossil fuels remain.
Governments in other countries have recognised that backing environmental industries through a mixture of subsidy, taxation and procurement makes sense because there will be monopoly profits for companies that can secure first-mover advantage. Far more ambition is needed in the UK to make the Green New Deal more than a soundbite.
Fourthly, it has to be recognised that any economic rebalancing will prove stillborn unless there are important changes to the way the financial sector operates. Over the past few months it has become clear that the Bank of England and the Financial Services Authority are both ready to embrace radical reform; Mervyn King has openly raised the question of whether there should be a legally enforced split between "safe" utility banks and "risky" investment banks. The governor has warned, repeatedly and almost certainly correctly, that leaving the banks broadly unreformed will lead to a fresh and perhaps even more serious crisis.
Strong stuff
Adair Turner is not a fan of legislating for a Glass-Steagall approach to breaking up the banks, but the FSA chairman has been voicing previously unthinkable thoughts. Turner made three points in a lecture to the Cass Business School: that the authorities needed specific controls on credit for the housing market; that the benefits of complex financial instruments had been hugely overstated, and that it should not be assumed that ever-greater market liquidity was "axiomatically beneficial".
This is strong stuff. Keynes was always sceptical of what he called the fetish of liquidity, arguing that the point of capital markets was to channel savings into productive investment rather than create casinos. Turner agrees, calling for a "bias to conservatism in setting capital requirements against trading activity; it reinforces the case for limiting via capital requirements the extent to which commercial banks are involved in proprietary trading, and it may argue in favour of financial transaction taxes".
The problem is that the third leg of the tripartite system, the Treasury, is far less open to new thinking. Years of the City lobbying Whitehall has paid off; government machinery has been captured by financial interests and conservatism is entrenched. One way to break the logjam would be a Royal Commission – on no account to be chaired by a City grandee – with a mandate to propose reforms of the financial system by the end of 2011.
Finally, a far greater proportion of UK savings should go into productive investment rather than bricks and mortar. The reason Britain has destabilising bubbles in property is simple: this is a small island with a large and growing population, tough planning regulations limiting new housing developments and a tax system that encourages owner-occupation. Reform is fraught with political difficulties; concreting over swaths of the green belt is just as unpopular as slapping capital gains tax on a prime residence. Nobody has yet come up with a better solution than that of David Lloyd George in his "people's budget" of 1909: a land valuation tax.
These then would be the bare bones of a sensible and workmanlike budget. Darling needs to get the economy moving again; he needs to build-up its long-term productive capacity; he needs to invest in a long-term future, and he needs to tackle the two roadblocks to reform: the City and the housing market. All he has to contend with are a record peacetime deficit, powerful vested interests and deep-rooted cultural inertia. Easy peasy.
Testing times: Addressing the Deficit Without Risking the Recovery, www.progecon.org.uk
larry.elliott@guardian.co.uk