David Kuo talks to economist Dr Linda Yueh.
You can listen to or download this podcast here.
David:
This is Money Talk, the weekly investing podcast from the Motley Fool, and today I'm joined by Dr Linda Yueh, who is a Fellow in Economics at Oxford University, a Senior Fellow at the London Business School, and author of numerous books that include "The Economy of China", and she's also a media commentator who is always in huge demand. So welcome to the Motley Fool, Linda.
Linda:
Thank you, David – nice to be here.
David:
Well, it is nice to have you in here. Now, the last time we met, Linda, was on BBC2, I think – it was on Working Lunch, which leads me very nicely, because you wouldn't have thought that economists would appear on a lunchtime show these days, and yet people are very interested in economics. So can you explain why the average person should have any interest whatsoever in economics?
Linda:
Oh, there's probably lots of reasons, but I'll only focus on a couple. I think the main reason is, this recession has been so bad that it's caused people to wonder what actually went wrong with all of the economic management of the government, of the central bank, of the regulators. So I think the interest really stems from trying to understand the world around us – how we got into the current mess, and I think more importantly, what kind of economic policies will get us out of the crisis, and ensure it doesn't happen again. So I think economics is of interest, wide interest at the moment, because it allows people to understand of the really complicated things which are happening, not just in the UK economy, but actually around the world.
David:
But isn't the big complaint that people have is that yes, if you guys are so clever, why didn't you see this happening in the first place? Why did you allow probably the worst catastrophe to happen to world economies to carry on?
Linda:
I think that's a great question that lots of people will be asking, and that's one of the ironies of being an economist at the moment, because even though economists certainly didn't foresee the crisis, we're much in demand now to explain the crisis. I think that's actually one of the conundrums, is that most economists don't actually forecast. So there's no real ... it's a very small segment of people who actually look at all the interconnectedness of the economy, and say, this is what happens in the future. Most of us look at the past, at what the data says, and try and interpret what this actually means. But of course this crisis is much more complicated than just economists; it involves regulators and financiers and central banks. So there's quite a lot of things that actually went wrong. So I'd probably say a lot of different professions need to look again at our models and assumptions and analysis.
David:
Now the thing is, most people know that we're in a mess, but can you get this mess into some kind of perspective for the average person? I mean, we're hearing lots of things about national debt and everything that's going on, but how bad is this mess, and is there any chance that we're going to get out of it?
Linda:
We will get out of it, but the hole is pretty deep. I think, if you think to the scale of this recession, this is certainly the worst since the Great Depression, which is why we economists have termed it the Great Recession. But I suppose we should be worried about what this scale of downturn means, because lots of jobs were lost, nearly two and a half million people are out of work, and quite a lot of the productive capacity of the economy, that is the credit system, a lot of companies have gone under, a lot of people feel threatened in terms of their mortgages, because of the credit crunch. So there's lots of reasons to be worried, but there's also lots of reasons to look ahead and say, there's quite a good budget in place at the moment to try and reduce the deficit over the next few years. There are a number of signs that the economy has come out of recession and is unlikely to plunge back into recession. So for instance, we've managed to sustain a couple of quarters, six months of growth out of the recession so far, and it looks as if, barring a second major banking crisis, we will just gradually get on the road to recovery.
But this is why I think the future actually looks more optimistic than the past, which is, in the last decade there was too much unsustainable credit growth, which really underpinned this crisis, and it took a crisis, I think, for the government and regulators to realise this. It was too easy to get loans, people became very indebted, and actually this was a wake-up call to say we can't sustain growth on the basis of cheap credit. So all the plans for the future are about how we can grow by real economic activity again, producing things, producing services, producing goods, moving our focus out of promoting the City into other regions of the country.
So to me, the future looks better if we can get the consequences of the crisis, in terms of the huge budget deficit and unemployment, under control.
David:
Now the thing is, you touch on this question about the budget deficit, and of course the budget deficit then goes on to accumulate and become the national debt. Everybody is saying the national debt has been there for a while; everybody knew that it was well in excess of a trillion pounds, and today's paper is suggesting that maybe it's four trillion pounds. Now the thing is, we know there is a national debt, but why is there suddenly all this finger pointing, all this red underlining going on, and people saying, this is now the problem? The problem has been there before – Japan has had a national debt that is in excess of its GDP, so why are we suddenly so focused on the national debt?
