Beyond the third way: A new inclusive prosperity for the 21st century – an edited version of my LBS speech

This article is an edited version of my speech to the London Business School on 30 June 2014. It foreshadows the findings of the Inclusive Prosperity Commission, which I co-chaired with former US Treasury Secretary Larry Summers and reported in January 2015.

It is published in a collection of essays by Policy Network alongside papers by Florian RanftCarlotta De Franceschi, Thor Berger and Adam Lent.

It is now almost 20 years ago that US president Bill Clinton and UK prime minister Tony Blair launched the progressive governance movement and called for a ‘third way’ in response to the challenge of globalisation.

Their purpose was to chart a course between passive, free-market laissez-faire on the one hand, and the rejection of open, global markets and a lurch to protectionism on the other. Their ambition was to show that a dynamic market economy and a fair society could go hand in hand.

Two decades on, this clearly remains work in progress.

Governments across the developed world continue to struggle with the consequences of seismic global and technological change, financial instability, rising inequality and stagnating median incomes.

And political disenchantment has continued to grow. Politicians of all parties, and in all countries, hear regularly on the doorstep the worries and fears of people that economic recovery is not working for them and their family. Not surprisingly, far-right and -left populist movements have flourished, as recent polls and political developments in both the United States and United Kingdom amply demonstrate.

In the face of such powerful global changes, we cannot take public support for this open, global vision of a dynamic market economy for granted. So how should progressive politics respond?

The third way of the 1990s

My starting point is the economic trends we have seen over the last 20 years and what they teach us about how we should shape our economic policy for the next 20.

Looking back, there are important differences to today – but also some striking similarities too.

Back then, the UK was recovering from a deep recession, following the exchange rate mechanism crisis. The fiscal deficit was very large and household incomes were being squeezed by tax rises and cuts to public spending.

And the political debate was focussed on the big global economic changes taking place – the rapid growth of international trade; new competition in manufacturing from emerging economies in eastern Europe and Asia; and technology replacing jobs and undermining wages among low-skilled, manual workers.

Of course, this debate was taking place across the developed world.

In America, as debate raged about the North American Free Trade Area and newspaper columnists agonised over what they called ‘the downsizing of corporate America’, the first-term President Bill Clinton called a G7 jobs summit in Detroit.

In Britain, as we debated the case for Bank of England independence and new fiscal rules to prevent another ERM-style crisis, Tony Blair and Gordon Brown led the public debate about how Britain should respond to these economic changes by calling for a ‘skills revolution’.

Meanwhile, Europe’s response was a single currency to deliver stability, a single market to deliver rising prosperity and a social chapter to deliver fairness. All of this was much to the anguish of the Eurosceptics.

Twenty years on

If a new insecurity was taking hold in the 1990s, today those concerns are deep, entrenched and undermining public trust that politics can offer a solution.

Indeed, the pattern we have seen in the UK – growth returning, but feelings of insecurity and discontent being expressed in the opinions polls – has been repeated in the US, France, Denmark and Austria too.

The best we can say is that the struggle to prove that a dynamic market economy and a fair society can go hand in hand remains to be won.

Some would say that the Blair-Clinton attempt to forge a third way did not succeed.

That steps were taken to improve the prospects of lower-paid workers, including higher national minimum wages and more generous tax credits to make work pay.

But not enough was done to improve the prospects of the non-university educated workforce. While the failure of financial regulation led to a global financial crisis and the global recession which followed hit middle- and lower-incomes families particularly hard.

I have some sympathy with this argument. In the UK, we did not do enough on skills and the failure of all parties in the UK, and all countries in the developed world, to see the coming crisis was a huge error.

But I do not believe that the progressives were wrong in their central belief that a path could be taken between free-market economics and protectionism and isolationism.

My argument is that the third way did not deliver because the world was changing in a more profound way than any of us anticipated.

And new times now demand a new approach.

Not only do we face new challenges from technological change and globalisation, we must also deliver at a time when both monetary and fiscal policy face great challenges.

So charting a new way forward for the even more challenging century we now live in is now the challenge for this generation – politicians, businesses, and trade unions – all of us.

The 21st century economic challenge

Over the last 20 years, the global economy has fundamentally changed – and changed for the better.

As communism collapsed and countries have liberalised their economies, there have been significant reductions in poverty and increases in living standards across Asia, south America, eastern Europe and now Africa.

Meanwhile, developments in information and communications technology have transformed the way we live our lives and brought the world ever closer together.

And as these trends have accelerated, the global economic map has been redrawn as new opportunities have opened up not just for developed countries, but for emerging markets like China and Brazil.

Back in the 1990s, we recognised that globalisation was creating new challenges. Trade and technology placed a premium on higher level skills and qualifications, and reduced low-skilled jobs.

Changes to the structure of labour markets – often caused by the strain of global competition and including the fall in trade union membership – also had a knock-on effect on wages.

And having more working mums has helped to increase living standards – but also made providing affordable childcare and family-friendly employment rights more important too.

While progressives attempted to address all of these challenges, we failed to foresee three other changes which were going to fundamentally reshape our world.

