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Globalisation, government and Britain's economic future

Rt. Hon. Lord Mandelson,  First Secretary of State, Secretary of State for Business, Innovation & Skills, Lord President of the Council
The Hugo Young Lecture, Chatham House, London,  03 December 2008

Hugo Young spoke for many things – for morality and high mindedness in public life without, it has to be said, prissiness or disdain for realities of high politics. For a particularly wise and pragmatic vision of Britain's place in Europe. I enjoyed my many and candid conversations with him. I think he would understand why I thought it better that a future generation of historians should have the first pleasure of reading about them, rather than have them included in the exciting volume of notebooks that have just been published! Hugo also wrote often about the role and responsibilities – and limits – of government. And that's my theme for tonight. How this role might and in my view should change in the light of globalisation and the crisis that is playing out now in our financial markets and real economy.

Since I agreed to give this lecture, I have "come back from Europe" – as far too many Brits say, although Hugo would never have put it that way. In Brussels my job was to negotiate trade agreements. But my main political mission, as I saw it, was to make the positive case for globalisation in the face of the rising threat of protectionism. I argued that for all its benefits, globalisation would only prove sustainable if we got the politics right.

This is broadly because modern economic life can be characterised pretty simply: new opportunity for many, new uncertainty for most. We live in a world that presents us with personal economic opportunities and social roles that would have been inconceivable a century ago. Deep integration into the European single market and openness to the growing global economy have created massive opportunities for us both in lower cost goods of improved quality and greater variety, and markets into which to sell the goods and services that Britain produces. Globalisation has been good for Britain.

But our economic world is also a very dynamic one, defined by rapid change. For most people in Britain and the rest of Europe their deepest concerns about globalisation relate to its impact on their personal economic security. Is their job going to be moved to China or India? Can the product they make be made more cheaply somewhere else? Is their pension going to wind up being collateral damage in some high-risk Wall Street or City securities trade?

All of these anxieties require a political response. Empowering people where the scale of global economic change can leave them feeling powerless. Ensuring that our confidence in the face of globalisation is not undermined by extremes of inequality or insecurity. Making sure effective welfare states and labour markets help people live with change.

In other words, I found myself becoming a strong advocate of a reformed European Social Model as the basis for an inclusive globalisation. Liberal economics in a framework of social democratic intervention. I shall develop this thought a little more in just a moment.

But I have to tell you the present crisis has made me deepen my thinking. I think we should be in no doubt. The global financial crisis of 2008 will be seismic in its political impact. It will change the mindset of a generation. It brings home to us very starkly the scale of the challenge that managing economic globalisation confronts us with. It should make us a lot more pragmatic in assessing the extent to which markets can and do fail, or at least fail to produce the best outcome for our society and our economy as a whole. In the last year we have seen governments intervening in failing markets in the most fundamental ways. We have been presented with problems that only government can solve. Both the crisis itself, and the broader changes being shaped by globalisation, oblige us to think seriously about the relationship between the market and the state.

For progressives this is a critical moment to think further about how Britain adapts to globalisation and the tougher economic challenges we are facing. Not to retreat from the strong and abiding commitment to open economies and free markets my party made in 1994. Certainly not to be hubristic that big government is back: I don't believe it is or should be. But to define urgently what smart government can do to resolve not just the present crisis, but to guarantee Britain's future prosperity. It is that future that I want to focus on tonight.

We will need to answer some complex questions. How do we manage risk in financial markets, especially internationally, where most financial markets now operate? How do we ensure that Britain has the quality public services, infrastructure and the smart, confident people that business and innovation depend on but which the market will not necessarily produce on its own? How do we ensure that government is helping people cope with the buffeting economic conditions that come with the benefits of rapid economic change?

These are all questions about effective government. They are political challenges that the right, with its mantra of small government or neutered governance, is badly equipped to answer. My basic argument tonight is that there are more than two ways of looking at government – being for it or against it. It is not a choice between, on one hand, the post-war, big state as a primary instrument of economic planning and a guarantor of equity; and, on the other, the minimalist view that state intervention simply gets in the way of efficiency and enterprise.

