History may judge the general election of May 2010 as important as those of 1906, 1945 and 1979 in radically redefining British capitalism and the future role of the state. If so, this will be a somewhat ironic outcome: for the new government was an accident, with no clear mandate for radical change, born out of a freak election result that delivered Britain’s first peace time coalition rule since the 1930s. To the Conservatives, the leading party in the Coalition, unexpectedly sharing power came as a disappointment that seemed likely to curb their ambitions for radical change, while to the media the most radical aspect of the new government seemed to be the surprisingly warm relations between the new Conservative prime minister, David Cameron, and his Liberal Democrat deputy prime minister, Nick Clegg, which they likened to a gay marriage. Nonetheless, the new government set about its work with such vigour that, after barely three months in office, The Economist wrote that in “its first 100 days the Con-Lib coalition has emerged as a radical force” and “the West’s test tube.”

A radical government is certainly needed – so long as it is the right sort of radical.The Coalition took charge as Britain struggled to escape from the deepest recession in more than half a century,after a catastrophic collapse of the financial system that had revealed fundamental flaws in the pro-market economic orthodoxy of the previous thirty years.

The three great reforming governments of the twentieth century also took power at times of economic and social turmoil and implemented radical reforms that reshaped the relationship between the state and the market for a generation.The New Liberals elected in 1906 gave birth to the welfare state with their People’s Budget. ClementAttlee’s 1945 Labour Government took the commanding heights of the economy into public ownership and created the National Health Service. And, starting in 1979, Margaret Thatcher’s Conservatives privatised and unleashed the market.

Although controversial at first, by the mid-1990s the Thatcherite settlement between state and market had become the bipartisan consensus, cemented by the election of Tony Blair’s market-friendly New Labour government in 1997. Over the three decades before the financial collapse, Britain had helped turn this conventional wisdom about the roles of the state and market into a global faith.
It was not until the autumn of 2007 that the first serious evidence emerged that this orthodoxy was flawed and a new approach would be needed. The cracks began to appear when what was now Gordon Brown’s Labour government reluctantly intervened to rescue – and ultimately nationalise – a failed mortgage lender, Northern Rock, after the supposedly always-open credit markets on which the bank depended froze shut. Then, on September 14th 2008, the conventional wisdom imploded along with Lehman Brothers, a big New York investment bank with significant operations in Canary Wharf, which became the world’s biggest ever bankruptcy.The ensuing panic triggered the worst economic crisis in the developed world since the 1930s.

In the aftermath of Lehman’s failure, as asset values plunged and banks even stopped lending to each other, the British government played a leading role in working with its counterparts around the world to deal with the mess. They together splashed billions of pounds and trillions of dollars in a co-ordinated effort to save the world’s financial institutions from the “toxic assets” on their balance sheets.With this help, the banks survived – albeit at enormous cost to taxpayers everywhere.

While this emergency rescue of the financial system by massive government intervention was ultimately quite impressive, restoring confidence to the firms and individuals that make up the economy has proved far harder. In large part, we believe, this is because the collapse of the old conventional wisdom about the roles of state and market has left an intellectual void that has yet to be filled. Dealing with the toxic ideas that led to the crisis is now just as important as cleaning up the toxic assets left in its wake. Until we have come up with better ideas, how can any business leader, worker or consumer go about his or her life with confidence that the economy is now on a sustainable road from ruin to recovery, rather than just another bad week in the City away from the next Great Depression?

The time has come for a fundamental overhaul of the British model of capitalism, to create the better markets and better government needed to thrive in what is likely to remain a turbulent global economy in the decades ahead. The crisis has revealed serious flaws in the relatively laissez-faire approach that had been taken towards the market, and in particular the financial markets. Yet the initial enthusiasm (in countries such as America, as well as Britain) for a return to bigger government has proved short lived, and not just because a sovereign debt panic in Europe reminded everyone that governments, Britain’s included, needed to get their finances in order. During the boom years the Labour Government had experimented with throwing public money at almost every problem, with decreasing effectiveness. According to Mr Blair (admittedly not an impartial observer), Labour’s defeat in 2010 owed much to the post-crisis embrace by his successor, Mr Brown, of “a big government Keynesian approach that seemed merely to turn back the clock, rather than to learn from what had gone wrong.”

The early actions by the new Coalition government showed that it understood the need to take a radically different approach to that of its predecessors to both the market and the state. Significant changes to financial regulation were announced, and a commission established to propose further, probably bigger reforms of the banks. Even more dramatically, it unveiled plans to sharply reduce the share of the state in the economy through unprecedented deep cuts to the budgets of most government departments. Mr Cameron’s talk of a “Big Society” also suggested that the changes to the state would be designed not merely to downsize government but to make it more effective by engaging in a partnership with citizens and private-sector organisations to meet the country’s needs.

The Coalition has shown considerable political courage in addressing some hugely controversial issues. Yet its agenda is now but a work in progress, with much of the detail still to be filled in. It remains to be seen if it has learned the correct lessons from this crisis – and the many other economic crises that have preceded it – that we describe in The Road From Ruin.Will it embrace the right set of ideas – and will it have the right set of political skills to execute its vision?

There is certainly a risk that its desire to take the axe was motivated more by political than economic calculation and could turn out to have been over hasty. Budgeting for “austerity” ran the risk of squeezing the life out of a weak economic recovery, potentially even leading to a “double dip” recession. And the pressure to save money fast had the potential to prevent the careful thought necessary to ensure that a smaller government is also a more effective one. Also, there is sufficient vagueness in Mr Cameron’s Big Society vision – as well as disagreement among his advisers – that it could easily emerge half-baked.

The Coalition has some particularly hard thinking to do about the future shape of the City of London, and of the role of financial services in the economy.The pre-crisis conventional wisdom saw the role of the government essentially as a cheerleader for the City – a huge earner for Britain in the global economy and a genuine rival to New York as the world’s leading financial centre.Winning the support of the City played a crucial part in New Labour’s election victory in 1997 and in government its philosophy was to regulate with a “light touch” that mostly suited the needs of those it oversaw.

When the crash came, both Conservatives and Liberal Democrats engaged in the banker-bashing that follows every financial crisis. (Happily, they did not go so far as the MP who, after the bursting of the South Sea Bubble in 1720, proposed that those responsible be sewed in sacks filled with snakes and drowned in the Thames.) In government, they face tough decisions about how to reform the City that populist rhetoric is unlikely to help them get right. A particular danger will be overly-heavy regulation, especially of financial innovation. Novel financial securities (such as “collateralised debt obligations”) and complex new financial risk-management systems used by the banks helped cause the crisis and there has since been an understandable backlash against such financial wizardry. Even George Soros, a veteran hedge-fund investor nicknamed the “man who broke the Bank of England” after he made a fortune when the pound fell out of the European Exchange Rate Mechanism in 1992, proposed that all financial innovations should have to be registered and approved by regulators, in much the same way as new pharmaceuticals are. Yet throughout history, innovations that have led to financial bubbles have gone on to be accepted as valuable and useful. Caging the creativity of the City could prove a popular but costly mistake.

Just as the Coalition should be wary of proposals to reform banks and other financial firms in ways that would reduce useful innovation, it should also take with a large pinch of salt the notion that financial services have become too large a part of the British economy, and should be reduced in favour of a larger manufacturing sector. There is plenty of nostalgia in Britain for when it was the manufacturing powerhouse of the world – but the Coalition would be badly mistaken to believe in the inherent superiority of physical products. Low-cost economies like China lead the world in manufacturing today. Like it or not, what Britain is actually good at, recent events notwithstanding, is high value-added intangibles like financial services.

History is clear that, to get an economy back on track after a bubble bursts, it is far better to focus on learning how to make better use of innovation than to try to regulate it away. Rather than “rebalancing” the economy away from finance, the Coalition should aim to foster a better City that does a better job of serving the British public and is more successful than ever in the global economy.The way to do that is not through heavier regulation but smarter regulation, based on improving the flow of information to participants in the financial markets and through setting the right incentives.
The challenge for government here is to move on from treating the symptoms – “fat cat” salaries and so forth – and start addressing the structural flaws. Many people in the financial sector did get rich by getting deals done, regardless of the long-term consequences, in order to get their bonus. But that does not mean that government should regulate the pay of bankers. Many of the changes that are needed, in pay structures and in the values of the people in the industry, particularly its top executives, must come from within the City itself. But it needs to be a reformed City.

