BRITAIN, BREXIT AND THE FAILURE OF NEOLIBERALISM
The Second World War was a time of enormous hardship for the British public. But there were some people for whom it was manna from heaven, and I’m not talking about black-marketeers. Poor service in a restaurant? “Don’t you know there’s a war on?” Shoddy workmanship? “Don’t you know there’s a…….” There seemed to be hardly anything that couldn’t be blamed on the war.
“Brexit” – the ugly label for the voters’ decision to leave the European Union (EU) – is being used similarly, as a stock excuse for any and all weaknesses in the British economy.
Behind the Brexit bluster, what is really happening in Britain is the culminating failure of a faulty economic model. The theory of “neoliberal” economics has been openness to foreign investment even in strategic areas, the adoption of mantras of deregulation and privatisation, and a willingness to surrender decision-making to the market. The practical outcome has been sluggish growth, an escalation in debt, widening inequality and a dangerous dependency on foreign creditors. If Brexit tells us anything, it is that critical scrutiny of the British economy has revealed some dangerous weaknesses.
When British voters defied the establishment by voting to leave the EU, then they were doing more than simply rejecting supposed European incursions on their sovereignty – they were rejecting an economic system whose failures have been manifested in the British economy.
Though regrettable, the use of Brexit as a catch-all excuse is understandable. Brexit, after all, is the first decision in decades to be taken directly by the public, rather than on their behalf by politicians. No-one grounded in reality would expect politicians to miss such a golden opportunity for wholesale blame-shifting.
This being so, we should be wary about “the Brexit excuse”. We should remember that America, Japan, China and others trade perfectly satisfactorily with the EU without being members of it. We should also note that many of Britain’s glaring economic weaknesses long pre-date the EU referendum.
Of course, there has been at least one direct result of Brexit – a sharp fall in the value of Sterling. Even here, though, politics has influenced markets. Overwhelmingly, government, big business, finance and the mainstream media urged a “remain” vote, so the voters’ “leave” decision was a ringing rejection of an arrogant establishment. It also, of course, created immediate uncertainty, with the departure of premier David Cameron and chancellor George Osborne.
Consequently, markets have had to recalibrate political risk, recognising that the British are not, after all, grumbling-but-resigned followers of their leaders’ diktats. Despite an electoral system (known as “first past the post” or FPTP) designed to entrench the incumbency, the public proved themselves far from supine when given a first-in-a-generation directly proportional consultation.
From a global standpoint, you might think that Britain doesn’t matter all that much in the grand scheme of things. But we do need to note two significant points. First, Britain remains important enough – particularly in finance – for her travails to influence global developments.
The demise of a paradigm
Second, the UK, even more than the United States, has been the poster-child for neoliberal economics – not for nothing is this called “the Anglo American model” – so Brexit may accelerate the demise of an increasingly discredited orthodoxy.
For three decades and more, the UK has championed an extreme variant of “laissez faire”. Britain has welcomed overseas investment even where that has meant strategic industries, protected in most other countries, falling into foreign hands. The UK has supported the deregulation of finance, championing the now-derided “light touch” regulatory system which helped lay the foundations for the 2008 banking crisis. Privatisation, though it began with industry, has now penetrated deep into public services, and few restraints have been exercised over immigration. To a significant extent, British failure constitutes the failure of an economic philosophy as well.
Mind the gap
The critical metric for the British economy is the current account, where the deficit has widened alarmingly – to 5.2% of GDP last year, from 1.2% in 2005. It hit 7% in the final quarter of 2015.
Within this, the trade shortfall has been a relatively stable component, being somewhat better in 2015 (at 2.0% of GDP) than in 2005 (2.7%).
The slump in the current account has instead reflected a collapse in the net flow of income. Back in 2005, this flow was positive, contributing £20bn (1.5% of GDP) to the current account, and usefully offsetting the trade gap. In 2015, however, income was in deficit to the tune of £60bn (3.2% of GDP), a sharp and dangerous reversal in a comparatively short time.
The disturbing connection here is that current account shortfalls have become a vicious circle. Each deficit, when met by asset sales or borrowing from overseas, sets up increased future outflows in the form of profits and interest.
