Thoughts on Rachel Reeve's uneasy reprieve, Labour's credibility trap, how (not) to grow an economy, Britain's lost competitiveness, breaking the Brexit omerta and advice for Kemi Badenoch
I think the EU question highlights the problem clearly. Closer relations with the EU would be compatible with an Osbornist or Brownite growth strategy but fits less easily with a developmentalist (which tends towards protectionism) and radical supply side agenda. Hence we had the slightly jarring spectacle last week of Starmer boasting of using Brexit freedoms to pursue a deregulatory approach to AI even as his government is committed to closer EU relations…
Speaking as an Australian, I am astonished that any level of UK governments still maintains and use any pension program that has a growing and/or ongoing unfunded liability position. Australia tackled this issue over 25 years ago. The government pension funds that had unfunded liabilities were 'closed to new members'. Existing fund members had their pension rights maintained. New funds were created to provide for new employees/members and real-time contributions were made by the employer to these new funds, hence no unfunded liability position has developed in the new funds. The unfunded liability position in the old funds has been reduced by the sale of some sale of public assets and as time passes, members (and dependents) die and then the unfunded pension entitlements cease.
It is indeed astonishing. I’ve written quite a lot over the last year or so about New Zealand which was one of the first to grip this problem and whose reforms informed Australia’s reform process. In both cases as I understand it the key was an embrace of accrual accounting and public net worth approach to the national balance sheet. Britain started on this path in the Nineties but then flunked it. The Turner review at the start of the century helped to put the private pension system on a sustainable basis but didn’t touch the public sector
Hey, it’s not just the uk - the vast majority of European government pension funds are unfunded. The UK perhaps does better than others in having some of it’s pensions fully funded (eg local gov). Only a handful of European countries even have half of the obligation fully funded per Eurostat data
And as to being astonished by it - it’s quite easy to understand if you think about it. These seemed affordable at one point amid lowballed life expectancy estimates and optimistic return assumptions and seemed like the right thing to do in the post ww2 state of affairs. Now it is tough politics to change that entitlement - no party wants to have that on their record.
I had a dive into the figures and - please correct me if I’m wrong - the 1990s liabilities in Australia were pretty small (sub 30% gdp) compared to present European levels (over 200% in many cases) which would make applying the same strategy difficult.
I think there is a deal to be done today along the lines that I suggest in the piece, but the biggest obstacle is inappropriate accounting and fiscal rules which create the wrong incentives for the Treasury. My reading of the experience of NZ and Australia is that you have to change these first
I think that makes sense. I agree that Reeves really dropped the ball in her choice of fiscal reform too and agree that a balance sheet approach would be much better. The thing I’m skeptical on is if Labour could make this change so in the next couple of years without markets seeing a second fiscal shift as a ploy to further expand borrowing (as the recent change seems to have largely been)
As a % of GDP Australia’s position in the mid 90’s was not as big as the challenge that UK and other nations now face. The ‘general point’ I was making is that the Australia government(s) in that era, identified and understood that the unfunded liabilities would be an ongoing and growing ‘public sector’ financial problem (to eventually be paid by all taxpayers) and so took action before the situation got further out of control. Many reforms were introduced re superannuation etc. Our system is not perfect, but it is a significant improvement on what we would have been facing if no action had been taken in the 1990’s. Kicking any ‘can’ down the road is never a real plan! Also, as life expectancy increases (in this country) the cost of 'not tackling the issue' would have been truly painful. Our national government did have 'public assets' to sell and although unpopular, the sale of public assets to reduce a part of the unfunded liabilities did kick-start the funding process. Also, the number and % of people in our various public service sectors (local, State, and Federal) in the 1990's was smaller than the same figures today.
Britain had public assets to sell too, famously North Sea oil and the utilities, but the receipts were used to cut taxes while providing continental levels of public services. Hence the world’s largest double deficit after America and chronic low levels of investment.
