Nick Clegg: Financial discipline and tax cuts will steer Britain through economic crisis

9.00.00am UTC (GMT +0000) Mon 11th Feb 2008

Liberal Democrat Leader Nick Clegg

Liberal Democrat Leader, Nick Clegg has called for a new era of financial discipline, an end to tax rises, and an economic stimulus package of tax cuts for low and middle income earners, to steer Britain through the coming economic turmoil.

He is extending the Liberal Democrat spending review to find up to £20 billion of government spending that can be scrapped, with the money reallocated to Liberal Democrat priorities.

A full copy of the speech is below

This is my first major speech on the economy since I was elected leader of the Liberal Democrats.

I wish it were going to be less gloomy.

But it seems pretty clear there are dark times ahead for the British economy. Gloomy is about as good as it gets.

Today I'm going to set out my view of where we are in economic terms, and the direction we need to go in if we're to ride out the storm that's brewing.

My starting point is liberalism.

I firmly believe liberal ideas are vital to our economic success as a nation.

I am an economic, as well as a social, liberal.

I am a proud inheritor of a British liberal tradition that has stood up, through the centuries, for free trade, and against protectionism.

That supported entrepreneurialism as well as laying the foundations for the protections of the welfare state.

That understood you can only deliver on progressive aims with the money delivered by economic growth.

In the past, while Labour was enthralled by socialism, and while the Conservatives were getting periodically carried away by economic nationalism, the Liberal Democrats have always supported competitive markets.

And in the modern age, it is liberalism that understands both the market economics that drive globalisation, and the internationalist politics needed to regulate it.

It's no wonder David Cameron claims to be a "liberal conservative", and Gordon Brown has hailed our British traditions of liberty.

But it's the Liberal Democrats who've had it right on the economy in recent years.

We were the first political party to call for the independence of the Bank of England.

We've spoken out for years about the unsustainable credit bubble that has been used to prop up our economy.

We have in Vince Cable the most credible shadow chancellor - or chancellor - of any political party.

He was right to call for the temporary nationalisation of Northern Rock, while the government and Conservatives spent months dithering over what to do.

I, personally, have a long standing commitment to business and economics.

I managed economic development projects in Central Asia.

I was an international trade negotiator - leading the EU team on China and Russia's accession to the World Trade Organisation.

I was Trade and Industry Spokesman in the European Parliament, where I pushed through new Single Market legislation in record time, opening telephone markets across Europe to competition.

I did some vital early work liberalising energy markets.

And in Westminster, I was at the forefront of the campaign against the extradition of the Nat West Three.

It's because these issues are at the heart of my political agenda that I'm determined for the Liberal Democrats to build on our credibility and become the most trusted party on the economy.

In us, you will have a party committed to economic liberalism, to internationalism, to fair taxes, and to competitive, fair markets.

Let's look at where we are today.

It has been well over a decade since confidence in the British economy has been this low.

There's no catastrophe yet. Economists are predicting below-trend growth, and weakened consumer spending for the next few years, not yet recession.

But the storm clouds are gathering.

And if the rain does start to fall, my concern is that Gordon Brown has - to stretch the metaphor - thrown out all our umbrellas.

In the last few years egged on by the Government's own profligacy we have borrowed too much, spent too much and saved too little.

In the harder times ahead, this will come back to haunt us.

Keen to shift the blame, Brown has quickly laid the cause of our current economic malaise firmly at the door of the USA.

But if our problems are merely the fault of the American mortgage market, why has the UK been so much worse affected than anywhere else?

Why is it only the UK who has seen a run on a bank?

The reality is that many of our current problems started far closer to home.

Gordon Brown must be given credit where it is due.

Since coming to power in 1997 he presided over a decade of solid growth. His boasts may have been a little over the top - like proclaiming the longest period of growth since the dinosaurs, or whatever it was.

But while problems beset other countries, in Britain consumer spending, employment and growth did all remain high while inflation stayed low.

