The U.K. Governing Coalition: The Challenges Ahead and Why America Has a Stake in Britain’s Success Robin Harris

SPECIAL REPORT NO. 102 | FEBRUARY 22, 2012 from THE CENTER for FREEDOM The U.K. Governing Coalition: The Challenges Ahead and Why America Has a Stake in Britain’s Success Dr. Robin Harris

SR-102 About the Author

r. Robin Harris served during the 1980s as an adviser at the Treasury and Home Office, as Director of Dthe Conservative Party Research Department, and as a member of Prime Minister Margaret Thatcher’s Downing Street Policy Unit. He continued to advise Lady Thatcher after she left office and has edited the definitive volume of her Collected Speeches. Dr. Harris is now an author and journalist. His books include Dubrovnik: A History (Saqi Books, 2003); Beyond Friendship: The Future of Anglo–American Relations (The Heritage Foundation, 2006); Talleyrand: Betrayer and Saviour of France (John Murray, 2007); and The Conservatives: A History (Bantam Press, 2011).

Photos on the Cover— © BL Images Ltd/Alamy

This paper, in its entirety, can be found at: http://report.heritage.org/sr0102 Produced by the Margaret Thatcher Center for Freedom The Heritage Foundation 214 Massachusetts Avenue, NE Washington, DC 20002–4999 (202) 546-4400 | heritage.org Nothing written here is to be construed as necessarily reflecting the views of The Heritage Foundation or as an attempt to aid or hinder the passage of any bill before Congress. Contents

Abstract...... iv

Section I: Introduction...... 1

Section II: The Legacy from Labour and the Compromises Reached Between the Governing Coalition Parties...... 2

Section III: The Story So Far...... 4

Section IV: The Current Crisis...... 10

Section V: The European Dimension...... 13

Section VI: The Future...... 17

Table 1: General Government Total Outlays...... 7

Table 2: General Government Cyclically Adjusted Financial Balance...... 8

Table 3: Cyclically Adjusted Budget Surpluses: Changes in OBR Fiscal Forecast...... 10 THE U.K. GOVERNING COALITION: THE CHALLENGES AHEAD AND WHY AMERICA HAS A STAKE IN BRITAIN’S SUCCESS

Abstract

n May 2010, the U .K . general elec- It is now clear how this biparti- For the United States, with its Ition resulted in a hung Parliament san model of governing has fared . different constitutional system and from which emerged a Conservative– First, little or no progress has been electoral cycle, the applicable lessons Liberal Democrat coalition with made in tackling either the bud- would seem to be twofold . The first Conservative leader get deficit or the British economy’s conclusion is encouraging . In the as Prime Minister . The experiment underlying weaknesses . Second, United Kingdom, an electorate not was widely justified by the evident no credible, coherent, or convinc- dissimilar from that in the U .S . has need to cope with the economic crisis ing path toward national recovery proved to be stoical if not enthusi- and, in particular, the unsustain- has yet been presented . The latter astic when convinced that unpalat- able budget deficit inherited from the is consequential, both in terms of able economic medicine is required . outgoing Labour government . Mr . the Conservative Party’s failure The second conclusion constitutes a Cameron and his Liberal Democrat when in opposition to think seri- possibly timely warning: Failure to Deputy Prime Minister, Nick Clegg, ously about large policy questions devise and present a clear analysis also claimed to be introducing a new and now in terms of the inability of the country’s ills before achieving and better kind of politics, one based of a coalition, hampered by inces- power will leave even a well-inten- on reasoned discussion and a rejec- sant compromise, to react to major tioned and right-thinking govern- tion of “tribal loyalties ”. In practical changes in circumstances—as with ment floundering as new, unforeseen terms, both sides then made a series the unresolved, and arguably unre- challenges threaten to throw it off of policy compromises . solvable, euro-zone crisis . course .

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Section I: Introduction

n May 2010, the U .K . general elec- have gone unfulfilled . Opposition coherent, or convincing path toward Ition resulted in a hung Parliament to public expenditure cuts has been national recovery has yet been pre- from which emerged a Conservative– relatively muted; trade union pro- sented . The latter is consequential, Liberal Democrat coalition with tests and strike action have had little both in terms of the Conservative David Cameron, the Conservative effect; and there is widespread public Party’s failure when in opposition leader, as Prime Minister . Britain acceptance, in the short term at least, to think seriously about large policy has a long history of coalitions that of the sharp pressure on living stan- questions and now in terms of the were not unsuccessful, but since the dards . Moreover, both the still-fresh inability of a coalition, hampered by Second World War, British party recollection of the shortcomings of incessant compromise, to react to politics has been sharply polarized . ’s government and major changes in circumstances—as So the 2010 outcome was a novelty . the perceived failings of the present with the unresolved, and arguably The experiment was, however, Labour opposition have kept up the irresolvable, euro-zone crisis . widely justified by the evident need coalition’s political ratings . For the United States, with its to cope with the economic crisis different constitutional system and and, in particular, the unsustain- THE PROBLEM IS THAT LITTLE OR electoral cycle, the applicable lessons able budget deficit inherited from the NO PROGRESS HAS BEEN MADE would seem to be twofold . The first outgoing Labour government . Mr . conclusion is encouraging . In the Cameron and his Liberal Democrat IN TACKLING EITHER THE BUDGET United Kingdom, an electorate not Deputy Prime Minister, Nick Clegg, DEFICIT OR THE BRITISH ECONOMY’S dissimilar from that in the U .S . has also claimed to be introducing a new UNDERLYING WEAKNESSES AND proved to be stoical if not enthusi- and better kind of politics, one based THAT NO CREDIBLE, COHERENT, astic when convinced that unpalat- on reasoned discussion and a rejec- able economic medicine is required . OR CONVINCING PATH TOWARD tion of “tribal loyalties ”. In practical The second conclusion constitutes a terms, both sides then made a series NATIONAL RECOVERY HAS YET BEEN possibly timely warning . This is that of policy compromises . PRESENTED. failure to devise and present a clear It is now clear how this bipartisan analysis of the country’s ills before model of governing has fared . The problem is, first, that little or achieving power will leave even a The overall judgement must so no progress has been made in tack- well-intentioned and right-thinking far be a qualified negative, though ling either the budget deficit or the government floundering as new, the final outcome remains unclear . British economy’s underlying weak- unforeseen challenges threaten to Certainly, the worst predictions nesses and, second, that no credible, throw it off course .

