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Not such an unhealthy free lunch Samuel Brittan Financial Times 05/05/06 Andrew Smithers, the respected London economist, has just published an analysis, “The End of the UK’s Free Lunch?”. If you take away the question mark you have his answer. His argument is that the UK has enjoyed 15 years of high consumption and high growth, spanning both the last few years of the Conservative government and the Blair period. Yet savings and investment have been abnormally low. This has been possible in his view partly because British saving has been supplemented by that of savers in other countries, which has shown itself in a current balance of payments deficit of 3½ per cent of gross domestic product. In addition, the country has flourished on abnormally low capital outlays because investment has been directed towards services where the capital to output ratio is much lower than in building or manufacturing. He believes future investment will be more capital-intensive and that foreigners are unlikely to carry on financing a current payments deficit on the recent scale. Thus, consumption must be curbed if national growth aims are to be met. By coincidence, he has been partially answered by Stephen Nickell, the well known “dove” on the Bank of England’s monetary policy committee, in a paper entitled “The UK Current Account Deficit and All That”. He draws attention to the overseas net asset position, covering both UK holdings of foreign assets and the liabilities arising from foreign holdings of UK assets. These assets and liabilities run to about £5,000bn ($9,245bn) on each side of the balance sheet – four times GDP. They are about equal – the exact balance depending on valuation methods. The important point is that income generated by UK overseas assets exceeds that generated by overseas holders in the UK by an average of more than 2 per cent of GDP. So long as this discrepancy continues, the position is probably tenable. A remarkably similar analysis is made by the “don’t panic” school in relation to the larger US deficit. The older people who keep asking Prof Nickell “What about the balance of payments?” are survivors from the fixed exchange rate era. Under a floating exchange rate the balance of payments automatically balances; and to the extent that there are insufficient net long-term investment inflows, the difference is made up by short-term financial ones. Overseas payments are only damaging if sterling falls so far or so fast as to alarm the MPC, which might then jam on the brakes for fear of an inflationary follow-through. On investment, a response to Mr Smithers comes from the latest National Institute Economic Review, which concludes that business investment has been only slightly weak, if at all, in relation to past behaviour. This is reinforced when one considers the relative cheapness of raising capital and the still attractive return on new outlays. I am not so convinced by the Institute’s dismissal of pension deficit worries as a factor affecting future outlays. The Institute is, however, at one with Mr Smithers in calling for low- saving advanced countries such as the UK and US to address the presumed saving shortfall as quickly as possible. How might this be done in the UK other than by a shock increase in short-term interest rates? International bodies can preach as much as they like about the virtues of curbing public spending but, in many countries, this is simply “not on”. We are left with measures such as a sharp increase in value-added tax, which constitute the most dubious element in Angela Merkel’s reform package in Germany. Such a package in the UK would come on top of an already weakening labour market and would lead to a severe growth slowdown and possibly a recession, which would torpedo the boasts about decades of non-stop growth with which Gordon Brown begins every Budget speech. In my view we should be sceptical about estimates of required investment based on past capital to output ratios. These remind me not only of Gosplan, the Soviet planning agency, but of Indian long-term plans when that country was under the influence of Fabian socialists. Business investment depends on perceptions of profit opportunities and general confidence. How far such investment can safely be financed by tapping the savings of other countries is something we can only ascertain by a policy of “suck it and see”. The safest assertion is the general one, repeated by Mervyn King, the Bank of England governor, that the past decade or so has been exceptionally fortunate and that the years ahead may be more difficult. Meanwhile, those who want to criticise Mr Brown should concentrate on his obsession with micro-management and control freak measures rather than on macroeconomic imponderables that would probably be the same whoever was chancellor and whatever the party in office. The motto for the next prime minister and chancellor should be that of Thomas Jefferson: he governs best who governs least.
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