At the root of the crisis was a profound failure in corporate governance, which is something that the Coalition can do something about. Institutional shareholders, such as pension funds and unit trusts, failed to oversee properly the behaviour of bank executives and allowed them to pursue the reckless strategies that pumped up their pay in the short term, at an ultimately huge long-term cost to their shareholders and the global economy.The Coalition has the chance to rewrite the rules of corporate governance to get institutional shareholders to take real responsibility, and to secure the transparency from companies that they need to do so. It would be entirely in keeping with the notion of the “empowered citizen” at the heart of the Big Society philosophy to engage the public in corporate governance by improving the accountability of institutional investors to those whose savings they are entrusted with. Indeed, for the Conservatives in the Coalition, that would offer the appealing possibility of fulfilling Mrs Thatcher’s dream of creating a genuinely “popular capitalism” based on meaningful share ownership by the public.

This is the key test for the “Big Society”: will it be anything more than an exhortation to citizens to volunteer and be more charitable, when it needs to be a genuine transformation in the relationship between the public, business and government? So far the Coalition has talked about engaging the public in the reform of public services.That makes sense. But to that idea it must add a vision for how the public can shape capitalism and how that reformed capitalism can play a role in meeting society’s needs. Bridging the gap between the City and the Big Society in this way will mean moving on from the blame game to a new, constructive dialogue. A final challenge for the Coalition will be figuring out how to bring about the reforms that are needed to the rules and institutions governing the global economy. Although aspects of this crisis have been unique to Britain and its model of capitalism, it was ultimately a global crisis – intimately linked to America’s housing bubble and to “imbalances” in the world economy due, not least, to China’s mercantilist exchange-rate regime.

At the root of the problem is the world’s reliance on the dollar as the basis of international finance. The crisis has proved that this system is as bad for America as it is for the rest of the world. Yet America has so far been reluctant to address this problem – clinging to the dollar’s reserve currency role as a political symbol of economic virility – or to lead the overhaul of institutions such as the International Monetary Fund and World Bank that is needed to meet the demands of the twenty-first century economy. Here is an opportunity for the new government to provide global leadership, not least by using Britain’s special relationship with America to explain that it risks repeating mistakes we made as we began to lose our dominant position in the global economy more than a century ago, and to urge it to take a more visionary path.

Britain’s model of “Anglo-Saxon” capitalism has much in common with America’s – which, so far, has not done a good job of reforming itself. Indeed, the failings of American capitalism have encouraged talk that the future of capitalism may look more like China’s authoritarian model (though it is hard to believe that many countries would want to imitate its oppressive political structure, or that as it gets richer China can avoid potentially highly disruptive internal political change). And whilst Germany has weathered the economic storm better than most countries, the eurozone sovereign debt mess has highlighted some significant weaknesses in the less financial-market-friendly continental European models of capitalism.

In short, there is no clear favourite in the race to define the model of capitalism best suited for the global economy of the twenty-first century. Britain has the opportunity to improve how its markets and government work, to create a new model of capitalism that, unlike the old one, produces prosperity that is financially, socially and environmentally sustainable. If the Coalition can deliver the right kind of radical change, Britain can become not only the “West’s test tube” but a model for the world.

Figuring out what that model might look like means understanding that this is not the first crisis capitalism has faced. Learning the lessons of the booms and busts that have punctuated the evolution of capitalism can help us to not repeat the mistakes of the past, which is why throughout the book we have set the issues we face today in their historical context. We have also taken a global perspective, for this is arguably the most genuinely global crisis of capitalism so far.

In this introduction, we set out the policies that we believe should form the “coalitionomics” needed to create a new Big Society capitalism. But first we look at the lessons the new government should learn from the successes and ultimate failure of the previous Labour government, and above all, of its economic philosopher king.


It was not long after the nationalisation of Northern Rock, as economic and political problems mounted, that Liberal Democrat MP Vince Cable joked at Prime Minister’s questions that Gordon Brown had undergone a “remarkable transformation in the past few weeks – from Stalin to Mr Bean.”After that, it became increasingly hard to remember the high esteem in which Mr Brown had once been held, as perhaps the brainiest and most economically-literate person ever to hold the office of chancellor of the Exchequer. Yet, for a decade, he was best known for a combination of bold reforms and his notoriously dogged commitment to “prudence”, which seemed to have put Britain’s famously volatile and underperforming economy on a path of permanently strong growth.

Where did it all go wrong? Partly Mr Brown’s problems were personal – those “psychological flaws” that his old political friend-cum-foe Mr Blair identified years earlier. A desire to be popular, perhaps, led him to abandon his prudence and spend beyond the government’s means. To the extent that he believed his own protests that he was still adhering to a policy of prudence, even as public spending soared and the government’s finances became increasingly fragile, to the list of psychological flaws can be added self-delusion. And there was hubris, too. Mr Brown was guilty of believing his own hype, just like the previous massive intellect to occupy Number 11 Downing Street, Nigel Lawson, who also claimed to have produced an economic miracle, only to turn out to have presided over the creation of a massive bubble.

Yet these personal failings were arguably dwarfed by an intellectual failure. The economic ideas Mr Brown believed in – ideas that were widely held – turned out to be seriously flawed. If Mr Brown’s political epitaph is “he said there would be no return to boom and bust” (as he did), then it should be recognised that he was not alone in proclaiming a new dawn for economic policy-making. In America, prominent thinkers such as Ben Bernanke (now chairman of America’s central bank, the Federal Reserve) declared that better economic policies had helped usher in a new era of steady growth, low unemployment and low inflation that was christened “the Great Moderation.”

The policy tool that had taken us to this economically sunlit upland, it was widely believed, was a central bank with the political power to do whatever was necessary to achieve low inflation. Alongside this was a faith in markets, and in particular the financial markets, as the best way to allocate an economy’s scarce resources. Indeed, many policymakers, especially in America, believed in an academic theory – or a simplistic version of it – called the Efficient Market Hypothesis (EMH). Developed in the 1960s and 1970s and then popularised, the EMH led the likes of Alan Greenspan, Mr Bernanke’s predecessor as Fed chairman, to doubt that bubbles in financial markets were even possible.

Through his frequent visits to America, and his friendships with many American academics and policymakers, Mr Brown was thoroughly immersed in this new conventional wisdom.While he did not have the real world economic experience of some of the Americans who have held the top financial post in the cabinet, such as Hank Paulson, the former boss of investment bank Goldman Sachs who was US Treasury secretary when Lehman Brothers went bust, he was probably more familiar with cutting edge economic thinking than any of his British predecessors. For sure, not least as a former City editor, Mr Lawson knew a lot of economics, enough credibly to dismiss his critics in the City as “teenage scribblers” – at least until his bubble burst. But Mr Brown had the confidence to lecture the City about “post-neoclassical endogenous growth theory”.

Despite having grown up in old Labour heartlands, and being perceived as more left-leaning and instinctively favourable towards big government than Mr Blair, Mr Brown’s enthusiasm for financial markets even in opposition was clearly convincing enough to make his “prawn cocktail offensive” to recruit supporters in the City a resounding success. Where Mr Brown believed he could succeed where the Conservatives had failed was in using macroeconomic policy to put Britain on a path of sustainable, steady growth.

