The Opposition front bench believe the Coalition Government has exaggerated the problem in the public finances. “Too far, too fast” is their easy, guiltless mantra.
In a culture – media and political – that has become used to “solving problems” with public money and leaving future generations to pick up the bill, every step the Chancellor is taking to reduce the deficit is met with varying degrees of hyperbole, with predictions of disaster ahead or fairness undone.
In truth, the concern should be that by focusing on deficit reduction rather than debt reduction, the Coalition government has not yet gone far enough in creating the conditions for stable, long term growth. The greater imbalance in the economy is not between sectors, it is between what we demand and our ability to pay – an imbalance between generations.
Twenty years of living beyond our means
If there is one chart that should guide our country’s thinking about our economic situation, it is the one by McKinsey, a global consultancy, on the debt of leading nations in the period from 1990 to 2010. In this chart, reproduced below with permission, you can see how the total indebtedness of the major economies – that is government debt and household debt, plus corporate debt and financial sector debt – grew over the period.
The stunning feature of this chart is the distinctive trajectory of the United Kingdom over the period from the late 1990s until 2008 – a period where the United Kingdom uniquely pursued policies of gorging ourselves with debt to satisfy our immediate needs.
For twenty years we have been living well beyond our means. The idea that somehow the results of this policy can be “fixed” in two years, or one Parliament, is an ambitious expectation to put it mildly. It will take a long period where we “expect less and produce more” to free us from the burdens of this debt.
There is a second aspect of the chart that should also make UK policy makers ponder. Look at the trajectory for Japan, which entered the period with debt already at 400% of GDP, and despite various policies found reduction of its debts stubbornly difficult to achieve.
Restoring our nation’s financial health is a journey which the Government has only just begun. The end point however is not only to achieve the elimination of the deficit, it is to achieve a substantial reduction in our debts, both public and private – and that needs a longer period of time, and a thorough rethink about the role of credit – and likely, the state – in our economy. Over the twenty years of excess, powerful vested interests have developed and without a stronger, clearer message, they will be hard to dislodge
Latent Risks from the Unwinding of QE
When, in 2007 the music stopped, in such spectacular fashion on our debt fuelled nation, the immediate concern was maintaining liquidity in the economy. For many years now, the UK government has pursued an aggressively expansionary monetary policy, quantitative easing (QE), in part using the Bank of England’s Asset Purchase Facility to buy the Government’s own debt (gilts).
However, this strategy only provides breathing space for corrective action and that breathing space comes at a cost. At some point soon, QE must stop – as even Robert Mugabe found out – and then someone else must start buying our debt – almost inevitably at higher rates of interest.
How significant is this threat? Purchases via the Asset Purchase Facility have been so significant that by September of last year the Facility represents 18% of all the nation’s gilt holdings (see chart above), or £315bn. In February of this year, the Bank of England authorised a further £50bn of gilt purchases over a three month period. As total gilt issuance for 2012/13 is forecast at £168bn, this represents a significant share of the annual appetite for UK government debt.
Those concerned with the probity of public finances will want to know what the impact will be on the economy of halting, and unwinding, QE. If the Government’s demand for credit remains high at the end of QE the interest rate risk could severely damage the recovery. The Government has a responsibility to spell out how it will further reduce its need for credit as QE is unwound.
A Future Fund to reduce debts for future generations
After correctly focusing on debt rather than deficit reduction and after successfully halting and unwinding QE, there remains a third issue that those concerned about our debts should confront: the cost of public sector pension liabilities. This previously “hidden” part of the government’s debt now exceeds £1 trillion and, as the chart below shows, this liability has increased significantly over recent years.
The Hutton review of public sector pensions and subsequent Government negotiations with public sector unions are establishing a fairer basis for public sector pensions that may well restrain the growth of these liabilities. However, the Hutton review ruled out a change that would have significantly unburdened future generations from a major debt – a move to a fully funded public sector pension scheme.
In Australia this is called a “Future Fund” and rightly so. Following the most commercial of investment principles, and with a focus on long term infrastructure investment, the Future Fund seeks to achieve a fully funded basis for all the pensions of Australian public sector workers by 2020. In so doing, the Future Fund will improve infrastructure for the next generation of Australians and lighten their taxes from the pension fund obligation. This comes at a price, and that is an annual contribution from public funds to provide the investment capital for the Fund.
In the UK context, that might mean finding an additional £20bn a year for twenty years. While we are running a budget deficit, that would be tough, but Government could signal its intent to do this – shifting the goal line for deficit reduction and finding a further £20bn of current public expenditure reductions to provide the capital for the fund.
Bring on the debt hawks
Each of these measures – a clear commitment to debt, not just deficit, reduction; a strategy to manage the potential interest costs of unwinding QE, and a future fund for public sector pension liabilities – would be bold for any Government, particularly as growth is proving elusive, but action on each of these would set the tone for the rest of the nation that a balanced economy means being honest and fair to future generations by properly dealing with the debts of our own generation.