We are all experts when we blog. So, let me break with convention and start by admitting I am no economist. What’s more, I really hope I am wrong.
If you read the discussion in the Observer on the future of the economy you might have been struck, like me, by what seemed to be a killer point from Will Hutton. Challenging the notion that government borrowing is unsustainable he pointed out that when he was a child in the 1950s the level of borrowing was even higher as a proportion of national income than it is now. Doesn’t that expose the great weakness in the Treasury View of the current crisis?
Mark Littlewood’s response was simply: ‘Greece’. Which is all well and good, but the world of sovereign debt has long horizons (the UK finished repaying its Second World War debt to the USA in 2006). Events like the Greek crisis come and go and are swallowed up in the long view.
But Will Hutton’s starting point left me feeling uneasy. In the past the UK relied on a combination of stability, growth and inflation to manage its debt. Can any of those be relied upon now?
Take growth. UK growth has been sluggish since the war compared to our European neighbours, but in a sense this has pretty much not mattered. With half the world held back by Communism no one of any size was around to compete aggressively with what we had to offer.
Now the Chinese economy is growing at a rate that sees it double in size every few years. We have enjoyed the benefits of that — t-shirts for a pound make us all feel wealthy — but in the future we face the twin threats of rising resource costs (as China and others consume more raw materials) and competition from a huge and increasingly educated workforce.
Can we truly be sure of a future of guaranteed economic growth for the UK?
Inflation erodes the real value of debt: only the lenders lose. Except, high inflation is no longer politically viable. In a society that is both older than it was in the 1950s and more aspirational, saving has become politically important. Lending has been democratised by the private pension plan. Will voters who want to enjoy long and comfortable retirements tolerate the erosion of their pensions and savings by high inflation?
And what of stability? Surely a critical difference between Britain in the 1950s and Britain today is the mobility of capital? Nigel Lawson abolished exchange controls in the 1980s. The UK can no longer guarantee a captive market for its debt. At the moment 10-year bonds carry interest rates of little more than 2%. The Greek government has to pay 26% – that’s more than I pay for my credit card!
Our rates are low because we trade from a position of strength in the debt markets. It does not have to stay that way and if the government signalled a loosening of its position on debt isnt it the case that the interest rates we pay could rise quickly to unsustainable levels?
I would love to be wrong but I have a nasty feeling that the easy assumptions of the baby boomer generation are as outdated as quiffs and crepe soles. Isnt austerity — an echo of the early 1950s — back in fashion?
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30 Comments
in the 1950s you had the bretton woods agreement, this prevented currencies from fluctuating in value as they do now, and thus prevented the supply side inflation we are seeing now from damaging the recovery, this meant you could borrow more, now you have currencies floating and fluctuating a lot mroe, and consequently, you can have much more inflation caused by currenyc depreciation, which is exactly what we are seeing now……
A major change since the 1950’s is the speed at which things happen. Markets now act at a speed dictated by computers and a lot of the time, computers take market decisions based on their software without any human interference. Garbage in – garbage out still applies which is why oscillations in the market are so big and fast.
Thanks Ed, an interesting article. What I feel is that servicing the debt (the cumulative deficit) is what opens you up to the whim of the markets… in good times one can borrow & borrow, as Greece and others found, but if the markets get skittish then suddenly one cannot roll the debt over and you’re in deep trouble.
It’s the same for individuals – in the good times the banks might be encouraging us to take out 125% mortgages, but that can suddenly turn into a reluctance to provide 70% mortgages.
That is why I have written on here before that the Lib Dems shld commit to paying down the debt over time – still borrowing in the bad times to keep things going, but over the course of an economic cycle we shld pay down the debt slowly but surely. It’s having that debt that opens you up to the power of market whim.
The principle issue with Hutton’s WWII debt analogy is that the deficits due to war-spending ended with the war. There was, to make an analogy a long period of ‘war austerity’ otherwise known as peace following the armistice. That rather more than the anaemic growth of the 50s and 60s helped bring down the debt.
