And there was an alternative: Cruise missiles tipped with nuclear warheads. The problem was that over their forty-year lifespan there was a risk that they would become comparatively slow as new defence systems were developed. They might have been less expensive than Trident, but by the time the tests had been done to see if they worked, they could well have cost the same or even more. Even though this proved a dead end, it was one that I was glad I explored.
Looking back over all this, I know that we left the nation’s defences in a better state than when we found them. Even though there were fewer personnel, there was better kit, better body armour, higher pay for those on tour, and military hardware fit for this century.
A navy built around two brand-new aircraft carriers, with replacement submarines for our nuclear deterrent, a fleet of hunter-killer subs, nineteen frigates and destroyers, and a modern amphibious task force manned by Royal Marine commandos.
An army capable of fighting three conflicts simultaneously – including complex stabilisation and peacekeeping missions – and of maintaining a force at high readiness for rapid deployment and, with sufficient warning, able to deploy 30,000 troops into action with maritime and air support.
And an air force with new fleets of transport planes – the C17s and A400Ms – and a large fleet of fast jets, principally Typhoons, soon to be augmented by the new F35.
The budget fell initially, but when I left office it was rising again. In the military expression, there was now ‘more in the tooth and less in the tail’. Or, for civilians, more fighting force and less backroom bureaucracy.
Far from having a smaller and less capable army, we could still field a force similar in size and capability to that deployed in the Falklands War in 1982 or Iraq in 2003. We could still sustain over several years a force similar in size to the Afghanistan deployment while taking on an additional small conflict (like Sierra Leone – or, as it turned out, Libya).
Among those who care about Britain’s standing in the world, there are many who think defence spending and army size are sacrosanct. For them, defence would have been completely exempt from the economic rescue we were undertaking – protected from cuts, like the health service or international aid.
But the reality is that a nation’s vulnerability is far greater if you have a tanking economy than if you have a temporary gap in your aircraft carrier capability. If you care about Britain’s standing in the world, you have to worry more than anything else about the economy and economic success. That is why it was right to ask the MoD to be part of the financial retrenchment – and why there would have to be many other cuts to come.
15
Budgets and Banks
I heard the chants from my office in No. 10 and saw the placards on TV. ‘Fight the ConDem Axe Men’. ‘Tory Scum, Here We Come’. ‘Stop the Cu*ts!’
Before the general election, the governor of the Bank of England, Mervyn King, had warned that the measures needed to fix Britain’s economy were so drastic that the winning party would be out of office for a generation.
And now, here I was, stuck in my office, as people protesting against those very measures in our October 2010 Spending Review encircled Downing Street, putting us in a ‘lockdown’, with no one allowed in, and no one allowed to leave.
As a pragmatist rather than an ideologue, I have always thought that the most important job for a prime minister is to do their duty – to tackle the most urgent task in front of them, whatever that might be. In 2010 there was absolutely no doubt what that was: to rescue our economy.
For me there wasn’t any doubt about how that could be achieved. It doesn’t require a degree in economics to appreciate that if you keep spending faster than the economy grows, and faster than tax revenue grows, eventually you will be in trouble. Which Britain had been doing and now was.
It wasn’t just the right economic moment but the right political moment. Cuts are always controversial. You can’t get them through if there isn’t political assent, and that assent is only forthcoming when people see how serious things are. Which, in 2010, they did.
I believed profoundly that, if done properly, it would work. And I was absolutely certain that far worse than administering the medicine would be failing to take action.
George and I would to and fro endlessly about the measures, but we never argued about the necessity of it all. Not once. After all, the budget deficit (the annual difference between what was coming into the country’s coffers and what was going out) was on course to be the highest in our peacetime history. That was adding an unprecedented amount to our national debt (the total outstanding stock of money owed by the government), which was already, again, the biggest in our peacetime history.
The more intelligent opponents of austerity would argue – rightly – that what really matters is the ratio of your outstanding debt compared to the overall size of your economy, the debt-to-GDP ratio. But even on this measure, real trouble was brewing. The debt as a share of our GDP was already forecast to rise from 34 per cent in 2003 to 75 per cent in 2015.
This matters for three reasons.
First, as the debt grows, so does the interest bill you have to pay – and that can squeeze out other vital government spending programmes. Indeed, when we took over, the government was spending more on debt interest every year than on defence. It was by far the fastest-growing government spending programme: £44 billion on simply servicing our debt.
Second, once your debt heads towards 100 per cent of your national income, there are dangers. Investors won’t invest in your country, and lenders won’t lend, or will ask for much higher interest rates in return for the risk they are taking. The higher rates choke off growth, tax revenues fall and the deficit rises, putting further pressure on interest rates.
In this situation, an economy can enter a form of ‘death spiral’: higher debt means higher rates means less growth means higher debt.
