#69. One flew over the British nest


Hollywood loves remaking the classic movies of the past, even if the new versions tend to be poor facsimiles of the originals. A Night to Remember, Tora Tora Tora! and even The Italian Job have been remade (though the “all time turkey” award surely goes to Village of the Damned). Might the time be ripe for a re-vamp of Jack Nicholson’s 1975 classic One Flew Over The Cuckoo’s Nest?

If so, Hollywood could do worse than set it in Downing Street.

What this discussion considers is the very real possibility that negative campaigning by British politicians, which involves talking down their own economy, risks pushing the UK into recession.

Recessions can result from many different causes, but I cannot recall a precedent of a government setting out to drive its own economy into the red.

This, almost incredibly, is the point that Britain has reached, through a process of serial bungling.

The script seemed simple enough. Member states, determined to keep Britain in the European Union, would give David Cameron a deal which, on paper anyway, looked like significant reform. This would enable Mr Cameron to trigger the referendum process whilst championing the cause of continued British membership of a “reformed” EU.

Unfortunately, the script unravelled in a manner worthy of Whitehall farce. First, EU ministers refused to play ball. Not only did they give Mr Cameron the thin end of nothing at all, but they couldn’t even be bothered to gift-wrap it. The Prime Minister then fired the referendum starting-gun anyway, perhaps before realising that the “remain” campaign had just lost the main plank of its campaign platform.

This in turn prompted a quick recourse to “project fear”, a scare campaign designed to frighten voters into the pro-EU camp. Unfortunately, a key component of “project fear” involves telling everyone quite how vulnerable the British economy really is.

Voters may or not be listening. They might well dismiss it for the scare-mongering that it is. They might even realise that the essential rebalancing of the economy is more likely to be accomplished outside the EU than in.

Markets, unfortunately, will be listening.

Economies run on confidence. If consumers lose confidence, demand weakens. If investors lose confidence, capital investment declines, as projects are either cancelled or deferred. Likewise, capital markets, and forex markets too, are barometers of confidence.

For this reason, negative economic prophecies can all too easily become self-fulfilling.
In this respect, Britain already stands at significant risk. The UK’s big current account deficit might well not be sustainable outside the EU, and a common “ready-reckoner” seems to be that the value of Sterling might need to fall by 20% to fix this problem. There is a gloomier view, of course, which is that no amount of devaluation, on its own, can do the trick, because the current account deficit is structural.

These considerations alone have put significant downwards pressure on Sterling since the referendum was announced. This can help exporters, of course, but it also makes essential imports more expensive.

This is merely the first and most obvious example of “talk-down risk”. According to press reports, the Chancellor will warn soon that the British economy is weaker than previously thought, and will use his Budget to implement the spending cuts that he so conspicuously avoided in the Autumn Statement.

A weaker economy, of course, implies a weaker market for goods and services, and this alone can cause investment plans to be deferred, or even cancelled altogether. This has knock-on effects, because investment projects provide business for contractors, and wages for their employees and sub-contractors.

If, as well as cutting its own spending, government says things which give investors pause for thought, aggregate demand will decline.

Consumers, too, are likely to react adversely to a climate of economic gloom. This could be a big problem for Britain, where economic growth depends so heavily on household consumption.

Let me put this very simply, by reminding you that GDP is, essentially, the sum of household consumption, government consumption and investment. If you set out to drive all of these downwards, you create a recession. You could also, while you were at it, kick the slats from under the property market.

Of course, economists in the City and the media are forever producing forecasts, sometimes good, sometimes bad. But no City or media economist carries the same imprimateur as government. This is why central bankers choose their every word with the utmost care. If a government warns that its own economy is in trouble, consequences follow.

In normal times, governments are very well aware of the “confidence effect”. For this reason, they often talk-up their economic prospects, or shrug-off negatives, the aim being to shore up the confidence of the markets. Hardly a day goes by without China, for example, telling markets that its economy is fine and dandy.

How on earth, then, did the British get to a point where they are talking down their own economic outlook? At root, it is a tale of serial bungling, in which each mistake has led directly to the next one.

The first mistake was a total misreading of the atmosphere in Brussels. Essentially, Downing Street started the negotiating process without taking into account the fact that the EU already has rather a lot on its plate.

First and foremost, of course, there is the migrant crisis, which is only likely to get worse as warmer weather approaches. This is both a humanitarian disaster on an epic scale, and a political crisis for the EU.

Then there is the economy, where the risk of a global downturn is increasing, as growth decelerates and capital continues to flow out of China and other emerging market economies (EMEs). Economic worries are a particular problem for the EU, whose own economy is very far from robust.

Third, of course, and with the horror of Bataclan still reverberating, there is the ever-present danger posed by terrorism.

This, then, was no time for turning up in Brussels with a list of demands which, to put it charitably, looked parochial.

The British position seemed lacking, not only in proportion, but in political logic as well. Why raise these issues now? Indeed, why raise them at all? No major British party supports Brexit. No major lobby group, such as business or organised labour, is campaigning for it either. The issue is not one of the major concerns that voters tell pollsters about.

In this context, it seemed fair to assume, either that this was really about internal Conservative politics, or that Britain was “trying to pull a fast one”.

The specific items on Mr Cameron’s shopping list were unrealistic. The EU cannot deliver restrictions on the free movement of labour, for the simple reason that too many of its member governments are committed to it. The issue of benefits for migrants is really a national rather than an EU issue, because it arises from the non-contributory nature of the British welfare system. Demanding special protection for the City of London rather overlooks the fact that regulation cannot be effective if those subject to it can pick-and-choose which provisions apply to them, and which do not.

At this point, and for all of these reasons, the Prime Minister should have put the process on hold, something which his own timetable made it perfectly possible for him to do. Instead, he triggered the referendum process. Exactly why he did this is likely to become one of history’s many minor mysteries.

The very weakness of the “remain” camp’s position made an early resort to “project fear” inevitable. From “project fear” to “project economic talk-down” is a small but dangerous step.

Let me spell this out, so that no-one is in any doubt. The British economy is built on consumer spending, much of which, in turn, is debt-funded through the conduit of an inflated property market. The economy sucks in imports, contributing to a current account imbalance which is funded by asset sales and overseas borrowing. In short, the British economy is fundamentally fragile, and could not withstand any dramatic undermining of confidence.

It is to be hoped, even at this late stage, that someone in government will realise quite how dangerous, and how potentially irreversible, a process of talking-down the economy can become. If, on the other hand, narrow political aims continue to trump the national interest, Britain’s political class will drive the economy into recession.

Nice one, lads.