britain at the crossroads the case for fundamental change Dr Tim Morgan Global Head of Research
strategy insights | issue four britain‘It isat the possible crossroads | the case for to fundamental envisage change a future in which the British population is subjected to ever-increasing taxation and charging to sustain an administrative superstructure which is increasingly coercive as well as unaffordably costly.’
2 strategy insights | issue four britain at the crossroads the case for fundamental change
“The UK needs to modernise, and to commence a new ‘quest for national efficiency’” contents introduction an unreal debate part one: the road to here 1 a golden inheritance? 2 the great experiment part two: where is here? 3 money troubles 4 the way we live now part three: the road out 5 limited options 6 practical choices
Note: In Issue Three, we said that our ‘Dangerous Exponentials’ core thesis would form the subject of Issue Four. However, because of the imminence of the UK general election, we have brought this report forward. ‘Dangerous Exponentials’ will now be the subject of Issue Five.
strategy insights | issue four 3 britain at the crossroads | the case for fundamental change
strategy insights | issue four britain at the crossroads the case for fundamental change – summary
• With a general election looming, 2. The debate is essentially short- quangos that have proliferated investors are being inundated with term in nature, so necessarily over the last 20 years, and (b) research, much of it suggesting misses some of the longer-term reducing the complexity and cost appropriate investment strategies. trends (such as the growth of of departmental administration to Given our remit – which is to bureaucracy) which are critical that of international best practice. stimulate debate on matters to an understanding of the In the final chapter, we explain of economic and financial current situation and of the • how this could be done. We significance, and to think outside future imperatives. describe a route to achieving a the box – this report is different. 3. Where the recent economic sustainable (3%) deficit over five We aim to probe some of the and fiscal crisis is concerned, years, while at the same both deeper and longer-term strands of the bill hasn’t turned up yet, and reducing (slightly) the overall the current UK situation. politicians are understandably burden of taxation, and actually • To this end, this report is divided loathe to reveal the full scale of improving public service provision. into three parts. After an the challenges confronting the introductory discussion of some United Kingdom. of the issues at stake, Part one 4. It is only by grasping both takes a detailed look at how we got the current situation and its here, reviewing both recent and historical precedents that longer-term economic and political we can frame practical developments. Part two assesses new directions. the issues as they now stand, and the final section offers radical The latter point is the most policy options going forward. • important. It is perhaps a • Readers might regard much of this simplification, but not much of one, report as gloomy. It may certainly to say that the best policy options seem so to those unaware of the for the future may lie in the flip- full scale of the problems with sides of the mistakes of the past which the UK is beset. Our analysis and the weaknesses of the present. is certainly intended to be hard- Our strategy is predicated on the hitting, for four main reasons: • belief that, after a decade of break- 1. Much of the political debate neck increases in public spending, is being conducted in an air of the UK system of administration unreality, and seems to assume is ruinously over-expensive as well a freedom of manoeuvre (on as absurdly complex. Huge savings issues such as the urgency of could be achieved simply by (a) deficit reduction) which may not consolidating or scrapping many in fact exist. of the plethora of ‘agencies’ and
strategy insights | issue four 1 britain at the crossroads | the case for fundamental change
principal recommendations
• Recognise that Britain’s public the real-terms level of 2007-08 • Tackle the deficit, reduce taxation. services are over-expensive (£615bn at 2010 values). Our calculations suggest that a because they are over-managed. • A quest for national efficiency. real-terms cut of £80bn in public This over-management has arisen Essential modernising steps spending would, if achieved by from (a) the fragmentation of include: 2015, reduce the deficit to 3% of services (such as the NHS) in the - reconsolidating fragmented GDP while enabling the overall tax vain pursuit of quasi-competition, public services burden to fall slightly, from 36% to and (b) the proliferation of quangos 35% of GDP. - reducing administrative costs to and semi-autonomous ‘agencies’. best-practice international levels • Helping at the margin. If scope • Live within realistic revenues. The - dispensing with large numbers did indeed exist for some modest next Parliament should adopt a of quangos and semi- reductions in taxation, our ‘self-denying ordinance’ which says autonomous ‘agencies’ preference would be to raise the that government must decide upon - capping the tax deductibility of basic tax allowance from the a realistic level of revenue and only interest expense current £6,475 to the level of the then decide how this spending minimum wage (about £10,200). - abandoning the wasteful should be allocated. Likewise, we would address the PFI process interface between benefits • Reduce public spending by - abolishing the failed tripartite and work. £80bn. Far from devastating regulatory system, with the public services, this would only banking oversight function cut outlays (currently £700bn) to restored to the Bank of England.
Fig. 1: Outline financing projections
£bn 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-5 vs 09-10
GDP £1,435 £1,409 £1,465 £1,520 £1,593 £1,672 £1,756
Revenue nominal £534 £508 £525 £541 £564 £588 £614
in 2010 £ £547 £508 £514 £522 £530 £538 £546 +£38.4
as % GDP 37.2% 36.1% 35.8% 35.6% 35.4% 35.2% 35.0%
Spending nominal £630 £674 £672 £667 £668 £668 £667
in 2010 £ £645 £674 £657 £643 £628 £611 £594 -£80.2
as % GDP 43.9% 47.8% 45.9% 43.9% 41.9% 40.0% 38.0%
Deficit nominal £96 £166 £147 £126 £104 £80 £53
in 2010 £ £98 £166 £144 £121 £98 £73 £48 -£118.6
as % GDP 6.7% 11.8% 10.0% 8.3% 6.5% 4.8% 3.0%
2 strategy insights | issue four about this report
Economic slumps do not happen by ‘boom and bust’. This was simply finances but of the front-line workers accident. Fiscal crises are not ordained hubris. Much worse, public spending and of the users of social services by a malignant economic deity. Though was allowed to rise dramatically, as well. For example, the Ministry of the immediate catalyst for the UK’s largely on the assumption that growth Defence spends 20% of its budget debt crunch was the global downturn was both real and sustainable. As a on administration while its foreign triggered by US sub-prime, this merely result, the government is running an counterparts manage to get by on crystallised the implications of a policy unprecedented deficit (of 12% of GDP) just 11%1. The situation in an NHS direction that, sooner or later, was that far exceeds either the IMF crisis fragmented both by this government always destined to hit the buffers of the 1970s (7%) or the post-ERM and by its predecessor is even worse. anyway. squeeze (7.7%) of 1993-94. Examples of administrative profligacy abound. Events follow from policies, and the When anyone calls for cuts in public policies which have been followed in spending, there are howls of protest, This report proposes an alternative the UK for more than a decade have and grim warnings that slashing strategy. We advocate reducing been fundamentally flawed. The spending would inflict unacceptable the deficit to 3% of GDP by 2015 country’s current straitened economic damage on the public services that are through radical overall of the public and fiscal circumstances are the logical required by a civilised society. This is sector, culling quangos and slashing outcome of these mistakes. bunkum. In 2009-10, the government overheads. An important implication spent £674bn. If this were reduced of this strategy would be that quality This report, which takes a radical by £50bn, it would remain higher public services could be maintained view of the British malaise, explains than the inflation-adjusted total for at a level of taxation (35%) that this process. The basics of the 2007-08, when the public services would give Britain’s economy a real UK’s self-chosen route to crisis are were hardly under-funded. Even a competitive edge. Any such strategy straightforward enough. ‘Light £100bn reduction would only take real would, of course, provoke screams touch’ (for which read ‘negligent’) spending back to the 2004-05 level. of protest from vested interests. regulation of the financial system Government should turn a deaf ear to led to a totally unsustainable, and In any case, the claim that big cuts such screams, and make a quest for almost entirely illusory, economic would devastate front-line services is national renewal as its overriding aim. ‘boom’. Far from recognising this, bogus. The reality is that the UK public It is a matter of choices. and responding accordingly, the sector is grotesquely over-managed, to government proclaimed an end to the detriment not just of the national
Fig. 2: An inexorable rise – public spending, 2001-10
£bn 01-02 02-03 03-04 04-05 05-06 06-07 07-08 08-09 09-10
Actual spend £389 £421 £456 £492 £524 £550 £583 £630 £674
In 2010 £ £480 £508 £533 £559 £580 £597 £615 £645 £674
1 Source: report by McKinsey, cited The Financial Times, 23rd March 2010. strategy insights | issue four 3 britain at the crossroads | the case for fundamental change
Fig. 3: Financial summary, 2009-15*
£bn 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15
GDP £1,435 £1,406 £1,464 £1,533 £1,621 £1,720 £1,824
Revenue £534 £508 £541 £582 £621 £660 £699
Expenditure £630 £674 £704 £713 £730 £748 £772
Surplus/(deficit) £96 £167 £163 £131 £109 £88 £73
Debt at year-end:
Reported debt £629 £761 £931 £1,065 £1,183 £1,281 £1,366
Treaty debt £796 £1,004 £1,179 £1,318 £1,438 £1,534 £1,618
As % GDP:
Revenue 37.2% 36.1% 37.0% 38.0% 38.3% 38.4% 38.3%
Expenditure 43.9% 47.9% 48.1% 46.5% 45.0% 43.5% 42.3%
Deficit 6.7% 11.8% 11.1% 8.5% 6.7% 5.1% 4.0%
Reported debt 43.8% 54.1% 63.6% 69.5% 73.0% 74.5% 74.9%
Treaty debt 55.5% 71.4% 80.5% 86.0% 88.7% 89.2% 88.7%
Memo:
Real growth -1.5% -3.8% 2.0% 3.0% 3.3% 3.3% 3.3%
GDP deflator 2.5% 1.8% 2.3% 1.5% 2.5% 2.8% 2.8%
*Source: Budget 2010
4 strategy insights | issue four Fig. 4: Financial projections 2009-15*
£bn 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15
GDP £1,435 £1,409 £1,465 £1,520 £1,593 £1,672 £1,756
Revenue £534 £508 £525 £541 £564 £588 £614
Expenditure £630 £674 £672 £667 £668 £668 £667
Surplus/(deficit) £96 £166 £147 £126 £104 £80 £53
Debt at year-end:
Reported debt £629 £761 £970 £1,109 £1,227 £1,320 £1,385
Treaty debt £796 £1,004 £1,218 £1,362 £1,482 £1,573 £1,637
As % GDP:
Revenue 37.2% 36.1% 35.8% 35.6% 35.4% 35.2% 35.0%
Expenditure 43.9% 47.8% 45.9% 43.9% 41.9% 40.0% 38.0%
Deficit 6.7% 11.8% 10.0% 8.3% 6.5% 4.8% 3.0%
Reported debt 44% 54% 66% 73% 77% 79% 79%
Treaty debt 55% 71% 83% 90% 93% 94% 93%
Memo:
Real growth -1.25% -3.50% 1.50% 2.00% 2.00% 2.00% 2.00%
GDP deflator 2.50% 1.75% 2.25% 1.50% 2.50% 2.75% 2.75%
*Source: Tullett Prebon projections, based on 2% real GDP growth, a tax target of 35% of GDP *bySource: 2014-15, Tullett and Prebon a deficit projections, target of based3% on 2% real GDP growth, a tax target of 35% of GDP by 2014-15, and a deficit target of 3%
strategy insights | issue four 5 britain at the crossroads | the case for fundamental change
summaries: part one – the road to here
1. a golden legacy?
• Though much of the blame for the • There has been a long-standing state of the economy and of the failure to target the welfare system national finances falls squarely at on those in genuine need, or to the feet of the current government, overcome the poverty trap. significant weaknesses pre-dated 1997. • Trends towards excessive deregulation of financial services • The British tax system has long began in the 1980s, and triggered favoured debt capital over equity. the regrettable de-mutualisation of While defenders of this bias claim the building societies. that it attracts investment, the reality is that it simply attracts • Since the early 1990s, the need for debt. The employers’ National energy security has been neglected, Insurance (NI) system penalises and short-termism (most notably job-creation, and NI itself has in the ‘dash to gas’ in power become nothing more than an generation) has damaged the income tax masquerading under longer-term outlook for energy. another name. • Britain has, since the 1990s, taken • The original aim of privatisation an unduly relaxed stance towards was to return to the private sector overseas ownership of key strategic industries which had no logical industries. Britain is almost alone place in government ownership. among major developed economies After the departure of Mrs Thatcher, in that it has allowed however, privatisation was pushed its utilities, airports and other into wholly inappropriate areas key strategic assets to become of public service provision. This foreign-owned. resulted in a costly and inefficient fragmentation of the public services, and claims that this would offer both efficiency and consumer choice were essentially bogus.
• The British bureaucracy has been growing, with few pauses and even fewer reversals, since 1945. This growth has long been out of control.
6 strategy insights | issue four 2. the great experiment
• Since 1997, Labour has attempted overstretch transitioned into to remodel society along essentially the national debt, while the ideological lines. Unfortunately, reversal of earlier, largely illusory these objectives have been growth pushed the relationship undermined by failed economic, between government revenue and fiscal, monetary and regulatory spending into the red to an extent policies which continued and unparalleled in the peace-time worsened, rather than reversing, history of the UK. inherited weaknesses. • This has in turn damaged the • Together, the introduction of the performance of an economy tripartite system, and the exclusion whose competitiveness has been of asset price inflation from undermined by excessive taxation monetary targeting, paved the and by burdensome regulation and way for a ‘notional value’ bubble of interference. Moral absolutism which the 2008 financial crisis was has been the cause of many of the the inevitable result. mistakes of the last 13 years.
• Far from realising that the 2000- 07 ‘boom’ was essentially both illusory and borrowed, government bought into the theory that ‘boom and bust’ had been abolished. This, it was believed, could pay for a remodelling of society based upon increases in public spending which took government outlays from 36% to 48% of GDP in the space of a decade.
• At this point, two inevitable processes combined to stretch the government balance sheet to somewhere near breaking point. Via an inevitable TAT (toxic asset transference) process, banking
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summaries: part two – where is here?
3. money troubles
• The United Kingdom has become assumptions, while the exclusion of mired in debt. Reported national pensions and PFI increments leads debt – which the government to the under-reporting of the real says will rise from £760bn today deficit. to £1.37 trillion by 2015 – severely • Britain faces significant ‘vortex risk’, understates indebtedness because by which we mean the danger that it omits both public sector pension the economy could be damaged, obligations (of perhaps £1 trillion) via much higher interest rates, and PFI (private finance initiative) if the markets conclude that UK commitments. government indebtedness is out • Projections for the future of control. trajectories of debt and the deficit • ‘Vortex risk’ makes resolute action are flattered by unrealistic growth imperative.
8 strategy insights | issue four 4. the way we live now
• The argument that cutting public • The debate over how long Britain • The wastefulness of government spending could put at risk the can defer spending cuts is spending has combined with ‘recovery’ (which has been anaemic essentially a false one. increasingly burdensome at best) misses the key point, regulation to undermine economic which is that the British system • The bill for the downturn is about competitiveness. of government has become both to turn up, and the markets may unaffordable and inefficient. not be willing to help pay it unless • Quasi-market ‘reforms’, and a a determination to reform is proliferation of agencies and • Thus far, ‘vortex risk’ has been demonstrated. quangos, have created a sprawling, averted thanks to ‘three props’ – costly and inefficient bureaucracy. quantitative easing, the imminence • The UK economy has been stifled of the general election, and the by a system of government which is weakness of sterling – each of at once both excessively costly and which is time-limited. unnecessarily interventionist.
strategy insights | issue four 9 britain at the crossroads | the case for fundamental change
summaries: part three – the road out
5. limited options
• The policy alternatives available to the next government are stark. Attempting to muddle through with a ‘business as usual’ approach will not work, because Britain’s economic and fiscal problems are structural, not transitory.
• Any attempt to repair fiscal balances simply through higher taxation would impoverish British households and inflict further damage upon the economy.