The deficits we, and the rest of Europe, are dealing with today are due to annual public spending commitments exceeding annual taxes. Some of those commitments like PFI and debt repayment extend 30-50 years into the future. If we dealt then only with current spending in the same way we paid back the Americans, it would involve demobilising large parts of the public sector.
There is perhaps unsurprisingly little political appetite for that, least of all from Hutton.
“even higher”
The phrase, ‘even higher’, suggests that our national debt is high by historic standards – in reality it’s lower than it has been for the majority of the last 300 years and less than a third of the level it was at at the end of the war.
Ed – I don’t think you have to be an economist to realise that only looking at one factor before coming to a conclusion i overly simplistic.
The real problem for the UK at the moment is not the percentage debt is of GDP, but the direction of travel this government inherited – a rapidly growing deficit with no clear plan about how to get back to balance. Had the government not addressed this the interest rate we pay on government debt would have risen anf the cuts would have ultimately been worse.
It seems to me that the argument that we shouldn’t worry about the level of debt because it was higher after each of the world wars falls down on the fact that we haven’t just fought a world war.
Will Hutton is so utterly wrong it would take a book to explain in full. The demographics of society were totally different then compared to now. The UK, for various reasons (political and demographic) has a much higher dependency ratio, with people claiming far more in terms of benefits (unemployment and disability) and pensions than was ever the case in the 1950s. We are now a much older society, with fewer productive people. Even those young people we do have have often been rendered unproductive or unemployable through family breakdown and devalued education. Employers have preferred to bring in their workforce from abroad (one look at the employment figures proves this beyond dispute), leaving Britain as a whole to pick up the bill.
Given the high dependency ratio Britain faces, its ability to grow its economy and repay debts is consequently much reduced. Getting even deeper into debt now without resolving some of the thorny problems facing the UK economy is exactly the kind of “Greek” solution that Labour is espousing and that is precisely wrong if Britain is to secure a prosperous future.
Good article, Ed. That comment from Will Hutton also leapt out at me, and I felt that Mark’s answer were decidedly insufficient.
The main difference is the extent to which we inflated away the debt. In the 1950s and 1960s we had inflation at levels akin to what we are experiencing today. That meant that the debt shrank in comparrison with nominal GDP. Some people (including, I suspect, Will Hutton and, if I am not mistaken, our own Tim Leunig) argue that a spot of 5% inflation to help manage the national debt is an acceptable price to pay.
However, one need only look at what that level of inflation is doing to people’s living standards in terms of a rapidly-rising cost of living to see that adopting an inflationay policy for the next two decades (as was the case in the two following Will Hutton’s birth) will severely hurt, especially those on low incomes. You are right. too, to note that it will undermine saving (which we should be encouraging) and degrade pensions (ditto).
Finally, it is questionable to what extent we can stop the inflationary train once it has started rolling. The inflations of the 50s and 60s were followed by the inevitable further-inflation of the 70s, when RPI peaked at 24.2% as governments printed money in a desparate attempt to keep the bubble inflated. When eventually the Thatcher government sought to stop the train, it plunged us into a hard and painful recession that was accompanied by 3 million unemployed.
Inflating the national debt away is really not an option. Consequently, we will have to pay it off, and grow our economy (and therefore tax base) to make it managable.
Interestingly, you mention that “UK growth has been sluggish since the war”. That was (at least in part) because of the debt, as high debt-to-GDP ratios act as breaks on economic growth.
To be fair to Mark, I don’t think that the Observer was likely to allow him to explain this in detail in that forum, and anyway Will Hutton is famous for interrupting people who disagree with him and talking over them. But I do think that the point needs to be made (and the proposal to run higher debts countered) because it is quite insidious and dangerous.
