The UK's political crisis

On the evening of Friday, September 22nd, the credit ratings agency Moody's downgraded the UK's credit rating. Admittedly, it was only by one notch. But coming as it did hard on the heels of Theresa May's grand speechin Florence, it was a shattering blow. 

Credit ratings agencies lost much of their lustre in the financial crisis of 2008, when they were revealed to have been complicit in the mispricing of complex financial derivatives – the “toxic waste” that brought down some of the world’s largest financial institutions. So it is tempting to dismiss Moody’s action as pointless and its analysis as economically illiterate. I confess that I have done so myself, in the past. But this time, Moody’s is on the money. It tells a story of a tragically weakened government struggling with a legacy of policy errors from previous governments as well as the growing likelihood of a chaotic and potentially disastrous Brexit.

Moody’s gives two main reasons for the downgrade:
  1. The outlook for the UK's public finances has weakened significantly since the negative outlook on the Aa1 rating was assigned, with the government's fiscal consolidation plans increasingly in question and the debt burden expected to continue to rise;
  2. Fiscal pressures will be exacerbated by the erosion of the UK's medium-term economic strength that is likely to result from the manner of its departure from the European Union (EU), and by the increasingly apparent challenges to policy-making given the complexity of Brexit negotiations and associated domestic political dynamics.
Unsurprisingly, most commentary has focused on the second of these, and tended to ignore or downplay the first. But in fact the two are inextricably linked.

According to the ONS, the UK’s fiscal deficit currently stands at 2.3% of GDP and its public debt (excluding publicly-owned banks) at 88% of GDP.  George Osborne had planned to eliminate the deficit completely by 2020 and run an absolute surplus thereafter to reduce public debt over time. Of course, ratios to GDP depend as much on the path of the denominator as the numerator: even if the absolute amount borrowed reduces, debt and deficits can still rise in relation to GDP if GDP falls. But until recently, GDP forecasts were buoyant: notwithstanding the Brexit vote, the UK economy was still expected to turn in GDP growth of 2% or more.

Those forecasts have now degenerated substantially. This is from the second section of Moody’s analysis:
Growth has slowed in recent months, with average quarterly growth of just 0.26% in the first two quarters, versus an average of 0.6% over the 2014-2016 period. Private consumption has slowed sharply and business investment has been weak since 2016, most likely linked to the Brexit-related uncertainty. While future years may see some recovery, Moody's expects growth of just 1% in 2018 following 1.5% this year and 2.25% on average in recent years.
Ouch. And no, this is not merely a minor setback which Britain will quickly transcend on its path to the "sunny uplands":
More importantly for the UK's credit profile, Moody's does not expect growth to recover to its historic trend rate over the coming years.
Brexit will make Britain poorer. Permanently.

Clearly, if GDP is not going to rise as much as previously expected, then debt and deficits will not fall as fast in relation to GDP as previously expected, even if government spending and revenues remain broadly the same. Ceteris paribus, therefore, Brexit thus threatens the UK’s fiscal position

The disastrous 2017 election further weakens the UK's fiscal position:
…..the government has yielded to pressure and raised spending in several areas, including for health and adult social care. It also agreed to above-budget pay increases for some public sector workers. While these additional expenditures will be funded out of current budgets, the pressure to continue to increase spending in the coming years is likely to remain high, in particular on health care and the public sector wage bill.
In addition, in order to secure a working parliamentary majority, the new government agreed a 'confidence and supply' arrangement that increases public spending by GBP1 billion for Northern Ireland. It also abandoned a pre-election promise to review the costly so-called "triple lock" on state pensions after 2020. Overall, Moody's expects spending to be significantly higher than under the government's current budgetary plans and higher than the rating agency expected when the negative outlook was assigned in June 2016.
The minority Conservative government is breaking spending limits all over the place in order to hold on to power. I criticised George Osborne's slash and burn approach to government finances, but this is no better. Giving in to spending demands to prevent a backbench revolt is hardly a responsible approach to managing public finances. It smacks rather of desperation. Theresa May, it seems, will do “whatever it takes” to prevent Jeremy Corbyn from becoming Prime Minister.

Government revenue, too, is compromised by the Tories’ desperation to keep Labour out:
At the same time, revenues are unlikely to compensate for higher spending. Earlier this year, the government abandoned a planned increase in national insurance contributions for the self-employed. Instead, the government has become reliant on highly uncertain revenue gains from tackling tax avoidance to fund tax cuts....
No government in history has ever managed to repair the fiscal finances by clamping down on tax avoidance. This is not a reason not to do it, of course. But it is a reason not to rely on it.