Unfortunately this growth was not built on firm foundations. Not even Gordon could abolish the business cycle.

By 2003 consumer debt was expanding at a rate of over £10bn a month.

Much of this borrowing was based on house prices which were increasing by over 20% a year.

These price increases were partly because of a housing shortage in some areas, particularly the South East, as household growth and immigration drove demand far faster than supply.

And partly because of massive speculation by people treating home ownership as their main form of saving and investment, propped up by reckless lending on the part of some banks.

Meanwhile we saw an explosion of investment in the public sector which further drove growth.

For the first time in a quarter of a century the growth of jobs in the public sector was higher than in the private sector.

The Liberal Democrats supported this investment in public services: after years of under investment, it was vital.

But because of the Government`s failure to address structural weaknesses in the economy, these conditions now combine to create the conditions for a perfect economic storm.

The collapse of the US mortgage market is not the reason for the economic turmoil we now face.

It was just the catalyst.

Our economy has become ever more dependent on the availability of cheap credit - without it, we're in trouble - as the directors of Northern Rock were the first to discover.

With the cost of credit seriously affecting people's spending power, a lower level of growth in the UK economy is now inevitable.

A fifth of our income is now used purely to maintain the debts we already have, while the ratio of debt to income is historically unprecedented.

It is hardly surprising then that as a country we are tightening our belts and spending less.

This will open up a considerable hole in the Government's finances.

Gordon Brown finds himself in a sticky situation, with a rapidly slowing economy, strong inflationary pressures and no money in the Treasury's coffers.

There's no wiggle room in fiscal policy to stimulate growth: even with the tight spending plans imposed under the Comprehensive Spending Review, the Institute for Fiscal Studies has identified an £8 billion shortfall.

By spending all the money in the years of plenty we have backed ourselves into a corner unable to cope with these leaner years.

The Prime Minister now finds himself in the unpalatable position of having to either raise taxes or abandon the fiscal rules on which he built his reputation.

Of course, one of those fiscal rules went down the toilet last night. Somehow I don't think this is a happy morning in the Treasury.

It isn't just Brown and Darling's hands that are tied, though.

There isn't much wiggle room in monetary policy either.

Our tight inflation target, which doesn't take house prices into account, has left the Bank of England hamstrung.

While it has found space for a quarter point cut, it's impossible for us to follow the Fed and slash interest rates to boost the economy while wage demands, the cost of oil and high food prices continue to drive up inflation.

Overall, we've managed to get ourselves into a situation where our economy is too fragile to withstand a serious external shock.

So the first thing to do is work out how we can protect ourselves from getting into this situation in the future.

To better stabilise our economic management, the fiscal rules should be independently monitored.

Remember last year when Gordon Brown was about to break his fiscal rules - and conveniently discovered the economic cycle was longer than his previous estimate, so he had a few billion pounds to spare after all?

The government can't go on marking its own exam papers. We need an independent body to analyse our fiscal position.

But more than that, we need to accept that the fiscal rules are now wholly discredited. Over the next few months, I'll look in depth at how we can build a new system to restore confidence in fiscal management.

The Bank of England's remit needs to be altered, too.

The measure of inflation the Bank targets doesn't include housing costs, so it bears little resemblance to actual inflation.

Excluding a measure that has such a profound impact on our economy is daft. It means the Bank can't act to counteract pressures that cause prices to spiral - or to counteract a potential crash.

Devising ways to stop us getting into this economic hole again in the future are important.

But they aren't enough.

It's like the old joke about the man who got lost, asked for directions and was told "I wouldn't start from here".

It doesn't help very much.

We are where we are.

And it's the job of an opposition party not to crow "I told you so" from the sidelines, but to propose an alternative.

There may be difficult times ahead but notwithstanding our fiscal position there are things the government could - and should - be doing to cushion the blows.

That's one of the reasons I'm so frustrated by the Conservative party.