• The obvious solution would be to reverse the growth in public spending by seeking, over a five- year period, real cuts of £80bn. This would amount to nothing more drastic than reducing real-terms spending to the levels of 2004-05, when public services were hardly cash-starved.
• Critics would contend that cuts of this magnitude would damage public services, but we completely disagree with such scare-mongering.
• Britain’s sprawling and inefficient bureaucracy is so vast and wasteful that it would not be difficult to find £80bn of savings without in any way damaging front-line services.
10 strategy insights | issue four 6. practical alternatives
• How, then, can public spending • This should include: be slashed without damaging essential services? - Driving down administrative costs
• No less a person than Steve - Scrapping many quangos and Bundred, Chief Executive of the quasi-autonomous ‘agencies’ Audit Commission, has stated - Reconsolidating fragmented that spending cuts are ‘inevitable, public services and perfectly manageable’, and that fears that front-line service - Simplifying the tax system (and impairment will result from combining National Insurance spending reductions is a ‘myth’. with income tax) Mr Bundred has urged the public not to ‘believe the shroud wavers - Abandoning the ID card and NHS who tell you grannies will die and computer programmes children starve if spending is cut. - Scrapping the wasteful PFI system They won’t.’ - Concentrating any possible scope Since our outline reform plan is • for realignment of taxation into aimed at slashing administrative raising personal tax thresholds overheads, we see no need to at least to the level of the reduce the salaries of public sector minimum wage workers earning less than £30,000 annually (though higher pension - Limiting corporate tax relief on contributions seem inevitable). interest expense
• Rather, we would aim to drive - Scrapping the failed tripartite administrative overheads down to system and handing responsibility best-practice international levels, for banking supervision to the and to cut entire agencies and Bank of England quangos out of the public sector gravy-train. - Imposing mortgage lending limits in order to minimise the risk • Essentially, Britain needs of future asset bubbles. to commence a ‘quest for national efficiency’.
strategy insights | issue four 11 britain at the crossroads | the case for fundamental change introduction an unreal debate
Within the next month, British electors exists a lot of freedom of choice over at a figure which is not drastically will go to the polls in an election the timing of a reduction in the deficit. dissimilar to the deficits recorded in which is widely (and rightly) regarded As the public both in Ireland and in 2009 by Greece (10.8%), Spain (11.1%) as the most important since 1979. Greece have discovered, such freedom or the United States (11.9%). Not surprisingly, investors are already of choice is illusory. being inundated with reports aimed at The UK number (and, no doubt, at influencing investment strategies. Second, none of the canvassed options least some of the others) understates for deficit reduction really tackles the the depth of the problem, because Our purpose, however, is a different structural problems it excludes very one, the aim of our strategy research which have rendered ‘Where the recession significant increments being to stimulate debate on issues the British system and the fiscal crisis are to off-balance-sheet of importance. The pivotal UK general of government ever concerned, the bill hasn’t obligations such as election of 2010, and the economic more expensive public sector pensions issues which will hinge upon it, clearly and burdensome turned up yet. But it will’ and PFI3 commitments. belong within our remit. In order to and, as a result, the By the same token, fulfil our brief, which is to present new economy increasingly uncompetitive. reported national debt – which, perspectives and to think outside the Moreover, and as we shall explain according to the budget, will rise box, we shall not confine ourselves later in this report, this debate is being from £760bn to £1.37 trillion, or 75% to – though of course we must conducted in the context of data which of GDP, by 2014-15 – very materially address – the near-term, battleground may be at best misleading. understates true government arguments over taxation, spending, the obligations, which we estimate at £2.1 deficit, and other current policy areas. In order to identify the real issues, this trillion, and believe could rise to £3.15 Rather, we endeavour to undertake a analysis will take a lengthy look at the trillion (180% of GDP) over the same longer-term and more fundamental underlying causes of Britain’s current time-frame. During 2009-10, the analysis of underlying issues. problems. We shall then examine deficit was essentially monetised the current situation, and pass on to through £200bn of quantitative easing There is, in any case, an air of unreality consider possible solutions. Many of (QE). For obvious reasons, this is not a about the current economic debate. these solutions will be radical but, as long-term solution. Essentially, the Conservatives are we shall explain, the circumstances arguing for an early (though by no call for fundamental reform, not for Neither is the burden of forward means swingeing) attack on the deficit, tinkering and muddling through. obligations by any means confined while the government counters that to government. According to recent early spending cuts could endanger the During 2009-10, the government reports, the liabilities of the private economic recovery. borrowed £167bn. This is equivalent sector pension system exceed £1 to 11.8% of GDP on the reported trillion4. Some £1.2 trillion is owed This debate is unreal, in two senses. format and, when calibrated on by individuals on mortgages secured 2 First, the assumption is that there an international basis , works out against a housing stock which, based
2 See appendix 1 for the basis of international comparisons used in this report. Essentially, we use CIA World Factbook dollar-denominated data for calendar year 2009. 3 Private Finance Initiative. 12 strategy insights | issue four 4 See Financial Times, 22nd February 2010. both on historic multiples and on homebuyers to energy companies, Of course, this situation cannot last. likely future trends in net-of-tax oil producing states, and reckless and In due course – and, we think, sooner incomes, continues to look overvalued. foolhardy bankers. rather than later – taxes will rise, and Commercial property probably government spending will fall. Unless represents another serious financial Over-rewarded bankers are an easy resolute action is taken on the deficit, black hole. And, through a process target, but the public is being asked there is every danger that raising that we describe later in this report to believe that the leaders of the sufficient new funds to finance the as ‘TAT’ (toxic asset transference), the UK banks suffered simultaneous deficit may prove difficult, resulting government is, in principle, the forced brain-storms, which seems to us in a sharp increase in interest rates. underwriter of any future setbacks in highly implausible. The problem was Indeed, and again unless resolute the banking system. clearly systemic and regulatory, not action is taken, we cannot rule out idiosyncratic. The crisis is indubitably the possibility of a ‘perfect storm’ It should be said from the outset global, but a lot of the UK’s problems for the UK economy – higher interest that the UK is by no means alone are self-inflicted. A country which rates, rising unemployment, falling where these problems are concerned. believed that it was ‘best placed’ to property prices, an even weaker American off-balance-sheet obligations weather a global downturn and, even currency, rising inflation (caused in part are probably well in excess of $50 more ludicrously, that it had abolished by higher import costs), and escalating trillion, and the administration itself ‘boom and bust’, will soon wake up public debt. admits that committed spending to reality. (in areas such as healthcare and social A report which looks ahead to a security) will rise, not diminish, over Indeed, part of the air of unreality post-election economic landscape the coming decade, even without which surrounds the current debate obviously cannot avoid politics. healthcare reform. There are similar springs from the fact that, where Political decisions are a critical part problems both in Europe and in the recession and the fiscal crisis are of the economic landscape because, Japan. The global dynamic – in concerned, the bill hasn’t turned up as we have explained in a previous which the west borrows from Asian yet. But it will. Public sector debt has report, economic outcomes are not savers to fund unsustainable levels escalated, but the deficit has been the workings of blind chance but, of consumption – is fundamentally funded thus far by QE to the point rather, are matters of choice5. In this unbalanced. where the UK has not been confronted assessment we shall be highly critical by the challenge of raising genuinely of the Labour administration which This said, Britain’s situation is by new debt. Indeed, and because of has governed the UK since 1997, but no means wholly (or even mainly) low interest rates, most consumers investors should be in no doubt that a consequence of global trends. To – so long as they have avoided many of Britain’s woes long pre-date understand the nature of the UK unemployment – have felt better off the advent of Blair and Brown. economic crisis, and to consider what than they did before the crisis. Thus far, happens next, and what shape a government spending has not been solution might take, we need to look cut, and there have been few material beyond a blame-shifting exercise increases in taxation. This, then, is the which has attempted to pin the unreal atmosphere in which fiscal and culpability on everyone from American economic choices are being discussed.
5 See Issue Two, Brave New World? strategy insights | issue four 13 britain at the crossroads | the case for fundamental change
‘most members of the public have, as yet, no real conception of quite how weak the economy of the UK has become’
14 strategy insights | issue four not broke, not broken – but in urgent need of repair
One big conundrum presents itself at The observation that, while Britain taxpayer at least £1m annually? Why, the outset and is, we think, central to is not ‘broken’, the public are clearly indeed, has the inquiry into Bloody the debate about the future of Britain. extremely dissatisfied, poses Sunday cost the taxpayer £200m? A recent opinion poll6 showed that a two questions. First, how is this clear majority of the British public are contradiction to be explained? Second, In other words, why has the British very dissatisfied with the state of the does it matter? The answer to the system of government become so country. By a significant margin (64% of latter question is, emphatically, yes – it expensive, so cumbersome, and so those asked), those polled responded matters very much indeed. A depressed divorced from reality? that Britain was going in the wrong population is not compatible with Second, politicians (of all parties) need direction, and, according to the a progressive, wealth-generating simply to listen to the general public, majority (56%), was a country that they economy. in order to appreciate the breadth of no longer recognised. A remarkably the divide that has arisen between large minority (42%) said that they The answer to the former question governing and governed. Bleak opinion would emigrate if it were practical for must follow an economic overview poll findings essentially highlight a them to so. which falls into three principal categories: deep sense of unease in a population Opposition politicians see such which increasingly believes that it is findings as support for their ‘broken 1. Weaknesses which pre-date 1997, serving, rather than being served by, Britain’ thesis – indeed, 70% of those and the evolution of the economy the apparatus of the state. Unless and polled agreed with them about this under Labour. until this can be resolved, the British - yet the evidence for this is actually public will increasingly believe that 2. The current state of the economy scant. Crime (including violent crime) they are governed by what they regard and the public finances. has diminished, not increased, while as a self-serving, gravy-train elite which has become disconnected from the teenage pregnancy and binge drinking 3. Future challenges and policy hinterland of broader society. have not been escalating, as is widely options. assumed (though both remain These are issues to which we shall uncomfortably high)7. In short, and In the meantime, however, we can return. First, though, let’s look at how while the ‘broken Britain’ tag does not anticipate two of the conclusions weaknesses, both recent and long- accord with the facts, it remains true which inform our thinking. First, and standing, led the UK economy to that a significant majority of the British simply as an indicative example, perform poorly, and the public finances public are deeply unhappy about the public anger over revelations about to deteriorate alarmingly, during an state of the country. The condition of MPs’ expenses has completely missed economic crisis that Ed Balls famously the economy is a factor here, of course, the point, which is this – why has it described as ‘the most serious though we are convinced that most cost perhaps £7m to recover £1.1m global recession for...over one hundred members of the public have, as yet, no in overpaid expenses, and why is the years’.8 real conception of quite how weak the simple task of monitoring the invoices economy of the UK has become. of just 646 people going to cost the
6 Populus poll for The Times, conducted 5th-7th February 2010. 7 See The Economist, 6th February 2010, for a discussion of this issue. 8 Quoted in Boom and Bust: The Politics and Legacy of Gordon Brown, Simon Lee (2007, 2009). strategy insights | issue four 15 britain at the crossroads | the case for fundamental change
part one: the road to here 1. a golden legacy?
This report is highly critical of Labour’s management of the economy, but it must first be said that several important strands of the current economic and fiscal malaise significantly pre-date 1997. The structural problems inherited by Labour included:
• Asymmetric fiscal treatment of debt and equity capital, and the employers’ National Insurance tax on jobs.
• A privatisation programme which had morphed from the ‘laudably- industrial’ into the ‘imitation- and-quango’.
• A long-standing tendency towards an ever larger and more costly bureaucracy, a trend worsened by the fragmentation of public service providers.
• A failure to target the welfare system on those in genuine need, or to overcome the poverty trap.
• Neglect of the longer-term outlook for energy security.
• A trend towards excessive deregulation of the financial services sector.
16 strategy insights | issue four a kingdom of quirks
Britain has always been a somewhat NI because it enables them to raise quirky country – within living memory, additional funds while claiming, it was possible to buy a bread roll or speciously, that income tax has not a copy of Playboy on a Sunday, but been increased. not a currant bun or a Bible9 – and the honours system is either a quaint Pre-dating the present administration, survival or a risible anachronism, the tax system has long favoured debt according to taste. But some quirks are over equity capital, because interest far more harmful. These include two payments on companies’ debt capital very long-standing fiscal idiocies – the are tax-deductible while dividends employers’ National Insurance (NI) paid to shareholders are not. This led system, and the very different ways in directly to excessive leverage and the which the tax system treats interest rise of private equity (which is actually and dividend payments. a euphemism for ‘little or no equity at all’). The objection to employers’ NI is that it is a tax on jobs. Particularly when Essentially, the current system set against the allowances that apply creates an uneven playing field to capital investment, NI skews the between debt and equity capital. system against employment. It has The tax-deductibility of interest is also contributed to the overseas often defended on the grounds that outsourcing of labour-intensive work. it attracts business, whereas the More broadly, employers’ NI is part of truth is that it simply attracts debt. a huge fiscal and regulatory burden Conservative politicians have hinted which places unquantifiable (but that the fiscal relationship between undoubtedly huge) obstacles in the debt and equity might be reviewed way of business start-ups, and is thus and, since excessive borrowing (public, extremely detrimental to economic corporate and private) has taken the renewal. (The nature of the offer which UK to the brink of a ‘debt vortex’, such Britain makes to new businesses is a review is surely long overdue. Later in considered later in this report). The this report, we look at how this might linkage between social protection be accomplished. and NI has long since been weakened but, far from consolidating NI into the income tax system, governments of both hues have tended to increase
9 On Sundays, shops were allowed to sell magazines (hence Playboy) but not books. Bread rolls were permissible, but currant buns – being deemed ‘luxury’ items – were not. strategy insights | issue four 17 britain at the crossroads | the case for fundamental change
privatisation – from wisdom to folly
‘Governments of the Another policy strand long pre- ordinary car (British Leyland) or sell you dating 1997 is privatisation. After a luxury vehicle (Jaguar). The Thatcher future face a compelling the departure of Margaret Thatcher, administration reasoned, surely very need to reverse the steady a fundamental (and extraordinarily logically, that none of these activities detrimental) shift took place in the remotely belonged in government rise of the bureaucracy, a aims and structure of privatisation. hands – why on earth was government Privatisation had been a flagship involved in manufacturing cars or rise which really began in policy of the Conservatives in the running an airline? Privatisation of 1945, and has continued 1980s, but the aim at that time was these industries made perfect sense, that government should withdraw as well as yielding huge windfalls for ever since, with few pauses from wholly-inappropriate industrial the taxpayer. activities. and even fewer reversals’ Thereafter, however, and under both In 1979, the state was involved in a parties, privatisation increasingly bewildering array of activities which moved from the appropriately- had no logical place in government. At industrial into areas which involved that time, the government controlled the provision of public services. One monopolies in telecommunications, effect of this was that the consumer ship-building, coal, gas and electricity. paid again for services previously The state could take you on holiday provided out of taxation. Where (British Airways), supply you with an outright privatisation was impossible,
18 strategy insights | issue four government moved to create quasi- create artificial ‘markets’ in essentially blunting the genuine benefits which independent ‘agencies’, and to make monopolistic, state-controlled fields. could otherwise have resulted from extensive use of out-sourcing. The This process, which began in the early the massive increase in health funding effect of this process was not to 1990s, has resulted in a huge increase which has been achieved since 1997. extend, but rather to reverse, Mrs in administrative costs, often with In an age of advanced information Thatcher’s famous ‘bonfire of the little or no benefit to the consumer technology, does the NHS really quangos’. It also helped pave the and sometimes with effects which are need to employ more than 200,000 way towards detrimental administrators? To put it mildly, we an excessive ‘If the apparent Conservative to the quality doubt it. This situation, which is dependency on and the cost- replicated across the gamut of state arbitrary targets in intention to restore the primacy effectiveness activities, has worsened under Labour, the public sector. of the Bank is surely wise, of public but the process has clear origins in Labour’s reluctance to accept that services. the pursuit of quasi-‘markets’ by the While privatisation the tripartite system has failed Conservative administration of the was being To take early 1990s. diverted from the looks a lot like hubris.’ just one industrial-and- example, the appropriate model percentage of of the 1980s to the imitation-and- National Health Service (NHS) funding quango hybrid of more recent times, absorbed by management appears government simultaneously set out to to have tripled over the last 19 years,
strategy insights | issue four 19 britain at the crossroads | the case for fundamental change
the seeds of light touch
‘Light touch’ (which has all too often amounted to ‘negligent’) supervision of the financial system has necessarily become a hot topic since the collapse of Northern Rock in 2007 and the government’s rescue of the banking system in 2008. Labour has received a lot of criticism for its supervision of the banking system – and gets a lot more such criticism later in this report – but the trend towards lax oversight and excessive deregulation really began under the preceding Conservative administration.
