Merlin Weekly Macro: “Just how stupid are we?”

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Andy Burnham will be prime minister on July 20th. He wants everyone to feel “valued”. But however much he feels the need to parrot such inclusive platitudes as every new prime minister does, most to the right of the centreline know that Labour despises them (achieving the opposite effect to the one intended, Conservatives wear Angela Rayner’s notorious accusation of “Tory Scum!” as a badge of honour).

It is difficult not to be cynical about politics these days. So when Burnham says we should all be “valued”, the suspicion is that the electorate will be unequally divided into two: beneficiaries of state largesse valued by Labour for their potential votes, and those whose sole value to the government is to be cash cows, milked with heavy taxes to pay for it. The Institute for Fiscal Studies estimates we need £120 billion from taxation pronto.

Apocalypse Now? Maybe not. Apocalypse soon? Almost certainly

Our significant and deteriorating imbalance between national income and expenditure has been freshly brought into sharp focus with this week’s publication of the latest official projections by the Office for Budget Responsibility (OBR) in its “Financial Risks and Sustainability” Report. It should be compulsory reading for every adult; it should be mandatory teaching in schools; its summary should be broadcast as a public warning by town criers up and down the land and writ large on the sides of tall buildings. Here’s why.

We quote Para 1.7 in full. “We should worry about fiscal sustainability because the consequences of an unsustainable path are severe. First, it means that governments will need to devote an ever-rising share of resources to paying the interest on debt. Second, higher debt and deficits reduce the fiscal space for governments to respond to unforeseen major economic shocks, which seem to have become more common in the 21st century. Third, rising debt interest costs and reduced fiscal space could lead to crowding out of other economic activity and eventually end in a fiscal crisis. The UK is not at that stage, but it would get there at some point in future if debt were to follow an ever-upward trajectory. There is significant uncertainty over where the tipping point lies, which will depend on many wider economic, political and financial market factors. But getting anywhere near that point would be running a substantial risk.”

The language is academic and nuanced, which makes its point even more alarming. Let us not beat about the bush: despite adherence to the fiscal rules, based on the current evidence and without making outlandish assumptions and in the absence of anyone being prepared to address the problems, in plain English the OBR is predicting a national economic disaster. It foretells of catastrophic financial melt-down; a state of penury for which the term “financial basket-case” could have been specifically coined.

“Just how stupid are we?”

In the context of US policy toward Taiwan, Donald Trump rhetorically asked of the United States, “Just how stupid are we?”. That is precisely the question we in the UK should all be asking of ourselves about our economic policy. We have spotted an economic car-crash ahead: we know it is avoidable and yet we are not only steering towards it but stamping on the accelerator.

The last sentence in the OBR report should be re-written: “But getting anywhere near that point would be really, really stupid.” Just how stupid are we? 

A 128-page national economic death warning

It was JK Galbraith who said, “There are two types of forecasters; those who don’t know, and those who don’t know they don’t know”. The history of economic forecasting at the national level is that, faced with such immense complexity and so many moving parts (significant elements of which are not directly controlled by the government), it is difficult enough to achieve an accurate result even only on a one-year projection. Yet here is the OBR heroically forecasting half a century hence; one thing is guaranteed: in absolute terms its projections for 2076 will be wrong. This is why it varies the assumptions for key inputs (economic growth, demographic composition, productivity, prices, taxation rates and thresholds etc); the result is a “fan” chart of potential outcomes around a central case and in which the sensitivity and the extent of interdependence of the variables can be gauged (in contrast, the 50 year projection for your correspondent’s longevity needs no fan chart; it is guaranteed to be binary: he’ll be either 113 or, most probably, dead).

With 128 pages of supporting data, analysis and sensitivity testing, the essential case is stark: today, public sector receipts (tax, interest on government cash balances etc) are 40.4% of GDP and by 2076 are expected to be 42.7%; total managed government expenditure in 2025/6 is 44.8% of GDP rising to 62.2% in 50 years, the biggest contributor to which is government interest payments. Public sector net borrowing (i.e. the government budget deficit) is 4.4% of GDP today but in 2076 will be 19.5%. Government net debt/GDP is currently 94% of GDP, projected to rise now to 300% in 2076 (revised up: the OBR’s previous projection two years ago estimated 275% in 2075). The only question is at what point the rubber band snaps.

Politically, fifty years out is too long to contemplate; even the Chinese Communist Party only plans on 25-year cycles. In the UK, it is at least 10 parliamentary terms (and, if recent history is anything to go by, a multiplicity of prime ministers). The problem gets shelved, filed under TBD: To Be Deferred, or more plainly, Too Bloody Difficult: it can wait (not least because those individuals in office today will not be in office in 2076 to be held responsible).

The train now leaving runs away in 2036

But that misses the point. Where the OBR’s work is invaluable is to indicate when the UK economy runs the risk of becoming uncontrollable. It is when the rapidly accelerating cost of servicing our burgeoning debt overwhelms our ability to finance public services. The OBR predicts that instead of being 50 years in the future, the tipping point is much sooner, between 2036 and 2045; and when it happens has been brought forward by a decade from the last projection made in 2024. Reasonably stable until then, the decade from 2036 to 2045 is when debt/GDP accelerates from 98% to 117% and then takes off on a parabolic upward trajectory towards 300% in 2076. If 2036 seems a long way off, it is only as far in the future as the Brexit referendum is in our past. It is not long. The problem needs addressing now.

