Callum Pickering (2:42)

My pleasure. Thank you so much for having me.

Marin Somerset Webb (2:45)

Right, and we're going to have one of our usual super upbeat conversations about the UK economy and UK Politics, right?

Callum Pickering (2:51)

That's right. Well, you know, I'm always trying my best at least to just not be counter narrative on purpose, but just kind of question the narrative a little bit. The last one, of course everybody was focused on the price of energy. I tried to make my case that it's really the supply. This time around I've taken issue with two things. The first is the idea that the economy is stagnating. It's actually not. Stagnating has some issues, but stagnation is not the right word. And second, that the problems are uncertainty and confidence. I consider these to be symptoms of a problem rather than the problem in of itself. And in this, this latest piece of research, I've tried to unpick some of this a little bit.

Marin Somerset Webb (3:29)

Okay, well let's start at the very beginning. When you say it's not stagnating, what is that that you mean? Because you know, growth rate of under 2% for quite some time, that looks like stagnating to me.

Callum Pickering (3:41)

So UK growth is probably in the sort of mid 1 to 2 range. I think it's probably around 1.6, 1.7%. If I look at the last two years of UK economic performance so late 2023, which roughly coincides with the normalization of the acute gas supply shock in Europe and the bank of England stopping raising interest rates. We've had annualized economic growth since then of 1.7%. It's been predominantly driven by domestic oriented services. Now this is not stagnation over say a full business cycle. If you had the normal fluctuations with growth above 2 for a while and then a period of recession, I think we'd be somewhat happy with this. To put it into context, between 2010, 2019, growth was 2.1% annualized, with bit better growth on things like exports and industry. But I think there's a kernel of truth, at least from the market's perspective and in the view that the economy is stagnating for the following reason. When I look at the components of this 1.7% growth, what I see is a big expansion in government spending and declines in cyclical sectors like new housing construction like durable goods expenditure, like broad construction in the private sector. Which suggests to me, and I call this kind of the flat white economy, the steady state, people buying coffees, people paying their bills, that stuff is actually ticking over. Okay, but the cyclical bit of the economy, which markets tend to look forward to, which companies need to react to by raising capital in order to then do a little investment that bit is actually not stagnating, but in many respects it's in decline. And I think the crux of the economic problem lies in trying to better understand why we have this absence of cyclicality right at the start of an economic cycle. And I put this on fiscal policymakers. I say that policymakers fundamentally are lacking the credibility to get benchmark interest rates to where economic fundamentals need them. And because they're obstructively high, probably to the tune of about 100 basis points on the 10 year, we are crowding out these cyclical parts of the private sector. And this is essentially the heart of the issue that the UK is facing and why these budgets matter so much.

Marin Somerset Webb (6:06)

Okay, we're going to come back to your, your three points on why you think the UK economy is sluggish if not stagnating. But I do want to make the point before we do that that you're looking at GDP as a whole. And a lot of our listeners are very interested in looking at population adjusted. So it's GDP per head. And if you look at GDP per head, as you know, this is barely budged for years and that is stagnation.

Callum Pickering (6:27)

Well, I have to push back on that. Again if I look at the.

Callum Pickering (6:32)

Living standards of workers, so real incomes, real wages, they're rising nicely and have been for three years. It pays to work in the uk what we have is a problem integrating new immigrants into the labor force. And therefore we have this ratio of output to population which is unchanged. But within that what you see is for workers, living standards are rising and for people that are not participating in the labor market, living standards are declining. And so the problem is not that we are not producing a means to raise living standards in the uk, it's that actually we are not properly integrating people into the labour market so that more and more people can participate in that wage story and lift per capita gdp.

Marin Somerset Webb (7:17)

Okay, so it's rising levels of non participation as opposed to stagnating levels of productivity per worker.

Callum Pickering (7:24)

Wages per worker. We have to be a little bit careful with the productivity statistics at the moment. But for wages in the uk, inflation adjusted wages have been growing at a nice clip for, for the past two to three years. If I look at real disposable income for the household sector as a whole, we've had faster growth over the past three years, about 1.8% year over year than we have had in the whole post GFC period. You have to go back to the pre global financial crisis period. And this is where you start to find some of the.

Callum Pickering (7:55)

Signs to what may be going on. So we've had this rise in real disposable income for the household sector since 2022, which is when inflation, of course, peaked at 11% and it's come down.

Marin Somerset Webb (8:08)

Do you know, I'm going to interrupt you, sorry. Kind of briefly say that not all of our listeners are economists. So when you say real disposable income per household, could you just break that down for us and explain to listeners what it is you mean by that?

Callum Pickering (8:20)

This is the total amount of income which can be spent post tax, adjusted for prices. So we have had this rise over the past three years, but since 2022, we've had a doubling of the savings rate in the UK from about 5% to 10%. Now, what's important to understand here is that conventional wisdom, which is households are saving more because they're uncertain about the future, they're lacking the confidence to spend, does not fit the facts on a relative basis. So what I mean by that is, suppose you were to compare the UK household to the US household. US households are saving just 4% of their income compared to 10% in the UK. And we, of course, have had this increase. Both sectors, both household sectors have had a nice increase in inflation adjusted incomes. What I don't see is.

Callum Pickering (9:16)

Additional weakness in British confidence versus US confidence. If I look at things like the Index of Economic Policy Uncertainty. Of course, with trade wars and the uncertainty around Trump's policy agenda, we report more uncertainty in the US than in the uk. So the facts don't fit the picture that confidence and uncertainty explain this savings rate.

