Democracy finds unexpected friend

ECONOMIC VIEW; Far from being an amoral force, the markets protect children and the unborn

There is a great temptation in the financial markets to wind up expectations ahead of Group of Seven meetings: the idea that when the finance ministers of the world's largest seven economies get together they must emerge with some grand policy initative to tackle the markets' preoccupation of the day. When they don't, the markets duly profess disappointment and accuse them of complacency.

Sometimes the concerns of the markets prove justified. There is some kind of dramatic movement either in bond or currency markets, and either policies change, or the markets get so far out of line that a spontaneous reaction takes place. And sometimes the markets have simply got things wrong.

The weekend meeting of G7, ahead of the IMF and World Bank meetings, which start today, already fits into this familiar pattern. The markets yesterday were in their usual ill-tempered mood. But to focus on this seems to me to miss a much bigger and more interesting change that is taking place in the relationship between the governments of developed countries and financial markets. It is a change that has been happening for perhaps a couple of years but it became rather clearer over the weekend.

For a decade at least, governments have been aware that they have to frame their economic policies to fit the concerns of the markets. They frequently resent it, witness the comments by the French prime minister, Alain Juppe, about the "gnomes of London" attacking the French franc. But the disciplines are accepted, maybe reluctantly.

What has been lacking in the developed world until recently has been the realisation that these externally imposed disciplines, far from being an unwelcome limit on the democratic freedom of governments, might actually be a positive protection of democracy. Thus, far from resenting the markets' preference for, say, a balanced budget, governments ought to welcome it.

Here the attitude of developed countries has lagged behind that of many developing ones. The great intellectual revolution in the developing world over the last 10 years is the way governments have seen the liberating effects of access to international capital and investment. Provide reasonably sound economic policies and the money and physical investment flows in. A country's economy can be transformed in a decade by such foreign investment. Without it, similar progress would take a generation at least, and might not happen at all.

Thanks to such growth, the large industrial countries are less important in relative terms than they were a decade ago. The new IMF World Economic Outlook expects that developing countries will account for a larger share of the world economy than the developed ones by 2004. But they are also less important in the world of economic ideas, for they have been slower to see the rise in the power of international capital markets as an opportunity rather than a threat.

They are changing their tune now. This change is encapsulated in a paper published here by the IMF under the off-putting title of Saving, Investment and Real Interest Rates. It is actually a revolutionary document. For the last year a team led by Mervyn King of the Bank of England has been analysing why real interest rates are exceptionally high at the moment. This might seem an arcane issue, but it is of enormous practical consequence. For the private sector, high real interest rates are bad enough, for they tend to inhibit investment and thus lead to slower growth. But for the public sector high real interest rates are a doomsday machine.

If real interest rates are 2-3 per cent, it is possible for governments to contain the growth of the national debt. The precise mathematics depend on the growth of the economy and the size of the debt, but you can see the general picture. Economies of developed countries grow at 2-3 per cent, and national debt is typically 50 -100 per cent of GDP.

So a government can match taxes and spending on services and rely on growth to cover the interest so that national debt does not rise as a proportion of GDP. But with real rates at 4 per cent, governments have to set aside more and more revenue simply to cover the interest on previous borrowings.

So the higher real interest rates, the greater the extent to which governments have to punish present taxpayers for the sins of previous governments. The arithmetic is made worse still by the ageing of our populations. Not only are we piling up debts that have to be serviced at higher real interest rates, there will be fewer workers to pay this interest and more pensioners who have claims on public spending.

Britain, as it happens, is relatively well placed, partly because the debt to GDP ratio is unusually low (just on 50 per cent) and partly because our demographic profile is more favourable than most. Italy and Belgium have debts of more than 125 per cent of GDP and have to run large primary surpluses just to stay in the same place. Doomsday looms.

Of course governments have become increasingly aware of these Micawberish problems, but they have never formally confronted them as a group. Last weekend the summit countries, plus Belgium, the Netherlands, Sweden and Switzerland accepted this report and by implication its remedy.

The remedy? Only by saving more can countries cut real interest rates. "The swiftest, surest and most equitable way to raise national saving would be to reduce fiscal deficits," the report says.

Now a report is a report and nothing more. Governments can agree on it and do precisely the opposite. But here the discipline of the markets kicks in, for if they do ignore fiscal reality, the markets impose "significant penalties in the form of higher interest rates". National self-interest, the report argues, requires the pursuit of sound economic policies.

