Hamish McRae: Leadership is what we should get, but competence would do for now

Economic View

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The Independent Online

Summertime but the living ain't easy. It has been particularly uneasy for José Luis Zapatero, who had to break his holiday and return to Madrid to crisis talks about the soaring interest rate on Spain's debts. But actually it has not been a bundle of fun for anyone involved in the financial markets – investors, of course, but particularly the political leaders on both sides of the Atlantic.

The prime reason the events of the past few weeks have been discouraging is that the political leadership in most of the democracies of the developed world has been shown to be inadequate. Some things are going right in the world economy: most large companies are sorting out their problems and serving their customers well, and that needs to be remembered. But general economic management in many countries has been going wrong.

So what we have learned in the past few months and what we might reasonably expect to happen come the autumn?

The first thing I have learnt, or maybe re-learnt, is that the early stages of a recovery after a recession always feel pretty dreadful. There is a very good reason for that. No big economy in the developed world is yet back to its previous peak of output. We thought the US was just about there but there has been a large downward revision of the data. So not only are we poorer on average than we were three years ago, we also have lost the expectation that we – that is just about everyone in the developed world – can expect a gradual rise in living standards and wider economic opportunities. In most of the emerging world it is an utterly different story, there the boom has, so far at least, continued apace.

That leads to a second thought. We have to ask what we have been doing wrong. Why have the economic policies of most developed nations produced outcomes so much worse than that of most of the large emerging nations? The eurozone has proved a disaster for many of its citizens, with unemployment averaging close to 10 per cent, yet the politicians still burble on about their visions for Europe. Citizens might reasonably ask for less vision and more competence.

The US has similar levels of unemployment to Europe but largely without an adequate social net to mitigate its effects. To see those US politicians clapping each other last week for agreeing on what will be seen to be a quite inadequate agreement seemed to me to be absurd. And here? Well, we have yet to receive a proper apology from the previous government for having bequeathed a deficit of 10 per cent of GDP to the coalition.

Some individuals understand it and are doing their best: I much admire the way Angela Merkel is playing a very difficult hand in Germany, and in a quite different position, the performance of Danny Alexander here in the UK. I also admire Barack Obama's handling of the US debt debacle. But none of them should be having to do what they are trying to do.

There's a third lesson that has become clearer in the past few months. The countries of the developed world have a limited time to get their finances in order before the next cyclical downturn. We don't know how limited. The present growth phase – and it is a growth phase notwithstanding the prospect of a difficult second half to this year – could last five years, conceivably 10. It won't go on for ever and yet the only politician I have ever heard make this point explicitly was the economics minister in Sweden, though such a plan was implicit in the golden rule that Gordon Brown set out when he first became Chancellor.

If all this sounds daunting I have just learnt something else that is rather more encouraging. Three countries – Canada, Sweden and Norway – all reduced their spending as a share of GDP by roughly 15 per cent between 1992 and 2007. Yet all three remained near the top of the World Bank's human development index. These figures come from the new book Government versus Markets by Professor Vito Tanzi, who argues that it is possible to make radical cuts in spending and still deliver good social and health services. He believes an efficient government should be able to do that taking around 35 per cent of GDP in tax, which is rather less than the British government has had on average over the past 30 years. (The peak in the tax take in Britain was 39 per cent and that was in 1982 under Margaret Thatcher.)

The past few months should have taught the policy-makers of the developed world some pretty harsh lessons. Just how harsh is dawning on people such as Mr Zapatero. But there are many – and I am afraid that includes members of the US Congress and much of the European political elite – who don't quite understand what is happening.

Their authority is slipping away. They may be elected leaders and so feel they have a democratic mandate, but they are subject to the rules of mathematics just like everyone else. They cannot magic up resources if those resources have already been allocated to something else. If they need to borrow to finance national needs they need to convince the savers lending them the money that there is a reasonable chance those savers will be repaid.

Some countries have retained that confidence and can borrow cheaply. Astounding as it may seem, the UK can borrow at a lower rate than at any time in the past 50 years. Germany can borrow at an even lower rate. Italy and Spain can't. Tough. They should have thought of that when they made all those promises a few years back.

My guess is that the recent bout of panic will subside and an uneasy calm will carry through to the autumn. But the scars will remain and electorates on both sides of the Atlantic will start to rethink what they ask of their political leaders. Above all, they – we – will want competence. Numeracy and competence: not grandiose plans dressed up as "leadership"; not self-congratulation; not the "blame everyone else" whining; not the attempts at micro-management. Just take a few decisions and try and get them mostly right. Is that too much to ask?

Let's just sit tight and hold on to our status as a safe-haven island of calm

And us? It is tempting to see Britain as an island of calm amid all this mess. We don't have the euro; we don't have a government in denial about the fiscal dangers; we have a competitive exchange rate; and we have a sort-of-growing economy.

But we are also an open economy heavily dependent on the rest of the developed world. Around two-thirds of the profits of our 100 largest firms come from exports or foreign subsidiaries. So, we are all in this together.

The data on the UK economy is very "noisy", with much uncertainty and distortion making it hard to hear signals that would tell us what is really happening. Underlying growth seems to be 1 to 2 per cent a year, but we can be more precise. Perhaps surprisingly, the economy seems still to be creating net jobs, with the private sector hiring three or so people for each one laid off by the public sector. But employment growth could halt, given the deteriorating international outlook.

Against this backcloth there will be understandable calls for the Government to do something, with the prime candidates being to cut spending more slowly, cut taxes, or to ease monetary policy further. The trouble with slowing the fiscal consolidation is that it would push up long-term interest rates. The Government last week could borrow more cheaply than at any time for the past 50 years. You do not want to throw that bonus away when you are still borrowing an additional £120bn a year. As for monetary easing, that might result in yet more inflation, squeezing real incomes and reducing consumer demand. Doing something might actually make matters worse.

There could be a set of circumstances where there needs to be a change of policy. But these will be external, most probably something going very wrong on the Continent. Meanwhile, let's keep our "safe haven" status, however improbable that might seem.

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