It is alarming when economics starts to sound like Buddhism. Yet the British economy is now beset by paradoxes worthy of a Buddhist sage. The banks must increase their lending, but also improve their balance sheets. The Government has to cut its deficit, without undermining economic growth. Although taxes will have to rise, Britain must remain a low-tax economy. These are contradictions which cannot be resolved merely by combining them in the same mantra. As one senior Tory put it yesterday, "Everyone is saying that we're on a tightrope, and we certainly are in mid-air over a gorge. But where is the rope?"
Alistair Darling will have to find one in this week's pre-Budget announcements. He too is straddling a gorge. On one side are the long-term interests of the British economy; on the other, the general election. If the leaks are to be believed, Gordon Brown wants Mr Darling to indulge in the crudest electioneering: devise taxes on toffs and then dare the Tories to disagree. Mr Brown is desperate for a Budget to please John Prescott.
The signs are that Mr Darling thinks differently. Like a lot of quiet men, Alistair Darling is tougher than he looks. He saw off Gordon Brown when the PM wanted to move him and he is not prepared to risk his reputation for the sake of a dubious electoral ploy. But Gordon Brown cannot help it. However often Peter Mandelson assures him that class war is bad politics, the Prime Minister is in the grip of a hatred of everything that he believes David Cameron stands for. Consumed by class resentments, he assumes that everyone else would share his feelings, if only he expressed them strongly enough.
Mr Darling is not a hater. Moreover, he was at Loretto, a major Scottish public school. If Alistair Darling were a Tory, Gordon Brown would despise him and his school almost as much as he despises Eton. But even if the Chancellor does not share Mr Brown's Heathcliffian intensity, this does mean that he is uninterested in electoral politics. It is merely that he sees no merit in a Budget which would have John Prescott cackling while it was pulled to pieces by all the serious commentators. Mr Darling thinks that Labour has only one hope: to be seen as the pilot who might weather the storm. In order for this to seem remotely plausible, the Chancellor will have to move beyond economic Buddhism and find a way of resolving the contradictions. This means a seriously argued four- or five-year plan for economic growth and fiscal tightening.
The tightening is essential. As long as quantitative easing continues, the Government is in effect selling its debt to itself. But that is only a short-term expedient. Within a few months, the Treasury's gilt salesmen will have to return to the markets. Unless there is a credible proposal to reduce government borrowing, the markets will be sceptical. There would be considerable upward pressure on interest rates, the UK's triple-A credit rating could be in jeopardy and the Government might well have to go begging to the IMF. Britain would be faced by stagflation – no growth plus inflation – and its hideous consequences, both economic and social. Any government could only avoid all that by a convincing commitment to spending cuts and tax increases.
The sums involved are daunting. Between them, a 10 per cent reduction in government spending over three years and an increase in VAT to 20 per cent would not even cut the deficit in half. Yet spending surgery of that magnitude would not be easy, and there is a further problem. All economic activity increases demand, including wasteful government spending. That has to be eliminated, in order to avoid stagflation. But it has to be done in a manner that is compatible with growth, for there is only one way to refloat our economy: a sustained period of growth.
In an ideal world, this could be encouraged by a range of supply-side measures. Why not decree that for their first three years, new employees would have no rights under employment protection laws? Though that might sound inhumane, it is not as inhumane as unemployment. It would help to restart the economy. But there is a problem: Europe. Because this government embraced the social chapter, we have forfeited many of our rights to help unemployed people back to work. The EU's regulatory chains will hamper the fight against recession.
That said, there is one obvious supply-side step which the Government could have taken, but has wilfully refused to do so. A few months ago, the Tories proposed a loan guarantee scheme to assist small and medium-sized businesses. A business approaches its bank and asks for a loan. The bank does due diligence in the knowledge that the Government would fund three-quarters of the loan. As the bank is liable for its quarter, there is every incentive for prudent lending. For its three-quarters, the Government would collect a healthy interest rate; the cash would be useful. This could be funded out of the proceeds of quantitative easing, and would ensure that the money the Government wished to make available actually reached those who needed it. Because it was a Tory proposal, nothing has happened. This is shameful.
That is a word to which bankers are becoming accustomed. Everyone has stories about meeting some prosperous-looking cove at a dinner party, who becomes oddly shifty when asked what he does. A chiropodist, perhaps, or an undertaker – or maybe a professional Morris dancer? None of the above; the chap who blushes as he looks down at his Lobb shoes is, of course, a merchant banker. It is easy to see why banker-baiting has become a popular pastime; it is also a dangerous one.
Britain needs bankers. They make an indispensable contribution to GDP and to tax revenues. Without financial services, our national standard of living would slump and stay slumped. It is not as if the bankers were solely to blame for the recent degringolade. Most politicians, most commentators and most economists were equally blind: equally guilty. But there is one crucial difference between bankers and the others, with the possible exception of the economists. Bankers are internationally marketable. There are already signs that financial service companies are moving to Geneva. There, one suspects, bankers have an easier time over the dinner table. Over the past few years, bankers' tax payments have built a lot of schools and hospitals. If Britain is ever to return to the days of well-funded public expenditure plus tax cuts, we will require a booming financial sector. If the City came to believe that the 50 per cent tax rate would be permanent, all that would be endangered.
There is a case for reforming bankers' bonuses. But this needs careful consideration. Although it might seem a good idea to pay the bonus in shares rather than in cash, that has happened in the past. Lehman Bros, the now extinct thundering herd, did precisely that, as did AIG, the stricken insurance company. Above all, we must remember that we are dealing with a mobile industry and mobile individuals. It is no use telling Manchester United to cap its footballers' salaries if the best of them promptly move to Real Madrid. Indeed, that analogy is insufficiently dramatic. In football, the players can move. In banking, the whole shebang could take wing.
It is true that bankers ought to make some reparation for their role in the crisis. But the best way in which they could do that is to recover rapidly, make large profits, pay large salaries – and thereby generate lots of tax revenue.Reuse content