Marin Somerset Webb (9:39)

Isn't one of the important things here that there is not a regular expectation in the US that there will be a consistently rising tax burden? Whereas in the UK, we've had, for the last three or four years, constant expectation of a rising tax burden. And that's particularly relevant now. So that's one big difference between the US and the uk in terms of individual confidence?

Callum Pickering (10:01)

No, I don't think so. And actually, if I just think about the size of the deficit in the US, the fiscal deficit, it's 7% of GDP. It's actually almost twice what it is in the UK. And at least in the UK's instance, it's likely to decline over time, whereas it's likely to remain around 7% of GDP in America, that deficit is, is a signal that at some point taxes have to go up. For Americans, that's a much stronger signal in the long run that taxes need to be adjusted upwards, sure.

Marin Somerset Webb (10:27)

But is that what ordinary people listen to? They listen to the political conversation as opposed to looking at the size of the deficit. If we're thinking about the ordinary person, not the economist, not the professional investor, not someone who understands the bond market, not someone who looks at how big a deficit is or isn't, what they're looking at is the political conversation. And here the political conversation is all about your taxes are going up. And in the US the political conversation is absolutely not like that. Of course, you live in New York.

Callum Pickering (10:57)

I suspect that part of the story may be that people anticipate taxes going up, but there's just something much more fundamental taking place, which is since 2022, UK household net wealth has declined appreciably. In the US it's up almost 50%. And what you find is in credit based economies, consumer oriented economies like the US and the uk, trends in household spending are influenced greatly by trends in household net wealth. So take the experience in the UK for instance, 2010, 2019, we had a dramatic appreciation in house prices, we had a dramatic appreciation in gilts, which is what drove interest rates down. Over that period we also saw actually quite a decent rally, sustained rally in UK equities. This supported net wealth and it meant over that period, even in the ghastly uncertainty of the post financial crisis period, when in 2012 we had a horrible budget, the omnishambles budget, with the weak confidence and the uncertainty, and in the wake of the euro crisis, UK households were reducing their savings rates with weaker income growth, because in net wealth terms they were becoming much better off. So when you had this dramatic upturn in net wealth, you had this corresponding reduction in saving this time around, you see from 2022 onwards, roughly coinciding actually with the big fiscal event which was the trust budget wobble in the bond market, you have this crash in household net worth to the tune of a trillion pounds, mainly in pensions, coincide with this sudden adjustment upwards in the household savings rate. So what I maintain here is we try to apply narratives about uncertainty over taxes, uncertainty over economic policy confidence, which I can't spot a clear trend in the fact. But then I see this very clear fact in front of me, which is households are actually poorer in net wealth terms. In the uk, they've responded by saving more. In the us we often see similar patterns of household behavior. Households are saving much less, but they've had a dramatic increase in net wealth, which means households are rational, they are reacting to being poorer by saving more. This is why this fiscal problem that we have comes at such a bad time and we should get into a conversation about what is underpinning higher interest rates in the uk. But these higher benchmark rates versus what you would expect given economic fundamentals and given rates in other countries are holding back asset prices by pushing up mortgages rates, by holding down the underlying value of the bonds and by forcing equity analysts to apply a discount rate that is higher than it ought to be to equities.

Marin Somerset Webb (13:46)

Okay, so most people will recognize that fall in their wealth. I mean, if you look at.

Marin Somerset Webb (13:52)

The shift in the bond market, a lot of people will feel that only through their pension portfolios. Right? And not everybody looks at their pension portfolios. Not everyone will be aware of that shift, but enough people will be.

Callum Pickering (14:06)

Plus the story in UK equities, plus the story we see in house prices.

Marin Somerset Webb (14:11)

But of course most, most people aren't very exposed to UK equities and we see that across all portfolios that they tend to be much more exposed to the US irritatingly than to to the UK particularly inside a pension portfolio, if it's one of their auto enrollment portfolios or something like that, where they might be slightly more exposed to the US than the old old fashioned pension, to the UK than old fashioned pensions. Still, it's a min they're holding. So they should be seeing rising wealth from their US portfolios and from the UK portfolios this year. Definitely. So they will be feeling it in the main through their bond.

Callum Pickering (14:42)

