Dear George
The economic story of the next decade will be the fallout from the banking crisis. It has already provoked the deepest recession since the 1930s, but the pace of economic recovery will be affected significantly by the banks' attitude to lending – and whether their historic aversion to lending to support manufacturing innovation can be changed. Otherwise it will be business as usual – a British economy too dependent on finance and property and not on making goods and services.
As you know, it has cost the government more than a trillion pounds to provide the cash, capital and guarantees to keep the banks alive. We have discovered that lightning strikes far more often in the financial system than the banks thought.
Mervyn King, the governor of the Bank of England, has floated the idea of separating commercial and investment activities from "casino" banking, while the Bank's Andrew Haldane has just co-written an article arguing that we "need a financial reform effort every bit as radical as after the Great Depression" because the scale of risk the taxpayer is now running is so enormous. But he thinks it is unlikely to happen. Lord Turner, chair of the Financial Services Authority, thinks that much current banking is socially useless.
But nobody has a clear idea of what you think. Do you share this view that the "shadow banking" system run by investment banks, the trading desks and hedge funds became too large, too accident-prone and thus too risky? What would you do to stop it growing larger and make the system less risky? The government proposes that banks simplify their organisations so they can break themselves up without cost to the taxpayer if they get into trouble and that they are run with more capital. Is that enough? Banks have been running rings around the regulators for decades.
The Bank is plainly becoming more radical. You propose to move the FSA under its wing, so presumably you endorse a radical approach to the future of British banking. So would you break banks up? How would you introduce more competition? Bank profitability has tripled in a generation as the shadow banking system has grown. Do you propose an excess profits tax or a bonus tax? What international initiatives would you make?
British bank lending is almost entirely focused on mortgages and consumer credit, with virtually no support for investment and innovation. The ideas we hear to guarantee lending for small businesses and enterprise presuppose that banks do such lending. They do not.
What reform do you propose? Would you create pro-business banks? Or will British banking look much the same in 2015 as it does in 2009? There is considerable concern that your policy will be made by City financiers who help fund the Tory party and want as little change as possible. I hope you will use this opportunity to commit to revealing the names of all City donors and to publish the content of all meetings with them .
Best, Will
Dear Will
We agree much more than we disagree. The financial crisis has inflicted enormous damage on our economy and unless we make changes it could happen again. I agree that there is a real danger that the momentum for change could falter and we fail to learn the lessons. As Mervyn King says, for all the government's rhetoric, there has so far been "little real reform".
Above all I agree that we need a new economic model for Britain that encourages more long-term investment in productive assets and innovation. We should use the shock of what has happened as a spur to making it a reality.
But first let me deal with your implied suggestion that our policies are influenced by party donations. We publish all our significant donors on the Electoral Commission website as required by law, and I hope you'll judge us by our actions not our opponents' accusations. I make no excuses for wanting Britain to be a home to the world's most successful and well regulated financial services industry. Directly or indirectly it employs millions of people in high-quality jobs. But I have always been prepared to take on vested interests.
I was the first politician on either front bench to call for the non-doms to pay their fair share of tax. In April I called for the partial break-up of the large state-owned banks, months before the European commission forced the government to agree. Three weeks ago I was attacked by Labour for saying that Britain's banks should not pay large cash bonuses this winter, only to see that many of those banks have signalled they will follow my proposal. As you wrote earlier this year, "while Labour seems to be content to be the City's creature, it is… George Osborne who has emerged as a critic of City short-termism". Naturally I agree.
Looking forward, it is clear that only the Conservatives are proposing real and lasting regulatory reform, for example with our proposals to give the Bank of England responsibility for bank supervision and create a powerful new Consumer Protection Agency. The current government remains wedded to the failed tripartite system for the simple reason that it created it, but my proposal is now backed by Jacques de Larosière, the architect of the new European regulatory system, and similar arguments are driving reforms in Germany and the US.