And third – and in my view the most vital reason – if your debt-to-GDP ratio gets too high, you may not be able to borrow through a crisis the next time trouble comes.
No one can abolish ‘boom and bust’. Or recessions. Or financial crises. Of course you try to prevent them, but nothing matters more than your country having finances strong enough to be able to cope – because you don’t know whether the next crisis is twenty or five years away. The alternative is collapse and state failure.
So during those early days in office I looked at the projected budget deficit of 11 per cent (it ended up hitting 10 per cent) and compared it with one of 6 per cent when we had gone cap in hand to the IMF in the 1970s – a humiliation seared into the memories of my generation. I looked at our debt-to-GDP ratio, projected to be nearly 75 per cent, and compared it with nearly 50 per cent in 1976.
We were at greater risk than I had ever experienced or envisaged – and it would be a complete dereliction of duty to fail to act and to leave the country unable to cope with future problems. Something Margaret Thatcher had said kept coming back to me: ‘We are in the business of planting trees for our children and grandchildren, or we have no business to be in politics at all.’ This wasn’t just today’s fight; it was a fight for all those future generations.
However, we couldn’t just address the debt and the deficit; we’d have to fix the broken economic system that had allowed them to get this bad. That meant picking apart everything that had gone wrong over the past thirteen years – and more.
People might look back at those years of economic growth under Labour and think that surely something must have gone right. On the face of it they would be correct. The number of jobs did increase. But over 70 per cent of them went to workers from overseas. If you took away immigration and the public sector, the number of jobs had actually fallen since 1997.
The unemployment rate did come down. But then it went back up again. And anyway, more revealing was the overall rate of inactivity (i.e. the perce
ntage of people not actually in work), which was 21.5 per cent – over a fifth of the working-age population. This was masked by a ballooning welfare system. One in three households – those out of work but also, unsustainably, those in work – got at least half of their income from benefits.
Tax revenues were flooding in. But largely these were from the City of London and financial services, which, along with corporation tax, stamp duty and bonuses, made up more than 11 per cent of UK tax revenue. They were also coming from banks, companies and households whose spending ability increasingly came from debt.
And there was growth. But this was primarily in the size of the state, which increased in a decade from 34 per cent of GDP to 45 per cent, faster than almost any other economy over the same period. And real growth – private-sector job growth – was focused on only one part of the country. A statistic George and I often referred to was that for every ten private-sector jobs created in the south, just one was created in the north and the Midlands.
So it turned out that Labour’s economic sunshine was just clever lighting. They had disguised falling employment, a shrinking private sector and a growing deficit with a ballooning state and welfare system, surging immigration and the tax revenue of an out-of-control financial services industry.
It wasn’t a placard that encapsulated this, but a note. When the new chief secretary to the Treasury David Laws looked in his office drawer, he found an envelope from his Labour predecessor. The message inside it read:
Dear Chief Secretary,
I’m afraid there is no money,
Kind regards – and good luck!
Liam Byrne.
The note struck a chord with the public. It symbolised Labour’s profligacy so perfectly that, five years later, I would carry around copies of it with me on the campaign trail.
By immediately establishing the Office for Budget Responsibility under a founding member of the Bank of England’s Monetary Policy Committee, Alan Budd, we were able to make sure all fiscal policy would be based on independent, public forecasts.
The step was part of a three-tiered response we had been working on since the crash first hit in 2008:
Monetary activism. Backing the Bank of England’s strategy of low interest rates – and in 2011–12 encouraging it to go further by directly extending liquidity to banks and building societies, so that borrowing and lending, including to small businesses and homebuyers, would actually take place.
If you like, low interest rates in principle needed to be backed by low interest rates and the availability of credit in practice. In opposition we spoke about a massive loan guarantee scheme. We took important steps in this direction, which I will briefly describe below. But with hindsight we should have been far bolder, far sooner.
Supply-side reform. Cutting regulation. Encouraging start-ups and entrepreneurs. Making it easier to hire staff and grow a business. Backing inward investment. Reforming education. Building infrastructure.
These changes to the so-called ‘supply side’ of the economy can raise your country’s underlying growth rate, particularly when other forms of stimulus are unavailable, because interest rates are already at rock bottom and the budget deficit is so big that tax cuts or spending increases are unavailable.
Our biggest supply-side move was on corporation tax, which would be slashed from 28 to 24 per cent, and eventually 17 per cent – the lowest rate of any major Western economy. By the time we left office there were a million more businesses up and running – and the UK had cemented its reputation as the start-up capital of Europe, the home of international commerce and one of the most competitive places in the world to do business.
Fiscal responsibility. In other words – and we were never afraid of using the word – austerity. Ensuring that Britain could live within its means was vital to giving businesses the confidence to invest and consumers the confidence to spend. And, of course, you could only rely on things like monetary activism if fiscal policy was credible.
