This is an excellent analysis of our current position and a glimpse of the unpalatable future too. Highly recommended!
He approves of raising the pension age but avers ut will be massively unpopular. As one who retired officially 11 years ago 12 years late I feel this is both desirable and - in practice - unavoidable. The present situation is clearly unsustainable.
Christina
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TELEGRAPH 14.7.09
Like Mr Micawber, Britain finds itself in a debtors' prison
"Annual income twenty pounds, annual expenditure nineteen pounds nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.” So says the Micawber Principle, after the character in Dickens’ David Copperfield.
By Jeremy Warner
Rarely has it seemed more apposite. Mr Micawber ended up in a debtors’ prison. The UK economy is arguably already in it. The long, credit-fuelled boom is over, leaving Britons with mountainous debt which will take years to work off. To that must now be added burgeoning public debt.
Rewind a decade, and the health of Britain’s public finances was the envy of Europe. [For those who’ve forgotten or who never knew this was literally true, in the days before Gordon Brown laid his hands on our economy -cs] In little more than two years, those advantages have ruinously been blown away. Even the Treasury admits that national debt as a proportion of GDP will rise to 80pc over the next several years . Many outside forecasters think it will be worse — more like 100pc.
Not since the Second World War has the situation looked so dire. At least on that occasion there was an understandable reason for it. This time around, we seem to have mortgaged our future for flat-screen TVs from China, BMWs from Germany, an unsustainable housing boom and an unaffordable surge in public spending, much of it of questionable long-term value.
Is there any way out of this mess? The good news is that ultimately, everything has a habit of sorting itself out. Even an economic calamity as bad as this one will in time self correct. The bad news is that it will take many years, with living standards badly squeezed in the meantime.
First, let’s analyse the problem of private debt and the changes this overhang is bringing about. It may not feel like it right now, but a seminal shift is under way in the relative merits of borrowing and saving as banks seek to restore solvency ratios and repair the damage wrought by bad lending decisions.
Regulatory efforts to make banks safer by imposing tougher capital controls [see -”Banking regulation or separation ?” sent earlier -cs] will at one and the same time further restrict credit and make it more expensive. Banks are finding it a whole lot more expensive to fund themselves. Government schemes to enable banks to obtain the funding that markets cannot or will not provide are costly.
For many years now, it has made little sense to save. The rewards went instead to those who geared themselves to the hilt and bought assets with borrowed money. Abundant liquidity meant that banks could obtain cheap credit from around the world which they would then transform into ever greater quantities of mortgage and consumer debt. Banks traditionally made their profits from “the spread”, the difference between the borrowing and lending rate. This was compressed to virtually zero during the boom, so freely available did money become. Instead, banks came to earn their profits from origination fees, the commissions on securitization, and so on.
Those sources of income are now substantially reduced, and the banking model is reverting to the more normal one of maturity transformation, or persuading savers to lend the money needed to finance business investment. As I say, it may not feel that way. Close to zero bank rate means that savers are struggling to get any kind of a return on their money. Those on existing tracker or standard variable rate mortgages have meanwhile found their debt servicing costs substantially reduced by the low interest rate environment.
Yet it won’t last. New tracker deals are now only available at rates substantially above bank rate, and in recent weeks there have been steep rises in the cost of fixed rate mortgages. With money and credit scarce, the balance of power is shifting decisively from borrower to saver.
This is obviously as it should be if the more “balanced” economy policy-makers aspire to is to come about. But the correction is at a cost. What John Maynard Keynes called “the paradox of thrift”, where an increased propensity to save further undermines demand and therefore adds to recessionary pressures, will only exacerbate the negative effect of the credit squeeze.
This is where the ruination of the public finances takes over. Like the consumer, the Government has been living beyond its means. It mistook the windfall revenues of the financial services and housing booms as a permanent addition to the tax base.
But that’s not the whole picture. In large measure, the deterioration is caused by policy attempts to stave off the worst effects of the banking and economic crisis.
Addressing the implosion has required the same poison as caused it in the first place - excessive debt. As governments seek to bail out their banking systems and revive their economies with fiscal stimuli, they are only replacing one form of debt with another. Public debt is substituting for the private debt that is no longer available. Governments judged credit worthy can for the time being still borrow almost as much as they like on reasonable terms.
The Government can also print new money to counter the effects of the shrinkage going on in the banking system. Unlike the eurozone, the UK Treasury has grabbed this opportunity with both hands .
The cost of bailing out the banking system – running to hundreds of billions of pounds once everything is taken into account – is one thing. As yesterday’s annual report from United Kingdom Financial Investments, the authority charged with looking after the taxpayers’ interest in Royal Bank of Scotland and Lloyds Banking Group, makes plain, it will be years before we know whether we are going to get our money back. But as the banking system and the economy recover, there seems a reasonable chance we will, so that’s at least one positive to take from the road crash in the public finances.
Sadly, the cost of fixing the banks is just the part of it. The bulk of the deterioration is caused by operation of the “automatic stabilisers”, the classic Keynsian response to a downturn which acknowledges that the deficit will rise precipitously as tax revenues shrink and social security spending picks up.
Eventually, this must be addressed through a painful fiscal consolidation. Deep cuts in public spending and/or big hikes in taxation are inevitable if Britain is to avoid a classic debt spiral, where it has to borrow more merely to pay for the servicing costs on existing debt.
To my mind, the most economically eloquent solution is that proposed by Ray Barrell, Ian Hurst and Simon Kirby of the National Institute of Economic and Social Research. Their big idea is the relatively simple one of raising the retirement age.
With workers spending longer in employment, this would at one and the same time cut long-term pension costs and increase tax revenues. Unlike immediate cuts in public spending or increases in taxation, there would also be no damage to demand, which to the contrary would be increased because people would need to save less for their retirement.
Unfortunately there is one obvious drawback. It would almost certainly be politically impossible. Brave indeed would be the political leader who launched this particular bombshell on an unsuspecting public.
Whatever the solution, it is essential Britain avoids the mistakes made last time debt got this high more than 60 years ago.
Britain mortgaged its economic future in paying for the war. High war time taxes – or compulsory saving as Keynes preferred to call them — continued into peacetime, lowering investment and therefore growth relative to the US and some parts of Europe.
Britain’s reward for freeing the Continent of totalitarianism was to become “the sick man of Europe”. [= we paid for saving them ! -cs] The tax burden was more than doubled, with punitive top marginal rates which persisted until the early 1980s and both undermined investment and destroyed the incentive to create wealth.
Spending cuts rather than higher taxation have to be the way forward, [the public seem to prefer this route, so that’s something! -cs] in the same way as fiscal consolidation in tandem with loose monetary policy seems preferable to the haphazard policy response taking hold on the Continent, where fiscal laxity is being countered with relatively harsh monetary policy.
Mr Micawber put his faith in something turning up. This might seem a desperate thing on which to base our hopes for the future. Having spent years trying to develop policy on how to pay for the war, Keynes concluded towards the end of his life that maybe Britain would just have to trust to Adam Smith’s “invisible hand”, or the markets, to sort things out. That will be the way of it this time around too.
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