The real downgrade is in economic expectations
Moody’s decision to withdraw the UK’s AAA rating is not a shock or a disaster, but it is a sign of policy failure.
The news – confirmed late on Friday night UK time – that the UK government’s sovereign debt is no longer rated as a completely safe bet, has caused quite a stir in the Westminster village. One of the major credit-rating agencies, Moody’s, has downgraded the UK’s rating by one notch, from AAA to AA1.
The change is a major embarrassment for the chancellor of the exchequer, George Osborne. His justification for the government’s programme of spending cuts has been that the financial institutions that the UK needs to borrow from must retain confidence in the ability of the UK to repay its debts. Or rather – given that UK debt is denominated in sterling and therefore the Bank of England could always repay the debt by simply printing money – that what gets paid back is actually worth as much as what was lent. If the British government had to print its way out of trouble, the value of the pound would fall sharply and lenders would lose out. Moody’s is now saying that such a scenario has gone from almost unthinkable to very unlikely – in Moody’s own terms, from a ‘minimal credit risk’ to a ‘very low credit risk’.
Having nailed his political colours to the mast of that AAA rating, the loss of this exalted status represents a significant loss of face for the government, and Osborne in particular. Of course, Labour has leapt on the event to argue that Osborne is incompetent. Osborne’s opposite number, Ed Balls, baited Osborne in the Commons yesterday: ‘He has gone in a weekend from saying he must stick to his plan to avoid a downgrade, to saying the downgrade is now the reason he must stick to his plan.’
In truth, the downgrade is a problem but by no means a disaster. It is more of a problem for the UK to be downgraded than it was for the US, which was downgraded by Standard & Poor’s in August 2011. The US is still the world’s biggest economy and is regarded as a ‘safe haven’. But the rate at which the UK has to borrow will probably change little in the short to medium term – even if, as expected, the other ratings agencies follow Moody’s and downgrade the UK’s rating later this year.
Nor is the downgrade really that much of a shock. Moody’s had been warning for a year that the AAA rating was under threat. The financial markets had been expecting such a move sooner rather than later and had already factored it in.
The downgrade itself is less important than what it represents. Moody’s noted, in its explanation for the move, the ‘continuing weakness in the UK’s medium-term growth outlook’, with sluggish growth to ‘extend into the second half of the decade’. The result is that the government’s fiscal-consolidation programme – its efforts to bring state spending into line with tax revenues – will take longer. Indeed, the cutbacks ‘will now extend well into the next parliament’. The upshot is ‘a deterioration in the shock-absorption capacity of the government’s balance sheet, which is unlikely to reverse before 2016’.
Few will disagree much with this assessment. UK economic output is still three per cent below its pre-crisis peak. With higher unemployment and lower tax revenues, even Osborne’s optimistic plans in his 2012 budget saw public spending (£683 billion) outstripping tax revenues (£592 billion) by £91 billion. To put it another way, the UK government’s plans were to spend 15 per cent more than it raised in taxes. As it happens, UK government borrowing in 2012-13 may well be higher than the year before, puncturing Osborne’s claim that the government is making progress in bringing down Britain’s debt. Total government debt will carry on rising for years to come.
But this also gives the lie to the idea that the UK government can have much impact on the economy through some kind of stimulus package or by slowing down the cost-cutting programme. Not only has the government been borrowing over £100 billion per year to fund spending but the Bank of England has been effectively printing money – a grand total of £375 billion since 2009 – through ‘quantitative easing’. Oh, and interest rates are at a historic low and are likely to remain there for a long time to come.
How much more stimulation can you get? The government and the financial authorities have attached a veritable defibrillator to the comatose British economy but the shocks are barely causing a twitch. The patient isn’t dead, but remains in a vegetative state.
As noted before on spiked, the problem is that the UK government saw off recession in the Noughties by bumping up government spending and making it easier for individuals and companies to borrow. But rather than providing the investment for new growth, that money had little lasting impact – except to create an enormous overhang of debt, both public and private. Ed Balls, in particular, was at the centre of Labour’s economic policymaking at the time. He’s in no position to gloat now.
The only way out of the mess is renewed economic growth, but there are still only tentative signs of any kind of growth strategy coming from Whitehall and Downing Street. Instead, all we get is a narrow fixation on cutting the deficit.
What is really striking is that for all the talk of austerity, there has been surprisingly little to date. Far from being a bunch of public-school neoliberals adopting a slash-and-burn policy to treasured aspects of government support, George Osborne and David Cameron have lacked the political will to push through even their fairly modest planned cuts to date. Capital spending has been squeezed heavily – even though it is the kind of spending that might help to create new growth – but cuts in day-to-day spending have, overall, been almost non-existent.
As one of the government’s most well-regarded critics, economist Jonathan Portes, has admitted: ‘Public-sector current spending overall is roughly flat in real terms, with cuts in some areas offset by the operation of the automatic stabilisers [things like welfare payments and lower tax revenues]. As yet, so far, there has been relatively little (overall) austerity in public services, with health and schools protected, although local-authority services have suffered.’
There is no painless way out of the economic mess the UK is in. What is required is a full-blooded drive to promote genuine new growth – through restructuring the economy, promoting new technology, research and development, investing in infrastructure and removing unnecessary regulations – alongside those cutbacks.
Yet the political class in general seems unable to cut spending or promote wealth creation. While there are serious, long-standing difficulties for the UK economy, both domestic and international, the inability of our leaders to pursue any kind of economic strategy with conviction is making things worse.