They'll be seeing it in the main through their bond exposure. And I suspect if you inflation adjust, most people's house prices, especially in London and the southeast, house prices have declined appreciably over this period. And again, just to get out of the abstract economics for a second, what we all know is true, and it's why QE worked so well to stimulate the recovery, is people on a Friday night at their dinner parties like to say, oh, I'm feeling frightfully well off. My house price has just gone up by £50,000 in the last month. I'm going to go and borrow some money to do some repair, maintenance, improvement on my extension or whatever. This is not happening in the uk. And so this net wealth shock which is persisted because we have these obstructively high interest rates, is holding back the normal cyclical momentum. Let me just come at this from two different ways because the thing that's really important when you have economic problems, which we do, is to demystify and to just sense check the narrative. And that's why I think it's important just to push back on these notions of confidence and uncertainty and tax worries when we can see this real effect. Consider this in a different way. If I look at consumer confidence for the UK and I look at it across age groups, the GfK index is split by four different demographics. Under 30, under 50, 50 to 65 and then 65 and over. You can, you can see the picture for these cohorts all the way back to the year 2000. And if you think about all the things that have happened since the year 2000, we of course had the dot com bus, we had 9, 11, we had the global financial crisis, the euro crisis, we had Brexit, we had Covid, we had the Russian invasion of Ukraine. And at every single one of these events, we have seen a co movement in cohort confidence. Younger people, and I think this is, this is the silver lining in all of this, remain and always are more optimistic. So young people are just looking forward to the future. I think that's great news. But very recently, the last two years, we've seen for confidence among young people. So those under 50 rise to the extent that for the youngest cohort it's actually close to its all time high, but for Those aged over 50, it's declining. Now again, it's where we apply a narrative in the UK without thinking about the underlying fundamentals. The common view is this is driven by political preference, that we have a left wing government and young people are happy about that and the older voters that would have preferred perhaps a Conservative government are unhappy that the Conservatives are no longer in office. Then I say, okay, let's ignore the narrative and look at what we can see in the underlying fundamentals. Two things that we've already established. The first is we've had decent income growth in inflation adjusted terms for the last three years. But we know that asset prices have suffered for young people. So under 50, they typically either don't own many assets or the assets that they have, such as a house, they tend to have debt associated with it. So they're not as sensitive to these net wealth effects. They're much more sensitive to income effects. For older voters that have gone through their lifetime earnings growth, that have accumulated assets, they tend to be sensitive to asset prices. And what you see is a decline in inflation adjusted house prices coincides with this weakness in confidence among older cohorts and explains confidence over a long period. The rise in real wages over the past two to three years explains the rising confidence among young workers and younger cohorts. And this is what the divergence is capturing in the confidence data, which means just returning to the economy. The wage driven, income driven parts of the economy, day to day spending are doing okay. That's the reason you have this 1.7% mostly services oriented growth. But the stuff that's really asset sensitive, where we need to feel better off before we go out and borrow and speculate. The people with the real purchasing power at the older, richer end of the income spectrum, they have such depressed asset values that they are reluctant to go out and drive the kind of cyclical activity. And the reason that this is such a confusing concept, I think, is because at the start of a cycle, we are viewing an economy that is entirely, entirely the inverse of what we typically see the start of a cycle. We normally have high unemployment, low real wage growth, low inflation and rapid falls in interest rates which spur on asset price inflation. And the first sectors that usually signal that there's a recovery to come are things like the housing sector, things like credit. Okay, credit's kicking up, let's get excited about economic growth. This time around we have the opposite. We have interest rates elevated. We also have elevated real wage growth. And so the pattern that's emerging at the start of the recovery is very different. And the kicker in all of this is to say I don't think that this is a one off in the UK's case. We have been here repeatedly through history and the fiscal framework that we need to understand in this context is that the UK goes through cycles of strong credibility in face of markets and it outperforms, followed by periods of weakness and impaired credibility that it needs to correct. And I'll stop because I suspect there's a question here. But I want to just go through the history to help people understand why this fiscal matter so much.

Marin Somerset Webb (20:05)

I'd like to do that, I'd like to do that. So I just want to go back. So we're talking about the reasons that you've given in your latest, latest piece about why the UK economy is looking sluggish, not stagnating. So we've talked about one of the things on your list, which is this high household savings and soft consumption since 2022, which are the result of this wealth shock in 2022, which is connected to the bond markets, et cetera. But the other major thing that you pull out is this idea that our policymaking credibility is damaged and that's a problem. And this, this is where you want to talk, I think, about the long term history of cycle of credibility effectively exactly Right.

Callum Pickering (20:46)

So just the, the one line to keep in mind here is I do this and I'm not drinking. I don't have milk in my coffee because it's. Apparently it's not bad, it's not good for you. But we're all warned about these health, these healthy lifestyle choices that we should make now. And if we don't make them, it gives us inflammation in our body. This is the same with the economy. Poor policy choices lead to inflation in the economy. It's exactly the same thing. When you have persistent inflation. It's a signal somewhere that you're organizing your economy badly. Historically, the UK.

Callum Pickering (21:21)

The data I look at starts in the late 70s. And just a quick history lesson. The late 70s, the early 80s, the UK underperformed the G7, so advanced major economies, excluding the UK of course, in a major way, and our bond yields rose relative to other countries.

Callum Pickering (21:40)

We then got back on track through the 80s until the late 80s when we had another inflationary crisis in the late 80s, early 90s.

Callum Pickering (21:48)

And we underperformed again. We then through the 90s, right up until 2007, go through a long period of outperformance. Then we underperformed through the financial crisis. We then outperform from 2000 and about 2011 to 2018, we then start to underperform again. What's the consistent here?

Callum Pickering (22:09)

