The New Conservative Covenant

Brexit provides for the first time in a generation the opportunity to recast the economy. For the ambitious, thoughtful Conservative there is little alternative to accepting and promoting a new covenant with those to whom is owed fresh and undeniable obligation, argues Johnny Leavesley

The New Landscape

The country's acute problem is the pandemic and how to ease out of lockdown. The government will, one way or another, solve our return to work and socialisation. The country's chronic problem is its debt mountain. The key to answering our other current and future problems lie with reducing and affording our national debt.

We are indebted to the NHS and those in care homes who tend to the elderly and vulnerable. Post pandemic public perception of this will be higher than any other aspect, financial or managerial, of how the government handled the crisis.

This sympathy for the NHS and the Care Sector is being amplified by the media. Risk analysis, and planning for further virus pandemics and other previously unforeseen black swan crisis events, will become the backdrop policy priority for the civil service. Government crisis planning will become a new industry, swallowing resources like counter-terrorism has done previously. These sentiments are likely to make structural reform of the NHS much more difficult.

Casting a deep shadow over this is an enormous and currently difficult-to-quantify debt mountain. No-one doubts that incurring this debt was necessary. It is the cost of government fulfilling its duty as insurer and support giver of the last resort to the health and economy of the nation. The country realises it will have to accept that running up such a high level of government debt will have serious financial consequences for us all.

In awakening business and society from lockdown, the government will need to stimulate economic recovery by appropriate infrastructure investment and will at the same time be tempted to use other macro-economic measures, such as stimulating inflation and increasing taxation, to manage the debt mountain. There will also be pressure for the government to protect existing industries and business with further loans and grants, as well as regulatory and tariff protections. However, as many examples of previous attempts to manage and reduce national debt have shown, these measures will not be successful, even in the medium term. Inflation eats away at the value of any growth, taxation blunts incentives, loans have to be repaid with interest, tariffs are barriers to trade. Another approach is needed.

The 2019 General Election shifted the tectonic plates of UK politics. Northern and Midlands voters in previously unassailable Labour seats turned Conservative. Several factors contributed to this – not least exasperation with Parliament's blockage of Brexit, the popularity of Boris and the implausibility of Corbyn. Such circumstances will not repeat.  These swing voters need to be reassured that they still have the government's attention.

The post Brexit agenda – freer trade, more control over British taxpayers' money and over our domestic laws – will still need to be delivered. This has already been set out as Conservative Party policy, but its delivery now has accelerated need. The EU is the world's most significant trading zone but is protectionist rather than outward looking. Its regulatory and federalising impulses seek to preserve existing industries rather than opening up new technologies and avenues of trade. The UK needs regulatory freedom for its economy and the ability to agree trade deals across the world. It is therefore crucial to ensure that a UK-EU trade agreement does not bind us to EU rules. The pursuit of such a deal must not take too long as it needs to be settled before a UK-US deal is done. To that end there should be no extension to the withdrawal timetable of the end of this year.  If there is No Deal with the EU, this would create inconvenience for business on both sides of the Channel; but would be preferable to a Rule Taking Deal.

Public services and rising standards of living are paid for only by a growing economy and that is most successfully achieved by a free market framework. Advocates of alternative economic systems such as socialism or high-borrowing social democracy may deploy more seductive political language to justify themselves, invoking such concepts as fairness and equality, but the truth is that free market capitalism has always been the most powerful and renewing agency for the alleviation of poverty.

Britain has the fifth largest economy in the world, to service the needs of a population that is estimated to become 73 million by 2041. At present, calls for government spending are manifold. They are rarely satiated. If the government continues to take an ever larger share of the nation's wealth for redistribution, then it will find itself fast running out of lenders to finance new budget deficits.

Brexit provides for the first time in a generation the opportunity to recast economic performance. We have shifted over the decades from a predominately manufacturing to a service-based economy and that will not change radically soon. However, moves toward a greater and higher value manufacturing capability will reduce the balance of payments deficit and that is essential for long term prosperity. Manufacturers often lament that the making of things is the best way to create wealth and that our capability to do so is diminishing. However, the value of manufacturing best lies not in the mass production of cheap goods but in products with the best combination of convenience, profit and market growth. To that end we need nimbleness and freedom from regulation to exploit new, higher value sectors in technology, robotics, bio-sciences, precision farming and medicine, to name a few. These are the modern equivalents of the improvements to mechanisation and power which drove the Industrial Revolution. They will create as much employment as old industries and create greater wealth.  It will not be a painless transformation but it has the potential to provide enough income to meet the country's needs.