The Conservative governments of Mrs Thatcher and John Major had successfully ended the failed bureaucratic “Keynesian” approach to planning the economy and restored markets to a leading role in economic decision-making. But they had failed miserably to end the stop-go cycle of growth and recession that had dogged the British economy for as long as anyone could remember. In the early 1980s, they had some success in bringing down Britain’s stubbornly high rate of inflation but were over-zealous in applying a simplistic version of the monetary policies advocated by the Nobel prize-winning American economist Milton Friedman, with the result that Britain was thrown into deep recession.When the recovery came it turned into the “Lawson Boom”, with its housing bubble and soaring inflation. The inevitable crash was followed by a deep recession made worse by Britain’s joining the European Exchange Rate Mechanism in 1990, and ended only when, cheered on by Mr Soros and the then chancellor, Norman Lamont, it quit it in 1992.

Mr Brown believed that the root of this boom-bust cycle was politics. In contrast to America’s Federal Reserve, the Bank of England could only change interest rates with the permission of the government, which tended to resist increases when it was politically inconvenient to have higher rates, such as at election time. That was also the usual time for British governments to splash the cash through tax cuts or public spending increases, even if economic fundamentals suggested it was unwise to turn on the fiscal taps.

Within days of becoming chancellor in 1997, Mr Brown made good on his promise of more responsible, technocratic economic management by transferring the power to set interest rates to the Bank of England, with the target of keeping inflation low. This decision, which had not featured in Labour’s manifesto, won plaudits from the markets. And to improve fiscal policy, he committed Labour to a new prudence in public spending, guided by his “golden rule” that was supposed, over the course of the economic cycle, to limit government borrowing to what was needed to invest in a better future, not to fund a consumption boom.

A decade or so later, as the markets crashed, threatening to drag the rest of the economy over a cliff, Mr Brown’s claim that he had put an end to boom and bust was repeatedly thrown back in his face. Watching as his legacy as Britain’s most successful economic leader crumbled into the dust, all he could do to defend himself was to protest that his once- proud boast had been to stop bubbles caused by reckless (mostly Conservative) government policies to pump up the economy at election times to win votes. This was not an ordinary crash, he argued, so he could not be blamed.

This defence may seem like self-justifying sophistry, but it is half true. This bust was different to most of those that had preceded it in postwar Britain, in that its cause was not primarily politically-driven macroeconomic policy. Mr Brown’s intellectual error had been to believe that by eliminating haphazard government management of fiscal and monetary policy he had found the secret to uninterrupted growth. His implicit faith in the Efficient Market Hypothesis had blinded him to the possibility that Britain was living through an economic bubble. It was this belief that the market was usually right that meant he did nothing to prevent or prepare for the bust that eventually came.

There are obvious lessons here for the new coalition government, not least that it should never promise an end to boom and bust. In Chapter 1 we show how in a world in which market forces are allowed to operate, bubbles and crashes are always a possibility, often as the result of essentially useful innovation.

Accepting that markets are not always rational may seem like anathema to laissez-faire Conservatives but this is an idea that Mr Cameron seems to accept. After all, he has been an enthusiastic proponent of the ideas of Richard Thaler, an American economist who analyses how people actually behave rather than how the textbooks say they should behave. It was another proponent of this “behavioural economics”, Robert Shiller, whose 1996 presentation to Federal Reserve staff had prompted Mr Greenspan to make a famous comment about“irrational exuberance” possibly affecting share prices. (Mr Greenspan’s brief flirtation with scepticism about the Efficient Market Hypothesis did not last long – when the markets surged ahead despite his warning he decided that they were right and he had been wrong.) When applied to markets, behavioural economics does not require a complete rejection of the idea of market efficiency or demand the abandonment of financial innovation. Rather, the implication of Mr Thaler’s book Nudge is that government needs to guide markets not with heavy regulation that tells people what to do but with incentives designed to “nudge” their behaviour in the right direction.When he came to power, Mr Cameron was quick to appoint Mr Thaler as an adviser on new policies. He would do well to keep his copy of Nudge somewhere handy, and encourage members of his government to do the same.

If Mr Brown’s faith in the pre-crash orthodoxy actually stopped him taking the pre-emptive action needed to prevent the worst financial market meltdown in Britain in living memory, on the other hand, once disaster struck, he acted with remarkable speed and effectiveness. Again, there are lessons here for the Coalition, some of whose Conservative members actually opposed some of his more sensible responses to the crisis. First, although his initial wish was not to nationalise Northern Rock when it got into trouble, once it was clear that no buyer could be found (not even Sir Richard Branson) and that its failure would shatter confidence in the financial system, he was willing to take the mortgage bank (temporarily) into public ownership. If only Hank Paulson had been equally wise when Lehman was on the verge of failure, the global economy could have been spared a great deal of pain. (There has been an attempt in America to blame the failure of Lehman on the refusal of British regulators, perhaps even Mr Brown, to sanction the acquisition of Lehman by Barclays – but even if the deal had been allowed, there is no guarantee that Barclays would have gone ahead with such a risky deal. The real problem was that Mr Paulson did not intervene to save the bank.)

As we explain in Chapter 2, the evidence from crises stretching back several centuries – including the Great Depression in America, the gory details of which should have been familiar to Mr Paulson – show that there are few worse things a government can do to its economy than let its banking system collapse.The time to stop banks causing a financial crisis by taking on too much risk is before the crisis occurs, not during it. In that spirit, the lesson for the Coalition is that it, too, could one day find itself facing the dilemma that confronted Mr Brown over Northern Rock – and a year later, other banks including Royal Bank of Scotland – and take care not to say daft, populist things like “we will never bail out a failing bank.”

Mr Brown also deserves credit for rallying the international response to the crisis. In April 2009 he even gave his tarnished public reputation a brief fillip through his leadership of the G20 conference in London that resulted in unprecedented co-operation between the world’s new and old economic powers to respond to the crisis. Chapter 3 describes how the origins of this crisis can be traced to serious flaws in the global economic system. Mr Brown’s international statesmanship was largely expressed in crisis management, rather than a concerted effort to tackle these problems. Yet there is a lesson here for Mr Cameron: Britain needs to “punch above its weight” in international affairs to help bring about much-needed reform of the rules and institutions governing the global economy.

If the G20 meeting was the high point of the crisis for Mr Brown, the feelgood factor quickly vanished. Still, the emergency measures he took in the early months of the crisis met with little real criticism, except some carping that he could have been more decisive. Here Britain’s experience was in sharp contrast to America’s, where even after Mr Paulson changed his mind and proposed it, Congress initially refused to sanction the rescue of the banking system. Far more anger was reserved for Mr Brown’s subsequent decision to follow this limited bank nationalisation with measures to cut taxes and increase government spending in order to stimulate the slumping economy.

As the government’s borrowing ballooned and Britain’s national debt soared during 2009, Mr Cameron criticised the stimulus in the harshest terms, alleging that this was the culmination of a tendency for Mr Brown to play fast and loose with the public finances that had been going on for years. Within a month of taking office the Coalition cut a largely symbolic £6 billion in public expenditure and then pledged to fix the country’s structural deficit within the space of a single parliament.

While deservedly winning plaudits for tackling the long-run fiscal crisis facing the British government,Mr Cameron’s refusal to acknowledge the need for a stimulus during the crisis was a mistake, which he was running the risk of repeating when in office by cutting public spending too quickly. In 2010, Britain’s economy was suffering from a chronic lack of demand, despite interest rates at unprecedented low levels near to zero. With the private sector running down its debts to compensate for past over-borrowing, government spending was helping to keep the economy ticking over. Suddenly cutting public spending risked throwing the economy back into recession – the so-called double dip.

Efforts to point out these risks were brushed aside as the Coalition argued that debt was now a bigger problem than feeble or non-existent growth and that, anyway, looser monetary policy through quantitative easing could take up the slack. As we discuss in Chapter 4, there are warnings from the history of America in the 1930s and Japan in the 1990s that ending a stimulus too quickly can prolong economic stagnation that makes it even harder to shrink government debt. Despite deteriorating sharply in the crisis, Britain’s finances were still nowhere near as wretched as, say, Greece – so dire predictions that the “bond market vigilantes” would spread panic by dumping British debt were surely overblown.