1 THE U.K. GOVERNING COALITION: THE CHALLENGES AHEAD AND WHY AMERICA HAS A STAKE IN BRITAIN’S SUCCESS

Section II: The Legacy from Labour and the Compromises Reached Between the Governing Coalition Parties he Labour government had over- tax increases . This approach showed in a telling sentence: “While parents Tspent under both Tony Blair and courage, but one should not exagger- worried about childcare, getting kids Gordon Brown 1. An inherited budget ate the severity of what was planned to school, balancing work and fam- surplus had become a regular bud- (let alone achieved) . Total public ily life—we were banging on about get deficit, predictions of economic spending in 2014–2015 would still Europe .”2 (Of course, the Prime growth were overly optimistic, and have been higher in real terms than it Minister is now himself “banging on plans for public spending were unaf- was in 2008–2009 . In any case, this about Europe ”). David Cameron also fordable . When the financial crisis announcement, with the underlying seriously damaged his credibility in and recession of 2007–2009 hit, Mr . intent it signified, reassured finan- the eyes of his Euro-skeptical party Brown, true to his prejudices and cial markets . The confidence thus by failing to honor what was seen as convictions, then spent much more . engendered has since kept down the a firm undertaking, made in oppo- This dramatically worsened the state cost of servicing existing debt and sition, to hold a referendum on the of public finances without avoiding new borrowing . European Union’s Lisbon Treaty . recession . But the Conservatives, in On the eve of the 2010 general exchange for agreement from their PRIME MINISTER CAMERON’S election, Labour finally promised to coalition partners, also made a INABILITY (IN COALITION WITH rein back the deficit, but without pro- series of concessions . Here many viding details . The Conservatives in of the current difficulties find their THE LIBERAL DEMOCRATS) TO the election campaign were equally— origin . Tax cuts were avoided or PRESS AHEAD WITH CURBING THE and deliberately—reticent, though slanted toward groups favored by IMPACT OF EUROPEAN HUMAN they promised quicker action to curb the Liberal Democrats . Upgrading RIGHTS LAW HAS LED TO A RASH OF borrowing . This urgency was amply of the Trident independent nuclear EMBARRASSING FAILURES TO DEPORT justified . The U .K . budget deficit in deterrent was postponed . Measures Labour’s last year rose to 11 percent to check the inroads of the European SERIOUS CRIMINALS, INCLUDING of gross domestic product (GDP), the Court of Human Rights were all but THOSE LINKED TO TERRORISM. highest in the country’s peacetime abandoned . history and the largest structural Of greatest current political The Prime Minister’s compromis- deficit in Europe . significance, promises to curb the es on other fronts have come back to An emergency budget intro- powers of the European Union (EU) haunt him .3 His inability (in coali- duced on June 22, 2010, by the new were diluted . This, it should be tion with the Liberal Democrats) to Chancellor of the Exchequer, George noted, was very much in line with press ahead with curbing the impact Osborne, promised to eliminate the David Cameron’s own tactical pref- of European human rights law has U .K ’s. structural deficit in 2014–2015 . erence . In his 2006 Conservative led to a rash of embarrassing fail- Debt was by then supposed to be fall- Party Conference speech, his first ures to deport serious criminals, ing as a share of GDP, with 80 percent as party leader, he had encapsulated including those linked to terrorism . of the deficit reduction to be secured his explanation of the party’s failure Similarly, limiting the government’s by spending cuts and 20 percent by to win the previous year’s election efforts to curb immigration—again

1. For more detail on the legacy from Gordon Brown’s government and the early decisions of the new coalition government, see Robin Harris, “Britain’s Coalition Government: A Preliminary Verdict,” Heritage Foundation Special Report No. 87, January 10, 2011, at http://www.heritage.org/research/reports/2011/01/britains- coalition-government-a-preliminary-verdict. 2. David Cameron, speech to the Conservative Party Conference, Bournemouth, October 1, 2006, at http://www.conservatives.com/News/Speeches/2006/10/ Cameron_We_stand_for_social_responsibility.aspx. 3. Comment, “Cameron’s Pledge on Europe…and Other Broken Pledges,” The Sunday Telegraph, October 23, 2011. 4. Tom Whitehead, “Net Migration Target to Be Missed, Warn Academics,” , June 21, 2011.

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in deference to Liberal Democrat fees—which they had promised to control (but are unrepresentative of) sensibilities—has seen the govern- oppose outright—and their introduc- the Conservative Party . As a result, ment fail spectacularly to reduce net tion at a high level . They thereby did priority within public spending was immigration to “tens of thousands ”. themselves great and possibly irre- given to the National Health Service In fact, net migration is at a six-year versible electoral harm . (NHS) and overseas aid over defense high 4. This is particularly unset- This has had a paradoxical effect and the police . Priority was also tling, since recent figures show that on the politics of the coalition . The given to reducing CO2 emissions and migrants currently take nine out of collapse in Liberal Democrat sup- tackling climate change over indus- 10 new jobs .5 port made its leaders fearful of an trial competitiveness . The Liberal Democrats, natu- early election yet even more dis- Unfolding events have since dem- rally, made their own compromises . posed to criticize particulars so onstrated that these priorities were They achieved key Cabinet posts . In as to achieve a higher public pro- the wrong ones . exchange, however, they accepted file . Generally, however, Liberal not just the program of spending Democrat priorities have largely curbs and deficit reduction, but both coincided with those of Mr . Cameron the introduction of university tuition and the group of “modernizers” who

5. Robert Winnett, “Frank Field: Migrants Take 9 out of 10 Jobs,” The Daily Telegraph, June 19, 2011. 6. For more detail, see Robin Harris, “Problems in British Foreign Policy,” Heritage Foundation Special Report No. 95, June 6, 2011, at http://www.heritage.org/research/reports/2011/06/problems-in-british-foreign-policy.

3 THE U.K. GOVERNING COALITION: THE CHALLENGES AHEAD AND WHY AMERICA HAS A STAKE IN BRITAIN’S SUCCESS

Section III: The Story So Far

oreign and defense policy under Statement . Nor is the wider strate- which Argentine sabre-rattling sug- Fthe coalition have been bedev- gic environment neutral . gests is not beyond the range of pos- illed by strategic incoherence . In The problems of the euro-zone sibilities 9. It was recently revealed response to the “Arab Spring,” countries mean that the contri- that last summer, because of the Britain took the lead with France butions of continental European demands of the Libyan war and in an ambitious military initiative, countries to NATO may shrink still defense cuts, no warship was avail- under disputable U .N . cover, to bring further, imposing more strain on able to guard Britain’s home waters down the Lybian régime of Colonel Britain—and, of course, on America, for the first time in 30 years 10. An Muammar Gaddafi . This was a suc- where President Barack Obama has unforeseen military crisis in some cess, but the eventual outcome in also announced a scaling down of distant theater can never be ruled Libya (as elsewhere in the Middle commitment to Europe and a shift out . For example, it has recently been East, where differing degrees and of strategic attention to the Asia– announced that in response to Iran’s brands of Islamism have benefited Pacific region 7. The subordination threat to close the Strait of Hormuz, from the disorder) is far from clear . of Britain’s defense effort to govern- the Navy is deploying Britain’s most Certainly, the operation was begun ment budget cutting has been accept- advanced warship, the Type 45 with a very imperfect assessment of ed by British military chiefs, but the Destroyer HMS Daring, to the Gulf 11. the risks and commitment required . strains they face are now acute .8 At the same time that it has been In a number of respects, it served as a downgrading its defense effort, 6 bad precedent . THE CONTRIBUTIONS OF Britain has heavily increased its This forward foreign policy was CONTINENTAL EUROPEAN overseas aid budget—by 37 percent . and is being played out against Aid was not only protected against very sharp cuts in defense spend- COUNTRIES TO NATO MAY SHRINK economies imposed elsewhere, ing and capability—cuts that went STILL FURTHER, IMPOSING MORE but singled out as epitomizing the against what the Conservatives STRAIN ON BRITAIN—AND ON coalition’s (and the Conservative had pledged in opposition . Britain’s AMERICA, WHERE PRESIDENT Party’s) values and priorities . The defense spending fell to 2 percent Prime Minister defends it robustly BARACK OBAMA HAS ALSO of GDP . Substantial manpower and has sharply criticized party cuts in all three services were ANNOUNCED A SCALING DOWN OF doubters who object that it makes made . The Navy was particularly COMMITMENT TO EUROPE AND A no sense to send aid to an upward- badly hit . Britain’s existing car- SHIFT OF STRATEGIC ATTENTION TO ly mobile superpower like India, rier, Ark Royal, is being scrapped; which is currently developing its THE ASIA–PACIFIC REGION. the Harrier aircraft have gone; and own overseas aid program . There the country will have no carrier- are even plans to legislate so that borne strike force until 2020 . Questions have even been raised the internationally agreed target These cuts are set to continue, as about how the Falkland Islands of 0 7. percent of GDP will continue was confirmed in the Chancellor would be defended in the event of to be met whatever the prevailing of the Exchequer’s 2011 Autumn a renewed conflict with Argentina, financial circumstances might be 12.

