We need to move from private debt to public investment as the means to stimulate demand and to link deficit reduction to the promotion of growth
A most urgent task for any incoming British government is to fix what is typically called the growth model. Since the early 1990s Britain experimented with a new kind of growth model – which we have termed Anglo-liberal and others ‘privatised Keynesianism’. That model, as we have argued, was always unsustainable. Indeed, its pathologies were not difficult to discern for those willing to look for them. It relied on a low inflation/low interest rate equilibrium that could never endure indefinitely and it generated, on the back of that, a series of asset-price bubbles. The global financial crisis was, in large part, a story of the bursting of such bubbles – not just in Britain – and the transmission globally of the contagion through a variety of instruments of financial intermediation which had allowed banks and other financial institutions to take a stake in Anglo-liberal growth. In this post we set out briefly the nature of Britain’s broken growth model and its pathologies before we turn again to elaborate some of the broad parameters of an alternative more sustainable model of economic development.
As is now widely accepted, Britain’s highly distinctive and, for well over two decades, largely successful growth model was based on the nurturing of a culture of conspicuous private consumption fuelled by ever rising levels of consumer debt. What made this possible was a combination of low interest rates, a competitive market for consumer credit and pervasive private housing tenure – the origins of each of which can be traced further back to the monetarist revolution, the demutualisation of mortgage provision (and the wider deregulation of financial services) and the extension of private home ownership in the early 1980s respectively. With such factors in place, this model generated sustained (if not sustainable) growth for nearly a quarter of a century, though at a relatively modest level in comparative historical terms.
Low interest rates reduced the effective cost of home ownership, though this had the side-effect of increasing demand in the housing market and hence prices. Ultimately, it was house price inflation on which the growth model was predicated – albeit, initially, without any conscious or deliberate strategy to promote it. For in a low interest rate world with low returns on savings, all the incentives – for those who could afford it – were to enter a rising housing market at the first opportunity. The housing market became an independent source of wealth for those able to run with it and, more importantly, a privileged point of access to credit for those prepared to release the equity accumulating in their home to fuel their increasingly addictive consumption habit.
In this way, asset appreciation and equity release became integral to growth. This is what is meant by ‘privatised Keynesianism’ – the heart of the Anglo-liberal growth model. Private debt — in the form of credit typically secured against property — became a demand stimulus to the economy, allowing higher levels of consumption, employment and growth than would otherwise have been the case. But this was always a fragile growth model. For it could only last so long as the low inflation/low interest rate equilibrium persisted. And, in the run-up to the crisis, this was shattered by steep rises in oil prices, reinforced by speculation in oil futures markets. The resulting interest rate hikes crashed first the American and then the British housing markets. The rest, as they say, is history — painfully recent history, but history all the same.
So what are the implications of this today? These come in two kinds – some immediate ones for the recent return to growth in Britain and some longer-term ones for the wider project of building a more sustained and more sustainable recovery consistent with the transition to a more genuinely Civic Capitalism not only in Britain but also across a number of advanced industrial countries.
The first implication is that Britain’s current recovery is largely an illusion and is dangerously unsustainable. Growth has, indeed, returned to the British economy since 2013. Yet this is a growth based on resuscitating, at least temporarily, the old unsustainable model of growth. The banks have been recapitalised with public funds and actively encouraged, through the ‘Funding for Lending’ scheme, for instance, to re-focus and re-concentrate the supply of credit on the housing market – and with some success. Growth has returned and house prices are rising, at least in the Southeast of the country. But the reality is that this is an inherently risky strategy – and one that is only imaginable in the short term (a pre-election gambit perhaps). The housing market is in fact significantly over-valued even after the recalibration of the crisis (especially if one looks at the question of affordability inter-generationally and at likely medium-term trends in interest rates). This means that we’re dancing on the edge of the precipice again!
So what might an incoming government do to put this right? Five practical implications follow directly from our analysis – each contributing to the transition from an unsustainable model of debt-fuelled growth to a more sustainable investment-led model of development.
- Politicising the cost of borrowing. If the economy is to be ‘rebalanced’, then the government and the Bank of England need to be putting concerted downward pressure on the actual cost of borrowing (independent of the base rate), particularly in sectors where a clear link to the growth strategy for the economy can be made and substantiated. The banks have in effect been allowed to recapitalise themselves by charging commercial borrowers, mortgage holders and those servicing consumer debt a sizeable interest-rate premium, relative to the base rate, to compensate for their huge investment banking losses during the crisis. This is both intolerable and a significant drain on the growth prospects of the commercial and consumer economy. It’s been said before, but remains true: the banks need to be named and shamed and held publicly to account for their behaviour.
- From private to public investment. Whilst such interest-rate premiums persist there is a strong argument to be made not just for private but for public investment in support of a clearly articulated growth strategy built on identifying and supporting a series of key export-oriented sectors. The cost of financing long-term public borrowing is significantly lower than for commercial lenders. Moreover, public infrastructure projects are likely to be critical to any reconfiguration of the economy towards a new (and more clearly export-oriented) growth strategy. Public investment – especially in infrastructure renewal – can be a highly cost-effective way of providing the public goods on which the transition to a new model of growth relies.
- Hypothecated investment or growth bonds. How might such investment be funded? There are many options which might be considered, but one is the use of public investment or growth bonds – a form of hypothecated government debt and, in effect, an ethical form of investment available to financial institutions and private citizens alike. The funds secured in this way would be earmarked for public infrastructural projects and might be distributed through a range of national or regional investment banks. In addition to infrastructure, these might fund sustainable technologies and the human capital to utilise such technologies.
- Conditional deficit and debt reduction. A further implication of the analysis presented here is that we cannot afford to consider deficit reduction as a goal in itself – and certainly not the principal goal guiding economic policy. Deficit reduction in a context of stagnant or negative growth is suicidal and threatens only to produce a vicious circle of declining economic output. But this is not to suggest that there is a simple choice to be made between deficit reduction and growth promotion – but rather that deficit reduction must be made conditional on growth. Any incoming British government would need not only to be clear about its strategy for securing growth, but also to make a strong, and public, pre-commitment to an explicit growth target and a linked, sliding, scale of deficit reduction (the greater the growth rate attained, the greater the deficit and debt reduction). This is the only way to ensure that deficit and debt reduction writ large does not even now turn a global crisis into a global recession in a manner analogous to the 1930s.
- International coordination of debt and growth management. The economic case for conditional deficit and debt reduction is a very strong one, but it undoubtedly has its political difficulties. To announce the end of deficit reduction in one economy alone, especially in the current ideological climate and in a context of the timidity of financial institutions, would threaten a run on the currency and a steep rise in the cost of servicing (short-term) national debt. Consequently, it is imperative that steps are taken at an international (and, ideally, a global or at least G20) level to agree a coordinated strategy for managing debt and growth – as well as, in time, for moving away from the crude notion of output growth as the predominant currency of economic performance.
These five points do not in themselves constitute a sustainable model of sustainable economic development for Britain or anywhere else, but they remain necessary steps in the direction of a more sustainable Civic Capitalism.