44 days. Flash to bang. So that went well. Now facing a self-inflicted existential threat, the Conservative & Unionist Party isn’t much good at conserving anything these days, including itself. Least of all conserving its own Prime Ministers for whom Tory MPs seem to have developed a casual and prodigious propensity for defenestration at any given opportunity; as for unity among Unionists, forget it.

 

Economically, there is no point speculating on the outcome of the latest leadership ‘election’. Jeremy Hunt is in control of policy, he has committed not to stand as PM and it would be a crass new occupant of No 10 who lobs out yet another Chancellor in quick succession (but with this crew, never say never!).

 

Whoever is the next Prime Minister, he or she faces the enduring leadership problems of trying to square the circle with a party whose political polar wings are determined to pull in opposite directions and regardless of the blue-on-blue and collateral damage, both so obtuse that neither will give an inch of ground. The seemingly unravellable political Gordian Knot is how to get the country living within its means, to make it competitive internationally and to be an attractive destination for foreign inward investment, and to restore decent real rates of growth and productivity, those not seen since before the Global Financial Crisis. 

“We will all have to pay” 

Our words, in one of these musings in 2020 when Rishi Sunak’s March budget planned deficit of £40bn had just been blown to bits by a factor of ten by the massive fiscal injections of the furlough scheme and business loan support schemes during lock down and when the economy was nose-diving, shrinking 10% that year.

 

The problem? In one word: debt. In 1997, Labour inherited a fiscally healthy and financially sound position. Debt/GDP was 35.6%. Gordon Brown committing to the same level of ‘Prudence’ (remember her?) as the Tories, kept that ratio at no more than a third (indeed in 2001 it was 26.7%) until the GFC and the banks’ rescue. By the time Labour was kicked out in 2010, debt/GDP was 68.8% and the outgoing Chief Secretary to the Treasury, Liam Byrne, left his infamous note on his successor’s desk, “Dear Chief Secretary, I’m afraid to tell you there’s no money left”. David Cameron’s Chancellor George Osborne instituted a period of fiscal restraint with government spending, what became known as ‘austerity’. However, the reality was that although annual government deficits might have steadily declined as a percentage of GDP, our nominal national debt still increased relentlessly, from £1.3 trillion in 2013 to £1.8 trillion in 2017; debt as a percentage of GDP rose too reaching 81.5% in 2016.

 

As the debt then stabilised it was Theresa May at the 2018 Tory Conference who officially pronounced that austerity was ended. She heralded a new era of investment, paving the way for her Chancellor, Philip Hammond, to launch a debt-funded fiscal splurge, earmarking £26bn for additional infrastructure spending. At that time the government could still borrow on a 10-year view at 1.3%. What could possibly go wrong?

 

Answer? The two ‘P’s: pandemic and Putin. By the time Covid arrived in 2020, debt/GDP was already 83%. Today we find ourselves at 96% and about to join the US (137%), France (113%), Italy (151%) and Japan (266%) in the “ton-up” club of major economies exceeding 100% gearing. But now our 10-year cost of funding is three times what it was in 2018 (or indeed four times what it was 9 months ago) on debt of £2.4 trillion. It is not a sustainable position. 

“Eye wateringly difficult decisions” 

So pronounced new Chancellor Jeremy Hunt last week (oh do keep up at the back! He’s only the fourth this year) when he comprehensively and publicly eviscerated in a trice his now ex-boss, her entire economic ideology, her budget and her political agenda as she sat in supine suspense by his side.

 

We have talked many times in these columns of the need to bring public expenditure under control. Hunt has already told the spending departments to be ready to tighten their belts, including suggesting that the planned increase in the defence budget to 3% of GDP by 2030 be scrapped (in fact in real terms, it already has been savaged, partly by the effect of inflation reducing its purchasing power, but as significantly thanks to the exchange rate and the strength of the dollar, big ticket purchases from the US including among others Lightning II fighters and their parts, and some of the missiles being used in Ukraine, are now significantly more expensive than a year ago). 

But not so eye watering as to include the NHS 

But it was with an impending sense of gloom to read in an interview with the Daily Telegraph, Hunt saying that we need to have enough money to invest in our ‘excellent health services’. He is completely ducking the biggest decision of all, running away from the enormous elephant in the room: health reform.

 

It is a well-known humorous trope that the UK is a “national health service with a small island attached”. But there is more than a nugget of truth in that. In astrological terms, the NHS is like the sun: the centre of the fiscal solar system, its gravitational pull so strong that every other planetary spending department orbits around it. At £230bn the UK currently spends 12% of its GDP on the NHS, a fifth of all government spending (considerably more when care for the elderly is included, taking the sum to over 40%). It is substantially the biggest employer in the UK with around 1.7m employees; it is the biggest in Europe and is believed to be the 7th biggest employer in the world. And yet it is not enough and even without a pandemic, it habitually falls over and must have emergency cash injections every winter. Financially, it is an insatiable monster, voracious in its appetite for cash and yet its performance never improving (indeed the opposite).