7. For the implications (and shortcomings) of this approach, see Bruce Klingner, “The Missing Asia Pivot in Obama’s Defense Strategy,” Heritage Foundation WebMemo No. 3443, January 6, 2012, at http://www.heritage.org/research/reports/2012/01/the-missing-asia-pivot-in-obamas-defense-strategy. 8. See, for example, the recent analysis by the director of the Royal United Services Institute, Professor Michael Clarke, in “New Enemies on the Horizon,” The Daily Telegraph, December 16, 2011. 9. Leading Article, “Falklands Warning: The Government Would Be Well Advised to Pay Heed to the Distant Sound of Sabre-rattling in the South Atlantic,” The Daily Telegraph, December 8, 2011. 10. James Kirkup, “No Warship to Guard Britain,” The Daily Telegraph, November 2, 2011. 11. Thomas Harding, “Royal Navy Sends Its Mightiest Ship to Take on Iranian Show of Force in the Gulf,” The Daily Telegraph, January 6, 2012. 12. Tim Shipman, “Now a Law for Foreign Aid,” The Daily Mail, December 3, 2011.

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In home policy, a similar incoher- for 30 years . More than 3,000 people In two areas of domestic policy ence has been evident, though there were arrested . The police initially where ministers have set out a guiding have been some successes . Far from failed to gain a grip on the disorder, philosophy rather than embarked on shrinking the functions of the state which then rapidly spread in classic a series of ad hoc measures, recogniz- and concentrating resources on copycat fashion . Although various ably Conservative priorities are being basic tasks that cannot be performed theories circulated as to the root reflected in policy . Work and Pensions well or easily by the private sector, cause of what occurred, the most Secretary Iain Duncan Smith has the government has continued to significant indicator is probably that been seeking to ensure that it is always increase spending on, for example, three-quarters of those charged worthwhile to work rather than to live the National Health Service . There already had criminal records . Those on welfare . Long-term welfare depen- is, of course, no reason to consider with criminal records had, on dence has rightly been identified as a most health provision a pure public average, committed 15 previous social scourge, not merely a burden on good that requires delivery by what offenses 14. public spending and diversion from amounts to near monopoly provision wealth creation . The Department for organized by government . THE SHOCKING URBAN RIOTS OF Work and Pensions has recently cast Early plans for radical reform of AUGUST 2011, WHICH INVOLVED light on the well-known but rarely the NHS had to be watered down mentioned connection between wel- in the light of pressure from vested SEVERAL DEATHS, INJURIES TO fare and criminality, releasing fig- interests and patients’ groups, but POLICE AND MEMBERS OF THE PUBLIC, ures which show that a third of those the current reforms still depend AND LOOTING AND ARSON ON A claiming unemployment benefit have 15 on giving general practitioners (i .e ., SCALE NOT SEEN FOR 30 YEARS, WERE criminal records . family doctors, the gateway to the The method adopted by Mr . THE UNPLEASANT TIP OF A MUCH system) much greater powers to pur- Duncan Smith to achieve radical chase care for patients from a variety LARGER ICEBERG OF CRIMINALITY reform of the system involves replac- of providers . Unfortunately, as has THAT THE AUTHORITIES HAVE BEEN ing dozens of existing benefits with occurred with other public-sector UNABLE TO TACKLE. a single Universal Credit . There are, reforms in the past, a high price has however, two significant problems been demanded by those who are with this radicalism . expected to exercise more respon- In other words, the riots were the sibility . In this case, it is envisaged unpleasant tip of a much larger and ■■ The first problem is inherent in that the pay for general practitioners, more menacing iceberg of criminal- what is proposed . Unless signifi- which rose sharply under the previ- ity that the authorities have been cant numbers of poorer people ous government, is to increase fur- unable to tackle . A long list of social are to receive less in benefits than ther—by a more than 25 percent .13 policy measures was announced they do at present, then making By contrast, expenditure on law in reaction to these events, but the it always worthwhile to work will and order has been cut, leading to obvious response—lengthening involve at least short-term increas- a reduction in police numbers . The sentences, increasing police num- es in public spending (or in tax dangers involved were demonstrated bers and enlarging prison capacity— revenues foregone) . So there will by the shocking urban riots of August would require reordering spending be an adverse effect on the already 2011, which involved several deaths, priorities in a way that is impossible swollen budget deficit . Naturally, injuries to police and members of the while the Liberal Democrats, always the Treasury will resist or frustrate public, and widespread looting and enthusiasts for liberal penology, such measures—as has been the arson on a scale not seen in Britain remain in the coalition . case in several instances .16

13. Rebecca Smith, “GPs’ Salaries to Rise by a Quarter,” The Daily Telegraph, December 31, 2011. 14. Alan Travis and James Ball, “Three-quarters Charged over Riots Had Previous Criminal Records,” , September 15, 2011. 15. Tim Shipman, “One in Three on Jobless Benefits Has Got a Criminal Record,”The Daily Mail, December 28, 2011. 16. For example, among the public expenditure measures announced in the recent Autumn Statement was a freeze on tax credits for those in work, while unemployment benefits—at the Liberal Democrats’ insistence—rose in line with inflation. This clearly makes it less, not more, worthwhile to have a job.

5 THE U.K. GOVERNING COALITION: THE CHALLENGES AHEAD AND WHY AMERICA HAS A STAKE IN BRITAIN’S SUCCESS

■■ The second problem is techni- Schools”), more than 1,500 existing of still-untackled structural prob- cal but no less serious . In order schools have adopted independent lems . Britain remains hampered by to give effect to the highly com- academy status under Mr . Gove’s high public spending . For three years, plex changes involving amalga- initiative . The difficulty has been in government has been spending 50 mation of taxes and benefits, a trying to persuade new providers percent or more of national income . new IT system is required . Past to start schools . In fact, fewer than (See Table 1 ). experience of such projects in the 50 have done so . Yet this is crucial if Overspending is the root cause public sector has been far from the existing vested interests and the of the swollen government bud- encouraging . Already, Members of egalitarian ethos they encourage are get deficit . The latest Organisation Parliament and others have voiced to be challenged through competi- for Economic Co-operation and their worries about the timetable tion . Supply has to exceed demand if Development figures show that on and practicability of what is now parental choice is to be real . this score, Britain is relatively badly proposed 17. A new “free schools” model, based placed . (See Table 2 ). improbably enough on Swedish A further result of an excessive By contrast, headway has already experience, is also receiving the share of national income taken by been made by Michael Gove, the Education Secretary’s quiet encour- government is usually low growth, Conservative Education Secretary . agement . These schools, in addition because productivity is character- Mr . Gove is engaged in a number of to being independent, could be run istically lower in the public sec- semi-public quarrels with his own on behalf of parents by profession- tor than in the private sector . Yet officials and teachers’ interests on a als, commercially and at a profit . The another, of course, is that high wide range of education issues, the first—itself only a halfway house to public expenditure over time leads outcome of which is still unclear . the fully functioning free school— to high taxes, which again discour- has long awaited Departmental age wealth creation—as has hap- ONE AREA WHERE PROGRESS approval . Liberal Democrat obstruc- pened in economically stagnating HAS BEEN SWIFTER THAN MANY tion within the coalition, joined to Britain . For example, the latest bureaucratic inertia, is a problem . World Economic Forum’s Global ENVISAGED IS IN PROMOTING A The fact remains that introducing Competitiveness Report finds that MODEL OF SCHOOLS THAT ARE some degree of profit motive is obvi- tax rates are viewed as the most GOVERNMENT-FUNDED BUT ously the best way both to set new problematic factor for doing busi- 20 FREE OF MOST GOVERNMENT— schools on a sound financial basis ness in the U K. . Similarly, the and then to help those that prove suc- most recent Heritage Foundation/ ESPECIALLY LOCAL GOVERNMENT— cessful to expand 18. Wall Street Journal Index of INTERFERENCE. The country’s and the coalition Economic Freedom marks down the government’s most serious worries, U K. . on both government spending So far, building on the previ- however, concern economic policy 19. and monetary freedom 21. ous Labour government’s model of This is not, it should be noted, simply One area where progress has independent “Academies” (which a question of the failure to achieve been swifter than many envis- itself resurrected the previously the planned budget deficit cut (itself aged is in promoting a model abandoned Thatcher government’s dependent on growth and bedevilled of schools that are govern- concept of “Grant-Maintained by the lack of it) . It is also the result ment-funded but free of most