In the 1980s, laws governing building societies were relaxed to enable these previously-narrow (but fiscally conservative and socially beneficial) organisations to act like banks. Under legislation passed in 1986, societies became able to demutualise. While some society managements were happy to embrace demutualisation, others were pressured into it by members seeking short-term gains. The crisis which engulfed Bradford & Bingley and Northern Rock happened on Labour’s watch, but the erosion of this valuable tier of the financial system began under the preceding Conservative administration.
Another problem inherited by Labour was the progressive abandonment of any really coherent energy strategy. As memories of the frightening energy
20 strategy insights | issue four the cost of government crises of the 1970s faded, an ever more The Conservative government of the A recurring theme of this analysis is laissez-faire stance was adopted, which 1990s became extremely – excessively, that the British system of government culminated in the abolition of the we believe – relaxed about overseas has become ever more expensive Department of Energy itself in 1992. ownership of British businesses. The and bureaucratic. If this was ever recent acquisition of Cadburys by affordable (which we doubt), those Simultaneously, the Conservative Kraft has attracted much attention times have surely gone. The state’s government scrapped most of Britain’s but, if looked at in practical rather fiscally-enfeebled condition – and coal mines, and permitted two than in emotional terms, ownership future challenges in areas such as dangerous trends in the management of a chocolate manufacturer is demographic change and the security of the UK’s reserves of natural gas. First hardly a matter of national strategic of energy supply – surely mean that - and despite a pretty modest reserves interest. The same cannot be said of this sprawling bureaucracy is no longer 10 base of 22 tcf of gas – exports were infrastructure assets such as airports, remotely affordable. Governments allowed. Between 1995 and 2003, the power generation and utilities, the of the future face a compelling UK exported about 1.7 tcf. Second, majority of which are no longer under need to reverse the steady rise of and in our opinion more damagingly, UK ownership. the bureaucracy, a rise which really a ‘dash to gas’ in electricity generation began in 1945, and has continued was initiated, prompted in part by In his well-known early 2009 slating ever since, with few pauses and even a structurally-botched electricity of the outlook for sterling, renowned fewer reversals. Though this problem privatisation which encouraged RECs investor Jim Rogers pointed out that has worsened since 1997, it was (regional electricity companies) to Britain had very little left to sell. not invented by the current Labour integrate upstream into less-regulated Other governments have notably administration. Since the ending of power generation activities. Not only avoided this relaxed approach to the the Second World War, successive did this deplete more gas (about 8 tcf ownership of strategic assets, which administrations have presided over a over the same period) than exports, but is why neither Spanish airports nor rise in the scale, scope and cost of the it has continued since, and has aligned the French electricity industry could administrative apparatus. Britain’s power generating sector firmly ever have become British-owned. towards gas despite the comparative If Mr Brown’s recent list of possible It must be emphasised, however, that paucity of the country’s remaining asset sales – essentially, the Dartford the dramatic increase in bureaucracy reserves. Partly as a result of exports crossing, the high-speed rail link and over the last 20 years has not primarily and of power generation, Britain’s gas the student loans book – underlined been a matter of the over-rapid reserves now equate to just 4.9 years quite how bare the national asset expansion of the conventional civil of current production, or 3.6 years of cupboard has become, it is a process service. Though the scale of expansion current consumption11, and imports that began under the Conservative in employment, especially in the are rising rapidly. Compounding energy government that preceded the current middle and junior ranks of the civil sector errors (and policy neglect) have administration. service, has been excessive – and, occurred since 1997. undoubtedly, inadequate use has been
10 trillion cubic feet. 11 Based on data for 2008. Source: BP Statistical Review of World Energy, June 2009. strategy insights | issue four 21 britain at the crossroads | the case for fundamental change
made of the labour-saving potential Britain played a pioneering role in ‘Why did government fail of information technology – the the creation of an all-encompassing expansion in the bureaucracy has been welfare system, Niall Ferguson has to spot the causal chain 13 concentrated primarily, not into the explained that Japan was the real here – a causal chain which civil service, but into the plethora of pioneer of the modern welfare state. agencies and quangos that have come But successive British (and overseas) included deregulation, lax into existence since 1990. governments have yet to find an answer to a conundrum described lending criteria, excessive Indeed, career civil servants would be by Professor Ferguson. Essentially, leverage, unsustainable entitled to resent the growth of the welfare was designed as a safety net administration outside the confines which, while eminently workable in increases in property prices, of the conventional civil service. ‘a culture of social conformism’ such This has seen outside advisers and as that of Japan, can rapidly become imprudent consumer consultants promoted over the heads unaffordable (and detrimental to behaviour, a serious skewing of professional civil servants, and has growth) in a more individualistic also seen the payment, to individuals culture which encourages people to of the economy and the in agencies and quangos, of salaries ‘game the system’14. vastly higher than those permitted by creation of a largely illusory the civil service pay scale. As we shall The future of welfare may be the remark later in this report, no less than subject of a future report in the acceleration in growth?’ 72 taxpayer employees are paid more Tullett Prebon Strategy Insights than the highest paid civil servant series but, for present purposes, it is while, of the 296 people who earn sufficient to note that flaws in the more than the Prime Minister, only 11 system now seem certain to are conventional civil servants (while be exposed by an ageing population, Transport for London alone accounts by strained government finances and for 21)12. by an uncertain economic future.
A second long-running (and related) theme concerns welfare. Although
12 See The Public Sector Rich List, 2009. 13 Niall Ferguson, The Ascent of Money, 2009, pp 207-212. 22 strategy insights | issue four 14 Ferguson, op cit, p 211. 2. the great experiment
Thus far, we have observed that the • Government made two cardinal • Reflecting these factors, on- and Labour government elected in 1997 errors in 1997 – the supervisory role off-balance-sheet debt has taken inherited many significant weaknesses of the Bank of England was fatally on an upwards trajectory which in addition to a reasonably strong weakened by the introduction of seriously threatens both national economy. Some of these weaknesses the tripartite system, and monetary creditworthiness and the ability were very long-standing, such as the policy was tied to a definition of of government to finance deficits NI tax on jobs, a fiscal system which inflation which wholly ignored the going forward. favoured debt rather than equity very concept of asset inflation. capital, a welfare state with inherent Where Labour’s management of contradictions and, above, all, a costly • There was no satisfactory the economy is concerned, let’s first and over-bearing bureaucracy which monetary, regulatory or fiscal consider some mitigating factors. had been growing, relentlessly and response to the house price bubble First, and where Labour’s stewardship almost continuously, since 1945. which inevitably ensued. is concerned, we cannot say that a government of another party would Other problems were of more recent • The largely illusory boom which have fared better, since we cannot origin, including the diversion of this bubble created was mistaken know this. Second, Labour has a privatisation from the logically- for real and sustainable growth, number of achievements to its credit, industrial into the quasi-market- in the ludicrous belief that even if the word ‘but’ has too often bureaucratic. Nothing had been done ‘boom and bust’ had somehow had to be appended to them. For about a looming energy squeeze been abolished. example, the introduction of a national which, while it lay far in the future in minimum wage was commendable, • Labour has presided over an 1997, nevertheless required urgent but why has the income tax threshold unsustainable escalation in public attention given the ultra-long-term not been raised in accordance with the spending and the worsening of a nature of the energy industries. implicit recognition that the wage floor pre-existing trend towards over- really does represent the minimum Our assessment of the conduct of the complex and excessively-expensive amount on which a working person economy and the public finances since government. can live satisfactorily?15 1997 is substantially negative, for the following reasons:
15 At the adult rate (of £5.80 per hour), and assuming a 37-hour working week, the annual equivalent of the minimum wage is £11,159, yet the income tax threshold is £6,475, meaning that 42% of the minimum wage is taxable. strategy insights | issue four 23 britain at the crossroads | the case for fundamental change
Likewise, George Robertson’s government, business and individuals admirable 1998 Strategic Defence – was running up unsustainable levels Review (SDR), while an excellent of debt. policy framework, was based upon an essentially expeditionary and Policy errors began straight away power-projection assumption in 1997, when the incoming which was wholly undercut by the administration made two cardinal commitment to long-term ground mistakes. The first of these was the involvement in Afghanistan and Iraq. notorious tax ‘raid’ on private pensions. The aggregate £18bn cost of these As well as breaking a long-standing wars has necessarily skewed defence cross-party consensus, this policy was spending away from the very sensible mean-spirited, and sent precisely the assumptions of the SDR. wrong signal where incentives for saving were concerned. In its first year If Labour’s inheritance was rather alone, this raid extracted some £5bn less ‘golden’ than it may have seemed from pension funds. Depending upon at the time – and the rates of return even allowing for ‘A false assumption which funds might achievements in other have achieved since areas – we believe that of permanent growth then, the aggregate Labour’s conduct of seems to have segued cost to investors the economy and of of the raid to date the public finances has into a reckless expansion is probably well in been strikingly weak. excess of £150bn, As it transpired, the in public spending and could be as denouement of this much as £225bn16. mismanagement came Over the same about in 2008, the catalyst being an period, state pensions can only be international (and domestic) financial said to have kept up with the cost crisis. Even if this catalyst had not of living if the government’s own occurred, however, we question quite preferred measure of inflation (the very how long Labour’s Great Experiment questionable CPI) is accepted as the could have continued before hitting basis of calculation17. It is true that the the financial buffers. On the faulty Conservatives first broke the traditional assumption that a largely illusory link to earnings in 1980, albeit under boom was both real and permanent, horrendous fiscal conditions. But public spending already appeared to Labour has done precious little to put be out of control, and every sector – this right.
16 See Terry Arthur and Corin Taylor, The UK Pensions Crisis, 2008. 17 Between 1996-97 and 2009-10, the single-person full weekly pension has increased by a nominal 56%, to £95.25 from £61.15. This compares with a nominal increase in GDP of 80% over the same period. On a CPI-adjusted basis, the rise in the weekly sum is equivalent to a 24 strategy insights | issue four real increase 15%, but the state pension has decreased by 15% relative to GDP. faulty reform – the tripartite system
The second (and far more serious) error scenes conversations with banks, to a supposedly-independent Bank concerned the regulatory structure. while no-one other than an authorised of England, were referenced wholly In 1997, new chancellor Gordon bank was allowed to lend - had been to retail prices, and specifically to the Brown gave the Bank of England replaced with something very close to new CPI measure which, we believe, quasi-independent status, but at the a free-for-all. leaves a great deal to be desired19. This same time, we believe, made two left a huge risk area – asset inflation very serious mistakes. First, he divided One of the biggest ironies of the – unmonitored and unchecked. With regulatory responsibility – previously Labour era has been that, while ‘light hindsight – though many observers the preserve of the Bank – between touch’ regulation contributed to the said so at the time – interest the Bank, the FSA18 and the Treasury in creation of the unsustainable debt rates should have been increased the new ‘tripartite structure’. Second, bubble, regulation in other, essentially significantly no later than 2002, by the Bank was given a very narrow petty areas has become ever more which point it should have been monetary policy remit based entirely onerous. At a time when supervision obvious that a housing bubble was on retail price inflation. This meant of financial risk was impaired by the being fostered to replace the previous that the Bank was not empowered to ill-starred tripartite system, other dotcom bubble. This new bubble monitor asset inflation, and amounted industries have suffered successive needed to be choked off. Tragically, it to a near-disastrous blunder in strangulation from a worsening was not. monetary policy. complexity of regulation. Meanwhile, businesses (and individuals) have These two factors – ‘light touch’ The tripartite system effectively been burdened by a tax code which regulation, and a monetary policy removed the long-established (and, has more than doubled in length which ignored asset inflation - should historically, very effective) role of the and complexity since 1997. The be considered together, since it is Bank as the informal guardian of government itself has put the annual unlikely that interest rate policy would, overall lending probity. As a result, no cost of regulation to business at of itself, have been sufficient to have single authority could act to rein-in £13bn, but we believe that this sum is prevented the dangerous escalation in excessive lending, most pertinently calculated on a very narrow basis, and indebtedness which has occurred over where mortgages were concerned. At that the real cost is far higher. the last decade. We suspect that the the same time, institutions other than Bank understood this perfectly well – banks began lending in forms which Together with the weakening of and, indeed, had a better grasp of the ran the gamut from junk-mail loan regulatory oversight through the situation than Alan Greenspan’s Fed – offers to shop cards and car finance. tripartite system, one of the biggest but was unable to take effective action ‘Anything goes’, in fact. Any concept of mistakes made by the government because of its reduced regulatory controlling credit seemed to have been was a complete failure to appreciate powers, and the straitjacket imposed progressively abandoned. The previous the concept of asset inflation. As a by a CPI-defined monetary policy remit. system - whereby the Bank regulated result, inflation-targeting and interest lending through cosy, behind-the- rate management, though devolved
18 Financial Services Authority. 19 For 2007 – when nominal CPI was just 1.8%, but fuel and food costs were soaring - supermarket group ASDA calculated inflation, as it affected consumers, at 5.2%. See ASDA press release, 27th March 2008. ASDA calculated that, within a cost-of-living rise of 5.2%, petrol costs had risen by 20.3%, transport by 6.2%, and food by 5.6%. Average after-tax incomes had increased by only 2.3%. strategy insights | issue four 25 britain at the crossroads | the case for fundamental change
As a result, mortgage lending criteria Thus seen, huge swathes of the of course, injected yet more borrowed became dangerously relaxed, with economy became hostage to an liquidity into the housing bubble. By borrowers able to obtain funds on intrinsically-unsustainable house 2007, 26% of mortgage issuance was unsafe LTV10 ratios, at excessive price bubble. It is not possible to going into buy-to-let and 39% into multiples of earnings, and often on isolate the broader housing effect equity release, such that just 35% was self-certified statements of income from the remainder of the economy, actually being used to finance house which were not verified by lenders. but it is more than probable that the purchases22. Again, this was ludicrous, Under the previous system, the Bank, ex-property economy – that is, the and should have sounded warning- in its role as supervisory authority, economy excluding bells. Again, it would have acted informally to check all housing- ‘Mr Brown mistook bubble seems to have the irresponsible lending practices related activities been either which saw outstanding mortgage debt - contracted very growth for the real thing, and unnoticed or rise from £500bn in 2000 to £1,220bn materially while the assumed that government ignored. by 2009, a nominal rise of 140% and a asset bubble was real-terms increase of almost 50%21. If taking shape. could safely spend up to Bank leaders the apparent Conservative intention played a part to restore the primacy of the Bank Impacted by low it (and beyond it), on the in all this, of interest rates – and course, but their is surely wise, Labour’s reluctance to grounds that ‘boom and bust’ accept that the tripartite system has by the savage tax actions need failed looks a lot like hubris. on pension funds had been abolished’ to be seen in introduced in 1997 the context of – savings ratios an economic deteriorated, which did not seem to and fiscal structure which amounted the distorting matter because of the availability of to an unwatched free-for-all. Those wholesale funding on international few banks which stood aside from bubble markets. Many individuals saw buy- this jamboree were often criticised to-let as an alternative to investing for being too cautious, while The housing bubble injected growth in tax-raided pensions, yet buy-to-let demutualisation had largely stripped into housing-related activities running was wholly predicated on capital gains the system of the building societies, the gamut from estate-agents to (through perpetual rises in house hitherto a stabilising tier in the domestic appliance suppliers via prices), because after-cost yields on housing finance structure. Almost all house-builders, builders’ merchants, UK domestic property never exceeded of the demutualised societies (such as white goods retailers, electrical and 3.5%, well below the cost of capital at Northern Rock and Halifax) have since plumbing contractors, furniture any time during the boom. Buy-to-let, come to grief. companies and the legal profession.
