#69. One flew over the British nest

WHY POLITICAL SCARE-MONGERING COURTS RECESSION

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.

25 thoughts on “#69. One flew over the British nest

  1. Just Great, Tim! How does one describe the cowards called politicians in government [by no means just in Britain]?- Mental defectives? Morons? Imbeciles? Cretins? What unbelievable incompetence all round. The EU has a terrific list of own goals it cannot manage. Add more of the same from the UK and we have a very shitty mess looming over everyone’s head.

    Just to rub in what you say, here in Oz we have 3% growth, precisely because aggregate demand is on the up. [savings are down]. Property prices haven’t yet topped out and imports are even with exports [I think they said that]. Our own “imbeciles” are actually struggling to cobble together an economic argument to take to the next election, so it looks like the economy is managing OK without government fiddling.

    This inaction is a saviour, because our politicians are economically as stupid as the rest. Since they will NEVER get it right as long as they are infected by mainstream economic incompetence, future prospects must remain dim. I wish I knew what would get the economic debate onto a sound footing, but since the last occasion was due to WW2 any hope is grim.

    Even If they just got ONE error corrected it would transform the debate! That is the simple one that for a Federal Government expenditure does not depend, not even for one penny, on taxation.
    The spending limit is to stay below run away inflation, or the Output gap to when the economy is running on full employment. There is a gap of trillions between today’s deflation and such limits.

    O woe is us!

    • Thanks John. What is happening in Britain really is without precedent. The nearest example I can think of is “Abenomics”, which has involved talking down the yen – and even then, this was countered by enormous demand stimulus.

  2. “Exactly why he did this is likely to become one of history’s many minor mysteries.”

    I think that the answer is that David Cameron is simply the weakest mind to have occupied the role of Prime Minister in my lifetime, and probably for at least a century. We see him making policy on the hoof in public pronouncements without consulting his own ministers of the government departments responsible; We see him announcing unsustainable ring-fencing around huge areas of government spending; He continues to guarantee vastly expensive, wasteful policies on foreign aid that have no benefit to this country and very little popular support; He has repeatedly kicked his own core middle class supporters in the teeth (child benefit changes, state pension changes, the expected reduction in pension tax relief); In areas like foreign affairs, even the melt down in Libya has a Cameron contribution, where he promoted the removal of a stable though despicable regime, and is now gormlessly surprised that the country has become a failed state; Even on privacy and civil rights, the man is pushing through the Snoopers Charter, with his small and self-absorbed brain failing to see that if his security services can’t find needles in haystacks, gathering more hay may not be a sensible idea. His failure to control welfare spending, immigration, or to resolve the challenges of the education or health systems are a matter of record, and the support for bad ideas like HS2 or the unbelievably expensive Hinkley Point C show a commitment to the sort of vanity projects not normally associated with the Tories.

    At every level, Cameron is failing this country. The actions of his government appear to be somewhat to the left of New Labour under Blair, and even within his own party he has ignited civil war. His solution is not compromise or reforming his own position, but to try and emasculate the constituency parties to avoid challenge. And this to a great extent explains the economic policy malaise: Cameron is an over-priveleged Etonian, a man who has never done a proper job of work in his life, is out of touch with the country, and whose judgement and instincts seem to be particularly poor at every turn. Even against the utterly disorganised and unpopular rabble of the 2010 Labour Party, he was still only able to squeeze a weak twelve seat majority.

    So, we now have a position that this country is run by a tiny number of champagne socialists who have hijacked the parliamentary Conservative party for their own misguided ends, in the form of Cameron, Osborne, Feldman, and the revolting members of the Chipping Norton set and the Bullingdon club. And that explains the incompetence of our current government, and its disinterest or inability to address the economic (and indeed energy) challenges we face.

    For traditional Conservative supporters, an “out” vote is an essential – either to regain sovereignty, or for the putative Tory “ins”, because it is essential that Cameron is forced out of the Conservative party. For the genuine left wing, European minded voters, there is a conundrum – if they vote “in”, they significantly strengthen Cameron’s hand at a time when the Labour party is unelectable.

    Leaving aside the EU referendum, there are probably no good economic outcomes as Dr Tim has analysed at length. The central banks are out of ammunition, the UK national debt mountain continues to climb at over £400m every single day, the commercial banks have returned to Ponzi lending schemes on over-valued property and complex financial products; Energy policy continues to be unpredictable and expensive (with more “market” interference due imminently from the desk bound academics of the CMA). And the best George Osborne can offer is to ask future state pensioners to work until they die, and to rob anybody who might otherwise want to save their own money for retirement.

    I have advice for young people: Emigrate. Sadly I can’t say where to, but Britain is doomed unless the current feckless, self obsessed political elite on both sides of the Commons are taken out on to the terrace at Westminster, each put in a weighted sack and thrown into the Thames. I daresay we could pay off a lot of the National Debt by selling seats for the sack throwing, and raise more by then selling (non-voting) peerages, as the most expensive and exclusive club in the world. And even that would just be a formalisation of the current process, with the important difference that it would be more transparent, fairer, and taxpayers would benefit, unlike the current enoblement of political cronies.

