Latest / Merryn Talks Money / The UK Government Must Cut Spending - Here's Why (with Kallum Pickering)

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The UK Government Must Cut Spending - Here's Why (with Kallum Pickering) · Merryn Talks Money

0:02
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Speaker 1: onto the show. Welcome to Meren Talks Money, the podcast
0:34
Speaker 1: and most people who know the markets explain the markets.
0:36
Speaker 1: I'm Meren Sumset Web. This week I am speaking with
0:38
Speaker 1: Callum Pickering Peel Hunt, chief economist. How close are we
0:43
Speaker 1: do an economic crisis in the UK? If you ask me,
0:45
Speaker 1: I say closer than we've ever been in my career
0:47
Speaker 1: of the financial journalist. If you ask Cullum, not quite
0:50
Speaker 1: as close as it feels to me. He argues at
0:52
Speaker 1: the nation and particularly the government, just don't fully understand
0:56
Speaker 1: the nature of the problem with the UK economy. In
0:58
Speaker 1: a recent research note titled why is UK Growth Sluggish?
1:01
Speaker 1: Callum lays it out his thesis. We talked about that
1:04
Speaker 1: note in this conversation, as well as getting his take
1:07
Speaker 1: on the upcoming budget. What exactly is going to happen? Callum?
1:11
Speaker 1: Welcome back, to myrin drugs.
1:13
Speaker 2: Money, my pleasure. Thank you so much for having me.
1:16
Speaker 1: Right, and we're gonna have one of our usual super
1:19
Speaker 1: upbeig conversations about the UK economy and UK politics.
1:22
Speaker 2: Right, that's right. Well, you know, I'm always trying my best,
1:25
Speaker 2: at least to just not be counter narrative on purpose,
1:28
Speaker 2: but just to kind of question the narrative a little bit.
1:31
Speaker 2: The last one, of course, everybody was focused on the
1:33
Speaker 2: price of energy. I tried to make my case that
1:35
Speaker 2: it's really the supply. This time around, I've taken issue
1:39
Speaker 2: with two things. The first is the idea that the
1:41
Speaker 2: economy is stagnating. It's actually not stagnating. Has some issues,
1:46
Speaker 2: but stagnation is not the right word. And second that
1:49
Speaker 2: the problems are uncertainty and confidence. I consider these to
1:52
Speaker 2: be symptoms of a problem rather than the problem in
1:55
Speaker 2: of itself, And in this this lady's piece of research,
1:58
Speaker 2: I've tried to unpick some of this a little.
2:01
Speaker 1: Okay, well, let's start at the very beginning. When you
2:03
Speaker 1: say it's not stagnating, what is it that you mean,
2:07
Speaker 1: Because you know, growth rate of under two percent for
2:10
Speaker 1: quite some time, that looks like stagnating to me.
2:13
Speaker 2: So UK potential growth is probably in the sort of
2:17
Speaker 2: mid one to two range. Let's get I think it's
2:19
Speaker 2: probably around one point six one point seven percent. If
2:22
Speaker 2: I look at the last two years of UK economic
2:25
Speaker 2: performance so late twenty twenty three, which roughly coincides with
2:29
Speaker 2: the normalization of the acute gas supply shock in Europe
2:32
Speaker 2: and the Bank of England stopping graizing interest rates, We've
2:35
Speaker 2: had annualized economic growth since then of one point seven percent.
2:40
Speaker 2: It's been predominantly driven to my by domestic oriented services. Now,
2:45
Speaker 2: this is not stagnation over say a full business cycle.
2:49
Speaker 2: If you had the normal fluctuations with growth above two
2:53
Speaker 2: for a while and then a period of recession, I
2:55
Speaker 2: think we'd be somewhat happy with this. To put it
2:57
Speaker 2: into context, between twenty ten two nineteen, growth was two
3:02
Speaker 2: point one percent annualized, with with bit better growth on
3:04
Speaker 2: things like exports and industry. But I think there's a
3:08
Speaker 2: kernel of truth, at least from the market's perspective, in
3:12
Speaker 2: the view that the economy is stagnating for the following reason.
3:16
Speaker 2: When I look at the components of this one point
3:18
Speaker 2: seven percent growth, what I see is a big expansion
3:21
Speaker 2: in government spending and declines in cyclical sectors like new
3:26
Speaker 2: housing construction, like durable goods expenditure, like broad construction in
3:31
Speaker 2: the private sector, which suggests to me and I call
3:35
Speaker 2: this kind of the flat white economy, the steady state,
3:38
Speaker 2: people buying coffees, people paying their bills. That stuff is
3:42
Speaker 2: actually ticking over, okay. But the cyclical bit of the economy,
3:46
Speaker 2: which markets tend to look forward to, which companies need
3:49
Speaker 2: to react to by raising capital in order to then
3:52
Speaker 2: do a little investment, that bit is actually not stagnating,
3:55
Speaker 2: but in many respects it's in decline. And I think
3:58
Speaker 2: the crux of the economic problem lies in trying to
4:02
Speaker 2: better understand why we have this absence of cyclicality right
4:06
Speaker 2: at the start of an economic cycle. And I put
4:09
Speaker 2: this on fiscal policy makers. I say that the policy
4:13
Speaker 2: makers fundamentally are lacking the credibility to get benchmark interest
4:17
Speaker 2: rates to where economic fundamentals need them, and because they're
4:22
Speaker 2: obstructively high, probably to the tune of about one hundred
4:25
Speaker 2: basis points on the ten year, we are crowding out
4:28
Speaker 2: these cyclical parts of the private sector. And this is
4:31
Speaker 2: essentially the heart of the issue that the UK's facing
4:34
Speaker 2: and why these budgets matter so much.
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Speaker 1: Okay, we're going to come back to your three points
4:40
Speaker 1: on why you think the UK economy is sluggish, if
4:42
Speaker 1: not stagnating, But I do want to make the point
4:44
Speaker 1: before we do that that you're looking at GDP as
4:46
Speaker 1: a whole, and a lot of our listeners very interested
4:49
Speaker 1: in looking at population adjusted. So it's GDP per head
4:52
Speaker 1: and if you look at GDP per head, as you know,
4:55
Speaker 1: this is barely budged for years, and that is stagnant.
4:58
Speaker 2: Well, I have to push back on that again. If
5:00
Speaker 2: I look at the living standards of workers, so real incomes,
5:06
Speaker 2: real wages, they're rising nicely and have been for three years.
5:09
Speaker 2: It pays to work in the UK. What we have
5:12
Speaker 2: is a problem integrating new immigrants into the labor force,
5:16
Speaker 2: and therefore we have this ratio of output to population
5:22
Speaker 2: which is unchanged. But within that what you see is
5:25
Speaker 2: for workers, living standards arise in and for people that
5:27
Speaker 2: are not participating in the labor market, living standards are declining.
5:31
Speaker 2: And so the problem is not that we are not
5:34
Speaker 2: producing a means to raise living standards in the UK.
5:38
Speaker 2: It's that actually we are not properly integrating people into
5:42
Speaker 2: the labor market so that more and more people can
5:45
Speaker 2: participate in that wage story and lift per capita GDP okay.
5:49
Speaker 1: So it's rising levels of non participation as opposed to
5:52
Speaker 1: stagnating levels of productivity.
5:54
Speaker 2: Per worker wages per worker. We have to be a
5:57
Speaker 2: little bit careful with the productivity statistics at the moment.
6:00
Speaker 2: But for wages in the UK, inflation adjusted wages have
6:03
Speaker 2: been growing at a nice clip for the past two
6:06
Speaker 2: to three years. If I look at real disposable income
6:09
Speaker 2: for the household sector as a whole, we've had faster
6:12
Speaker 2: growth over the past three years, about one point eight
6:15
Speaker 2: percent year over a year, than we have had in
6:17
Speaker 2: the whole post GFC period. You have to go back
6:20
Speaker 2: to the pre Global Financial Crisis period and this is
6:23
Speaker 2: where you start to find some of the signs to
6:28
Speaker 2: what may be going on. So we've had this rise
6:31
Speaker 2: in real disposable income for the household sector since twenty
6:34
Speaker 2: twenty two, which is which is when inflation, of course
6:37
Speaker 2: peaked at eleven percent and it's come down.
6:39
Speaker 1: Do you know I'm going to interrupt you sorry, kind
6:41
Speaker 1: of briefly say that not all of our listeners are economists.
6:45
Speaker 1: So when you say real disposable incamp per household. Can
6:48
Speaker 1: just break that down for us and explain to listeners
6:50
Speaker 1: what is is you, This.