17. Christopher Hope, “Benefits Reform Risks Being ‘Another Whitehall Slip-up’,”The Daily Telegraph, September 13, 2011. 18. Fraser Nelson, “Profit Needn’t Be a Dirty Word When It Comes to Education,”The Daily Telegraph, December 16, 2011. 19. I am grateful to Ryan Bourne, economist at the Centre for Policy Studies, , for advice on the next section of this paper. 20. World Economic Forum, The Global Competitiveness Report 2011–2012, Chapter 2.1, “Country/Economy Profiles: United Kingdom,” pp. 360–361, at http://www.weforum.org/reports/global-competitiveness-report-2011-2012. 21. See Terry Miller, Kim R. Holmes, and Edwin J. Feulner, 2012 Index of Economic Freedom (Washington: The Heritage Foundation and Dow Jones & Company, Inc., 2012), at http://www.heritage.org/index/Country/UnitedKingdom. The 2011 edition of the Index rated the U.K. as having declined in business freedom, fiscal freedom, and government spending. See Terry Miller and Kim R. Holmes, 2011 Index of Economic Freedom (Washington: The Heritage Foundation and Dow Jones & Company, Inc., 2011), pp. 419–420.

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TABLE 1 General Government Total Outlays

PERCENT OF NOMINAL GDP 2007 2008 2009 2010 2011 2012 2013

Australia 32.6 33.5 36.3 36.4 35.0 33.8 33.2 Austria 48.6 49.4 52.9 52.6 51.7 52.0 51.8 Belgium 48.3 50.0 53.8 52.9 52.2 52.3 51.8 Canada 39.4 40.0 44.4 44.1 43.2 42.3 41.2 Czech Republic 41.0 41.1 44.9 44.1 43.5 43.3 42.8 Denmark 50.8 51.9 58.4 58.5 59.3 61.0 59.6 Estonia 34.0 39.5 45.2 40.6 38.1 39.2 36.9 Finland 47.5 49.4 55.9 55.3 53.2 52.7 52.7 France 52.6 53.3 56.7 56.7 56.2 55.9 55.0 Germany 43.5 44.1 48.1 48.0 45.5 45.3 44.7 Greece 47.6 50.6 53.8 50.2 49.9 49.2 48.7 Hungary 50.6 49.2 51.4 49.5 48.8 49.3 49.3 Iceland 42.3 57.6 51.0 51.5 46.0 45.1 43.6 Ireland 36.6 42.8 48.9 66.8 45.9 44.1 43.1 Israel 46.4 46.1 45.7 45.4 44.9 44.7 44.4 Italy 47.6 48.6 51.6 50.3 50.1 49.8 49.4 Japan 35.9 37.2 42.0 40.4 42.5 42.1 41.7 Luxembourg 36.3 37.1 43.0 42.5 42.5 43.0 42.4 Netherlands 45.2 46.2 51.5 51.2 50.5 50.4 50.0 New Zealand 39.6 41.8 42.8 43.1 49.3 43.5 43.0 Norway 41.1 40.7 47.3 46.1 43.8 44.5 45.2 Poland 42.2 43.2 44.6 45.4 44.7 44.3 43.5 Portugal 44.4 44.8 49.9 51.3 49.4 46.9 45.8 Slovak Republic 34.2 34.9 41.5 40.0 39.4 37.9 36.8 Slovenia 42.5 44.2 49.3 50.1 50.1 49.9 48.9 South Korea 28.7 30.4 33.1 30.9 30.9 30.7 30.2 Spain 39.2 41.5 46.3 45.6 42.7 41.0 39.7 51.0 51.7 55.0 52.9 51.8 52.7 52.1 Switzerland 32.3 32.4 34.1 34.2 34.0 34.2 33.9 Turkey 34.5 34.2 39.4 37.1 36.3 36.3 36.0 United Kingdom 43.9 47.9 51.1 50.6 49.8 48.9 47.5 United States* 36.9 39.1 42.7 42.5 41.9 41.1 40.7

Euro area 46.0 47.2 51.2 51.0 49.3 48.8 48.1 Total OECD 39.8 41.5 45.2 44.6 44.0 43.3 42.7

Note: Data refer to the general government sector, which is a consolidation of accounts for the central, state and local governments plus social security. * Data include net outlays of operating surpluses of public enterprises.

Sources: OECD, Economic Outlook Annex Tables, Annex Table 25, at http://www.oecd.org/document/61/0,3746,en_2649_34573_2483901_1_1_1_1,00.html (January 23, 2012).

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7 THE U.K. GOVERNING COALITION: THE CHALLENGES AHEAD AND WHY AMERICA HAS A STAKE IN BRITAIN’S SUCCESS

TABLE 2 General Government Cyclically Adjusted Financial Balance SURPLUS OR DEFICIT AS PERCENTAGE OF POTENTIAL GDP

2007 2008 2009 2010 2011 2012 2013

Australia 1.6 0.1 –3.7 –4.3 –2.5 –1.0 0.0 Austria –1.8 –1.9 –3.0 –2.9 –2.4 –2.1 –1.9 Belgium –1.0 –1.6 –4.1 –2.9 –3.1 –2.3 –1.5 Canada 0.8 –0.6 –3.4 –4.3 –4.1 –3.2 –2.3 Czech Republic –2.1 –3.8 –4.8 –4.0 –2.8 –2.1 –2.0 Denmark 2.9 1.9 –1.0 –0.1 –1.3 –2.7 –1.0 Estonia –1.5 –5.4 1.5 3.4 1.3 –0.7 0.9 Finland 3.9 3.2 0.4 –0.3 –0.3 0.3 0.6 France –3.4 –3.6 –6.0 –5.1 –3.9 –2.3 –0.6 Germany –0.5 –0.8 –1.6 –3.3 –1.1 –0.8 –0.4 Greece –8.1 –10.0 –13.5 –6.5 –1.8 2.0 3.8 Hungary –6.8 –5.0 –2.9 –2.5 5.0 –1.5 –1.5 Iceland 3.3 –15.5 –8.9 –6.9 –2.7 –1.0 0.7 Ireland –2.4 –7.8 –10.6 –25.5 –6.6 –5.3 –4.7 Israel –2.6 –4.9 –5.8 –4.7 –4.0 –3.3 –3.0 Italy –3.3 –3.8 –3.9 –3.1 –2.5 –0.3 1.4 Japan –3.3 –2.6 –7.0 –6.5 –7.3 –7.6 –8.5 Luxembourg 1.5 1.1 –0.1 0.5 0.2 –0.2 0.1 Netherlands –0.8 –1.0 –5.7 –4.2 –3.8 –2.8 –2.5 New Zealand 4.2 1.0 –0.9 –2.6 –6.9 –3.5 –3.1 Norway 3.3 2.2 –0.3 –0.6 –1.0 –1.6 –2.0 Poland –2.1 –4.2 –7.2 –8.0 –5.9 –3.2 –2.1 Portugal –3.8 –4.0 –9.1 –9.1 –4.6 –1.7 –0.3 Slovenia –2.8 –5.2 –5.4 –4.7 –3.6 –2.1 –0.9 South Korea 4.2 2.7 –0.5 0.2 1.0 1.5 1.9 Spain 0.2 –5.5 –9.8 –7.0 –3.6 –1.4 0.0 Sweden 1.6 1.9 2.3 1.8 1.1 1.4 2.0 Switzerland 1.1 1.8 1.6 1.1 1.1 1.1 1.1 United Kingdom –4.1 –5.6 –9.2 –8.4 –7.5 –6.5 –5.2 United States –3.9 –6.8 –9.8 –9.0 –8.3 –7.7 –6.8

