by Simon Tilford

The British tend to deride France as a hopelessly statist, anti-entrepreneurial country full of bolshie workers intent on extracting disproportionate rewards for their labour and a state too weak to resist them. This characterisation is not wholly inaccurate. But the implicit (and sometimes explicit) assumption is that the UK is everything that France is not. This is not the case.

In some respects, Britain now looks worse than France. For all its faults, France produces good public services and decent social outcomes, such as relatively low levels of poverty and high overall skills levels. Britain, by contrast, now combines a very big state, patchy public services, generally poor social outcomes and increasing barriers to wealth creation. This is a poisonous mixture. The situation can be rescued, but not without breaking some eggs.

The figures are arresting. Britain has gone from having one of the smallest states in the EU to one of the largest. In 2000, public spending accounted for 37% of GDP in the UK, just three percentage points above the US and a full 15 percentage points below France. By 2010 the OECD estimates that state spending will account for 49% of GDP in Britain, against 53% in France (52% in famously high-spending Sweden). Britain has already overtaken Germany and the Netherlands (44% and 46% respectively).

This unprecedented expansion of the British state would be less of problem if the UK now had Scandinavian (or even French) levels of public services or first-rate physical infrastructure. But improvements in British public services over the last ten years have been nowhere near big enough to justify the increase in expenditure. Most of the money has gone on increased employment and wages, rather than improvements in services. Perhaps unsurprisingly, given the stranglehold that the unions have on the public sector, productivity has stagnated.

It is also notable that Britain’s welfare-state is not comparable to that of Germany or the Netherlands, let alone France or Sweden. Unlike in these countries, many of the ordinary Britons currently losing their jobs will receive only derisory sums in unemployment benefits because these are means-tested. And only a forensic scientist could spot significant improvements in the country’s physical infrastructure. Britain’s roads remain as congested as ever and its railways expensive and unreliable.

Of course, the tax burden in the UK is still lower than in France. In 2008, taxes accounted for 49% of GDP in France compared to just 42% in Britain. But the gap between tax and expenditure in Britain is completely unsustainable, given the parlous state of the country’s public finances. How it is closed will to a large extent determine Britain’s economic prospects. If the gap is bridged by cutting expenditure, the UK stands a chance of returning to a relatively strong growth path. But if it is closed primarily through increased taxes, Britain will have a bleak future. The tax burden will be among the highest in the OECD, but public services (and the country’s social outcomes) will be nowhere near good enough to justify the tax take. In short, Britain will have Scandinavian levels of taxation and American levels of public services and social welfare.

The Labour party is poorly placed to sort out this mess because of its close links to the public sector unions. Under Labour the public sector has become a privileged class that is impervious to change and reform. By way of illustration, public sector wages are currently rising by close to 4% a year at a time of economic crisis. And this despite the fact that public workers are on average better paid than their private sector counterparts and enjoy generous pension entitlements. What about the country’s physical infrastructure? On the government’s forecasts, public investment will halve over the next 4 years. In fact, the only significant cuts the government intends to make are to investment.

The Tories stand a better chance of taking on entrenched public sector vested interests, but it will be a battle. Moreover, they will need to avoid the mistakes of the 1980s when they reduced spending by cutting services and investment rather than by increasing public sector efficiency. If they do this again, UK taxes will remain very high relative to what those taxes deliver in terms of services.

Britain still has strengths, of course. It is straightforward to set up a business in the UK and the labour market remains flexible. But overall Britain looks increasingly like one of the sick men of Europe, and certainly as sick as France. The French state is an efficient provider of services and quasi-state institutions construct and manage first-rate physical infrastructure. France, unlike Britain, has bitten the bullet on public pensions, increasing the retirement age to 65. The French have no qualms about allowing private companies to provide healthcare. Even the Tories do not appear to have the stomach for dismantling the NHS’s near monopoly on the provision of public healthcare.

The British need to get over the idea that they took all the difficult decisions in the 1980s and that Britain is an example for others to follow. It has a huge state, yet has poor social outcomes. Much of its growth in recent years has been down to a turbo-charged financial services industry and an unsustainable expansion of the public sector. Both trends have now run their course and the public sector has become a dead weight on the economy. Britain needs to concentrate on improving the climate for wealth creation. This will require much better public sector productivity and high levels of investment in human capital and physical infrastructure.