Mr Cameron is right to argue that Mr Brown’s failure to exercise prudence in the years before the crisis had allowed Britain’s public finances to deteriorate alarmingly. As a result, it was much riskier than it should have been to execute an essential emergency post-crisis stimulus. It was certainly far harder than it needed to be to reassure the markets that Britain did not face a sovereign debt crisis similar to that which afflicted Greece in 2010. Mr Brown can be criticised, too, for failing to come up with credible plans to restore Britain’s public finances to health whenever the economic recovery got into its stride. Nevertheless, there are strong grounds for believing that Mr Brown’s stimulus, co-ordinated with similar efforts by other governments, including America’s, helped the world avoid another Great Depression. On the subject of Greece and its sovereign debt crisis, Mr Brown should also be praised for doggedly keeping Britain out of the euro, despite Mr Blair’s desire to join it, thereby sparing Britain a lot of expensive problems. Instead, faced with a crisis potentially spreading to other financially-stretched eurozone members, including Spain, Portugal, Ireland and Italy, it was left to Germany to dig deep into its pockets to lead the “bailout” of Greece. Having had a lucky escape, it may be a long time before even Europhile Brits argue with any seriousness that the time has come to give up the pound and join the euro – which is probably just as well for the Coalition, given the pre-crisis opposition of the Conservatives to euro membership and the long Liberal Democrat support for joining it.

Mr Brown’s biggest failure after the crisis hit was in figuring out how it should change government. On one issue, financial regulation, he was probably right to bide his time. As we explain in Chapter 5, the history of financial crises is littered with rushed, botched attempts to fix the regulatory system that end up making matters worse. On the wider reform of government, Mr Brown got it completely wrong. To the end, he clung on to the belief that more government spending was the answer to every problem, justifying himself by calling it “investment”. Here, with its Big Society agenda, Mr Cameron may have found one of the big ideas that the Coalition needs if it is to build a better British model of capitalism. Whether it turns out that way, of course, will depend on how that vision is put into practice – and it is to the details of what should comprise “coalitionomics” that we now turn.


George Osborne, the Coalition’s then newly-appointed chancellor of the Exchequer, looked relaxed and comfortable in his black-tie and dinner jacket as he addressed the grandees of the City at their annual Mansion House dinner in June 2010. How different from Mr Brown, who in each of his 10 years as chancellor had refused to dress up, defiantly delivering his speech in a business suit as if to say that, for all his cosying up to the City, he was still a man of the people and not one of “them”. If Mr Osborne’s choice of attire was intended to reassure – and, unlike Mr Brown, the wealthy Conservative really is one of them – his words contained an unambiguous promise to shake the City out of its bad old ways.Yes, he wanted Britain once again to be “home to the most successful and global banks in the world”, but this time “without the British taxpayer being exposed to the most unacceptable of risks.” Let’s hope he meant it.

Figuring out how to reform the City in ways that improve it and make it even more competitive internationally yet also less risky for the taxpayer is the right agenda for the Coalition. Yet it is an extremely challenging one. In its first few months in office, it was almost hyper- active towards the City – not necessarily in the right way.

The Coalition began by acting on the Conservative election pledge to scrap the Financial Services Authority (FSA), which had been created by Mr Brown to integrate Britain’s then rather ineffective and inconsistent gaggle of different financial regulators. To get the Bank of England out of financial regulation, he argued, would let the Old Lady of Threadneedle Street focus on her new role in charge of monetary policy. During the crisis, the unwieldy split in responsibilities between the FSA (the regulator), the Bank of England (the lender of last resort) and the Treasury (the political lead) had made decisive action more difficult. Far better to replace this “trilateral structure” with a bilateral one, in which responsibility for financial regulation was returned to the Bank, argued the Conservatives.

Well, we shall see. But would the Bank of England really have done a better job if it had regulated the City during the crisis? After all, it was the perceived failure of the Bank to prevent previous banking scandals (such as the collapse of BCCI in 1991) and its over-reliance on old-fashioned informal techniques to rein in financial excesses (such as the governor of the Bank’s famous “raised eyebrow”) that had, in part, prompted the creation of the FSA in the first place.

The Coalition’s initial actions also suggested a determination to be seen to be doing something about the arrogance of the City, rather than having first figured out changes that would actually make our banks better servants of the economy. Another of Mr Osborne’s early moves was to impose a levy of 0.04 per cent on the liabilities of banks owned or operating in the UK. This scored some easy political points, as well as generating a welcome couple of billion pounds for the Treasury.The banks predictably howled that it would hit their profits. The levy was introduced in tandem with similar moves by the governments of Germany and France, as other countries considered jumping on the bank tax band wagon (President Obama had supported a similar tax in the US but struggled to get Congress to act).While the levy was billed as a way to reduce the riskiness of the financial system by providing banks with an incentive to borrow less, it was hard to find any serious commentator who believed it would make a significant difference, let alone prevent another crisis.

The Coalition also had to figure out what to do about some international proposals to address flaws in capitalism that had been under development long before the new British government took
office. Mr Osborne was less than happy with his European Union counterparts when they pushed through new restrictions on the hedge-fund industry despite his objections. (London is home to 80 per cent of the hedge-fund activity in Europe.) To the other European finance ministers, hedge funds were “vulture” speculators who profited from destablising the markets, and should be caged. Some may have attributed Mr Osborne’s opposition to the new rules to his friendship with hedge-fund bosses, some of whom have made significant donations to the Conservatives. On the other hand, despite many predictions over the years that hedge funds would cause a financial crisis, when the crisis eventually came, they were more victims than villains.

Mr Osborne was more enthusiastic about international action when, in September 2010, the world’s central bankers agreed new rules on how much capital banks would have to hold in reserve as protection against losses. These rules were called Basel 3, after the Swiss city where the bankers met, under the auspices of the Bank for International Settlements, and because there had been two earlier attempts to get these international bank capital rules right. Assuming they are implemented – a process scheduled to start in 2015 and be completed by 2023 – banks will have to set aside capital of at least £7 for every £100 they loan out or invest, a significant increase on the £2 minimum required before the crisis.The central bankers also reserved the right to demand that big or important banks hold even more capital, and to be able to vary the rules if they think even larger capital cushions are needed in the future.

The BBC’s Robert Peston – the semi-official “voice of the crisis” thanks to his breathless, on-the-spot reporting of the meltdown – hailed this as “the most important global initiative to learn the lessons of the 2008 banking crisis and correct them.” If that is true we have a lot to be worried about. Yes, the rules mean a big hike in so-called reserve requirements from two per cent to seven per cent but Lehman Brothers had “tier 1” reserves of 11 per cent just before it went pop. The muted opposition offered by banks to Basel 3 reinforces our impression that this is a regulatory Maginot Line that will be bypassed easily come the next financial blitzkrieg.

The real war for the future of the City remains to be fought. One battleground will be the Independent Commission on Banking, a committee of the great and good appointed by Mr Osborne and led by the economist Sir John Vickers. Its report, due by September 2011, is expected to propose big reforms to make the financial system safer and protect the economy from the problem of “too big to fail” banks. Although the commission is the direct result of sharp differences of opinion between the two parties in the Coalition – as well as his wisecrack about Mr Bean, Mr Cable (appointed Business Secretary by Mr Cameron) also made headlines by calling for Britain’s bigger banks to be broken up – the Vickers Commission is no bad thing. America has answered the crucial questions about financial reform not through the sort of careful thought that Sir John et al. will engage in, but by the deeply unsatisfactory process of horse-trading in Congress.The Dodd- Frank Act that resulted was a more than 2,000 page mess (though to have agreed any legislation at all arguably counted as a triumph over the prevailing fiercely partisan mood in American politics).

Can the Vickers Commission do better? Let’s hope so. The collapse of the financial system imposed massive costs on taxpayers and the economy. Worse, after being rescued, Britain’s banks, like their counterparts in America,reduced their lending to households and businesses.Ominously, however, many of the ideas that the Coalition asked the commission to consider had been tried before and found wanting.

