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Tony Blair once said that ‘we’re at our best when at our boldest’.
Gordon Brown is – finally – heeding that advice. His plan to shore up
Britain’s banking system is our best hope of pacifying the financial
panic, getting credit flowing through the economy again and avoiding a
1930s-style depression. No wonder it is being copied across the world.

The need for massive state intervention in the banking system is
regrettable. But exceptional times call for exceptional measures.
Britain – and the world – is suffering a full-on financial heart
attack. Unless the financial arteries of the economy are unclogged
soon, huge job losses, bankruptcies, repossessions and a sharp fall in
living standards beckon.

The government must do whatever it takes – including, if necessary,
fully nationalising Britain’s banks for a while – to rescue the economy
from financial oblivion. Once the immediate crisis has passed, better
and tougher financial regulation should be a priority. But while the
glaring failings of global finance clearly need fixing, should the rest
of the economic rulebook be torn up too?

Many on the left think so. Ken Livingstone, the Guardian’s Seumas
Milne and others argue that the government should turn its back on
market economics. Since capitalism seems to be collapsing under the
weight of its internal contradictions, they believe, the government
should finish it off and regulate left, right and centre. More measured
voices, such as the TUC’s Brendan Barber, favour a ragbag of measures
such as curbs on boardroom salaries and a new industrial policy.

But the priority now is tackling the crisis and averting a
depression; everything else is a dangerous diversion. If struggling
businesses that have just had their overdraft cut fear that they are
about to be clobbered with higher taxes and more red tape, investment
and jobs will suffer. The last thing a heart attack victim needs is to
have a healthy leg amputated.

The government’s bank rescue
plan needs to be accompanied by measures to support the economy, not
shackle it. The Bank of England should continue to cut interest rates,
soon. Even though inflation is well above the target rate of two per
cent, it is set to fall sharply as oil prices tank. Collapsing demand
means that the real threat now is deflation, not inflation.

Some argue that the Bank of England’s independence should be
compromised. But that would be a mistake. Even the perception of
political meddling in setting interest rates would add to financial
uncertainty, undermine the credibility of monetary policy and raise the
cost of government borrowing. As we learnt to our cost in the 1970s and
the late 1980s, letting inflation rip does not lead to a sustained
improvement in unemployment and economic growth; quite the reverse.

But once the crisis has passed, the government should reform the
setting of monetary policy. The Bank of England’s target measure of
inflation should be amended to include housing costs. Its mandate
should also be broadened so that it takes more account of asset prices.
This would allow the Bank to raise interest rates to prevent bubbles
getting out of hand – and thus avert future busts.

Faced with the threat of a depression, the government must not be
hamstrung by its fiscal rules. Rightly, the government plans to borrow
huge sums to finance the rescue of the banking system. It is well
placed to do so since government debt as a share of GDP is low. This
need not increase the national debt in the long term: Sweden’s
government turned a profit on its investment when it rescued its banks
in the early 1990s. The government must also be ready to boost demand
with tax cuts and spending increases if the recession turns really
nasty. Fiscal tightening will certainly be needed – but only once the
economy is recovering.

The bigger question, though, is whether, once the immediate crisis
has passed, economic policy in areas other than finance needs to be
revised. Leftwing populists have been quick to bury what they describe
as the era of ‘unfettered markets’, but an economy where the government
takes around 40 per cent of national income in tax, pays for and
provides essential services such as healthcare and education, and
regulates everything from employment rights to credit-card contracts,
can scarcely be described as one where the state has shrivelled and
markets have free rein. So the issue is not whether the financial
crisis sounds the death-knell for the free market, but whether it tips
the balance towards greater state intervention.

That question is in fact two: first, does the crisis in financial
markets suggest that competitive markets more generally do not work as
well as we previously thought?; and second, will the crisis shift
public opinion towards supporting a bigger role for the state? My
answer to the first question is no; and while the answer to the second
question is still unclear, people do not appear to be hankering to turn
the clock back to the 1970s – notwithstanding the success of the TV
series Life on Mars.

As I wrote in 2002 in my first book, Open World: The Truth about
Globalisation: ‘Financial markets are unlike other markets. They are
inherently unstable. They are prone to Manias, Panics, and Crashes …
Why? Because they involve bets on an unknown and unknowable future.’
Product markets are very different: the market for cars or baked beans
is not prone to destabilising speculation – and even if people did
start gambling on the price of baked beans, its impact on jobs and the
economy would be limited. The temporary part-nationalisation of
Britain’s banks does not call for increased intervention elsewhere.
Royal Bank of Scotland may have come unstuck, but Tesco continues to
deliver the goods.

Faced with a nasty recession partly caused by reckless lending in
the US, the temptation to blame outsiders for our woes will grow. But
we shouldn’t throw the baby out with the bathwater. Britain benefits
hugely from its openness to foreign products, ideas and people. The low
prices in ASDA and Primark are only possible thanks to free trade, and
commerce with China will provide many of the jobs of the future. Recent
migrants from eastern Europe have filled vital jobs and revitalised the
economy through their dynamism. Beggar-thy-neighbour protectionism made
the Great Depression much worse; we would be crazy to repeat the same

Britain’s flexible labour markets will be a key strength in the
tough times ahead. They allow the economy to adapt rapidly to change,
helping to redeploy workers from shrinking industries to growing ones
and keeping unemployment down. Combined with measures to make work pay,
help people find jobs, and equip them with the skills they need, New
Labour’s labour-market policies stand us in good stead. We should not
be trying to protect yesterday’s jobs at the expense of tomorrow’s.

While tax rises will probably be needed in the medium term to pay
for the costs of the crisis and an unexpectedly deep recession, support
for higher taxes is hardly likely to be an election winner. Taxes must
also remain low enough to support opportunity and enterprise. If
working hard and starting a business is not rewarding enough, economic
growth will suffer – and with it the ability to invest in public
services. And unless public services continue to be reformed, with
choice driving up standards and giving people what they want, voters
are likely to feel their money is being wasted.

With Labour so far behind in the polls, the only chance of recovery
depends on rescuing the economy from the worst crisis since the 1930s.
Brown has come into his own in the past month, while the Conservatives,
who are unconvincing critics of City practices, are flailing. But
lurching to the left in the mistaken belief that markets no longer work
and that voters are crying out for bigger government would be a huge

Posted 29 Nov 2008 in Published articles

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