I want to argue for a model that is neither. Not larger government, but a more capable strategic state that works with markets. One that does not try and run everything itself, but which understands how to steer and shape the networks and institutions of a globalised economy and society. Without the dynamism of markets we lose innovation and creativity. Without economic openness, we lose the stimulus of international competition and the opportunity to win a fair share for Britain of the expected doubling of global growth in the next generation. So these things need to be defended and preserved. But we also need to recognise that reaching our potential in this open and more competitive world means asking what smart government can do differently or better to help us succeed.

A problem of governance

It's a fair question to ask if our optimism about the ultimate benefits of global economic integration should be shaken by the events of the last year. It is of course true that without financial globalisation we would not be asking how it is that a foreclosed mortgage in California can cause a collapse of bank liquidity in the City of London.

But I think we have to see the problem this way: globalisation works by widening economic networks. It increases the sizes of markets, magnifies the economies of scale that push down prices, and offers the chance for countries to tap into sources of productive investment from markets outside their own. Those networks have created a global economic engine that is the biggest eliminator of poverty and creator of opportunity the world has ever seen.

But, as we have seen over the last year, globalisation transmits risk and volatility as well as benefits. It is not possible to cut yourself off completely from the risks without cutting yourself off from the networks that deliver the benefits of globalisation. The people of North Korea would no doubt be pleased to know that they will not feel the negative consequences of the credit crunch. But they also have the exceptional misfortune to live in the one country in the world that has put itself entirely outside of the global economy, at a cost of crushing poverty and deprivation.

And I think that put that way, the core problem that globalisation confronts us with is one of governance. Subprime risk found its way into the system because of a failure of regulatory and professional governance. The answer is not to roll back current levels of global integration and retreat from the global economy, because the economic costs would be immense. The answer is to manage the system so as to minimise and deal with the shocks.

Many of these questions of governance necessarily force us to think not just in British terms but internationally and as Europeans. For years, financial markets have been regional and global more than national. Asset bubbles in one market can have serious consequences in another. The effects of monetary or currency policy are easily exported. Yet the machinery of multilateral economic governance is weak or non-existent. Europe has a single market for banking, but no single lever to pull to recapitalise troubled institutions, or to guarantee deposits. Europe's coordinated domestic response to the banking crisis showed a willingness to act quickly to shore up confidence rather than an ability to do so. The response has been ad-hoc and the political strains, for example over the early Irish bank guarantees, were clear to see. So national policy now and in future has to be made in awareness of its European and global implications, and close and habitual coordination is vital.

Internationally, the problem is even more acute. As the Chancellor, Alistair Darling, pointed out in his Mais lecture last month there is no international institution with a mandate or real capacity to address systemic risk in financial markets, or to counsel states on global risks. The existing institutions of global coordination are also tailored to an economic order that is increasingly outdated. The G20 summit in Washington last month was historic simply because it finally expanded the steering committee of the global economy to reflect the growing capital and demand represented by the emerging economies.

Helping the losers from globalisation

These big questions of international institutional design are immensely important. They are now going to be carried forward under Britain's leadership, as chair of the G20 and the international conference we are convening in London in April. Gordon Brown's insight and leadership on these issues has earned Britain huge international credit. But these aren't the issues that will ultimately define the domestic politics of globalisation. We're not going to fight elections on the composition of the IMF board, or the revised mandate of the Financial Stability Forum. But we will be fighting elections on our ability to deliver fair chances and genuine opportunities to people living with rapid economic change. Here too, the Prime Minister has set out a clear vision.

Of course it is conventional wisdom for many on the right that government activism of this kind is not just undesirable, but impossible. That globalisation makes active social safety nets untenable: too unwieldy to cope with the flexible conditions that globalisation demands. But is this true?

In the OECD over the last twenty years, as globalisation has accelerated and Europe as a whole has become progressively more economically productive and more competitive, the proportion of country spending on social transfers and goods provided by public spending has consistently risen. Where this spending has been done right it has helped boost national income growth and built some of the most open and competitive societies on earth – including in Scandinavia and here in Britain. Basically, strong social welfare systems and redistribution can be contributors to economic growth.