The biggest of those ideas is the so-called Glass-Steagall option – named after Depression-era legislation in America – which is shorthand for an enforced structural separation between “retail” banking operations (taking in savings, lending money) and risky investment banking activities (usually taken to mean high-stakes gambling in the global financial markets). Supporters of Glass-Steagall point to nearly 70 years without a major banking crisis in America after the legislation was passed and contrast this with the mother of all crises that came within less than a decade of its abolition by Congress in 1999. Cut the link between retail and investment banking, supporters of a new Glass-Steagall contend, and never again will losses incurred by the casino side of the banking business threaten to destroy the public utility business that keeps the wheels of commerce turning in the real economy.

In America, Paul Volcker, a veteran former chairman of the Federal Reserve, urged the president to make a version of Glass-Steagall (quickly renamed the “Volcker Rule”) a key part of the financial reforms. (The adopted version of the Volcker rule in the Dodd-Frank Act was ultimately a shadow of what he had wanted.) Another supporter of this sort of structural reform is former Chancellor Lawson, despite having once removed many structural separations of financial activities through his “big bang” deregulation of the City in 1986.

Yet would such a reform actually prevent another crisis? A Glass- Steagall rule would not have stopped the failure of Northern Rock, nor of Lehman Brothers. Moreover, it would potentially put British banks at a competitive disadvantage to their counterparts in continental Europe, where the universal banking model – the opposite of the Glass- Steagall model – is well-established.

There is a decent case to be made on competition grounds that British finance has become too concentrated, especially at the high street level. Reducing the size of banks on anti-monopoly grounds is long overdue. But the “too big to fail” argument for breaking up banks misunderstands what happened in the crisis. It was not the case that one, big institution collapsed and dragged everyone else down together. Rather, as Andrew Haldane, the Director of Financial Stability at the Bank of England, has explained, the main problem was the inter- connectedness of banks: the crisis was the result of risks building up across a network (the financial system) that caused the banks to all fall over together.

Given the cost of the crisis to the economy some might say that a British Glass-Steagall Act is worth a try anyway.Yet history shows that misguided regulatory reforms can impose significant costs. Too much regulation can make the banking system so inefficient that it becomes a drag on the rest of the economy. Badly designed regulation can also displace rather than mitigate risk, driving risk-taking from the more-regulated parts of the financial system to its less-regulated corners.

Instead of trying to turn back the clock, the Coalition should learn from this crisis and develop a radically different approach to regulation, based on encouraging but managing financial innovation and risk taking.

To see what is at stake, compare the financial system to the motor car. Both are useful and can get us from A to B more quickly (in the case of finance,say,by getting from being a non-homeowner to a homeowner, without first having to save for 30 years to pay for a house). Both are also prone to crashes that are bad for the drivers (homeowners) and often worse for whomever they hit (taxpayers). In the early days of motoring these risks led to the now unfathomable rule that a car needed to travel at no more than four miles per hour and be preceded by a man carrying a flag. Happily, this structural approach to risk reduction was soon dropped, and instead ways were found to make cars safer and drivers better. Not all accidents are prevented but a tolerable balance has been achieved between the risk of accidents and the wider benefits of driving.

The Coalition should develop its response to the financial crash along similar lines. A good start would be to accept that accidents will happen. One of the causes of the current mess was the delusion that bubbles are impossible. In the post Efficient Market Hypothesis era, it should not be unacceptable to countenance that there is irrational exuberance in the market and, as we describe in Chapter 6, to use tools such as monetary policy (through higher interest rates) to “lean into the wind” to stop bubbles forming.

Another factor contributing to the crash was the inadequacy of financial risk-management models used by banks. Bankers were slow to see the crash coming because their risk models told them everything was fine. One reason they were deluded was that they each had good visibility about what they owned and owed, but could not see how risk was building up across the entire financial system. They thought they could see but, in reality, they were driving in a thick fog. A solution to this would be to encourage better information sharing by better informed and more joined-up regulators, so that financial institutions that have a clearer sense of what is really happening will be able to avoid crashes.

The collapse of Lehman caused so much damage because it was such a chaotic process. Lehman did not know to whom it owed money; no one knew which banks were ultimately exposed to it. In cars, seatbelts and airbags make accidents less lethal. Likewise, measures such as “living wills”, written to allow a controlled restructuring of failed banks, and mechanisms to convert debt into equity (known as a “bail-in”) when a bank is teetering on the brink of insolvency because of a systemic crisis would help to reduce the damage caused by bank failures.

“I met the other day with a collection of hedge funds.While it would be fair to say they did not promise there and then to up sticks and vanish, the key point is that if you do undermine their competitive advantage in the way that is proposed, then you simply hand that advantage not to Frankfurt or Paris or to any other European capital but to other cities around the world – to New York or Shanghai or wherever it happens to be.” As the Mayor of London, Boris Johnson has been a sometimes lonely voice defending finance, on this occasion speaking out against the EU directive on hedge funds.Yet the City as it is now is under fire not just from European bureaucrats mistrustful of Anglo-Saxon capitalism, the usual anti-globalisation protestors or old Labour die-hards, but also from erstwhile allies. The former chairman of the FSA, Lord Adair Turner, for example, has dismissed much of what banks now do, particularly their whizzy new financial innovations, as “socially useless”. Much of this hostility was deserved. Certainly there was plenty wrong in the City that contributed to the crash. The unpopularity of finance, and its emergence as everyone’s favourite whipping boy, is in large part a self-inflicted wound.The banks communication with the public since the crisis has been a disaster.The grovelling apologies by bank bosses to parliamentary select committees were better than nothing, but came late and under duress, and showed little understanding that things had to change. Bank bosses seem to think that hunkering down, denying responsibility and resisting reform by refusing to engage is the best way to handle the crisis. But there can be no going back to “business as usual”. Engaging seriously in the debate about how to ensure that finance is socially useful and tackling this failure of leadership in capitalism is as important and urgent as better regulation in getting Britain on the road from ruin.


There has been a great deal of enjoyable banker bashing on both sides of the Atlantic. In America, Dick “the gorilla” Fuld was even attacked (allegedly) in the Lehman Brothers gym for driving the bank that he ran into bankruptcy. In Britain, the banker who came closest to suffering that fate was Sir Fred Goodwin, the onetime boss of RBS – who was known as “Fred the Shred” due to his ruthless cutting of staff costs – who had the windows of his house smashed and the tyres of his car slashed by protestors.

Like Mr Fuld, Mr Goodwin was an obvious target. Not only was RBS a huge player in the subprime mortgage market, right at the end of the bubble Mr Goodwin had led the firm into one of the worst mergers of all time, the acquisition of the Dutch bank ABN AMRO.Today, it is hard to fathom how Mr Goodwin had thought it made any sense for RBS to lead a consortium of banks into a more than £60 billion acquisition of another bank just as the storm clouds gathered in the financial markets in mid-2008. After Lehman collapsed, RBS’s reserves of capital, already stretched by the acquisition, proved inadequate to protect the bank from its mounting bad mortgage debts. Mr Goodwin had no option but to turn for help to the Treasury in October 2008, and RBS was eventually nationalised.

RBS was the biggest British banking casualty of the crisis, posting a record loss of £24 billion in January 2009, two thirds of which resulted from the ABN AMRO acquisition. By then Mr Goodwin had fallen on his sword, though any sense of having done so with dignity was wiped out by the revelation that his departure had been sweetened with a pension of £700,000 a year. That “the worst banker in the world”, as he was dubbed, had got spectacularly rich by being so spectacularly wrong provoked a storm of outrage (and the attack on his home), which was only slightly ameliorated when under pressure from the government he “volunteered” to trim his payout.

So why did nobody stop Fred the Shred as he went about his disastrous empire building? Taxpayers and RBS employees suffered from his executive hubris, but so too did the bank’s shareholders, whose interests he was supposed to be representing. What were their representatives, the chairman and the non-executive directors on the RBS board, doing?

Like many previous crises, this one has highlighted the severe flaws in the way companies are governed. Instead of restraining him, the RBS board seems to have greeted his every move like a bunch of groupies. By the summer of 2008, when the ABN AMRO deal took place, the credit markets were full of the sort of froth that ought to have alarmed a prudent bank board chairman.