@Liberal Neil: “the argument that we shouldn’t worry about the level of debt because it was higher after each of the world wars falls down on the fact that we haven’t just fought a world war”
That is a very good point. Rather than viewing the high national debts in the 50s as proof that we can cope with high national debt, we should view them as adults in the 50s viewed them: the unfortunate price that we had to pay for something awful but unavoidable.
The two world wars brought our nation together in a way that increasing NHS spending to the European average, or introducing tax credits, really doesn’t.
“Can we truly be sure of a future of guaranteed economic growth for the UK?”
If you will forgive me for linking a blog post then the three economic forecasts therein may provide an idea of our prospects come the middle of the century:
http://jedibeeftrix.wordpress.com/2011/03/09/britain-in-the-world-%E2%80%93-a-long-slide-into-oblivion/
As to Will Hutton pointing at the 1950’s it may have been due to a much healthier demographic profile, i.e. the tax-payers to non-tax-payers ratio:
http://www.nationmaster.com/country/uk/Age_distribution
oops, forgot this one too –
check out the 2040 debt profile of the UK even assuming the deficit reduction plans announced in the 2010 election:
http://www.bis.org/publ/work300.pdf
Correct me if I’m wrong but weren’t taxes lower before the war which meant that they had to go up (and stay up) both to fight the war and pay off the debt. We don’t have as much leeway to increase them as we did then.
@Tom Papworth:
“Inflating the national debt away is really not an option. Consequently, we will have to pay it off, and grow our economy (and therefore tax base) to make it managable.”
Tom you are making the assumption that Britain CAN grow its way out of recession. What is to say with any certainty that cheaper, better products from other countries will not gobble up some of our export markets faster than we can ever create new ones? There is no divine right of British people to not be scavenging on top of waste tips.
Inflation averaged 5% in the 1950s. That gets rid of about half the debt in real terms in a decade… Not a difficult result to achieve again if we wish to do so.
@Tim Leunig: Indeed, it’s fairly easy to achieve inflation. It’s not clear that it’s so easy to stop. In the meantime, it destroys the value of saving, including the value of private pensions, which will increase government’s un-funded liabilities in the future. It also hurts people on fixed or low incomes, who experience a real-terms fall in their standard of living. As I noted above, people are already complaining about the pain of 5% inflation. How do you think they’re going to feel if it goes on for a decade?
Anyway, roughly a third of our national debt is index linked? You can’t inflate that away no matter how much you try.
It is not a killer fact, and we have had this question before. The government is committed to reducing the spending deficit. Gordon Brown inherited a budget that was in balance, but left a dangerous and increasing spending deficit. Debt is the accumulated deficit. The position was so bad that we will not be able to bring the budget back into balance over this parliament, so the level of debt will continue to increase. If we had not shown that we could bring our spending under control, amongst other problems, the money markets would have lost faith in us. Mark Littlewood shortened this argument to ‘Greece’. The document referred to by Jedibeeftrix (above) gives a much longer explanation.
Charles Dicken understood the point perfectly when he had Mr Micawber say “Annual income twenty pounds, annual expenditure nineteen nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.”
All the above points about why the war debt isn’t relevant are true. We slowly extracted ourselves from such huge debts in the post-war years, but there was considerable post-war austerity, we did it with relatively high growth, we did it with high inflation which led to other serious problems, and it took us decades to do it. We did it in a world where we had an advantage in our access to world war materials and world capital funding, which we don’t have today.
To be fair to Will Hutton, he didn’t claim that, because the debt was so high after the war, we don’t have to worry about the deficit. He said that, under the coalition’s plans the debt would peak at 70%, and under the Alistair Darling’s outline plan, it would peak at 75%.
What Will Hutton doesn’t say, and probably should, is: “If the difference between the Darling plan and the Coalition plan isn’t that large, so it’s silly for Guradian commentators to be screaming in apoplexy about the cuts.”