Adding in the effect of a weak government being forced to increase spending and failing to raise the anticipated revenues, Moody’s anticipates that the deficit will remain at or above 3% in the coming years. Debt/GDP will continue to rise, peaking at 93% in 2019.

All in all, this adds up to a poor economic outlook and worsening fiscal finances. This is the reason for the downgrade. To be sure, the current fiscal forecasts are at least realistic, unlike Osborne’s. But as Moody’s says, repeated revisions to government targets don’t exactly inspire confidence.

So far, so meh. Then Moody’s drops this bombshell:
Moody's is no longer confident that the UK government will be able to secure a replacement free trade agreement with the EU which substantially mitigates the negative economic impact of Brexit.
Wait, haven’t we always known this?

Apparently not. Moody’s seems to have had its head in the sand. Belatedly, it recognises that the obstacles the UK government set up from the start – such as refusing to accept the jurisdiction of the ECJ – have rendered a new free trade agreement all but impossible. The window of opportunity is closing rapidly, there is as yet no substantive agreement on any of the EU’s showstoppers, and therefore little prospect of significant progress on trade before the UK leaves the EU in March 2019.

But even if trade were up for discussion, there is no way any new agreement could come close to matching what the UK currently has as a full EU member. According to Moody’s, Brexit “would likely impose additional costs, raise the regulatory and administrative burden on UK businesses and put at risk the close-knit supply chains that link the UK and the EU.” The UK’s vital services sector is particularly at risk: Moody’s warns that “differences of outlook between the UK and the EU suggest that the most likely outcome is now a rather more limited free trade agreement which may exclude services.”

Putting it all together, Moody’s concludes:
Aside from the direct impact on the UK's credit profile, weakening growth prospects are likely to exacerbate the government's evident fiscal challenges. And this is likely to be happening during a period in which policymakers will be increasingly distracted by the twin challenges of sustaining a domestic political consensus on how to operationalise Brexit and reaching agreement with EU counterparts.
UK policymakers will spend all their time working out how to implement a policy that will make Britain considerably poorer and substantially weaken its fiscal finances. Lovely.

Of course, the UK government hit back. A spokesman from the Treasury, quoted in the Financial Times, said this:
The assessments made about Brexit in this report are outdated. The prime minister has just set out an ambitious vision for the UK’s future relationship with the EU, making clear that both sides will benefit from a new and unique partnership.
So Theresa May's grand aria will make all the difference. Unfortunately the head of sovereign ratings at Moody's doesn't think so. "I've read the speech and it doesn't change our view at all", he said on the BBC's Today programme, downgrading Mrs. May's credibility to junk.

I criticise Mrs. May's government, but I am equally critical of a Labour party whose tax and spending plans are every bit as unrealistic as those of the desperate Tories. Brexit will make Britain poorer. High wages, generous pensions, universal healthcare and quality social care are the luxuries of rich nations. Even without Brexit, these create a substantial burden for younger generations, including the children and the unborn who have no voice in this debate. The impoverished outlook for Britain may render them unaffordable. But neither party as yet shows any willingness to admit that the prosperity they have promised the British people is completely incompatible with any sort of Brexit. The British people are being systematically deceived by blue and red politicians alike.

Ever since the referendum, the UK has been engulfed in a deep political crisis. Indeed, it started long before the referendum. It is a crisis of lies and dishonesty which is rapidly destroying all trust in the political establishment.

Moody's says (I paraphrase), "Thank goodness for the UK's institutions, because its politicians can't be trusted." The downgrade itself does not matter, and I would be the first to dismiss calls for further austerity measures to bring the deficit and debt down in relation to GDP. We know now, all too well, how disastrous fiscal consolidation can be in a weakening economy. But the picture that Moody's paints, of a weak and untrustworthy political establishment and an economy entirely dependent on the soundness of institutions that are increasingly under political pressure, is shocking. This, even more than Brexit, threatens the future of the UK.

Where have the honest and courageous politicians gone? Whatever happened to doing the right thing, not merely the most popular thing? Who will speak up to avert the coming disaster?

The Lord said, “If I find fifty righteous people in the city of Sodom, I will spare the whole place for their sake.”27Then Abraham spoke up again: “Now that I have been so bold as to speak to the Lord, though I am nothing but dust and ashes, 28what if the number of the righteous is five less than fifty? Will you destroy the whole city for lack of five people?”“If I find forty-five there,” he said, “I will not destroy it.”29Once again he spoke to him, “What if only forty are found there?”He said, “For the sake of forty, I will not do it.”30Then he said, “May the Lord not be angry, but let me speak. What if only thirty can be found there?”He answered, “I will not do it if I find thirty there.”31Abraham said, “Now that I have been so bold as to speak to the Lord, what if only twenty can be found there?”He said, “For the sake of twenty, I will not destroy it.”32Then he said, “May the Lord not be angry, but let me speak just once more. What if only ten can be found there?”He answered, “For the sake of ten, I will not destroy it.”
- Genesis 18: 26-32


  1. At Waterloo, Wellesley had Blucher come to the rescue at a critical moment. May has Merkel. I think I will cash in my Premium Bonds.