This is not as counter-intuitive as it might seem to some. Strong safety nets that don't cut across flexibility in labour markets protect individual workers with wage insurance, which means they are able to move confidently between jobs. A high level of general education and support for adult retraining not only boost the skills base in the economy but help people move between jobs and sectors over their working lives. When you use tax credits to allow people to move off welfare and into work without losing their full benefits overnight you encourage them to take that vital step. Providing childcare helps women return to work and boosts labour market participation rates.

Some people speak derisively about the percentage of GDP that we spend collectively in a society as if it were a measure of freedom or efficiency. But where that spending is done well it can actually be a measure of the extent to which a state has adapted to a fundamental reality of living with rapid global economic change. A society that leaves individuals to cover the often catastrophic costs of healthcare or unemployment will spend less collectively. But it will not be a good place to find yourself at the sharp end of ill health or global economic change. It will be an insecure society, and insecure societies are not societies equipped for long term success, even if some in them are getting richer. Insecure societies are one political step away from protectionism and self-isolation. You cannot ask people to face up to globalisation and then pull away the social infrastructure that empowers them to do so.

From helping the losers to creating more winners

But is putting a safety net under the short-term losers from globalisation the limit of the role of government? I have come to believe that it is not. Without in anyway backing away from our commitment to free trade, open markets and the discipline of competition, I think we can actually do more in government to widen the circle of winners from globalisation in Britain. Public policy, including a more active industrial policy, has, I believe, a role in ensuring that the market functions effectively as a means of maximising our economic potential in the long term – which it does not always do on its own. That is the core role of the smart strategic state.

I want to return to these policy requirements in a moment. But, again, we come up here against some of the most dogmatic politics of the last thirty years. In particular the argument that the inherent rationalism of markets makes any role for the state in industrial policy unwise or damaging. If we are honest, we have to accept that progressives have too often failed to mount an intelligent critique of this claim. Indeed, in Britain, New Labour reacted very strongly against the failed attempts of previous ministers to intervene in the market. The memories of the discredited National Enterprise Board and the forlorn attempts to turn round British Shipbuilders by state intervention or prop up the Meridan motorcycle co-operative have lingered long in New Labour minds, and for good reason. As a result, and as part of our political re-assurance drive in the 1990s, we made great play, rightly, of rejecting the failed interventionism of previous Labour governments.

Markets are extraordinary tools. They can coordinate the billions of buying and selling decisions that make up a modern economy in a way that no government could ever do. They facilitate experimentation and innovation, and the production of new products and services in response to customer demand. In doing both these things they can bring huge dynamism and efficiency both to our private economic relations and to the ways in which we provide some public services. But they are not possessed of unique or infallible wisdom. The outcome of a hundred individual decisions in the market – rational or not - cannot necessarily be regarded as by definition the optimal outcome for society as a whole.

Innovative businesses, especially in technology and manufacturing, can often require substantial initial investments in product development and long investment cycles. The people they need have to be highly skilled and technically educated. The research they build on is often time and capital-intensive. Sometimes markets alone do deliver these things, but sometimes the mismatch between commercial incentives and wider outcomes mean they do not. The knowledge that spills over from one business to another is vital in a dynamic economy, but diffusing that skill and experience through the economy will not always happen as a result of market operators pursuing their own interests.

Our conclusion has to be that for all their value markets will not necessarily produce all the conditions that maximise our potential to prosper and compete in a global economy. Those conditions will result from political choices and public debate and will be produced in many cases through the action or influence of government. It is political choices and government that will make sure our society continues to produce the general education, science base, research and development that businesses tap into and build on. It is politics and government that will determine the infrastructure we develop and on which a successful economy is utterly dependent. Government itself is a big enough actor in the market to influence the market just by its choices. For example, it is political decisions on climate change and our energy and low carbon future, or on our telecoms and digital infrastructure that will shape the risk calculus for companies and innovators looking at long term investments. We will use the dynamism of markets and myriad decisions taken by private enterprise to deliver many of the goods we need. But our priorities themselves, and the overall frameworks within which private sector decisions are made, will be defined by our democracy and the interaction between government and business.

What government is not

It is important to be very clear what the argument for government that takes a pragmatic view of the ability of the market to generate long term conditions for growth is not an argument for. It is not an argument for state socialism, direct market controls, import barriers and widespread national ownership or direction of industry. It is not a call for the kind of economic nationalism that threatens to undermine the economies of states like Russia and China. It is not an argument for the failed solutions of the past.

