In his first budget George Osborne set out his economic approach when he said cuts in public spending were necessary because the state is “crowding out private endeavour”. This line has also been parroted by some business organisations in Scotland as an excuse for the lack of growth in the private sector.
The concept was developed by Roger Bacon and Walter Ellis in their 1977 book ‘Britain’s Economic Problem: Too Few Producers’. In essence make the state smaller and the private sector will grow. The problem with this theory is that not even the Treasury’s own economic model could find any crowding out effect. Of course Osborne’s mentor Mrs Thatcher didn’t let the small matter of evidence get in the way of ideology when it became a guiding principle of her strategy.
Even Bacon and Ellis would struggle to find the factors that underpin their theory today. If crowding out occurs it is limited to very specific conditions such as a budget deficit leading to a hike in interest rates. Today these rates are at a record low that means that the public deficit can easily be funded. The problem is inadequate, not surplus demand.
The real problem is an imbalance in the private sector. In recent years the growing dependence on a finance driven business model has pinned back productive parts of the UK economy. The hedge fund gambling, takeovers and mergers have provided short term cash gains at the expense of long term investment in factories and new products. Successful economies are those that ensure adequate funds for infrastructure and technology.
Between 1999 and 2007, 45% of all UK bank lending went on property. In contrast, as a share of total lending the value of loans to manufacturing firms more than halved. In 2007 R&D intensive companies spent £17bn while £86bn was spent on mergers and acquisitions. As Angus Tulloch (a global fund manager) put it in the Scottish Parliament in 2010 “The financial sector has become totally detached from the real world”. The relentless drive for short term shareholder return may have made a few parasites very rich, but it has wrecked the UK economy.
If the Tories could get past their Euro-sceptic wing they would see that countries like Germany have a banking system designed to support productive industry. Financial profit is not allowed to crowd out real investment. They don’t have the destabilising dominance of the City of London that dismantles the UK’s biggest companies. In the 1960’s shares were held for an average of five years – by 2007 it was seven months.
UNISON Scotland commissioned research from the University of Strathclyde before the crash that confirmed that crowding out has simply not been an issue in Scotland. And all is not lost. Half of UK exports still come from the manufacturing sector and there are many sound firms. However, there is a real risk that unless we give greater value to long-term returns the UK will slip into a low-wage, low value-added, low knowledge-based economy.
It was the ideology of the 1980’s that drove us to the financial crash, not public spending. The real crowding out is the imbalance in the private sector caused by the get rich quick dominance of the financial sector. That’s were the focus should be. Scottish public sector institutions are critical to the success of the Scottish economy through providing basic infrastructure as well as key human and technological resources for the private sector.