The situation in Europe showed how urgent this was. Some countries – especially Greece, but others too – looked in danger of entering a death spiral of low or no growth, ballooning deficits and high interest rates. In fact, one of the first briefings I received in government said just that: there was a risk that the markets would shift their focus from the Eurozone to other highly indebted countries, like us. That could mean much higher interest rates – and real trouble ahead.
As I’ve said, one of the first decisions we took was to make immediate in-year savings. Consultancy fees, IT costs, first-class travel, unnecessary quangos; they were obvious candidates for the axe. We managed this while paying to scrap Labour’s ‘jobs tax’ – their proposed increase in National Insurance contributions, which we believed would make the situation worse, and had played an important role in our election campaign. Interest rates came down in response to these savings, which were, bit by bit, reducing the amount the government was spending on its debt – some proof that we were on the right path.
But there was criticism too. The one that hit me most was that our action was akin to Margaret Thatcher’s in the 1980s – illustrated by one of those placards, which had my face on it and the words ‘I can’t believe it’s not Thatcher’.
I would argue that this was not like the 1980s. Then, the rhetoric was very tough, but the overall cuts were really quite mild. Conversely, what we were attempting in terms of cutting government spending was far tougher in reality, but I wanted to take more of the country with me.
Of course, economic responsibility was our goal. But another value – fairness – would be our guide. I wanted us to be the ones to prove that you could do more for less. To demonstrate that those with the broadest shoulders could bear the greatest burden. To protect the weakest and most vulnerable. To come out at the end of it with not just the books balanced but with a fairer balance between those who were fortunate and those who were not.
‘We are all in this together’ was the slogan I used in my 2005 victory speech, and which was adopted by George in the years to come. Winston Churchill’s grandson Nicholas Soames, the MP for Mid Sussex, had given us the idea: ‘It’s as if you are leading the country through a time of war,’ he boomed down the phone. ‘You need people to see that this is a great national endeavour – that we are all in this together.’
There were many who didn’t feel part of the endeavour. They thought cuts weren’t just unnecessary but cruel, particularly to those receiving reduced public services, who were often the most vulnerable. Did those critics not think, though, about what would happen to those public services if we let Britain’s economy tank? Take the moment when Britain teetered on the brink of bankruptcy in the 1970s. A condition of the IMF loan was £2.5 billion of immediate spending cuts – 4 per cent of all government spending. That meant an inevitable fall in funding for areas like unemployment benefits and the NHS – in fact, the only ever fall in the NHS budget since the first few years after it was established.
We knew we could also mitigate the impact on the most vulnerable with our approach towards the regions. This was another way in which we differed from Thatcher. A hit to the regions had been inevitable in the 1980s because of the closure of old and inefficient industries. This time revitalising the regions was a priority, since half of all the country’s growth was concentrated in London and the south-east. The Regional Growth Fund started off as a pot of over £1 billion to help lever private investment into parts of the country that relied more heavily on state spending. It would be down to those areas, via local businesses, councils and new metro mayors, to dictate where that money was spent.
However, we couldn’t rely on cuts alone to balance the books. There would also have to be tax increases, and a decision about how much to impose of each – cuts and taxes – would have to be made. The evidence internationally was that the best economic outcome would be achieved if 80 per cent of deficit reduction was made through c
uts to spending and 20 per cent through taxation. It was the ratio we had promised at the election.
The question was which taxes we could increase. Increasing income tax blunted incentives and put off inward investment. Raising National Insurance was a jobs tax. There were changes we could make to the taxes paid on buying property and capital gains that would make the system fairer and ensure that the rich contributed the most – and we made them – but they couldn’t raise the sort of revenue we needed.
Raising VAT, on the other hand, would take a little bit of money off a lot of people, and raise a lot of revenue in the process. The distributional effects weren’t perfect, but the rich paid the most because they spent the most, and because some basic goods were VAT-exempt. So after putting the Treasury through its paces, I assented to something I’d made sure we’d never ruled out. Increasing VAT from 17.5 to 20 per cent was the biggest act of our Emergency Budget on 22 June 2010, and it would take effect from January 2011.
As well as raising VAT, we took action on Capital Gains Tax. I have always been in favour of a low rate for this tax. You don’t want people holding onto assets simply to avoid paying tax (not least because it holds back the revenue you raise). And setting a low rate is one of the ways a country can build a more entrepreneurial climate. But Labour had left an unsustainable situation. Their main rate, at just 18 per cent, was so much lower than the top rate of income tax (too high, at 50 per cent), that people were finding ever more clever ways of turning income into capital growth and therefore circumventing income tax. Proposed increases included 40 per cent (the rate it had been throughout most of the Thatcher years) and 30 per cent, but I agreed to what the Treasury said was the revenue-maximising rate: 28 per cent was fair.
For the Record Page 24