Storm, The (26 page)

The property ‘bubble’ was, in turn, a consequence and a symptom of a wider and deeper problem: the spilling over into the
British banking system of an excess of liquidity originating in cheap foreign money. Britain has had declining rates of household
saving for over a decade – from 7 per cent of disposable income in 1998 to under 3 per cent in 2008 – and has imported savings
from overseas. Rising living standards were maintained by household borrowing. Another way of putting the same thing is to
say that
Britain has been running current account deficits financed by imported capital. Since Nigel Lawson’s economic boom in the
late 1980s, under Mrs Thatcher, it has become fashionable to regard the balance of payments as of no great interest: merely
an accounting identity which adjusts automatically through capital flows and the exchange rate. We now realize that it is
important and that our persistent deficits are a symptom of a dearth of domestic savings. While the immediate priority of
government is to stimulate spending to stave off recession, the longer-term need will be to boost savings for pensions, long-term
care and the financing of mortgage deposits. There is a long period of austerity ahead.

The same is true of the public sector. In the immediate future it is a safe haven for employment and a necessary support for
economic activity. In the longer term, structural deficits (negative savings) have to be reduced, which will bring severe
constraints on public-spending growth and call into question expensive commitments such as generous future public-sector pensions,
big defence contracts, government databases, welfare payments to high earners, and the expansion of government bureaucracy
and quangos.

The next illusion, the rebirth of British industry and enterprise, stems from a laudable willingness to embrace overseas partners
and investors. The relaxed approach to the ownership of the car industry by Japanese and Indian firms, to electricity generation
and distribution by French and German utility companies, and to Spanish banks makes Britain better placed in the long run
to operate within a globalized world. But the price has been a shocking complacency about domestic capabilities. The paucity
of British students coming through school and university with mathema -t ical literacy, specialized sciences and modern languages
means that there is an inadequate base for ‘blue-skies’ science, for applied science and engineering, and for global business
negotiations. A generation’s neglect of vocational skills has led to a situation where only Polish immigrants know how to
repair leaking pipes and lay
bricks. Such dependence is spreading up the occupational chain, unless future governments try to stop the rot within the school
system. Instead of constant meddling, centralized intervention in every aspect of national life, the government has to focus
on its core functions such as education and research. This emphasis is an essential building block in the creation of a ‘knowledge
economy’ with a broader base than the current economy, over dependent on banking.

Not least of the illusions is the belief that investment banking, mortgage-broking and complex financial product design were
a source of national comparative advantage and wealth creation. The obsequious pilgrimage of Labour politicians to the City
and their exaggerated deference to its concerns have led to a seriously unbalanced economy, more exposed to major financial
shocks than others. I discussed in the penultimate chapter some of the reforms at national and international level needed
to curb the destabilizing excesses of the financial sector. There may be a deeper problem. Thirty years ago, Britain had a
‘Dutch disease’, arising from the damaging effect on the exchange rate of oil and gas. What should have been an opportunity
became a problem. The oil and gas reserves have now been run down (and, arguably, wasted), ending that disease. But it has
been replaced by the ‘Icelandic disease’, whereby a banking sector outgrows its host economy, creating chronic financial instability.
A brutal solution would be drastically to prune back the industry, as Mrs Thatcher did to coal-mining when Mr Scargill posed
a threat to stability comparable to that created by Mr Adam Applegarth of Northern Rock, Sir Fred Goodwin of RBS/Nat West
and Mr Bob Diamond of Barclays today. That would be destructive of much productive and genuinely wealth-creating activity
in business services.

An alternative approach would be to anchor the currency and country in a bigger economic space, as Ireland has done in the
eurozone. There is at present no great appetite for eurozone membership, and the eurozone has undoubted internal strains of
its own. I have grown a little Eurosceptic in recent years and
have recognized the short-term tactical merits of monetary and exchange rate independence. The current devaluation in particular
could provide a helpful short-term stimulus to offset the recession. But if that independence looks to be largely illusory,
with no enduring benefits, the attractions of external disciplines would become much stronger. That conclusion is strengthened
when we see that national fiscal disciplines have also proved illusory, and have allowed the accumulation of structural budget
deficits which might have been subject to stronger peer group pressure in the eurozone. Germany has moved out of recession
very quickly and France was scarcely affected. But several southern European countries face big, long-term problems. Should,
however, the eurozone navigate its way out of the current crisis quicker and with less damage than the UK, then the pressure
in the UK for membership will grow. Whether or not that particular option is open, there will have to be a radical economic
rebalancing in which the financial services sector is relatively smaller and other traded activities, notably manufacturing,
larger – and there is a parallel economic shift from the South-East to the provinces.