Political patronage of individual companies has a bad track record. Broadly speaking, picking winners or substituting themselves for company boards are not things governments are equipped to do. The eternal temptation to protect our own industry by closing our market to imports or international competition has the weight of economic experience against it, to put it mildly. We have to be confident in the basic economic model of the market and the state that over two centuries of experience has produced in Britain: a huge and open and dynamic private economy bounded by legal protection, strict rules to enforce fair competition and effective regulation.

This matters because the current crisis is likely to start a fresh debate in Europe on what industrial policy should look like. There are some in Europe who still see the European economy, and indeed the European Union, as an essentially insular project – a protected market walled off from the global economy. One of Britain's most important contributions to the EU over the last decade has been to lead – and largely win - the argument against this kind of approach. Indeed, all the EU's governing institutions – Commission, Council and Parliament – adopted the pro-openness Global Europe strategy I presented in 2006. It is important that Britain continues to make a vigorous case for an open industrial activism that engages with globalisation and competition rather than trying to shut them out. If we don't, others will occupy that ground with a much more defensive vision.

From 1997 to 2008

What does a ‘globalisation audit' of UK public policy over the last decade tell us about where we need to go now? This government inherited the central challenge of progressive politics in the last century, which was to preserve the huge collective benefits of life in a market economy by reducing some of the economic risks for individuals, especially healthcare and unemployment. This government recognised that an economically competitive society with the flexibility to respond to rapid economic change is vital. But also that government's ability to empower individuals and communities is the key to a dynamic and ultimately, a fairer society.

This government recognised that this social compact is not cheap – reformed, quality public services and modern social safety nets require investment, and every part of society will legitimately be asked to contribute to their maintenance. But it also recognised that to be legitimate, spending on public services must be disciplined and offer clear, efficient value for money.

The successful programme that this government has followed in power has always reflected this desire to promote an open economy along with policies that help people get the most out of rapid economic change. Unprecedented investment in training and the UK's science base. Three million jobs and one million small businesses created. A massive expansion of free nursery education and internet access. Tax credits that remove the economic disincentive to return to work. This government has modernised welfare and introduced an active welfare state. We have invested hugely in regional economic development that has powered a genuine renaissance in many of our regional cities like Newcastle, Manchester, and Leeds. We've engaged more closely with the EU is a way that has shaped the liberal and open character of our most important market and the springboard for British companies to expand globally. We have built up major strengths during the last decade in both manufacturing and services.

But the world of 2008 is simply not the world of 1997. In the mid-1990s, in different economic circumstances, this government's vision was an ‘enabling state' that strengthened the supply side of the economy, welcomed the dynamism of markets and worked to ensure that as many people as possible benefited from the greater economic opportunity markets provided. The priorities of macroeconomic stability, supply side investment and public service reform were crucial and right. It is essential that they are taken forward now with continued commitment. But they are no longer the whole picture. Why? Because the last decade has reshaped the global economy and our understanding of what is at stake in managing globalisation and securing our share of its growing markets.

I am absolutely confident of Britain's competitive future in the global economy. But while the government is doing a lot to back enterprise and support entrepreneurs, some of its efforts appear to business as insufficiently joined up and often overlapping. Britain is at a critical juncture in its economic fortunes and the government cannot afford to under-perform. We will repair our banking system and we will get through the downturn. But on the other side we will encounter an even tougher place to do business in – albeit one with huge opportunities - and we need to be fully prepared.

Globalisation is going to continue to push us to improve productivity and carve out our specialisations and comparative advantages in the global economy. Those specialisations should be based on the high levels of value-added we bring to what we produce. We all recognise that we are going to come out of this financial crisis with a consolidated financial services sector. As much as we admire the resilience of the British shopper, we all recognise that British consumer spending is going to have to be driven less by debt, and the British retail sector may also account for a smaller share of the British economy. British public service employment is also not going to grow at recent rates. What these things mean in practice is that we will need to widen and diversify the specialist bases of the British economy by investing further and better in the technologies, skills and infrastructure that will allow us to set the pace in the industrial revolution that will define the current century.

