Fear is back. It is perfectly normal at this stage of an economic recovery for there to be a bump in both stock-market sentiment and growth in the real economy – indeed these columns warned of the likelihood of this last month. Recoveries are never straight-line and the collywobbles last week should be seen in this context.
The trigger for the disruption was a rising concern that Greece would default on its debt. This spread to fears about other weak eurozone countries – this grouping of Portugal, Ireland, Greece and Spain having the unfortunate acronym of Pigs. The result was that the euro was pushed down to its lowest level for nine months and shares worldwide were back to their October levels.
At first sight, this all seems a bit implausible. Greece is a wonderful country, albeit with weak fiscal management, but it is not a big economy. Why has the Greek tail managed to wag not just the eurozone dog but the Wall Street wolf too? The answer is that this is not just about Greece or the other weaker European nations but the whole developed world.
Greece first. I am quite confident that eventually Greece will be bailed out by the rest of the eurozone. That decision has, in effect, been taken by Germany, the paymaster. It will sign the cheques. The authorities cannot say that because they cannot set a precedent. In any case, they would not want to as they have to put as much pressure as possible on the Greek government to put its finances in order.
But there is a complete awareness that there could be a domino collapse of confidence in the other governments up to and including Italy. If that were to happen, the future of the euro itself would be imperilled. The fledgling currency would have failed at its first real test, the first serious downturn since its launch. For the moment, there is enough political will to stop that.
Unfortunately, the problem of Greece is reflected elsewhere. As you can see from the main graph, it has experienced a rapid increase in unit labour costs over the past decade. But so too have the other members of the "Pigs" fraternity, the astounding contrast being between that group and Germany. We tend to forget just how disciplined Germany has been in the management of its economy, not just at a macro-economic level but at a corporate level too.
You can see two other manifestations of the Pigs' ill-discipline in the right-hand graph. The red bars show the current-account deficit for the latest 12-month period, the orange bars the fiscal deficit. Greece is in the most serious position but Portugal and Ireland run it close. Spain, interestingly, appears in better shape, but it has taken the blow on the chin in the sense that its unemployment rate has doubled to nearly 20 per cent. That is the highest in the EU. Its financial numbers may look better than the others but in human terms its outcome is worse. Italy, by contrast, has things under reasonable control.
So why is there this sense that the creditworthiness of Europe as a whole is under threat? The answer to that comes in two parts. First, there is a realisation that, from now on, both fiscal and monetary policy around the world will have to tighten. So if the world dips back into recession all the ammunition has been fired and governments cannot help. And second, in the medium-term, all governments will have to get their debts under control, so we face a decade or more of unpleasant adjustment.
On the first, we have just had the ending of quantitative easing here in the UK and rising concerns about the scale of the cutbacks the next government will have to take. In the US, the budget proposed by President Barack Obama has been seen as anti-growth. Discouraging employment numbers from the US suggested that those strong, last-quarter growth figures were a mirage. And outside the G7, there is the perception that China and India will increase interest rates shortly, for both have recently tightened bank reserve requirements, a common preliminary to an increase in rates.
On the second, the issue is not what happens in the next few months but rather what happens in five or more years' time. The developed world will exit this recession with public debts double the level that it had before the downturn. So not only has all the ammunition been fired to check this recession; there will not be much left should another recession come along. The Institute for Fiscal Studies calculated last week that under present projections it would not be until 2033 that the debt to GDP level is back below 40 per cent of GDP, the level set in Gordon Brown's famous rules as the sustainable level. No one knows what will happen between now and 2033 but two things are sure. The world cannot try to borrow its way out of another recession. And it has a 10-year slog ahead of it, paying back debts. That does not mean there can be no recovery but it does mean that governments throughout the developed world will have to run surpluses, not deficits. So the growth, as it comes through, will not be able to go into consumption as it has in the past. You might say that the good news is that there will be growth but the bad news is that it won't feel like it.
You may ponder why it took so long for people to realise all this. What I think has happened is that the markets became caught up in the relief that the recession was over and failed to appreciate the scale of the difficulties ahead. Governments seemed to be the saviours; now we see them as the problem. Once these difficulties have been assessed and reflected upon, the markets will realise that while there will be an inevitable period of austerity, the normal functioning of the world economy will resume. The adjustment will be greater in countries that have been particularly ill-disciplined in their public finances, especially the "Pigs" but also including the UK. But there is a reasonable model in the case of Ireland, a country that has corrected most of its mistakes and has embarked on the slow slog back. Greece, Portugal and Spain will be forced to follow that example.
But as far as the euro is concerned, huge damage has been done. Yes, it will be held together this cycle. But the idea that some countries may be forced to leave is now clearly established. It is respectable in the markets to warn of the possibility – a number of market commentators have done so. Indeed, it would be irresponsible for any investment adviser not make that warning explicit.
My own view remains that while the eurozone will hold together through this downturn, the balance of probability is it will break up during the next one. That is a view that 10 years ago seemed extreme. After the events of the past week it is beginning to seem almost respectable.
Policy cannot fix regional inequalities that have existed for centuries
There has been rising concern, in the past few weeks, at inequalities within Britain, in particular between regions. We have a reasonably progressive tax system, with the result that only three regions are net contributors to the Exchequer: London, the South-east and East Anglia. The rest all get more out of the state than they put in. A lot of government policy has been directed at trying to narrow the gap, you might say cynically because there are fewer Labour voters in these three regions than elsewhere. But there has been little discernible progress. That leads to a debate as to whether spending public money is effective: does having relatively well-paid public sector workers in poorer areas make it impossible for the private sector to compete for staff and accordingly undermines private enterprise?
It may seem counter-intuitive, but it is possible that well-meaning policies have actually increased inequality instead of reducing it. The parallel is with job-protection legislation. Countries in Europe with high job-protection tend to have high unemployment, as firms don't take on new staff because it is costly to get rid of them.
There is, however, a further reason to be sceptical of policies designed to reduce regional inequality. It is that for most of the past 1,000 years – the exception being the Industrial Revolution – the South and East have always been richer than the North and the West. I have been looking at a map of wealth distribution in England and Wales in 1334, reproduced in David Crystal's wonderful study of the development of our language, The Stories of English.
The three richest regions then were London, the Thames Valley and northern East Anglia. This does not exactly fit the present pattern, which is skewed by commuters into London, but the bias of wealth towards the South and East was remarkably similar nearly 700 years ago to what it is now. The inevitable, if troubling, conclusion is that policies to change a relationship that has lasted that long are bound to fail.Reuse content