20 Loan To Value. 21 Adjusted for the GDP deflator, outstanding mortgages of £500bn in 2000 would correspond to £590bn in 2009 money, far below the actual outstanding total of £1,220bn. 26 strategy insights | issue four 22 Source: FSA – Address by Adair Turner: The Mortgage Market: Issues for Debate, 12th May 2009. the perils of notional value
• Slack lending behaviour had Notional value was discussed in Issue model which itself exploited the 21 consequences far beyond a Three of this series , but this concept bizarre way in which the tax system simple and unsustainable is of such importance that we need to favours debt over equity capital. As bubble in property prices. These reiterate it here. Essentially, notional Robert Peston has explained, Labour consequences included: value means that increases in property seems to have made ‘a bit of a cock- prices need to be distinguished from up or a case of mistaken identity’ by • An illusory economic boom that realisable rises in wealth. While an confusing private equity with venture was mistaken for the real thing. individual feels richer if the notional capital, and encouraging the former price of his or her house rises, this with generous tax breaks24. When the • An escalation in public spending increased wealth is essentially tax status of private equity began to driven, in part, by false confidence theoretical, and capable of reversal. It attract adverse public comment, the in the sustainability of the apparent is obviously impossible for the whole government compounded this mistake boom. of the national housing stock (or by raising CGT25 from 10% to 18% even a material proportion of it) to be without discriminating between the • Imprudent consumer behaviour monetised. types of gain involved. driven by inflated property equity.
At the heart of the problem, where Mistaking notional for real value can Once notional value – most notably consumers were concerned, was the be lethally dangerous if it distorts in the housing market - took hold critically-important concept of notional behaviour. The danger with notional in an under-regulated environment, value, a misunderstanding which, value occurs when its owners borrow the unavoidable result was that both while it can accompany any asset up to it (or, in absurd cases, beyond it), debt and risk escalated. After that, the bubble, is particularly dangerous via mortgage and consumer debt in transitioning of unsustainable private when it results from a bubble in the instance of individuals, or increased debt, via banks, to the government - a property prices. leverage in the case of corporates, and process that we describe as TAT (toxic this is what happened in the UK. asset transference) – became an inevitability. This process is described Drawing upon confidence falsely later in this report. derived from the ‘notional value’ of rising property equity, individuals Why did government fail to spot the – and, to a considerable extent, causal chain here – a causal chain businesses as well – bought into which included deregulation, lax the belief that leveraging was good. lending criteria, excessive leverage, While mortgage debt escalated, so unsustainable increases in property did consumer and corporate debt, the prices, imprudent consumer behaviour, latter reflected in the private equity a serious skewing of the economy
23 See Forever Blowing Bubbles, March 2010, pp8-10. 24 Robert Peston, Who Runs Britain?, 2008. 25 Capital gains tax. strategy insights | issue four 27 britain at the crossroads | the case for fundamental change
and the creation of a largely illusory ‘boom and bust’, thereby implying that ‘The European Commission acceleration in growth? Critics would growth had become permanent, and no doubt ascribe it either to wishful that the law of economic cyclicality is quite right to warn thinking about the abolition of ‘boom had, presumably, been abolished. that the pace at which and bust’, or to a simple failure of comprehension. The theory that Mr Worse still, government appears to the government plans to Brown has never really understood have believed its own rhetoric, since a economics seems to be supported by false assumption of permanent growth tackle the deficit shows seems to have segued into a reckless his gobbledegook 1994 reference to insufficient urgency’. ‘the importance of macro-economics, expansion in public spending. It is post neo-classical endogenous growth difficult to avoid the conclusion that theory and the symbiotic relationships government simply did not understand between growth and investment, and the concept of bubbles and asset people and infrastructure’26. Right. inflation or, conversely, understood it all too well but was happy to ride the Far from recognising the unsustainable wave in the Micawberish hope that nature of the housing boom and ‘something will turn up’. Something did the dangers implicit in the notional indeed ‘turn up’ – a full-blown banking value trap – and therefore trying to and fiscal crisis combined with massive do something about it - government consumer and corporate indebtedness. itself fell into notional value thinking. Instead of realising that the UK was riding an unsustainable debt bubble, government proclaimed an end to
26 See Michael White, ‘The gift of tired tongues’, The Guardian, 30 September 1994, 28 strategy insights | issue four and Norman Macrae, ‘You’ve never had it so incoherent’, Sunday Times, 2 October 1994. this and TAT
When the crisis struck in 2008, The TAT process is shown schematically • Believing that, because of the the preceding expansion in non- in fig. 5. The TAT model divides the abolition of ‘boom and bust’, the government debt (and most notably stages of the financial crisis into three bubble was permanent, sustainable of mortgages) inevitably dragged phases – problem creation, toxic asset and benign. government into costly intervention transference and long-run implications. (which, to their credit, both In the second stage of TAT, the burden chancellor Alistair Darling and Bank In the first phase, policy weakness of the resulting debt, by becoming governor Mervyn King handled with results in a failure to recognise and excessive for originators (such as considerable skill). This was inevitable, to curb an asset bubble in a timely home owners), becomes a problem because over-extension of private fashion. In the UK, this policy weakness for the banks. When the banks in turn borrowing, if it imperils the viability of took three main forms: are unable to withstand the resulting the banking system, necessarily draws damage to their balance sheets, the • Failure to appreciate and manage in governments through a process state is forced into shouldering the the concept of asset inflation. which we describe as ‘TAT’ (toxic asset burden as the only alternative to an transference). The TAT concept is an • Weakening, through the tripartite implosion of the financial system. important tool in understanding how system, a largely informal the financial crisis developed, and supervisory structure which where it might go from here. could hitherto have choked off a borrowing bubble.
Fig. 5: Toxic asset transference
Problem creation
Policy weakness Excessive borrowing Asset bubble
Toxic asset transference
Fiscal stress Bank Stress Originator stress Long-run implications
Reduced competitiveness Economic underperformance
strategy insights | issue four 29 britain at the crossroads | the case for fundamental change
Fiscal stress inaugurates the third phase of TAT. Escalating government debt threatens to drive interest rates upwards, and at the same time forces government into fiscal tightening, in the form both of increased taxation and of reduced expenditure. This in turn results in economic under- performance. The UK story is a classic example of this process, and has left the economy firmly in the talons of toxic asset transference.
TAT is, of course, by no means unique to the UK. Seen as a global phenomenon, TAT explains why the consequences of excessive lending have transitioned from the banking system into sovereign debt, where a string of countries now look vulnerable. Though by no means alone where the sovereign debt problem is concerned, Britain is one of a number of countries where TAT-related problems have piled additional burdens onto a government balance sheet which had already been stretched by excessive levels of public spending.
30 strategy insights | issue four spend, spend, spend
When Labour returned to power in 1997 after an absence of 18 years, a key element of the party’s election manifesto had been a commitment to stick to the spending plans of the outgoing administration. This commitment - designed to rebut accusations that Labour would return to the profligacy of the 1970s – tied the government’s hands during the first Blair-Brown term.
After the 2001 election, with Labour now free from this commitment, government expenditure began to escalate in a wholly unsustainable way. Between 1999-2000 and 2008-09, annual public spending increased from £343bn to £628bn. To understand the step-change which this represents, we need to appreciate that, had spending simply risen in line with inflation27, the outturn for 2008-09 would have been £429bn. Conversely, if expenditure growth had matched the increase in nominal GDP, the total would have risen to £521bn. So the £628bn out- turn for 2007-08 represented a real- terms increase of £200bn (46%) and an above-GDP rise of £107bn (21%).
27 The GDP deflator is used in this calculation. strategy insights | issue four 31 britain at the crossroads | the case for fundamental change
Fig. 6: Spend, spend, spend – public spending, 2000-09
700 Actual GDP-constant £628bn 600 Inflation-adjusted £521bn 500 £429bn 400
300 £343bn 200
100
0 99-00 00-01 01-02 02-03 03-04 04-05 05-06 06-07 07-08 08-09
The above-inflation increase – of to James Buchan, ‘Brown thought that as it affected the average consumer, £200bn – should be seen in the context the profits of the City would finance was far higher (5.2%) than the of a fiscal deficit of £167bn during a new welfare state that would be reported CPI number (1.8%) or the GDP 2009-10. In other words, the surge in a monument to him more lasting deflator (3%). The reliability of official public spending correlates pretty closely than bronze. He was mistaken’28. Our statistics is a controversial topic in with the deficit. own view, which is not at odds with America, where analysts such as John this interpretation, is that Mr Brown Williams (of Shadow Government Between 1999-2000 and 2008-09, mistook bubble growth for the real Statistics) have done a great deal the proportion of GDP spent by the thing, and assumed that government to call this reliability into question. government increased from 36% to could safely spend up to it (and beyond Where inflation is concerned, both 44%, and reached 48% in 2009-10. it), on the grounds that ‘boom and substitution and hedonics seem to play Unfortunately, government income did bust’ had been abolished. a significant role in distorting reported not behave in the same way, rising only out-turns, while the GDP number itself fractionally - from 38% of GDP in 1999- One factor which we believe should may be distorted by the controversial 2000 to a peak of 38.6% in both 2007- be borne in mind here is that reported use of imputations29. 08 and 2008-09 - before declining to inflation numbers may well be 36% in 2009-10. misleading. If this is true, it has at least two implications for government Exactly why this was allowed to spending. As remarked earlier, ASDA happen is open to debate. According data for 2007 indicated that inflation,
28 ‘Is Britain Bust?’, Prospect, August 2009, pp28-33 29 Hedonics – lowering the recorded price of an item because its quality has improved, even if the actual price has increased or remained unchanged. Substitution – replacing an item in the measurement basket on the grounds that, as its price has increased, consumers would purchase something else instead. Imputation – 32 strategy insights | issue four attaching cash values to goods and services where no money has actually changed hands. In the absence of such comprehensive ‘UK government spending is external analysis, the UK position is less clear, but it is at least possible more wasteful than that of that inflation, particularly as measured by CPI, is understated. If Tunisia, the Gambia, Malawi, such understatement were to be Ethiopia or Albania, and reflected in the GDP deflator as well, this would imply the overstatement government regulation is of GDP growth. So, where the superheated growth in public spending more burdensome in Britain is concerned, it is possible that than in Bulgaria, Nigeria, government planning was predicated on an exaggerated reading of the real Pakistan or China’ strength of the economy during the ‘boom’ years before 2008. Moreover, much of the growth of those years was essentially borrowed, funded by wholesale borrowings from overseas and distorted by the impact on consumer behaviour which resulted from the property price bubble.
If, as we very strongly suspect, inflation has been routinely understated, this would have had a second implication for government spending. It would mean that ‘real’ inflation, as it impacted activities such as health, education and defence, was a great deal higher than was generally assumed.
strategy insights | issue four 33 britain at the crossroads | the case for fundamental change
remodelling society
In any case, government seems to have Though a sense of purpose is desirable involve increased state spending), or been philosophically inclined towards in government, politicians always by a media which often pushes these increased public spending. From the need to be aware that, at any level groups’ agendas without an adequate outset of the Blair-Brown project, the other than that of platitude, morality recognition of the limitation of fiscal assumption seems to have been that is essentially subjective. At a very resources. the ills of society can be cured if state general level, everyone is surely in activity (and, by implication, fiscal favour of ‘fairness’, but this means very Reflecting both the breadth of Labour’s redistribution) is increased. In the different things to different people. ambitions and an increasing and Thatcher and Major eras, much stress For example, a wealthy person might regrettable tendency towards moral was placed on holding taxes down, believe that a ‘fair’ tax would take absolutism, a large part of the increase and reducing them wherever possible. the same percentage of everyone’s in spending has resulted from a But much higher spending seems to income, while a poor person might hands-on, interventionist philosophy have been an implication of Tony Blair’s argue that the better off should pay which puts emphasis on ‘fairness’ (as 1994 leadership election manifesto, a higher proportion. Philosophically, Labour defines it) when an emphasis Change and National Renewal, in which there is no wholly objective ‘right’ or on efficiency, wealth-generation and Mr Blair wrote of ‘social renewal’30. ‘wrong’ answer to such a conundrum, individual choice might have been which therefore needs to be resolved much more desirable. It is noteworthy Certainly, a great deal of the increase in pragmatically. that a whole chapter of the 2009 government spending seems to have budget was entitled ‘Helping people been predicated on social activism, And, in any case, politics is essentially a fairly’. Helping them effectively might, and upon an agenda of remodelling matter of choices. Most people would we think, have been a much better society. Within the expansion in applaud Labour’s aim of eliminating idea. More generally, Labour seems to public spending, there have been child poverty, but what if we have have had a preference for the most huge increases in benefits paid, on to choose between this and, say, complicated solution on offer. Since an essentially capricious basis, to eliminating pensioner poverty? (And, 1997, the length of the tax code has people of working age, while the cost for that matter, what was the moral more than doubled, an ultra-complex of government, too, has escalated. justification for Labour’s pension tax credit system has been preferred By contrast, the sums paid to state raid?) Both reducing child poverty to simplifying reforms, and a torrent of pensioners, for example, have barely and helping the elderly are laudable legislation has been passed on every kept pace with relevant inflation, aims, but both make competing conceivable subject. while defence spending seems to have claims on limited resources, meaning been inadequate in the context of two that choices have to be made. In this Ultimately, the purpose of a tax system simultaneous wars and of pre-existing regard, Labour has not been helped by is to raise money. But Labour, from its defence commitments. lobby groups which push particular standpoint of moral absolutism and special interests (almost all of which a preference for the complicated, has
34 strategy insights | issue four 30 Quoted by Simon Lee in Boom and Bust: The Politics and Legacy of Gordon Brown (2007, 2009). taking count
often seemed to regard the primary Overall, where the Labour oil crises, major financial failures purpose of taxation as a means administration is concerned, it seems or political instability in important of social engineering. The recent impossible not to conclude that a lot of economic players. The assumption introduction of a 50% top tax rate is very serious mistakes have been made, of perpetual economic growth defies largely gesture-politics, since any sum though sometimes with the best of all past history, pre-supposes that realised from this is likely to be modest, intentions, and often in furtherance of nothing can ever go wrong, and leads and may be more than offset anyway adverse trends already in place before to highly dangerous assumptions by collateral damage in the form of 1997. about affordable reduced incentives. Governments need ‘It is possible to envisage levels of spending and to realise that, in a global economy, ‘Light touch’ borrowing. tax rates need to be competitive with regulation clearly a future in which the represented a Within the increase in those operative in other countries, British population is since individuals and businesses are continuation public spending, the quite capable of moving to a more of pre-1997 subjected to ever-increasing simple fact seems to attractive fiscal (and regulatory) policy, though be that, at least since environment. the tripartite taxation and charging to 2001, government has system – and the been living beyond its The effectiveness of a fiscal system exclusion of asset sustain an administrative sustainable means, can be judged by three criteria - yield, inflation from superstructure which is not just in terms of distortion effects and cost of collection monetary policy the cost of public - and Labour’s complex fiddling with - look like grave increasingly coercive as well services but also, the system fails all three tests. and idiosyncratic and less forgivably, in mistakes. As the as unaffordably costly’ the cost of delivering housing market those services, which overheated and as debt escalated, the has escalated over the last decade. largely illusory nature of the ensuing Tax assumptions, too, seem to have ‘boom’ was not appreciated, and been over-optimistic, at least in the government spending was allowed sense that, even before the present to escalate on the assumption that administration came to power, a period of temporary and illusory government was reaching a level growth was a genuine and sustainable of public fiscal resistance, resulting pointer to the future. in a recourse to so-called ‘stealth taxes’. This has continued relentlessly, In particular, the claim that ‘boom combined with an insidious (and and bust’ had been abolished was largely unremarked) process of manifestly absurd. Even at times when charging for services hitherto paid for the global economy appears to be out of taxation. The latter, in particular, performing well, shocks are always is extremely damaging to businesses. possible. These could take any one of numerous forms, including wars,
strategy insights | issue four 35 britain at the crossroads | the case for fundamental change part two: where is here?