Official inquiries since the crash, such as by the Parliamentary Treasury Select Committee and the Sir David Walker Commission on bank corporate governance, have come up with lots of ideas for improving how boards work. Many of these ideas are sensible – although to anyone unfamiliar with the sophistication of the modern corporate board, they may seem blindingly obvious. For instance, Sir David, himself a veteran banker and long-time member of the community of the “great and good” that supplies most British board members, recommended that directors spend more time on the job and getting to understand the business. Now there is a radical thought.

As with most jobs, some relevant previous experience would be helpful.At least RBS’s chairman, Sir Tom McKillop, had served as a top executive of a pharmaceutical company before taking the helm, even if he was not a banker by training.The same cannot be said of Northern Rock, whose chairman Matt Ridley is an author of various Panglossian popular science books about evolutionary biology who inherited the job from his father the Viscount Ridley. Passing on the chairmanship of a bank’s board within the family of the feudal overlord made little enough sense when Northern Rock was a small local building society. To continue to do so after it evolved into a high risk mortgage lending operation dependent on constantly refinancing itself in the capital markets was, simply, asking to be a victim of Darwinian natural selection. How can even a well-intentioned, gifted amateur be expected to keep an eye on the riskiness of what a modern financial institution is doing?

The most conspicuous failure of boards has been to tackle the question of pay and reward. Too often the structures of salaries and bonuses in the City and on Wall Street have encouraged a short-term mentality focused on doing deals to pocket a commission, rather than asking if the deals actually make sense. This attitude was known among those doing the deals as IBGYBG (I’ll Be Gone, You’ll Be Gone): shorthand for take the bonus because you won’t be around to suffer the consequences.

In the immediate aftermath of the fall of Lehman, the British government (along with its counterparts in America and elsewhere) resisted popular pressure to lay down rules limiting how much and in what ways bankers are paid. Some additional oversight was applied to banks in which the state had taken a significant shareholding, but it was made clear that this would cease with a return to full private ownership. That approach is probably the right one. We wouldn’t advocate the government setting the pay of footballers or rock stars either (though, on the other hand, David Beckham and Lady Gaga pose no obvious systemic risk to the global economy). But incentives and rewards in finance do need to change. The ideal solution would be for shareholders in banks to demand this change. Unfortunately, however, shareholders currently lack both the power and, it seems, the inclination to do this. The Coalition should set out to do something to remedy both these critical weaknesses in British capitalism (albeit weaknesses which are even worse in America).

The Labour government took a step in the right direction by introducing an advisory vote on pay for shareholders in 2002 – something America has only just got around to – but these powers need to be strengthened further. An objection to giving shareholders the last word on pay is that, if they were to reject a board’s proposals, this might breach contractual obligations already entered into with executives. The obvious answer here is to change the governance culture so that no deals are signed until shareholders have agreed. Perhaps this would slow down the process but that cost would be outweighed, surely, by the benefit in terms of concentrating the board’s mind on how they are spending shareholders’ money. Indeed, why limit shareholders say to board-level executives only? Shareholders should also get to vote each year on a report by the board on the overall structure of pay in the company.

The Coalition should see a say on pay as the first step in a far-reaching campaign to empower shareholders. In most British companies the election of board members is staggered over three years, allegedly to ensure continuity of management. But surely it should be for shareholders to decide if that continuity is valuable. Annual elections for the entire board would help to keep non-executive directors on their toes a bit more.

The inevitable protests that this would lead to a shortage of people willing to serve as directors should be ignored; such claims accompany every reform, and so far have been disproved every time. A bigger worry is that there have been many previous reforms to strengthen corporate governance, and they didn’t prevent this latest failure. In 1990 it was the revelation after the death of media tycoon Robert Maxwell that his companies had been raiding their own pension funds that led to the Cadbury report that recommended strengthening the role of non-executive directors. In 2003 this was followed by the Higgs report that again reviewed the role of non-executives in light of fraud and manipulation of corporate results at Enron and Worldcom (which in the United States led to the rushed and flawed Sarbanes- Oxley Act on corporate reporting). Given that the latest crisis came after so many attempts to revive and reform corporate boards, Lord Turner, the former head of the FSA, and officials at the Bank of England have been sceptical that changing the rules again will make much difference.

We disagree. The problem with the past reforms has been too much emphasis on box ticking and, crucially, too little focus on how to empower and motivate shareholders to play their proper role.

When Mr Goodwin pushed through the acquisition of much of ABN AMRO, some 94.5 per cent of RBS shareholders voted in favour of this catastrophic deal.This majority, of North Korean proportions, is good supporting evidence for the argument made by Paul Myners, a financier and the City Minister in the Labour government during the financial crisis, that supine institutional investors who are unwilling to behave like owners, leaving boards and executives unscrutinised, have created “ownerless corporations”.

Mr Myners attributed this phenomenon to a “leaseholder” mentality among pension and mutual funds, meaning that if investors see something they do not like they take the easy route of selling their shares rather than getting stuck in to challenge corporate bosses.While this may explain the behaviour of small pension funds and investment trusts, cutting and running in this way should not be an acceptable option for larger funds that have no choice but to invest broadly across the market. It was those big investors in the decades before the crisis that, perhaps unwittingly, had increasingly fallen under the thrall of Efficient Market Hypothesis. They took the current share price as a decent guide to long-term value and relied upon having a diversified portfolio of investments as the best way to manage risk, in many cases in effect operating as index funds that simply tracked the overall market. Those activist investors who did take on boards were mostly demonised, not least by the company bosses they targeted, as either corporate raiders (especially those nasty hedge funds that the EU is so keen to clamp down on) or politically motivated, like trade unions or local authorities, and therefore not always looking to maximise the company’s value.

Hopefully, this myopic approach will end naturally with the break down in the Efficient Market Hypothesis. Even before the crisis, some pension funds adopted a more long-term, engaged approach to investing, such as Hermes, which manages the BT pension scheme. Colin Melvin, the CEO of Hermes Equity Ownership Services, a good-governance offspring of Hermes, has been an outspoken critic of
the failure of previous corporate governance reviews to grasp the nettle.

“Fund managers must be told it is OK to consider value in a long-term perspective,” he told the Financial Mail in 2009.That is not in the Walker report and we think it needs to be there.” In the summer of 2010 this message was echoed by the Financial Reporting Council in its revised UK Stewardship Code, which called for greater responsibility and transparency from pension funds.

This was a welcome sign of a voluntary change in attitudes. However, it needs to be reinforced with the full force of the law. The current definition of a “prudent man” that guides the investment strategies of pension funds requires little more than diversification. This has been compounded by recent regulations, such as those on pension funds post-Maxwell, in which an emphasis on ensuring that the fund has the money to meet its obligations has unintentionally created powerful incentives to focus on strategies that maximise the current, short-term, value of pension fund assets. Longer-term thinking is not rewarded. The rules on fiduciary responsibility need to be refefined with an explicit requirement to take a long-term perspective.

Ultimately, the behaviour of institutional investors is unlikely to change much unless the public whose money they invest demands it. Here is an opportunity for the Coalition to drive change by reinventing one of Mrs Thatcher’s greatest successes for the twenty-first century. The terms “popular capitalism” and “share owning democracy”, although absorbed by New Labour, still have a Thatcherite resonance. But “Tell Sid”, the memorable slogan created for the privatisation of BT in 1984, was merely an advert, in effect, for £10 notes being sold for a fiver, like most of the privatisations of those early days when no one was sure whether the public would be interested. Sid was told to buy shares to get a bargain. Now it is time to tell Sid how to be an effective long-term owner.

Can ordinary citizens really change big business? They have already: look at the emergence of ethical consumerism over the past couple of decades, a movement in which Britain is already a global leader. What may have started as cranky campaigns by a few activists championing fair trade or environmental sustainability have gone mass-market and are changing corporate behaviour as firms try to keep up with their customers’ demands. This has not been achieved overnight. Educational campaigns have enabled citizen consumers to make quite sophisticated decisions about what they buy, and campaigners have developed accessible ways to think about the social or environmental choices we are making at the checkout, helped by fuller disclosure and labelling.