If deregulation and low taxes had been embraced by the country at the end of WWII, the country might not have suffered decades of industrial decline.  At that point, socialism and high state expenditure in peace time had not been discredited with the certainty of failure, but we now know that forever increasing the size of the state was an error which must not be repeated. Yet carrying on at trend growth rates for the last two decades (around 2% a year) will not cover current levels of spending plus the interest on the government's debts.  This will inevitably lead to spending cuts, especially since the government's capacity to increase its borrowing will not be unlimited. So we have to find a way to turbocharge economic growth and, broadly, the way to do this is threefold:

1. Lower taxes and deregulation;
2. Tax incentives to invest in assets and research designed to reverse de-industrialisation;
3. A weaker currency managed by an exchange rate policy to encourage exports.

The Forgotten English

Northern and Midlands English voters are not so different from any other part of the United Kingdom outside of London and the south east.  Ignored for too long by the metropolitan media and political class, they voted to 'Get Brexit Done'. Tired of Austerity, or at least tired of the sort of underinvestment in public services that it was been blamed for, the most attractive and persuasive aspect of Conservativism for them at the 2019 General Election was Boris Johnson. By dint of his personality as much as his convictions, he gave the impression of his new administration being a fresh government.

Similarly, Conservative party activists feel refreshed by Johnson. A smallish army numbering less than 200,000, elderly and from a narrow social demographic, they have long been ignored by a leadership of MPs noticeably more liberal and centrist than they are. Yet what unites the middle-class southern party activist and the working-class northern voter who supported the Tories for the first time is what also appeals to another constituent element of Conservative support – the instincts of the Celtic unionist. Cognisant of the financially supportive aspects of the United Kingdom, whereby London pays for services elsewhere, there are aspects of underlying patriotism to be polished. A post Brexit, post pandemic, Johnson government will have the unashamed energy and lack of embarrassment to advertise the country, its values, culture and business. A Global Britain can be promoted and celebrated as a necessity.

Having just emerged from the peak of a pandemic wave and one which came close to taking the life of the Prime Minister himself, public sympathy for NHS and care workers is understandably high. Calls for higher pay are increasing and will be difficult to resist. This will be politically implausible to deny and will itself trigger similar demands for, firstly, other key workers and then across the economy.

Despite having been in government and with responsibility for the NHS for longer than Labour since its foundation in 1948, the public has continually suspected that the Conservative heart was not in the NHS. Indeed, given that its socialist free-at-point-of-delivery principle is almost unique amongst the healthcare systems of advanced nations, there has always been a significant if often subdued element of Conservativism that has wanted reform enough to transform the NHS into an insurance based European style system. Given that the national network of hospital trusts is an administrative and expenditure behemoth and one which the country has at various times seemed as if it could not afford, such looking at alternatives is understandable. No longer, however. The pandemic is a crisis that offers no alternative to that of embracing the NHS and Care Sector and the Conservative Party- and the Prime Minister especially – now has an opportunity to banish that long term suspicion the public has of it by flooding it with convincing praise and new political settlement.

There has long been an image, simplistic and untrue, that Conservatives do not care for the underprivileged. A new covenant can dispel that myth forever.

The National Debt

The main problem is the debt mountain. The country's balance sheet is not in a fit state to take on so much new borrowing. The last estimate of extra borrowing that the government has had to take on to pay for the pandemic was £300 billion. It is likely that this would take two or three generations to repay using the most likely tools that the Treasury mandarins will recommend. A recent policy paper leaked from the Treasury (dated 5th May) with proposals for how to approach this problem is predictably disappointing and, in showing instinctive financial stringency, unimaginative. It proposes a public sector pay freeze, cuts in welfare and general expenditure, as well as heavy tax rises; in combination raising and saving between £25bn and £30bn. Given our recent experiences of Austerity one does not have to be a genius to accurately predict that these measures would have severe negative social implications and suppress economic growth.

The last time we had comparable debt crisis was immediately after WWII. Through a combination of high taxes, regulation, austerity and inflation this was whittled down – and simultaneously the size of the UK's economy and wealth reduced in comparison to others.

For the moment this debt is affordable because global interest rates are at historic lows. With countries in lockdown and the decline of oil prices exacerbated by a double hit of a trade war between Russia and Saudi Arabia, and complications in the futures market for buying crude oil, the short term outlook is deflationary. But with a massive increase in the money supply, this will not last forever. The pandemic will cause a partial reversal of globalisation as industries seek to shorten supply chains and this will raise input costs, as wage demands increase, starting with NHS and key workers. Inflation will take off at some point.