Euro area –1.8 –2.9 –4.9 –4.6 –2.7 –1.3 –0.3 Total OECD –2.6 –4.3 –7.1 –6.6 –5.7 –4.9 –4.2

Source: OECD, Economic Outlook No. 90, November 2011, “General government cyclically-adjusted fi nancial balance,” p. 230 (January 23, 2012).

SR102 heritage.org

government—especially local Business Research estimates that it is (even now) yields little or no revenue government—interference . set to cost the government £1 billion a to the Exchequer, it is still likely to The 50 percent top income tax rate, year in lost revenues by the middle of be retained . Even if it is ended, some introduced in 2010 by the Labour gov- the next decade .22 equally socialistic and damaging ernment but retained by the coalition, No major progress on tax or measure—a “mansions tax” has been remains a significant disincentive to deregulation seems possible, how- mooted by the Liberal Democrats—is those who might be minded to locate ever, while the Liberal Democrats likely to be introduced in its place . to or stay in Britain . It is, with Japan’s remain in the coalition . If, as expect- Britain also suffers from a sur- top rate, the highest of all the G8 coun- ed, a Treasury report on the 50 pence feit of regulation . Labor-market tries . The Centre for Economics and rate this coming spring shows that it regulation currently inhibits job

22. Robert Winnett, “50p Tax Band Will Cost Britain £1 Billion a Year,” The Daily Telegraph, November 24, 2011.

8 SPECIAL REPORT | NO. 102 FEBRUARY 22, 2012

creation—something that is particu- to negotiate the return of social and larly serious at a time of high and ris- employment legislation powers to ing unemployment . (A review of the Britain—is also reducing flexibil- current law relating to employee dis- ity and pushing up costs . The Open missal has been announced, but the Europe think tank, for example, has Liberal Democrats are opposed to estimated the cost of EU social law to any far-reaching measures) . Energy U .K . business and the public sector policy, where the Cabinet minister at £8 6. billion a year . The point is not, in charge is also a Liberal Democrat, of course, that all these regulations is forcing up costs to industrial and could or should be repealed, but that private consumers .23 This is another the U .K . is currently effectively pre- inhibitor of growth . vented from deciding what deregula- Finally, the flow of European reg- tion in these areas makes sense in ulation, which the government has order to make business more com- been unable to check—despite the petitive and government smaller .24 Conservative Party’s earlier pledge

23. Apart from the impact of the EU’s Emissions Trading system, which will be more damaging beginning in 2013, the coalition government acted unilaterally to introduce a “floor price” for carbon. Policy generally is sharply tilted in various ways toward “renewables,” which are inherently unreliable and will lock the U.K. into high costs for years to come. 24. Stephen Booth, Mats Persson, and Vincenzo Scarpetta, “Repatriating EU Social Policy: The Best Choice for Jobs and Growth?” , 2011, at http://www.openeurope.org.uk/research/2011EUsocialpolicy.pdf.

9 THE U.K. GOVERNING COALITION: THE CHALLENGES AHEAD AND WHY AMERICA HAS A STAKE IN BRITAIN’S SUCCESS

Section IV: The Current Crisis

he Chancellor’s Autumn TStatement, delivered on TABLE 3 November 29, 2011, confirmed that Cyclically Adjusted Budget Surpluses: no progress has been made in either Changes in OBR Fiscal Forecast curbing the deficit or generating PERCENT OF GDP, BY FISCAL YEAR growth . To the contrary, the Office of Budget Responsibility (OBR), set 2011–2012 2012–2013 2013–2014 2014–2015 up the previous year by the govern- March 2011 forecast –3.2 –2.0 –0.6 0.4 ment to provide an authoritative and November 2011 forecast –4.6 –3.9 –2.7 –1.6 independent analysis of the public finances, radically revised its earlier Sources: H. M. Treasury Autumn Statement 2011, Cm. 8231, November 2011, estimates . (See Table 3 ). Table C.7: Changes to OBR Fiscal Forecast. SR102 heritage.org ■■ The OBR cut its growth predic- tions from 1 7. percent to 0 9. per- cent in 2011, from 2 .5 percent to commodity increases, instability and is greater than the probability of 0 7. percent in 2012, and from 2 9. uncertainty in the euro zone feeding an outcome much better than our percent to 2 1. percent in 2013 . through into domestic and interna- central forecast .25 tional lending and consumer spend- ■■ It forecast that unemployment ing decisions, and a sharper than In any case, the question con- would rise from 8 .3 percent expected decline in the trend rate of fronting the government was: What to 8 7. percent in 2012 but then growth resulting from the damage could be done to bring the deficit and start to drop back . done by the 2008–2009 financial cri- debt reduction plan back on track? sis . It should be noted, however, that The answer it devised was fourfold . ■■ It showed that public-sector net these forecasts are also based upon First, the Chancellor rolled the debt would peak at 78 percent of what seems to many people an inor- deficit elimination target forward GDP in 2014–2015, which is 7 .5 dinately optimistic reading of future two years from 2014–2015 to 2016– percentage points higher than events . The OBR itself thus qualifies 2017 . Had he simply done that, the forecast in the March 2011 budget . its projections with an obscure but government’s strategy would have unsettling observation: been rendered incredible, with dan- ■■ Most notably, given the high gerous implications for market con- political importance the govern- The central economic and fis- fidence . So, second, he also pencilled ment has attached to it, the OBR cal forecasts and judgements into his plans £15 billion of spending forecast shows that the targeted assume that the euro area finds cuts in 2016–2017, after the expected reduction and elimination (by a way through its current crisis, date of the next election . 2014–2015) of the cyclically but a more disorderly outcome The reaction of markets to these adjusted budget deficit was way off is clearly a significant downside announcements was relaxed . Britain track . risk . This risk cannot be quan- continues to borrow to finance its tified in a meaningful way, as debt much more cheaply than most The OBR and the government there are numerous different of the euro zone does . But, apart blamed this failure and the lack of ways in which such an outcome from the implications of what hap- growth that explains it on three fac- could unfold . Suffice to say, the pens to the euro, there is another tors: higher than expected inflation probability of an outcome much reason to worry . The politics of going driven by a sharp increase in global worse than our central forecast into an election with the prospect