Linda:
The main reason is that the level of the debt is due to double over the next few years, if it isn't brought down. So even though yes, we've always had a pretty high level of national debt, about 40% of national output or GDP, this figure is going to double, which makes it really worrisome. The reason it's going to grow by so much is because the government has essentially incurred a lot of borrowing to rescue the banks, to increase benefits payments, like unemployment during a recession. So there's lots of reasons why the government has had to borrow more money. Now if it doesn't get its house in order, the debt will continue to grow. So at the moment, what this means is we have to say, if the national debt continues to grow at this rate, we've already spent more on paying the interest on that debt than on the entire defence budget every single year, and the amount of debt interest is going to expand, so it's got to come down.
David:
But are we in a worse position than say Japan? I mean, Japan's national debt is in excess of its GDP, and yet nobody really bothers too much about Japan, do they? So why is Britain singled, or particularly Europe is singled out, as the sick people in the economies?
Linda:
The main reason why Japan's debt is sustainable, at least for the moment, is that over 90% of it is borrowed from its own people, so it's domestic savings that is lent to the government. So they pay a very low interest rate, so their debt interest payments every year are actually quite manageable, even though their total amount of national debt is close to 200% of GDP. Now, in the UK we don't have that luxury, because we have a very low savings rate. So a lot of our debt is ...
David:
In some cases, no savings rate!
Linda:
... or no savings rate, that's right. It's really, like I said, the debt-fuelled consumption last decade hasn't been great for the savings rate. So that means we borrow from international creditors' markets, and they will charge a higher interest rate, the larger the stock of debt. This is why the UK, and a number of European countries, have to be much more vigilant in bringing this debt down. But not every European country – Italy actually has a debt level which is equivalent to its GDP, but again it's drawing on domestic savings. So it makes the Italian debt more sustainable than say our debt, or the French debt, or the Spanish debt, or the Irish debt.
David:
Or the Greek debt, or any other ...
Linda:
Oh, I didn't want to go there!
David:
I'm not surprised! Now, one strategy that the coalition government is hoping to employ is to try and reverse this balance of trade deficit that we have, in other words, they want the UK economy to export itself out of its problems. Is this a realistic strategy for the UK?
Linda:
Not particularly, the main reason is that the proof of the pudding is in the eating. At the moment, sterling has lost more value than in the early '90s, when there was a serious depreciation of the currency, a huge fall in the value of the currency, and yet actually we're still running a trade deficit. So this reflects a number of things. One is that we are not producing enough of the things the rest of the world wants to buy; another reason is that global demand, so the people who would buy our goods and services, are themselves struggling out of recession. So primarily we would sell to Europe and the United States, and both of those, the Continent and the American economies, are actually doing not so well. So there just isn't enough overseas markets for us to sell to. So yes, in theory we can recover via exports, and in fact that's what happened in the early '90s, but when you have a synchronised global downturn, like we have now, which was the same as in the '80s, the recovery takes longer.
David:
So it will work? – is that what you're saying, that it will work eventually, provided that the UK makes the goods that the rest of the world wants to buy?
Linda:
Yes, I think there's a good potential for it. We sell a lot more services than we do goods overseas, because we're predominantly a services economy, and a lot of what we sell is very high quality. In fact, the goods we produce is also very high value-added. We tend to sell things like pharmaceuticals, very sort of highly R&D intensive, high technology, so basically, things which are based on a good amount of skills. So we do actually produce quite a lot of things, whether it's goods or services. I think the only question is, do we sell more of that, because of say a cheap currency, which I have some questions over, because that doesn't seem to be how our goods and services are priced. So in other words, if we don't sell lots because it's cheap – we sell lots because it's good quality. So I have a feeling the valuation of sterling isn't going to make a huge impact, in which case, the only way for us to turn our trade deficit around is to produce more things and not rely on the things that we currently produce, and that is no easy task. It's very difficult to create new industries, even though that is what we need to do, if we don't want to rely on the City and the financial sector as the main drivers of growth in the future.
David:
Now the thing is, the UK government is fighting the downturn in the economy on a number of fronts, and one front that it is really focusing on is to try and shift the emphasis from the public sector to the private sector. Again, is this going to be a realistic proposition for the UK, to try and get these workers to move from the public sector to the private sector?
Linda:
This is where I think the budget projections are slightly less realistic, because there's this sense somehow that if the public sector sheds 600,000, 760,000 jobs over the next five to six years, which is the current projection, that there will be a total of two-and-a-half million jobs created over the next five years, giving us a net employment gain. That's pretty iffy, because given the devastation of this recession, and the credit crunch, which prevents lots of private businesses from really getting enough credit to invest and to build themselves, it's very unlikely we could see that rate of job creation – in fact, we've never seen that rate ...