We British may be increasingly competent shoppers but we are not yet engaged owners. Requiring institutional investors to publish how they vote on shareholder motions would help give activists something to organise around – as would making encouraging pension funds to consult with their members on how to vote.

One of the reasons why high street banking became so concentrated was the demutualisation of many building societies (including, tragically, Northern Rock). The Coalition should explore how it could encourage mutual forms of ownership (albeit in ways that learn from the failings that led to demutualisation in the first place, such as de facto unaccountable management). It should also look for ways to encourage co-operatives and meaningful employee share ownership (though not to such an extent that workers are overexposed to their employer’s fortunes). There is a great opportunity for Britain to be a leader in giving workers a real stake and voice in the firms that employ them.

The crisis has shown that the British (like their counterparts in America and many other countries) are far from being what we call in Chapter 9 an “economically competent citizenry”. The Coalition should make it a high priority to improve on the generally low levels of financial literacy in Britain, to help people make better choices when they open a bank account, get a credit card or take out a mortgage.The goal, at its broadest, should be to get the public to take responsibility for how their money is invested: to become citizen capitalists.

We believe that the impact of the consumer movement can be matched or exceeded in corporate governance through a serious government-backed campaign of promoting popular capitalism. If you
agree, Tell Sid – or better still, Tell Dave. This sort of citizen activism should appeal to the Coalition not least because engagement by ordinary people is the centrepiece of its Big Society agenda.


“When the spaceship arrives from Alpha Centauri and lands in the middle of Barnsley and goes up to number 23 Acacia Avenue, and the spaceling says to the lady that answers the door: ‘take me to your leader’, she would say:‘I’m in charge’.” Certain comments by coalition government ministers, such as this one by Eric Pickles, the Communities Secretary, to describe what the legacy of its flagship policy will be, have not helped get the Big Society taken seriously. Nor was it an idea that particularly excited voters, despite Mr Cameron’s manifesto being published as an “Invitation to join the government of Britain.”

During the election campaign, the idea of shifting responsibility for solving many of society’s problems from the state to its citizens was much attacked by Labour and the Liberal Democrats, who portrayed it as a fig leaf to cover up the harsher implications of the Conservative “austerity plans” to slash public spending. Indeed, its lack of resonance on the doorstep led some in the Conservative party to hope that, once the election had been won, the Big Society would be quietly shelved. To some disappointment and even more surprise, Mr Cameron has pressed ahead with this project, and history may reward him for doing so. The Big Society has the potential to be the most important and radical part of his government’s agenda. Part of its significance is symbolic. That the heir to the still-totemic Conservative leader Mrs Thatcher, who famously said “There is no such thing as society”, not only admits there is such a thing but wants to make it as big as possible is a strong signal that the “nasty party” of the 1980s has been on a genuine intellectual journey. More fundamentally, as Mr Cameron put it himself, “we have run out of money”.

The Labour government did achieve some improvement in public services by pumping in buckets full of cash but, post-crisis, the era of easy money is surely over, like it or not. The pressure for the coming decade will be to pay back the public debt incurred (rightly) to stop a complete meltdown of the economy in 2008 and 2009, and to return government spending as a share of GDP at least to the more sustainable level it was at a decade ago.Add to that the long term financial challenge of a growing ageing population and it is clear that Britain faces not just a period of belt-tightening but needs a fundamental rethink of what its government does.

Critics of this analysis will argue that higher taxes, particularly on the wealthy, who did so well during the Labour years, could fill the hole in the public finances. Yet you do not need to believe that it is morally wrong to soak the rich to recognise that this argument does not wash. Denis Healey, chancellor in the Labour government in the 1970s, did not succeed in his plan, as he allegedly put it, to “squeeze the rich until the pips squeak.” There is even less chance of doing so now. In a global economy, the marginal tax rate a country can charge is effectively capped by the fact that people, businesses and their money will relocate elsewhere if tax rates rise punitively high.

Even without these fiscal constraints, the case for a fundamental reform of government was already strong. It had become clear that while Labour’s spending in its early years in office, making up for previous under-investment in public services, did have a positive impact, in later years it ran into the problem of rapidly diminishing returns. Even flush with cash, government has not proven effective in solving many of today’s most pressing problems. The hope of the Big Society is that approaches that rely more on private actors, or partnerships between the state and private actors, will hold out a better prospect of success.

One basic message of the Big Society – that if you involve the people who are closest to the problem you might get better solutions – has an intuitive appeal, especially for those who favour more local decision making. But what should this mean for Mr Pickles’ householder in Acacia Avenue, as she prepares for her close encounter of the third kind?

If you believe Phillip Blond, whose article “Rise of the red Tories” in Prospect magazine in February 2009 established him as the media- appointed high priest of the Big Society, this is fundamentally an idea about the reassertion of an older tradition of conservatism that rejects both big government and the free market. These twin forces, he says, have disempowered all but the rich and undermined communities. His attack on capitalism is as fierce as his attack on big government. The reality of the market, Mr Blond argues, is that it will always tend towards exploitative cartels and monopolies. He urges Conservatives “to break with big business” and embrace a new economy dominated by co-operatives and mutuals, insulated from global capital.

Mr Blond’s writings are quirky and, in its nostalgia for a Britain of the past that was so much better than today, sometimes downright odd.Yet he does offer some valid ideas.The Coalition could and should do more to promote alternative economic structures to the for-profit business or the non-profit charity. As we have argued, cooperatives and mutuals have plenty to offer – including as a way to engage communities in their own regeneration. Insulating Britain from global competition is another matter. The problem is that, for Mr Blond, capitalism is almost wholly negative and these new economic models are to replace rather than complement and collaborate with mainstream business and finance.

Philosophers, of course, are free to think Mr Blond’s sort of radical thoughts. But is it likely that a Conservative Prime Minister will turn against his traditional business supporters? Maybe not, although Mr Cameron has seemed reluctant to extend his invitation to be part of the government of Britain and participate in the Big Society to business in general and finance in particular. Excluding the commanding heights of capitalism from the Big Society would be a catastrophic mistake.

Despite all the excesses of recent years, and unfashionable as it is to say so, it is a mischaracterisation of capitalism to see business as being primarily about greed. Britain has a long tradition of values-driven business, even if that has been on the back foot in recent years as a result of the City’s demand for ever-rising short-term profits. From the Cadburys and the Rowntrees of the nineteenth century through to

Anita Roddick of the Body Shop and Sir Richard Branson we have had successful business leaders who realise that they can “do well by doing good”. This is one element of the global movement we call philanthrocapitalism – capitalism with a soul. In part, as we explain in Chapter 8, philanthrocapitalism is about effective giving. But it is also about harnessing market mechanisms to build a better society, including through businesses that recognise that they do not operate in a vacuum and should give back to society, not least by building markets that are sustainable over the long term.

It is popular to dismiss talk of values in business.The free-market right dislikes the idea of diluting the moral supremacy of the market with the suggestion that there is any true measure of worth but profit.The liberal left is happier in a world where all corporations are evil and ripe to be campaigned against and regulated, with any do-gooding just a distraction from their inevitable rapaciousness.Philanthrocapitalism may not conform to these stereotypes but, nonetheless, it is taking hold in the executive suites and boardrooms of more and more companies around the world.

Finance, as much as any other sector, is part of this movement. One of the greatest successes of philanthrocapitalism has been turning microfinance – the business of lending to small entrepreneurs in the developing world – from a small-scale tool of charity into a multi- billion dollar global industry that can meet the needs of millions more people. It has done so by leveraging the power of the profit motive in financial markets.The private-equity pioneer (and Labour party donor) Sir Ronald Cohen, has spent the past decade testing new ideas to harness private capital for social good in Britain through his role as chair of the Chancellor Brown-sponsored Social Investment Task Force. The Coalition should overcome its surprising distaste for capitalism and embrace these ideas. We are encouraged by its decision to press ahead with a pilot “social impact bond” that gets private investors to put up the money for charities to reduce the recidivism rate of released prisoners, with government paying the investors on the basis of results. Let’s hope there are many more such bold collaborations between government and capitalism to come.


