Can the private sector take up the slack?

The Coalition’s plan is that as people are made redundant from the public sector over the next few years they will be mopped up by a private sector that, freed from some of the overhead cost of ‘big government’ will be able to expand at record rates.   This is an attractive notion, especially to those of us who like the idea of ‘small government’, but does it actually stand up to critical analysis?  

Unfortunately, it turns out that you have to believe rather a lot of difficult things before breakfast for it to be true.  As Marshall Auerback points out, “The claim that consumers and business investors are paralyzed by the state of public finances has never been empirically proved. Yet ample historical evidence supports the proposition that fiscal austerity can kill growth.”  In other words, this is just Tory (and neo-Liberal) dogma, not science.  

Consider first the scale of the problem.  The Shadow Chancellor quoting the Office of Budget Responsibility on the ‘World at One’, today said that 2.5 million new jobs must be created which implies a growth in private sector investment and exports in each of the next three years that has only ever been beaten once (in 1966) in recent decades.   I haven’t checked his data but this soulds about right.   To have any chance of hitting this target the government must somehow immediately, magically you might say, reverse the deep-seated problems that have been causing our economy to gently decline for many, many years as other more dynamic economies have roared past.   Yet revitalising the economy has been a central objective of successive governments of all colours for as long as I can remember.  It is pretty clear that government as a whole, and again irrespective of colour, has remarkably little grasp of what is required.  (To give credit where it’s due, I think Vince Cable does have a fair idea, though not necessarily a comprehensive blueprint.  He is, however, only one man and from the junior Coalition partners).

Then there are the more specific difficulties the private sector faces as it tries to take up those made redundant by the public sector and top of this list is the cost and availability of bank loans, especially for small and medium-sized businesses which in government parlance means up to many hundreds of employees.  (The problem is less acute for large business because they have the option to bypass the banks and fund themselves wholesale from the money markets.)  Yet it is these same small and medium-sized firms that are the engines of job creation.  Large firms create few net new jobs and when they do it is just as likely to be in Bangalore as Birmingham.

The cost (and availability) of loans is not just a bump in the road, it’s a complete deal breaker because, with very rare exceptions, it’s takes lots and lots of capital to start a business and even more to expand it.    Here the difficulty is that although Base Rate has been reduced to record lows the banks are still charging sky-high rates (typically around 10% according to the stories I hear) along with unreasonable demands for security even for perfectly ordinary loans – including in many cases just for rolling over existing loans to perfectly well run and viable businesses.   This factor alone will ensure that most companies will have to focus on surviving and that expanding will be completely out of the question.

The difficulty for the Coalition is what to do about it.  Administrative interventions – forcing the banks to make loans at lower rates is a slippery slope to hell and would lead to fraud and crony capitalism.   We need to get back to an efficiently functioning loan market fast; if doing so involves violence to banks, breaking them up or whatever, well, they deserve it.  

The cost of capital may be a deal breaker but it’s not the only serious problem; to my mind the poor structure of training in this country is not far behind.  For as long as I can remember the objective across the political spectrum has been to reduce wage costs to make/keep British firms internationally competitive.  Under Tories this has usually been more or less explicit – for example breaking union power – while under Labour it’s been covert and by devaluation – for example Wilson’s infamous “This doesn’t mean … that the pound in your pocket … has been devalued” claim (oh, yes it had!).  

That competitiveness is all about cost is a common delusion among economists I’ve met (I put it down to spending too long thinking about supply-demand curves).   In the real world it’s got far more to do with efficiency and effectiveness so getting training right is crucial.  Government should stop throwing money at it and just hoping some of it works.  They must instead work out a scheme that introduces some market disciplines (and I don’t mean outsourcing it to some crony capitalist friends).   Unfortunately, to set up an effective system will take several years even if it were ready to launch right now with the basic thinking already done in the relative calm of opposition – and I see no sign of that.

Then consider the chilly global economic climate.  Every country in the world is trying to boost exports as a way out of this mess so it’s going to be hard pounding at best.  Don’t get me wrong on this; I’m basically an optimist in that I believe that if we get the conditions right we can take on and beat the best in the world.  It’s just that conditions are clearly not right at the moment so we’re not quite making it.  As in football we seem to lose to the Germans rather too often for comfort!

For most firms, especially the smallest and least specialised, the UK domestic market is what counts and here too there is a problem.   By far the biggest customer in the domestic market (aka the Government) is planning to massively cut its purchases at the worst possible time and this is bound to cause a degree of domino collapse as firms that supply the government respond by reducing their own purchases and so on down the line.  Just how far this might go is hard to say.  PWC accountants think it will cost another 0.5 million jobs on top of the 0.5 million the government plans to cut directly.  And if the private sector doesn’t manage to expand faster than it’ ever done in living memory, then the lost tax revenue and extra unemployment costs will blow the government’s forecasts right out of the water which might mean more cuts if the Coalition follows the same logic again leading to less revenue and yet more unemployment benefits paid out.  

This is not a fanciful scenario – it’s more or less what’s happened in Ireland.  It’s also what happened in the UK after WW1; government spending was aggressively cut from £1.85 billion to £480 million but the public debt to GDP rose from 114% to 180%  (via Auerback as above).

We are between a rock and a hard place, on the one hand we are in trouble if we cut ahead of the private sector taking up the slack but on the other hand we simply cannot go on running a monster deficit.   We must either adjust to a lower standard of living commensurate with what we earn (not a happy thought) or we manage a quantum leap in the efficiency of our industry greater than any seen since the industrial revolution.

We should not let the crisis go to waste but should aim for the latter.  It’s perfectly doable but we will have to spend far more time talking about the real economy and far less obsessing about political froth.

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3 responses to this post.

  1. Posted by Cat on 26 October 2010 at 9:11 pm

    Just as they did in the 80s, Osborne will start selling or giving away state assets and companies, transferring potentially millions of employees into the private sector. If he sold off the shares in Lloyds & RBS he’d put 100,00ish workers back into the private sector. See the Adam Smith Institute ideas, Cleggy will be spouting them soon enough.

    Unless we are in 1930 not 1990, the economy in the city and south east will no doubt start motoring off the back of huge bonuses made on deals advising the government how to dispose of its assets. But the rest of the country will stagnate with little actual growth and high unemployment, any new jobs will be McJobs. The have nots will be chastised by the Chingford skinhead MkII for being idle and will have their benefits slashed to make the minimum wage jobs more appealing money wise.

    Reply

  2. Posted by Dougf on 27 October 2010 at 10:28 am

    “We are between a rock and a hard place. On the one hand we are in trouble if we cut ahead of the private sector taking up the slack but on the other hand we simply cannot go on running a monster deficit. We must either adjust to a lower standard of living commensurate with what we earn (not a happy thought) or we manage a quantum leap in the efficiency of our industry greater than any seen since the industrial revolution.”

    Absolutely correct. And unhappily for everyone, “we are in 1930 not 1990”, and even The City ain’t coming back this time. The difference between 1930 and now however is that ‘the good stuff’ has been out-sourced to Asia. That’s BAD.

    No easy solutions here. None at all.

    Reply

  3. Posted by Cat on 27 October 2010 at 5:35 pm

    Why are we in 1930/1?

    Osborne is banking on a massive spending spree by businesses, reading the torygraph it seems big business has been paying down debt since 2007 and will be ready to start spending now.

    Reply

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