Pain must always come before gain

Allister Heath
CREDIT rating agencies have come in for a lot of flak, not least in this newspaper, but yesterday they proved that they can still tell the Emperor it has no clothes. The downgrade of Japan’s credit came as a stark reminder that government debt will be the new sub-prime. It certainly ought to serve as a wake-up call to any politician stupid enough to believe that a country can keep on adding to its national debt without any consequences. Standard & Poor’s, the agency that rightly downgraded Japan for the first time in nine years, blamed a lack of a “coherent strategy” to reform the economy and tackle its liabilities. Quite right – Japan’s decades-long inability to sort itself out is a depressing reminder that even great economic superpowers can go into permanent relative decline if they make the wrong choices. This issue, while fundamental, is never sufficiently reflected upon; the modern political cycle is far too short-termist and parochial for that.

Fortunately, the UK is not Japan. Britain is gradually beginning to turn a corner with its budget deficit, even though the national debt is still growing at a sickening rate. The deficit has so far reached £118.4bn in the financial year to date, down £8.4bn from £126.8bn recorded in the same period a year ago. The final, full fiscal year shortfall may end up slightly under the Office for Budget Responsibility’s £148.5bn forecast.

But what is starting to rattle some in the gilts markets, however, is the collapsing support for the coalition – Labour is 6 points ahead at 44 per cent in this morning’s YouGov/Sun opinion poll, while the LibDems are languishing at a disastrous 8 per cent. Elevated inflation levels are also putting upwards pressure on gilt yields. Yesterday’s poor consumer confidence figures aren’t helping sentiment towards UK assets either. There is a real risk that the four-year austerity programme mapped out by the coalition will never see the light of day. Labour’s policies are now the most left-wing they have been since the 1980s – though a Prime Minister Ed Miliband would eventually be forced to push through much of the same tightening as the coalition is planning, the rise in Labour’s political fortunes is beginning to make some large global funds nervous. All of this will push up the cost of borrowing for the government and the private sector.

Huge reforms – tax, regulatory, spending, welfare, health, education, energy and transport – are needed if Britain is to be brought back to health and become competitive once again. Yet countries are not doomed to decline. One of the greatest structural recovery stories of the past few years is that of Germany. Hermes Fund Managers calculates that since the birth of the euro, unit labour costs in the Eurozone have risen 20 per cent relative to its trading partners. But Germany, almost uniquely, has bucked this trend: it has cut its relative costs by 2 per cent, while Spain and Italy allowed theirs to surge 25 and 34 per cent. This is the main reason why Germany enjoyed a veritable economic boom in 2010. The country’s post-war growth miracle slowed in the late 1970s and the 1980s, before grinding to a halt after reunification in 1989. Its return to success represents a remarkable turnaround. If Germany can do it, so can the UK – and even Japan. But it can’t be done without strong and determined political leadership – and a public that accepts that pain must come before gain.
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