• Andrew O'Brien

Why are Conservatives obsessed with the state?

Updated: Aug 6, 2020

Eyes are once again turning away from the economy back to the still unresolved health emergency as a second wave of COVID begins ripples throughout Europe. Keeping on top of this virus is still the single most important thing that the government can do to support the economy. However, the next few months will set the tone for the economy over the coming decade as the UK and the world recovers from this once-in-a-generation shock – in the same way that the summer of 2010 set the parameters for the following decade.

Expansionary fiscal contraction (or austerity as it is otherwise known) has already been rejected by the Prime Minister and his advisors. Partly on political reasons as everyone knows that it is political unpopular but also on economic grounds. Conservatives have grudgingly accepted that cutting departmental spending and reforming welfare is neither likely to reduce debt nor the size of the state. As any reading of debt and state reduction over the course of the 19th and 20th Centuries would tell you, the only way to effectively shrink debt and the size of the state over the long term is to boost growth.

This just leaves one simple question for this Conservative Government to answer, therefore, how do you boost growth?

Before the last election, there was much conversation about “boosterism” as the governing philosophy of this government. This philosophy appeared to have two main pillars. The first was related to the personality of the PM himself, his optimism and salesmanship as a politician. Boris would reverse the media and establishment antipathy about Brexit and fears around British decline, steering the country towards a vision of Brexit as an opportunity to turbocharge the economy.

Fibre optic broadband to the rescue?

The second pillar was to upgrade the country’s infrastructure. Again, this was partly related to the Prime Minister’s personality as someone who wants “get things done” and leave a legacy behind. Politically this is also attractive as infrastructure is something tangible. A railway station is either built or it isn’t. Fibre optic broadband is either installed or it isn’t. People can see and feel the change.

The good news is that both bits of this agenda are still as relevant as they were before. The animal spirits will need to be reinvigorated if consumers and businesses are to spend and invest. It is important that this is more than just rhetoric. Words are important, but as we see with Brexit, warm words have not shaken the views of many businesses that this is going to be a tough period. Businesses and consumers will need to be shown a credible pathway for the future of the economy which will see high enough growth to justify investment. Infrastructure has also been brought to the fore, particularly digital infrastructure. We’ve all had to deal with the problems of weak internet connections. Fixing this infrastructure will be important for the future.

But there is a recognition across Government and the wider policy community that optimism and infrastructure alone will not be enough, a wider and more comprehensive approach is needed.

Unsurprisingly, there is less agreement on what this is. As I wrote in a previous article, there is a division within the Conservatives between the Smithians and the Schumpeterians. The Smithians want trade deals – which even the optimists believe will generate only minimal economic returns – and the Schumpeterians that want to focus on R&D.

In both cases though all the focus is on the state. For the Smithians, the problem was not that UK businesses were unable or unwilling to export. It was that the Brussels bureaucracy was too slow at negotiating trade deals and too protectionist. Remove the “blob” and trade will flourish.

But as the former Trade Secretary and WTO Director-General Candidate Liam Fox said back in 2017, part of the problem is the culture of British business. Germany and France have both seen exports grow faster in recent decades than the UK and they have been inside the EU. UK Government support for exporting has also been significant through campaigns such as the GREAT campaign and significant increases in Export Finance Guarantees. Although the volume and number of exports has increased in the past few years, the UK is still trailing peers. As Liam Fox asked, bluntly, “what is the point of us reshaping global trade, what is the point of us going out and looking for new markets for the United Kingdom, if we don’t have the exporters to fill those markets?”

"Worryingly, the Bank of England found in a major survey of businesses in 2017 that 70% of businesses that said they underinvested cited lack of internal funds as a barrier. In the same survey, over 60% of respondents judged distribution to shareholders and purchasing financial assets as the most important use of internal funds – not investment."

On the Schumpeterian side, the Government has focused on boosting R&D spending (by £15bn by 2027) and reforms to the Civil Service to bring more experts and scientific expertise into the sector alongside a new £800m DARPA-style “blue skies” research investment agency. Government has a critical role to play in innovation and R&D, but again, most of the work needs to be done in the private sector. Nearly 70% of R&D was carried out by the private sector, compared to 30% by the public sector. Worryingly, the Bank of England found in a major survey of businesses in 2017 that 70% of businesses that said they underinvested cited lack of internal funds as a barrier. In the same survey, over 60% of respondents judged distribution to shareholders and purchasing financial assets as the most important use of internal funds – not investment.

Even more worryingly, in recent years despite public capital investment increasing by 15% since 2016, we have not seen private sector investment grow in a similar way. Some of this may be due to Brexit, but given historic under-investment by the UK corporate sector, a one-off event cannot be the only reason. There is no reason to expect that increased public spending will generate results.

So given this, why the Conservative obsession with the state?

Conservatives need to develop a more comprehensive diagnosis of the country’s economic challenges beyond just looking at the state. It is the individual decisions of British businesses over the coming years which will determine whether levelling up succeeds.

There is an interesting parallel with the Thatcher Ministry. For Thatcher just as important as “rolling back the state” was “encouraging enterprise”. The view was that British business had become flabby and poorly managed, not focused enough on growth and innovation. Thatcher’s supporters saw this very much through the “Principal-Agent” problem, where managers were too busy feathering their own nests. Restore power to the “principals” (i.e. shareholders), who had a direct interest in efficiency and expansion to increase their profits, and business would improve. There were multiple flaws with this diagnosis, but it drove an economic programme which for good or ill was able shaped the UK economy for decades.

So what is the Johnson Ministry’s diagnosis of the state of British business? This must be beyond the need for "optimism" or "infrastructure". Why is R&D not a priority for British businesses? Why are businesses not exporting? Why do we not see enough long-term planning in the private sector?

The answers to these questions will determine policy. Not answering them or ignoring them, will just create a vacuum and undermine the levelling up agenda.

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