Governing the ungovernable

In years to come economists may well reflect on the past decade of British political history as the period where the UK lost a hold on the relative stability that enabled it to make progress from the early 1980s through to the EU Referendum in 2016.

The decade that has followed has offered us up seven different leaders. The only other G7 nation that previously hit a record like that was the Japanese, and they have mended their ways.

Such instability no doubt in part reflects the individual weaknesses of particular prime ministers but also speaks to how fundamentally hard the country has become to govern. The economic shortfall produced by Brexit coupled with the pain of the pandemic and the debt build-up ever since has created a scenario where no political leader has any good choices left. Taxes are too high, but so is debt. Welfare bills are rising exponentially but the government's own backbenchers will not permit any new restraint. The country is suffering from a labour shortage in key areas but greater legal immigration is politically impossible in the current climate.

The country desperately needs to build but can't afford it. It desperately needs to reinforce its defences but precious little resource is available.

Overarching all of these challenges is the fact that the British public has perhaps never before felt they are paying so much and getting so little back. The populace is unsettled and rebellious, ready to throw off the shackles of conventional party politics, feeling they have logically exhausted each option on the left and right. Devoid of hope, the polls suggest many are ready to try a wild card. 

For a Labour leader the challenge is that his own party is demanding a pivot to the left just as the polls suggest the country is demanding a pivot to the right.

Andy Burnham will suffer these problems just as painfully as Keir Starmer did. He walked lightly into the Commons this week and riffed on a Monty Python joke. When he walks in as Prime Minister he will carry this enormous load on his shoulders.

The immediate fear for investors is whether Burnham will lurch to the left and unsettle bond markets. We think this fear is probably unfounded. The room for manoeuvre on spending and the fiscal rules is so slight that whilst he may have made overtures to the left politically he will in reality hold the narrow safe ground that the current administration occupies.  This has been evidenced in the past week by his choice of leading economic advisers such as former chief economist at the Bank of England Andy Haldane, the former head of the Office for Budget Responsibility Richard Hughes and former Goldman Sachs chief economist Jim O'Neill.

Of the three the potential maverick is O'Neill who may well try to search for creative ways to take infrastructure spending off the government balance sheet to get it started. This is however no bad thing provided it is done with restraint around the bond market response. But any economic team made up of Haldane and Hughes can hardly be seen as market unfriendly. 

There remains some room for market uncertainty if the more left-wing Ed Miliband is chosen as chancellor. However, we believe even here the reaction to calm markets would be swift. There is also scope for much frustration for savers and investors if Wes Streeting becomes chancellor. He has appealed to his party by offering to bring capital gains tax rates in line with income tax. This is something of an 'old chestnut' that reappears each time a Labour chancellor wants to shore up support. It tends to follow a predictable pattern: the idea is asserted loudly as 'fair', the Treasury responds by presenting another new batch of evidence showing it would cost more money than it would make, and then the government backs down. But it is an unpleasant journey and one where investors are grateful for their financial adviser to navigate the uncertainty it creates. 

The bigger challenge therefore is likely not a fresh crisis in the gilt market but whether there is any realistic blueprint to lift the UK from its economic malaise in the long term. So far it is fair to say that Burnham's focus has been on second-order problems such as discussions about funding for public services and the relationship of government to the private sector. 

These are reasonable debates but ultimately the UK government must define its answer to the primary question: how do we make the UK more productive again? There is little to no consensus on this point from the Bank of England, the Treasury or the Office of Budget Responsibility. To quote the economist Paul Krugman: 'productivity isn't everything, but it's almost everything.' The answer to this question that Burnham's government produces may not be perfect - it is a dizzyingly complex problem. Yet fundamentally the country is perhaps ready to try responding to a plan in this area, however imperfect, rather than fiddle at the margins at each budget time pushing problems down the road. Any answer will be painful. It will require big decisions like perhaps removing the pensions triple-lock, significantly cutting welfare spending or raising personal income tax whilst easing conditions for business. The Starmer government marched up the hill on many of these challenges, only to retreat at the first sign of opposition. But the scale of this challenge will require far more political bravery to make progress.

 History may be kind to the leader who makes these choices; the polls may well not.

In the meantime we continue to view the UK bond market with scepticism. We believe that the US Treasury market offers us similar returns with  lower volatility. We have also seen our holdings in UK shares progressively fall in recent years as the UK's economic woes have progressed. 

Perhaps as one MP chirped from the sidelines as Burnham entered the House of Commons, 'Rome {really is} saved.' But we have yet to see the evidence of that and continue to pursue high levels of geographic diversification in portfolios.