Jon Moulton is a top businessman and insolvency expert. In this think piece, adapted from a speech to the Economic Research Council, he argues that the government's current policies amount to a deferral of pain onto the next generation through borrowing and artificially-low interest rates. This will ultimately lead to much worse pain in the long run.
This piece attempts to lay out the economic, and moral, arguments for more strenuous and rapid government spending cuts. Further, it makes the case for accepting the consequences of more severe cuts – less prosperity in the short run in return for better prospects for our economy and people in the long run. We may already be guilty of doing too little too late.
We all know the UK and its citizens have lived beyond its means for far too long, with consumption and government expenditures allowed to range well ahead of the ability to repay the debt that was being run up – UK government debt is approaching 100% of GDP, and is perhaps twice that if you add in public pensions, PFI and bank support. (See Miles Saltiel’s On Borrowed Time for a detailed look into some of these commitments.)
We reached a position last year where the Government was spending £4 for every £3 it raised in taxes. Only a couple of nations – Ireland and Iceland – managed to increase their debt relative to GDP faster than the UK in the last 3 years.
We are, however, far from alone – the Western world is generally overspending and overindebted – and has poor demographic prospects too. The USA will spend $1.40 for every dollar the government raises this year. Ireland, Greece, Portugal, Spain, Italy are all ropey in considerable measure. Events outside our borders are a risk for our economy. Global financial stability seems unlikely.
The debt binge has been going on for a long time – 20 years ago, total private debt in the UK ran at 150% of GDP, which doubled to 300% eight years ago and has now increased to 450%. Consumers and industrial companies roughly doubled their leverage in those 20 years whilst financials went up by a factor of around 5 times – though almost no-one can now really disentangle or define the debts of the financial sector as they trade in increasingly impenetrable derivatives and structured finance products.
Only 20 years ago the Government was briefly spending less than its income. State spending’s share of GDP has risen steadily towards 50% of the economy. Experience of history suggests that 40% is about the limit – above this growth tends to slow and stop.
In 2008, failures in the structured finance and investment banking industries precipitated a major global financial collapse – Lehman, RBOS, AIG, Bear Sterns, Northern Rock, and even the seemingly-secure Alliance and Leicester failed. Britain’s GDP fell by around 6% in a year. Unemployment went up painfully, but actually, surprisingly little – from 5% to 8%. This was much less than the rise from 4.5% to 10% in the USA.
And we have suffered much less pain and failure than might have been expected in our economic system – company failures are at near 30-year lows and housing repossessions are remarkably low, given the financial shambles. House prices have suffered little – indeed, people with large mortgages on variable rates have seen a huge rise in their disposable incomes, as Lord Young pointed out (perhaps unadvisedly) last month.
The recession hasn’t been anything like as bad as we might have feared – or perhaps deserved. Or has it? The remarkably mild short-term consequences of the last decades of debt orgy have mostly been the result of policies designed to lower interest rates to levels not seen in 30 years in the UK. You can manage a lot of debt if you pay next to no interest. The government has printed money (lightly disguised and much obscured by the new name “quantitative easing”) and increased borrowing to avoid cutting government spending and to maintain low interest rates. This may have reduced unemployment and mitigated some financial distress in the short-term. Put simply, we’ve tried to solve the difficulties of having too much debt by using more debt and making that debt tolerable – at least for a short time. Quite a few people have compared the process to treating a hangover by drinking more alcohol, and it’s a good analogy. You feel better temporarily, but actually the problem grows. The debt is still there, and bigger, the day after.
These policies punished individual savers who saw the value of their savings slashed, whilst those with reckless levels of personal lending were given a sharp rise in disposable income. The massive increase in Government borrowing enabled the current generation to live comfortably whilst leaving the burden of paying off the deficit to our children.
The inflationary policies meant that savers and people buying annuities have been hurt, while borrowers have been rewarded and protected. Parents might be fine for now, but their children will struggle paying for their irresponsibility. It is pretty likely that by avoiding pain now we ensure that the future economy will be weaker and riskier. It does not feel a very noble policy, and the continuation of these policies seems increasingly likely as we try to protect our current excessive consumption.
In the corporate world, the very low failure rate of large companies is the consequence of very low interest rates, massive Government support of businesses with uncollected taxes of some £30bn-plus propping up a number of enterprises, and a banking sector generally unwilling or unable to recognise losses. Industrial debt runs at twice the level of the early 1990s recession. That recession was only one third as deep as our recent one. So, if interest rates rise, we should expect more failures than then – and corporate insolvencies then ran at 6 times today.
