Thursday, 21 May 2009

Private productivity and public debt

Robert Peston, famous among his blog commenters as the BBC's banking editor (with a sideline in other businesses) has come up with his most creative definition yet of a "business" - the UK government.

He points out, in a surprisingly sanguine article, that UK government debt has been put on negative watch by Standard and Poor's. As he says, it's not that big a deal - I suppose the surprise is that it didn't happen earlier. As the UK is likely to be one of the world's top ten debtors in the next few years, with about £1 trillion of public debt (still less than Citigroup or RBS, incidentally, and much lower than the Japanese, US or Italian governments), it is only natural that people would keep an eye on the figures.

S&P have said that the downgrade might happen if the next government does not come up with a credible plan to put the debt on a long-term downward trend. Seems fair - and everyone expects the next Chancellor, whoever it might be, to do exactly that.

If, as I expect, the next election results in a hung parliament, there's a strong possibility this could be Vince Cable. Apparently he is the most trusted politician around and he's regarded by the public as a very good economist (though I do think Alistair Darling knows what he's doing, and even George Osborne wouldn't be a disaster). Vince as Chancellor could be the Liberal Democrats' price for a coalition, and would probably give them their best chance of establishing themselves as a serious, credible choice in future elections.

Back to the public debt - one of the key questions for investors in UK debt is not the (tiny) possibility of default, but the likely value of their sterling-denominated assets in terms of other currencies. I don't think S&P's evaluation takes this into account, but today's 3-cent fall in sterling raises an interesting question. The pound has fluctuated by about 40% in dollar terms over the last 18 months - over $2 at its highest point and $1.20 at its lowest. It's slightly below the middle of that range at the moment, and rational expectations theory says that's exactly where investors expect it to stay.

The price of the pound is determined in the short-term by interest rates relative to other countries; in the medium term by expectations of inflation, and in the long-term by the money supply - which in turn is a function of productivity and thus the central bank's reaction to real and nominal growth rates.

Do we think the productivity of the UK economy is likely to keep up with other countries? Against the rest of the world in aggregate, it certainly will not - because productivity in China and India has a lot of catching up to do, driving world productivity growth to perhaps 4%, and the UK has no chance of matching those rates of growth. But in comparison with the other OECD countries? I am more positive about the UK economy than many observers, because I believe financial and business services do actually drive genuine productivity, and the UK is strong on both.

But there are interesting challenges for the UK in day-to-day management, and the skills of its people. The government is well aware of this long-term issue in British industry, and has made various attempts to remedy it through industrial and education policy - with mixed success. I believe that this is the key long-term challenge for all modern economies - but the UK probably has more work to do on it than most. The strength of the British business services sector is a big advantage, but I feel that there is a corresponding weakness of general management skills and human capital in the rest of the economy. The government (and indeed private companies) would do well to try to disseminate some of this expertise more widely through the private sector, and for that matter the public sector.

We can have a useful debate about whether this should be done via an interventionist industrial policy, by laissez-faire, by strengthening education or other means - but it does have to be done. The success of this programme will be the real determinant of how quickly we can pay off our public debt and how much those repayments are worth: the debate about cutting public spending or increasing taxes is, frankly, a sideshow.

2 comments:

JayPee said...

There is no chance of Cable being Chancellor (assuming the Lib Dems are a junior coalition partner). No large coalition partner surrenders the Finance function to a junior member, as it's so crucial to all other aspects of government. The Lib Dems would only be able to insist on Cable as Chancellor if they had parity of seats following the next election, a highly unlikely scenario.

Leigh Caldwell said...

You are probably right, of course. Something similar has happened in the past (Austen Chamberlain was a Liberal Unionist Chancellor under a Conservative prime minister) but the two parties were allied in advance of the election rather than forming an ad hoc coalition after it. Still, it might be a nice idea.