It’s politics not economics that threatens our AAA rating

The announcement by Standard and Poors that it might, in four years or so, downgrade the UK’s credit rating from AAA to AA, has brought forth predictable hysteria from the usual suspects.

But this doesn’t mean that the UK is currently in a worse financial situation than most comparable economies. Our debt to GDP level is currently lower than that of the USA, Germany, France and Japan. The IMF predicts that, by 2014, the UK’s debt levels will be similar to those of Germany, France and the USA. The OECD forecasts the UK’s debt to be higher than that of Germany and France but less than that of the USA.

In other words, the big western economies are all in poor shape, with the debt levels of the USA and the UK rising slightly faster due to a heavier dependence on consumer debt and financial services and the presence of bigger banks to bail out.  If the UK were to be downgraded to AA status in four years time, it is likely that the same would happen to France and Germany and highly probable that the USA would be downgraded too, as a number of American journalists and bloggers have noted today.

So we’re all in the crap and if the UK is downgraded it is likely that others will follow.

However, this quote from S&P’s David Beers is interesting.

The outlook could be revised back to stable if comprehensive measures are implemented to place the public finances on a sustainable footing.

This has led some commentators to conclude that S&P’s reason for picking on the UK is due to its political rather than its economic situation. As the FT’s editorial said:

[T]he risk that hangs over the UK is political. S&P and the IMF are right to be concerned. A general election must be called within a year; this has created a credibility hiatus. Lenders want to know how the next government will restore order to the public finances. But, in the run-up to polling day, no party wishes to set out how exactly it intends to make taxpayers pay more for fewer services.

Lacking a concrete set of fiscal rules from either party, and without realistic plans for managing the public finances, investors have no idea what either party intends to do.

In short, neither party dares to give a clear and honest message about the spending cuts that whichever one of them wins the next election will have to implement.

The Independent has a similar view:

S&P joins the Institute for Fiscal Studies, the National Institute for Economic and Social Research and scores of City economists in highlighting the political as well as the financial issue we face: that no political leader has yet summoned the guts to tell the British people the ugly truths about what will have to be sacrificed if we are not to end up in a situation where the very size of the burden of public debt prevents the economy from growing fast enough to begin paying it off.

This quote in the Daily Mail from Citigroup economist Michael Saunders struck a chord with me:

It sounds as if the Government is still trying to deny the fiscal problem and does not regard its own plans for fiscal consolidation as a very high priority.

In our view, they are not living up to the responsibility of having to address the fiscal challenge.

This concurs with my recent experience. I still don’t get the feeling that managers in the public sector, and especially in central government, appreciate the size of the problem. For example, a friend of mine working in one government department explained to me that there is a lot of talk about  “headcount ceilings” but little about wholesale cuts. The view still seems to be that just stopping the department from growing will be enough to make the problem go away. My admittedly unscientific research leads me to conclude that the urgency of drastic cost savings is not being transmitted from government ministers to public sector executives.

Unless and until the political parties start being honest about the scale of the cost savings and headcount reductions that will be needed in the public sector, and the corresponding implications for public services, the UK’s credit rating will probably remain under threat. As the FT concludes:

Whatever it does, the next government will have no choice but to change the reach of the British state. UK politicians would let down the country if this were to happen without a serious, meaningful discussion. They must not try to win the election without winning the argument for their plans.

The financial markets and the electorate need to see a clear political will to make the necessary tough decisions to reduce the British economy’s debt. So far, no concrete proposals have been made. If we don’t want to damage our standing in the world even further, politicians need to make some clear and workable proposals to reduce the level of public debt. And that needs to happen soon.

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