To this extent, Britain has been trashing her balance sheet to sustain consumption in excess of current output. British GDP and, with it, British viability, has become increasingly dependent on what central bank chief Mark Carney has dubbed “the kindness of strangers”.
This is a misnomer, of course, because lending and investment are determined by calculation, not altruism – and here lies the immediate problem. The slump in Sterling means that those who lent to or invested in Britain last year are now sitting on losses of about 20%. If they decide that putting further capital into Britain would amount to “throwing good money after bad”, the UK will be in very, very deep trouble. The harsh reality is that about 6% of British GDP, or £120bn, comes courtesy of foreign creditors.
Deep in the hole
If selling assets and taking on debt to subsidise consumption looks feckless (which it is), further evidence to the same effect can be found in Britain’s aggregates of debt and quasi-debt.
Between 2000 and 2007 – but expressed at constant 2015 values – growth of £354bn in GDP came at a debt cost of £1.34 trillion, or £3.80 of borrowing for each £1 of growth. Since then, the ratio has worsened dramatically, with £127bn in net growth requiring £1.24 trillion of new debt, a borrowing-to-growth ratio of £9.70 per £1 (see chart). Even these numbers exclude borrowing in the “financial” or inter-bank sector.
Of course, this very strongly suggests that “growth” has really amounted to nothing more than the very inefficient spending of borrowed money.
This addiction to borrowing has ravaged the British balance sheet. Whilst a 268% ratio of debt to GDP (1) may not look too serious, inclusion of the banking sector (2) increases this to around 450%. On top of this, the most recent, knee-jerk cut in policy rates worsened the deficit in private pension provision to £945bn (52% of GDP) (3), whilst unfunded public sector pension commitments are generally put at £1,000bn (55%).
This has three disturbing implications for the British economy. First, it is becoming ever clearer that past irresponsibility has undermined Britain’s future financial security. Second, it has turned Britain increasingly into a supplicant for the goodwill of China and others.
Third, the UK is in no condition to cope with increases in interest rates, yet such rises may become inevitable if international markets continue to take a tougher stance on British risk.
No quick fix
Some believe that the slump in Sterling might itself start to improve things, making imports more expensive whilst boosting the competitiveness of British exports.
One obvious snag with this is that a weaker currency increases the cost of essential imports, which include food, raw materials, components, the consumer iFads to which many in Britain seem addicted and, thanks to serious policy failures, rapidly increasing quantities of energy. A second is that it is by no means clear what Britain has to export – or that exporters will use a cheaper pound to boost volumes, rather than simply pocketing fatter margins.
Above all, of course, the British external problem does not lie in her trade deficit so much as in a rapidly-worsening income balance – and this will continue to worsen, until and unless the UK ceases relying on foreign creditors to subsidise consumption.
Two things are clear. The first is that, as exemplified by Britain, neoliberalism has failed, widening inequalities whilst sacrificing the balance sheet on the altar of immediate self-gratification.
The second is that Britain must reform to survive, specifically by shifting incentives from speculation to innovation. In short, innovation has weakened – and productivity with it – because riding state-backed inflated asset markets has been made into a surer and less risky route to prosperity than developing new products and services.
Here, some of the early statements of new PM Theresa May are encouraging, but the really tough calls – such as increasing capital gains taxation, and extending it to all property gains, in order to reduce the tax burdens on small and medium enterprises (SMEs) – still lie in the future.
She may be helped in this, ironically enough, by the very same “baby boomer” generation which hitherto has ridden the wave of asset inflation and demographic unfairness.
Boomers, sitting complacently on inflated property values, might soon begin to wonder to whom they are going to sell their property when they need to turn it into cash. Well, they won’t be selling to a younger generation that they have helped to impoverish. That they might have to monetise it at all has been made much more likely, and more imminent, by the undermining of pension investment.
Historically, the impetus for reform has seldom come from smugly comfortable beneficiaries of the system. This time, though, might just be different.
- Source: BIS data for end-2015
- Based on financial sector debt of 183% of GDP as at mid-2014
- Source: FT