    • There is a lot in what you say here. Cameron does not impress me, in fact a parallel might be drawn with another Old Etonian PM, Anthony Eden, best known for the Suez fiasco.

      Lack of prior “real world” experience is a major weakness in Britain’s political class (which is why David Davis could have been a much better choice). Be that as it may, the decision to trigger the referendum looks hare-brained. One also has to wonder at the quality of advice available in Whitehall. The conduct of the negotiations in Brussels was niaive in the extreme.

      What concerns me now – even though I live abroad – is that the UK could stumble into an unnecessary recession through incompetence. This would be the second time this has happened in a decade, Brown bearing much of the responsibility for the previous one.

      How on earth do they choose these people?

    • Excellent polemic – you need to get on BBC Question Time – or write a piece in the Salisbury Review (a proper right-wing organ edited by the excellent Roger Scruton).

    • Thank you Jonathan. They’d never let me go on Question Time – I’m not PC enough! – but I’ll follow up your other suggestion.

      TM

    • @Euphrosene

      A pleasure to entertain! But if you got me started on energy policy it gets even better (imagine a passionately angry but lucid, articulate and occasionally convincing lunatic ranting from a soap box at Hyde Park Corner).

      Unfortunately, both in the generic and the energy specific, too many key bad decisions have already been made by government, the money already committed and wasted, so that response to Dr Tim’s article was rather (no, very) self-indulgent in pointing out the spilt-milk, and the real need is for some coherent way forward. Tim’s done that a number of times, but I think this corner of the internet has generally like-minded readers, and that doesn’t include any of the heads-up-own-bottoms people who exist purely in the Westminster bubble.

      Regards

  3. Very much my thoughts too. Why is so much of the negotiation based on ‘what can we get out of it?’ rather than ‘what can we contribute?’. We’ve still got to remember that we are the second wealthiest country in Europe and much of the East needs lifting out of sometimes real poverty. Something of this I think still exists in Europe but was central to the founders.
    However since we are facing a referendum based on fear and sound bites I wonder whether you would consider a post on the economics of the in/out debate or at least air the issues. Currently my brain hurts with the triviality of the media / press.

    • David

      Thank you for this. My original intention was to do exactly what you suggest, and I had even completed the draft. My conclusion was that leaving the EU would have a better outcome (from a purely UK perspective) than staying in, always provided that it was handled effectively, not bungled.

      But it then occurred to me that “project fear” stood every likelihood of creating a recession, and this was an angle that (so far as I’m aware) no-one has talked about.

      One would like to assume that the PM’s staff and/or other departmental advisors have pointed out this risk, but I no longer take this competence for granted, given the scale of the fiasco in Brussels, and the folly of then triggering the referendum process. In short, DC may be receiving shockingly bad advice.

      I also note that no political opponent has raised this issue – were I, say, Jeremy Corbyn, my first question at PMQs would have been “why are you trying to talk us into recession?”

      As I see it, recession risk is significant, not least because the global economy is slowing. I am surprised if (as I assume) Mark Carney has not notified the Treasury of this risk, as I’m certain Mervyn King would have done. But, if this government functions anything like the Blair-Brown one did, it is likelier to shoot the messenger rather than listen to the message, if the message is unwelcome.

  4. Accepting your comments on recession which I’m sure you are right about and makes you wonder who gives advice to DC (if anyone!) it would be still interesting to read your thoughts on the in/out issue before we have to vote in June!

    • Thank you David.

      Exit could have the better outcome because it plays to British strengths rather than weaknesses. Those strengths include invention, innovation and entrepreneurship.

      Britain’s greatest weakness is management – we are simply no good at it. The car industry – now under Indian, German and Japanese management – illlustrates this perfectly. The big difference between JLR and Leyland is management.

      British companies all too often trip up once they reach a size at which bean-counters and bureaucrats take over from innovators. This is why so many British inventions end up making profits for non-UK companies.

      The EU is a regulatory machine. Compliance is far easier for big corporates than for smaller ones, which are therefore disadvantaged, competitively, by membership. That, by the way, is why big corporates support staying in. The EU stifles competition, which suits their book.

      This hasn’t stopped Germany building its famous mittlestadt, the network of small and medium companies which supply the likes of Mercedes and Bosch. But Germany and the UK are very different. Germany hasn’t tied up huge amounts of potential investment in the “capital sink” of an inflated property market, and German managers are pretty good. It is a different mentality, because in Germany career paths for engineers etc can reach right to the top. Here, to rise beyond a certain level, an engineer has to put on a suit and become an “engineering manager”!

    • Agree about management, but ownership is also key. There are plenty of very capable British managers working in the UK and abroad for foreign owned companies, as well as UK companies. The problem in the UK is where ownership meets control, in the boardroom. To be a director of a large UK company you’ve got to be part of the establishment (for want of a better word) and it’s the establishment that is the root of so many things that are wrong with the UK.

    • Tim B

      With you there, 100%.