All they have to say is "I wouldn't start from here".

Take Northern Rock.

My colleague Vince Cable was quick to assess the situation and propose what I still believe would be the least worst option: temporary national ownership of the bank, to best protect the taxpayers' investment.

It's clear the government knows that's the best idea on the table, but they're too afraid of their past to go ahead with it.

Instead of nationalising Northern Rock, they've nationalised the risk, and privatised the profit.

But what have the Conservatives got to say?

Nothing. They've taken up our proposals for better deposit protection and stronger banking regulation so there's never another Northern Rock.

But they don't have a single concrete proposal or idea about where we go from here.

That's just "I told you so" politics. And it offers nothing for Britain.

It's an attitude that has taken the Conservative party into a confusing series of half-promised tax cuts and half-promised spending commitments.

I will never take that approach.

The Liberal Democrat approach to the economy, and to public spending, will always be responsible.

First and foremost, we need to accept that our fiscal position is in such a mess that we must be extremely firm on public spending.

It's time for a new approach, based on financial discipline. We simply don't have additional spare money to pour into our public services.

That doesn't mean giving up on improving services - or using them to tackle inequality, and improve opportunity for British families.

But it means focusing on "how", not "how much".

I'm committed to reforming our public services, making them more personal in nature, and using them to empower individuals, families and communities.

I outlined proposals on localising the NHS at a Public Services Summit just this morning.

And last month proposed ways to free our schools to deliver a better education for all.

By changing the way our public services operate, we can deliver more with less and continue to improve our health and education even through an economic downturn.

We mustn't let public services pay the price for economic mismanagement.

But that means we have to make sure every penny is spent well.

It's the end of the line for unaffordable public sector pay deals. We need pay that rewards great service delivery and best practice, not just a fixed national pay policy.

We do need to look again at public sector pensions which are not only regressive but remain unsustainably generous for the highest paid.

And we need to go back to Gershon and Lyons and make sure every job is needed - and every job is based in the most efficient location.

Disgracefully, the Lyons Review proposals to move civil servants from expensive central London locations have fallen pretty flat.

I want to see radical proposals - like moving the Treasury out of London to a cheaper location, like Liverpool.

There's just no need for civil servants who don't have contact with ministers to be based in one of the most expensive office districts in the world.

We shouldn't tolerate government waste at the best of times.

But we cannot tolerate it when the money's running short.

So we must address how we can make government a better purchaser.

The private sector has a role in the delivery of public services.

I'm not some anti-PFI ideologue, and I understand there are occasions when private contractors are a good value way to deliver government objectives.

But let's face it: the government is awful at buying things from business, and often leaves the taxpayer paying over the odds whilst the private sector avoids taking on real risk. The botched contracts for the London Underground, not to mention Northern Rock, are reminders if any were needed of that.

Never mind the endless IT projects that have gone over budget - this government has wasted £2 billion on computer systems they abandoned before they even came into operation.

If we're to get the best deal for tax payers, we need better purchasers in government and a new approach to public private partnership.

My criticisms of government spending are not just about efficiency, however.

They're about political choices, too.

As I've said, there's no room in the budget for extra spending.

So if the Liberal Democrats are to identify money to pay for our political priorities, like boosting education funding, or putting more police on the beat, we need to find it within existing spending plans.

That means tough choices.

It means identifying government spending that's taking the country in the wrong direction, or just not delivering what we want.

Like Identity Cards. The government's planning to spend billions, and is already pouring in £100,000 a day: under the Liberal Democrats we wouldn't waste a single penny more.

But there are harder choices, like the Eurofighter, which I don't think on balance is the best investment when our armed forces don't even have decent housing or adequate body armour. Choices like abolishing the Child Trust Fund, because it isn't working to increase savings or deliver better opportunities for the poorest children.

At the next election, the Liberal Democrat manifesto will be fully costed, with a balanced budget.