25. Office for Budget Responsibility, “Economic and Fiscal Outlook, 1.10,” Cm. 8218, November 2011 (emphasis added).

10 SPECIAL REPORT | NO. 102 FEBRUARY 22, 2012

of large spending cuts, and no tax privatized some of the financing . This may help provide employ- cuts, after it, are so unattractive as to The government also wants to ment to a population that is particu- make it likely that the politicians’— ease credit for business and would-be larly at risk, but as government must especially Liberal Democrat politi- home buyers, but measures to make borrow the funds to provide these cians’—resolve may crumble . it easier for small and medium-sized jobs, thereby destroying other jobs Third, the government has firms to borrow, through a National in the private sector, this should not announced specific measures Loan Guarantee Scheme, and to be confused as a net job creator . It is intended to stimulate growth and make it easier for people to obtain not . The Chancellor also announced jobs, but these are neither very far- mortgages for newly built homes run a number of fiscal bribes to various reaching nor necessarily very well the risk of once more encouraging vocal groups—cutting one region’s focused . There is a concentration on companies and individuals to incur water bills, restricting rail fare developing Britain’s infrastructure . debts they cannot repay . In any case, increases, and enlarging the scope The Prime Minister is on the record to demand easier credit from banks of subsidized child care . These will as believing that, “in terms of future that are also under pressure from have no effect on growth, but rather productivity [Britain’s] infrastruc- increased tax and from planned new suggest a basic lack of seriousness ture deficit is as serious as our budget regulation is arguably to demand the reminiscent of Gordon Brown at his deficit .”26 Accordingly, £5 billion is to impossible . worst, as commentators have noted . shift from current to capital spend- Finally, underpinning the whole ing . This, though, is only part of what THE GOVERNMENT HAS ANNOUNCED approach to reviving growth is the the Autumn Statement terms “a new SPECIFIC MEASURES INTENDED TO continued commitment of the Bank strategy for coordinating public and of England, strongly endorsed by the private investment in UK infrastruc- STIMULATE GROWTH AND JOBS, government, to “Quantitative Easing” ture ”. The government hopes to per- BUT THESE ARE NEITHER VERY FAR- (QE) . In 2009, , suade the U .K . pension funds, which REACHING NOR NECESSARILY VERY then Shadow Chancellor, described currently are starved of investment WELL FOCUSED. printing money as “the last resort opportunities giving savers a useful of desperate governments when all return, to channel billions of pounds other policies have failed ”. In office into such projects .27 A series of other measures of vary- as Chancellor, however, Mr . Osborne Questions remain, however . The ing benefit and importance were also has shown no such reticence and has actual rather than potential sums announced . Reforming the terms repeatedly urged a continuation of involved remain modest and will of public-sector pensions (whose the program . take several years to have an effect . benefits are well out of line with their The Bank of England has dis- The real economic benefits of such private-sector equivalents); bring- missed fears that QE will lead to projects are notoriously difficult to ing forward the planned change future inflation (now standing at judge, are often exaggerated, and in the state retirement age (to 67); more than twice the official 2 per- typically have little effect on unem- and reform of employment law (if cent target) . However, the London- ployment—as was exhaustively dem- pursued vigorously despite Liberal based Centre for Policy Studies notes onstrated when the same debates in Democrat obstruction) may all con- that the Bank’s Monetary Policy similar circumstances occurred in tribute to improvements in economic Committee has recently had a poor Britain in the early 1980s . Perhaps efficiency but will have little or no record of prediction, significantly most important of all for the pen- impact in the immediate future . A underrating the actual inflation out- sion funds managers, it is notoriously new “Youth Contract” scheme worth turn .28 High inflation, among other difficult to capture or privatize the almost £1 billion will fund employers effects, redistributes wealth in favor returns to such investment having to take on young people . of overindebted government and

26. Christopher Hope, “£1 billion on 100 Projects to Kick-Start the Economy,” The Daily Telegraph, October 31, 2011. 27. The ambitious plans were published at the time of the Autumn Statement as HM Treasury National Infrastructure Plan 2011. 28.“UPDATE: The Recent History of MPC Inflation Forecasts,” Centre for Policy StudiesStatistical Factsheet No. 6, December 2011, at http://www.cps.org.uk/files/ factsheets/original/111205120805-Factsheet6InflationforecastsUPDATE.pdf.

11 THE U.K. GOVERNING COALITION: THE CHALLENGES AHEAD AND WHY AMERICA HAS A STAKE IN BRITAIN’S SUCCESS

banks, and those on indexed ben- efits, and against savers and those in work . It also threatens consumer and business confidence, thus depress- ing the actions necessary for growth, and lays in the necessity of a growth- depleting subsequent disinflation . The strategy is, therefore, far from risk-free in the short run and inher- ently self-defeating after only a couple of years in practice .

THE ONLY SURE WAY TO GENERATE GROWTH IN THE CURRENT CIRCUMSTANCES, IN WHICH DEMAND AT HOME AND ABROAD IS DEPRESSED, IS THROUGH RADICAL SUPPLY-SIDE REFORM TO INCREASE EFFICIENCY.

The only sure way to generate growth in the current circumstances, in which demand at home and abroad is depressed, is through radical sup- ply-side reform to increase efficiency . This is not currently occurring; nor is there any evidence that it can occur, given the political constraints of coalition .

12 SPECIAL REPORT | NO. 102 FEBRUARY 22, 2012

Section V: The European Dimension

ritain’s economic and, in the long who have argued over the years expense of the weaker members of Brun, strategic problems intersect for closer integration with Europe . the system . This tactic caused deep with those of Europe in a number of Indeed, their predictions have been resentment among euro-zone leaders, ways . The reaction to the euro-zone held up to humiliating ridicule .29 It as Mr . Cameron would later discover . crisis and specifically to the British has, similarly, led to acceptance of It was apparently assumed by Prime Minister’s effective veto of a the fact that Margaret Thatcher was Britain that the only risk to British new treaty at the Brussels summit on correct when she fought in 1990 to national interests was to be found December 9, 2011, highlighted some keep Britain out of the emerging euro in a possible collapse of confidence, of these difficulties . and, indeed, when, 12 years after including a collapse of European The fact that Britain is outside of leaving office, she predicted: “The banks, arising from the crisis . That the euro and thus able to set its own European single currency is bound eventuality, it was reckoned, would interest rates and pursue its own to fail, economically, politically and still further postpone British eco- monetary policy, reflecting its own indeed socially ”. 30 nomic recovery . The government interests, is arguably the single most seems, however, to have given little important guarantee of the coun- THE FACT THAT BRITAIN IS OUTSIDE or no serious thought to three other try’s economic stability . Monetary OF THE EURO AND THUS ABLE TO questions that should go to the heart sovereignty is a necessary, albeit of British strategic calculations in necessarily insufficient, condition for SET ITS OWN INTEREST RATES AND Europe: prosperity, which ultimately depends PURSUE ITS OWN MONETARY POLICY, on selling goods and services that REFLECTING ITS OWN INTERESTS, ■■ Is it compatible with British people wish to buy . This is because it IS ARGUABLY THE SINGLE MOST national interest to see a tightly allows Britain to respond to external controlled, German-dominated, IMPORTANT GUARANTEE OF THE shocks with flexibility and without single power bloc emerge in the kind of endemic crisis that now COUNTRY’S ECONOMIC STABILITY. Europe in place of the malfunc- afflicts even the stronger countries tioning but largely unthreatening in the euro zone . The markets’ per- On the other hand, the coali- European Union in its present ception of this advantage currently tion government had not, at least form? allows Britain to continue to bor- until the Brussels summit, seriously row cheaply to fund its borrowing, grasped where events were leading ■■ If, for well-known reasons—above despite the lack of progress so far in and which options were opening— all, because of the difference in bringing down the budget deficit and and which closing—for Britain . For productive potential between the increases in debt . months, both the Prime Minister and member states—the euro simply By contrast, the AAA sovereign the Chancellor had publicly called cannot work, is it not a recipe for credit ratings of not just the weak- on the euro-zone countries to move chaos rather than order to urge est euro-zone members, but now much closer toward a single eco- and support its retention?31 France—joint leader of the pack with nomic government . While leaving Germany—have been downgraded . the prescriptive details to others, the ■■ Of most immediate significance, Recognition of this divergence of for- British government was also strident how can Britain’s interests be tunes with those of the euro zone has in its criticisms of European leaders’ safeguarded within the European led in Britain to the wholesale dis- failure to create what was termed a Union under current treaty crediting of politicians and pundits “firewall” against speculation at the arrangements, which largely

29. Notably in Peter Oborne and Frances Weaver, Guilty Men, Centre for Policy Studies, September 23, 2011, at http://www.cps.org.uk/publications/reports/guilty-men/. 30. Margaret Thatcher, Statecraft: Strategies for a Changing World (London: HarperCollins, 2002), p. 354. 31. For a discussion of the unworkability of the system, see Robin Harris, “Europe: What Future?” Heritage Foundation Special Report No. 81, July 15, 2010, at http://www.heritage.org/research/reports/2010/07/europe-what-future.