6:52
Speaker 2: Is the total amount of income which can be spent
6:54
Speaker 2: post tax, adjusted for prices. So we have had this
6:59
Speaker 2: rise over the past three years, but since twenty twenty
7:03
Speaker 2: two we've had a doubling of the savings rate in
7:05
Speaker 2: the UK from about five percent to ten percent. Now
7:10
Speaker 2: what's important to understand here is that conventional wisdom, which
7:16
Speaker 2: is households are saving more because they're uncertain about the future,
7:20
Speaker 2: they're lacking the confidence to spend, does not fit the
7:24
Speaker 2: fact on a relative basis. So what I mean by
7:27
Speaker 2: that is, suppose you were to compare the UK household
7:30
Speaker 2: to the US household. US households are saving just four
7:33
Speaker 2: percent of their income compared to ten percent in the UK,
7:37
Speaker 2: and we, of course have had this increase both sectors,
7:40
Speaker 2: both household sectors have had a nice increase in inflation
7:43
Speaker 2: adjusted incomes. What I don't see is additional weakness in
7:49
Speaker 2: British confidence versus US confidence. If I look at things
7:53
Speaker 2: like the index of economic pulsy uncertainty of course, with
7:56
Speaker 2: trade wars and the uncertainty around Trump's policy agenda. We
8:02
Speaker 2: report more uncertainty in the US than in the UK,
8:06
Speaker 2: so the facts don't fit the picture that confidence and
8:08
Speaker 2: uncertainty explain this saving trade isn't.
8:11
Speaker 1: One of the important things here that there is not
8:13
Speaker 1: a regular expectation in the US that there will be
8:17
Speaker 1: a consistently rising tax burden, whereas in the UK we've
8:21
Speaker 1: had for the last three or four years a constant
8:24
Speaker 1: expectation of a rising tax burden. And that's particularly relevant now.
8:27
Speaker 1: So that's one big difference between the US and the
8:30
Speaker 1: UK in terms of individual continence.
8:32
Speaker 2: No, I don't think so. And actually, if I just
8:35
Speaker 2: think about the size of the deficit in the US,
8:37
Speaker 2: the fiscal deficit, it's sevenercent of GDP, it's actually almost
8:40
Speaker 2: twice what it is in the UK. And at least
8:42
Speaker 2: in the UK's instance, it's likely to decline over time,
8:45
Speaker 2: whereas it's likely to remain around seven percent of GDP
8:47
Speaker 2: In America. That deficit is a signal that at some
8:52
Speaker 2: point taxes have to go up. For Americans, that's a
8:54
Speaker 2: much stronger signal in the long run that taxes need
8:57
Speaker 2: to be adjusted upwards.
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Speaker 1: Sure, but that what ordinary people listen to. They listen
9:02
Speaker 1: to the political conversation as opposed to looking at the
9:05
Speaker 1: size of the deficit. If we're thinking about the ordinary person,
9:09
Speaker 1: not the economist, not the professional investor, not someone who
9:12
Speaker 1: understands the bond market, not someone who looks at how
9:15
Speaker 1: bigger deficit is or isn't. What they're looking at is
9:17
Speaker 1: the political conversation. And here the political conversation is all
9:21
Speaker 1: about your taxes are going up, And in the US
9:24
Speaker 1: the political conversation is absolutely not like that. Of course
9:27
Speaker 1: you live in.
9:28
Speaker 2: New I suspect that part of the story maybe that
9:31
Speaker 2: people anticipate taxes going up, but there's just something much
9:34
Speaker 2: more fundamental taking place, which is since twenty twenty two,
9:38
Speaker 2: UK household net wealth has declined appreciably. In the US
9:43
Speaker 2: it's up almost fifty percent. And what you find is
9:47
Speaker 2: in credit based economies, consumer oriented economies like the US
9:51
Speaker 2: and UK, trends in household spending are influenced greatly by
9:56
Speaker 2: trends in household net wealth. So take the experience in
10:00
Speaker 2: the UK, for instance, ten twenty nineteen, we had a
10:04
Speaker 2: dramatic appreciation in house prices. We had a dramatic appreciation
10:09
Speaker 2: in guilt, which is what drove interest rates down over
10:12
Speaker 2: that period we also saw actually quite a decent rally
10:16
Speaker 2: sustained rally in UK equities. This supported net wealth and
10:22
Speaker 2: it meant over that period, even in the ghastly uncertainty
10:28
Speaker 2: of the post financial crisis period, when in twenty twelve
10:31
Speaker 2: we had a horrible budget, the Omni shambles budget, with
10:35
Speaker 2: the weak confidence and the uncertainty, and in the wake
10:38
Speaker 2: of the Euro crisis, UK households were reducing their savings
10:41
Speaker 2: rates with weaker income growth because in net wealth terms
10:45
Speaker 2: they were becoming much better off. So when you had
10:48
Speaker 2: this dramatic upturning net wealth, you had this corresponding reduction
10:52
Speaker 2: in saving This time around, you see from twenty twenty
10:55
Speaker 2: two onwards, roughly coinciding actually with the big fiscal event
11:00
Speaker 2: which was the Trust budget wobble in the bond market,
11:03
Speaker 2: you have this crash in household net worth to the
11:07
Speaker 2: tune of a trillion pounds, mainly in pensions, coincide with
11:11
Speaker 2: this sudden adjustment upwards in the household savings rates. So
11:15
Speaker 2: what I maintain here is we try to apply narratives
11:18
Speaker 2: about uncertainty over taxes, uncertainty over economic policy confidence which
11:22
Speaker 2: I can't spot a clear trend in the fact. But
11:25
Speaker 2: then I see this very clear fact in front of me,
11:28
Speaker 2: which is households are actually poorer in net wealth terms
11:30
Speaker 2: in the UK, they've responded by saving more. In the US,
11:34
Speaker 2: where we often see similar patterns of household behavior, households
11:37
Speaker 2: are saving much less, but they've had a dramatic increase
11:39
Speaker 2: in net wealth, which means households are rational. They are
11:44
Speaker 2: reacting to being poorer by saving more. This is why
11:47
Speaker 2: this fiscal problem that we have comes at such a
11:50
Speaker 2: bad time, and we should get into a conversation about
11:54
Speaker 2: what is underpinning higher interest rates in the UK. But
11:57
Speaker 2: these higher benchmark rates versus what you would act expect
12:00
Speaker 2: given economic fundamentals and given rates in other countries, are
12:05
Speaker 2: holding back asset prices by pushing mortgage rates, by holding
12:10
Speaker 2: down the underlying value of the bonds, and by forcing
12:13
Speaker 2: equity analysts to apply a discount rate that is higher
12:16
Speaker 2: than it ought to be to equities.
12:18
Speaker 1: Okay, so most people will recognize that fall in their wealth.
12:21
Speaker 1: I mean, if you look at the shifts in the
12:25
Speaker 1: bond market, a lot of people will feel that only
12:28
Speaker 1: through their pension portfolios, right, and not everybody looked at
12:31
Speaker 1: their pension portfolios. Not everyone will be aware of that shift,
12:35
Speaker 1: but enough people will be.
12:37
Speaker 2: Plus the story in UK equities, plus the story we
12:41
Speaker 2: see in house prices.
12:42
Speaker 1: But of course most people aren't very exposed to UK equities,
12:46
Speaker 1: and we see that across all portfolios that they tend
12:48
Speaker 1: to be much more exposed to the US, irritatingly than
12:51
Speaker 1: to the UK, particularly inside a pension portfolio if it's
12:55
Speaker 1: one of their auto enrollment portfolios or something like that,
12:57
Speaker 1: where they might be slightly more exposed to the US
12:59
Speaker 1: than the old fashion pension to the UK. Then old
13:02
Speaker 1: fashion pensions are still it's a minority of their holding.
13:05
Speaker 1: So they should be seeing rising well from their US
13:08
Speaker 1: portfolios and from the UK portfolios this year definitely, so
13:11
Speaker 1: they will be feeling it in the main through their bonds.
13:14
Speaker 2: We'll we've seen it in the main through their bond exposure.
13:16
Speaker 2: And I suspect if you inflation adjust, most people's house prices,
13:20
Speaker 2: especially in London and the Southeast, house prices have declined
13:23
Speaker 2: appreciably over this period. And again, just to get out
13:27
Speaker 2: of the abstract economics for a second, what we all
13:30
Speaker 2: know is true and it's why QI worked so well
13:32
Speaker 2: to stimulate the recovery is people on a Friday night
13:36
Speaker 2: at their dinner parties like to say, Oh, I'm feeling
13:39
Speaker 2: frightfully well off. My house price has just gone up
13:41
Speaker 2: by fifty thousand pounds in the last month. I'm going
13:43
Speaker 2: to go and borrow some money to do some repair
13:44
Speaker 2: maintenance improvement on my extension or whatever. This is not
13:49
Speaker 2: happening in the UK, and so this net wealth shock,
13:52
Speaker 2: which is persisted because we have these obstructively high interest rates,
13:56
Speaker 2: is holding back the normal cyclical momentum. Let me just
13:59
Speaker 2: come at this from two day two different ways, because
14:01
Speaker 2: the thing that's really important when you have economic problems,
14:05
Speaker 2: which we do, is to demystify and to just sense
14:08
Speaker 2: check the narrative. And that's why I think it's important
14:11
Speaker 2: to push back on these notions of confidence and uncertainty
14:14
Speaker 2: and tax worries when we can see this real effect.
