by Jonathan Todd
John Moody first offered credit rating services in the US in 1909. By this time, Dutch investors had been buying bonds for three centuries, English investors for two, and American investors for one century. Investors have, therefore, prospered for long periods without credit rating agencies.
Many would argue that they could again. The agencies did not facilitate wise investment by giving triple A ratings to the collateralized debt obligations (CDOs) that were at the heart of the financial crisis. CDOs are, however, complex financial instruments. While the ratings were misplaced, it is understandable that financiers would place value on independent assessment of credit worthiness in the face of such complexity.
The UK is less complicated. We are, obviously, struggling. National wealth has not increased since George Osborne became Chancellor. But national debt has increased by over 30 per cent, taking it over one trillion pounds for the first time in history.
Osborne likes household analogies. His UK is a household with no more wealth than it had almost three years ago and little likelihood that this wealth will significantly increase in the near term. But ballooning credit card debts. This is the kind of household that finds it very difficult to get a mortgage in Osborne’s Britain.
Osborne has not practised the “arithmetic” that Bill Clinton beautifully described and praised in his speech to the Democratic National Convention last year. And we hardly need credit rating agencies to tell us this. Those trading in UK debt certainly don’t. This is why – like France and the US before us – a downgrade may have little impact upon the cost of UK debt. The factors that have led to the downgrade have already been factored into the price.
While the downgrade told us what we already knew, Osborne might privately lament: “The agencies told me to cut or be downgraded, so I cut. Then we didn’t grow and they downgraded me, anyway.” Not only are agencies discredited after their poor assessments of instruments like CDOs, they also urged cuts upon Osborne and welcomed his willingness to go further and faster than Alistair Darling had proposed. Osborne may be frustrated for being punished for following this path.
Up to a point, Chancellor, more balanced counsel would insist. What matters is not only that cuts are made but what is cut. The composition of public spending matters, as well as its level. Net public investment for 2015-16 was cut to just 1.1 per cent of GDP from 3.5 per cent in 2009-10 in Osborne’s 2010 budget.
There was no disagreement in 2010 between the major political parties that without some form of fiscal consolidation – some mix of spending cuts and tax increases – the cost of UK debt would dangerously increase, eating ever further into resources that might otherwise be spent on schools and hospitals. However, by failing to protect investment, Osborne cut deeply into the kind of spending that does most to stimulate growth and through this stimulation generate the tax receipts that reduce the need for cuts.
The Conservatives have sought to make political hay out of claiming to protect international development and the NHS. The truth is that the form of public spending that it is most economically important to protect is investment. It is also one of the most politically easy to cut: no one protests over a road that is not built; many protest over a proposed hospital closure. Deeper cuts in relatively unpopular forms of spending – local government, welfare – further betray the fundamentally political motivations of Osborne.
He has given us bad politics and worse government when what was needed was good government guided by sensible economics. Such economics would have protected investment and Nick Clegg has recently admitted investment cuts have been mistaken.
But it is not the deputy prime minister’s belated conversion to arithmetic that is most damning of the government. It is, as Martin Wolf wrote last week, “to ignore the signals given by the very markets in which it is supposed to believe so strongly; with index-linked gilts showing real yields of zero, or even less, savers are in effect screaming: borrow and spend”.
These market signals came much louder and earlier than last week’s downgrade. These signals were ignored by Osborne because, despite professing belief in markets, he only really believes in his reading of the politics. And these politics may yet work out for him. More people blame the last government than his for the cuts and a clear majority see them as necessary.
The policy and political task for Labour is to embrace this necessity, while finding convincing and credible ways to both protect public investment and unlock private investment. Without this investment there will be further downgrades.
Jonathan Todd is Labour Uncut’s economic columnist