Better regulation alone will never guarantee that the regulators won't get it wrong. Living wills and more capital are the bare minimum needed to protect taxpayers. I believe that there is a case for finding ways to protect deposit-taking banks from the riskiest investment banking activities, such as large-scale proprietary trading, but this has to be done internationally. That's why I continue to discuss this issue with a number of European finance ministers.
I also think we should consider the innovative solutions to better insure taxpayers against future losses being examined by the IMF and others. In a globalised financial economy, unilateral action by us won't achieve anything if the same system simply relocates somewhere else. I want Britain to be the undisputed home of a safer, better regulated global financial industry.
But if I can move our email exchange on to new territory, I am sure you agree that alongside this agenda – and tackling the G20's biggest budget deficit – we need long-term supply side reform. That means creating an economic culture that measures returns over years and decades, not just quarters.
That will require reform across the spectrum – better corporate governance, more support for long-term equity finance and a focus on infrastructure. The government's use of PFI [the private finance initiative] has become totally discredited, so we need new ways to leverage private-sector investment.
Much as I want the City to succeed, surely we have finished with the experiment of hitching our entire economic fortunes to its back? What are the reforms that you think could really create a more stable, productive and balanced economy? Which new incentives and institutions could bring about real change? I have my own ideas, but it's your turn first.
Best wishes, George
Dear George
Interesting. But I fear you want to have your cake and eat it. You talk my language about needing to unhitch our economic fortunes from the City and building a more productive and balanced economy, while also "making no apology" for the need to host the world's most successful, best-regulated financial services industry. But do you accept that the City has become too large and too risky for a country our size? In detail, how much extra capital should banks hold? Would best regulation include limits on derivative trading and stock lending, as I propose? There are trade-offs and choices. Every graduate who goes to the City to make millions, their potential losses guaranteed by the state, is a graduate lost to the rest of the economy.
Now for your challenge. I think the next government has to build an architecture to dynamise innovation and investment. The decades ahead are going to see exponential growth in technologies from the life sciences to energy, which we must exploit to create tomorrow's Rolls-Royces.
This means a huge increase in investment in science and technology and in particular for our top 20 research-based universities. I do not detect your commitment. Indeed your focus on cuts above investment would endanger our science base. We need new institutions to get scientific research into business.
What is your view on Britain's business culture? Do you agree that we need committed owners and not greedy transient shareholders? We need to dismantle the apparatus that makes it so easy for companies to be taken over, reform corporate governance to stress long-termism. Will you require firms to declare their business purpose? There are powerful vested interests opposed to these ideas – anxious to entertain you. Are you prepared to challenge them?
Create a financial system that offers support to enterprise at every stage of the firm's life cycle. Break up the current banking system to create at least a dozen new banks. Maintain infrastructure investment with an Infrastructure Bank. This is not acting when the market fails. It is institution building – a real departure from market fundamentalism. Are we on the same page?
How committed are you to a paradigm shift in competition policy? To attack monopoly and promote real economic and social opportunity? Britain should say no to Kraft's attempted takeover of Cadbury on competition grounds; we don't want another deadbeat foreign monolith strangling competitive dynamism. What do you think? We need to open up all the protected routes to the top, including the privileges of private education. We need to enfranchise everyone in a competitive, challenging society. It is a revolution, George. Are you up for it?
Best, Will
Dear Will
When it comes to financial services, you present a false choice. As billions of people join the global economy, they will demand financial products. Given our comparative advantage in this high-value industry, it would be a missed opportunity if we didn't reap the benefits. But the key to doing that is to create a safer, more stable system that eliminates the moral hazard provided by taxpayer guarantees. To use your example, I support proper regulation of derivatives, but we should want central clearing houses to be based in London, not Frankfurt or Chicago.
More importantly, though, I agree with the ambition and direction of your "revolution". Over the past few years, I have changed my view on the role of government. The attempts to pick winners in the 1970s led to the emergence of a view in the 1980s that government should be neutral about the structure of the economy. This Treasury view didn't change when Gordon Brown entered No 11.