First, global economic integration led to much greater instability in our financial and tax systems than any of us anticipated.

As we now know, the global financial sector was taking risks that both bankers and regulators did not fully comprehend.

As leverage increased and balance sheets grew, bulging corporate tax receipts gave the impression that everything was rosy.

And in Britain, the Labour government ended self-regulation by introducing the Financial Service and Markets Act.

But while voices in the City and across the right argued that we were being too tough on the financial sector, we should have been much tougher still.

And when the global crash came, the result was the near-collapse of the financial system and unprecedented state intervention in our banking sector.

Alongside this, globalisation also created much greater complexity in our tax system. Offshore tax havens, transfer pricing arrangements and well-paid accountants have all helped some international firms stay one step ahead of the taxman, while technology companies, which do not need a shop front that physically anchors them in a particular country, have benefited in particular.

Second, labour mobility has also been much greater than anyone expected. Just as hundreds of thousands of eastern European people have come to live and work in the UK, so too have millions of Mexicans and Latin Americans moved to the United States, and Indians and Chinese to the relative riches of the Middle East – a new global and mobile middle class.

Additional competition for low-skilled jobs, and increasingly intermediate-skilled jobs, has put great pressure on communities. And developing countries’ use of natural resources like energy, water, precious metals and other commodities has risen.

Third, we have seen profound technological change which is not just substituting for unskilled labour, but replacing traditional middle-income jobs too.

Two decades ago, we were right to worry that low-skilled jobs in sectors like manufacturing would go overseas. Sophisticated machine tools and software are already reducing the need for routine jobs on production lines and in offices. But the advances in robotics and artificial intelligence – 3D printers, not to mention Google’s driverless cars or Amazon’s drones – mean that intermediate skilled jobs are also being lost too, in what economists call a ‘hollowing out’ of the labour market.

Meanwhile at the top, the returns from ideas, capital and top-class qualifications are getting greater and greater. And the result has been, for most developed countries, rising income inequality on a scale not seen since before the first world war.

No developed country has escaped the impact of these global trends. All are dealing with the twin challenge of dealing with the aftermath of the financial crisis, while also trying to adapt to the relentless forces of globalisation, immigration, and technological change. But the UK has been particularly hit hard:

– Britain’s financial sector – larger and more exposed to international shocks than our competitors – has experienced bigger hits to growth and to the fiscal position;

– the UK’s openness and ‘safe haven’ reputation, alongside the lack of transitional controls on EU accession states in 2004, has seen low-skilled immigration put additional pressure on our labour market;

– and while many countries have tried to increase labour market flexibility in the face of ‘hollowing out’ the UK has seen a particular shift to low-wage, part-time and often insecure employment.

A new inclusive prosperity for the 21st century

So how do we respond? Some on both the left and right say that if rapid globalisation and technological change have undermined the pay and prospects of working people, then the simplest thing to do is to turn our back on those economic forces – putting up trade barriers, stopping migration into Britain and leaving the European Union.

In my view, Britain has always succeeded, and can only succeed in the future, as an open and internationalist and outward-facing trading nation, with enterprise, risk and innovation valued and rewarded, by backing entrepreneurs and wealth creation, generating the profits to finance investment and winning the confidence of investors from around the world.

Turning our face as a nation against the rest of the world and the opportunities of globalisation is the road to national impoverishment.

Open markets and business investment are part of the solution, not the problem – as is a Britain that is properly engaged in a reformed Europe.

But we cannot just bury our heads in the sand and ignore the legitimate and mainstream concerns of people across our country that our economy is not currently working for them and their families.

A return to business as usual won’t work. It won’t work economically. There is no future for the UK in trying to compete on cost with emerging countries round the world.

It won’t work politically either. Cutting workers’ rights, undermining public services and reducing taxes only at the top in the hope that wealth will trickle down will not persuade a sceptical and hard-pressed electorate.

New times demand a new approach. And I want to set out three ways that I believe that a new inclusive prosperity for the 21st century must be different from the approach taken in the 1990s:

– first, we need tougher global co-operation;

– second, we need good jobs and skills, especially for those being left behind;

– and third, we need a new industrial policy.

Hard-headed internationalism

First, we need a much tougher international response to these global trends. We have to show that we understand and can respond to people’s concerns about financial instability, immigration and tax avoidance while staying open to the world and continuing our commitment to a dynamic market economy.

I call this a hard-headed internationalism – and it must start with Europe.

We know that we need reform of the EU to deliver value for money for taxpayers and to make Europe work in our national interest. But it is not in our national interest to walk away from the huge single market on our doorstep. To do so would be anti-investment, anti-jobs and anti-business.

Instead of marginalising ourselves with fringe parties, and isolating ourselves from key allies, we should be at the centre of the debates. And we need that cooperation to make progress in vital areas, including on security, trade and climate change.

On financial regulation, we need new impetus to global efforts to reform our financial system which are grinding to a halt.

On immigration, too, we need greater international cooperation so that we can keep the benefits of skilled migration, while controlling and managing it fairly – and finding a fair solution for refugees.

