Why the ratings agencies could be right about Britain Russell Lynch
Adam Smith put it best almost 300 years ago when it comes to the crucial ingredients which make things tick in a modern economy. Nearly 20 years before he put quill to paper on The Wealth of Nations, he wrote: “Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism, but peace, easy taxes, and a tolerable administration of justice; all the rest being brought about by the natural course of things.”
Later on, in Wealth, he expanded on the theme to stress that “commerce and manufactures can seldom flourish in any state in which there is not a certain degree of confidence in the justice of government”. What Smith is talking about here is the institutional strengths of a nation which underpin economic growth.
It was the outgoing chairman of the Office for Budget Responsibility, Robert Chote, who brought that Smith quote to mind at the end of a withering presentation of the risks to the public finances. As a former journalist never shy of speaking during his stint as the Government’s official watchdog, you didn’t have to read too far between the lines.
The chairman remarked that “more now than ever, it is important to value institutions that can give investors and citizens confidence in good government and good economic management”, highlighting a “nonpartisan civil service, an independent central bank, robust regulatory agencies and a fiscal watchdog empowered to serve the public and Parliament”.
Plunging debt interest costs will allow Rishi Sunak, the Chancellor, to sell more than £500bn of gilts in the current financial year to pay for the Covid-19 crisis. But the OBR chief ’s parting shot was a clear hint that things may not always be so. In a world where both public and private debt is soaring, the risk that interest rates will creep higher on our £2 trillion debt pile is also greater. Hence the importance of institutions and governance.
Close watchers of sovereign debt markets say institutional strength tends to be one of the saving graces for advanced economies with low trend growth and very large debts such as the UK. But ours has diminished, according to Moody’s, which has had the UK’s overall rating on a negative outlook since last November.
Moody’s still has praise for our courts system, a credible central bank and a “highly qualified” civil service. But before the Brexit referendum in 2016, the UK received its highest possible score for institutional strength. Now it is a much more middle of the road “a1” rating. To put that into context, the agency rates our institutions and governance at a lower level than every single member of the G7 except Italy, at “a2”: we are one notch above a country consistently rated as one of the most corrupt in Europe.
Why has the Moody’s rating drifted south? Its view is that the predictability and effectiveness of economic and fiscal policy have “diminished” following the Brexit vote. The complexity of the challenge (as underscored by the blizzard of customs paperwork announced last week) “dominates policymaking and leaves limited political capital and civil service capacity to address other challenges relating to the UK’s growth potential and weak productivity growth”. It isn’t just Moody’s either: Standard & Poor’s says “destabilising shifts are possible and policy predictability has reduced in recent years”.
All in all, you wouldn’t pencil in now as the best time to launch a full-blooded attack on the civil service. Hence some of this Government’s moves during the pandemic – the defenestration of Sir Mark Sedwill, the Cabinet Secretary, for example – have been surprising, to say the least. The appointment of Brexit negotiator and long-term Johnson ally David Frost as our new national security adviser, despite no expertise in the field, also falls into that category. In the background, the PM’s special adviser Dominic Cummings talks about the “hard rain” ready to pour down on the civil service, when going to war on Whitehall at this juncture feels like rebuilding an engine on an airliner at 35,000ft while flying through extreme turbulence.
What about the courts? An independent judiciary is one of the country’s crown jewels and the English legal system is so wellregarded that around 70pc of all cases heard involve a foreign claimant or defendant. So more eyebrows were raised among ratings agencies by the Conservatives’ manifesto pledge for a Constitutional, Democracy & Rights Commission “to restore trust in our institutions” weeks after the Government’s Supreme Court defeat over its attempt to prorogue parliament last September.
Ensuring judicial review is “not abused to conduct politics by another means or to create needless delays” smacks of Don Corleone coming for his enemies. It implies the commission’s results have already been decided. Is it “trust in our institutions and in how our democracy operates” we want, or institutions that can be trusted to deliver the right result?
Attorney General Suella Braverman’s previous comments that the “delicate relationship between law and politics is off-balance” and her talk of taking back control “not just from the EU, but from the judiciary” raises more doubts. Braverman argued rightly that restoring the sovereignty of Parliament is a key benefit of Brexit, but the whole point of the Supreme Court’s prorogation decision was that the executive’s act prevented the ability of that very Parliament “to carry out its constitutional functions without reasonable justification”. The judges defended the institution of Parliament; it was just that the Government didn’t like Parliament.
The OBR reckons the UK’s debt interest bill has dropped by more than £50bn since March alone, and as long as it remains low, Downing Street is unlikely to give a fig what the ratings agencies think. Even if the UK is downgraded in the months ahead, as is likely, the pain would only really kick in if gilts lose their investment-grade status and there is no chance of that in the near future. But as the Treasury embarks on drafting its sixth set of fiscal rules in a decade and the borrowing piles up to pay for the pandemic, ministers should take more care of the pillars of the British state rather than bringing them down brick by brick. Confidence in those institutions, as Chote put it, “is hard to build and all too easy to erode”. If too much damage is done, we might all pay a higher price – quite literally – in the longer term.
Rishi Sunak plans to sell £500bn of gilts in the current financial year to pay for Covid-19 crisis