He also fails to point out that Ed Balls disagreed with the Darling plan, claiming it would involve cutting too far and too fast. How high would the debt have risen under Balls? We don’t know for sure, because he’s never produced a plan. But, clearly a lot higher than 75%.
There’s also a problem with both the Darling and the Coalition plans. They assumed a reasonable pace of world growth, and particularty of European growth. It now looks like growth will be slower, so the deficit reduction programme will be harder (as it would have been for Darling).
And neither of those plans allow for the possibility of another economic crisis.
The risk of this second crisis, now worryingly likely, only makes it all the more important we have our finances under control. If we went into a second world recession without the credibility to borrow, it would make the pain of the last recession look mild in comparison.
What Will Hutton doesn’t say, and probably should, is: “If the difference between the Darling plan and the Coalition plan isn’t that large, so it’s silly for Guradian commentators to be screaming in apoplexy about the cuts.”
After trying to parse that into English, I still can’t see much logic there.
Could the point be that the cuts are going to hit the poor where it hurts – without making that much difference to the peak debt?
@tim leunig “Inflation averaged 5% in the 1950s. That gets rid of about half the debt in real terms in a decade… Not a difficult result to achieve again if we wish to do so.”
If we wish to. But, as you know, there’d be major downsides to sustained inflation. You’ll know the following much better than I do, but the arguments are still worth putting.
Sustained inflation might be less of a problem, if we had a large debt but a low deficit.
There are many countries with much bigger debt problems, but it’s our deficit that’s the problem, not the debt. The deficit means that every year we’re having to borrow many billions on the financial markets.
At the moment, we’re borrowing that debt at relatively low long-term interest rates, because the financial markets think our current inflation rate is due to temporary factors. But if they start to think the government may deliberately keep inflation high, the interest on new and future debt will rise, and the long-term cost to the country will be considerable.
It’s not the debt that’s the killer, it’s the interest you have to pay on the debt. At the moment, the interest we’ll pay on most new debt is low. If we lost our reputation for low inflation, it could become prohibitive.
Or …
Great Moderation
Great Ponzi
Great Recession
Great Reset ?????
Maybe there’s a stage missing … or is it a different way of describing the last one …
Great Haircut
@George Kendall:
“We did it in a world where we had an advantage in our access to world war materials and world capital funding, which we don’t have today.”
And we also had a massive captive market who gave us raw materials for pennies and bought anything off us they could afford to as they had no skills, education or manufacturing in the main. A kind of ‘post-Saddam Iraq times 20’.
To answer the main question of the article, there is no garenteed growth for the UK. Baby boomer assumptions are obsolite, and following nostalgic instincts from the 1950s-70s will place my generation’s future at risk. Britain’s place in the world has shifted fundementally, as has the global political economy. We face two economic crisies simultaniously.
The globalised financial system is sitting on credit in order to safeguard lenders if a number of their deals should go south: bets are being hedged. This is because for one consumer confidence is at an ebb because they are worrying about the future of their own jobs, and for another government debt is no longer a garenteed winner. The result is a reduced credit flow.
With huge deficits being run by many major Western economies inside and outside of the EU, lenders are on the brink of a crisis of confidence in government debt because of the risk of default as weak leaders fail to adress their budget deficits. This blocks off our ability to introduce a meaningful stimulus of new spending projects.
Therefore, the government’s duty is to retain the faith of the markets (as displayed by our credit rating) whilst dealing with the shortage of private captial. This means cutting and redistributing: reducing government expendature in areas less likely to influence growth, and redistributing a proportion of the resulting savings to areas of government expendature more likely to result in growth. In practice, this means something akin to cutting military spending in favour of a programme of liberalisation of the education system, where private capital (re-assured by the falling deficit) will be able to step in and create thousands of new jobs (re-assuring consumers whose transferable skills can always be used by schools), resulting in increased spending from newly-employed caretakers, teachers, librarians and IT technicians (as well as overhauling the historically weak British education system).
