The Default Line: THE INSIDE STORY OF PEOPLE, BANKS AND ENTIRE NATIONS ON THE EDGE (9 page)

The total bill for all PFIs signed to date is over £200 billion, ‘the greatest ever British public policy experiment’ according to the PFI campaigner Jesse Norman MP. The NHS is facing a £70 billion cash bill in the coming decades for PFI hospitals worth £11 billion. Even then, PFI’s proponents justified it on the basis of an amorphous ‘transfer of risk’ to the private sector. Actually, will any government allow a school or a hospital to go bust, and move pupils and patients into an alternative school or hospital? Up to £4 billion in consulting fees have been earned on PFIs, and the cost over and above conventional exchequer funding is in the tens of billions of pounds.

So the Birmingham super-hospital where Gordon Brown chose to launch his election campaign turns out to have been a particularly apt symbol of New Labour’s time in power. In 1997 the New Labour health minister and Blairite loyalist Alan Milburn had famously said, ‘If it’s new hospitals you want, it’s PFI or bust.’ Alas for the NHS, New Labour’s ‘Third Way’ thinkers seem to have sown the seeds of destruction of their cherished health service. PFI hospitals have been saddled with large non-negotiable mortgages at a time that their other costs are sky-rocketing. The Queen Elizabeth Hospital itself has turned out to be too small for the rising demand from a rapidly ageing population. Wards in the 1930s hospital it replaced had to be reopened in March 2013. Elsewhere, large shiny PFI palaces are draining resources away from tight education and health budgets, simply because there is very little to negotiate. It’s turning out to be ‘PFI
and
bust’.

The risks and the costs were socialised, the profits privatised and the projects financialised, in what would become the signature of a wide swathe of New Labour economic policy initiatives. It simply made no financial sense to determine that this was the only way to fund such public infrastructure, if the country required it. So why were these projects done in this way? Partly to ward off the bond vigilante bogey men.

By October 2005 Gordon Brown was agitating to move from Number 11 to Number 10 Downing Street. That month I found myself in Number 11 at the launch of a campaign imploring a new generation of young entrepreneurs to ‘Make Your Mark’. Child stars from the
Batman
movies mingled with the Kaiser Chiefs rock band, Anthea Turner, and hiphop MCs. The then chancellor, riding the crest of a wave after nearly a decade of uninterrupted economic growth, tried to inspire his bewildered young audience with a well-worn joke. ‘There are two types of chancellor,’ he declared. ‘Those who fail, and those who get out in time.’ Although the architect of the PFI boom
did
escape from Number 11 ‘in time’ in 2007, the crash that began just weeks later shows that he did also fail.

‘You aren’t using “in the red” in your headline, are you?’ It was November 2002, when I was a journalist on the
Observer
. It was just before the pre-Budget edition of the newspaper went to press, and I was facing one of Brown’s faintly menacing lieutenants. He was trying to persuade me that my Budget preview story, that Britain was heading for ‘£20 billion in the red’, was an unfair and pejorative description of the planned deficit, the first under Brown after years of surplus. He wanted me to drop the description ‘in the red’. I asked him what colour he preferred. Earlier that year, Brown had taken a big political gamble by raising direct taxes, in the form of one penny extra on National Insurance contributions, to fund a rise in spending on the NHS. A truly reckless fiscal gambler would never have bothered. As it was, borrowing went up, as well as taxes. The bigger picture was that the first decade of New Labour could not be depicted as an uncontrolled spending binge. Taxes, spending and borrowing all went up. But both the deficit (2.4 versus 3.4 per cent of GDP) and the national debt (36.5 versus 42.5 per cent) were lower in 2007 than in 1997. Welfare spending was also just lower in 2007 (11.9 versus 12 per cent). The argument might well be that there was no way Labour should have run any type of deficit given that the economy was booming, and the ‘roof should have been fixed while the sun was shining’. Certainly, other advanced nations at the time were running much smaller deficits and even surpluses, and cutting into their national debts. That said, at 36.5 per cent of GDP, the national debt was low by historical standards, and only Canada in the G7 nations had a smaller debt. Even in 2007–08, the deficit on current budget (stripping out infrastructure/investment spending) was just 0.3 per cent. Perhaps a more hawkish Conservative chancellor might have raised more taxes and not spent as much on, for example, tax credits and housing benefit, so delivering a pre-crisis debt/GDP ratio of 30 per cent, where it had been in 2000–01. We do know that from 2007 George Osborne promised to stick to Labour spending plans, so at that point, by deduction, he could not have been overly worried about a national debt of 35 per cent of GDP. The other consideration is that significantly tighter fiscal policy, right or wrong, would have invited looser monetary policy, or a cut in interest rates in the middle of a credit boom.