13 THE U.K. GOVERNING COALITION: THE CHALLENGES AHEAD AND WHY AMERICA HAS A STAKE IN BRITAIN’S SUCCESS

provide for majority voting rather bulldoze through a compromise that justified himself 34. Finally, he let it than decision by consensus, if his already rebellious backbench- be known that on future occasions, the euro-zone countries, joined ers would certainly have regarded he would attend such summits and by aspirant members and other as a sellout . Luckily for him and for conduct his own diplomacy 35. By dependents making up the great Britain, the plan did not materialize contrast, the Prime Minister was majority, henceforth act as a because Mrs . Merkel did not deliver, lionized by his own party in and united bloc? so he had no choice but to use the out of Parliament . In the country, veto, which he did . opinion polls showed overwhelm- Such is the background of the ing approval of his stance, and the diplomatic crisis in Europe that is HOW CAN BRITAIN’S INTERESTS Conservative Party achieved a sig- now imposed on the economic crisis . BE SAFEGUARDED WITHIN THE nificant lead over the Labour Party Mr . Cameron went to Brussels in in an opinion poll 36. December poorly prepared in every EUROPEAN UNION UNDER CURRENT It is not yet clear where the euro sense . He had not resolved how he TREATY ARRANGEMENTS IF THE zone, the European Union, or Britain was to respond to the demands of EURO-ZONE COUNTRIES, JOINED BY goes from here . First, the Brussels his own party for a return of powers ASPIRANT MEMBERS AND OTHER diplomatic débâcle served to obscure to Britain from Europe in exchange how little progress was made by the DEPENDENTS MAKING UP THE GREAT for agreement to treaty changes euro-zone countries in resolving required for a European fiscal union . MAJORITY, HENCEFORTH ACT AS A their own crisis . Commentators and He had not prepared the Germans UNITED BLOC? markets have remained unimpressed for the demands he was to make for by schemes that, in essence, center a protocol to be added to the pro- In France, the British Prime on reviving the now widely discred- posed new treaty so as to protect the Minister’s veto led to an outburst of ited approach of the Maastricht interests of the City of London from undignified name-calling . President Treaty’s Stability and Growth Pact damaging regulation and a proposed Sarkozy described him as a “stub- without the European Central Bank new tax on financial transactions . born child .”32 The French Finance adopting a much more active role in He also had not reckoned at Minister said that Britain was “mar- support of—and lender of last resort all, it seems, with French plans to ginalised” and attacked the coali- to—euro-zone member states . force Britain out of the cockpit in tion government’s economic policy . Second, the European Union Europe—plans that fit in well with The Governor of the Bank of France itself looks increasingly artificial— President Nicolas Sarkozy’s desire called for Britain’s sovereign credit a framework of arrangements that for a noisy coup that would help his rating to be downgraded rather emerged out of past events and (more re-election prospects and with a than that of France .33 In Britain, the or less) suited past requirements well-entrenched resentment in Paris Liberal Democrats expressed various but no longer corresponds to today’s at London’s primacy in financial ser- degrees of dissent from the Prime global realities . The EU contains too vices . The British Prime Minister’s Minister’s veto . many contradictions and states with own hope was, it appears, to strike a Deputy Prime Minister Nick too many incompatible interests to deal with German Chancellor Angela Clegg first supported it, then criti- stay as it is . There has to be parting Merkel, then agree in principle to cized it, then modified his criticism . of several ways . One way or another, the treaty changes, and then return He absented himself from the House such a parting will certainly and cru- to the House of Commons and try to of Commons while Mr . Cameron cially involve Britain .37

32. James Kirkup, “PM Behaved Like Stubborn Child, Says Sarkozy,” The Daily Telegraph, December 15, 2011. 33. James Kirkup, “France Declares a War of Words on Europe,” The Daily Telegraph, December 16, 2011. 34. James Kirkup, “Coalition at Odds as Clegg Snubs Cameron,” The Daily Telegraph, December 13, 2011; “State of the Union: The Coalition After the Veto,” , December 17, 2011. 35. James Kirkup, “Clegg Seeks Role at EU Summit,” The Daily Telegraph, December 24, 2011. 36. Robert Watts, “European Veto Gives Cameron His Biggest Lead for Eighteen Months,” The Sunday Telegraph, December 18, 2011. 37. An interesting confirmation of this analysis is provided, paradoxically, by the Euro-enthusiasticEconomist journal. See its Bagehot column, “How Britain Could Leave Europe,” in The Economist, December 17, 2011.

14 SPECIAL REPORT | NO. 102 FEBRUARY 22, 2012

For political reasons, the Prime goes to the heart of a long-standing veto, the EU’s Economic Affairs Minister is desperate to avoid complaint . But if a tightly controlled Commissioner, Olli Rehn, comment- any decisive shifts in the compro- bloc of euro-zone members and oth- ed: “If [Britain’s] move was intended mise policies adopted by the coali- ers, deciding as a caucus, effectively to prevent bankers and financial cor- tion . He fears that a referendum on uses European institutions and porations of the City from being reg- Britain’s future relations with the mechanisms to outvote Britain on a ulated, that’s not going to happen ”. 38 EU, demanded by much of his party regular basis, the country’s position The economic facts speak for and (as polling data show) desired by will become impossible . themselves, and they show that most people in the country, would Britain cannot afford to see the City 39 open the road to Britain’s exit and, COMMENTATORS AND MARKETS strangled . In 2009–2010, the U .K . more immediately, also precipitate HAVE REMAINED UNIMPRESSED BY financial services sector made a tax the collapse of his alliance with the contribution of £53 4. billion—11 .2 Liberal Democrats . Nor is he willing SCHEMES THAT CENTER ON REVIVING percent of total tax receipts—to to press for a significant repatriation THE NOW WIDELY DISCREDITED the Exchequer . Financial services of powers from the EU to Britain, APPROACH OF THE MAASTRICHT accounted for a £35 .2 billion trade despite his previous pledges to do so . TREATY’S STABILITY AND GROWTH surplus . Although it is fishing and He knows that in present conditions, agriculture that are always men- PACT WITHOUT THE EUROPEAN he has no goodwill to use with—and tioned in domestic political dis- insufficient weapons to use against— CENTRAL BANK ADOPTING A MUCH cussion of powers abandoned to the euro-zone bloc and its hangers- MORE ACTIVE ROLE IN SUPPORT OF— Brussels, these two sectors now on (though, of course, there is still AND LENDER OF LAST RESORT TO— account for just 0 7. percent of U .K . a possibility that several countries GDP . Financial services, by contrast, EURO-ZONE MEMBER STATES. may shy away from the new fiscal account for at least 10 percent . union proposals when once the full In the past, there was a more bal- details emerge) . The immediate matter of dis- anced trade-off between accepting Mr . Cameron would clearly prefer pute—and the one that precipitated regulation from Europe and gaining to continue the indeterminate policy the Cameron veto, on which Britain access to European financial mar- he was pursuing before Brussels, yet cannot afford to compromise—is kets . London both influenced regu- this may not be viable . Other things taxation and regulation of the City lation within European countries being equal, Britain would clearly of London . It is a battlefield that the and acted as the main entry point to benefit from a resolution of the crisis government would certainly rath- the EU’s single market in financial in the euro zone . On the other hand, er not have chosen . That is partly services . In current and likely future Britain’s ability to influence events because, as an element of its “fair- conditions, with the depressed out- is extremely limited . It cannot, for ness” agenda, it has spent much time look in the euro zone, British busi- example, afford to collaborate in chastising financiers for their alleged ness—including financial business— large bailouts, whether through the misdeeds in the run-up to the bank- will increasingly look elsewhere . IMF or otherwise . Its main focus has ing crisis and recession . At the same Accepting burdensome rules to be on preserving its own economic time, a core element of European motivated by an increasingly hostile interests . But is this possible without (and particularly French) ideology is attitude to financial services as such fundamental change? that the root of all current problems becomes much less attractive . At Decisive in making that assess- is the excessive exuberance of unreg- least 49 new EU regulatory propos- ment will be how Britain now fares ulated Anglo–Saxon capitalism . als affecting the City are either in the in ensuring that the European Single The Europeans will thus pursue pipeline or being discussed . Notable Market provisions are not used this particular vendetta with rel- specific threats are a proposed against its economic interests . This ish . Significantly, in the wake of the EU-wide financial transaction tax,