Inflating our way out of the public debt will be a tempting policy to pursue. The value of the debt will fray each year as assets rise by the same value and the amount of money in circulation increases. However, inflation will cause problems, not least eroding the value of savings and causing illusory growth in the value of old economy assets. To rely on a combination of inflation and high taxes will undoubtedly stifle economic growth. Every government that has ever introduced high taxes blends it with the belief that the rises are selective, targeted and of overall benefit to the state because intelligent application leaves other aspects of the economy undisturbed. (Hence the fondness for wealth taxes). This does not work because behaviour changes rapidly. All levies on revenue are distortions that alter economic behaviour, very often the impact being to reduce or avoid economic behaviour altogether.

Regulation

Periodically politicians announce that they will slash business regulations but, since they and their civil servants are remote from day to day business, they often have little idea which to remove or reform. Also, the unspoken truth is that larger businesses and their lobbyists quite like many aspects of regulation – they are large enough to afford them and red tape acts as a defensive barrier to entry to new competitors. The solution is to approach regulation from the perspective of what is needed rather than of what can be removed. Government should establish industry specific (but not industry dominated) taskforces to decide which regulations are needed as de minimis to achieve aims and minimum standards. Much that does not make it upon the blank sheet and is on the statute book should therefore be removed. Urgently. That methodology will remove more red tape than any previously attempted exercise. To have the freedom to do this it is essential that any trade agreement with the EU does not make the UK sign up to EU created 'standards'.

Turbocharging economic growth through deregulation has been done before. West Germany underwent an 'economic miracle' (the wirtshaftswunder) after WWII when it radically swept away regulation and embraced free market economics. We should do the same, concentrating on modern growth areas in science, robotics, IT and med-tech, as well as simplifying planning controls, promoting generous R & D tax incentives and creating Free Ports and Enterprise Zones. Some of this is part of government plans but it needs to be bolder than whatever was previously envisaged.

The West German example was based on an export-driven manufacturing resurgence, made possible by devaluing their currency to a level that rendered their goods attractive to buy in global terms. This was the basic foundation of their productivity strength. We need to do similar. Monetary expansion of the kind currently being practised by the Bank of England should enable sterling to be devalued to an extent that gives us more competitive advantage for our exports.

Every business has its bugbear regulation and whilst not everything should be abandoned, it is well known, for example, that the EU inspired data protection rules have imposed an avoidable burden on most firms. The City functioned very well before the MIFID rules came along. This should be made permanent with a Freedom Commission (from regulation), set up in a similar manner to the Office of Tax Simplification.

Taxes

When calling for greater economic growth it is easy to call for a blanket reduction in taxes and it is true that low tax countries are generally more prosperous than those under redistributive, higher tax systems. The government will desperately need more income and will be under pressure to raise or at least maintain taxes. Whilst tax rises can initially raise revenue in the short term before behaviours are altered to adapt and avoid, the UK's economy after lockdown does not have enough strength to take on any tax rises. After its intensive care, the patient is too weak.

Tax reductions should therefore be targeted at stimulating business and, to lift post pandemic unemployment levels, mainly at payroll taxes. This means lowering Corporation Tax again, to match our neighbour Ireland's 12.5% and looking at a long-ignored merger of National Insurance Contributions tax with Income Tax.

Whereas a 1% rise in the basic rate of Income Tax is estimated to raise £5bn in revenue, to reduce by 1% is almost certain to stimulate demand by increasing consumption, much of which the Treasury will recoup through other taxes. The compounding effect of that will raise £5bn but through tangential and more beneficial sources. To do this and reduce the Basic Rate would send the wrong message to the international debt markets which buy UK government debt. Those financiers need to see more predictable revenue. Better to raise the level at which earned income is taxed. Currently up to £12,500 can be retained before Income Tax is imposed. If this level were progressively raised it would have several beneficial effects: raise standards of living, increase consumption and stimulate the economy, make housing and the mortgage market more affordable, allow greater capacity for saving and obviate the argument gaining traction amongst left-leaning commentators for a Basic Universal Income for all – a helicopter money idea that promotes the counter-intuitive concept of money for nothing.