This lack of corporate casualties is not necessarily good news. Though in the short term it reduces job losses and the (very real) pain that involves, many enterprises that would normally have perished continue to trade. Assets and people that are tied up in those hopeless businesses would do more good for the economy deployed elsewhere.
It is unlikely you will hear our politicians say it but actually we live in a time with an unhealthily low rate of corporate failure – an infeasible line for any political party. The policies of low interest rates have protected the weak, inefficient and, in some cases, blameworthy parts of the economic world and prolonged a misallocation of resources in areas that could not survive by themselves.
Consider what has happened in the world of banking, especially investment banking. A combination of state guarantees, abundant state subsidies and a capricious approach to regulation has enabled flawed banking models to survive in spite of their mistakes. Why did this happen? In part, simply because of an unwillingness to take the pain of more bank failures during the crisis. Now I fear an unwillingness to tackle the remaining threats to the financial sector caused by the immediate pain of restricting and dividing banks into the essential bits and the gambling pieces – or allowing the riskily-structured ones to fail outright.
In general, society is pretty short-term in its views – sadly this often leads to trading off integrity against short-term profits. This obviously generates a bias against integrity and stability, which is allowed free rein when the moral hazard of bailouts are present. This creates a vicious cycle of irresponsibility, the consequences of which are paid for by the taxpayer.
It was not easy to believe from their words that any of the parties in the last election actually were aware of the scale of public spending cuts that had to come. Pain aversion was at the core of the politics. Politicians danced throughout the election campaign between the awful reality that they faced and their desire for election.
Margaret Thatcher never actually cut public spending overall, and older souls may remember the pain during her reign. Simply to stop the national debt from rising even higher, the current government needs to get the gap between spending and revenue down by £150bn – which would mean a 28% cut in spending. All history says that tax rises can only play a very small part in bridging the gap – spending has to take the strain. Indeed, tax cuts to stimulate growth can be sensibly argued for.
And given that the Coalition has said they will protect the spending of the NHS and international aid actually the rest would have to drop by around 35%. The Coalition will need extraordinary courage and cohesion to get anywhere near this. As it is a willingness to avoid short term pain whilst harming future prospects is clearly in the Government plans to cut net investment by two thirds over the next five years rather than deal with the further grief of more cuts in revenue spending.
Even relatively mild cuts will be very difficult. Trident, social workers, cancer drugs, school milk, nursing care, pensions, and the list goes on. Choosing where the pain is to be felt is a very difficult task with a great deal of pain to be distributed.
What price a good short-term economic recovery?
Is the FT’s Martin Wolf right to say “Any recovery is better than none”? This simply cannot be true – the costs have to be measured. Short-term growth is not worth having if we mortgage our futures to get it.
Should we carry on with a policy designed to simply reduce the rate of increase of the national debt in order to get a rapid recovery? Current Government plans see some £400bn added to the Government debt before it is planned to stop that debt increasing.
It is generally the experience that highly indebted economies grow more slowly than less indebted ones. Less wealth is likely to be available in the future if there is more debt.
It is very likely that the economy will grow slower with the state at half the economy rather than the 40% or so which has generally proved just about sustainable. It is certain that every pound of debt put onto the national balance sheet either has to be serviced, defaulted or inflated away.
It is certain that the levels of debt and deficits in the developed Western economies are in historically high and largely uncharted territory. Whilst there have been times of very high debt – say post WWII – things were very different. When creditors get to fear default or inflation, interest rates will certainly rise, and that would really hammer the highly leveraged UK economy. Only the timing of this event is uncertain.
The government is currently talking quite toughly but its plans still mean continuing to load debt onto the next generation over the coming years and relying on low interest rates persisting, decent economic growth and stable international financial conditions to get close to equality in spending and income in 5 years – a very uncertain prospect. Even if all the winds blow in the right direction, achieving this equality is not in itself a victory – there will be a very considerable debt mountain to be lived with.
It must be right to be concerned that the Coalition may lack the necessary stomach and cohesion to grasp the nettle firmly. Union opposition seems increasingly likely to be resolute.
With all this in mind, it’s pretty clear that it would be better for the country to take the pain now and get the deficit down more quickly. Yes, it would probably mean more unemployment and business failure in the short run, but it could provide a much better base for future growth. Resources would move from the public sector to the private sector quicker and, with a more sensibly balanced and less levered national economy, growth would return. It would be less risky and definitely a great deal more morally honest to cut the state quicker. Our kids do not deserve our debts.