      One has to keep articles down to readable length. In my longer draft, I looked at the reasons for weak management, and one of the factors I identified was an undue concern with status, titles and so on. This extends to the public sector as well as big private corporations. The British do seem to me unduly status-conscious, again an establishment factor. One job in 8 in the UK has “manager” in its title, which seems absurd. The people who start their own companies tend to be as good or better in Britain as anywhere else.

      Lastly, given corporate enthusiasm for hiring staff from abroad, it is – hmm – odd that this doesn’t extend to the board-room.

    • Thanks, Tim for these thoughts- however I wonder whether an exit would solve our management problems which I agree are major and intractable. Also if outside Europe we would still have to abide by EU regulations if we wanted to export there. Interesting that recently The Economist came out strongly in support of remaining inside for these reasons and the likely costs that would be imposed to renter EU markets.

    • Your point that the EU favours large corporations over small businesses and start ups is, I believe the most pertinent in the in / out debate. As I recall, you dealt with this in a previous article, but went on to point out that our own governing classes are just as capable of introducing layer upon layer of bureaucracy. I agree on both points, but would argue that we have a better chance of replacing those in Westminster than those in Brussels and Strasbourg.

      I’m not sure that I agree with you now about the prospects for engineers in the UK. I think that the picture you paint was true 20 years ago, but things have changed since then. Now it is much more usual to see people still involved in hands on engineering well into their 50s or 60s.

    • Peter

      Thanks. I read yesterday – in an article by Daniel Hannan – that, between them, the 36 FTSE companies who signed the pro-membership letter spent, between them, E21.3m lobbying the EU, and got back E120.9m in grants. Hannan also mentions something that I already knew from a lobbying contact, viz that these corporate giants lobby for more regulation, not less.

      As for engineers, what concerns me isn’t whether people can still work as engineers in their 50s and older, but whether opportunities for advancement are closed off unless they “swap their overalls for a collar and tie”.

  5. I think I ought to add that, of the UK’s big current account deficit, most of it involves transactions with other EU countries. The “rest of the world” component is pretty modest.

  6. Hi Tim

    Let’s face it the EU referendum is only one problem that the economy has to contend with.

    We have the strong ( and getting stronger) secular forces of demography, automation and the continuance of globalization, about which it seems to me the politicians are completely oblivious, now compounded by the oncoming reassertion of the normal business cycle.

    What I find quite extraordinary is the lack of recognition of the potential effects of the secular forces which are going to wreak major changes to the economy over the next twenty years. The difficulties are compounded by the failure to tackle the issues left over from the last crisis, perhaps most notably the TBTF banks and the welfare state and which simply set us up for the next one, which is inevitable.

    I grew up in the 1960s and then you could look at either major party and you could pick any one of ten that had the stature to be prime minister; now there is no-one and there are very few people who, in my view, could even be considered cabinet material. At a time when we need competent political leadership perhaps more than for many years we are totally bereft.

    • You’ve touched on a number of interesting themes here. One point to note is that the UK has now sold so much of its asset base, and borrowed so much, that it has created a permanent (and increasing) net outflow of profits, dividends and interest. Much of this goes to other EU countries, often (ironically) to state-owned entities!

      Second, President Hollande has spoken of “consequences” if the UK leaves. True enough. But no-one has mentioned the consequences of staying in – once a referendum has been held, that’s it – the UK could no longer bluster or demand special treatment, but would have to become a team-player, and often go along with majority decisions. That would be a very different world….

  7. Tim,

    Where are you living these days?

    I rather liked this article http://www.theguardian.com/commentisfree/2016/feb/26/irrational-unhinged-gullible-many-who-want-britain-out-of-europe-deserve-listened

    As far as I can see the ‘Precariat’ who blame the EU for many of their woes – basically competition for Jobs & Housing from EU Migrants are not going to have their woes addressed by either camp, whatever the outcome.

    That in turn may well make for an ‘interesting’ time especially in the event of Brexit……………..

    • John

      I’m in Spain – though not (I would add) in a place like the Costas, with lots of expats – I’m firmly in “Spanish Spain”.

      That’s an interesting link, for which many thanks. With opinion polls, I’ve often wondered if people are increasingly likely to lie to them – after all, a minority might feel that the questions are intrusive, and people are increasingly wary (rightly) about revealing personal information. It wouldn’t take many (say 5%) to fib and polls could be way out of kilter.

      My hunch is that the majority favours “out”. Scare campaigns may be over-rated, especially by those who use them. The government’s tactical awareness may be weak, judging by the way it mishandled Brussels.

      The “precariat” is something I’ve written about quite a bit. I think it’s a widely underestimated factor, as the precariat are by definition hard to quantify, poll or research. This may be part of a broader measurement problem – for instance, US unemployment has fallen, but replacing 1.4 m lost factory jobs with 1.5 m new waiters and bartenders suggests that traditional measures of “employment” and “unemployment” are less useful than they once were.

  8. Just seen the latest current account deficit figures – rather supports what you have been saying for a long time!

    • Indeed. Though this may not interest non-British readers, I feel I need to write something soon-ish about Britain’s self-liquidating economy.

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