Small Businesses

Small businesses are the most numerous (about 5.6m of them before the lockdown), employ more than others (12.9m employees) and yet are the most ignored by government. They would be the most responsive to the levers government can pull and be at the vanguard of economic recovery. The winds of recession and recovery affect them first and more strongly. A Simple Consolidated Tax for businesses turning over less than £1m, to replace the four main tax and compliance headaches of Corporation Tax, VAT, NI and rates should be levied at a rate of 12.5% of turnover. It would be approximately tax neutral but hugely beneficial in saving the compliance time of administrivia and itself be a substantial boost to economic growth.

Immigration

Control of our borders to the extent that we can determine who we grant the right to live here is a popular repatriation of powers from the EU. We should use it flexibly to meet the country's labour needs. This is likely to be more restrictive and selective than it has been because sentiment has turned against the large influxes of unskilled immigrants that boomed under the Blair-Brown governments and which the Cameron-Clegg coalition found impossible to restrict. However, so that immigration reform is not done in a tone of uncharitable harshness or perceived racism we should open a window of amnesty to illegal immigrants who can prove a residency here of a suitable minimum period – say, 5 years.

Obviously, we do not know the numbers this will affect. It is estimated that there may be between 500,000 and 1.2m such people in the UK. By bringing them into society as legal residents and taxpayers, this will boost economic figures as their activities emerge into official data.

Sovereign Wealth Fund

Not only do we have a debt mountain and an exacerbated need for increased spending on the NHS and social care, we have the long term structural problem that our aging population will increasingly have to be paid for by a smaller active working population. This 'Dependency Ratio' is going to worsen.

As explained earlier, the UK government is going to need revenue and diversifying from the tax base will be useful. Return on global equities has historically been 5%-6% and this return on capital could be improved if initial investments were made now at a time of stock market volatility. The 30 or 40 billion needed for a fund of sufficient scale will be easy to raise by selling gilts because, even though this adds even more debt to the mountain, the debt markets view this type of sovereign debt as an investment in real assets, rather than the funding of day to day government spending.

If public sector pensions were paid into the fund and private pensions had the option of doing so its size would rapidly be over £1trn within 10 years or so, assuming contributions of 5% of salaries. The potentials of this huge size allow for imaginative options for subsidiary regional funds investing locally whilst the main fund invests in growth markets globally. To be fair, a scheme could be worked out to tax contributions on the way in rather than on withdrawals.

Prudently run, this initiative alone should be able to pay for the annual increases needed in healthcare budgets, as well as the pension annuities.

Conclusion

For the ambitious, thoughtful Conservative there is little alternative to accepting and promoting a new covenant with those to whom is owed fresh and undeniable obligation. This now means key workers – the public sector labour force essential for national life. Also, whether or not a Conservative victory was expected in late 2019, it was an unexpected landslide delivered by voters whose natural political home had always previously been Labour. This means addressing their concerns to be able to retain their votes lent in usufruct.

Key workers deserve reward. They tended to the nation during the pandemic, especially in the NHS and the care sector. In public perception the NHS has always been the most important of all the state services. It has now been deified in sentiment, irrespective of inefficiency and regardless of alternative models of achieving the same, or better, aims and results.  That sentiment should be embraced because no nuance of structural reform will be achievable when the opposing current is so strong.

The aim should be to make this a Conservative century, in the party's longevity in power as much as democratically possible and when not, in successfully dominating the centre ground with these new accepted norms that mean, even for the most politically unengaged voter, the Conservative Party is the natural home for all those in work, whether for profit in private enterprise or in the employment of cherished agencies of the state. Such acceptance will come from a covenant that renders unions, in terms of representation of and sympathy for the worker, little more than an indulgent and unnecessary social club membership.

To make this possible economic growth and productivity needs supercharging; to do that there needs to be substantial deregulation, lower taxes and a weaker currency.

The Conservatives should be the natural home for all elements of society that want to progress and improve standards of living, healthcare, nationhood and the union of the United Kingdom, regardless of age, gender, race, class or disability.

The New Conservative Covenant:

1. The NHS is merged with the Care Sector and remains forever true to its founding principles of the best healthcare available to all and free of charge. It is acknowledged as the most important state service and as cherished by Conservatives as much as other constitutional institutions – the monarchy, the union of the United Kingdom's four nations and the Commonwealth;
2. Standards of living are raised for the poorest through annual increases in Universal Credit in line with inflation, by rigorously prioritising economic growth and by progressing towards raising out of payroll taxation all workers paid less than the median average wage;
3. Public spending is targeted at rebalancing opportunity across all regions of the United Kingdom;
4. A Sovereign Wealth Fund;
5. A Freedom Commission to recommend continual deregulation in national life and industry;
6. A Simple Consolidated Tax for small businesses; and
7. An immigration amnesty.