1980s libertarianism must have been a lot of fun with all those state assets to fund the party - I honestly don’t understand how this sort of thing hasn’t tarnished Mrs Thatcher’s reputation in retrospect (or at least it doesn’t seem to have to me)
Interesting, I don’t know much about 1990s Australian government, but my perception was that policymakers were willing to take on a tough fight - this + post port Arthur gun control - let me know if my read there is wide of the mark
UK state assets are in a sorry state - so we wouldnt have much luck with following Australia
The Australia solution is good in that it pushed a lot of capital into Australian equities, which the UK could do with with only around 2% (ish) of UK pf money heading to UK equities, but I do believe the particulars of the Australia solution has swung this the other way with the superannuation schemes being far too bigger players?
As to your broader argument - I fully agree, and this kicking the can down the road on pensions, health, defence etc was a subject of a recent blog of mine
Most local government pension funds are in surplus and have cut the employer contribution required from councils so it’s possible that pension costs in the UK are now less than 25% of council tax.
There is a difference between the funded local government scheme (2 million members) and the unfunded public sector schemes for the NHS, civil service, armed forces and teachers (3 million).
On a point of detail, Dieter Helm says that the government should ask fundamental questions, such as why manufacturing industry is "very much on the exit path". There is an even more fundamental question for government, which might be expressed in these terms: "Do we think it matters much if manufacturing is on the exit path." There has been an ambivalence on that subject within government for decades, which is one of the reasons it is weaker now.
Reeves unboxing her position on taxation might be done by merging NI and income tax. She could claim she didn’t do it in last years budget cos it needed modelling and they didn’t have time.
Economically, it would allow to raise taxation without showing a rate increase as the two taxes would need merging and it would be hard for people to understand whether they were paying more or less. And certain groups such as the retired and self employed would contribute more as they avoid NI currently.
Politically, she could claim not to have broken her promise, and probably win the argument. A number of think tanks would welcome the change as its pro growth. And businesses that currently bemoan the NI increase might back her as she could claim she listened to their concerns and has addressed them.
And maybe it would give her Gordon Brown moment as he had with interest rate setting moving to BOE at the begging.
But I fear she won’t, I get impression that Starmer and her aren’t that courageous. Shame as the lack of willingness to get stuff done early in their reign maybe their undoing later.
We need to achieve net zero ASAP - that has to be the overriding priority for this government.
We are one of the most nature-depleted countries in the world, and still getting worst - our second priority needs to be not just reversing that, but significantly increasing both biodiversity and bioabundance.
One constant frustration I have with UK politics (especially living in Australia with our 3 year terms) is that UK Govts have this incredible luxury of 5 year terms and a weak upper house, but still they think about reelection from day 1.
You can change a country in 5 years, LBJ pushed through the Civil Rights Acts and VRA as well as passing most of The Great Society and even had time for a disastrous war in 5 years, Keating as PM pushed through Native Title, competition policy, enterprise bargaining and superannuation as well as creating APEC in 5 years. If UK Govts just said ‘screw reelection I’m just going to change the country’ from day one, who knows they might even find the public would reward them and reelect them anyway
Only the local government schemes are funded. It is the private sector schemes, which are mostly closed but are fully funded, that the government hopes can be a source of investment in UK infrastructure and manufacturing, but is currently held back to a certain extent by regulation
Referring to section 1, you refer to "havoc" if US and UK/European interest rates diverge; the question is the impact on currency markets.....do we get a slow decline in the pound (to, say, parity) or a more dramatic "run" which requires a rate rise? I think there is appetite for the former. But hard to achieve.
Thanks David. I agree the currency question is the big unknown here in terms of whether Europe can de-link from US yields. We’re clearly heading for weaker sterling versus the dollar but interesting that trade weighted sterling didn’t fall much when yields rose, which is partly underpinning eg Goldman call for four rate hikes this year. But a quick slide to parity is exactly the kind of havoc I had in mind!
On the different economic models, where might joining the EU's custom union fit?
This, in effect, increases the size of the profitable market, but it seems more than just Osbornism - making the investment environment sound?