Of course, in practice it was only the appearance of neutrality. When the City raised concerns about a tax or a regulation, it was usually addressed by the sponsoring department, which happens to be the Treasury. But when the pharmaceutical or hi-tech engineering sectors raised concerns, they were fobbed off on junior ministers in less powerful departments.
So the question is what government can do to make our economy more balanced without reinventing the failed industrial policy of the past. You and I agree on the things we shouldn't change. To quote you again: "Osborne has also at last understood that reform is not about excessive state control or abandoning free trade." Instead we need to complement open markets with a focus on innovation, infrastructure and institutions.
You mention Rolls-Royce, one of our most successful exporters. Both David Cameron and I have spent hours in conversation with its chief executive, Sir John Rose, discussing what we can do to support high-value manufacturing. Indeed he sits on our economic recovery committee, which meets regularly. Similarly we recently engaged Sir James Dyson to set out how we can turn Britain into Europe's leading hi-tech exporter.
What are our early conclusions? More support for long-term equity investment in new start-ups, active support for higher education, and more powers for local councils to encourage economic activity. In some regions that will mean replacing regional development agencies where they have failed to deliver.
But you seem to ignore our record budget deficit. The rating agency Fitch this week said that Britain's credit rating was the most at risk of any major economy, and Mervyn King again emphasised the need for a credible fiscal plan. The lack of one is already undermining confidence at home and overseas. You know as well as I do that whoever is elected will have to cut departmental spending.
Where I agree strongly is that we should avoid the mistakes of some previous consolidations by protecting key investments in innovation and nationally important infrastructure. I consciously avoided that in the package I announced at our party conference. Indeed it is Labour that is proposing to halve the investment budget, while the Conservatives have been the first to develop plans for a fully costed high-speed rail network. I am personally committed to this project.
Of course, given the constraints, we also need new ways to encourage private investment in infrastructure such as smart electricity grids and low carbon energy. Labour's PFI model is flawed and must be replaced. We need a new system that doesn't pretend that risks have been transferred to the private sector when they can't be, and that genuinely transfers risks when they can be.
Do you agree? Just as Conservative economic thinking on supply-side reform has evolved, so surely has yours? What would you do about investment in an era of tight government budgets?
Best wishes, George
Dear George
Conservative economic policy is becoming more pragmatic – and I welcome the change. I remain concerned about values, whether you will mobilise behind the economy beyond the City and whether your obsession about lowering the budget deficit will damn us to prolonged stagnation. . On values, for example, the debate about Lord Ashcroft's tax status is not low point-scoring. It is how the rest of us are to reconcile your rhetorical commitment to productive entrepreneurship, inclusion and fair play with how he has made his millions – and what his influence on you will be.
Our national challenge is awesome. The private sector is traumatised. The prospects for exports and private investment are at best moderate. The only spender we have to compensate is the government – hence the big deficit.
The job of reducing it is very delicate. Basic economics spells out that, if the government, business and consumers all save simultaneously, we will have a prolonged recession. You have never made a public pronouncement recognising this truth. Instead you make bellicose statements about menacing debt and deficits, and promise deep cuts in spending come what may.
Of course the deficit has to be lowered. The issues between us are sequencing, timing , balance between tax increases and spending constraint. We took seven years in the 1990s to repair the damage of the 1990-92 recession, with Conservative chancellors lifting taxes by some £35bn in today's terms. Why do you want to do the job faster today from a deeper recession with even more of the load taken by spending cuts? We are talking real lives, real businesses and the real scar of unemployment. Put them first.
I would take a decade over it, acting only once it is clear that private consumption, investment and exports are rising. I would raise taxes on the Clarke/Lamont scale. I would ring-fence public investment. And what do you mean by replacing PFI? Our so-called "Anglo-social" model, combining counter-recessionary public spending and flexible labour markets, is working better than the US and EU in keeping the growth of unemployment down. Why do you want to trash it? The buyers of our debt want deficit reduction. But they also want growth. Your task is to balance those demands .