And to make that possible I'm asking my Shadow Cabinet team to look further, and deeper than before, and identify spending cuts equal to 3% of government spending.

That means up to £20 billion a year of government spending that we will reallocate to our priorities - so we can deliver a more liberal Britain within the overall spending envelope.

Controlling public spending is my top priority.

Once that is secured, we must concentrate on stabilising the economy, so that it merely slows rather than crashing.

We need to take seriously the risk of domestic property recession and the impact on the banking system.

The current mainstream forecasts of house price stabilisation do not capture the extent to which the British market has experienced asset inflation greater than in other developed countries.

Real house prices have more than doubled since the mid-1990s and have outstripped the comparable boom in the US, which of course has now turned to bust.

We must ensure that the rise in home repossessions we have already seen does not become an epidemic.

If we don't, fire sales will turn a housing market slowdown in to a full-on slump, with potentially dire consequences.

There are minimal state security nets for people facing negative equity and repossession, following benefit reforms in the 1990s.

The payments protection market is underdeveloped, expensive and prone to misselling.

So we must take steps to ensure that repossession is only ever a last resort - by making financial advice compulsory at the point repossession claims are issued.

Leading banks should agree practices to prevent large-scale repossessions - like allowing those in arrears because of circumstances beyond their control to move to shared ownership arrangements.

This will be in banks' long term interests because they too would suffer from a downward spiral induced by repossession activity.

We need to look at banking regulation in the round.

It's not clear to me that the era of "light touch" regulation can survive when banks depend for their survival on "lender of last resort" privileges rather than the more brutal disciplines facing other companies.

The truth is, the British banking industry is cosseted and closed. It is not truly competitive.

For years it's been almost impossible to get a new banking licence. New banks are usually just a subsidiary of existing banks.

And the Northern Rock episode has demonstrated that it's also nearly impossible to stop being a bank.

The government and regulators are too afraid to let a bank fail.

Unless we lower the barriers to market entry and market exit, we will not have a truly competitive banking industry that can eradicate the poor service and high charges consumers currently face.

To make true competition possible without jeopardising customers, deposit protection needs to be beefed up, and widely publicised, to protect individuals' deposits and give them confidence in the banking system.

Deposit protection should be peer-funded by the banks themselves, as in the US.

And then we need to look at making banking truly competitive again: allowing new entrants in more easily and allowing failure too.

Whatever happens, the Bank of England also needs - at a senior level - to secure greater expertise in relation to the workings of the financial markets.

And it must be given a stronger role in the regulation of banking.

I am convinced the government's decision to hand extra powers to the failing FSA in the wake of Northern Rock will prove to be a mistake.

Stability is vital in our approach to taxation, too.

By the next General Election, Labour will have changed Corporation Tax rates eleven times.

Businesses need stability - so they can plan for the future.

You don't want a set of tax rates and allowances set out in one Budget, only to be overturned a year later.

The government just can't make up its mind: not least on Capital Gains Tax.

The latest proposals, for entrepreneurs' relief, are welcome, but the government really made a hash of these changes.

But I'm afraid I'm no fan of taper relief. Taxation should be simple.

I don't often agree with Nigel Lawson, but on this, I do.

I see no reason why income and capital gains should be taxed differently.

That's what the Institute of Fiscal Studies recommends.

And that's what we've proposed - a fair, progressive and simple system with no perverse incentives.

One final point on securing stability.

In the long run, the biggest external shocks to our economy could be coming from climate change.

Climate change has the potential to devastate and overwhelm our assumptions, our predictions and our plans for the future.

We must not take it lightly.

That doesn't mean constraining growth for the sake of it, because growth is somehow incompatible with safeguarding the environment.

Far from it.

In the future, the only kind of growth that will be sustainable is growth that takes the environment into account.

We should, as a matter of urgency, scrap tariffs on the global trade in green goods and services to give this crucial growth industry a boost.