I think the EU question highlights the problem clearly. Closer relations with the EU would be compatible with an Osbornist or Brownite growth strategy but fits less easily with a developmentalist (which tends towards protectionism) and radical supply side agenda. Hence we had the slightly jarring spectacle last week of Starmer boasting of using Brexit freedoms to pursue a deregulatory approach to AI even as his government is committed to closer EU relations…
Speaking as an Australian, I am astonished that any level of UK governments still maintains and use any pension program that has a growing and/or ongoing unfunded liability position. Australia tackled this issue over 25 years ago. The government pension funds that had unfunded liabilities were 'closed to new members'. Existing fund members had their pension rights maintained. New funds were created to provide for new employees/members and real-time contributions were made by the employer to these new funds, hence no unfunded liability position has developed in the new funds. The unfunded liability position in the old funds has been reduced by the sale of some sale of public assets and as time passes, members (and dependents) die and then the unfunded pension entitlements cease.
It is indeed astonishing. I’ve written quite a lot over the last year or so about New Zealand which was one of the first to grip this problem and whose reforms informed Australia’s reform process. In both cases as I understand it the key was an embrace of accrual accounting and public net worth approach to the national balance sheet. Britain started on this path in the Nineties but then flunked it. The Turner review at the start of the century helped to put the private pension system on a sustainable basis but didn’t touch the public sector
Hey, it’s not just the uk - the vast majority of European government pension funds are unfunded. The UK perhaps does better than others in having some of it’s pensions fully funded (eg local gov). Only a handful of European countries even have half of the obligation fully funded per Eurostat data
And as to being astonished by it - it’s quite easy to understand if you think about it. These seemed affordable at one point amid lowballed life expectancy estimates and optimistic return assumptions and seemed like the right thing to do in the post ww2 state of affairs. Now it is tough politics to change that entitlement - no party wants to have that on their record.
I had a dive into the figures and - please correct me if I’m wrong - the 1990s liabilities in Australia were pretty small (sub 30% gdp) compared to present European levels (over 200% in many cases) which would make applying the same strategy difficult.
I think there is a deal to be done today along the lines that I suggest in the piece, but the biggest obstacle is inappropriate accounting and fiscal rules which create the wrong incentives for the Treasury. My reading of the experience of NZ and Australia is that you have to change these first
I think that makes sense. I agree that Reeves really dropped the ball in her choice of fiscal reform too and agree that a balance sheet approach would be much better. The thing I’m skeptical on is if Labour could make this change so in the next couple of years without markets seeing a second fiscal shift as a ploy to further expand borrowing (as the recent change seems to have largely been)
I think Labour missed its chance and may ultimately pay a price for its timidity…
They certainly haven’t made it easy for themselves to say the least
As a % of GDP Australia’s position in the mid 90’s was not as big as the challenge that UK and other nations now face. The ‘general point’ I was making is that the Australia government(s) in that era, identified and understood that the unfunded liabilities would be an ongoing and growing ‘public sector’ financial problem (to eventually be paid by all taxpayers) and so took action before the situation got further out of control. Many reforms were introduced re superannuation etc. Our system is not perfect, but it is a significant improvement on what we would have been facing if no action had been taken in the 1990’s. Kicking any ‘can’ down the road is never a real plan! Also, as life expectancy increases (in this country) the cost of 'not tackling the issue' would have been truly painful. Our national government did have 'public assets' to sell and although unpopular, the sale of public assets to reduce a part of the unfunded liabilities did kick-start the funding process. Also, the number and % of people in our various public service sectors (local, State, and Federal) in the 1990's was smaller than the same figures today.
Britain had public assets to sell too, famously North Sea oil and the utilities, but the receipts were used to cut taxes while providing continental levels of public services. Hence the world’s largest double deficit after America and chronic low levels of investment.