3. money troubles
So much, then, for the unedifying We have no such compunction, so 3.25% annually from 2012 – are far too history of how Britain got into its this section of our report might optimistic. current economic and fiscal mess. hurt. For a start, the reported figures Two questions remain. First, exactly for government indebtedness Each of these points will be addressed how bad is the situation? Second, and seriously understate the situation. In later in this report. There are other much more importantly, how can the comparison with reported national problems, too, but this should act as UK progress towards sustainability? As debt (of £760bn, excluding the one-off a clear summary of the scale of the we explained earlier in this report, the effects of interventions, and projected issues needing to be tackled. The good appropriate sequence here is to let the to rise to £1,370bn by 2014-15), news – and there is some – is that answers to the first question prompt we estimate the real public sector the solutions may be a great deal less answers to the second. It is not too obligation at £2.1 trillion, a number difficult than is often supposed. much of an over-simplification to say which could rise to £3.2 trillion, or Are these problems simply part of an that the best policies for the future will more, over the same timescale (see international malaise, and will they lie in the reverse of the mistakes and figs. 9 and 10). therefore self-rectify if and when the weaknesses that have brought Britain global economy returns to pre-2008 here. Second, Britain’s 2009-10 fiscal deficit – of £167bn, or 11.8% of GDP – exceeded levels of growth and prosperity? Since First, though, where is ‘here’? For the prudent, Maastricht-required 3% the financial crisis began in 2008, understandable reasons, the election limit by £135bn, equivalent to £5,300 ministers have gone to great lengths battleground is being fought in a fog of per UK household. This is the sum to insist that Britain’s problems are, unreality, because no politician really which needs to be rebalanced through almost entirely, part of a worldwide wants to tell the electorate quite how tax increases and/or cuts in public downturn. No mention is ever made serious Britain’s problems are, or, more spending. Third, we believe that the of ‘crisis’ or ‘recession’ without the to the point, how painful the necessary official projections for the economy obligatory prefix ‘global’ being tacked post-election responses will need to be. – essentially, a real growth rate of on to it. Even if the government had not previously claimed that the UK
36 strategy insights | issue four was ‘best placed’ to weather any – escalating western indebtedness, These issues are: downturn, this ‘globalisation’ of the and rapidly increasing energy costs - issue is, essentially, an exercise in were running pretty much in tandem 1. The true extent of government blame-shifting, as have been attempts prior to 2008. Borrowed liquidity and indebtedness, including off- to fix the entire responsibility onto excessive consumption – ‘excessive’, balance-sheet liabilities such as bankers. The reality is that domestic that is, in relation to domestic output public sector pensions and PFI trends – most notably, slack regulation, – do not form a solid basis for a obligations. the reckless boom in property markets sustainable economy. 2. The real scale of the deficit when and the out-of-control surge in public increments to these off-balance- spending – would, sooner or later, have Second, the Anglo-American model, sheet items are taken into account. resulted in a crisis even without the which has been a dominant economic ideology for three decades, has now catalyst of a global economic slump. 3. The very real risks posed by excessive suffered a serious (perhaps a crippling) government borrowing. This said, of course, there is a global setback. This issue was discussed at dimension to the crisis. The key length in Issue Two, and will no doubt In examining each of these issues, it elements of the global problem are recur in future reports as we comment is essential to bear in mind that the structural, and form an essential further on the implications of the solutions to these problems can only context to the UK issues. emergence of the ‘new normal’. be found if policymakers and the public (a) face the current situation as it really First, the global dynamic is seriously Since this section of our report – which is, and (b) understand the root causes flawed. A system in which the west aims to examine the true scale of of these problems. borrows Asian savings and spends the problems which the UK faces – is the proceeds on imported consumer necessarily depressing, let’s take a line- goods from Asia – and on imported item look at the biggest challenges. energy, principally from the Middle Only then can some solutions be East – is fundamentally unsustainable. explored. In this context, two adverse trends
strategy insights | issue four 37 britain at the crossroads | the case for fundamental change
the real scale of national indebtedness
According to the 2010 budget, and current figure is not an accurate had a capital cost to the contractors excluding the one-off effects of the reflection of the true scale of public of £55bn. Annual payments by the financial sector intervention, public sector indebtedness, while the forward government currently stand at some sector net debt stands at £760bn, projections seem to us to be fancifully £7.8bn, and are projected – on the equivalent to 54% of GDP. Based on optimistic anyway. basis of current projects only – to official forecasts, this number will rise peak at around £9bn in 2017 before to £1.37 trillion (75% of GDP) by 2014- First of all, the reported debt figures declining gradually over a repayment 15. Neither figure, we are reassured, exclude obligations under the PFI schedule which runs to 2047 is particularly high by international (Private Finance Initiative) programme. standards, which is true – but only Based on published data, projects as far as it goes. Unfortunately, the completed thus far under PFI have
Fig. 7: PFI economics – existing projects
Year to end Pre- March (£bn) 2010* 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025
Capital cost £55
Payments £45 £7.8 £8.1 £8.3 £8.6 £8.7 £8.9 £8.9 £9.1 £8.5 £8.7 £8.6 £8.3 £8.2 £8.2 £8.4 £8.3
NPV of future £110 £7.8 £7.7 £7.4 £7.3 £6.9 £6.6 £6.2 £5.9 £5.2 £4.9 £4.6 £4.1 £3.9 £3.6 £3.5 £3.2 payments
Total repayment £155
Discount rate 4.0%
*1997-2009
38 strategy insights | issue four Fig. 8: PFI economics – example hospital
Year to end Pre- March (£bn) 2010* 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025
Capital cost £158
Payments £319 £46.0 £47.2 £48.3 £49.5 £50.8 £52.0 £53.4 £54.7 £56.1 £57.5 £58.9 £60.4 £61.9 £63.4 £65.0 £66.6
NPV of future £699 £46.0 £44.6 £43.0 £41.8 £40.2 £38.6 £37.1 £35.6 £34.2 £32.8 £31.5 £30.3 £29.1 £27.9 £26.8 £25.7 payments
Total repayment £1,019
Discount rate 4.0%
*2002-09
Applying an annual real discount rate First, it fits within our ‘generational had a capital value of £158m (fig. of 4%, the NPV (net present value) theft’ analysis, which is that the 8). Against this, the government has of the forward payment stream is current generation – not just in the already paid the contractors £319m some £110bn. Of course, it might be UK but throughout the developed over seven years. Future money-of-the- argued that 4% is a rather generous world – is piling hefty (and perhaps day payments are stated at £1.6bn. real discount rate and, in any case, unsustainable) financial burdens Applying a 4% real discount factor to this calculation is based on existing onto future generations31. PFI is a the future payment stream reduces projects, so does not factor in the particularly good (by which, of course, this sum to £700m. So the ultimate NPV of any new developments. On we mean a particularly bad) example cost to the taxpayer of past and future this basis, we include £115bn in our of generational value-transfer – the payments for this £158m hospital is assessment of current true obligations, current generation gets to use the new over £1bn. It is very difficult to see how and assume that this figure rises to hospitals, while future generations get this can possibly represent good value a (money-of-the-day) total of about to pay for them. for the taxpayer. £165bn by 2015. Second, the financing part of PFI During the financial crisis, the PF We make no secret of the fact that can look bizarre. We have examined, part of PFI essentially dried up we dislike PFI, on several grounds. simply as an example, a hospital which anyway so, under a seemingly-surreal
31 See Strategy Note 001 – The Dick Turpin Generation. strategy insights | issue four 39 britain at the crossroads | the case for fundamental change
arrangement, government agreed to Next – and vastly larger in absolute lend money to contractors who would, terms – is the issue of public sector in return, effectively lend it back to the pensions. These are operated on a government (at a profit) through PFI. PAYGO (pay as you go) basis, meaning There must surely be better ways of that they are not funded – rather, those financing public sector capital projects. drawing pensions today are paid from the contributions of today’s workers. Third, we suspect that the capital Because of the way in which unfunded repayment stream does not capture public sector pensions obligations are the full value to contractors (who, for accounted, the future liability does not example, can control the maintenance appear on the government balance of facilities such as hospitals, sheet, but exclusion of this committed thereby denying the government liability hugely distorts perceptions of the competitive benefits of either the national debt. competitively out-sourcing these services or taking them in-house – anecdotes abound about nurses being forbidden even to change light-bulbs in PFI hospitals).
40 strategy insights | issue four Fig. 9: Estimated public sector indebtedness, based on budget debt forecasts
2010 2015*
£bn % of GDP £ per household** £bn % of GDP £ per household**
Reported debt £761 54% £29,843 £1,366 75% £53,569
Increment £243 17% £9,529 £252 14% £9,882
Treaty debt £1,004 71% £39,373 £1,618 89% £63,451
PS pensions £995 71% £39,020 £1,195 66% £46,863
PFI £110 8% £4,310 £160 9% £6,289
Total obligations £2,109 150% £82,702 £2,973 163% £116,603
Memo items:
GDP £1,406 £1,824
External debt*** £5,902
*Reported and Treaty debt based on budget forecasts **Based on 25.5 million households ***Source: CIA World Factbook data for end-2009
How big is the pension liability? In mind a critical distinction between 2009-10, £760bn – is computed on the 2006, the government calculated the on- and off-balance sheet public government’s own methodology. But sum at £650bn. In December 2008, sector obligations. A government government also reports ‘Treaty debt’, the CBI estimated the liability at which controls the printing presses which is debt calculated on the criteria £915bn, a figure which the CBI itself is unlikely to go bankrupt in its own specified by the Maastricht Treaty. said was ‘conservative’. We believe currency. Rather, sovereign debts tend The official number for the end of the that the liability is rising by not less to be deflated away through the ‘soft 2009-10 fiscal year is 71% of GDP, or than £40 billion annually, so now default’ mechanism of devaluation and £1.0 trillion. probably stands at about £1,000bn inflation. But the critical distinction is (official figures do provide annual that this process does not work where Together, then, Treaty debt, plus the increments, but then write them out). off-balance-sheet obligations are two principal off-balance-sheet items, Later in this report, we look at the concerned, because the monetary cost total some £2.1 trillion, or 150% of role that tightening of public sector of these obligations tends to rise if the GDP, as set out in fig. 9. According to pension provisions will need to play if value of the currency deteriorates. budget projections, Treaty debt will Britain is to get its real public sector increase to £1.6 trillion by 2015. Adding indebtedness under control. In addition to off-balance-sheet off-balance-sheet items – and our liabilities, one further component expected increments to these items Before we move on to tot up our is required if we are to assess the – to this forecast suggests that total assessment of the ‘real’ level of full extent of the national debt. The obligations will reach £3 trillion (163% national debt, we need to bear in reported debt number – for the end of of GDP) by that date.
strategy insights | issue four 41 britain at the crossroads | the case for fundamental change
Fig. 10: Estimated public sector indebtedness, based on 2% real growth
2010 2015
£bn % of GDP £ per household** £bn % of GDP £ per household**
Reported debt £761 54% £29,843 £1,542 88% £60,454
Increment £243 17% £9,529 £252 14% £9,882
Treaty debt £1,004 71% £39,373 £1,794 102% £70,336
PS pensions £995 71% £39,020 £1,195 68% £46,863
PFI £110 8% £4,310 £160 9% £6,271
Total obligations £2,109 150% £82,702 £3,148 180% £123,470
Memo items:
GDP £1,406 £1,752
External debt*** £5,902
* Reported and Treaty debt based on lower growth forecasts, assuming real GDP growth of 2.00% from 2011-12 **Based on 25.5 million households ***Source: CIA World Factbook data for end-2009 Nor is this all. Budget debt projections, all private sector commitments (such – a very high proportion of overseas used in fig. 9, assume a real annual as outstanding mortgages of £1.2 assets is owned by corporates (such economic growth rate of 3.25% from trillion, big pension liabilities, and very as oil companies) whose debts are 2012. Since we believe that this large corporate and consumer debts). comparatively small – so netting off is growth assumption is extremely over- Britain as a whole – government, not realistically applicable. optimistic (for reasons which will be businesses and individuals – is very explored later), we have run alternative deeply mired in debt. At $9.1 trillion, British external calculations, again discussed later, on debt equates to a rather disturbing the basis that growth actually averages In one sense, the domestic component $149,000 (say £96,000) per person, or 2% whereas public spending remains of these debts is less important than £230,000 per household. The $149,000 at the officially-projected monetary the sums owed to overseas lenders. per capita figure is far higher than level. On this basis, the total obligation The CIA World Factbook puts the United the equivalent numbers for France rises to £3.15 trillion, or 180% of GDP Kingdom’s end-2009 external debt at ($78,000), Germany ($63,000) or the (fig. 10). $9.1 trillion, equivalent to about £5.85 US ($44,000), and is much larger than trillion32. Though this debt is materially the equivalents for Spain, Greece, Before leaving the subject of debt and offset by overseas assets, the net Portugal or Italy (see fig. 11). (The turning to the more important issue of sum remains very large (perhaps $7.5 figure for Ireland is frighteningly higher deficits, we need to bear in mind that trillion). Moreover, asset ownership even than that for the UK)33. the obligations discussed so far exclude and debt obligations are asymmetric
32 Based on a sterling exchange rate for 2009 of $1.54 = £1. 33 The CIA World Factbook puts end-2009 Irish external debt at $2.4 trillion, or $568,000 for each of Ireland’s 42 strategy insights | issue four 4.1 million citizens. what is the real deficit?
In any case, the absolute level of accounted for 47% of all net gilts both quantitatively and in terms of debt with which the taxpayers of the issuance34, and foreign gilts ownership the threat which excessive deficits future have been burdened is not the (of £191bn) equated to 32% of the represent. We believe that the immediate point. The real issue is the outstanding total by the end of 2008, European Commission is quite right ability to raise fresh funding from up from 16% as recently as 2000. (This to warn that the pace at which the international markets going forward. situation, incidentally, puts into context government plans to tackle the deficit A deficit-to-GDP percentage anywhere the sheer absurdity of the sometimes- shows insufficient urgency35. The near double-digits is more than expressed belief that the government counter-argument – which is that enough to give these markets grave ‘should not have policy dictated to it precipitate fiscal tightening could cause for concern. by international markets’. The reality damage the economic recovery – will is that Britain is hugely dependent be addressed shortly. And international markets are critical not only on overseas trade but on here. Although the process of debt international capital markets as well). Quantitatively, the foregoing recycling through QE has reduced examination of national debt – in the foreign-owned share of total Though most people seem to be which we explained that the debt is government debt over the last year, aware of the problem represented by understated because it excludes huge overseas investors continue to own the public sector deficit, we believe off-balance-sheet items – is equally 28% of all outstanding gilts. Between that the underlying scale of the applicable to the more pressing issue 2003 and 2008, foreign purchasers problem is improperly understood, of the deficit.