David:
Well, exactly.
Linda:
... of job creation before, even in the boom time, so I think that is pretty difficult. But I think the government has to, unfortunately, downsize the government, because if you think about the deficit, it's the difference between government revenues and government expenditure. Government revenues was artificially boosted in the boom times by the revenues from the City, and at one point it was as high as a quarter of all corporate revenues came directly from the financial sector.
So this devastation from the financial crisis suggests the revenue base is going to be permanently down, so we cannot sustain the current level of government spending, because it was based on an unrealistic revenue boom. So therefore, spending has to come down, and given that about 30% of the government's expenditure is on public sector salaries, downsizing the expenditure is the same as downsizing the number of public sector workers. So that's why it's a tough, tough ask. But, if the economy can replace the financial sector and create new industries, then it is possible for these public sector workers to move into new industries, but they have to be new industries, and not just rely on the old drivers to create these jobs.
David:
But that is, unless of course, there is a fairy godmother somewhere who is going to be sitting on the shoulder of David Cameron, and say, "Look – we've found something new here, another source of revenue for you" – like they found North Sea oil, which was really a big boom for the UK economy. So what are the chances of them finding another industry that is capable of sustaining growth in the UK sufficient enough to take all these people out of unemployment?
Linda:
I think it's tough, but at the same time, economies do restructure themselves. We certainly saw this when the economy deindustrialised in the '80s, for instance. The role of government, I think, is to be supportive and to create the right incentives to help private businesses develop, and to themselves choose the niches that they can specialise in, and because of the flexibility of the labour market, and the fact that a lot of these public sector workers who are downsized will be pretty highly skilled. On average, the public sector workers are actually a fairly skilled, educated bunch. It's not impossible for them to move into new areas.
Now of course, structural change takes time, and there are some measures in the budget, though many would argue not enough, to promote new businesses, finding these new areas. So for instance, there is a tax exemption on employers' national insurance for the first ten employees which are hired for a business starting outside of London and the south east. There has been an increase in the amount of lifetime income from entrepreneurs' earnings from two to five million pounds, which will only be taxed at 10%. So there are some things in the budget which are geared at doing that, but again arguably there isn't enough, because for instance, lots of critics say what the government has to do is to invest more in R&D, because that's where the future lies. We specialise in higher skilled, higher value-added industries which require a good scientific research and development base, and that has been underfunded for some years now, so we will never become a leader, say in green technology, if there isn't good research in skills and technology being developed in the economy itself, and by the way, not just for businesses, but to retrain workers, so they can work in these new industries.
David:
But they will be able to attract outside investment into the UK, do you think? I mean, I come from the Far East, where the strategy has always been to try and attract outside companies to try and invest in these individual countries in south east Asia in order to provide the employment for people. Will the UK be able to sustain that, be able to do that?
Linda:
It can, so long as it maintains credibility of the government institutions that are promoting trade and investment, so UKTI; the government needs to show it's in control of the budget deficit; it needs to show stability in the way that it sets regulations and monetary policy, so there's no surprises of a bout of inflation. That's one of the things that overseas investors worry about the most, because you put in a million pounds, lots of inflation means your million isn't worth very much. In fact, that's actually one of the reasons why the trade deficit we've had is sustainable, because the other side of trade is the capital inflows. So we've been able to sustain a high level of consumption, including of imported goods, because lots of other countries and companies invest in our country. So therefore we've never had to fund our consumption of imports via say borrowing, like the Americas. And so we've actually always had a good track record of being open for business, and I think, looking at some of the weakness on the Continent, I actually think that our prospects actually look better, not worse, because I think the euro zone would make a lot of investors quite worried about where the future lies for the single currency, if you were to invest using that currency.
David:
Right, you mentioned the word currency now, and this is one area where people are a little concerned. They want to see a stable currency. What is the outlook for sterling versus the euro and also the US dollar?