14:17
Speaker 2: Consider this in a different way. If I look at
14:20
Speaker 2: consumer confidence for the UK and I look at it
14:23
Speaker 2: across age groups. The GfK index is split by four
14:27
Speaker 2: different demographics under thirty, under fifty, fifty to sixty five,
14:31
Speaker 2: and then sixty five and over. You can see the
14:34
Speaker 2: picture for these cohorts all the way back to the
14:37
Speaker 2: year two thousand and if you think about all the
14:39
Speaker 2: things that have happened since the year two thousand, you
14:41
Speaker 2: of course had the dot Com bus, we had nine
14:44
Speaker 2: to eleven, We had the Globe of financial crisis, the eurocrisis,
14:47
Speaker 2: we had Brexit, we had COVID, we had the Russian
14:49
Speaker 2: invasion of Ukraine. And at every single one of these
14:53
Speaker 2: events we have seen a co movement in cohort confidence
14:57
Speaker 2: younger people, and I think this is the the silver
15:00
Speaker 2: lining in all of this. Remain and always are more optimistic.
15:03
Speaker 2: So young people are just looking forward to the future.
15:05
Speaker 2: I think that's great news. But very recently the last
15:08
Speaker 2: two years we've seen for confidence among young people, so
15:10
Speaker 2: those under fifth day rise to the extent that for
15:14
Speaker 2: the youngest cohort it's actually close to its all time high,
15:17
Speaker 2: but for those aged over fifth day it's declining. Now. Again,
15:22
Speaker 2: it's where we apply a narrative in the UK without
15:24
Speaker 2: thinking about the underlying fundamentals. The common view is this
15:28
Speaker 2: is driven by political preference. That we have a left
15:31
Speaker 2: wing government and young people are happy about that, and
15:34
Speaker 2: the older voters that would have preferred perhaps a conservative
15:36
Speaker 2: government are unhappy that the Conservatives are no longer in office,
15:41
Speaker 2: then I say, okay, let's ignore the narrative and look
15:43
Speaker 2: at what we can see in the under fundamentals. Two
15:47
Speaker 2: things that we've already established. The first is we've had
15:49
Speaker 2: decent income growth in inflation a just in terms for
15:51
Speaker 2: the last three years, but we know the asset prices
15:53
Speaker 2: have suffered. For young people, so under fifth day, they
15:57
Speaker 2: typically either don't own many assets, or the assets that
16:01
Speaker 2: they have, such as a house, they tend to have
16:04
Speaker 2: debt associated with it, so they're not as sensitive to
16:07
Speaker 2: these net wealth effects. They're much more sensitive to income effects.
16:12
Speaker 2: For older voters that have gone through their lifetime earnings growth,
16:17
Speaker 2: that have accumulated assets, they tend to be sensitive to
16:20
Speaker 2: asset prices. And what you see is a decline in
16:22
Speaker 2: inflation adjusted house prices coincides with this weaknessing confidence among
16:27
Speaker 2: all the cohorts and explains confidence over a long period.
16:31
Speaker 2: The rise in real wages over the past two to
16:34
Speaker 2: three years explains the rising confidence among young workers and
16:37
Speaker 2: younger cohorts, and this is what the divergence is capturing
16:42
Speaker 2: in the confidence data, which means just returning to the economy,
16:46
Speaker 2: the wage driven income driven parts of the economy day
16:49
Speaker 2: to day spend in are doing okay, that's the reason
16:51
Speaker 2: you have this one point seven percent mostly services oriented growth.
16:55
Speaker 2: But the stuff that's really asset sensitive, where we need
16:58
Speaker 2: to feel better off before we go out and borrow
17:00
Speaker 2: and speculate. The people with the real purchasing power at
17:04
Speaker 2: the older, richer end of the income spectrum, they have
17:07
Speaker 2: such depressed asset values that they are reluctant to go
17:11
Speaker 2: out and drive the kind of CycL collectivity. And the
17:13
Speaker 2: reason that this is such a confusing concept, I think
17:17
Speaker 2: is because at the start of a cycle we are
17:20
Speaker 2: viewing an economy that is entirely, entirely the inverse of
17:24
Speaker 2: what we typically see the start of a cycle. We
17:26
Speaker 2: normally have high unemployment, low real wage growth, low inflation,
17:30
Speaker 2: and rapid falls in interest rates, which spur on asset
17:33
Speaker 2: price inflation. And the first sectors that usually signal that
17:36
Speaker 2: there's a recovery to come are things like the housing sector,
17:41
Speaker 2: things like credit. Okay, credits kicking up, let's get excited
17:43
Speaker 2: about economic growth. This time around, we have the opposite.
17:46
Speaker 2: We have interest rates elevated. We also have elevated real
17:51
Speaker 2: wage growth, and so the pattern that's emerging at the
17:53
Speaker 2: start of the recovery is very different. And the kicker
17:57
Speaker 2: in all of this is to say, I don't think
18:01
Speaker 2: that this is a one off in the UK's case.
18:05
Speaker 2: We have been here repeatedly through history and the fiscal
18:09
Speaker 2: framework that we need to understand in this context is
18:16
Speaker 2: that the UK goes through cycles of strong credibility in
18:20
Speaker 2: face of markets and it outperforms, followed by periods of
18:24
Speaker 2: weakness and impaired credibility that it needs to correct. And
18:28
Speaker 2: I'll stop because I suspect there's a question in here,
18:32
Speaker 2: but I want to just go through the history to
18:34
Speaker 2: help people understand why this is.
18:35
Speaker 1: Fiscal matters so much I'd like to do that. I'd
18:38
Speaker 1: like to do that, So I just want to want
18:40
Speaker 1: to go back. So we're talking about the reasons that
18:43
Speaker 1: you've given in your latest piece about why the UK
18:45
Speaker 1: economy is looking sis luggage, not stagnating. So we've talked
18:49
Speaker 1: about one of the things on your list, which is
18:52
Speaker 1: this high household savings and self consumption since twenty twenty two,
18:56
Speaker 1: which are the result of this wealth shock in twenty
18:58
Speaker 1: twenty two, which is connection to the one markets, et cetera.
19:02
Speaker 1: But the other major thing that you pull out is
19:04
Speaker 1: this idea that our policy making credibility is damaged. And
19:10
Speaker 1: that's a problem, And this is where you want to talk.
19:12
Speaker 1: I think about the long term history of our cycle
19:15
Speaker 1: of credibility effectively exactly right.
19:17
Speaker 2: So just the one line to keep in mind here
19:21
Speaker 2: is I do this and I'm not drinking. I don't
19:24
Speaker 2: have milk in my coffee because it's apparently it's not bad.
19:27
Speaker 2: It's not good for you. But we're all warned about
19:29
Speaker 2: the health these healthy lifestyle choices that we should make now,
19:32
Speaker 2: and if we don't make them, it gives us inflammation
19:34
Speaker 2: in our body. This is the same with the economy.
19:37
Speaker 2: Poor policy choices lead to inflation in the economy. It's
19:41
Speaker 2: exactly the same thing. When you have persistent inflation, it's
19:44
Speaker 2: a signal somewhere that you're organizing your economy badly. Historically,
19:50
Speaker 2: the UK, the data I look at starts in the
19:54
Speaker 2: late seventies, and just a quick history lesson the late
19:57
Speaker 2: seventies the early eighties, the u K underperformed the G
20:02
Speaker 2: seven so advanced major economies excluding the UK of course,
20:06
Speaker 2: in a major way, and our bond yields rose relative
20:09
Speaker 2: to other countries. We then got back on track through
20:13
Speaker 2: the eighties until the late eighties, when we had another
20:15
Speaker 2: inflationary crisis in the late eighties early nineties and we
20:20
Speaker 2: underperformed again. We then through the nineties right up until
20:23
Speaker 2: two thousand and seven, go through a long period of outperformance.
20:26
Speaker 2: Then we underperformed through the financial crisis. We then outperform
20:30
Speaker 2: from two thousand and about twenty eleven to two thousand
20:33
Speaker 2: and eighteen. We then start to underperform again. What's the
20:37
Speaker 2: consistent theme here? In nineteen eighty one, following the underperformance
20:44
Speaker 2: of the late seventies and the early eighties, the Conservative government,
20:48
Speaker 2: recognizing that markets feared another decade of huge inflation in
20:53
Speaker 2: the UK, issued index link guilts for the first time. Basically,
20:58
Speaker 2: we will compensate you for any inflation that we create.
21:01
Speaker 2: Will transfer the cost of bad policy choices from the
21:05
Speaker 2: people that lend to us in markets to taxpayers, but
21:09
Speaker 2: de facto to government. We'll guarantee a real rate of
21:13
Speaker 2: return that established credible commitment to low inflation. The UK
21:19
Speaker 2: then sees its bond yards come down, the economy outperforms.
