Trouble Ahead? Let the Market Work! Interviewer: Steve Macaulay Interviewee: Professor David Myddelton November, 2008 SM The Pre Budget Statement came out yesterday – it was said to put in £60bn into the system with a hope to kick start the economy. With me today, David Myddelton is going to look at this and give me his comments on the subject. So David, what do you think came out of yesterday? DM I think the main thing that came out of yesterday is we are in one hell of mess, much bigger I think than anyone had realised and to be honest, much bigger even than was revealed yesterday. The Government’s borrowing is completely unprecedented and it is not clear that they will be able to borrow what they want to borrow. To borrow people have to lend you the money and the credit of the British Government now, I’m afraid, must be in serious question. SM It felt a bit like a gamble that in the Government’s eyes, that they had to take. DM Well the Government is certainly gambling in two or three ways. One, they have put in some very optimistic assumptions about how short the recession will be, how mild it will be and how quickly the recovery will come. Conveniently expected just after the next election, so there is a big political element there which I needn’t stress. But no, I think they have got the numbers completely wrong. Personally I do not think it is sensible to cut Value Added Tax. Its £12bn or something more borrowing, when we are very tight already, and it is not clear that is going to make any different at all actually. People have said if the retailers are discounting by 15, 20, 25% an extra 2.13 per cent because of the VAT reduction is really not going to show at all. SM I would like to get behind the surface of the statements, and say what are the underlying issues here? DM Well the underlying issue is too much borrowing, which brings one immediately to the thought: well, is more borrowing likely to be a solution? Too much borrowing because there has been too much consumption. We have been living beyond our means. Well the solution to that, I am afraid, is a painful one, namely cut your consumption. Not cut it tomorrow: the Augustinian solution, you know, after the election, cut it now. So I think they shouldn’t put any money back into the economy, they should let the recession start and let it get over as quickly as possible. SM So isn’t the terror that we end up in the 1930s and all the drama that that caused? DM No, I think there were big monetary contributions to the 1930s which even with the mistakes that have been made, they are not going to make again. I mean they contracted the money supply. The problem really now isn’t the money supply, it’s the velocity of circulation – how quickly people spend. And essentially what you need you need to get that right again is confidence. So the key to this whole thing is confidence. And I am afraid that is where I don’t see what was said yesterday in the Pre Budget Statement, I don’t see that as restoring confidence in the British Government. SM So is it all a confidence trick? DM Well, let’s remember you are talking I think again about the solution, but if I can pick up your question about where did it come from. Don’t forget in the ten years that we have had leading up to this disaster, monetary policy has been relatively loose. Interest rates, particularly in America, but here too, have deliberately kept low. Taxes haven’t been as high as they should have been. Governments have over‐borrowed and governments have encouraged consumers to over‐borrow as well. Now that has been going on for a long, long time. Bubble if you like. And it is always painful. The silliest thing Gordon Brown said, and I think he genuinely believed it, I don’t believe he was telling lies, was that we have put an end to boom and bust. That was a complete misreading of what was going on. Don’t forget what the bust is though – its essentially investments that have gone wrong. Housing is a big part of it. Now it will turn out ordinary commercial investments will have gone wrong too because the consumer spending isn’t there. And that has got to work its way out of the system; that is very painful. Its misinvestment, misdirected investment. SM So the implications behind what you are saying is very high unemployment, lots of pain of companies going bust – is this actually you are saying you have got to take the medicine? DM Yes, absolutely. But don’t forget a lot of employment we have had has been pseudo employment – working for the Government, lots of waste, contribution to the national product virtually nil. I mean the amount of money they threw at the National Health Service, meaning well no doubt, but essentially it just put people’s wages up. It hasn’t improved the service at all. SM I guess one of the things that will go through my mind is to say electorally, no politician is going to go along that route. DM Well you have put your finger on a key problem in our whole political economy: namely, what most politicians want is simply to get re‐elected. That is not a satisfactory basis for running the show. SM So, if we put you in as Chancellor of the Exchequer, you would be saying we have got to think long term, you take the pain now and things will turn out right later on. DM Yes – the market will recover. John Stewart Mill has a very interesting thing in one of his books about how quickly countries recover after a war. And in a way that was true for us too after the Second World War – for the whole of Europe. An absolutely devastating war, but within five, ten years things were getting back to normal. Now even Mr Darling, the Chancellor of the Exchequer, says it is not until 2015 that he expects to be balancing the books again. Frankly, I think he is being far too optimistic, I think it will probably be the end of the decade. So we are talking literally about ten years. That is a very long time because we are in a very deep hole. SM If we take different scenarios – Alistair Darling continues in the role and the medicine that he has proposed does not do very much, where next? DM I am not a politician. It seems likely to me whenever the Government has an election they will probably lose it – especially if things seem not to be working as you are hypothesising. So that means it will be another Government coming in. But that won’t make any difference. I mean you will have the same civil servants, you will have the same political calculations. It will be a nasty problem for an incoming Government of a different colour, but they will have the same problems. I think the only solution is to take the medicine, as you say, as quickly as possible to get it over with. If you have got flu really all a doctor can say is ‘Bad luck old man, you have got flu. There is not a lot I can do’. That is the thing for the Government to realise. There isn’t a lot they can do in this kind of situation, you will just have to grin and bear it until you are over it. SM One of the things that the wise men say is ‘Ah, but we have learnt from all of that, really. We are a very modern, sophisticated economy now. We can engineer things’. DM Well we may be a modern sophisticated economy, but the scale of error in the forecasts these people were making – only six months ago the forecasts were completely different from what they are now. The idea that these chaps know what they are doing, I think is laughable. SM Isn’t it true that one of the things that we can do is to say, ‘Mr UK, I will take the decisions here’. But if what goes on in America, what goes on in China – aren’t they actually the real determinants and we are just small players in a much bigger game? DM There is some truth in that. This clearly is a global crisis, and it clearly derives partly from the American set up where the American Government, by the way, made a complete mess and encouraged people to lend to people who could never pay the loans back. So that was a disaster. But we have had our own problems here, it’s not just the Americans. It was Gordon Brown, I think, who set up the new financial regulation which has turned out to be so hopeless when it was tested. Now that is a Government responsibility, ultimately. But we are small in the world economy, we are small. That doesn’t make it better or worse for us, I think, it just means we too have got our share of the problem. SM I think then in summary, what you are suggesting to me is a fairly bleak future and that even the measures that have been taken will actually have very little effect and that we are in for a fairly long, difficult time ahead? DM Yes, but the good news is the market will work. The essential problem here is too much Government. If we didn’t have the Government spending so much, borrowing so much, taxing so much, interfering so much and let the market work it is tremendously powerful in creating wealth and it will be so again. So its not all doom and gloom, but hang on for five or ten years, yes. SM OK, I’ll be hanging on. Thank you very much David.