Linda:
Sterling's come down a lot. In terms of the ultimate valuation, I think the euro is the greater source of uncertainty. I think vis-a-vis the dollar, the dollar has strengthened, because it's viewed as a safe haven, and increasingly people are also viewing sterling as a safe haven. So in other words, if you buy gilts issued by the British government, or treasuries issued by the US government, there is no real serious worry of default. So that makes these currencies desirable, which keeps their value stable. Whereas if you compare this to the euro, there are a lot of questions over the future of the euro, and the euro has lost about 15% of its value over the last few months. There's still a lot of expectation in the markets that the euro crisis is yet to be resolved, in which case the euro is likely to weaken until all that uncertainty lifts, and it's a lot of uncertainty over what's going to happen to countries like Greece? What's going to happen to fiscal discipline which is needed to maintain the single currency? What's going to happen when German taxpayers decide they really don't want to borrow money to lend to the Greeks who want to retire before the age of 60? These are all serious problems in the euro zone that we don't have. So therefore I think sterling, and the dollar, will be pretty stable as a result.
David:
Now the thing is, I was just reading recently a report from the Office for Budgetary Responsibility. They came up with two scenarios: one was that the UK would suffer a double-dip recession; and another was saying that growth could actually be stronger than expected. How can you possibly have two totally contrasting predictions about what is going to happen to the UK economy?
Linda:
I think they work on the basis of forecasts, and there's a range of their forecasts. Nobody rules out the prospect of a double-dip scenario, and the reason is, there's quite a lot of evidence that economies, when they experience this size of financial crisis, limp out of the recession. So therefore you kind of limp along at very low growth rates, and then it could double-dip, in the sense the economy contracts again, just a little bit, and that's very very possible. But on the other hand, if all goes well, the budget brings the deficit down, it's implemented effectively; there is a real resurgence in the private sector, because the government also sorts out the banks, so the credit crunch no longer bites; there's a rebalancing of the economy towards industry and services other than the financial sector, and exports rebound, then over the next few years, say in this parliament, it is very possible that our growth rate recovers strongly back to its trend growth rate, which is about two-and-three-quarters percent, where at the moment we're only at just over one percent. But again, if you heard all the ifs I added in there, there's a lot of ifs for us to get there. So I probably traverse a middle road, whereas I think we're unlikely to get that kind of strong growth, but on the other hand we're unlikely to have a serious double-dip, because our banking sector is in much better shape now than it was, say, a year ago.
David:
In other words, if we're firing on all cylinders, then the rosy scenario may actually work. Now, I know you're very pushed for time, because as I said at the top of this podcast, somebody who is in huge demand everywhere, so one final question for you, and that is, with regards to one country that is firing on all cylinders at the moment, and I know you are also a China expert. Now China at the moment is embracing capitalism, but at the same time, China is also probably one of the biggest command economies that we have. What are the chances of China eventually relinquishing command economy and embracing capitalism completely? What is the chance of that happening?
Linda:
Not very likely in the next few years. I think China will go its own way, it'll be a very gradual adoption of the market economy, but the state will continue to exert quite a lot of control. I think, had China gone down the capitalist route, it would have happened a few years ago when it joined the World Trade Organisation, because at that time it looked as if they were getting rid of the state-owned enterprises, they were having IPOs of the state-owned banks, they were pressed to become a "market economy" under the WTO rules, to open their markets. But, in the decade since, it's become clear that they're going to retain the big state-owned enterprises, they're going to retain ownership of the state-owned banks, and they're going to go down a route which will be much more, I suppose, what you would call a mixed model, a state market. It works for China, but there are certainly downsides, as we often find the Chinese market to be both exciting, but also very puzzling, because it is not a straightforward capitalist system. Nevertheless, it is a fast-growing economy, whatever it's doing seems to work for its people, because hundreds of millions have been lifted out of poverty, and many more will be, if it can keep up this growth rate for the next 30 years, but that is also a pretty big ask.
David:
That's wonderful, that's a great answer. Thank you very much for coming in today, Linda.
Linda:
Thank you very much, David, for having me.
David:
Now, all I can say is, if my economics lecturer, when I was at university, was more like you than the grizzly old man that he was, I would probably today be setting interest rates at the Bank of England, rather than worrying about interest rates and what they're going to be doing with them every month.
Linda:
You may still be! There's always that chance – the MPC beckons.
David:
So thank you very much for coming in today, Linda.
Linda:
Thank you.
David:
At this point, I could just turn the mikes off, but then we wouldn't have the quote of the day, which comes from Joe Weinstein, who said: "My dog is worried about the economy because dog food is up 99 cents a can. That's almost seven dollars in dog money."
This has been Money Talk, I have been David Kuo, and my guest today has been Dr Linda Yueh, Senior Fellow at the London Business School. If you have a comment about today's show, you can do so on the Money Talk blog, which you can find at fool.co.uk/podcast. If you have a suggestion for future shows, please email me at moneytalk@fool.co.uk. Until next week, have a great week, and happy investing!
