By Claire West

Richard Lambert, CBI Director-General, gave a speech last week outlining his concerns about the future of the UK economy at Politeia, the forum for social and economic thinking, in London.

“The UK economy is undergoing a massive course of steroids,” he said. “The big question for policymakers is about how to generate sustainable growth once the impact of the medication starts to wear off.”

Mr Lambert set out a series of difficult issues confronting the UK. They included:

- The timing of changes to tax and spending in ways that help rebalance the public finances without unnecessarily damaging recovery

- The challenge of returning state-owned banks to the private sector in a way that doesn't further restrict credit in the economy

- The need for public service reform including a “bonfire of centrally imposed targets”

Highlights of Mr Lambert’s speech are below.

Addressing the level of public borrowing:

“Almost everyone now recognises that the current pathway is unsustainable, and that whoever wins the next election will face some painful choices. George Osborne wrote as much in the Times a couple of weeks ago, although he has yet to spell what his priorities will be if he makes it to the Treasury.

“The longer that politicians fail to grasp the nettle, the greater the risk that the cost of capital will rise through the next economic cycle, as the public sector competes with the private sector for funding. That in turn would mean less investment in jobs and wealth creation.

“This year, the Government has to sell a total of £220 billion of gilt-edged securities, and the size of the gilts market will have to double in the next four years. This is doable - provided the government retains the confidence of international investors. Otherwise, the price will be higher long-term interest rates and a weaker currency.

“As the OECD pointed out politely this week, credit default swap rates for UK 10-year government bonds have climbed considerably above those for Germany, France and the US. We are now challenging Italy in this particular league table.”

The need for a credible, transparent path to rebalance the public finances:

“Of course the economic outlook remains very uncertain. But as the FT put it yesterday, that’s a reason for drawing up contingency plans, as well as a plan based on the Treasury’s current central forecast.

“A failure to do this would have two damaging consequences. The first would be that it that it would leave all those institutions who rely on public finance in a state of suspended animation. They know that a squeeze is coming, but they don’t know when and where. Many of them are now preparing budget cuts in the dark.

“The second is that the next government is going to need a mandate for change — one that has been secured by informed debate in the coming election period. That will absolutely require the political parties to set out their stalls in a clear and open fashion.”

On credit markets:

“On the credit market side, step one must be to do more of the same. The implication of the Bank of England’s latest Financial Stability Report, published at the end of last week, is that unless financial market liquidity starts to recover and more long-term debt finance becomes available, the Bank’s current arrangements for supporting the liquidity of the banking system may have to remain in place for some time to come.

“More radical steps might even be necessary if conditions don’t improve. It’s noteworthy that the Financial Stability Report goes into some detail about the pros and cons of restructuring a distressed bank’s balance sheet into a good and bad bank model - not, presumably, an idea you would discuss if you thought it was completely irrelevant.”

On the future of the state-owned banks:

“UK Financial Investments, the holding company for the taxpayers’ shareholdings in the banking system, has an important part to play in rebuilding the stability of the system. Its overarching objectives, we are told, ‘will be to protect and create value for the taxpayer as shareholder’.

“Sensible enough. But what will best serve the interests of the taxpayer?

“One answer might be to seek to maximise the share price of each institution, and sell it back to the private sector as quickly as possible.

“But taxpayers also have a longer-term interest in these institutions. It may be rational for an individual bank to act as quickly as it possibly can to knock is balance sheet back into shape. But the interest of the broader economy is that the banking system as a whole should take a little time to rebuild its profits and its balance sheets, so that the process does not lead to a sharp contraction in credit. It would be good to have more clarity about policy in this area.”

On the the timing of measures to rebalance the public finances he said:

“Choosing the moment to squeeze the public finances will be almost as difficult as deciding when to start monetary tightening.

“The economy is still too fragile for strong medicine, in the form of rapid moves to cut spending or raise taxes. As evidence of what not to do, you only have to look back to Japan in the mid 1990s, when a sudden fit of fiscal austerity led the government to push up taxes too soon, and sent the country spinning back into recession.

“That’s why it’s so important that politicians make credible commitments to get spending under control well before the process gets under way. Sitting around doing nothing will only make the problems worse.

“All the evidence from history is that a focus on expenditure cuts, rather than on tax increases, is the best way forward. That approach is more likely to result in lower interest rate spreads, and to instil confidence that government means business.

“For the UK today, that will require radical changes in the way our public services are designed and delivered, with a new emphasis on value for money at every stage of the process. And it means big changes, too, in the way public money is managed and disbursed.”

On reforming the public sector:

“Talk of billions of pounds of efficiency savings imposed from above fairly chill the blood. Instead managers at all levels of the public service should be empowered to change their way of working in order to deliver more with less.

“Have a bonfire of centrally imposed targets, and encourage managers to manage.

“Clues about what might be possible here are to be found in a recent analysis from the Office of National Statistics showing how productivity in the public services had changed in the ten years to 2007. After allowing for improvements in the quality of service, the statisticians conclude that total productivity across the piece actually fell by an average of 0.3 per cent a year.

“That may not sound like much, But think about how increased competition, together with improvements and technology and work processes, have transformed the productivity of the private sector over that same period of time.

“While the public sector number was falling by 3.2 per cent, productivity in the market sector rose by nearly a quarter - and very much more than that in the tradable goods sector.

“The back of my envelope says that if the public sector had matched the private sector's performance over that period, we could have had overall output increases of 11 per cent from unchanged resources.

“Plainly that’s unrealistic. Public sector services are not businesses, and they can never match the performance of competitive private industry. But these numbers do point to what has to happen over the next few years.

“We’ve seen an enormous increase both in the pace of public spending and the number of public sector jobs.

“Now the emphasis has to change. We have to start squeezing more out of all this extra capacity - finding better ways of giving citizens services of the quality and breadth they have a right to expect.

“We need more market testing, and much more engagement with the private and voluntary sectors in the delivery of our public services.

“Fair completion between these providers is the best single tool policymakers have at their disposal for controlling costs and increasing quality.

“Above all, we need to get away from the narrow focus on inputs that seems to dominate political discourse at the moment, and to concentrate instead on what drives good outputs.”

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