    1. Merkel won't help. She has already made that clear.

  2. This comment has been removed by the author.

  3. Hi Frances. You talk of deficits and increased public spending and so on, but couldn't this problem just go away if the government just printed the money and spent it? What's stopping this? Ignorance? Political dogma? Or a genuine fear about the practicalities eg inflation (esp. given effect of Brexit on GBP)? Thanks!

  4. Two points on Labour. First, distribution of wealth matters as well as growth. Brexit with austerity would be nightmarish all round, but Brexit with rent controls, a rebuilt welfare state and progressive taxation might be an improvement on the current situation for many people. If Brexit can't be stopped (and, like you, I pray that it *can*) then planning a post-Brexit settlement "for the many" is the responsible thing for Labour to be doing.

    Second, if Brexit can be stopped, *how* can it be stopped? I really doubt that Labour going Remain would do the job. As we saw from the Article 50 vote, almost all Conservative MPs are tribally-minded enough to vote against their own beliefs if it also means defeating Labour. And even if an anti-Brexit motion passed in Parliament, I suspect the main effect would be UKIP coming back from the dead to breathe down the government's necks. I think Keir Starmer is doing to Brexit what Ed Miliband did to British intervention in Syria: killing it, but very, very slowly and carefully. It's not so much politics as hostage negotiation: just keep the madman calm and keep him talking, and take control of the situation without him noticing.

    1. I tend to agree. It's all in the numbers of course, there will be less pie to go around but if my minuscule share of a large pie is replaced with a absolutely larger amount then I'm better off. I'll leave it to Ms. Coppola to provide numbers.

      Also it seems to me that an economy is about more than making things to sell to other people. Yes we need to do that to buy iPhones - but there's lots we can do here to just utilise the resources we have and use them better.

      I don't want to dismiss the challenges - I remain a remainer. But I think it's potentially complicated. Also, I think (well hope really :-)) Labour will let the Tories hang themselves and then end up negotiating a deal that allows us to remain a part of the single market.

  5. The labour party has recently been talking about war gaming for a run on the pound.

    What would a sterling crisis under a Corbyn/McDonnell labour government look like?

    Is it correct that all previous crises from 1992 black Wednesday back to the start of time have
    been due to defending some form of sterling peg? How can you have a sterling crisis if you are not trying to defend a level against another currency? The BoE has no fire power for this game, what level of foreign currency reserves does it have? The gold is long gone.

    The pound now floats free.

    If you need a deficit to worry about perhaps it should be the current account. The City of London seems to be able to recycle all the pounds foreigners get for keeping the UK supplied to all the foreigners who want to save in pounds. If labour throw a spanner into this delicate contraption it could be a problem.

    Lets say Corbyn gets in and the pound falls like a stone on D-day plus 1. At some point every share on the London Stock Exchange looks very cheap to anyone with dollars or euros or yen and the demand for pounds picks up, D-day plus 5 maybe. As long as McDonnell doesn't insist on marching 500,000 city workers into Kent to pick hops, things should stabilize.

    With the pound really low could there be a risk of serious inflation. I guess there could. The root cause would be the same as Weimar or Zim or Venezuela the real economy had become knackered. The economy is knackered first then you get the inflation. Sadly the UK real economy maybe weak enough for this to be a possibility. We don't make enough stuff.

    The fix could be exchange controls. (Can you hear me Wynne Godley, your time may finally have come). You would need to learn from China how to make it very easy to put money into the UK but very difficult to get it out. This would be tricky because you need the City of London to still work recycling pounds. Fuel, food and medicine would be your priority imports then raw materials and capital goods. After that import substitution. You would have to sit down and find out just what we are importing and see if we can't make it here.

    Is such a shock likely? Probably not. McDonnell probably won't harm the City much. The UK real economy may be stronger than it looks. If there was a shock, it would be manageable and may even be a spur to finally having a crack at re-balancing the UK economy. The only snag is the boys and girls in charge would have to be able to think straight and have monumental stone cojones. A rare combination.

  6. Frances I mostly agreed with your post up until this point: "Brexit will make Britain poorer. High wages, generous pensions, universal healthcare and quality social care are the luxuries of rich nations. Even without Brexit, these create a substantial burden for younger generations, including the children and the unborn who have no voice in this debate. The impoverished outlook for Britain may render them unaffordable."