In 1981, following the underperformance of the late 70s and the early 80s, the Conservative government, recognizing that markets feared another decade of huge inflation in the uk, issued index link gilt for the first time. Basically, we will compensate you for any inflation that we create. We'll transfer the cost of bad policy choices from the people that lend to us in markets to taxpayers, but de facto to government. We'll guarantee a real rate of return that established credible commitment to low inflation. The UK then sees its bond yields come down. The economy outperforms this inflationary Crisis, the late 80s, early 90s, gives way to another loss of credibility and rising bond yields. We join, erm, to try and stabilize and reassert credibility. It doesn't work. In September 1992, of course, we crash out Black Wednesday. Very famous people, I think, Forget that in October 1992 we introduce inflation targeting for the first time. We say we'll commit to inflation between 1 and 4% retail prices, excluding mortgages. The bank of England, of course, wasn't independent at that point, but the Conservatives were viewed as credible enough that it helped to restore confidence, bring bond yields down then into 97 when Labour win Gordon Brown Makes the Bank of England operationally independent and reduces the inflation target, switches to CPI and this once again strengthens the commitment. He also introduces fiscal rules for the first time which at that point were viewed as credible. The UK then continues to outperform. We then get to global financial crisis which reveals the policy mistakes of the past on banking regulation, on fiscal policy and some other such things. George Osborne leading the coalition government in 2010 introduces the fiscal sustainability pact. He legislates to reduce the deficit for five years in a row. He makes the Office for Budget Responsibility which is our independent budget scoring committer, an independent institution to, to check to budget score the government. This works. Bond yields come down, the UK economy continues to outperform and then we start to undo this credibility with a succession of policy mistakes. We mismanage Brexit, we have the trust fiasco, we create too much inflation through Covid. And so the failure, now we come to present day of Rachel Reeves and the Chancellor and the government is not so much that they've, and this is true by the way, they chose in their first budget the wrong kinds of tax increases. It's that she is the first Chancellor following a significant period of damaged credibility and underperformance that has not tried to introduce some fresh new commitment to credible money in the UK to sound money.

Marin Somerset Webb (25:03)

Okay, she's fiddled around the edges of the old stuff, but she hasn't introduced a new system. And you think that would change things.

Callum Pickering (25:10)

Would change things or you need such a big policy change to re establish your commitment to sound money. Now it begs the question like to what extent are we actually seeing this as a problem? So the UK is a mid Atlantic economy geographically. It's also in its behavior, sort of mid Atlantic. It's not quite as sclerotic as the Eurozone, but it's also not dynamic like the us. It has faster growth than the Eurozone, but it doesn't quite grow as quickly as the us. It's small state relative to the Eurozone, but not small state relative to the us. It really fits this mid Atlantic picture. And for that reason historically UK 10 year bond yields or fives or twos or even bank rate tends to sit somewhere between the average of, well, US and the Eurozone today. If I look at markets, French 10 is sort of 2 and a half, excuse me, German 10 is 2 and a half, the French 10 is 3 and a half. So the Eurobond basically 3 US is at 4.1, we're at 4.5, we should be around 3.5. The maths there is we have a 2% inflation target and potential growth probably around 1 and a half 1.6%. You can add inflation to potential growth and roughly get your 10 year bond yield. So we're above to 100 basis points and you can see the moment when we jump above this G7 range. It's October 2022 with the list Trust bond crisis. This is when we dispense the credibility that we had earned after the GFC period and with the Labour government winning the election and having a chance to restore credibility, not taking it and instead reminding everyone that the UK is badly managed and we had the additional inflation thanks to the last budget has just validated market expectations that the UK is still not an economy which properly commits itself to sound money. And so this hundred basis points extra is the reason why we don't have the cyclical momentum and we need some renewed commitment to bring these rates down. And this for me is not about borrowing so much as it's actually about inflation.

Callum Pickering (27:26)

Foreign.

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Marin Somerset Webb (29:42)

Okay, so if we were to. I mean, this, this is something that a lot of people say that the reason why UK bond yields are so high is because there's no expectation of a change in that will take inflation out of the system or that will bring spending down. But you think it's not really about.

Callum Pickering (29:58)

Spending, it's about spending. We have lots of evidence where advanced economies with very low potential growth can run huge deficits for a long time. So long as inflation is under control, as long as lenders feel like the money that they give will be roughly the same in value to the money that they get back. Japan is a point in case Japan is only now facing some fiscal issues because inflation has returned to its economy. If I compare. And again, you don't need to take my forecast, just look at the economic consensus function on a Bloomberg terminal. What you'll see is the UK has probably, over the next three years, US will be the fastest growing economy, followed by Canada because markets expect to pick up in 2027. Then it's the UK and then it's everyone else. So third fastest in the G7, second or third lowest debt to GDP and second or third lowest deficit. And we're the only country where the deficit is actually declining over this period. Even with all the uncertainty over fiscal policy, markets still expect this. So it doesn't seem to be a fiscal issue. But if I compare the UK economy, say over the last 10 years to the G7, we've had extra inflation to the tune of about 100 basis points. In that sense, markets are mostly rational. They're pricing in this inflation. And again, we can just. We don't need to guess narratives. We can see the evidence before our eyes. The market liked the idea of an income tax increase because an income tax increase would have depressed demand, depressed inflation, and yes, reduced borrowing. That's important. And it would have happened immediately. It wouldn't have hinged on the Office of Budget responsibilities forecast relative to the government's target being correct three years out, which is when the fiscal targets kick in. And so you'd have had this immediate recommitment to disinflation by fiscal policymakers. And we've had this jump in bond yields as the government's abandoned this plan and it Just reminds us actually that.

Callum Pickering (32:10)

Fiscal credibility is a serious problem in the uk we are paying a real price for this. And I think the challenge for policymakers to understand is just because we're not facing an immediate crisis doesn't mean that these rates, which are obstructively high for the private sector to get going, are not a serious, serious problem and a serious dysfunction in the private sector.

Marin Somerset Webb (32:34)

Okay. The third thing that you talk about in this report that we've been discussing is an extension of that, to say that interest rates, obviously, they have this effect on asset prices and make people feel bad, but also crowding out.

Callum Pickering (32:50)

Exactly. So crowding out is kind of a bit of a technical concept, but it happens in two ways. One, quite simply, that interest rates are prohibitively high because of fiscal policy for interest rate sensitive parts of the economy to get going. And so, for instance, the government's unwillingness to address either its excessive spending, excessive borrowing, or the inflation that it's creating as a result of those two policies is basically on a collision course with its housing market.