Apart from defence and law and order, EVERY SINGLE other aspect of government spending has alternatives in how they are paid for and managed, whether it be health, benefits, education, transport etc. Just because the politics are difficult does not mean the alternatives do not exist. Governments only have two fiscal levers to pull: one controls expenditure and the other sets the rate of taxation with which to raise income. Other than in a hermetically sealed, command economy, the government might try to influence growth but it does not control it.

10 Year Plan 

You’ve heard us say this before. We make no apology for repeating it. We will keep banging on about it until somebody in authority listens. But listening is not enough; they also need to understand.

The UK has an enduring, structural systemic problem: a profoundly unbalanced economy. We have developed an over-reliance on a burgeoning public sector particularly for marginal employment; we have too many people of working age who are economically inactive and too many who depend on benefits for their income; a relatively diminishing private sector is heavily over-reliant on services and is under-invested and under-represented in manufacturing from both of which flows a constant current account deficit and an imbalance between imports and exports; we have a gross imbalance in the taxation system under which the over-reliance on a very small proportion of asset-rich and well-paid people to pay a disproportionate percentage of income and capital taxes is a structural weakness and a threat to sustainability; we have an unbalanced and very expensive energy policy. As a nation we are over-indebted, over-taxed and woefully underproductive.

It is an irresponsible government which wilfully and recklessly pursues an economic and fiscal policy which, according to its own official arbiter of fiscal probity (the OBR), will drive the economy onto the rocks.

It is certainly not too late to put things right. Andy Burnham talks of his 10-year plan of Manchesterism and the balkanisation of England. Forget all that; it’s a political distraction from what matters. If he’s really concerned about the national interest and valuing us, he needs to address everything in the previous paragraphs. It will take 10 years. Taxing our way to penury is not the solution; fiscal restoration must be done by controlling costs and helping stimulate growth. 

Lend us a fiver, guv

Risking charges of market abuse, the OBR is naturally reluctant to predict debt crises, i.e. when the authorities have to step in when the government runs out of cash and cannot raise finance. As the report says in a footnote, “Recent debt crises occurred with levels of debt at around 150 per cent of GDP in Greece, and 90 per cent of GDP in Ireland, while Japan has not had a debt crisis despite debt of over 200 per cent of GDP.” It could have added that the UK had to resort to a bail-out from the International Monetary Fund exactly forty years ago in 1976.

Japan is indeed heavily indebted but while it has not had a debt crisis, markets are becoming concerned about the new government’s economic policy and the affordability of rearmament; 10-year Japanese Government Bond yields at 2.9% are now their highest this century but helping maintain confidence is that Japan enjoys a regular significant current account surplus (exports exceeding imports) in 2025 valued at 4.2% of GDP; in contrast the UK has an enduring structural current account deficit (2.4% of GDP in 2025).

The UK government bond yield curve is at least behaving conventionally: investors’ required rates of return rise on the chart from bottom left to top right as certainty diminishes over time (today, 2-year Gilts carry a yield of 4.24%, the 10-year is 4.90% and 30-year 5.62%). In terms of steepness, whether it is rational in accurately reflecting the risk or not is a different matter. Bond investors tend to work on “spreads”, differential yields against other comparators. The equivalent German 30-year Bund is priced at 3.62%; US 30-year Treasuries are 5.05%. Measured in “basis points” (a hundredth of a percentage point), UK 30-year government paper is relatively expensive at 200bp and 57bp “over” Germany and the US respectively. Both countries are facing financial pressures (Germany this week announced its intention to expand defence spending by €800 billion; to borrow a quotation from Brideshead Revisited, America is “spending money like a bookie”). But is that premium enough? And what about the nominal?

Rationalising the argument, a nice man from the Treasury knocks on your door today and asks for a 30-year loan; what would you do? The OBR predicts that in 2056 when the loan falls due, instead of being 94%, UK debt/GDP will be 154%; the deficit will have more than doubled to 9.4% on its way to 19% in 2076; the government will be struggling to satisfy bond holders and the electorate’s expectations of public services but with a rapidly diminishing ability to do both. Is 5.62% enough to tempt you? What is the right price? Is it really a gilt-edged investment? Should you be lending to him at all? Will he be back on your doorstep in 2056 with a cheque and a thank you?   

The electorate needs to understand our predicament. Andy Burnham needs urgently to address it; not by tinkering at the edges but through fundamental economic reform that irons out the systemic imbalances which are eroding the foundations of the economy. In terminology to which he can relate, he needs to overcome his natural political prejudices and level up, not level down. The one offers a way out; the other makes the OBR’s assessment a self-fulfilling prophesy.

Memo to a new prime minister

Mr Burnham, you’re an intelligent man. You do not want to go down in history as the prime minister who put the seal on the inevitability of our economic collapse. That would be really, really stupid. You’ve got the job you always coveted. You’ll be called Prime Minister but your official title is “First Lord of the Treasury”: you call the fiscal shots, not your Chancellor. And the buck stops with you. Monty Python’s Life of Brian featured in that amusing exchange across the dispatch box in your swearing-in as an MP. By your own admission, you’ve been a “very naughty boy” (ha!ha!ha!). You could still be “the Messiah!” Get it right and even we will follow you.

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