Two decades after the first President Bush declared the dawning of a New World Order, it finally arrived – thanks to the economic crisis. Before the financial meltdown, the key decisions on global economic policy were taken at the annual G8 meeting of the western industrial nations, plus Japan and Russia, with the United States carrying a de facto veto on decisions of any importance. In 2009 that power shifted to the far broader G20 group, which has given an influential seat at the global decision- making table to emerging powers such as China, India and Brazil.

Britain’s past two prime ministers found ways for the country to “punch above its weight” in global economic affairs in both these international forums. Mr Blair memorably persuaded the G8 to commit billions of dollars to aid and debt forgiveness at Gleneagles in 2005, whilst Mr Brown’s curation of a co-ordinated global economic stimulus in London in 2009 was arguably the most positive moment in his ill-fated premiership.

Whether the Coalition can achieve similar success remains to be seen. But what its agenda should be is clear: to ensure the continued deepening of globalisation, not least by ensuring the ongoing viability of the international trading system; to modernise the institutions and rules governing the global economy so that they reflect the needs of the twenty-first century, not the world as it looked from Bretton Woods in 1944; and to reduce the imbalances in the global economy (not least the pernicious Chinese current account surplus) that helped create the crisis, from which, for all their high standing in the G8 and G20, neither Mr Blair or Mr Brown were ultimately able to insulate the country.

Clearly, none of these goals can be achieved by Britain acting alone. The Coalition will need to be unusually adept in its diplomacy. And, just as the great British economist John Maynard Keynes (whose legacy was unfairly tainted by his “Keynesian” heirs) played a crucial intellectual leadership role at Bretton Woods, Britain today can punch above its weight in the battle of ideas.

It makes strategic sense to brand Britain as a caring capitalist nation, by building on Mr Blair’s and Mr Brown’s legacy of showing that the country takes seriously its responsibilities to the developing world. Mr Cameron seemed to recognise this when he pledged to maintain Britain’s aid budget, but how determined he really is to protect it from the axe of austerity remains to be seen.

Britain must also remain a strong advocate for globalisation and free trade, and, as we explain in Chapter 7, for modernising the Bretton Woods institutions, including the IMF and World Bank. They are no longer merely the instruments of Western powers, instead they should be a legitimising force that gives China, India and other emerging powers a genuine voice in exchange for more responsible behaviour, on everything from exchange-rate policy to buying up commodities from dodgy governments in Africa. (This may require some self- sacrifice: Britain’s permanent seat on the UN Security Council looks to others ever more as an anachronism.)

Get its reforms right, and the Coalition can transform Britain into a role model for those who seek a more attractive, democratic alternative to China’s authoritarian capitalism. Closer to home, Britain will be able to, again, show the way to its partners in the European Union as they reform their economies. The new British brand of capitalism should also continue to stand for the sort of European Union that can accommodate important emerging countries, such as Turkey.

The crisis may have done the Coalition a favour by taking membership of the euro off the table for the foreseeable future. But the Coalition should stand for a fundamental reform to the worldwide monetary system: the creation of a new global reserve currency to replace the dollar. This idea is more timely today than when Keynes proposed it at Bretton Woods, not least because we have seen at first hand the cost in terms of global economic imbalances of the primacy of the dollar. Make no mistake, the problem that America, Britain and other developed nations are dependent on borrowing from emerging economies has not gone away. Before the crash it was private debt that was being financed by the savings of Chinese workers, today it is our governments’ borrowing.

The challenge here – regarding the dollar, and more broadly America’s de facto domination of all Bretton Woods institutions – is to persuade Uncle Sam that it is in its interests to voluntarily give up some power now, in order to create a more sustainable global economy over the longer-term.The entire system of global economic governance created at Bretton Woods was based on America being the world’s creditor. Today, America is the world’s biggest debtor, with much of that money owed to China.

As Fareed Zakaria argues in his book The Post-American World, even if America cannot dictate to today’s new world order, “it has not lost the ability to lead.”This new leadership will have to rely increasingly on soft power, and vision. Getting it to play that new role may not be easy: and there is a real risk that America will follow Britain’s disastrous example of pretending the inevitable decline is not going to happen and clinging to the trappings of domination (in Britain’s case, the gold standard) long after they have turned from an asset to an albatross.

Is it too much to hope that Britain could use its special relationship with America to point it in a better direction, not least by reminding its leaders of our mistakes in managing our transition from hegemon to one among several major powers? Shortly before his first meeting as prime minister with President Obama, Mr Cameron criticised Mr Blair’s relationship with the second President Bush, saying that “Blair was too much the new friend, telling you everything you want to hear, rather than the best friend telling you what you need to hear.” What sort of friend to America will Mr Cameron be?


The Technology Entertainment and Design conference – best known as TED – is perhaps unparalleled as a place where the world’s serious thinkers want to be seen and above all heard. Strike the right chord in one of its (up to) 18 minute talks (speakers are told “imagine you had just 18 minutes left to live, what would you say?”) and thanks to YouTube, email and Twitter you can become an instant global celebrity. It was to TED – albeit via a video link from London – in early 2009 that Mr Cameron gave his most important big ideas speech as leader of the Opposition. The Big Society did not get a mention (well, not explicitly), but behavioural economics and the potential of technology to empower citizens in a “post-bureaucratic age” dominated the speech. The crescendo of the talk, however, was a call to happiness – not just to be it, but to measure it.

The current way we measure how society progresses is badly flawed, he pointed out.To illustrate it, he used a quote from a 1968 speech by Robert Kennedy about the flaws in the commonly used measure of national income.“The gross national product does not allow for the health of our children, the quality of their education, or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages; the intelligence of our public debate or the integrity of our public officials. It measures neither our wit nor our courage; neither our wisdom nor our learning; neither our compassion nor our devotion to our country; it measures everything, in short, except that which makes life worthwhile.” Mr Cameron argued that, though measuring what actually is worthwhile may have been a dream four decades ago, the combination of new information technologies and advances in behavioural economics have put it within our reach.This optimistic claim built on his earlier championing of an alternative measure to GNP called Gross National Happiness, which was developed in the 1970s by the then king of Bhutan.

It is easy to dismiss Mr Cameron’s musings on happiness as the flimflam of a former PR man then enjoying the luxury of being out of office. Mainstream economists have tended to rubbish gross national happiness as something that might make sense for a primitive Asian kingdom, but is impossible to apply to a complex modern society such as Britain.Times change, however. Look at the mess focusing narrowly on measuring only money got us into. Who knows? If Mr Cameron puts this agenda into practice in office, it could turn out to be the Coalition’s greatest legacy.

This book is about the choices we face on the road from ruin to a more sustainable, prosperous future. Mr Cameron is right to raise the issue of how we can better measure our progress.An overhaul of the data we use should be a high priority for the Coalition. During the Great Depression, economists in America and Britain recognised that huge policy mistakes were made because those in charge simply did not know what was going on in the economy. They committed themselves to better measurement, and came up with the first comprehensive national income accounts, which greatly improved economic policymaking.

This crisis has revealed the flaws and limitations of those measures. Rising GNP turned out to be evidence not of a lasting improvement in our national wellbeing but of a short-term bubble, that would cause plenty of misery when it burst. Like our predecessors in the 1930s, we should now respond to this massive failure of metrics with a similar commitment to produce the data we need – and, yes, why shouldn’t that be Gross National Happiness?

Indeed, across the Channel, President Sarkozy has convened a commission jointly with Joseph Stiglitz, a Nobel Prize winning economist, to come up with better measures of social progress than GNP. Mr Cameron should up the ante in this ancient rivalry by committing Britain to introduce these new measures first. Yet whilst beating the French is always worthwhile, the real reason to do this is that we cannot afford not to. Fail and we may find ourselves driving blind on the road from ruin, and miss the better future that, if we make the right hard choices now, is certainly within our reach.

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