Marin Somerset Webb (33:20)

I should say. One step back, one step back. So it is the fiscal policy that creates the inflation, it's the borrowing and the spending.

Callum Pickering (33:27)

That's exactly right. That's exactly right. Of course, you can make some adjustments here or there, but this is the problem. In that sense, the real limit on an advanced economy when it comes to borrowing is inflation. Right? It's not the overall level of debt. You can carry huge debts in a low inflation economy. You can carry very little debt in a high inflation economy. Markets care about getting their money back in inflation adjusted terms. So the interest rate effect, of course, is significant. And we can see that with the weakness that we see in the housing market. We can see that in the weakness that we see in other interest rate sensitive sectors like manufacturing, investment and so on. The second way we see this effect, and this is where.

Callum Pickering (34:10)

This problem lends itself to a broader theme, which I, which I, which I think we just need to get into a little, which is to say that the government is much less price sensitive when it comes to spending than the private sector. And so the government, when it spends, strips away scarce resources for the private sector to use. And so the crowding out takes place through the interest rate, but also as spending rises, rises as a share of GDP over time. What we're doing is we're reallocating more and more scarce resources away from a private sector which is not as productive as it used to be in growth terms, but it's still growing its productivity and towards a public sector where productivity has been stagnant for more than two decades. And so we're creating more dysfunction through this rising share of government spending as a percent of gdp. And it comes through the way the government consumes resources that could be used by the private sector to do something that would be much more more productive.

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Marin Somerset Webb (37:45)

Co.

Marin Somerset Webb (37:58)

So we've got a lot of problems here. What should happen on November 26 at the budget? What choices can Rachel Reeves make that can at least mitigate some of the damage or actively improve the state of the.

Callum Pickering (38:17)

Uk? I think I'd emphasize three things here. Let me go one point on the immediate problems, one point on the long problems, and then we should discuss capital spending. The first thing is to say think of the budget like a traffic light. There's a green outcome, there's an amber outcome, and there's a red outcome. The green outcome is the best outcome. It's where government recognizes that it's demands on the economy are simply too large and we will cut spending in order to close the borrowing gap. And by cutting spending, we'll depress demand and we'll depress inflation and it will get markets on side. And you could do that through addressing something like welfare or departmental spending. The advantage with welfare is if you cut it in the right place, you can reset incentives for participation in the labor market, especially among young people, where we know we have a problem politically, that's going to be very, very difficult. Yep, that's, that's close to a zero probability event. I suspect the Amber outcome, which is where I think we were for basically a month, which is where the government realizes actually we need to counteract the inflationary narrative that we introduced a year ago by doing a big policy change that is.

Callum Pickering (39:33)

Clearly disinflationary and create space for market interest rates to fall and for the bank of England to be more aggressive with interest rate cuts, which was the advantage with the income tax increase on its own. This is not a good policy. As you mentioned, consumers are skittish and they're not spending enough anyway, so why hit them with an income tax increase? However, because this interest rate problem is such a big deal, you can have this offsetting effect. It's kind of the Clinton Rubin approach in the early 90s. You raise taxes, the Fed cuts interest rates and the economy kicks on. Markets would have reacted well to that because you would have had this bank of England offset. That's the Amber outcome. And I call that amber because it's contingent. It's contingent on the bank of England doing something I fear the government's abandoned this.

Callum Pickering (40:25)

Last Friday and the challenge is that understanding what quite happened. I suspect the government realized it needed to do a lot, convinced itself that its one option was the income tax increase, decided we better signal this to market since we're breaking our manifesto commitment into households and to businesses who've all factored in this expectation and adjusted bond yields declined over this period which validated the idea that this was actually a good policy. The governments then received a new forecast from the OBR seen that with lower bond yields everything looks better. We don't need to, we don't need to do so much taxation and decided to U turn as opposed to saying well perhaps we cut stamp duty on shares or stamp duty on housing or something like this. This is unbelievable. So this amber outcome is now off the table. We're now in what I would consider to be the red zone again. This traffic light idea where we have this horrible patchwork of anti growth tax measures which even if on the face of it are not inflationary, if they land on businesses, businesses may try to pass them on to final prices. But I fear that government is going to go after things like pensions and assets and as I think I established with quite a lot of evidence convincingly it's the weakness in asset prices and the desire to offset that through higher saving that is causing the underlying problem in the economy. So if you go after assets, what you're doing is you're agitating the fundamental problem that the economy is facing. So I think this is a real, real issue and what we're doing is unfortunately by being in this red zone is base case for me into next year would be in this scenario growth still around 1.5%, very little cyclicality, inflation will come down mechanically because we just have a disinflationary trend. The bank of England I think will cut three more times. We might get 10 years down to a little below 4% but the income tax increase would have add two or three more cuts to the bank of England. Take benchmark interest rates down by 100 basis points, revise your growth forecast up to 2%. We've taken away this very clear upside risk which the government had set about. So this is the frustration and now we're left with a real danger that the economy just has this slow motion puncture into next year. Growth dwindles, we get a bit more inflation than we like because businesses try to pass this on. The bank of England finds it hard to cut even three times the bond Market's not convinced, thinks we're going to have to come back for tax increases next year so bond yields stay elevated and the frustration that the economy is producing for people leads to impatience in the Labor Party. That then leads to the uncertainty that could erupt around leadership challenges and all that kind of stuff. So that's now the downside risk, which has become real. So in one week we've replaced a very real upside risk with a downside risk. So in the short run, they just need to somehow pick one or two big policies that close the gap in a disinflationary way that avoid this. They've called it a smorgasbord, but I don't think that's right. I think it's an anti growth patchwork of.