    Huh? Isn't your longstanding position that we have to stop austerity and increase borrowing for a fiscal stimulus instead until the recovery from the Great Recession has finally been completed?

    If so, the damage from Brexit would blunt the effect of this because the stimulus is having to fix two problems. But we should still do it and that means electing Labour.

    As for how-do-we-pay-for-things, you know incomes would be higher without austerity and the ability to raise tax revenues would be better too. We could have inflation or balance of payments problems but we could spread out the policy over a long period to avoid them.

    I hardly think Brexit could do such damage to our economic growth rate permanently that we can't have left-wing policies any more. The growth rate before and after joining the EEC are basically the same. The short-to-medium term pain can be lessened by voting out the Tories even if Labour doesn't have the balls to stop Brexit.

    I agree with Phil that I don't see even the bones of an argument (anywhere) for how to stop Brexit, except maybe Labour doing a super-"soft" Brexit. If we could get a transitional deal by the deadline, we might make very few changes to our status after that, and at a safe pace.

    1. We have to be realistic. If the long-term outlook for the economy is that it will not generate the level of income of the past, then we cannot have the lifestyles of the past. This is not about left or right wing policies - those are political decisions. It is simply about the economics, or perhaps more accurately the arithmetic. If you commit now to spending money that the economy cannot generate in the future, the children and the unborn of tomorrow will be poorer.

      I'm amazed that you downplay the terrible damage that any form of Brexit will do to the UK's supply side, already damaged by the financial crisis. I'm all in favour of fiscal stimulus, but it cannot cure widespread and deliberate wilful harm. To say that a badly damaged productive capacity will definitely recover sufficiently to generate the income to pay for the pensions, healthcare and social care to which we seem hell-bent on committing is folly, frankly.

    2. How can you confuse income with growth? We will generate the existing level of income in future except during recessions (one may be caused by Brexit). The arithmetic is Labour's plans were costed, but short to medium-term performance of the economy deteriorating from Brexit can easily throw them off course. That is both the demand-side problem (business uncertainty, even during any transitional deal), and supply-side (adjusting 40 years of relationships with the continental economies), which I haven't downplayed at all, only put in context.

      We all know the economy will recover but how quickly depends both on willingness to stop or slow Brexit and willingness to borrow money or raise taxes. You know that deficit-scolds are wrong and many continental countries have higher taxes than us. "Labour manifesto" economies, if you like. In the long term there's not much reason to believe Britain outside the EU will have a slower growth rate when EU membership didn't obviously improve it.

      That Brexit will hurt us economically, a harder recovery not an easier one, is the right argument to use to try and stop it. That it would somehow resurrect terrorism in Northern Ireland or make Labour's manifesto policies impossible -- in the long term! -- are weak arguments and the distraction is harmful to the Remainer cause which I still support.

  7. Brexit will be the most calamitous event of my lifetime both politically and economically. The referendum was called solely for party political reasons by David Cameron in order to silence internal in fighting on Europe. That act backfired spectacularly and will in all likelihood destroy the Tory party as it tries to grapple with implementing something the parliamentary party doesn't believe in but has enough support among the membership to mean it has to carry it out.

    The Labour Party has never been a supporter of Europe and Jeremy Corbyn would not be able to contemplate implementing his current policies if the UK remains. The Labour plan involves a huge expansion in state aid and increases in public sector pay at a time when the UK will be contracting. It will instill a belief that personal wealth will and should increase at the worse possible moment and could lead to huge social unrest.

    The idea that increasing corporate taxes will resolve the funding issue seems somewhat hopeful. Inward investment must decline if European tariff increases lead to higher import costs as they must and corporate tax increases will further reduce incentives for overseas businesses to invest in the UK. Modern business is not tied to states as they once were so it is relatively easy for them to simply move.

    It is possible that currency depreciation may reduce the impact of this but if governments need to borrow to fund their programmes then interest rates will have to rise to attract capital and consequently the currency should strengthen. If the government simply prints the money to pay off current debt as it could the impact would be to reduce the ability to borrow since who would want to lend if the government would simply inflate the debt away.

    The hideous fact is as a nation we are caught between a rock and a hard place of our own making. To reverse the referendum result would make a mockery of our democratic system. There are a significant number of people out there who still believe Britain is a nation of empire, the leading industrial nation and a powerful military force but it is not. The Brexit process is attempting to dismantle what took over forty years to establish in a two to five year period. Even in the most equanimous of atmospheres that would be a difficult proposition but our European partners are in no mood to give the UK an easy passage. To do so would jeopardise their own European project. Eventually everything will settle down but at a lower level than we currently enjoy.

    1. Are you serious? Please reconsider. The most calamitous event of your lifetime politically and economically was the Great Recession.


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