We want the UK and Europe to be the best place in the world to develop and implement low-carbon solutions and a magnet for new green-collar jobs. If China and India are going to need half a billion low carbon vehicles in two decades time - we must be working very hard to ensure that British companies are helping to design and make them. We should be leading the technological work that will power the nuclear renaissance. UK companies which can capture work supplying low carbon technologies will have first-mover advantage in a growing global market.

None of this involves trying to fix these markets in our favour or running industries from Whitehall. It means recognising that by investing the right way in people and infrastructure, and joining up the relevant decisions taken by government, we can dramatically improve our chances of coming out ahead. That is where smart government will count. Smart government means using existing resources better, connecting up the different parts of the government charged with this work and asking where we can do more. We need to focus on areas of policy like technology, skills, regulation, investment and export markets – and how we set the relevant conditions for business success in these areas.

We should also not be afraid to focus on the present and future needs of individual sectors and the way that horizontal policy can affect them. In this respect the work that Stephen Carter is doing in producing the Digital Britain report is breaking new ground and exemplifying the potential value of a sectoral approach.

Over the last few weeks I have been meeting and speaking to business people around the UK to understand how they see Britain's industrial future. I have started with the assumption that both government and the private sector bring something useful to the table – and nobody has disagreed with that. In two weeks time I will set out what I believe business expects of government. Building on what we have learnt over the last decade to deliver a fresh market-driven industrial activism in government.

Conclusion

These will be watershed years in the way in which our politics thinks about the capitalism that drives our economies. Nobody seriously suggests – or at least nobody serious suggests – that this essential structure in our economies should change. Its benefits in innovation, prosperity, efficiency, choice and individual opportunity are something we should value and demand. But managing a capitalist economy involves pragmatic judgements about what more can be done to enable markets to deliver, and where exactly the roles and responsibilities of governments lie. The state as lender of last resort is an important metaphor: ultimately it is government that keeps the show on the road.

We will not get the most out of globalisation either as individuals or as communities without effective government. But globalisation is also going to change how we think about the ways and the levels at which governance should function. It will force us to adapt to the idea of greater global or European governance, not least of financial globalisation. I think it will increasingly lead us to conclude that the EU is a magnifier of British global influence rather than an obstacle or an alternative to it – something that Hugo would have argued for passionately. But globalisation will also define what we expect smart government to do for us in terms of equipping us, and our communities, for rapid economic change.

The evidence from across the OECD is clear that we can empower people, address levels of inequality, fairness and opportunity in our societies without compromising our openness and our long term economic competitiveness. These things have to be regarded as political choices. The dividing line in British politics should be between those who believe that government can help us get the best out of markets and globalisation - and those who don't. This is not a choice between the nanny state and the nightwatchman state. It is not an ideological or inflexible choice between big and small government. It is a choice between smart government that boosts long term competitiveness while delivering the necessary degree of social justice, and government that doesn't.

Part of the reason why so many on the right have been blindsided by the events of the last two months is because they have no coherent theory of the state's role in an open economy, beyond the mantra that it must be limited. They continue to draw a sharp line between the state and the market that suggests a failure to understand both the limitations of markets, and the potential of government – and vice versa.

This government has both the experience and the instincts to build a fresh compelling case for the role of government in helping people live with globalisation. That case is rooted in the very ideas that drove us into politics and into government. Our challenge is not so much to change course, as to change gear. The same determined commitment to change and improvement in the coming decade that characterised our last ten years in office, and the same belief in the power of government to help people and communities. A combination of idealism and realism – and real optimism about the future – that the British public are crying out for now more than at any time since the mid 1990s. We have to provide a vision of our economic and industrial future that both excites and reassures. There is immense opportunity for Britain in a globalised world. At a time when anxiety is high and optimism low, we need to demonstrate afresh that Britain can and will prosper if we recognise our strengths, plan our future and provide for the upturn that will follow the current downturn in our economic fortunes.

If there is anything immediately cathartic in the events we are living through it will be a healthy new scepticism for financial products we don't understand, a heightened intolerance for excessive risk-taking and associated rewards in markets, and a new conviction that a global economy cannot do without global economic governance. We also need a new commitment to using government as well as the forces of the market to drive and reinforce the long term strength of our people and our economy. We have an extraordinary chance to make this work. But we have to re-double our efforts now.