 

Those statistics tell you intuitively that something is very wrong. To which Hunt’s response simply to give it a lot more money is surely not the answer. Yes it performs medical miracles daily under arduous circumstances but the system itself is fundamentally broken. And here is the rub with Hunt himself, his conflict of interest and why he is part of the problem and not the solution. He was Health Secretary between 2012 and 2018, the longest serving in that position in history; it would be an admission of his own culpability then to be cleaning up the mess for which he shared significant responsibility in creating. But further, since he left Boris’s government in 2020, he has been chairman of the Parliamentary Health & Social Care Select Committee and a vocal critic of the government, insisting on yet more NHS money and yet more staff; to consider anything but spending more would leave him open immediately to being charged by Labour with hypocrisy and undertaking a U-turn on his personal stance reinforced as recently as only a couple of weeks ago.

 

But there is a broader political problem with the NHS: its protected status as a National Treasure, a totem, the recipient last year of the George Cross and in 2020 the beneficiary of the ritual Thursday 8pm nationwide street pan-banging in recognition of its national covid service. In short, it is political suicide for any government or politician to tinker with it, let alone consider replacing it with a model fit for the needs of 2048 instead of 1948. Hunt bears the scars from his own modest reforms, trying to amend the Junior Doctors’ contracts. In public spending terms, the NHS tail still wags the dog. Plus ca change. 

War on waste? What war? 

But it is not just a question of how much to spend or how much to cut. It is also as fundamentally a question of how well the money is spent, maximising value and efficiency and minimising waste. Governments tend to have a terrible track record and ours is no exception (and after 12 years in office, the Tories have nobody to blame but themselves). Last December, Boris launched a ‘war on waste’; so far given the political dislocation it has gone nowhere.

 

With the highest tax burden in the UK since the late 1940s at 33% of GDP, and yet still running habitual government budget deficits despite the Osborne austerity era, and the quality of public services in decline almost across the board, that is a sure-fire indicator of significant ‘frictional inefficiencies in the transmission mechanism’, as economists say. In plain English, money being poured down the drain. In our 4th February 2022 column we identified £120bn of unplanned government spending since 2010 which has been wasted either through significant project overruns (e.g. Crossrail) or through projects which have failed or are already redundant and the investment has been written off (including the £37bn on the useless and completely redundant NHS Track & Trace system, and too many examples in the MoD to list).

 

While Jeremy Hunt is still looking for £40bn with which to plug the ‘fiscal credibility gap’ to convince the markets that order is restored, all that money down the loo is three times the amount he needs to find. It is a serious indictment. Hunt’s instruction to the spending departments to find cuts should include an unconditional requirement for radical reform as to how what remaining expenditure is put to work. Any Chancellor not ensuring proper value for money for every single pound of tax-payer’s money spent has no business in No 11. And for Hunt, that includes tackling the Health Department. So far, he has failed the acid test. 

One hand tied behind the back, the other arm in a Nelson 

There is only one way to reduce debt: spend less and raise more. The notion of inflation being a viable strategy for debt reduction is demonstrably for the birds. We have discussed the spending side of the equation. However fiscally necessary, it is politically toxic. The term ‘Austerity’, never to be uttered by a government again, has been replaced by the phrase ‘eye wateringly difficult choices’.

 

But how to raise more is equally glowing nuclear green to the point it has just exploded a party. As the Tories have demonstrated, ostensibly under the same political umbrella an ideological chasm divides the Keynesian fiscal social democrats who appear supremely relaxed with high and rising rates of income and corporation tax despite the inevitable long-term fiscal drag inherent in such a policy. Their orthodoxy, that of Sunak, is not only ascendant but now unquestionably supreme. The conservative monetarists, those whose ideology is empirically proven in data that shows that over the longer-term lower rates of taxation help create sustainable growth which delivers higher nominal tax revenues are once more out in the cold, out of business for a very long time thanks to Kwarteng’s over-aggression and using borrowings to cover the near-term funding gap. But however much Tories as a whole profess to be believers in low taxation, by junking Trussonomics in the way they have done (most obviously by Hunt himself), they have ensured that it will be politically nigh-on impossible to deliver a growth strategy that involves using taxation as a lever, certainly this side of the election.

 

The markets’ febrile nerves about the UK have been settled a little. But in reacting the way they did, what they too have revealed is their own comfort zone for financing: long-term economic repression is the price worth paying to get the fiscal maths to stack up today. Growth is tomorrow’s problem. As it has been for more than a decade. And all the while government bond yields in Europe and the US are pushing relentlessly higher. It really is a much wider problem of which the UK and our own peculiar brand of chaos is merely symptomatic; just ask the Italians, where another government has fallen this year (one led by a former President of the ECB no less), or the French where Macron is teetering on the brink of a national strike. 

The value of active minds – independent thinking

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Fund specific risks

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