21:22
Speaker 2: This inflation to crisis the late eighties early nineties gives
21:25
Speaker 2: way to another loss of credibility and rise in bond
21:28
Speaker 2: yo olds. We join erm to try and stabilize and
21:33
Speaker 2: reassert credibility. It doesn't work. In September nineteen ninety two,
21:38
Speaker 2: of course we crash out Black Wednesday. Very famous people,
21:41
Speaker 2: I think forget that. In October nineteen ninety two we
21:45
Speaker 2: introduce inflation targeting for the first time. We say we'll
21:48
Speaker 2: commit to inflation between one and four percent retail prices
21:51
Speaker 2: excluding mortgages. The banking Land, of course wasn't independent at
21:55
Speaker 2: that point, but the Conservatives were viewed as credible enough
21:58
Speaker 2: that it helped to restore confidence bring yields down. Then
22:01
Speaker 2: into ninety seven when labor Win Gordon Brown makes the
22:05
Speaker 2: Bank of England operationally independent and reduces the inflation target,
22:09
Speaker 2: switches to CPI and this once again strengthens the commitment.
22:14
Speaker 2: He also introduces fiscal rules for the first time, which
22:16
Speaker 2: at that point we viewed as credible. The UK then
22:19
Speaker 2: continues to outperform. We then get to global financial crisis,
22:23
Speaker 2: which reveals the policy mistakes of the past on banking regulation,
22:27
Speaker 2: on fiscal policy and some other such things. George Osbourne
22:31
Speaker 2: leading the Coalition government in twenty ten introduces the Fiscal
22:36
Speaker 2: Sustainability Pact. He legislates to reduce the deficit for five
22:39
Speaker 2: years in a row. He makes the Office for Budget Responsibility,
22:42
Speaker 2: which is our independent budget scoring commitment, an independent institution
22:46
Speaker 2: to check to budget score the government. This works, Bond
22:51
Speaker 2: yields come down, the UK economy continues to outperform, and
22:54
Speaker 2: then we start to undo this credibility with a succession
22:57
Speaker 2: of policy mistakes. We mismanage breaks it. We have the
23:00
Speaker 2: trust fiasco, We create too much inflation through COVID, and
23:04
Speaker 2: so the failure. Now we come to present day of
23:07
Speaker 2: Rachel Reeves and the Chancellor in the government is not
23:11
Speaker 2: so much that they've and this is true by the
23:16
Speaker 2: way they chosen their first budget the wrong kinds of
23:18
Speaker 2: tax increases. It's that she is the first chancellor following
23:23
Speaker 2: a significant period of damaged credibility and underperformance that has
23:27
Speaker 2: not tried to introduce some fresh new commitment to credible
23:32
Speaker 2: money in the UK, to sound money.
23:35
Speaker 1: Okay, she's filled around the edges of the old stuff,
23:38
Speaker 1: but she hasn't introduced a new system. And you think
23:40
Speaker 1: that that would change things.
23:42
Speaker 2: Would change things, or you need such a big policy
23:45
Speaker 2: change to re establish your commitment to sound money. Now
23:51
Speaker 2: it begs the question to what extent are we actually
23:55
Speaker 2: seeing this as a problem. So the UK is a
23:58
Speaker 2: mid atlantic economy geographically. It's also in its behavior sort
24:02
Speaker 2: of mid atlantic. It's not quite as sclerotic as the Eurozone,
24:06
Speaker 2: but it's also not dynamic like the US. It has
24:09
Speaker 2: faster growth than the Eurozone, but it doesn't quite grow
24:11
Speaker 2: as quickly as the US. It's small state relative to
24:15
Speaker 2: the Eurozone, but not small state relative to the US.
24:18
Speaker 2: It really fits this mid atlantic picture and for that reason,
24:22
Speaker 2: historically UK ten year bondials are fives or twos or
24:25
Speaker 2: even bank crepe tends to sit somewhere between the average
24:28
Speaker 2: of well US and the Eurozone. Today. If I look
24:33
Speaker 2: at markets, French ten is sort of two and a half.
24:36
Speaker 2: Excuse me that German ten is two and a half.
24:38
Speaker 2: The French ten is three and a half. So the
24:40
Speaker 2: eurobone basically three. US is at four point one, we're
24:43
Speaker 2: at four point five. We should be around three point five.
24:47
Speaker 2: The maths there is we have a two percent inflation
24:49
Speaker 2: target and potential growth probably around one and a half
24:52
Speaker 2: one point six percent. You can add inflation to potential
24:55
Speaker 2: growth and roughly get your ten year bondial. So we're
24:57
Speaker 2: above to one hundred basis points and you can see
25:00
Speaker 2: the moment when we jump above this G seven range.
25:04
Speaker 2: It's October twenty twenty two with the List Trust bond crisis.
25:09
Speaker 2: This is when we dispense the credibility that we had
25:13
Speaker 2: earned after the GFC period and with the Labor government
25:18
Speaker 2: winning the election and having a chance to restore credibility
25:20
Speaker 2: not taking it. And is said, reminding everyone that the
25:23
Speaker 2: UK is badly managed and we had the additional inflation
25:26
Speaker 2: thanks to the last budget has just validated market expectations
25:30
Speaker 2: that the UK is still not an economy which properly
25:34
Speaker 2: commits itself to sound money. And so this one hundred
25:36
Speaker 2: basis points extra is the reason why we don't have
25:40
Speaker 2: the cyclical momentum and we need some renewed commitment to
25:44
Speaker 2: bring these rates down. And this for me is not
25:46
Speaker 2: about borrowing, so which is it's actually about inflation?
26:13
Speaker 1: Okay, so if we were too I mean, this is
26:17
Speaker 1: something that a lot of people say that the reason
26:19
Speaker 1: why UK bond deals are so high is because there's
26:22
Speaker 1: no expectation of a change in policy that will take
26:25
Speaker 1: inflation out of the system or that will bring spending down.
26:27
Speaker 1: But you think it's not really about expense about spending.
26:29
Speaker 2: We have lots of evidence where advanced economies with very
26:33
Speaker 2: low potential growth can run huge deficits for a long time,
26:38
Speaker 2: so long as inflation is under control, as long as
26:42
Speaker 2: lenders feel like the money that they give will be
26:46
Speaker 2: roughly the same in value to the money that they
26:48
Speaker 2: get back. Japan is a point in case. Japan is
26:51
Speaker 2: only now facing some fiscal issues because inflation is returned
26:56
Speaker 2: to its economy. If I compare an and again you
27:01
Speaker 2: don't need to take my forecast. Just look at the
27:04
Speaker 2: economic consensus function on a Bloomberg terminal. What you'll see
27:07
Speaker 2: is the UK has probably over the next three years,
27:13
Speaker 2: the US will be the fastest going to economy, followed
27:15
Speaker 2: by Canada because markets tect to pick up in twenty
27:19
Speaker 2: twenty seven. Then it's the UK and then it's everyone else.
27:21
Speaker 2: So third fastest in the G seven, second or third
27:25
Speaker 2: lowest debt to GDP, and second or third lowest deficit,
27:31
Speaker 2: and we're the only country where the deficit is actually
27:32
Speaker 2: declining over this period. Even with all the uncertainty over
27:36
Speaker 2: fiscal policy, markets still expect this, so it doesn't seem
27:39
Speaker 2: to be a fiscal issue. But if I compare the
27:42
Speaker 2: UK economy, say, over the last ten years to the
27:44
Speaker 2: G seven, we've had extra inflation to the tune of
27:48
Speaker 2: about one hundred basis points. In that sense, markets are
27:51
Speaker 2: mostly rational. They're pricing in this inflation. And again we
27:55
Speaker 2: can just we don't need to guess narratives. We can
27:58
Speaker 2: see the evidence before our eyes. The market liked the
28:01
Speaker 2: idea of an income tax increase because an income tax
28:04
Speaker 2: increase would have depressed demand, depressed inflation, and yes, reduced borrowing.
28:11
Speaker 2: That's important, and it would have happened immediately. It wouldn't
28:14
Speaker 2: have hinged on the Office Budget Responsibilities forecast relative to
28:20
Speaker 2: the government's target being correct three years out, which is
28:23
Speaker 2: when the fiscal targets kick in, and so you'd have
28:27
Speaker 2: had this immediate recommitment to disinflation by fiscal policy makers.
28:33
Speaker 2: And we've had this jump in bond yields as the
28:35
Speaker 2: government's abandoned this plan, And it just reminds us actually
28:39
Speaker 2: that fiscal credibility is a serious problem in the UK.
28:44
Speaker 2: We are paying a real price for this, and I
28:46
Speaker 2: think the challenge for policy makers to understand is just
28:49
Speaker 2: because we're not facing an immediate crisis now, doesn't mean
28:52
Speaker 2: that these rates, which are obstructively high for the private
28:55
Speaker 2: sector to get going, are not a serious, serious problem
29:00
Speaker 2: and a serious dysfunction in the private sector.