This means new laws to stop agencies and employers exploiting cheap migrant labour; while also making sure people who come to this country learn English and contribute to Britain. While in Europe, we need longer transitional controls, stronger employment protection and restrictions on benefits – because when we face such an acute challenge to make work pay for unskilled people, we should not be subsidising unskilled migration from the rest of the EU.

And on business taxation, we also need greater international cooperation to strike a fairer deal for the future. Our system must be competitive, promote long-term investment and innovation, and be simpler, predictable and fair. The purpose of a competitive tax system must be that companies view Britain as a great place to do business, not simply a cheap place to shift their profits.

So alongside action in the G20 and OECD to tackle tax avoidance and enhance transparency, we need a business tax system that promotes long-term investment, supports enterprise and innovation, provides a stable and predictable policy framework for business and a foundation built upon fairness. With this approach, Britain can compete in a race to the top, with a highly skilled, productive workforce directly benefiting from sustainable economic growth.

Work and skills

The second task for our inclusive prosperity agenda is to provide good jobs and skills for everyone and especially for those who feel they have been left behind.

Demand for high-skilled jobs in advanced manufacturing, financial and business services, and across the creative industries will continue to increase – so we must maintain our global excellence in higher education.

But we must also ensure that the highest skills can be achieved through our vocational system. We cannot just meet the shortage in trained technicians that businesses repeatedly highlight by importing labour.

Those with intermediate skills are most at risk of the ‘hollowing out’ phenomenon. We must help equip them to take up new opportunities as baby boomers retire and ensure the skills they have developed are recognised by prospective employers.

In lower-skilled sectors, we must ensure that the minimum wage continues to increase, is properly enforced and that employers have clear incentives to pay a living wage – with tax credits an added reward for hard work rather than a subsidy for low pay, and training available to all to support career progression.

We must ensure that young people entering the world of work have the ambition, skills, knowledge and qualifications they will need to succeed.

We need a major expansion of university technical colleges to ensure Britain is producing enough trained technicians in STEM subjects and other subjects where there is clear demand.

We need to get young people into training rather than unemployment, and improve the quality of apprenticeships, with a greater role for employers in designing vocational qualifications and a key role in commissioning and planning skills provision in their area.

A new industrial policy

And third, to deliver inclusive prosperity, we need to match policies for open markets and skills with a new industrial policy which puts innovation, long-termism and growth centre stage.

After the debacle of British Leyland in the 1970s, ‘industrial policy’ were dirty words in Britain. So while Margaret Thatcher had an industrial policy in the 1980s – the Big Bang for financial services, bringing Japanese car manufacturers to Britain and investing heavily in Airbus and its supply chain, including Rolls-Royce – she kept quiet about it.

And 20 years ago, we also steered clear of talking openly about industrial policy. Instead, with our economy returning to full employment, we focussed on providing macroeconomic stability and reforms to increase competition, encourage enterprise, support science and improve skills.

But since the global financial crisis and following the pioneering work of Peter Mandelson as business secretary, a consensus has emerged that focusing on specific sectors is not only essential; it is inevitable.

Mike Wright’s report on manufacturing and the supply chain made clear there is a clear role for government to give strategic direction, bring sectors together to foster long-term planning and tackle issues like the cost base and skills.

At a national level, we also need clear long-term direction. We need action, as George Cox’s report said, on boardroom pay, and corporate governance.

We need more competition in banking and a British Investment Bank to support small and growing companies.

We badly need an independent infrastructure commission that can work to put aside the dither and squabbling that has dogged our approach to infrastructure for decades.

From Silicon Valley to the City of London, the world’s best industries tend to be clustered. In the UK, our automotive sector is concentrated in the Midlands and north-east; the offshore wind sector brings jobs to many coastal regions; and aerospace is predominantly based in the north-west; and our creative industries are centred major cities like London, Manchester, Bristol and Leeds. The government cannot create clusters – but it can do a lot to support those that already exist, especially at the local level.

But we also need a new long-term framework for science and innovation. Mike Wright and Andrew Adonis’s reports both looked carefully at government support for innovation and science. They both come to similar conclusions, in particular that the 10-year framework for science funding, set up by David Sainsbury as science minister, provided the stability and long-termism that our research base and companies need.

I believe that a similar long-term funding framework for innovation policy, covering initiatives like the Technology Strategy Board and Catapult centres, will be equally important to delivering an inclusive prosperity.

Conclusion

This agenda for inclusive prosperity is pro-business, but not business as usual.

It demands we steer a midcourse between laissez-faire complacency on the one hand and protectionism and anti-Europeanism on the other.

It requires us to forge a long-term consensus to embrace open markets while actively working to secure the skills, long-term investment and market reforms we need to deliver rising prosperity for all.

And it recognises that if we are to maintain public support for an open market economy, we need to address public concerns, promote competition and long-term investment and make sure markets like energy and banking work better for consumers and businesses alike.

This is today’s road to a new inclusive prosperity for the 21st century.

Posted November 26th, 2015 by Ed