Britain must save and rebuild to prosper

  • Published: June 2009

Financial Times piece.

How did the UK get into such an economic mess? There are many causes, but central to any explanation is that consumption has been unsustainably high at least since 2000, and this excess has been based upon ever-higher levels of private and public debt. In simple terms, we have been writing a large mortgage on future generations, without bequeathing them a compensating set of assets.

The implication is that a sustained economic recovery depends upon a major rebalancing of the economy - less consumption, more savings and more investment. But current economic policy is exactly the reverse: to try to boost consumption and borrow unprecedented sums; an even greater mortgage. This is what "crass Keynesianism" in economic policy amounts to - short-term consumption against long-term sustainability.

The scale of the rebalancing necessary to get back on to a sustainable consumption path is considerable. Given the unfunded public sector pensions, the precarious state of private pensions, the ageing population and the squeezing of the productive base, the economy may need in the medium term to save perhaps 7 per cent of gross domestic product. Add in the mountain of debt inherited from the structural deficits since 2000, and the borrowing just embarked upon, and that might push higher.

Then there are big structural challenges. Most of the North Sea oil and gas has been depleted, without any serious regard for future generations. The current selfish generation had all the benefits, allowing consumption at a higher level supported by a higher exchange rate. The City of London, too, has dimmer prospects, with the rest of the economy having to take up the slack. Not surprisingly, a devaluation has already hit living standards.

Finally, there is the environmental dimension. The economy needs to decarbonise; put another way, we are not paying the full costs of the damage we are doing, so our consumption is higher than is consistent with a path towards a greener future. Contrary to claims by politicians and the recent Stern Review, this is likely to cost significantly more than 1 per cent of GDP every year.

It is impossible to avoid the conclusion that we are living well beyond our means. Predictions of exactly how much further living standards have to fall to get back to a sustainable consumption path cannot be precise, but if, for example, consumption was to fall back to the 2000 level - when the bubble burst, and before the first round of monetary and fiscal stimuli started to be applied - the required adjustment is at least 10 per cent and perhaps considerably higher. Already, sterling has depreciated, house prices fallen and pension funds plunged. There is probably further to go.

The appropriate transition policy may well require deficits; there is probably no other option. The (temporary) demand gap should, however, be filled with investment in infrastructure which, like the economy, is in a mess. The capital investment requirements of the next decade are considerable. Major upgrades are needed to the electricity and gas networks, smart meters, high-speed trains, upgrading the London Underground, Crossrail, new runways, new water resources and sewerage systems, and broadband roll-out, to name but a few. Add new power stations, energy efficiency and renewables, and it is not hard to get to £500bn.

Infrastructure investment would not only stimulate the economy, but would also address its chronic productivity and competitive problems. Infrastructure networks are public goods, complementary to the rest of the economy, affecting everyone's costs. It is one reason why countries such as France have higher productivity levels - despite sclerotic labour markets and nationalised industries.

To finance this programme for rebuilding Britain's infrastructure, savings, not consumption, will be required. China, with its 50 per cent savings ratio, understands this - and China's stimulus package is all about infrastructure. Borrowing requires lenders, and as the recent credit warnings on the UK's sovereign debt have brought into sharp focus, there may be increasing reluctance on their part.

There is a way forward. Instead of trying to boost consumption, the emphasis should shift to savings and investment. Britain needs to rebuild its infrastructure if it is to compete. It needs assets on its balance sheet to offset the debt. The analogy is with 1945, not the 1930s: Britain's infrastructure was devastated by the second world war, and the remarkable recovery in the late 1940s was built not on consumption but investment. Standards of living have to adjust, savings need to rise, and it would be better to get on with this now, rather than trying to defy gravity by yet more borrowing and consumption. Keynes' much-quoted comment, "in the long run we are all dead", accurately reflects the selfish shorttermism some of his new followers have embraced. If the current policy stance remains, the neglected prospects of our children and grandchildren may be a lot bleaker.

© Dieter Helm. All rights reserved.Copyright & Terms|Contact