IN the long run, we are all dead, as John Maynard Keynes used to say. But plenty of us will still hopefully be around by 2061, by which time the Office for Budget Responsibility informs us the public finances will once again be in crisis. The UK faces a demographic timebomb which will, in my view, test our current welfare state model beyond destruction.
The proportion of the population aged 65 and above is expected to rise from 17 per cent in 2012 to 26 per cent in 2061, assuming net inward migration flows of half the recent level. The result, according to the OBR, is that on current policies public spending other than on debt interest will rise from 35.6 per cent of GDP in 2016-17 to 40.8 per cent of GDP by 2061-62.
Even that may be too optimistic: the OBR is almost certainly underestimating non-interest spending by 2016; and health spending is expected to rise from 6.8 per cent of GDP in 2016-17 to 9.1 per cent of GDP in 2061-62 on the central estimate, which feels like far too little given the huge expectations from voters. Even more significantly, higher spending is bound to reduce sustainable GDP growth.
But even if we assume that the OBR is not too optimistic, the impact will be disastrous: net debt will fall from 74 per cent of GDP in 2016-17 to a trough of 57 per cent in the mid-2020s, before rising to 89 per cent of GDP. That is the kind of level which leads to a permanent reduction in growth. There is simply no way that the state will continue to afford to provide as many services as it does today. Of course, one could increase immigration – but that is unlikely to be politically palatable.
So whether we like it or not, individuals will have to save more for their own retirement and in most cases also contribute more to their own healthcare costs. The sooner we accept that the current model is broken the better.
WE NEED MORE PROFITS
COMPANIES are not spending much on factories and computers. That is one central reason for our non-recovery. Net of depreciation, business investment by non-financial companies is down from 3.3 per cent of GDP in 2008 to a catastrophically low 1 per cent of GDP in the first quarter. Increasing that number would be the best way to kick-start growth.
There are lots of reasons for this corporate reluctance, including Eurozone fears. But there is an even more fundamental reason why firms are not investing more: they are not making enough money from their existing capital, while the opportunity cost of investing has gone up.
Manufacturing has become hugely unprofitable, an analysis of the official figures by Citigroup reveals. The net rate of return on capital for manufacturing remained at an appallingly low 4.9 per cent in the first quarter, the same as for the prior two quarters and the lowest since 1991. Services (excluding finance) are doing better but even there the situation is deteriorating. The net rate of return on capital for non-oil non-financial companies has dropped to 11 per cent, the lowest level for two years.
It is not just that returns have slumped: the cost of capital has gone up substantially, in a devastating pincer movement. One metric that shows this is the earnings yield on UK equities, which has shot up from 6.5 per cent in early 2011 to 9.9 per cent in the second quarter.
Profits have become a dirty word in today’s Britain. But companies won’t open their wallets and spend and hire unless they think it is worth their while – and that is something that those who want to tax and regulate everything that moves would do well to bear in mind.