29:05
Speaker 1: Okay, And the third thing that you talk about in
29:08
Speaker 1: this report that we've been discussing is an extension of
29:11
Speaker 1: that to say that interest rates, obviously they have this
29:15
Speaker 1: effect on asset prices and make people feel bad, but
29:19
Speaker 1: also crowding out exactly.
29:22
Speaker 2: So, crowding out is kind of a bit of a
29:24
Speaker 2: technical concept, but it happens in two ways. One quite
29:27
Speaker 2: simply that interest rates are prohibitively high because of fiscal
29:31
Speaker 2: policy for interest rate sensitive parts of the economy to
29:36
Speaker 2: get going. And so, for instance, the government's unwillingness to
29:41
Speaker 2: address either it's excessive spending excessive borrowing or the inflation
29:46
Speaker 2: that it's creating as a result of those two policies
29:49
Speaker 2: is basically on a collision course with its housing markets.
29:51
Speaker 1: One step back, one step back. So it is the
29:55
Speaker 1: fiscal policy that creates the inflation, it's the borrowing on
29:58
Speaker 1: the spending.
29:58
Speaker 2: That's exactly right, that's exactly right. Of course, you can
30:01
Speaker 2: you can, you can make some adjustments here or there.
30:03
Speaker 2: But this is this is this is the this is
30:04
Speaker 2: the problem. In that sense, the real limit on an
30:07
Speaker 2: advanced economy when it comes to borrow in is inflation. Right,
30:11
Speaker 2: It's not the overall level of debt. You can carry
30:13
Speaker 2: huge debts in a low inflation economy, you can carry
30:16
Speaker 2: very little debt in a high inflation economy. Markets care
30:18
Speaker 2: about getting their money back in inflation just in terms.
30:21
Speaker 2: So the interest rate effective, of course is significant, and
30:24
Speaker 2: we can see that with the weakness that we see
30:26
Speaker 2: in the housing market. We can see that in the
30:28
Speaker 2: weakness that we see in other interest rate sensitive sectors
30:32
Speaker 2: like manufacturing, investment and so on. The second way we
30:36
Speaker 2: see this effect, and this is where this problem lends
30:42
Speaker 2: itself to a broader theme which I which I which
30:44
Speaker 2: I think we just need to get into a little
30:46
Speaker 2: which is to say that the government is much less
30:50
Speaker 2: price sensitive when it comes to spending than the private sector,
30:56
Speaker 2: and so the government, when it spends, strips away scarce
31:01
Speaker 2: resources for the private sector to use, and so the
31:05
Speaker 2: crowding out takes place through the interest rate, but also
31:07
Speaker 2: as spending rises as a share of GDP over time.
31:10
Speaker 2: What we're doing is We're reallocating more and more scarce
31:13
Speaker 2: resources away from a private sector which is not as
31:16
Speaker 2: productive as it used to be in growth terms, but
31:18
Speaker 2: it's still growing its productivity and towards a public sector
31:22
Speaker 2: where productivity has been stagnant for more than two decades.
31:26
Speaker 2: And so we're creating more dysfunction through this rising share
31:29
Speaker 2: of government spending as a center of GDP, and it
31:33
Speaker 2: comes through the way the government consumes resources that could
31:36
Speaker 2: be used by the private sector to do something that
31:38
Speaker 2: would be much much more productive.
32:00
Speaker 1: I've got a lot of problems here. What should happen
32:04
Speaker 1: on November twenty six at the budget? What choices can
32:09
Speaker 1: Rachel Reeves make that can at least mitigate some of
32:13
Speaker 1: the damage or actively improve the state of zulkcare.
32:18
Speaker 2: I think identphasize three things here. Let me go one
32:23
Speaker 2: point on the immediate problems, one point on the long problems,
32:27
Speaker 2: and then we should discuss capital spending. The first thing
32:30
Speaker 2: is to say, think of the budget like a traffic light.
32:34
Speaker 2: There's a green outcome, there's an amber outcome, and there's
32:36
Speaker 2: a red outcome. The green outcome is the best outcome.
32:39
Speaker 2: It's where government recognizes that it demands on the economy
32:44
Speaker 2: are simply too large, and we will cut spending in
32:47
Speaker 2: order to close the borrowing gap. And by cutting spending,
32:51
Speaker 2: we'll depress demand and we'll depress inflation and it will
32:54
Speaker 2: get markets on side. And you could do that through
32:56
Speaker 2: addressing something like welfare or departmental spending. The advantage with
33:00
Speaker 2: welfare is if you cut it in the right place,
33:03
Speaker 2: you can reset incentives for participation in the labor market,
33:08
Speaker 2: especially among young people, where we know we have a
33:10
Speaker 2: problem politically. That's going to be very, very difficult YEP.
33:14
Speaker 2: That's close to a zero probability event. I suspect the
33:17
Speaker 2: Amber outcome, which is where I think we were for
33:20
Speaker 2: basically a month, which is where the government realizes, actually
33:25
Speaker 2: we need to counteract the inflationary narrative that we introduced
33:28
Speaker 2: a year ago by doing a big policy change that
33:32
Speaker 2: is clearly disinflationary and create space for market interest rates
33:38
Speaker 2: to fall and for the Bank of England to be
33:41
Speaker 2: more aggressive with interest rate cuts, which was the advantage
33:45
Speaker 2: with the income tax increase on its own, this is
33:47
Speaker 2: not a good policy. As you mentioned, consumers are skittish
33:50
Speaker 2: and they're not spending enough anyway, so why hit them
33:53
Speaker 2: with an income tax increase. However, because this interest rate
33:56
Speaker 2: problem is such a big deal, you can have this
34:00
Speaker 2: setting effect. It's kind of the Clinton Rubin approach in
34:03
Speaker 2: the early nineties. You raised taxes, the Fed cut's interest
34:05
Speaker 2: rates in the economy kicks on. Markets would have reacted
34:11
Speaker 2: well to that because you would have had this Bank
34:13
Speaker 2: of England offset. That's the amber out comen. I call
34:17
Speaker 2: that amber because it's contingent. It's contingent on the Bank
34:20
Speaker 2: of England doing something. I fear the government's abandoned this
34:24
Speaker 2: and yeah, last Friday, and the challenge is that understanding
34:29
Speaker 2: what quite happened. I suspect the government realized that it
34:33
Speaker 2: needed to do a lot, convinced itself that it's one
34:36
Speaker 2: option was the income tax increase, decided we better signal
34:39
Speaker 2: this to market since we're breaking our manifesto commitment into
34:42
Speaker 2: households and to businesses who have all factored in this expectation,
34:46
Speaker 2: and adjusted bondials declined over this period, which validated the
34:51
Speaker 2: idea that this was actually a good policy. The governments
34:54
Speaker 2: then received a new forecast from the OBR seen that
34:56
Speaker 2: with lower bond deals everything looks better. We don't need
34:58
Speaker 2: to we don't need to do so much taxation and
35:02
Speaker 2: decided to U turn as opposed to saying, well, perhaps
35:05
Speaker 2: we cut stamp duty stuty on shares, or cut stamp
35:07
Speaker 2: duty on housing or something like this. This is unbelievable.
35:12
Speaker 2: So this Amber outcome is now off the table. We're
35:15
Speaker 2: now in what I would consider to be the red zone.
35:17
Speaker 2: But again this traffic light idea, where we have this
35:20
Speaker 2: horrible patchwork of anti growth tax measures which, even if
35:26
Speaker 2: on the face of it are not inflationary, if they
35:29
Speaker 2: land on businesses, businesses may try to pass them on
35:33
Speaker 2: to final prices. But I fear that government is going
35:36
Speaker 2: to go after things like pensions and assets. And as
35:40
Speaker 2: I think I've established with quite a lot of evidence convincingly,
35:44
Speaker 2: it's the weakness in asset prices and the desire to
35:47
Speaker 2: offset that through higher saving that is causing the underlying
35:50
Speaker 2: problem in the economy. So if you go after assets,
35:52
Speaker 2: what you're doing is you're agitating the fundamental problem that
35:54
Speaker 2: the economy is facing. So I think this is a real,
35:57
Speaker 2: real issue, and what we're doing is unfortunately by being
36:00
Speaker 2: in this red zone is base case for me into
36:03
Speaker 2: next year would be in this scenario, growth still around
36:07
Speaker 2: one and a half percent, very little sickly cality. Inflation
36:10
Speaker 2: will come down mechanically because we just have a disinflationary trend.
36:14
Speaker 2: The Bank of England, i think, will cut three more times.
36:16
Speaker 2: We might get ten years down to a little below
36:19
Speaker 2: four percent, but the income tax increase would have add
36:24
Speaker 2: two or three more cuts to the Bank of England.