Perhaps the real splurge came after the crisis hit in 2007–08. The Conservatives opposed Brown’s borrowing-funded VAT tax-cut stimulus, designed to boost the economy after the collapse of the world banking system. Let’s look at that record deficit of £156 billion in 2009–10. It was predicted in Alistair Darling’s 2008 Budget at £38 billion, so where did the extra £114 billion deficit come from? Actually, the problem was very much more to do with a collapsing tax base and a declining economy. Here’s why. The main issue was that GDP ended up far smaller in cash terms versus the 2008 forecast. Spending did end up £23 billion higher than the 2008 forecast, and about half of that was extra benefits, as you would expect in a sharp recession with rising joblessness. But taxes slumped by £91 billion versus the 2008 forecast, so 80 per cent of the epic deficit miss was a collapsing tax take. As Carl Emmerson, deputy director of the Institute for Fiscal Studies, puts it, ‘Tax revenue disappeared as the economy disappeared.’ Income taxes, corporation taxes and stamp duty all slumped.

Part of the problem was that the government growth forecast was too rosy compared to those of independent forecasters, particularly given the recession. A fiscal conservative would naturally blame the fact that the sustained increase in spending was predicated on a sustained rise in the taxes coming into the exchequer, a predicted rise that was itself based on a hopelessly ambitious growth target. New Labour’s run of deficits after 2002 followed a pattern of ambitious boom-time growth projections at the end of the forecast period, which were never met. A fiscal hawk would further suggest that an incorrect guess at ever-increasing taxes coming from an inherently cyclical FIRE (Financial Industry Real Estate) economy is no justification for simply ploughing on with all of those spending rises.

It is important to point out, however, that Britain’s record budget deficit was a consequence, not a cause, of this crisis. If New Labour had followed Conservative policy, the record deficit might have been smaller, but it would undoubtedly still have been well above £100 billion, and probably still a peacetime record. The problem was the reliance of the British economy on financial services and property. The golden goose of the City had fundamentally reduced its egg production. Brown’s light-touch management of financial services is far more important in explaining Britain’s problems, but that is a subject for another chapter (see Chapter 6,
here
). There is little evidence that the Conservative touch would have been any heavier.

This does matter. If the main problem in the build-up to the crisis is wilfully misunderstood, then there may be a problem with the solutions proposed to escape the crisis. Rachel Lomax, the former deputy governor of the Bank of England, put it rather clearly in May 2013. ‘We need to get the narrative straight. The fact of the matter is that we have a public-sector debt problem not because Gordon Brown went on a spending spree, but as a consequence of a private-sector credit explosion, much of which was not even in this country. And really the failure to understand the nature of recession that we’re in at the moment explains some of the weakness in dealing with it.’ Britain clearly had a deficit problem in 2010. It needed to be dealt with credibly. But was public-sector debt the biggest drag on the UK economy? Or was it rather the overhang of debt in the private sector, combined with the fact that large swathes of the City machine involved in the manufacture of toxic derivative waste was gone, along with its taxes, never to return?

In 2009 all the woes of America’s Great Recession seemed to converge on Elkhart, Indiana, the expressway junction to economic hell. The city lived off the manufacture of RVs (recreational vehicles, i.e. motorhomes and trailers), and now it was hit by the crisis in the auto industry, the crisis in the housing market, the credit crisis, and high petrol prices. ‘This area has been hit with a perfect storm of economic troubles,’ said President Obama on a visit to the county with the second highest rise in unemployment in the whole of the USA. Whenever a crisis in motor manufacturing coincided with a crisis in the housing sector, the trailer industry was always going to get trashed.

RVs are the embodiment of the American dream, the means of driving the open road in luxury. The problem is that they only do eight miles to the gallon. ‘When the price of fuel went up to $4–$5 a gallon, and the availability of credit went the other way, our RV industry collapsed and we went from 4.5 per cent unemployment to 20 per cent unemployment in a few months,’ Elkhart’s mayor, Dick Moore, told me. The day after Obama’s inauguration, Mayor Moore went to Washington DC with a list of shovel-ready investment projects: roads, bridges, sewers and an airport runway.