Marin Somerset Webb (43:32)

Taxes. I mean, this is the problem. And then every single one of those new fiddle taxes, because they will be fiddles, right? Every single one of them will come with a furious lobby group. And so the fight back against every single one will be much harder than if they had just come out, as you say, with one big tax across the.

Callum Pickering (43:53)

Board. That's right. And I think just to add another dimension to this, the government seems to have traded off the opportunity to reassert credibility now with an income tax increase in April and to not just be a passive.

Callum Pickering (44:12)

Observer in this disinflationary narrative into next year, but actually in the market's eye, the driver of the disinflationary narrative to now a budget which will rely on the OBR's ever optimistic forecast. Been right on borrowing, growth and inflation. And the market is tired of it's going to happen tomorrow. The amount of foreign investors. I've been sort of everywhere in the last few months, including faraway places like Singapore and Australia. They say, why does the OBR keep including this fuel duty increase when it's been delayed for 14 years, which never happens. This is the kind of thing that is eroding credibility. So it's now no longer. It's going to come tomorrow. Tomorrow never comes. Do something today. A week ago we thought we were there. Now we think we're not there. This is a real policy.

Marin Somerset Webb (45:04)

Failure.

Marin Somerset Webb (45:06)

What do you think that the.

Callum Pickering (45:08)

Smorgasbord. Can't say that.

Marin Somerset Webb (45:10)

Word. I'm going to say that sentence again. Smorgasbord. What do you think the smorgasbord of tax changes is going to.

Callum Pickering (45:16)

Involve? I think it's anyone's guess at this point. I hope that they do a little bit on the spending side. Maybe after the spending round is over, assume lower departmental spending. I think they'll probably they should spend a couple of hundred million to try and reduce tax avoidance and things like that. The OBR might reward them with sort of 3 or 4 billion. I think they'll freeze income tax thresholds from 2028, which is sort of sensible. But again it's in the future. Then I think we're probably looking at something on pension contributions. We're probably looking at the changes to council tax bans, might be looking at the bank levee, fuel duty may go up. But when you're faced with a complicated economic scenario where again I don't want to make the case that the future is so certain, it's just that uncertainty doesn't seem abnormally high in the uk. What you need is a clear narrative. Income taxes up, interest rates down, economy's actually we're sorted, get over it and be on and then come back in a year with a load of headroom. We've given up that. Then there are the two other issues. So let's address capital spending first and then tackle what is the problem not just for the UK but for all advanced countries, which is this rise in debt to gdp, public debt to GDP as the population ages that you mentioned. Before we had our online chat, you were discussing at what point is the government just put up against the wall by bond markets to say fix things. I think that's where the problem lurks, so we should touch on that. But just on capital spending, I really taking issue actually with this abstract view that if only you raise capital spending in the economy, we'll see more productivity growth. Okay.

Callum Pickering (47:06)

This is a nice sentence to include in a policy report, but what this means in the real world is businesses increase their current spending in capital goods and energy and commodities. They combine those factors of production to produce capital stock that can then be plugged in, receive some energy from the grid and make workers more productive. The problem is when you have a regulatory system which says you can't dig that commodity up from the uk, we can't use the energy that we produce in our own market. You can't build on that land, we won't produce those capital goods. So you have to import all of this stuff. Productivity is just the ratio of GDP to workers. If when you raise capital investment you have to import all of this stuff, yes, you'll get some benefit. But what you really need to subtract from that benefit is all the imports you're sending capital abroad. You can't have a proper productivity revolution that is driven by capital expenditure unless you permit yourself to use your own domestic factors of production. The UK is an economy with huge factor endowments. It's the reason we had the Industrial Revolution first. This is what people forget. We have this stuff underground. We just have a lawmaker saying, you can't use that mine, you can't use that energy field, you can't build there. And now with the Employment Rights Bill, you can't employ this person under certain circumstances. This is economic suicide. It doesn't work. And so we won't transform this ambition to have higher capital spending into higher productivity unless we radically deregulate the domestic economy to allow that capital spending to go towards extracting our own domestic factors of production and combining them in a productive way. And again, this is just one of those problems where in the UK we have consensus around another narrative, and yet governments repeatedly try to fit their policies with this narrative. We heard under Osborne, we're going to increase capital spending. We heard under Boris, we're going to increase capital spending. We now hear it under Rachel Reeves. And yet the productivity statistics are just not showing the rise that we want to see, which means there's something fundamentally going wrong in our understanding of the economy. It's not that if we just do cut more capital spending, eventually we'll force our way to higher productivity. The chain of events that we think is true, the narrative, is not wedded in the facts in the right way. And this practical problem that I mention, you know, escaping this weird abstraction that economists do, is where I think the root of the problem lies. And it's why you see the best productivity growth in the economies that are open to using their own domestic factors of production. The US is a point in case. But look at what you see in the Middle East. Look at what you see in parts of the emerging world where they're digging up stuff from their own economy, they're combining it and they're making their workers more productive. Until we accept that we have to do this, we won't see a re acceleration in productivity.

