Financial Times., 27th February 2006
“What curious attitudes he goes into!” “Not at all,” said the King. “He’s an Anglo-Saxon Messenger – and those are Anglo-Saxon attitudes.” (Lewis Carroll, Alice Through The Looking Glass.)
The claim that there are no free lunches may be one of the most important principles of economics. If it is correct, the prospects for British consumers, and those who live off them, including the Treasury, are far from rosy. Over the past 15 years, among mature economies at least, those that have invested least have grown fastest. The UK and the US have been at the bottom of the investment league and at the top of the growth one.
Capital investment has been far more efficient among Anglo-Saxons than in Germany, France and Japan. Either the British and Americans are much better at investment or the growth of their economies has been driven by sectors that need little capital. If the former is true, then UK and US investment is likely to rise relative to that in those other countries; if the latter, higher investment will be necessary to avoid a sharp slowdown in US and UK growth. The prospects for consumption are poor either way.
Corporate output is divided between wages and profits. The split varies a bit from one mature economy to another but not by much. The return on capital largely depends, therefore, on the efficiency of investment. On new capital, at any rate, UK and US returns must be far higher than those in Germany, France and Japan. It must be highly probable that either investment in the UK and US picks up to take advantage of these high returns or growth falters and these high returns will be no longer available.
Many goods and services, such as haircuts, mortgages and most building materials, are provided only locally. These “non-traded” goods and services generally need far less capital to produce than traded goods and services. If the relative output of traded and non-traded products was growing at the same pace in the five biggest economies then, in the absence of differences in efficiency, growth potential would rise in line with the amount devoted to investment. If, however, there has been an imbalance, the economies that have favoured the production of non-traded goods and services will grow more rapidly with less investment and will have growing international trade deficits. Since the relative success of the UK and US has been accompanied by rapidly growing trade deficits, this explanation fits the facts very well.
Trade deficits may rise further in the short term, but they are large already. If the relative success of Anglo-Saxon economies has depended on their growth, we should be prepared for a big and fairly imminent change. Either growth will slow or investment must rise. British growth has slowed recently. Over the past 12 months it has been under 1.7 per cent, a full percentage point below the rate at which it has grown for the past 15 years. This may be a temporary blip caused by inadequate demand but, if it were, spare capacity should be appearing in the economy. It is far from clear that this has happened.
It seems, therefore, that we are faced with a choice between lower growth or higher investment. The latter could be financed by even greater capital flows from overseas, but not without an even larger trade deficit. If investment has to rise just to keep the growth rate in place, consumption will have to slow and savings rise. One likely consequence is higher taxes. If we take the slow growth option, it is unlikely public sector spending will slow sharply enough to prevent a steady rise in its ratio to national output. If we go for higher savings and investment, then tax revenue will probably grow more slowly than gross domestic product.
The UK economy is usually presented as less stressed than that of the US. In particular, it is widely believed that household savings are higher than those in the US and the current account deficit much lower. In both cases the presentation of the data shows the UK in a more favourable light than is justified by the fundamentals. UK household savings are usually quoted gross, while US ones are net of capital consumption. On a net basis, the most recent savings data show that both are almost identical and both negative. Similarly, different treatment of income from direct and portfolio investment gives a misleadingly favourable impression of the current account deficit.
If the reality behind the figures is considered, then UK consumers are just as profligate as those in the US, the current account deficit is almost as bad and the investment ratio is even lower.