Simon Tilford is chief economist at the Centre for European Reform.

by Philip Whyte

Disasters often provoke unseemly bouts of finger-pointing. This has certainly been true of the global financial crisis. In the Anglo-Saxon world, libertarians have blamed it on governments, and governments on ‘bankers’. But in continental Europe, many blame Anglo-Saxons for their supposed reluctance to regulate financial markets. The crisis, they believe, would never have happened if the British and the Americans had regulated and supervised their financial sectors like the French and the Germans. On this view, the UK needs to change, notably by clamping down on hedge funds. Does this narrative stack up? Or have some Europeans just turned Anglo-Saxons and hedge funds into their scapegoats of choice?

Tirades against Anglo-Saxons long predated the crisis, but they have gathered in intensity since it began. In the run-up to the G20 summit in April, Luxembourg’s prime minister, Jean-Claude Juncker, stated that this crisis “started in the US. The Anglo-Saxon world has always refused to add the dose of regulation which financial markets needed.” At the end of the same summit, the French President, Nicolas Sarkozy, announced the death of “unregulated Anglo-Saxon finance”. And in July, Germany’s chancellor, Angela Merkel, told a political meeting in Nuremberg that “with us, dear friends, Wall Street or the City of London won’t dictate again how money should be made, only to let others pick up the bill.”

In any analysis of the causes of the crisis, the UK and the US clearly deserve a share of the blame. They tolerated unsustainable domestic credit booms which wreaked havoc on themselves and the rest of the world. But they were hardly the only countries to experience credit-fuelled housing booms. Denmark, France, Ireland and Spain did too. Nor were they the only countries which allowed ‘shadow banking’ entities to proliferate and banks’ exposures to complex financial instruments to grow. It was a funding crisis at two ‘special investment vehicles’ (SIVs) that brought the regulated German bank, IKB, to its knees. And German banks built massive exposures to collateralised debt obligations (CDOs).

What of hedge funds? Listen to French and German leaders, and you would think that hedge funds were central to the financial crisis. France and Germany have leaned on the European Commission to propose a directive that would regulate hedge funds; they have criticised the Commission’s resulting legislative proposal as too weak; and they have accused the British of dragging their heels. France and Germany are not entirely wrong: the example of Long Term Capital Management in 1998 shows that some hedge funds can pose a threat to financial stability. Even so, it is hard to avoid the conclusion that France and Germany have used the crisis as an opportunity to advance one of their hobby horses.

Both the EU’s de Larosière report and the UK’s Turner review agree that hedge funds did not cause the global financial crisis. They did not drive the growth in sub-prime lending. They did not cause house prices to fall. And they did not force regulated banks (such as Germany’s Hypo Real Estate) to hold CDOs on their balance sheets. So it is quite wrong to imply, as some French and German politicians do, that the crisis would not have occurred if hedge funds had been more tightly regulated. It is also wrong to suggest that the British are reluctant to regulate hedge funds. The British government has accepted the Turner review’s recommendation that “regulation should focus on economic substance, not legal form”.

The Turner and de Larosière reports point to a broad, technocratic cross-Channel consensus on the causes of the financial crisis and the lessons to be learned. Does it matter if this is not reflected in political rhetoric? Yes, for two reasons. First, political obsessions can often drag policy in undesirable directions. (Remember that when Germany chaired the G7 in the months leading up to the crisis in 2007, it was so fixated with regulating hedge funds that it was blind to what turned out to be the central problem: the excessive leverage and effective under-capitalisation of the regulated banking sector). Second, rhetoric can poison negotiations unnecessarily, making agreement more difficult to reach.

Populist broadsides against Anglo-Saxons and hedge funds are unlikely to help the prospect of pan-European regulatory reform. If French and German politicians are not careful, the scenario which they paint of a recalcitrant Britain at odds with the rest of Europe could become a self-fulfilling prophesy. It is no secret that sections of Britain’s media and political class are primed to detect sinister motives in anything emanating from Europe. More often than not, such fears are just paranoid fantasy. But for once, the British may be forgiven if they conclude that France and Germany are exploiting the crisis to promote some of their longstanding objectives and to weaken London’s position as a financial centre.

Philip Whyte is a senior research fellow at the Centre for European Reform.