36:26
Speaker 2: Take benchmark interest rates down by one hundred basis points,
36:29
Speaker 2: revise your growth forecast up to two percent. We've taken
36:32
Speaker 2: away this very clear upside risk which the government had
36:36
Speaker 2: set about. So this is the frustration, and now we're
36:40
Speaker 2: left with a real danger that the economy just has
36:43
Speaker 2: this slow motion puncture into next year. Growth dwindles, we
36:47
Speaker 2: get a bit more inflation than we like because businesses
36:50
Speaker 2: try to pass this on the Bank of England finds
36:52
Speaker 2: it hard to cut even three times. The bomb market's
36:56
Speaker 2: not convinced, thinks we're going to have to come back
36:57
Speaker 2: for tax increases next year, so bond yield stay l elevated,
37:01
Speaker 2: and the frustration that the economy is producing for people
37:04
Speaker 2: leads to impatience in the labor party. That then leads
37:08
Speaker 2: to the uncertainty that could have erupt around leadership challenges
37:11
Speaker 2: and all that kind of stuff. So that's now the
37:13
Speaker 2: downside risk, which has become real. So in one week
37:15
Speaker 2: we've replaced a very real upside risk with the downside risk.
37:19
Speaker 2: So in the short run they just need to somehow
37:21
Speaker 2: pick one or two big policies that close the gap
37:24
Speaker 2: in a disinflationary way that avoid this. They've called it
37:27
Speaker 2: a Shmaugus board, but I don't think that's right. I
37:30
Speaker 2: think it's an anti growth patchwork of taxes.
37:35
Speaker 1: I mean, this is the problem. And then every single
37:37
Speaker 1: one of those new fiddle taxes, because that's what we fiddles, right,
37:42
Speaker 1: every single one of them will come with a furious
37:44
Speaker 1: lobby group and so the fight back against every single
37:48
Speaker 1: one will be much harder than if they had just
37:51
Speaker 1: come out, as you say, with one big tax across
37:54
Speaker 1: the board.
37:55
Speaker 2: That's right. And I think, just to add another dimension
37:58
Speaker 2: to this, the government seems to have traded off the
38:01
Speaker 2: opportunity to reassert credibility now with an income tact increase
38:06
Speaker 2: in April, and to not just be a passive observer
38:14
Speaker 2: in this disinflationary narrative into next year, but actually, in
38:17
Speaker 2: the market's eye, the driver of the disinflationary narrative to
38:22
Speaker 2: now a budget which will rely on the obr's ever
38:25
Speaker 2: optimistic forecast being right on borrowing, growth and inflation, and
38:29
Speaker 2: the market is tired of it's going to happen tomorrow, right.
38:34
Speaker 2: The amount of foreign investors I've been sort of everywhere
38:37
Speaker 2: in the last few months, including far away places like
38:40
Speaker 2: Singapore and Australia. They say, why does the OBR keep
38:45
Speaker 2: including this fuel duty increase when it's been delayed for
38:49
Speaker 2: fourteen years, which never happens. This is the kind of
38:52
Speaker 2: thing that is eroding credibility. So it's it's now no
38:55
Speaker 2: longer it's going to come tomorrow. Tomorrow never comes. Do
38:58
Speaker 2: something today. A week ago we thought we were there,
39:01
Speaker 2: Now we think we're not there. This is a this
39:04
Speaker 2: is a real policy failure.
39:07
Speaker 1: What do you think that the smalls that sense again,
39:13
Speaker 1: Smagas Board, what do you think the Smagat Board of
39:16
Speaker 1: tax changes is going to involve.
39:18
Speaker 2: I think it's anyone's guess at this point. I hope
39:21
Speaker 2: that they do a little bit on the spending side,
39:26
Speaker 2: maybe after the spending round is over, as hume lower
39:28
Speaker 2: departmental spending. I think they'll probably they should spend a
39:33
Speaker 2: couple of hundred million to try and reduce tax avoidance
39:36
Speaker 2: and things like that. The OBR might reward them with
39:38
Speaker 2: sort of three or four billion. I think they'll freeze
39:41
Speaker 2: in contact thresholds from twenty twenty eight, which is sort
39:44
Speaker 2: of sensible, But again it's it's in the future. Then
39:47
Speaker 2: I think we're probably looking at something on pension contributions.
39:52
Speaker 2: We're probably looking at the changes to council tax bans,
39:56
Speaker 2: we might be looking at the bank leve fuel duty
39:59
Speaker 2: make up. But when you're faced with a complicated economic scenario,
40:06
Speaker 2: where again I don't want to make the case that
40:09
Speaker 2: the future is so certain, it's just that uncertainty doesn't
40:12
Speaker 2: seem abnormally high in the UK, what you need is
40:14
Speaker 2: a clear narrative income taxes up, interest rates down, economies
40:19
Speaker 2: actually were sorted, get over it and beyond and beyond,
40:22
Speaker 2: and then come back in a year with a load
40:23
Speaker 2: of head we've given up that. Then there are the
40:26
Speaker 2: two other issues. So let's address capital spending first and
40:30
Speaker 2: then tackle what is the problem not just for the
40:32
Speaker 2: UK but for all advanced countries, which is this rising
40:35
Speaker 2: debt to GDP public debt to GDP as the population
40:38
Speaker 2: ages that you mentioned before me before we had our
40:42
Speaker 2: online chat. You were discussing at what point is the
40:44
Speaker 2: government just put up against the war by bomb markets
40:46
Speaker 2: to say fix things. I think that's where the problem looks,
40:50
Speaker 2: so we should touch on that. But just on capital spending,
40:53
Speaker 2: I'm really taking issue actually with this abstract view that
40:59
Speaker 2: if only you raise capital spending in the economy, we'll
41:01
Speaker 2: see more productivity growth. Okay, this is a nice sentence
41:08
Speaker 2: to include in a policy report, but what this means
41:11
Speaker 2: in the real world is businesses increase their current spending
41:17
Speaker 2: in capital goods and energy and commodities. They combine those
41:22
Speaker 2: factors of production to produce capital stock that can then
41:26
Speaker 2: be plugged in, receive some energy from the grid, and
41:29
Speaker 2: make workers more productive. The problem is when you have
41:32
Speaker 2: a regulatory system which says you can't dig that commodity
41:36
Speaker 2: up from the UK, we can't use the energy that
41:39
Speaker 2: we produce in our market. You can't build on that land,
41:42
Speaker 2: we won't produce those capital goods, so you have to
41:45
Speaker 2: import all of this stuff. Productivity is just the ratio
41:48
Speaker 2: of GDP to workers. If when you raise capital investment
41:53
Speaker 2: you have to import all of this stuff, yes, you'll
41:55
Speaker 2: get some benefit, but what you really into subtract that
42:00
Speaker 2: benefit is all the inputs you're sending capital abroad. You
42:03
Speaker 2: can't have a proper productivity revolution that is driven by
42:07
Speaker 2: capital expenditure unless you permit yourself to use your own
42:11
Speaker 2: domestic factors of production. The UK is an economy with
42:14
Speaker 2: huge factor endowments. It's the reason we had the industrial revolution. First.
42:18
Speaker 2: This is what people forget. We have this stuff underground.
42:21
Speaker 2: We just have a lawmaker saying you can't use that mind,
42:25
Speaker 2: you can't use that energy field, you can't build there.
42:28
Speaker 2: And now with the employment rights build you can't employ
42:30
Speaker 2: this person under certain circumstances. This is economic suicide. It
42:35
Speaker 2: doesn't work. And so we won't transform this ambition to
42:38
Speaker 2: have higher capital spending into higher productivity unless we radically
42:43
Speaker 2: deregulate the domestic economy to allow that capital spending to
42:47
Speaker 2: go towards extracting our own domestic factors of production and
42:51
Speaker 2: combining them in a productive way. And again, this is
42:55
Speaker 2: just one of those problems where in the UK we
42:59
Speaker 2: have concent census around another narrative, and yet governments repeatedly
43:05
Speaker 2: try to fit their policies with this narrative. We heard
43:08
Speaker 2: under Osborne, we're going to increase capital spending. We heard
43:11
Speaker 2: under Boris, we're going to increase capital spending. We now
43:13
Speaker 2: hear it under Rachel Reeves. And yet the productivity statistics
43:17
Speaker 2: are just not showing the rise that we want to see,
43:20
Speaker 2: which means there's something fundamentally going wrong in our understanding
43:24
Speaker 2: of the economy. It's not that if we just do
43:26
Speaker 2: cut more capital spending eventually we'll force our way to
43:28
Speaker 2: higher productivity. The chain of events that we think is true,
43:31
Speaker 2: the narrative is not wedded in the fact in the
43:34
Speaker 2: right way. And this practical problem that I mention, you know,
43:37
Speaker 2: escaping this weird abstraction that economists do is where I
43:40
Speaker 2: think the root of the problem lies. And it's why
43:43
Speaker 2: you see the best productivity growth in the economies that
43:46
Speaker 2: are open to using their own domestic factors of production.