And we should lead in the development of "green capitalism" - leading the way in environmental technologies that will be so much in demand in the future.

There are opportunities ahead to create thousands of green jobs for the future.

This should be a priority for our research and science investment too - if Britain is to be globally competitive we need to be leading the field in environmental technology, not waiting at the back of the queue.

These measures will help to insulate our economy against the worst external shocks, now and in the future.

Our final step must be to stimulate the economy.

As I made clear, there isn't much scope in fiscal or monetary terms for a stimulus package.

But there are things we can do.

First, we can restructure our tax system to give tax breaks to low and middle income families, to support consumer spending.

Those families who are already feeling the pinch of rising energy bills, rising Council Tax, rising food prices will struggle most if the economy worsens.

Overall the tax burden should not rise. And it's vital that we shift the burden of taxation away from hard work and onto pollution.

So the Liberal Democrats would cut income tax by 4p, paid for by closing tax loopholes used by the super-rich, and increasing green taxes.

Next, we must invest in skills.

On too many measures Britain is struggling to compete against both traditional competitors in Western Europe and the United States but also emerging economies like India, China and Brazil.

I recognise and applaud the dynamism and diversity of the City. It is now the leading finance centre of the world. British skills, not least in accountancy, are world leaders but we must never and can never be complacent.

It is a national disgrace that as many as a quarter of our young people can't read and write properly.

Without better skills, we will inevitably struggle as a nation in a more hostile global economy.

I've promised to put £2.5bn into boosting education funding for the poorest children - as well as freeing schools to provide the best education for everyone.

And to help tackle the skills gap for adults, I've pledged to change the way we charge for work permits to raise extra money to train domestic workers.

Finally, we must turn towards, not away from Europe, and engage fully in the multi-lateral trade system.

Keeping the flow of trade going even in the teeth of a global downturn will be challenging - the siren calls for protectionism will come, often carefully disguised in beguiling language about protecting consumer and health standards.

But trade is absolutely crucial to our ability to get through the difficult times ahead

Globalisation is one of the greatest forces of our time. And it has down sides as well as up sides.

Both business and government have a role in recognising that, and mitigating the helplessness that people feel in the face of untrammelled globalisation.

And multilateralism must be at the heart of our response.

Britain wouldn't have anything like the international leverage we have without our role in the European Union.

The EU has transformed itself into one of the most sophisticated responses to globalisation there is.

And it is leading the way in market-led responses to climate change, with carbon emissions trading.

And yet the Government does its best to pretend the EU doesn't exist, while the Conservatives are flirting with an agenda that will lead us out of Europe and into isolation and decline.

Of course Europe needs reform - it must become more transparent, and it must return some powers to focus on what it does best. And it must dump the remaining vestiges of damaging and outdated agricultural protectionism.

But our increasingly unserious engagement with Europe is a betrayal of our business interests.

The government could learn a huge lesson from the City's pro-active and productive engagement with the European Union.

For starters, I want to see the UK play a fuller leadership role in the EU and the WTO to bring the ongoing WTO Doha Development Trade Round to a successful conclusion.

Business groups have, if we're frank, not been forceful enough either in explaining the importance that the WTO talks should succeed.

I was present at the inception of those talks in Doha. I am in no doubt that their failure would lead to a rash of trade unilateralism and protectionism which would be disastrous for British business.

And their failure is only made more likely by Brown and Cameron's parochial failure to engage on the international stage.

Too many politicians take wealth generation for granted.

You are the people who create the revenues which allow Government to deliver public services.

You are the people whose work allows politicians to try and build a fairer society, where everyone has the opportunity to fulfil their potential.

Government must be an enabling state, laying the foundations for economic success - a skilled workforce, strong competition policies, a tax system that is fair and regulation that is effective and proportionate.

And then stepping back to let business get on with the job of creating wealth, for the benefit of all.

Wealth creation for a fairer and greener society is the hallmark of a true liberal society.