When I visited in July 2009, many of the workers who could not get jobs were losing their eligibility for unemployment benefit. I met a hungry 28-year-old called Corey Lovell, who used to manufacture bathrooms for RVs and lost his job in the crisis. Corey was one of 300 people who applied for a job as a shop assistant at a 7-Eleven in Elkhart. He got a few hours of minimum-wage work at a petrol station, but could only survive by selling the plasma in his blood for $50, twice a week. He pointed to the bruising on his arm. ‘I have to, there’s no alternative,’ he told me. ‘I’m not making ends meet. We need assistance now.’ I came across Corey at a food bank, where the newly unemployed are given ten minutes to pick up eight free food items, including cereal and bread. They also get a book. Corey is young, healthy, intelligent and articulate – not the type of person you would expect to meet at such a place. The church minister responsible had seen a 40 per cent increase in use of the facility. In the last month alone, in this small town, he had seen 350 new families turn up at the food bank. The demand was so high that they were having to buy food wholesale in addition to donations. The local churches were encouraging people to become more self-sufficient, providing seeds so that they could grow their own food in community gardens in the backyards of houses that had become empty after the banks had foreclosed.

This is not what you expect in America. The fear is that many of the jobs lost in manufacturing will never come back. President Obama wants to replace the eight-mile-a-gallon jobs with green jobs, but I’m sceptical about how many of those there are. The White House poured $40 million into grand infrastructure projects here in Elkhart. At Elkhart Municipal Airport the main asphalt runway had been cracked and was sprouting weeds. Within months of Obama taking office, it was resurfaced with concrete, using a $4 million slice of the $787 billion Obama borrowed for his stimulus plan. The refurbishment created 250 jobs, but these lasted less than two months. The new runway would last thirty years, but is only used by private jets and military planes. There are no commercial passenger flights, although there is a fully functioning airport just fifteen minutes drive away in the neighbouring town of South Bend. The runway was the very essence of the Keynesian response to the financial crisis: borrow money from China to fund an airport runway not viable under commercial market forces. Elkhart is less than a hundred miles away from the nemesis of Keynesianism at the University of Chicago. Milton Friedman would have been turning in his grave, had he not been cremated in 2006.

At the University of Chicago the success drips off the faculty walls. The university boasts nine Nobel prize-winners in economics. They transformed the discipline and then fanned out across the world transforming Western and then developing economies with their commitment to free markets and sound money. Robert Lucas is one of the Chicago Nobel laureates. He told me that the bailouts were wasted, but that the quantitative easing being practised by Ben Bernanke’s US Federal Reserve was ‘following the Friedman prescription’. He expressed a concern about inflation later down the track, because reversing printing money is ‘hard to do politically’.

Lucas said that economists overestimate their abilities: ‘You had a bunch of guys who thought they knew a lot. It turns out we didn’t know a damn thing about the stability of the banking system, so it’s back to the drawing board and we’ll see what comes out of it.’ But the University of Chicago had nothing to apologise for, he said. ‘Milton Friedman was right about some things, wrong about others, but maybe we should all apologise for not grasping the fragile nature of the banking system.’

Would Friedman be turning in his grave? Lucas pointed out that he would have backed a more tightly regulated banking system with ‘100 per cent reserves’. He defended the ‘efficient markets hypothesis’, the intellectual basis of pre-crisis financialisation, as ‘a law of nature’, but conceded his colleague Eugene Fama might have been wrong in naming it ‘efficient’. So there was a sliver of self-doubt.

Three years on, and Elkhart was back on its feet. Un-employment had fallen from 20 to 8 per cent. Jewellers who in 2009 had been tempting residents to pawn their gold teeth were now back to selling engagement rings. The RV factories were again churning out their behemoths of the road, and some of them were employing as many workers as they had pre-crisis. True, the runway at the airport was still mired in local political controversy over whether the town should support its losses, but the myriad of bailouts had helped bring about a renaissance in US manufacturing. The industry bailout of GM and Ford had also helped to keep manufacturers of components in business too. At the same time, the credit bailout had helped customers take out loans to buy new motorhomes. Again this government intervention did not seem to be typical of an America that had been so long in awe of the economic thinking of Friedman and friends. Neither Indiana nor Elkhart voted for President Obama in 2012. But elsewhere in the auto industry’s Midwestern ‘rust belt’, particularly in neighbouring Ohio (which was crucial to Mitt Romney’s hopes of beating Obama), the message that Obama’s ‘spine of steel’ had saved General Motors and the auto industry won the day, and helped Obama stay put in the White House.