The financial and economic crash has also exposed the weakening of social cohesion that has followed in the wake of Britain
becoming an international financial centre. The amoral, cynical financial dealings which, we were assured, created wealth
have contributed not just to instability but to a weakening of the wider ‘social contract’. The tax system has been corrupted
by the perceived need to defer to tax havens, the special needs of ‘non-domiciled’ residents, and the demand for capital gains
to be treated more generously than earned income. There must now be a reconnection. We can surely learn from the open, social
democratic Nordic economies and from Canada that a commitment to openness and fiscal discipline can be – and has to be – matched
by a commitment at a national level to a balancing sense of ‘fairness’. By this I do not mean a return to the illiberal, statist
controls of the 1970s and before; the government is generally not very good at running complicated organizations and systems.
But it should be possible, despite public spending constraints, through the generous but efficient provision of public goods,
genuinely redistributive taxation and strong, solid safety nets for working families and pensioners, to remove extreme inequalities
of wealth, income and opportunity; to recreate a sense that the country is a community; and to repair some of the damage that
this great storm has wreaked. While there is crucial, urgent work to be done on the blocked financial plumbing and dangerous
economic wiring, it is the job of the political class to redesign the home so that it is better able to withstand future disasters.

This publication was written in some haste, against a background of rapidly changing and largely unprecedented events, without
the prop and discipline of a comprehensive review of related literature. My main source has been the daily news and the commentary
on it by business and economic journalists.

My approach has both the strengths and weaknesses of a commentary given by an active participant in the political debate,
exposed to events and decision making at first hand, but also lacking detachment. Keynes once observed that ‘all men of affairs
are the slaves of some defunct economist’. I shall try, in my own case, to identify some of those defunct, as well as contemporary,
sources of ideas.

In the
Introduction
, I try to locate the subject matter in the broad context of international economic, and specifically financial, integration:
what we loosely call ‘globalization’. I sum marized the debates around globalization in a book I wrote a decade ago:
Globalization and Global Governance
(Royal Institute of International Affairs / Pinter, 1999). Two iconic texts around the subject of globalization are particularly
relevant: Richard O’Brien’s
Global Financial Integration: The End of Geography
(Royal Institute of International Affairs / Pinter, 1992), and Francis Fukuyama’s
The End of History and the Last Man
(Hamish Hamilton, 1992). Since
then, the most satisfactory and comprehensive analysis, and one that broadly reflects the author’s view, has been in Martin
Wolf’s
Why Globalization Works
(Yale University Press, 2004), and also in Jagdish Bhagwati,
In Defence of Globalization
(Oxford University Press, 2007). There is an early, balanced assessment in P. Hirst and G. Thomson,
Globalization in Question
(Polity Press, 1996), and a comprehensive multidisciplinary survey in John Benyon and David Dunkerley,
Globalization: The Reader
(Athlone Press, 2000).

I also endeavour to locate the arguments in a historical context, and in particular the history of financial crashes and of
economic cycles (which are often closely related). The classic texts on financial crises of which I have made good use are
John Kenneth Galbraith’s
A Short History of Financial Euphoria
(Penguin Books, 1990), Charles Kindleberger’s
Manias,
Panics and Crashes
(Basic Books, 1978), Hyman Minsky,
Stabilizing an Unstable Economy
(Yale University Press, 1986), and Edward Chancellor,
The Devil Take the Hindmost: A History of Financial Speculation
(Macmillan, 1999). There is a good contemporary study in John Calverley,
Bubbles and How to Survive Them
(Nicholas Brearley, 2004). Among academic studies that remind us that there have been many cyclical swings in commodity prices
and economic growth are Phyllis Deane and W. A. Cole,
British Economic Growth 1688–1959
(Cambridge University Press, 1969), and Douglas North and R. P. Thomas,
The Rise of the Western World
(Cambridge University Press, 1973).

Of particular relevance to a cycle prominently featuring house prices are John Parry Lewis,
Building Cycles and Britain’s Growth
(Macmillan, 1965), and Fred Harrison,
Boom Bust: House Prices, Banking and the Depression of 2010
(Shepherd Walwyn, 2008).

Periodic banking crises and economic cycles and the links between them were, I believe, first tackled systematically and theoretically
by John Stuart Mill, ‘Paper Currency and Commercial Distress’, 1826, in
Collected Works of J.
S. Mill
, ed. J. M. Robson, Vol. 4:
Essays on Economics and Society
(Routledge and Kegan Paul, 1967). His insights were built upon by Alfred Marshall in
The Economics
of Industry
(Macmillan, 1884). A good source on the history of economic thinking about cycles is W. W. Rostow,
Theorists of Economic Growth from David Hume to the Present
(Oxford University Press, 1990). Such theory as I understand on the subject I can trace back to my main undergraduate text:
R. C. O. Matthews,
The Trade Cycle
(Cambridge University Press, 1959).

While there have been many boom and bust cycles in economic history, the one that matters and with which ominous parallels
are now being drawn is that of the inter-war period. I returned to some familiar sources, notably John Kenneth Galbraith’s
The Great Crash 1929
(Houghton Mifflin, 1988). Keynes’s ideas are best surveyed in Robert Skidelsky’s three-volume work,
John Maynard Keynes
(Macmillan, 1992–2001). The contrary, Austrian view of economics is to be found in the classic texts of von Mises, Bohm-Bauwerk,
von Hayek and Schumpeter. These are briefly summarized in relation to economic cycles in Rostow (above). There is a restatement
in a contemporary context in Sandy Chen’s Equity Research paper for Panmure Gordon (23 September 2008).