38. Louise Armitstead, “City Not Shielded by Cameron’s Veto, EU Insists,” The Daily Telegraph, December 12, 2011. 39. What follows is based on Stephen Booth, Christopher Howarth, Mats Persson, and Vincenzo Scarpetta, Continental Shift: Safeguarding the UK’s Financial Trade in a Changing Europe, Open Europe, December 2011.

15 THE U.K. GOVERNING COALITION: THE CHALLENGES AHEAD AND WHY AMERICA HAS A STAKE IN BRITAIN’S SUCCESS

possible short-selling bans, and the to take account of non-European European Central Bank’s insistence opportunities as well as European- that transactions in euro-denomi- focused problems . The fact that the nated financial products be cleared Liberal Democrats in the coalition within the euro zone rather than in will oppose it by all possible means London . may well suggest an early election— More generally, and irrespec- which also, of course, would allow tive of the agonies of the euro zone, the Conservative Party to rectify Britain clearly needs to rethink its economic program in the light from scratch its relations with the of events and with a view to putting European Union . This is an historic economic growth through supply- opportunity as well as an obvious side reform at the head of a new necessity 40. Such a review needs mandate .

40. For a development of this theme, see Robin Harris, “Cameron Has at Last Learned to Confront, not Conciliate,” The Sunday Telegraph, December 11, 2011.

16 SPECIAL REPORT | NO. 102 FEBRUARY 22, 2012

Section VI: The Future

fundamental rethinking of traditionally Euro-enthusiastic even at a time when Labour was four ABritain’s relations with Europe is Liberal Democrats can be rallied points ahead of the Conservatives something that should be welcomed to what amounts to a bitter war of (now reversed), that by 37 percent rather than, as hitherto, discouraged attrition against the euro-zone core to 26 percent, voters preferred Mr . by the United States . The U .S . has in defense of British interests . If Cameron and Mr . Osborne to Mr . its own large problems . Like Britain, they cannot, and despite the techni- Miliband and his Shadow Chancellor, it cannot do much to help solve cal problem presented by the coali- Ed Balls, to manage the country’s Europe’s . But in the years ahead, it tion’s Fixed-term Parliaments Act, economic affairs . should be a priority in Washington an early election could result 41. The In the longer term, the two deter- to reset U .S . relations with Europe . other short-term factor pointing in mining factors will be, first, the That reassessment will need to take the same direction is the increas- state of the economy—if there is no into account the economic potential ingly fragile position of Labour Party sustained improvement at least a and stability of individual countries, leader Ed Miliband, whose poor rat- year before the pencilled-in 2015 not just treat all alike . ings might tempt Mr . Cameron—and election date, the coalition parties The assumption that has gov- certainly do tempt his backbench- will probably lose, whoever leads erned the U .S . view of European ers—toward an early poll . Labour—and, second, a possible developments more or less since the intriguing, if intangible, long-run Treaty of Rome in 1957—that coun- IN THE LONGER TERM, THE TWO change in attitudes . This is the sort tries will move, albeit at an uneven DETERMINING FACTORS WILL BE THE of thing to which political pragma- pace, toward “ever closer union”—no tists, like those in charge of the three longer applies . Whether Europe STATE OF THE ECONOMY—IF THERE main parties, habitually attach small splits into different currency zones, IS NO SUSTAINED IMPROVEMENT importance . But such transforma- or countries reissue their own cur- AT LEAST A YEAR BEFORE THE tions, as was demonstrated with the rencies, or some other new geometry PENCILLED-IN 2015 ELECTION shift under Margaret Thatcher in the of relationships emerges, nothing 1980s against socialism and in favor DATE, THE COALITION PARTIES can ever be the same again after the of small-government individualism, euro-zone crisis . Moreover, what- WILL PROBABLY LOSE, WHOEVER can be seismic . ever the shape of Europe that finally LEADS LABOUR—AND A POSSIBLE, IF A recent report from the National emerges over the next few years, the INTANGIBLE, LONG-RUN CHANGE IN Centre for Social Research suggests U .S . will be better served by having a that, under pressure of economic ATTITUDES. British ally that is financially stable, austerity, underlying “Thatcherite” economically prosperous, unencum- values in Britain may have resur- bered by onerous obligations to sup- An interesting opinion survey faced . Its British Social Attitudes port unsustainable arrangements in from last autumn is also relevant Survey found a shift in sentiment Europe, and clear about its priorities here . This suggested that in a refer- against greater government inter- and its position in the world . endum on EU membership, 49 per- vention to rectify inequalities; a As for the immediate pros- cent would vote to leave against 40 reduction in popular hostility to pri- pects for the U .K . coalition gov- percent who would vote to stay . This vate health and education; a marked ernment, these will be deter- shows the depth of popular disillu- drop (to less than a third) in the mined by two short-term and two sionment with Europe, on which a number of people favoring tax rises long-term factors . In the short Euro-sceptic Tory Party could draw . in order to improve public services; term, it is not at all clear how the The same survey demonstrated, another notable drop in the number

41. For the contrary case, see Paul Goodman, “Divorce Isn’t an Option for David Cameron and Nick Clegg,” The Daily Telegraph, December 29 2011. Sidelining the provisions of the Act would require the Conservatives to support a motion of no-confidence in the current government.

17 THE U.K. GOVERNING COALITION: THE CHALLENGES AHEAD AND WHY AMERICA HAS A STAKE IN BRITAIN’S SUCCESS

willing to support high taxes to protect the environment; and a clear majority view that unemployment benefits were too high 42. This suggests a return to real- ity . Upon such changes—in whatever country they occur—conservative successes may be built . It remains to be seen whether they will be .

42. James Orr, “Social Attitudes Research: Britons Lose Sympathy for the Unemployed as They Become More Self-Reliant,” The Daily Telegraph, December 7, 2011.

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