By Matt Falloon

LONDON, Dec 17 (Reuters) - The British government should not try to prop up or run failed companies, business minister Peter Mandelson said on Wednesday as speculation grows the state is about to step in to help struggling car makers.

Mandelson, delivering a lecture on industrial policy, also said Britain's economy would emerge from the downturn with a smaller financial sector, weaker consumer spending and fewer public sector jobs.

"Whatever the short-term decisions we make on transitional assistance for businesses faced with the extraordinary strains of the downturn, in the long term there is no propping up unviable companies or running businesses from Whitehall," Mandelson said, according to a text of his speech.

"We need to let the dynamics of competition operate within sectors, so that even in strong sectors weak companies can and do fail."

British media have reported this week the government is about to announce support for car manufacturers, with a possible loan guarantee scheme for finance departments among the options.

Unions have warned up to 40,000 car industry jobs are at immediate risk.

The government has already intervened to save struggling banks this year because of the credit crunch and fears are growing a prolonged recession could threaten the viability of other industries.

"There will be major consequences from the current economic slowdown for the structure of the UK economy, long after growth has resumed," Mandelson said at the Royal Society for the encouragement of Arts, Manufactures and Commerce.