1980s libertarianism must have been a lot of fun with all those state assets to fund the party - I honestly don’t understand how this sort of thing hasn’t tarnished Mrs Thatcher’s reputation in retrospect (or at least it doesn’t seem to have to me)
Interesting, I don’t know much about 1990s Australian government, but my perception was that policymakers were willing to take on a tough fight - this + post port Arthur gun control - let me know if my read there is wide of the mark
UK state assets are in a sorry state - so we wouldnt have much luck with following Australia
The Australia solution is good in that it pushed a lot of capital into Australian equities, which the UK could do with with only around 2% (ish) of UK pf money heading to UK equities, but I do believe the particulars of the Australia solution has swung this the other way with the superannuation schemes being far too bigger players?
As to your broader argument - I fully agree, and this kicking the can down the road on pensions, health, defence etc was a subject of a recent blog of mine
https://open.substack.com/pub/jbmacro/p/public-finances-are-broken?r=2tong2&utm_medium=ios
Most local government pension funds are in surplus and have cut the employer contribution required from councils so it’s possible that pension costs in the UK are now less than 25% of council tax.
There is a difference between the funded local government scheme (2 million members) and the unfunded public sector schemes for the NHS, civil service, armed forces and teachers (3 million).
Excellent pieces.
On a point of detail, Dieter Helm says that the government should ask fundamental questions, such as why manufacturing industry is "very much on the exit path". There is an even more fundamental question for government, which might be expressed in these terms: "Do we think it matters much if manufacturing is on the exit path." There has been an ambivalence on that subject within government for decades, which is one of the reasons it is weaker now.
Reeves unboxing her position on taxation might be done by merging NI and income tax. She could claim she didn’t do it in last years budget cos it needed modelling and they didn’t have time.
Economically, it would allow to raise taxation without showing a rate increase as the two taxes would need merging and it would be hard for people to understand whether they were paying more or less. And certain groups such as the retired and self employed would contribute more as they avoid NI currently.
Politically, she could claim not to have broken her promise, and probably win the argument. A number of think tanks would welcome the change as its pro growth. And businesses that currently bemoan the NI increase might back her as she could claim she listened to their concerns and has addressed them.
And maybe it would give her Gordon Brown moment as he had with interest rate setting moving to BOE at the begging.
But I fear she won’t, I get impression that Starmer and her aren’t that courageous. Shame as the lack of willingness to get stuff done early in their reign maybe their undoing later.
We need to achieve net zero ASAP - that has to be the overriding priority for this government.
We are one of the most nature-depleted countries in the world, and still getting worst - our second priority needs to be not just reversing that, but significantly increasing both biodiversity and bioabundance.
One constant frustration I have with UK politics (especially living in Australia with our 3 year terms) is that UK Govts have this incredible luxury of 5 year terms and a weak upper house, but still they think about reelection from day 1.
You can change a country in 5 years, LBJ pushed through the Civil Rights Acts and VRA as well as passing most of The Great Society and even had time for a disastrous war in 5 years, Keating as PM pushed through Native Title, competition policy, enterprise bargaining and superannuation as well as creating APEC in 5 years. If UK Govts just said ‘screw reelection I’m just going to change the country’ from day one, who knows they might even find the public would reward them and reelect them anyway
Many public sector pension schemes are fully funded? They also represent a major means of investing in UK infrastructure and manufacturing.
Only the local government schemes are funded. It is the private sector schemes, which are mostly closed but are fully funded, that the government hopes can be a source of investment in UK infrastructure and manufacturing, but is currently held back to a certain extent by regulation
Yes LGPS whether merger will help or hinder don’t know.
Simon, interesting as always.
Referring to section 1, you refer to "havoc" if US and UK/European interest rates diverge; the question is the impact on currency markets.....do we get a slow decline in the pound (to, say, parity) or a more dramatic "run" which requires a rate rise? I think there is appetite for the former. But hard to achieve.
Thanks David. I agree the currency question is the big unknown here in terms of whether Europe can de-link from US yields. We’re clearly heading for weaker sterling versus the dollar but interesting that trade weighted sterling didn’t fall much when yields rose, which is partly underpinning eg Goldman call for four rate hikes this year. But a quick slide to parity is exactly the kind of havoc I had in mind!