43:49
Speaker 2: The US is a point in case, but look at
43:51
Speaker 2: what you see in the Middle East, look at what
43:52
Speaker 2: you see in parts of the emerging world, where they're
43:54
Speaker 2: digging up stuff from their own economy, they're combining it,
43:58
Speaker 2: and they're making their workers more productive. Until we accept
44:00
Speaker 2: that we have to do this, we won't see a
44:04
Speaker 2: reacceleration in productivity growth.
44:06
Speaker 1: Interesting now you say, as you say, we're having a
44:09
Speaker 1: conversation before we started recording about all these things, and
44:12
Speaker 1: we were discussing your view that the UK is not
44:16
Speaker 1: in crisis mode or not near crisis mode, but is
44:18
Speaker 1: in a state of serious dysfunction, is what you call it.
44:22
Speaker 1: And I definitely agree with you that we're in a
44:24
Speaker 1: state of serious dysfunction, no doubt about that. But look
44:28
Speaker 1: at what you've just said about about CAPEX and about
44:30
Speaker 1: you know, increasing capital spending and why we won't use
44:32
Speaker 1: our own stuff, and what you said earlier about capin
44:36
Speaker 1: welfare spending and why that simply isn't going to happen.
44:39
Speaker 1: It slightly feels as though all the solutions are there.
44:43
Speaker 1: You know, you're very good. You've written a marvelous report.
44:45
Speaker 1: It's all absolutely true. Can't disagree with you on any
44:48
Speaker 1: of it. But no one in government is listening, and
44:52
Speaker 1: there doesn't appear to be any political appetite at all
44:56
Speaker 1: in the UK to shift on any of the things.
45:00
Speaker 1: Be it a bit well, there, be it at zero
45:02
Speaker 1: beard any any of these things. Although this shift on
45:05
Speaker 1: immigration is kind of interesting. Maybe that's the door opening
45:07
Speaker 1: to some rational thinking in government, but nonetheless without the
45:12
Speaker 1: feeling that there is any kind of political appetite for change.
45:17
Speaker 1: It feels that the point at which the bond market says,
45:20
Speaker 1: do you know what enough and as you said, puts
45:21
Speaker 1: so you get up against a wall is significantly closer
45:26
Speaker 1: than it has been for a long time now, is
45:29
Speaker 1: that we may move from dysfunction to crisis faster than then.
45:32
Speaker 2: Of course I might be front run here by what's
45:35
Speaker 2: happening in US tech. But my guess is, and this
45:38
Speaker 2: is this is not the first time I've said this.
45:39
Speaker 2: I've happily said this three or four times on the
45:41
Speaker 2: show this year, that the government debt problem that we
45:45
Speaker 2: have around the advanced world, and this is where the
45:47
Speaker 2: UK just is ordinary, not in a good way, is
45:51
Speaker 2: the root of the next crisis for sure. The reason
45:55
Speaker 2: why I think governments are in the UK and elsewhere
45:58
Speaker 2: this is a broad point, but let's just us the
46:00
Speaker 2: UK's point in case. Governments are reluctant to address this.
46:03
Speaker 2: So so for anyone listening, what is going to happen
46:06
Speaker 2: in these in our advanced economies is we have made
46:10
Speaker 2: legal commitments. And by the way, I think this is
46:14
Speaker 2: the right thing to do. So to be absolutely clear,
46:19
Speaker 2: rich societies should not be inflicting poverty and health related
46:25
Speaker 2: indignities on retired people. We can avoid that problem if
46:28
Speaker 2: we get our act together, no question. So this is
46:31
Speaker 2: not about saying we're not going to look after you.
46:33
Speaker 2: But as we see an aging population and the share
46:39
Speaker 2: of dependence rises, especially at the upper end, our public
46:46
Speaker 2: debt to GDP ratios are going to rise as far
46:49
Speaker 2: as the eye can see. In the UK's case, we
46:51
Speaker 2: have one hundred percent debt to GDP today. The OBR
46:53
Speaker 2: thinks we'll get to two hundred and fifty percent within
46:55
Speaker 2: our lifetimes. I just don't think the market's going to
46:58
Speaker 2: let us get there, by the way, but this is
47:01
Speaker 2: driven by dramatic increasing health spending, dramatic increasing things like
47:04
Speaker 2: pensions and welfare. And this is true across the advanced world.
47:09
Speaker 2: And we're just at the foothills of this debt mountain.
47:13
Speaker 2: And just as we reached the foothills, the natural buyers
47:16
Speaker 2: of government debt, things like pension funds, which already saw
47:19
Speaker 2: this problem far in advance and had to prepare and
47:23
Speaker 2: money risk for it, have basically decided we've got enough
47:26
Speaker 2: of this paper we don't need any more, and so
47:28
Speaker 2: the price that the market is charging us to issue
47:31
Speaker 2: more debt is too high relative to to again what
47:37
Speaker 2: the private sector would would prefer to really get going. Okay,
47:41
Speaker 2: Why why are governments not addressing this? Is as the
47:43
Speaker 2: central economic problem. First is governments don't distinguish between chronic
47:51
Speaker 2: problems and crises, and so you'll often see that policy
47:57
Speaker 2: makers simply taken as given UK is a an economy
48:01
Speaker 2: with slow potential growth, as if this is just normal,
48:03
Speaker 2: we should just accept this and we should just manage
48:05
Speaker 2: around it. So you need to raise taxes. We remember
48:07
Speaker 2: the New Statesman title early this year. Just raise tax Hey,
48:11
Speaker 2: that's the solution, accept it, raise tax You're a slow
48:14
Speaker 2: growth economy. Make sure you can fund the state. Okay.
48:19
Speaker 2: So there's there's there's a degree of naivety in that view.
48:23
Speaker 2: The second problem for me is that and of course
48:26
Speaker 2: in the absence of a crisis, you just kind of
48:29
Speaker 2: never have your priers on this front challenge. The second challenge,
48:33
Speaker 2: which for me is more important, is policymakers, I think
48:38
Speaker 2: overestimate the positive impact which government spending has on GDP
48:44
Speaker 2: under conditions of normal balance sheet strength in the private sector,
48:47
Speaker 2: which is roughly what we have now, which is to say,
48:50
Speaker 2: in the middle of a financial crisis, do you want
48:52
Speaker 2: to cut government spending? No? When you have a fundamentally
48:55
Speaker 2: healthy private sector with full of smart people, low levels
48:59
Speaker 2: of debt, and clear opportunity to raise productivity through things
49:03
Speaker 2: like AI, should government fear just pulling back a little
49:07
Speaker 2: bit in not small ways to rebalance fiscal policy. No.
49:13
Speaker 2: But I think they fear if they could spend in
49:15
Speaker 2: they'll tank their economies into recession and that will mean
49:18
Speaker 2: they'll be out of office. I think this gets it
49:21
Speaker 2: exactly the wrong way around because of the way that
49:23
Speaker 2: I explained this crowding out effect. So what's going to
49:28
Speaker 2: happen I suspect is at some point these policy choices
49:33
Speaker 2: will these bad policy choices which have compounded over time.
49:37
Speaker 2: It's not just the labor government's previous conservative government too,
49:40
Speaker 2: and the previous labor government before that will erupt into
49:42
Speaker 2: another bout of inflation and the bomb market will say
49:46
Speaker 2: that's enough and governments will be forced. And actually I
49:50
Speaker 2: quite liked the idea that Andy Halding, in the previous
49:54
Speaker 2: Chief Economist that the Bank of England came up with
49:56
Speaker 2: this week's say, you should say we'll raise taxes by
49:59
Speaker 2: a pound, we also cut spending by a town. This
50:01
Speaker 2: is a nice handy rule of thumb. You will be
50:05
Speaker 2: forced to dramatically cient fiscal policy in near term or
50:11
Speaker 2: say we need a better way to manage these long
50:13
Speaker 2: term liabilities. The result will be markets I suspect and
50:19
Speaker 2: governments will fear recessions. The actual consequence will be the
50:23
Speaker 2: bond market. We'll see much less issuance, much less inflation.
50:28
Speaker 2: It will reward governments that fix these fiscal problems, drive
50:32
Speaker 2: down interest rates, and then the private sector will start
50:35
Speaker 2: to do much better, which is why you see so
50:37
Speaker 2: many instances where bloated states suddenly decided to austerity and
50:42
Speaker 2: the private sector comes alive. I mean, Argentine is our
50:45
Speaker 2: point in case today, Britain, in the eightiers, We've seen it, Canada, Sweden,
50:48
Speaker 2: There's lots of examples. But we actually have a better
50:52
Speaker 2: option here in my view, which is to say, we
50:56
Speaker 2: have not properly managed our public services for the past
50:59
Speaker 2: fourteen years, and justifiably so, people are uhappy with things
51:02
Speaker 2: like education and health and welfare. Is there a solution
51:07
Speaker 2: where we don't have to cut this? Yes, I think
51:10
Speaker 2: we can address these long term issues. What we need
51:12
Speaker 2: to do is find clever ways to address our long
51:16
Speaker 2: term pension commitments, our long term health commitments, which mean
51:19
Speaker 2: that yes, debt will rise, but instead of getting to
51:22
Speaker 2: two hundred and fifty percent, maybe it gets to one
51:24
Speaker 2: hundred and fifty percent and rolls over. And I'm going
51:28
Speaker 2: to stop. But if you want, I think I have
51:30
Speaker 2: a solution to this.