Marin Somerset Webb (50:05)

Growth. Interesting. Now, you say, as you say, we're having a conversation before we started recording about all these things, and we were discussing your view that the UK is not in crisis mode or not near crisis mode, but is in a state of serious dysfunction, is what you call it. And I definitely agree with you that we're in a state of serious dysfunction. No doubt about that. But look at what you've just said about capex and about increasing capital spending and why we won't use Our own stuff. And what you said earlier about capping welfare spending and why that simply isn't going to happen, it slightly feels as though all the solutions are there. You're very good, you've written a marvelous report. It's all absolutely true. Can't disagree with you on any of it. But no one in government is listening and there doesn't appear to be any political appetite at all in the UK to shift on any of these things, be it, be it welfare, be it net zero, be it any, any of these things. Although this shift on immigration is kind of interesting. Maybe that's the door opening to some rational thinking in government, but nonetheless, without the feeling that there is any kind of political appetite for change, it feels that the point at which the bond market says do you know what? Enough and as you say puts the UK up against a wall is significantly closer than it has been for a long time now, is that we may move from dysfunction to crisis faster.

Callum Pickering (51:31)

Than. Of course I might be frontrun here by what's happening in US tech, but my guess is, and this is not the first time I've said this, I've happily said this three or four times on the show this year, that the government debt problem that you have around the advanced world, and this is where the UK just is ordinary, not in a good way, is the root of the next crisis for sure the reason why I think governments are in the UK and elsewhere. This is a broad point, but let's just use the UK as point in case governments are reluctant to address this. So for anyone listening, what is going to happen in our advanced economies is we have made legal commitments.

Callum Pickering (52:12)

And by the way, I think this is the right thing to do. To be absolutely clear.

Callum Pickering (52:18)

Rich societies should not be inflicting poverty and health related indignities on retired people. We can avoid that problem if we get our act together, no question. So this is not about saying we're not going to look after you. But as we see an aging population and the share of.

Callum Pickering (52:40)

Dependence rises, especially at the upper end, our debt, public debt to GDP ratios are going to rise as far as the eye can see. In the UK's case, we have 100% debt to GDP today. The OBR thinks we'll get to 250% within our lifetimes. I just don't think the market's going to let us get there by the way. But this is driven by dramatic increase in health spending, dramatic increase in things like pensions and welfare. And this is true across the advanced world and we're Just at the foothills of this debt mountain. And just as we reach the foothills, the natural buyers of government debt, things like pension funds, which already saw this problem far in advance and had to prepare and manage risk for it, have basically decided, we've got enough of this paper, we don't need any more. And so the price that the market is charging us to issue more debt is too high relative to.

Callum Pickering (53:35)

Again, what the private sector would prefer to really get going. Okay, why is, why are governments not addressing this as the central economic problem first is.

Callum Pickering (53:47)

Governments don't distinguish between chronic problems and crises. So you'll often see that policymakers, simply taken as given, UK is an economy with slow potential growth. As if this is just normal, we should just accept this and we should just manage around it. So you need to raise taxes. We remember the New Statesman title early this year. Just raise tax, okay? That's the solution, accept it, raise tax. You're a slow growth economy, make sure you can fund the state. Okay? So there's, there's, there's, there's a degree of naivety in that view. The second problem for me is that, and of course in the absence of a crisis, you just kind of never have your priors on this, this front challenged. The second challenge, which for me is more important is policymakers, I think, overestimate the positive impact which government spending has on GDP under conditions of normal balance sheet strength in the private sector, which is roughly what we have now, which is to say in the middle of a financial crisis. Do you want to cut government spending? No. When you have a fundamentally healthy private sector full of smart people, low levels of debt and clear opportunity to raise productivity through things like AI, should government fear just pulling back a little bit in not small ways to rebalance fiscal policy? No, but I think they fear if they cut spending, they'll tank their economies into recession and that will mean they'll be out of office. I think this gets it exactly the wrong way around because of the way that I explained this crowding out effect. So what's going to happen, I suspect is at some point these policy choices will, these bad policy choices which have compounded over time. It's not just the Labour government, it's previous Conservative government too, and the previous Labour government before that will erupt into another bout of inflation and the bond market will say that's enough and governments will be forced. And actually I quite liked the, the idea that Andy Haldane, the previous chief economist at the bank of England, came up with this week, say you should say we'll raise taxes by a pound, but we also cut spending by a pound. This is a nice handy rule of thumb. You will be forced to dramatically tighten fiscal policy near term.

Callum Pickering (56:09)

Or say we need a better way to manage these long term liabilities. The result will be markets, I suspect, and governments will fear recessions. The actual consequence will be the bond market will see much less issuance, much less inflation. It will reward governments that fix these fiscal problems, drive down interest rates and then the private sector will start to do much better. Which is why you see so many instances where bloated states suddenly decide to do austerity and the private sector comes alive. I mean, Argentine is our point in case today. Britain in the 80s, we've seen it. Canada, Sweden, there's lots of examples. But we actually have a better option here in my view, which is to say we have not properly managed our public services for the past 14 years and justifiably so. People are unhappy with things like education and health and welfare. Is there a solution where we don't have to cut this? Yes, I think we can address these long term issues. What we need to do is find clever ways to address our long term pension commitments, our long term health commitments, which mean that yes, debt will rise, but instead of getting to 250%, maybe it gets to 150% and rolls over. And I'm going to stop. But if you want, I think I have a solution to.

Marin Somerset Webb (57:30)

This. Yeah, you have to stop there so I can ask you what are these clever ways? Everyone wants to know the clever ways where we can not have to cut spending and not end up at.

Callum Pickering (57:44)

250. Let me kill a lazy narrative here. First to say that you often hear naively that government debt is less risky than private debt.

