Thursday, January 21, 2010

Power Without A Plan




As Benedict Brogan reminds us this morning, if Cam has a secret plan for government, he is keeping it damned quiet. We still have no idea how he and George plan to deliver the massive spending cuts required to fend off financial and economic melt-down.

And just to put our plight into its broader horrific context, take a look at the somewhat dense chart above (click on image to enlarge) from this week's McKinsey report on Debt and Deleveraging. For each of ten OECD economies, it shows the ratio of total debt (ie government debt plus private sector debt) to GDP - otherwise known as a country's leverage ratio. And it shows how that ratio has changed over the last two decades.

As we can see, the UK (light green line) has clocked up by far the biggest increase in debt of any country bar possibly Spain. And we are now right at the top of the debtor's league, more indebted than any other country bar Japan. And most of it accumulated on Brown's watch.

Now as we've blogged before (eg see here), the bulk of this debt was not incurred by the government directly. It was incurred by individuals and companies. But by effectively nationalising the liabilities of our banks, the government has now taken much of the debt onto its - ie taxpayers' - shoulders. Moreover, right now, it is the government itself which is doing most to add to the national debt mountain through its ballooning fiscal deficit.

So back to the Plan, or lack of it. To recap (see this blog), Cam and George will need to close a structural fiscal deficit that is both the biggest in the developed world, and the biggest in our own peacetime history. It is estimated by the OECD at 10% of GDP - around £150bn pa.

Labour has so far pencilled in cuts and tax increases amounting to just over 3% of GDP - although one-third of that comprises tax increases (mainly the new tax on jobs via NICs), and they have outrageously failed to provide any detail on what specific areas of public spending will be cut (other than admitting that capital expenditure will be slashed).

George has so far promised specific cuts totalling £7bn, but has failed to explain whether they are in addition to Labour's cuts, or simply a bit of detail within Labour's existing totals. And Cam has compounded the problem by excluding the NHS and overseas aid from the cuts (thereby loading all the pain onto the other 80% or so of spending).

So what are they actually going to do come 6th May? Yes, Cam will stand in the sunshine on the steps of No 10, looking great with Sam by his side, and deliver his homily. But what happens once he goes inside and that wonderful old door closes behind him?

Here's what: the tradesmen's entrance from No 11 suddenly bursts open and an ashen faced George races in waving the secret Treasury file spelling out the real options:
  1. Lean and mean - immediate 20% cut in all Departmental Expenditure Limits, increase in State Pension Age to 70 by 2015, outright abolition of Child Benefit and other working age benefits, 5 year freeze on all public sector salaries and pension entitlements.
  2. Siege economy - whack up taxes - double VAT, 30% standard rate of income tax, 60% higher rate, 35% Corporation Tax - manage loss of competitiveness by leaving EU and imposing Bennite tariff wall.
  3. Weimar Republic - rescind Bank of England independence, fire up the presses, inflate the debt away
  4. Whistling in the dark - do none of the above and hope the economy somehow grows us to salvation before the markets take fright
Most helpfully, the McKinsey report looks at how these approaches have panned out in the past (32 separate episodes since the Depression).

Whistling in the dark, aka growing out of debt, is the most attractive, involving least pain, and least loss of GDP in the process of deleveraging (ie reducing the ratio of debt to GDP). Unfortunately, McKinsey could find only three cases where that has happened, and they all involved WW2 or oil booms.

Weimar Republic, aka high inflation, has been the way out in a quarter of cases, so it's definitely a runner. But it doesn't always pan out altogether for the best, as Weimar showed all too clearly. And with today's skittish globalised bond markets it could easily end in a Götterdämmerung of high interest rates and collapsed sterling. Which might not be that great.

Massive default is a possibility not explicitly covered in the secret Treasury file - yet. But McKinsey reckon it too has been deployed in a quarter of cases. We'd just need to decide if we wanted to rank alongside Mexico and Argentina, and give up any hope of international credit for a generation or two.

Still, the clear winner - the approach that's been deployed in half of all cases - is what McKinsey call simply belt-tightening. The most common response of over-indebted countries is to borrow and consume much less.

Of course, individuals and companies know that, and many are already taking action to cut their debts. But governments are not always so bright. Or so decisive.

So as they contemplate maybe putting together some kind of plan, Cam and George might care to note a specific concern McKinsey raise:
"Current projections of government debt in some countries, such as the UK... may offset reductions in debt by households and the commercial sectors. We therefore see a risk that the economies may remain highly leveraged for a prolonged period, which would create a fragile and potentially unstable economic outlook over the next five to ten years."
I hope someone at the Treasury remembers to highlight that point with a particularly flourescent marker.

We cannot afford any more faffing around.

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