Fig. 11: External debt, selected countries, end-2009*
External debt Population Debt per capita ($bn) (millions) ($)
UK $9,088 61.1 $148,708
France $5,021 64.1 $78,382
Germany $5,208 82.3 $63,258
Spain $2,410 40.5 $59,469
Greece $553 10.7 $51,486
Portugal $507 10.7 $47,348
US $13,450 307.2 $43,781
Italy $2,328 58.1 $40,051
Canada $834 33.5 $24,899
Japan $2,132 127.1 $16,777
* Source: CIA World Factbook
34 Between the end of 2002 and the end of 2008, net overseas ownership of gilts increased by £145bn, within total net issuance of £307bn. 35 In a report issued on 24th March 2010, the European Commission called upon the UK to reduce the deficit to the 3% Maastricht ceiling by 2013-14. strategy insights | issue four 43 britain at the crossroads | the case for fundamental change
Fig 12: Foreign net purchasing of gilts, 2003-09
£bn 2003 2004 2005 2006 2007 2008 2009
Net issuance £20.7 £39.8 £50.3 £27.1 £41.6 £127.6 £149.2
of which foreign: £9.0 £17.8 £26.7 £25.0 £22.7 £43.3 £16.9
Foreign % 43% 45% 53% 92% 55% 34% 11%
According to budget figures, the fiscal year. On this basis, the deficit is in this line, together with smaller deficit is projected to fall from £167bn set to fall from £208bn (14.8% of GDP) annual additions to outstanding PFI (11.8% of GDP) in 2010-11 to £73bn in 2009-10 to £84bn (4.6%) by 2014-15. obligations. After adjustment both (4.0%) by 2014-15. In fact, this is a for the Treaty definition and for these rather misleading set of figures, for the Increments to PFI and public sector off-balance-sheet items, we estimate following reasons: pension obligations are difficult that the underlying deficit was £255bn to estimate, but are undoubtedly (18.2% of GDP) in 2009-10, and is likely • These numbers are based on the significant. The CBI, in the report to fall to £135bn (7.4%) by 2014-15. Treasury’s own definition of public mentioned earlier, calculated that sector debt, whereas adjustment the pension obligation increased by However, one further adjustment is to the Treaty basis is necessary for £265bn – from £650bn to £915bn - in required. Where forward projections effective comparisons. the 29 months between March 2006 are concerned, the above calculation and August 2008, an annualised rate of is based on Treasury forecasts which • The official numbers exclude increase of £110bn. assume annual real GDP growth of annual increments to outstanding 3.25% from 2012 onwards. Since PFI and public sector pension Because the CBI calculation assumes we find this growth rate pretty obligations. a significant item which might be implausible, we have calculated regarded as a one-off – a £90bn ‘move likely forward deficits on the basis of • Official projections assume annual to realistic mortality’ - this might a more restrained (2%) real growth real GDP growth of 3.25% annually materially overstate the ongoing rate trajectory. On this basis, the underlying from 2012 onwards, a forecast of increase, though the remaining deficit – that is, aggregate additions to which (for reasons outlined later) increment (of £175bn) still equates to government indebtedness including we regard as over-optimistic. £72bn annually. On the assumption Treaty adjustments and off-balance- – perhaps an optimistic one - that Of these, the Treaty adjustment is the sheet items – is projected at £170bn in progress has been made towards simplest, and can be calculated by 2014-15, equivalent to 9.7% of (lower) containing the rise in the public sector comparing official Treaty debt numbers GDP for that year. pension obligation since 2008, we for the beginning and end of each include annual increments of £40bn
44 strategy insights | issue four Fig. 13: Reported and underlying deficits
£bn 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15
Official deficit* £167 £163 £131 £109 £88 £73
Adjustment: Treaty basis +£41 +£12 +£8 +£11 +£8 +£11
Deficit: Treaty basis* £207 £175 £139 £120 £96 £84
Adjustment: low growth +£52 +£26 +£30 +£33 +£34
2% growth basis £207 £227 £165 £150 £129 £118
Increment to PFI** +£8 +£8 +£9 +£9 +£10 +£11
Increment to pensions*** +£40 +£40 +£40 +£40 +£40 +£40
Underlying deficit: low growth case £255 £275 £213 £199 £179 £169
As % GDP:
Official basis* 11.8% 11.1% 8.5% 6.7% 5.1% 4.0%
Treaty basis* 14.8% 12.0% 9.1% 7.4% 5.6% 4.6%
Low growth basis 14.8% 15.6% 10.9% 9.4% 7.8% 6.8%
Including OBS**** 18.2% 18.8% 14.1% 12.5% 10.8% 9.7%
Memo: GDP
Reported basis £1,406 £1,464 £1,533 £1,621 £1,720 £1,824
2% growth basis £1,406 £1,462 £1,517 £1,589 £1,669 £1,752
*Source: Budget 2010 **Private Finance Initiative: estimated increment to obligations *** Public Sector Pensions: estimated increment to obligations **** Off-balance-sheet items – PFI and Public Sector Pension increments
strategy insights | issue four 45 britain at the crossroads | the case for fundamental change
Even if we leave out both Treaty levels are. In 1976 – when the UK adjustments and the off-balance- needed an IMF bail-out to preserve sheet items, our 2% growth case puts the public finances – the ratio reached the 2014-15 deficit at some £107bn a hitherto-unprecedented 7%. In (6.1% of GDP) rather than the £73bn 1993-94, after the UK had crashed (4.0%) predicted by the Treasury. In out of the European ERM36, the ratio that year, we estimate government reached an all-time (until now) peak revenue at £665bn (£30bn below the of 7.7%. Historically, there seems to Treasury forecast) and assume that be a very strong correlation between public spending is in line with the the Maastricht-required 3% deficit projected £772bn. These calculations ceiling and the health of the economy, are summarised in fig. 12. Moreover, a correlation which suggests that the this calculation suggests only sluggish current (and projected) levels of UK annual change between the out-turn deficits may be unsustainable. Both for 2009-10 (£167bn) and our estimate in 1976 and in 1993-94, the value of for 2014-15 (£107bn). The European sterling crashed, and drastic cuts in Commission is surely right to call for public spending became unavoidable. much more resolute action. Yet on neither occasion did the deficit/ GDP relationship reach anywhere Investors need to be aware of quite near the double-digit rates now being how unprecedented such borrowing experienced.
46 strategy insights | issue four 36 Exchange Rate Mechanism. vortex risk
The danger with running deficits at of its value that has haemorrhaged term ‘money supply’ typically conveys these unprecedented levels is that the since 2007. This in turn could lead to the idea of a simple quantity of money, UK runs significant ‘vortex risk’. What an inability to borrow in sterling at all. the effective money supply is actually we mean by this is that the process In this situation, the sterling burden a quantity-and-velocity equation. may become a downward spiral if of servicing borrowings taken out in By velocity, economists mean the a lack of perceived determination foreign currencies would escalate. frequency with which money changes to reduce the deficit spooks the hands. In the context of the financial international markets, at which point a This kind of scenario seems to crisis, velocity naturally declined very nasty, multi-dimensional feedback have been in the mind of Steve sharply as businesses and individuals loop could kick in. Bundred, chief executive of the Audit scaled back their spending and Commission, when he warned, in endeavoured to hoard cash. Therefore, What happens first under this scenario February last year, that the UK ran the increasing the quantity of the money is that the UK finds it increasingly risk of ‘[an] Armageddon scenario most supply was an appropriate offset to a difficult to secure foreign borrowings, feared by the Treasury - that there decline in its velocity. meaning that interest rates rise. This will be insufficient lenders to match in turn would have no less than three the planned level of borrowing’. This, As the authorities admitted when the adverse implications. First, and most he warned, ‘begins to look a distinct policy commenced in March 2009, the obviously, higher rates would damage possibility’37 use of QE is on this scale took the UK an economic recovery which already into uncharted territory. There were looks extremely fragile. Second, higher It was in this context – that of two obvious risks with this policy. rates would drive property prices a looming problem of funding The first was that QE would stoke up downwards, inflicting further severe government spending through new inflation. Though this is a real risk, it damage to consumer spending. Third, borrowings on international markets – can be averted if – but only if – the the cost of servicing government debt that the decision was taken to engage QE process (a) is not over-used, and would rise, worsening the deficit. in ‘quantitative easing’ (QE). (b) is reversed at a later stage. The second risk was that QE could spook It should be said from the outset that The end-game of such a vortex process international markets by conveying the use of QE, though a dangerous is full-scale currency crisis, in which the impression that the government decision, was the right one. Though the sterling loses even more than the 25% was printing new money because
37 ‘Our public debt is hitting Armageddon levels’, The Times, 27th February 2009. The article can be read at www.timesonline.co.uk/tol/comment/columnists/guest_contributors/article5811186.ece strategy insights | issue four 47 britain at the crossroads | the case for fundamental change
it was running out of the genuine back door, despite official protestations could be extremely dangerous. QE commodity. This impression may to the contrary38. has bought the government a vital have been reinforced by the fact that breathing-space (as well as artificially virtually all (99%) The introduction of QE was handled depressing the rates at which superbly in terms of QE purchasing ‘The excessive cost of government can borrow). But QE is a has been directed of public relations. one-off, emergency contingency - if to gilts rather than government provides a Rather than international markets ever came to corporate bonds. ‘printing money’ – a believe that QE was anything other valuable pointer towards term which conveys than a temporary, stop-gap measure, Printing money images of Weimar necessary reforms, and the UK could very soon find itself with which to wheelbarrows slipping into the kind of ‘vortex’ (the fund government leads us to believe that or Zimbabwean ‘Armageddon scenario’) described borrowings – billion-dollar loaves above. the so-called it is perfectly possible for – a shiny new name monetisation was coined for a From here on, government, irrespective of debt – is government to cut spending process which, it of party, must move decisively towards specifically very markedly without is insisted, is quite balancing expenditure and revenue. forbidden under different from This may appear difficult, especially if, Article 101 of the damaging the provision of ‘printing money’ as we strongly suspect to be the case, Maastricht Treaty. anyway. This is the British economy is appreciably The UK got around front-line services’. simply not true. weaker than is generally supposed. this restriction Second, markets by purchasing existing gilts from have been informed that QE is wise Actually, we believe – and will explain (principally domestic) institutional and prudent because Britain faces a in Part Three of this study - that investors whose risk profile essentially threat, not of inflation, but of deflation. cutting public spending may be a lot required them to reinvest the Again, and in anything other than the less painful than most commentators proceeds in new government paper. short-term, this is simply not true either. believe. In other words, the use of QE to buy government debt paper seems to us Where QE is concerned, our view is that to have confirmed the impression that the gamble has paid off, but that any debt was being monetised through the further significant use of the process
38 ‘the Bank is not being forced to create money in order to cover the gap between the government’s tax income and its spending commitments. If it were carried out to finance the budget deficit, it would be a violation of Article 101 of the Maastricht Treaty (which the United Kingdom must abide by, even though it is not a member of the euro zone). Rather, the Bank is undertaking quantitative easing in order to meet the inflation target and will sell the government debt back to the private sector once the economy recovers, thus unwinding the original increase in the money supply. ‘Central banks routinely buy and sell government debt in the secondary market as part of their normal operations in the money markets and such operations are not deemed to amount to monetary financing under the Maastricht Treaty. The only thing that distinguishes quantitative easing from normal operations is their scale and the length of time for which the assets are likely to be held’. Source: Bank of England web site
48 strategy insights | issue four strategy insights | issue four 49 britain at the crossroads | the case for fundamental change
‘The UK is in great need of a system of governance which is more efficient, less expensive, less intimidating, less ideological, and more responsive to the broader public’
4. the way we live now
To the limited extent to which there has been any public debate at all about the urgency of deficit reduction, the dividing line, essentially, has been between two views. The first, associated with the Conservatives, is that there is a need to commence deficit reduction without too much delay. The counter-argument, advanced by the government, is that early action to reduce the deficit would imperil the economic recovery. An ironic (and seemingly counter-intuitive) by- product of this positioning is that any bad news about the economy appears to strengthen the government’s case for ‘safeguarding the recovery’.
In fact, and as we have been at pains to argue throughout, this is a false debate, for two main reasons. First, the government’s argument assumes that Britain has plenty of time in which to tackle deficit reduction. This is not true. Time is in fact very limited. Second, the implicit assumption – and one underpinned by the optimistic budget growth projection – is that economic expansion will go a long way in itself towards bringing down the deficit. This isn’t true either. Britain cannot expect to ‘grow out of’ the deficit.
There has been a natural progression – through the TAT process described earlier – in which toxic risk has migrated from individuals, via the
50 strategy insights | issue four banking system, to government Each of these ‘props’ is now fast recent GDP figures (for the fourth balance sheets. Most conspicuously approaching its sell-by-date. For quarter of 2009) showed growth of in the case of Greece, this has put reasons outlined earlier, QE is a strictly just 0.3%. Though the revised number sovereign debt into the firing line. Thus limited expedient which cannot be was better than the initially-released far, Britain has largely escaped from used on an ongoing basis without figure (+0.1%), growth of 0.3% is, by serious market pressure. In one sense, shaking investor confidence and any standards, anaemic, particularly Britain’s comparative immunity is triggering inflation. The election when the weakness of sterling ought surprising, given the severe weakness defence is obviously about to become to be benefiting net trade. Far from of public finances which are, in the time-expired. And sterling weakness benefiting from currency depreciation, words of Pimco’s Bill Gross, ‘resting on does not appear to be boosting the trade figures for January showed a bed of nitroglycerine’39. economic performance. that the deficit had widened to £3.8bn. Moreover, the net figure emerges from This immunity is purely temporary, and Our ‘three props’ interpretation leads a combination of weak imports (which results, we believe, from three factors – us to believe that resolute action have negative implications for levels of we term them ‘the three props’ – each immediately after the election is economic activity) and sluggish exports of which is essentially short-term in imperative, such that the debate (which suggest that exporters are not nature. These ‘props’ are: over timing is essentially a false one. benefiting from the depreciation of We believe, first, that it would be too sterling). 1. Quantitative easing, which hazardous for the UK to use QE to obviated any need for the monetise its deficit for a second year The clear impression, then, is that the UK government to seek new – if this happened, QE would begin UK economy is mired in recession, even borrowings from the international to look like a permanent instrument, if a single quarter of only marginal 40 markets despite a CGNCR fund- and markets would punish the UK growth is sufficient to mark the raising requirement of £201bn accordingly. technical end of recession (which is during 2009-10. defined as two or more quarters of Second, markets are not going to wait consecutive GDP shrinkage). As we 2. The imminence of the general indefinitely for a UK economic recovery explained earlier, we suspect that election, which has given the UK which, thus far, appears pretty feeble. reported GDP growth figures may be a fragile ‘year of grace’ through Third, a post-election government (of questionable anyway. market recognition that resolute whichever party) will no longer be action is unlikely to happen before able to play the ‘pre-election hiatus’ the election takes place. card. Markets will expect swift action immediately after the election. 3. The weakness of sterling, which is regarded as an automatic stabiliser Thus far, and despite solid recoveries which should boost exports in other developed nations such as and deter imports, thus helping the US, France and Germany, the economic recovery. British economy is lagging. The most
39 Quoted in The Guardian, 26th January 2010. 40 Central Government Net Cash Requirement. strategy insights | issue four 51 britain at the crossroads | the case for fundamental change
the economy – what is the problem?
