The Olympics should have taught us the benefits of picking winners

Despite the Olympic euphoria, there is growing pessimism about the short-term prospects of the British economy. The new orthodoxy is that Britain is too sickly to be cured by a short-term fix; policy should concentrate on bringing about sustainable long-term growth.

This rules out an immediate boost to public spending and swings the debate to the more familiar territory of the causes of Britain’s relative economic decline, with the right pressing for freer markets and a reduction in the size of the state, and the left rediscovering the virtues of industrial policy.

But there is no need to place the short run and the long run in such dramatic opposition. Britain faces both a short-run problem of deficient demand and a long-term problem of unbalanced supply. Government needs to develop policies to deal with both simultaneously.

The British economy is still reeling from the economic collapse of 2008. It is 2%, or £27bn, smaller than it was four years ago and 12%, or £165bn, smaller than it would have been had growth continued at its postwar trend of 2.5% a year (today’s prices). These are big numbers. People take comfort from the fact that the percentage of unemployment has risen less than the percentage of output has fallen. But this is because productivity has dropped: as the Guardian put it last week, “it now requires many more of us to labour away to churn out the reduced volume of stuff”. That still leaves about 2.2 million extra idle and partly idle workers, many of them young, who could produce more “stuff” if the market for it was there.

This market for output should be supplied by government initiative in two ways. First, the government should rescind its cuts in capital spending. According to the Treasury, departmental capital budgets are set to fall from £50bn to £40bn a year in cash terms from 2010-11 to 2014-15 – that is, by £50bn altogether, with the heaviest cuts to school building, universities and social housing. “Shovel-ready” schemes, abandoned by the coalition, should be reactivated. The advantage of this is that it combines short-run demand expansion with long-run improvements in infrastructure.

Secondly, the government should issue all households with time-limited spending vouchers, in sufficient annual amounts to provide a net stimulus to consumer spending. Ideally, these vouchers should be spent only on UK-produced goods. This could be encouraged by a “Buy British” campaign. Their spending would be far more effective in reviving the animal spirits of entrepreneurs than quantitative easing practised by the Bank of England.

The two short-run programmes combined could add about £100bn to GDP over five years – almost enough to completely offset the contractionary effect of George Osborne’s cuts to public spending.
So much for the short run. By contrast, long-term policy should be addressed to correct the consequences of the failed Thatcherite gamble on financial services and the housing market. Without a strong manufacturing base there can be no export-led recovery, however low the pound sinks in international currency markets. The old smokestack industries are gone, but new industries can be developed. How?

Nothing is more upsetting to the conventional wisdom than the thought of government “picking winners”. Yet governments have been picking winners all over the world, notably in east Asia. What industrial policy does need, though, is clear focus and sustained commitment – such as was shown in plotting the success of Team GB. Previous attempts at industrial policy in this country have failed because of endless chops and changes.

To spearhead a new-style industrial policy, the government should set up a national investment bank with capital of £10bn, the right to borrow immediately, and a mandate to secure Britain a significant presence in cutting-edge technologies like mechatronics, optics, new materials and nanotechnology, and to invest in such green energy sources as wind power, solar power, hydropower and biomass. These may be too risky for private investors looking for quick returns, but may well attract institutional investors such as sovereign wealth and pension funds, and insurers looking for long-term income streams.

As a further element in the rebalancing of supply we need to reduce the speculative role of finance, restoring it to its proper role as the conduit of savings to investment. Two measures would help: a government-sponsored revival of local banking, on the model of the old Scottish country banks and borrowing from the current example of the German Landesbanken; and a transactions tax on financial operations to cut down on what Adair Turner has called “social waste”.

These are the twin pillars of a policy that could bring about the short-term recovery of the UK economy and set it on the path to a prosperous future.