51:33
Speaker 1: Yeah, you have to stop there, so I can ask
51:35
Speaker 1: you what are these clever ways? Everyone wants to know
51:40
Speaker 1: the clever ways where we cannot have to cut spending,
51:42
Speaker 1: okay and not end up at two hundred.
51:45
Speaker 2: And for me, let me kill a lazy narrative here
51:48
Speaker 2: first to say that you often hear naively that government
51:53
Speaker 2: debt is less risky than private debt. This is fundamentally
51:59
Speaker 2: wrong in a properly regulated economy, and roughly speaking in
52:04
Speaker 2: the UK, basically is now, when a bank issues a loan,
52:07
Speaker 2: it will have done the due diligence to make sure
52:10
Speaker 2: that the borrower is using that loan for something good.
52:14
Speaker 2: And when it comes to big loans generally it's like
52:17
Speaker 2: are you actually investing? Are you increasing the value of
52:19
Speaker 2: your house? Right? So, there's there's a there's an income
52:21
Speaker 2: generating asset that goes with the loan, and so that
52:25
Speaker 2: the net yield, the net return is positive, which means
52:30
Speaker 2: on the private sector, yes, you have rising debt over time,
52:32
Speaker 2: but you tend to have rising assets and you generate
52:35
Speaker 2: an ever greater positive net wealth position, which is which
52:40
Speaker 2: which is why we can tolerate ever growing levels of debt.
52:43
Speaker 2: With the public sector, it's completely different. What we've had
52:46
Speaker 2: actually across the advanced world is this ratcheting effect where
52:49
Speaker 2: to avoid recessions in the short run, which would have
52:53
Speaker 2: had some bad consequences, but also some good consequences. They're
52:57
Speaker 2: great cleansing events. We have increased debt substantially to fund
53:02
Speaker 2: current spending just to avoid the recession. The result of
53:06
Speaker 2: this ratcheting effect is we've had a succession of crisis
53:09
Speaker 2: where we've just added and added to debt and we
53:12
Speaker 2: have no assets that are productive on the other side
53:15
Speaker 2: of it. If we would have raised all of this
53:17
Speaker 2: debt to GDP to expand energy and infrastructure and minds
53:23
Speaker 2: and all the rest of it, Okay, I'm not in
53:25
Speaker 2: favor of making everything statement, that would have been a
53:27
Speaker 2: very very different result so now we have a situation
53:30
Speaker 2: where we have no assets to go alongside of all
53:33
Speaker 2: of this debt. But the debt itself requires an interest
53:37
Speaker 2: which is now aheadwind. We spend one hundred billion pounds
53:39
Speaker 2: a year. Okay, so we need to start re evaluating
53:43
Speaker 2: the way we think about government debt so that we're
53:47
Speaker 2: generating assets and actually again to an extent, Rachel Reeves
53:51
Speaker 2: adjusting her fiscal rules to not exclude capital, to exclude
53:54
Speaker 2: capital spending sort of gets there, and to look at
53:56
Speaker 2: a net wealth measure. But take the two big costs
54:00
Speaker 2: that people will impose in retirement on the public. First
54:05
Speaker 2: is their pension. The second is health costs. With pension,
54:10
Speaker 2: it's through their entire period out of work. With health costs,
54:14
Speaker 2: for most people it's sudden increases very late in life
54:18
Speaker 2: or in one or two instances. What we should do
54:23
Speaker 2: is recognize there's a difference between government providing pensions in
54:29
Speaker 2: healthcare and guaranteeing it. And so what I would like
54:32
Speaker 2: to see in the UK when people enter the workforce
54:36
Speaker 2: for the first time, and you could probably apply this
54:39
Speaker 2: to anyone under the age of forte you get a
54:41
Speaker 2: two thousand pound tax cut in your first year, that
54:46
Speaker 2: two thousand pounds goes into pick something. Take an ETF
54:51
Speaker 2: fifty percent global, fifty percent UK. It'll give you anywhere
54:54
Speaker 2: between eight and ten percent per year. You con pound
54:57
Speaker 2: that until you retire, and that is your pension pot,
55:00
Speaker 2: and you will get a big number. By the time
55:02
Speaker 2: you're seventy you'll be anywhere between three hundred and fifteen
55:04
Speaker 2: four hundred thousand pounds. You'll be better off than if
55:07
Speaker 2: you've got your your state pension today in a lump sum.
55:10
Speaker 2: And that small tax cut generates a huge asset that
55:14
Speaker 2: takes off the liability side of the government balance sheet
55:17
Speaker 2: funding your pension either through taxes or borrowing. When you
55:20
Speaker 2: actually get to that point in the second year, you
55:23
Speaker 2: get another thousand pound tax cut. It goes into the
55:26
Speaker 2: same instrument, but it's used as a pot of money
55:31
Speaker 2: that can finance health costs, and you can spend that
55:34
Speaker 2: however you like. When the time comes go to the
55:36
Speaker 2: private sector, you can spend it on the NHS. It
55:38
Speaker 2: really doesn't matter. But what you do is you de
55:40
Speaker 2: risk those sudden health costs from the taxpayer. But I
55:45
Speaker 2: think with both of those things, what you can actually
55:48
Speaker 2: say is if you don't use these parts, your children
55:52
Speaker 2: can inherit them, which means on the health side, you're
55:56
Speaker 2: incentivized to make good lifestyle choices, which is something that
56:00
Speaker 2: we need to seriously talk about in order to get
56:02
Speaker 2: fiscal sustainability. But then on the pension side, it will
56:05
Speaker 2: induce people to contribute more to their private pension so
56:09
Speaker 2: that there's more that can be inherited down the line.
56:13
Speaker 2: And so we're addressing some of these fundamental issues. And
56:16
Speaker 2: I think once the market sees these credible commitments to
56:19
Speaker 2: longer run sustainability, you then don't need to be up
56:22
Speaker 2: against the wall every six months, every twelve months to
56:25
Speaker 2: find ways and to resolve all these very very bitter
56:29
Speaker 2: and politically tense issues around welfare and the like.
56:33
Speaker 1: Yeah. I mean, I love this idea, callum, but I'm
56:35
Speaker 1: going to add it to the list of things that
56:37
Speaker 1: simply aren't going to happen.
56:39
Speaker 2: Under this government nobody. Eventually, I suspect we will reassert
56:42
Speaker 2: credibility in these clever ways at some.
56:44
Speaker 1: Point this kind of thing will have to happen. But
56:46
Speaker 1: I mean, that's the other side of the crisis, isn't it,
56:49
Speaker 1: Because that's that's giving giving money away, that's so we
56:54
Speaker 1: thought and I did that already it's there, And of
56:56
Speaker 1: course it's too long term because there are the positive
56:59
Speaker 1: results of that fit into the five year four cust
57:01
Speaker 1: And who's gonna do anything that doesn't fit into the
57:03
Speaker 1: five year four cust that's it. So filing that under
57:08
Speaker 1: an excellent idea, marvelous tuns great never gonna happen.
57:11
Speaker 2: In this budget. No, I suspect in future. That's we
57:15
Speaker 2: will get to these kinds of places in the end.
57:18
Speaker 1: Well, callum, I guess we will pin our hopes not
57:22
Speaker 1: on this month, but on the future, when hopefully a
57:26
Speaker 1: government will start reading your reports and acting.
57:29
Speaker 2: You're speaking be from Edinburgh. There's a statue of Adam
57:31
Speaker 2: Smith with his great quote fear not, there's a great
57:35
Speaker 2: deal of ruin in a nation. If we can get
57:38
Speaker 2: one or two things right, suddenly this gloomy narrative will
57:41
Speaker 2: turn positive. And so it's incumbent upon us to just
57:45
Speaker 2: solve these one or two big issues. And it's amazing
57:48
Speaker 2: how much then we can tolerate day to day.
57:50
Speaker 1: Oh okay, well, fingers crossed, Callum, thanks so much for
57:53
Speaker 1: joining us today.
57:55
Speaker 2: Oh my pleasure, thank you, thanks for listening to.
58:04
Speaker 1: This week's Marin Talks Money. If you like our show,
58:06
Speaker 1: rate review, and subscribe wherever you listen to podcasts, and
58:09
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58:13
Speaker 1: on Twitter or x I'm at marins w and John
58:16
Speaker 1: is John Underscores Stepic. This episode was hosted by me
58:19
Speaker 1: Mary Zumset Web is produced by Someersadi and Moses, and
58:23
Speaker 1: sound designed by Blake Maples and Aaron Casper especial thanks
58:26
Speaker 1: of course to Callum Pickering