Tom Papworth
The inflations of the 50s and 60s were followed by the inevitable further-inflation of the 70s, when RPI peaked at 24.2% as governments printed money in a desparate attempt to keep the bubble inflated.
Don’t you think the quadrupling of oil prices when supply was largely in the hands of the OPEC cartel also had something to do with that?
George Kendall
We slowly extracted ourselves from such huge debts in the post-war years, but there was considerable post-war austerity, we did it with relatively high growth, we did it with high inflation which led to other serious problems, and it took us decades to do it. We did it in a world where we had an advantage in our access to world war materials and world capital funding, which we don’t have today.
Inflation was not particularly high in the immediate post war era – as I have suggested, the 1970s peak was in part due to other factors, though I accept also that some of the mid-1970s inflation was an evening out of early 1970s house price inflation. There was actually a house price collapse in the 1970s, but disguised as house prices standing still while other prices and wages rose.
In the immediate post war era, industry was largely in British hands, so we were not held to ransom by those in control of business threatening to move off abroad if they were asked to pay their share. Also the welfare state did give ordinary people more confidence. There was greater social cohesion, which helped develop a more co-operative and productive manner, though one can say aspects of it were socially stifling. This may be how we came to have greater economic growth then when we had taxation and welfare policies of a sort the experts tell us now are ruinous for growth.
Over two thirds of our GDP is made up of domestic demand, so I don’t really obsess about export led growth as much as some people do (of course it’s still important). Whilst low and middle earners (the working-middle classes) are squeezed we’re unlikely to see much growth. India & China on the other hand are lifting millions out of poverty and into the middle classes, creating huge domestic demand, and therefore rapid growth. Add to this all the research that shows economies with high income inequalities cannot sustain growth over even the medium term, and you begin to see how important it is to protect domestic demand.
For me, economics is about development. You can’t enhance an economy by reversing its development. The IMFs ruinous Structural Adjustment policy showed that. Whilst developing nations that rejected the IMF prescription by investing in infant industries are becoming the new powers. Similarly with Greece, they won’t get out of their mess by destroying their middle class.
Anyone wanting to read more on this, there’s an IFS briefing paper on it:
http://www.ifs.org.uk/publications/1776
Tim Leunig and others,
Inflation is not the solution
the problem with inflation is that a majority of the government bonds are indexed to inflation. This means that when inflation rises the government debt rises with it!
Also many benefits are inflation linked. Increases in inflation do not make the government’s current liabilities smaller they simply increase with inflation.
Adding to this the cost of a loss in reputation, which means that people demand higher interests on any savings thinking inflation is an not option, and simply insane!!!
Stable prices are essential for growth! With fear of inflation and devaluation of currencies elsewhere, stable prices would increase confidence in the UK and make it attractive investment.
Um, following the 2008 banking crisis GDP fell 6%, causing the relative proportion of debt to jump unexpectedly. This raises the question about how we calculate sustainability.
So doesn’t the growth of the financial sector within the UK economy offset Hutton’s argument about debt as a proportion of income, since the potential for GDP volatility is massively increased compared to 1990 (let alone 1950) under conditions of retrenchment?
Perhaps it would be wiser to measure the sustainability of debt levels against the real economy, excluding the artificial economy of circular capital flows.
Clearly all the correspondents above are very young. Between the austerity of the 1950s and now was the sight of Labour’s Dennis Healey, having to go to the IMF for a bailout when the country was broke in the 1970s.
What LibDems should be discussing is – if politically we accept that the government should live within its means across the economic cycle, what share of the national cake should the government take to ensure fairness in society?
Analysis in the US showed that the share of income by the top 1% of earners before the collapse in 2008, reached the levels it was at in 1929. In between the share of the top 1% was much lower. So not only is taxing the rich to provide services for the poor, good for fairness, its also makes extreme financial situations less likely! We should only be encouraging the type of entreprener who willingly pays 50% tax to settle in this country.