But not just national self-interest, also equity between generations. The report points out that a government deficit is postponement of taxes. So the markets, in punishing governments that run deficits, are on the side of the children and the unborn. Far from being an amoral force, imposing an arbitrary discipline that challenges democracy, the market gives a voice to future voters in a way the ballot box cannot. It reinforces democracy.

All this may seem a long way from whether interest rates and share prices will go up or down. But it is the key to future market movements. We are too close to the change in mood among governments to be able to see it properly, just as it was impossible in the early 1980s to see the beginning of the conquest of the market economy across two-thirds of the world.

But one thing we can see. Tell Monsieur Juppe French fiscal policy needs to be tightened because London foreign exchange dealers want it and not much will happen. But if it is in the French national self-interest that is a rather different matter.

Start your day with The Independent, sign up for daily news emails
ebooks
ebooksA special investigation by Andy McSmith
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

SThree: HR Benefits Manager

£40000 - £50000 per annum + pro rata: SThree: SThree Group have been well esta...

Recruitment Genius: Office Manager / Financial Services

£30000 - £37000 per annum: Recruitment Genius: Established in 1999, a highly r...

Jemma Gent: Year End Accountant

£250-£300 Day Rate: Jemma Gent: Are you a qualified accountant with strong exp...

Jemma Gent: Management Accountant

£230 - £260 Day Rate: Jemma Gent: Do you want to stamp your footprint in histo...

Day In a Page

The difference between America and Israel? There isn’t one

The difference between America and Israel? There isn’t one

Netanyahu knows he can get away with anything in America, says Robert Fisk
Families clubbing together to build their own affordable accommodation

Do It Yourself approach to securing a new house

Community land trusts marking a new trend for taking the initiative away from developers
Head of WWF UK: We didn’t send Cameron to the Arctic to see green ideas freeze

David Nussbaum: We didn’t send Cameron to the Arctic to see green ideas freeze

The head of WWF UK remains sanguine despite the Government’s failure to live up to its pledges on the environment
Author Kazuo Ishiguro on being inspired by shoot-outs and samurai

Author Kazuo Ishiguro on being inspired by shoot-outs and samurai

Set in a mythologised 5th-century Britain, ‘The Buried Giant’ is a strange beast
With money, corruption and drugs, this monk fears Buddhism in Thailand is a ‘poisoned fruit’

Money, corruption and drugs

The monk who fears Buddhism in Thailand is a ‘poisoned fruit’
America's first slavery museum established at Django Unchained plantation - 150 years after slavery outlawed

150 years after it was outlawed...

... America's first slavery museum is established in Louisiana
Kelly Clarkson: How I snubbed Simon Cowell and become a Grammy-winning superstar

Kelly Clarkson: How I snubbed Simon Cowell and become a Grammy-winning superstar

The first 'American Idol' winner on how she manages to remain her own woman – Jane Austen fascination and all
Tony Oursler on exploring our uneasy relationship with technology with his new show

You won't believe your eyes

Tony Oursler's new show explores our uneasy relationship with technology. He's one of a growing number of artists with that preoccupation
Ian Herbert: Peter Moores must go. He should never have been brought back to fail again

Moores must go. He should never have been brought back to fail again

The England coach leaves players to find solutions - which makes you wonder where he adds value, says Ian Herbert
War with Isis: Fears that the looming battle for Mosul will unleash 'a million refugees'

The battle for Mosul will unleash 'a million refugees'

Aid agencies prepare for vast exodus following planned Iraqi offensive against the Isis-held city, reports Patrick Cockburn
Yvette Cooper: We can't lose the election. There's too much on the line

Yvette Cooper: We can't lose the election. There's too much on the line

The shadow Home Secretary on fighting radical Islam, protecting children, and why anyone in Labour who's thinking beyond May must 'sort themselves out'
A bad week for the Greens: Leader Natalie Bennett's 'car crash' radio interview is followed by Brighton council's failure to set a budget due to infighting

It's not easy being Green

After a bad week in which its leader had a public meltdown and its only city council couldn't agree on a budget vote, what next for the alternative party? It's over to Caroline Lucas to find out
Gorillas nearly missed: BBC producers didn't want to broadcast Sir David Attenborough's famed Rwandan encounter

Gorillas nearly missed

BBC producers didn't want to broadcast Sir David Attenborough's famed Rwandan encounter
Downton Abbey effect sees impoverished Italian nobles inspired to open their doors to paying guests for up to €650 a night

The Downton Abbey effect

Impoverished Italian nobles are opening their doors to paying guests, inspired by the TV drama
China's wild panda numbers have increased by 17% since 2003, new census reveals

China's wild panda numbers on the up

New census reveals 17% since 2003