The Chancellor's job is about vision, trade-offs and epic judgment calls. If your alpha and omega is simple deficit reduction, you will not succeed – bad for you, worse for the country.
Best, Will
Dear Will
I'm glad that you too are becoming more pragmatic and accept that the record budget deficit cannot be sustained. When credit rating agencies, independent economists, business organisations and the Bank governor are all warning about the absence of a credible plan, you can't accuse us of some odd obsession. A failure to set out that plan would choke off the recovery with higher interest rates. It is already contributing to the lack of confidence that has left Britain the last major economy in recession and increasingly talked of abroad as the sick man of Europe.
Of course the judgment is about timing and balance. I am not proposing to eliminate a £90bn structural deficit overnight. My proposals to freeze public sector pay, shrink Whitehall, reduce benefits for better-off families and bring forward the planned increase in the state pension age have a cumulative effect over several years, do not damage public investment and are designed to protect the poorest.
Your prescription for a recovery led by yet more government spending is too defeatist. Surely we can find a more balanced model of growth? For I fear that, if we stick with Labour's approach, we are heading for a Japanese-style lost decade. To avoid simply pumping the bubble back up, a sustainable recovery must be led by exports and private investment. Theory and evidence show that the best policy combination to achieve that is responsible fiscal policy and low interest rates.
But there is a further issue – trust. When public trust in government is already at rock bottom, how can anyone seek election without being honest about the tough choices ahead, or govern without a mandate to take those choices? The PM talks about ever more spending, but every week Whitehall leaks show he faces unavoidable cuts. Just last Sunday this newspaper revealed planned Labour cuts to training and apprenticeships, completely at odds with his rhetoric.
On PFI, we are drawing up alternative models that are more transparent and better value for taxpayers. The first step is transparent accounting, to remove the perverse incentives that result in PFI simply being used to keep liabilities off the balance sheet. The government has been using the same approach as the banks did, with disastrous consequences. We need a more honest and flexible approach to building the hospitals and schools the country needs. For projects such as major transport infrastructure we are developing alternative models that shift risk on to the private sector. The current system – heads the contractor wins, tails the taxpayer loses – will end.
You talk about vision. Let me tell you mine. Real financial reform that challenges vested interests and establishes Britain as a safer and properly regulated financial centre. A deficit plan to restore confidence without balancing the budget on the backs of the poorest. A balanced economy where sectors other than finance thrive and with more long-term investment in the likes of low-carbon technology. Much more productive public services and a reinvention of Whitehall. A radically simpler business tax system with lower headline rates. Radical welfare reform to get Britain working. That's how you reduce unemployment and go for growth for the long term.
I have enjoyed this email exchange. Let's continue the conversation offline.
Best wishes, George
George Osbourne: The biography
Name: George Gideon Oliver Osborne.
Born: 23 May, 1971, London.
Spouse: The Hon Frances Osborne.
Children: Luke and Liberty.
Education: Norland Place School, St Paul's and Magdalen College, Oxford, where he was a member of the Bullingdon dining club and graduated with a second-class degree in modern history.
Wealth: Estimated at £4.3m. Osborne is next in line to inherit the family baronetcy of Ballentaylor in County Tipperary, as well as a substantial share of Osborne & Little, his father's luxury wallpaper company.
1994: Joined the Conservative Research Department, becoming head of the political section.
1995 -1997: Special adviser to Douglas Hogg at the Ministry of Agriculture, Fisheries and Food during the BSE crisis.
1997-2001: Speechwriter and political secretary to the then Conservative leader, William Hague.
2001: Elected as MP for Tatton, Cheshire.
2004: Appointed to the shadow cabinet as shadow chief secretary to the treasury.
2005: Re-elected with increased majority. Promoted to shadow chancellor of the exchequer.