The overall impression, then, is that do not have a huge impact on overall which are by no means unique to UK’s economy is not performing either rankings. But as individual measures the UK. However, we believe that as well as competitors’ or as well as they are telling. They mean that UK over-complex and excessively costly might have been expected as the world government spending is more wasteful government has been a by-product economy gradually emerges from than that of, for example, Tunisia, the of an attempt to remodel society, recession. Why? Gambia, Malawi, Ethiopia or Albania, certainly since 1997 and arguably since and government regulation is more 1990. This shows up most obviously The bottom line, we believe, is that burdensome in Britain than in Bulgaria, in bureaucracy where, as explained UK competitiveness is being stifled Nigeria, Pakistan or China. earlier, the bulk of the expansion has by a system of government which is occurred not in the conventional civil at once both excessively costly and These factors – government service but in a plethora of ‘agencies’ unnecessarily interventionist. Industry wastefulness and bureaucratic and quangos. This is a critical issue, not is burdened by a level of regulation, meddling – adversely impact the ‘offer’ just because of its adverse implications much of it essentially petty, which runs which Britain makes to businesses, for business, but also because of the the gamut from unduly prescriptive which can be summarised as follows: role that the expansion in the cost of health and safety rules to a pursuit of government has played in creating an ‘We encourage you to invest in Britain. equality which, while commendable in unsustainable fiscal deficit. principle, imposes too great a burden If you do so, you will be required to on enterprise. comply to the letter with vast codes of Given that the Prime Minister is the practice governing all aspects of your elected chief executive of the British This interpretation seems to be borne activities. You will be expected to act government, one might expect him out by the Global Competitiveness as an unpaid tax collector, collecting to rank at least somewhere near the Report 2009-10, produced by the sales, income and local taxes. Your top of the public sector pay league. World Economic Forum (WEF). The business will be subject to a tax code In fact, this is not the case. Based on UK has fallen by four places in the which, having more than doubled in remuneration of £194,000 – and even last two reports, and now ranks 13th length since 1997, now exceeds 10,000 excluding the government-owned in the rankings. While 13th sounds pages. Even our own tax authorities banks from the list – Mr Brown ranked a reasonable position, this in part do not fully understand the tax code 297th in the 2008-09 league table of reflects some natural advantages (such but, where in doubt, we reserve the those employed by the taxpayer. Of the as market size, and developed world right to interpret it to our advantage. 296 people above him, only 11 were levels of education and health). In addition to national regulatory and civil servants (of whom the highest fiscal agencies, you should also expect paid earned £248,000). Some of the detailed findings and interference from local authorities, to trends are much more worrying. whom you will pay substantial taxes in Of the other 285 people paid more Britain ranks 75th on ‘wastefulness return for minimal services. Welcome to than Mr Brown, no less than 82 were of government spending’, and 86th the United Kingdom’ employed (at an aggregate cost of on ‘burden of government regulation’. £17.5m) by the health care trusts into These are only two categories within Obviously, this is put rather starkly. which the NHS has been fragmented the 110 covered by the research, so Obviously too, it highlights problems
52 strategy insights | issue four by quasi-market reforms. Some £4m was paid to seven employees of National Rail, £6.1m to 21 members of Transport for London, £3.2m to six Channel Four executives and £13.9m to fifty BBC managers. The £3.3m paid to four Royal Mail executives surely needs no further comment41.
In total, the 296 people who were paid more than Mr Brown in 2008-09 cost the taxpayer £81m. While this is not a major sum in the context of total public spending of £630bn during that year, it does highlight the sheer extent of the UK bureaucracy. The total cost of government administration – including all quangos, agencies and local authorities – is difficult to isolate, but our outline estimates suggest a figure of at least £150bn annually. We suspect that the overall cost of administering the NHS alone exceeds £25bn, with MoD administration costing about £8bn and HMRC perhaps £16bn.
As we explain later in this report, the excessive cost of government provides a valuable pointer towards necessary reforms, and leads us to believe that it is perfectly possible for government to cut spending very markedly without damaging the provision of front-line services. To be sure, this will not be easy. But, in a situation in which the deficit exceeds safe limits by more than £5,000 per household, there are no pain-free and easy solutions.
41 Source: The Public Sector Rich List, 2009. strategy insights | issue four 53 britain at the crossroads | the case for fundamental change part three: the road out
5. limited options
Thus far in this report, our aim has 1. Business as usual. inflation will actually be as low as the been to examine the origins and nature official forecasts assume). of the fiscal problems facing the United 2. Narrowing the deficit through tax Kingdom. Essentially, government has increases alone. A business-as-usual scenario - in which allowed itself to be misled by a largely growth is relied upon to bridge the 3. Applying a balanced approach in illusory boom in economic growth, and deficit – is effectively the government’s which taxes are increased and has driven spending up to – or rather, default position, and is summarised spending is reduced. far beyond - levels that, surely naively, in fig. 14. As yet, there have been neither major tax increases nor drastic appeared affordable under those 4. Tackling the deficit entirely through spending cuts. The government has circumstances. As a result, and as soon spending reductions. as the illusory boom gave way to an all- spoken of ‘restraint’ in public spending, too-real bust, the gap between revenue We think that we have made clear but restraint and cuts are quite and expenditure widened, reaching our view – which appears to be the different things. Essentially, growth is levels which are both unprecedented view of informed observers, such as relied upon to do most of the work in and unsustainable. the European Commission, as well - bringing down the deficit to 4% of GDP that relying on growth to rectify the by 2015. The funding gap has, thus far, deficit is not going to work, neither This objective is less ambitious than been met by the one-off (and risky) will any such attempt command the the European Commission – with expedient of QE. Britain thus faces the confidence of markets once the ‘three which our own analysis agrees - very real risk of a ‘debt vortex’ unless props’ – QE, the pre-election hiatus believes to be necessary. Moreover, resolute action is taken to reduce the and the devaluation of sterling – have it is heavily dependent upon growth deficit to a more viable level, by which fallen away. we mean the 3% limit mandated by assumptions which look to us the Maastricht Treaty. It is to be hoped Specifically, we believe that relying on pretty heroic. We have tested the that our examination of the causes of real GDP growth of 3.25% annually is government’s spending plans against the problem has suggested some of neither realistic nor, where markets a core 2% growth assumption and a the solutions. First, though, we need to are concerned, convincing. Therefore, downside 1% case. In the former, the assess some of the basic options where we have assumed real growth of deficit is over £100bn in 2015, is an the balance between revenue and 2% annually in each of our case- uncomfortable 6.1% of GDP. Using a 1% spending is concerned. These options studies. (We have also accepted the growth assumption, the outcome is, can be summarised as: government’s inflation projections, naturally, even worse. though we are far from persuaded that
54 strategy insights | issue four Fig 14: Budget projections
£bn 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 vs 09-10
Revenue £534 £508 £541 £582 £621 £660 £699
(as % GDP) 37.2% 36.1% 37.0% 38.0% 38.3% 38.4% 38.3%
Expenditure £630 £674 £704 £713 £730 £748 £772
(as % GDP) 43.9% 47.9% 48.1% 46.5% 45.0% 43.5% 42.3%
Deficit £96 £167 £163 £131 £109 £88 £73
(as % GDP) 6.7% 11.8% 11.1% 8.5% 6.7% 5.1% 4.0%
Treaty debt £796 £1,004 £1,179 £1,318 £1,438 £1,534 £1,618
(as % GDP) 55% 71% 81% 86% 89% 89% 89%
Memo:
GDP £1,435 £1,406 £1,464 £1,533 £1,621 £1,720 £1,824
Growth -1.50% -3.75% 2.00% 3.00% 3.25% 3.25% 3.25%
GDP deflator 2.50% 1.75% 2.25% 1.50% 2.50% 2.75% 2.75%
In 2010 £:
Revenue £547 £508 £529 £561 £584 £604 £622 +22.6%
Expenditure £645 £674 £689 £687 £686 £684 £687 +2.0%
Deficit £99 £167 £159 £126 £102 £81 £65
strategy insights | issue four 55 britain at the crossroads | the case for fundamental change
Next, let’s consider dealing with the a reduction of almost 15% in average that are affordable within the levels deficit entirely through raising taxes household after-tax income. After the of government revenue that are likely (a strategy that would no doubt be deduction of non-discretionary costs given a realistic growth trajectory. popular with many in the public such as utilities, food, housing and Incorporating already-announced tax sector). Using this approach, narrowing fuel, this would decimate the average rises, achieving a reduction of the the deficit to our self-imposed but, we consumer’s discretionary spending deficit to 3% of GDP over five years via think, reasonable objective – a deficit capability. This would wreak havoc on this route might see the real-terms tax of 3% by 2015 – involves increasing the discretionary industries (such as leisure take rise by about 20%, combined with tax take by 26%, in real terms, over five and non-food retailing). Since the a real-terms spending reduction of years. To put this in broad-brush terms, word ‘lethal’ would not be too strong 4%. If huge swathes of spending (such this increase, were it spread equally a term to apply to the implications as health and education) were ring- across all categories of taxation, would of this for business, investment and fenced – which we think would be a imply VAT of 22%, basic-rate income trade, a national decision to fix the mistake – then real-terms spending in tax of 25%, and higher-rate tax of 50%, deficit entirely through tax hikes unprotected areas could fall by 8-10%. accompanied, of course, by big hikes in could amount to a collective economic In many ways, this scenario would be excise duties on items such as alcohol suicide pact. commendable only in the sense that it and fuel. would spread pain across the board. A balanced approach might work, In real (2010) terms, it would burden and seems likely to be applied unless the average household with extra taxes the next UK government is serious of over £5,200 per year, equivalent to about reducing spending to levels
56 strategy insights | issue four Fig 15: Case study based on tax at 35% of GDP, deficit at 3%
£bn 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 vs 09-10
Revenue £534 £508 £525 £541 £564 £588 £614
(as % GDP) 37.2% 36.1% 35.8% 35.6% 35.4% 35.2% 35.0%
Expenditure £630 £674 £672 £667 £668 £668 £667
(as % GDP) 43.9% 47.8% 45.9% 43.9% 41.9% 40.0% 38.0%
Deficit £96 £166 £147 £126 £104 £80 £53
(as % GDP) 6.7% 11.8% 10.0% 8.3% 6.5% 4.8% 3.0%
Treaty debt £796 £1,004 £1,218 £1,362 £1,482 £1,573 £1,637
(as % GDP) 55% 71% 83% 90% 93% 94% 93%
Memo:
GDP £1,435 £1,409 £1,465 £1,520 £1,593 £1,672 £1,756
Growth -1.25% -3.50% 1.50% 2.00% 2.00% 2.00% 2.00%
GDP deflator 2.50% 1.75% 2.25% 1.50% 2.50% 2.75% 2.75%
In 2010 £:
Revenue £547 £508 £514 £522 £530 £538 £546 +7.6%
Expenditure £645 £674 £657 £643 £628 £611 £594 -11.9%
Deficit £98 £166 £144 £121 £98 £73 £48
strategy insights | issue four 57 britain at the crossroads | the case for fundamental change
This kind of pain-spreading approach administrative costs can deliver would then pose two possibilities. One huge savings, what would be the is that government would become implications for fiscal balances? Our unpopular with virtually everybody, ‘drastic reform’ case-study, set out from tax-payers and businesses at in fig. 15, assumes that government the one end of the spectrum to public makes two very bold decisions. sector workers at the other. The alternative (and much more politically The first is thatgovernment should likely) possibility is that government live within its means. This means would go soft on the deficit target. This reversing the current situation, in would deliver the worst of all worlds which government decides what it – sluggish economic growth, and a would like to spend and only then sets continuation of all of the potential out to find this sum through taxation hazards (such as higher interest rates and borrowing. and inflation) that accompany ‘vortex The second bold decision is that the risk’. UK needs to create a more competitive Is there, then, a viable alternative? economy by reducing the tax take, We believe that there is. The massive albeit only slightly, to 35% of GDP from increase in public expenditures over the current 36%. Therefore, the object the last decade has been hugely of the exercise is to tailor spending to wasteful, most notably in terms of the the twin objectives of (a) fitting within costs of administration. For example, a 35% tax take, and (b) reducing the administration absorbs 20% of the deficit to 3% of GDP over five years. budget of the Ministry of Defence, Naturally enough, this means cutting whereas international peers get by on public spending from 48% of GDP in just 11%. Much the same applies to 2009-10 to 38% by 2014-15. How this the NHS and, indeed, to most aspects seemingly-difficult challenge might be of administration. On top of that are accomplished is considered in the next the huge expenditures incurred by the chapter. forest of quangos that has proliferated In nominal, money-of-the-day terms, over the last two decades. this objective indicates that spending If we start with the assumption – in 2014 would, at about £670bn, be before going on to look at how it about the same as the sum spent in might be accomplished – that slashing 2009-10. In real, inflation-adjusted
58 strategy insights | issue four terms, of course, spending would benefit from lower taxes and less simply, this means that an economic decline by 12% in this scenario, to intrusive government. The scope system which, by its nature, must £594bn at 2010 values, compared with for discretionary spending by the grow, may be on course to collide the 2009-10 out-turn of £674bn. consumer would increase, leaving him with a global resource set which, or her better off. The deficit would by definition,cannot grow. This, to At this point, some will doubtless decline to 3% by 2015, and would be us, unmistakably spells inflation on suggest that a spending cut of this likely to fall further thereafter. And anything other than a short-term magnitude would be impossibly spending reductions on this scale view. Additionally, the UK faces local difficult, and would inflict serious would give Britain a margin of error for inflationary pressures through an damage on the public services. But coping with any unexpected economic ominously weak currency, through the reducing spending to about £590bn setbacks in the future. temptation to push inherently-risky at 2010 values would still leave QE one stage too far, and through a real expenditures well ahead of the And there is every reason for factoring looming energy squeeze. 2004-05 level (£560bn), let alone the a significant degree of caution into out-turn in 2001-02 (£480bn). Public forward planning, because current The latter poses an additional risk for services did not seem desperately cash- assumptions seem to us unduly the next government. For a start, UK starved in the first half the decade. optimistic – and not just where future production of natural gas is declining growth rates are concerned. The first rapidly, meaning that imports will Moreover, both of the main parties of these concerns inflation, which we increase successively. Second, energy have, in the recent past, accepted the are by no means convinced will follow policy has been bungled by successive need for precisely the kind of cost- the benign course assumed in current governments. The Conservatives cutting that we advocate here. In 2005, official projections. Though much presided over a ‘dash for gas’ which, in David James, for the Conservatives, has been made of deflationary risk, addition to depleting reserves, skewed 42 produced a report in which he the fact remains that inflation (even Britain’s power generation industry identified £35bn of potential savings, as measured on the far-from-ideal firmly towards gas. equivalent to about £49bn at 2010 CPI basis) remains obstinately above values. On behalf of the government, expectations. Peter Gershon produced a report43 pointing to similar potential savings. Our core thesis – to be outlined in detail in Issue Five – is that the global If – as we very strongly believe to financial system is in the grip of a be the case – a real-terms saving series of ‘dangerous exponentials’, of £80bn can be accomplished which include a trend towards sharply over five years largely by cutting higher levels of debt and of fiat money, bureaucracy, the benefits would be combined with demographic pressure enormous. Competitiveness would and looming resource constraints. Put
42 See The James Review of Taxpayer Value. 43 See HM Treasury, 2004 Spending Review, www.hm-treasury.gov.uk/d/sr2004_ch1.pdf strategy insights | issue four 59 britain at the crossroads | the case for fundamental change
