Hamish McRae: The First World debt crisis only serves to hasten the shift of power to the East
Economic Life: The problem is not just public debt. It is total debt. The governments of the developed world have over-borrowed but so have consumers and companies
Friday 11 June 2010
It will be a two-speed world, and the events of the past few days in Europe seem likely to widen the gap. What has happened is that Europe has collectively made the decision that it will have to cut public deficits more swiftly. You could say that we all have to do a Greece.
Of course the detail and the timing will vary. Ireland has already made a start, while Greece, Portugal and Spain are waiting to see whether they will have done enough. But now Germany has come out with solid deficit-cutting plans and the Netherlands, with its change of government, will surely do the same. Then there is the UK... let's wait until the emergency Budget to see exactly what we will be doing but it will not be agreeable. Indeed, the only major European country that has not recently announced new deficit-cutting plans is France and it is no coincidence that the premium France has to pay for its borrowings over the rate Germany has to pay has widened sharply. Indeed, it now costs a borrower more to insure against a default by the French on their public debt than it costs to insure against a British default, despite the fact that our running deficit is twice as big.
Now you can deplore this. You can say that harsh public spending cuts will damage the most vulnerable. And you can argue that such cuts may withdraw public demand before the private sector is able to replace it. There are certainly both social and economic reasons to be seriously concerned. But actually, there is no option. What we think is irrelevant. It is going to happen. So we need to try to think through the consequences.
There is something else. Unfortunately the problem is not just public debt. It is total debt. The governments of the developed world have over-borrowed (or at least most of them have, for there are few shining examples of restraint) but so too have the consumers and, in many cases, the companies. By contrast, the largest economies of the emerging world have not fallen into this trap and overall debt has remained low. Go back 20 years and we used to talk of a Third World debt crisis; now we have a First World one.
In terms of total debt over the past decade, the UK has become an outlier, moving from having more or less the same level of debt as the US, Germany and France – a little higher but not dramatically so – to joining Japan at the top of the debt league table. That is partly because we allowed public finances to get out of control, or, more specifically, because the government wanted to spend money that it was not prepared to raise in taxation. But it is also partly because we as consumers and homebuyers went on a borrowing binge too.
Now contrast that with the borrowing burden of the BRICs, to use that acronym coined by Goldman Sachs to group together the four largest emerging economies, Brazil, Russia, India and China. Those countries are very different, both in their economic make-up and their political history. But they have one thing in common: low debts.
Naturally they have been helped by high growth, for if you grow your economy quickly you will find it much easier to hold down debt as a percentage of GDP. You can argue, too, that it is natural for a developed economy to have more debt because it has invested in more infrastructure and housing. Its debt is balanced by more physical assets. But actually China at least is putting in huge amounts of infrastructure and has also experienced a housing boom, and for the UK at least – well, we are now being told quite rightly that we need to invest much more in infrastructure. Trouble is, we can't afford it.
In any case there are some developed countries that do not have such debts. I have just returned from Korea which, along with Australia, looks like being the fastest-growing developed economy. Its public debt is around 30 per cent of GDP and, as far as I can calculate, its total debt is under 100 per cent of GDP. And it has achieved this with a heavy defence burden, for obvious reasons, yet been able build high-quality infrastructure. Seoul, like so many cities in East Asia, makes the cities of western Europe and North America look dull and shabby.
So what is going to happen next? The first thing is surely that the two-speed world will continue through this recovery. The West, Europe particularly but also the US, will be increasingly preoccupied by its debts. Much of the fruits of growth will have to go, first in stopping public debt rising further, then starting to pay it off. That will restrict private consumption as well as public spending. Germany has not had any significant rise in living standards over the past decade, while in the case of Japan it is more like the past two decades. Well, we – and other European nations – seem likely to have much the same experience. We are not used to that, or at least not in peacetime. There is, of course, fat to trim in personal budgets (do we really need to drink so much?) as well as government budgets, but it is always hard to adjust downwards.
The second thing is that it looks more and more as there will be a second leg to the downswing. You may have noticed that Finland has just reported a downturn in activity: it is the first country to go into a double dip. We have just had Ben Bernanke, head of the US Federal Reserve, saying that he hoped the US would not experience that, a statement that carries the concern that it might. It is not at all clear whether the US will have that second leg to the recession but given what is happening across Europe it would be surprising if some European economies did not have at least one quarter of negative growth before the end of next year.
The third thing that is going to happen is that we in Europe, and that is all of us, will think differently about public spending. You cannot put people through what will happen over the next five, actually 10, years without them feeling quite differently about the role of the state. We have in effect been lied to – not just in Britain but everywhere – about what the state can provide at any particular level of taxation. And as a result of that lie, we have transferred a huge burden on to our next generation of working people. They have to provide not only for the pensions and healthcare of the retiring workers but also pay interest on the debts that have passed on.
All this is obvious enough. The hardest thing to see is the financial consequences. Will governments try to reduce the real burden of debt by encouraging inflation? There will certainly be a great temptation to do so but the interests of pensioners will be against that and they will be an important political lobby. Look how the possible cut in dividend by BP has become a political issue because of the way it would hit pension funds. Many people think the incentive to inflate will prove irresistible and that is what the gold market is saying. My instinct is that the costs of inflation, in terms of higher interest rates, coupled with the memory of the inflation of the 1970s and 1980s, will check that. But the course of inflation is the great imponderable; what is certain is that the shift of power from West to East will continue.
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