Callum Pickering (57:57)

This is fundamentally wrong in a properly regulated economy. And roughly speaking, the UK basically is now, when a bank issues a loan, it will have done the due diligence to make sure that the borrower is using that loan for something good. And when it comes to big loans generally it's like, are you actually investing, are you increasing the value of your house? Right, so there's an income generating asset that goes with the loan and so the net yield, the net return is positive. Which means on the private sector, yes, you have rising debt over time, but you tend to have rising assets and you generate an ever greater positive net wealth position.

Callum Pickering (58:39)

Which is why we can tolerate ever growing levels of debt. With the public sector, it's completely different. What we've had actually across the advanced world is this ratcheting effect where to avoid recessions in the short run, which would have had some bad consequences, but also some good consequences. They're great cleansing events. We have increased debt substantially to fund current spending just to avoid the recession. The result of this ratcheting effect is we've had a succession of crises where we just added, added, added and added to debt, and we have no assets that are productive. On the other side of it, if we would have raised all of this debt to GDP to expand energy and infrastructure and mines and all the rest of it, okay, so I'm not in favor of making everything a very, very different result. So now we have a situation where we have no assets to go alongside of all of this debt. But the debt itself requires an interest, which is now a headwind. We spend £100 billion a year. Okay, so we, we need to start re evaluating the way we think about government debt so that we're generating assets. And actually again, to an extent, Rachel Reeves adjusting her fiscal rules to not exclude capital, to exclude capital spending sort of gets there and to look at a net wealth measure. But take the two big costs that people will impose in retirement on the public. First is their pension. The second is health costs. With pension, it's through their entire period out of work. With health costs, for most people, it's sudden increases very late in life or in one or two instances.

Callum Pickering (60:20)

What we should do is recognize there's a difference between government providing pensions and health care and guaranteeing it. And so what I would like to see in the uk, when people enter the workforce for the first time, and you could probably apply this to anyone under the age of 40, you get a 2,000 pound tax cut in your first year. That 2,000 pounds goes into. Pick something. Take an ETF, 50% global, 50% UK. It'll give you anywhere between 8 and 10% per year. You compound that until you retire. And that is your pension pot. And you will get a big number. By the time you're 70, you'll be anywhere between 350 and £400,000. You'll be better off than if you got your state pension today in a lump sum. And that small tax cut generates a huge asset that takes off the liability side of the government balance sheet, funding your pension either through taxes or borrowing. When you actually get to that point in the second year, you get another thousand pound tax cut. It goes into the same instrument, but it's used as a pot of money that can finance health costs and you can spend that however you like. When the time comes, go to the private sector, you can spend it on the nhs, it really doesn't matter. But what you do is you de risk those sudden health costs from the taxpayer. But I think with both of those things, what you can actually say is if you don't use these parts, your children can inherit them, which means on the health side, you're incentivized to make good lifestyle choices, which is something that we need to seriously talk about in order to get fiscal sustainability. But then on the pension side, it will induce people to contribute more to their private pension so that there's more that can be inherited down the line. And so we're addressing some of these fundamental issues and I think once the market sees these credible commitments to longer run sustainability, you then don't need to be up against the wall every six months, every 12 months to find ways and to resolve all these very, very bitter and politically tense issues around welfare and the.

Marin Somerset Webb (62:31)

Like. Yeah, I mean, I love this idea, Callum, but I'm gonna add it to the list of things that simply aren't going to happen under this.

Callum Pickering (62:38)

Government. No, but eventually, I suspect we will reassert credibility in these clever.

Marin Somerset Webb (62:42)

Ways. At some point, this kind of thing will have to happen. But I mean, that's the other side of the crisis, isn't it? Because that's, that's giving, giving money away. That's it. So we thought NI did that already. And of course it's too long term because the positive results of that won't fit into the five year forecast. And who's going to do anything that doesn't fit into the five year.

Callum Pickering (63:02)

Forecast? Well, that's.

Marin Somerset Webb (63:03)

It. So.

Marin Somerset Webb (63:06)

Filing that under, excellent idea. Marvelous. Sounds great. Never going to happen in this.

Callum Pickering (63:11)

Budget. No, I suspect in future that we will get to these kinds of places in the.

Marin Somerset Webb (63:17)

End. Well, Callum, I guess we will pin our hopes not on this month, but on the future when hopefully a government will start reading your reports and.

Callum Pickering (63:28)

Acting. You're speaking to me from Edinburgh. There's a statue of Adam Smith with his great quote, fear not, there's a great deal of ruin in a nation. If we can get one or two things right, suddenly this gloomy narrative will turn positive. And so it's incumbent upon us to just solve these one or two big issues. And it's amazing how much then we can tolerate day to.

Marin Somerset Webb (63:49)

Day. Okay, well, fingers crossed. Callum, thanks so much for joining us.

Callum Pickering (63:53)

Today. Oh, my pleasure. Thank.

Marin Somerset Webb (63:55)

You.

Marin Somerset Webb (64:02)

Thanks for listening to this week's Marin Talks Money. If you like our show rate review and subscribe wherever you listen to podcasts and keep sending your questions or comments to marinmoneyloomburg.net. you can also follow me and John on Twitter or x. I'm Ariansw and John is JohnStepek. This episode was hosted by me, Marin Somerset Webb. It's produced by Sam Asadi and Moses Andam Sound designed by Blake Maples and Aaron Casper. And special thanks of course to Callum.

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