Under both administrations, there functioning as an effective free- is deeply dissatisfied. In our earlier has been a lamentable failure to bite market economy is clearly at risk, even discussion of this conundrum, we the nuclear bullet. Of Britain’s eight if this can be addressed only briefly suggested that politicians might nuclear reactors, five44 - accounting for here. This is an increasing tendency actually try the innovation of listening 60% of installed capacity – are due to towards coercion and surveillance. No to the public. Were they to do this, they close within the coming eight years, yet less a person than then Information might appreciate that the governing past government vacillation has meant Commissioner Richard Thomas warned elite is increasingly out of touch with that no new capacity is likely to come in 2004 of the danger of ‘sleepwalking the governed on a gamut of issues on stream until 2019. into a surveillance society’45. One ranging from discontent at ‘fat cat’ does not need to be Walter Wolfgang government, to excessive taxation The combination of local weaknesses or Maya Evans46 to suspect that and charging, to over-complex and and global ‘dangerous exponentials’ anti-terror laws are being used for petty regulation. It is well known that obviously spells inflationary risk, but it purposes far beyond the original depression and de-motivation can also spells higher interest rates, even if intentions of Parliament. It is possible, seriously undermine the performance government succeeds in retaining the indeed, to envisage a of the individual, confidence of the international bond future in which the ‘The future is fraught but it is perhaps less markets (something which is by no British population appreciated that this means certain unless resolute action is is subjected to ever- with economic risk is equally true of a taken). This would be a multi-pronged increasing taxation and at a time when the society or an economy. threat. In addition to the ‘vortex risk’ charging to sustain So efficiency, social described earlier, higher interest rates an administrative pre-election debate cohesion, economic would cause an escalation in the cost superstructure which weakness and fiscal of servicing government debt – which is increasingly coercive is characterised overstretch seem to already costs more than defence or as well as unaffordably by vagueness and point towards the law and order - and would put further costly. same conclusion, pressure on consumers both through unreality’. which is that the UK higher mortgage costs and falling This brings us to a point is in great need of a property prices. raised much earlier in system of governance this report, where we addressed the which is more efficient, less expensive, The future, then, is fraught with apparent mismatch between, on the less intimidating, less ideological, and economic risk at a time when the one hand, a society that is by no means more responsive to the broader public. pre-election debate is characterised as ‘broken’ as is widely supposed and, by vagueness and unreality. And there on the other, a population which is one further area in which Britain’s
44 Hartlepool and Heysham 1 (2014), Hinckley Point B and Hunterston B (2016), and Dungeness B (2018). 45 See The Times, 16th August 2004. 46 Mr Wolfgang (then aged 82) was a long-time Labour activist who was forcibly ejected from the 2005 party conference (and briefly detained under Section 44 of the Act) for heckling a speech by Jack Straw about the 60 strategy insights | issue four Iraq War. Maya Evans (25) was arrested for reading out a list of British war dead opposite the Cenotaph. 47 Our favourites from the 2008 crisis included ‘Origami Bank has folded, Bonsai Bank is cutting its branches and Karaoke Bank is being sold off for a song’. 6. practical alternatives
In any financial crisis, a grim gallows modest number of strikes, public equates to more than £6,500 per UK humour tends to develop in the sector workers in Ireland have largely household48. markets47. One of the pithiest – but, as accepted the need for government it turned out, most inaccurate – such spending restraint. While it is too The second perceived obstacle to quips of the 2008 crisis was that ‘the soon yet to judge whether public spending cuts is that front-line services only differences between Iceland and sector employees in Greece will will necessarily suffer severe damage. Ireland are one letter and six months’. respond as phlegmatically as their Irish But, as our analysis of the nature of counterparts, there seems to be every the over-spend has endeavoured to To be sure, Ireland had faithfully likelihood that Greece will succeed in explain, this assumption need not be followed the same irresponsible imposing significant restraint without correct. Essentially, the British public economic approach which had system-stopping unrest. sector over-spends because it is over- effectively bankrupted Iceland. But managed. Far from improving the Ireland has – albeit painfully – avoided There are, essentially, two perceived quality of public services, this over- the fate of Iceland, for two main obstacles to the implementation of management has resulted in excessive reasons. Since an independent Irish big public spending cuts in the UK, of complication, an undue reliance on an currency would almost certainly have which the first (and biggest) is a fear arbitrary and distorting target culture, disintegrated in much the same way as that public sector workers will react by and a diversion of resources away from the Icelandic króna, it is clear that the bringing government to a standstill. front-line services. first of these reasons has been Ireland’s We think that this fear is over-rated. membership of the Eurozone. But the When the delayed bill for the recession This suggests that cutting spending second reason for Ireland’s comparative arrives – which it indubitably will – will be by no means as difficult as is resilience is that the Irish government public sector employees will become generally supposed. Writing in The 49 reacted with commendable resolution, aware of two things. First, that they Guardian , Audit Commission chief most notably by introducing public have hitherto enjoyed not only better executive Steve Bundred explained why sector pay restraints which, combined conditions of employment (and far the need for big cuts in public spending with a pensions levy, effectively superior pension arrangements) than need by no means lead to a degrading amounted to reductions in public their private sector counterparts but, of front-line services, pointing out sector pay of between 12% and 15%. latterly, have received higher average that ‘the idea that spending cuts will earnings as well (so that the traditional destroy the quality of public services’ This is not a policy which we defence of the pension scheme, is a ‘myth’. ‘Even if a budget reduction recommend in Britain’s rather different on the grounds that it is a form of of some £50bn fell entirely on lower circumstances, but there is one aspect compensation for lower earnings, is spending rather than higher taxes, of the Irish story which has particular no longer valid). Second, it needs to be that would still leave us with a real significance in this context. It is explained that the British state has, level of public spending greater than the observation that, beyond some for many years, been living beyond in 2003/04, when services were not noisy demonstrations and a pretty its means to an extent that now noticeably worse than they are now.
48 The per-household equivalent of a £167bn deficit is £6,550. 49 5th July 2009. strategy insights | issue four 61 britain at the crossroads | the case for fundamental change
‘Efficiency, social cohesion, Moreover, as most public sector bill, but this, we think, can be best workers know, some services remain accomplished by a sharp reduction in economic weakness and underfunded, but the relationship the numbers of administrative staff. fiscal overstretch seem to between spending and service quality Entire entities – to name just one is at best complex and in many category amongst many, the regional point towards the same instances tenuous’. ‘So don’t believe development agencies – could be the shroud wavers who tell you scrapped with no detriment to the conclusion, which is that grannies will die and children starve if quality of public services. Spending the UK is in great need of spending is cut. They won’t’, concluded cuts need not mean that public Mr Bundred. ‘Cuts are inevitable, and services suffer, or – contrary to the a system of governance perfectly manageable’. predictable protestations of some public sector unions – that the incomes which is more efficient, less Mr Bundred is surely right about this. of such low-paid worthies as school Moreover, we believe that the approach expensive, less intimidating, dinner-ladies or hospital porters need to be adopted in the UK needs to be suffer either. less ideological, and more rather more nuanced than it has been in Ireland. For the most part, we do not Moreover, and since the real level of responsive to the broader believe that government needs to cut government expenditure increased by the wages of any public sector workers 55%50 between 1999-2000 and 2009- public’ earning less than the national average 10, it would be remarkable if current wage (about £21,000 per year). In this outlays did not include huge swathes category, a pay freeze is likely to suffice. of waste. As we have remarked earlier, Rather – and in addition to tackling the the template for future success is pensions problem - government needs often to be found in the errors of the to look at imposing graduated cuts, past which, in this instance, means restricting Irish-scale reductions to reversing much of the improperly- those earning more than £30,000 per controlled expansion in the scale and year. Though any future government is cost, not of public services, but of going to need a pretty thick skin where government itself. public sector pay restraint is concerned, there are ways of handling the need for cuts which can help to offset adverse reactions.
This said, there is an undoubted need to reduce the overall public sector pay
50 Adjusted for subsequent inflation, public spending in 1999-2000 (of £343m) equates to £437m in 2010 62 strategy insights | issue four money, meaning that actual spending (of £676m) equates to a real terms increase of 55%. So what is needed is wholesale reform information technology should be the potential resource constraint (most of a public sector which has become efficient conduct of administration, notably, but by no means only, in terms massively over-managed. Since this not an increase in the endeavour to of energy). applies as much in health and in control a population which is already education as it does in other areas, subject to massively intrusive systems Britain’s public sector pension we see no need (beyond pre-election of surveillance. Abuse of anti-terror obligations, unless tackled resolutely, posturing) for ring-fencing any powers should itself be rendered a could turn into a fiscal time-bomb. spending areas where the requirement criminal offence, and made subject Therefore, a key imperative is to ensure for reform-driven spending reductions to the binding oversight of the that this obligation ceases to grow. is concerned. In several areas – most Information Commissioner. Specifically, government needs, at notably health – government needs the minimum, to raise public sector to start reversing a quasi-market As well as dealing with current issues, pension contributions to the point process which has fragmented public a future government needs to look where annual income at least covers services, and ahead, and to try to annual outgoings. Similarly, to avoid increased costs, ‘The British public sector anticipate future trends the build-up of future financing while generating which could put the problems, we advocate scrapping PFI little if any real over-spends because it is public finances under with immediate effect, and reverting renewed stress. In to the historic policy of directly funding competition and over-managed’ giving the public doing this, two key capital projects. very little real factors need to be As well as seeking to defuse future freedom of choice. We believe that borne in mind. The first of these is the fiscal time-bombs, it is imperative that patients, and for that matter parents, demographic challenge posed by an action is taken to prevent a recurrence would prefer good quality public ageing population and a worsening of the borrowed boom of 2000-07 services based locally, rather than an ratio between working-age and and the ensuing crash of 2008-09. The often spurious (and impossible-to- retired people. The second is the trend first requirement here is to dismantle exercise) ‘choice’ between different towards ‘dangerous exponentials’, the failed tripartite system. The FSA hospitals and schools. mentioned earlier, and which will be explained in a forthcoming Strategy has a vital role to play in ensuring We also believe that government Insights report. For UK purposes, this probity and consumer protection in needs to become far smarter where issue points to a need to move away the financial services industries, but the use of technology is concerned. from a growth-and-debt model which, regulation of the banking system Government employees need to in Britain as elsewhere, is based upon itself needs to be handed back to the understand that laptops and data- the assumption that the economy can Bank of England. It is essential that sticks are not designed to boost continue to grow indefinitely despite monetary targets be recalibrated to freedom of information by being left the confines of a finite resource set. include asset inflation. on trains or in cabs. The aim with Specifically, this implies awareness of
strategy insights | issue four 63 britain at the crossroads | the case for fundamental change
Since property price expansion is by would go a long way towards it). down the surveillance and intrusion far the largest cause of bubbles, the Consequently, if the excessively- route – should be scrapped, as, indeed, government should re-impose limits narrow difference in quantity cannot should an NHS IT programme which on mortgage lending, where we believe be widened sufficiently, it could be is on course to cost Britain more than that a maximum multiple of 5.5 times counterbalanced £20bn. There is a crying need for proved net income, and a maximum by a distinction “The UK needs to thoroughgoing reform of local LTV of 85%, are essential. of quality. In modernise, and to government. other words, While bank regulation needs to part (perhaps as commence a new The essence of our analysis is be tightened, essentially petty much as 80%) of that the UK needs to modernise, intervention in other areas needs to benefits could be ‘quest for national and to commence a new ‘quest be reduced. Government needs to for national efficiency’51. Other paid not in cash efficiency’” adopt a ‘self-denying ordinance’ and, in but in kind. As a progressive measures could follow addition to creating mandatory limits result, a person from this, including electoral to deficits, start to reverse the historic who moved from benefits to work reform (moving away from the process of ever-greater interference in would enjoy not only a larger income unrepresentative first-past-the-post the conduct of business. in the absolute but the significant system), an overhaul of the welfare/ additional incentive of a greater taxation interface (where a system Welfare reform needs to focus freedom in how this could be spent. of ‘negative income tax’ would be a primarily on eliminating the poverty bold step forward), and the creation trap. Essentially, this trap refers to We have remarked earlier that the of an elected (rather than, as now, marginal changes of income which tax system has long incentivised debt and ludicrously, a nominated) second impose a severe deterrent on those over equity capital by allowing interest chamber. But the most important seeking to move from benefits to expense, but not dividends, to be need by far is for economic and work. One step in the right direction offset against tax. It has been argued, administrative reforms designed both would be to seek to raise the income disingenuously, by defenders of the to reverse the economic and fiscal crisis tax threshold to the equivalent of current system, that removing interest and to prevent such crises recurring in the minimum wage (some £10,000, relief would damage big UK corporates. the future. based on current rates). This could The solution would be simple – a cap be paid for by dismantling the over- limiting the interest deduction to no complicated and capricious tax credit more than 20% of pre-tax profits. system. At the same time, the National Insurance fiction should be abolished Other desirable reforms will have by combining NI into income tax. been obvious from our analysis of the history and nature of the British Alone, these measures might malaise. The ID card scheme – which, Dr Tim Morgan not be sufficient to eliminate as well as being ludicrously expensive, Global Head of Research the poverty trap (though they threatens to take the UK even further April 2010
51 The quest for national efficiency was the title of a ground-breaking 1971 study by G.R. Searle, which examined Britain’s attempt to respond to the growing industrial rivalry of the United States and Germany 64 strategy insights | issue four between 1890 and 1914. appendix 1 financial and economic data
In the interests of consistency, and stated at purchasing power parity), the In some instances, and reflecting a except where otherwise noted, table shows budgetary information commonality of method, this data financial and economic data used summarising revenues, public differs from nationally-published in this report for the purposes of expenditure, the surplus or deficit and numbers. All data is for the 2009 international comparison is sourced reported government debt at year-end. calendar year, whereas some countries from the CIA World Factbook. The table also shows exports, imports (including the United Kingdom and and the trade balance. Key items – the United States) report on the basis To assist readers with comparisons, a the fiscal deficit, public debt and the of their own fiscal years. With the summary of key data for 2009 is shown trade balance – are also shown as exception of percentages, all data is in fig. 16. In addition to GDP (which is percentages of GDP. shown in billions of US dollars.
Fig. 16: Summary economic data, 2009*
Budget Trade As % GDP
$bn GDP** Revenue Spending +/- Debt Exports Imports +/- Deficit Debt Trade
Canada $1,287 $515 $547 -$33 $931 $299 $305 -$7 -2.5% 72% -0.5%
China $8,767 $972 $1,137 -$165 $1,596 $1,194 $922 $273 -1.9% 18% 3.1%
France $2,113 $1,229 $1,445 -$216 $1,684 $457 $532 -$75 -10.2% 80% -3.6%
Germany $2,812 $1,398 $1,540 -$142 $2,171 $1,187 $1,022 $165 -5.0% 77% 5.9%
Greece $339 $109 $145 -$37 $367 $19 $61 -$43 -10.8% 108% -12.6%
Iceland $12 $4 $5 -$2 $12 $4 $3 $1 -13.2% 101% 11.4%
India $3,548 $123 $223 -$100 $2,132 $155 $232 -$77 -2.8% 60% -2.2%
Ireland $177 $75 $105 -$30 $113 $107 $65 $42 -16.8% 64% 23.9%
Italy $1,756 $960 $1,068 -$108 $2,023 $369 $359 $10 -6.1% 115% 0.6%
Japan $4,141 $1,614 $1,997 -$383 $7,955 $516 $491 $26 -9.2% 192% 0.6%
Portugal $232 $92 $107 -$15 $175 $41 $59 -$17 -6.4% 75% -7.5%
Russia $2,103 $205 $307 -$101 $145 $296 $197 $99 -4.8% 7% 4.7%
Spain $1,367 $489 $640 -$151 $813 $216 $293 -$78 -11.1% 60% -5.7%
UK $2,165 $820 $1,132 -$312 $1,483 $351 $474 -$122 -14.4% 69% -5.6%
US $14,260 $1,914 $3,615 -$1,701 $5,661 $995 $1,445 -$450 -11.9% 40% -3.2%
Memo:
UK in £bn £1,406 £532 £735 -£203 £963 £228 £308 -£79 -14.4% 69% -5.6%
* PPP ** Based on CIA World Factbook exchange rate of $1.54=$1
strategy insights | issue four 65 britain at the crossroads | the case for fundamental change
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