Guest contribution from Nicholas Carn, Odey Asset Management
Governments are talking about reducing spending – some are even doing it. Naturally most people are sceptical. Turkeys don’t vote for Christmas, vested interests are well entrenched, in the past reductions have been short lived - strong arguments that the current efforts will eventually run into the sand.
But what if it were true? With hindsight it is clear that the first salvo in the war on inflation was fired at the FOMC meeting of September 1979. Markets then spent years refusing to believe that Volcker was serious or that he had a strong enough mandate. Gorbachev’s “Perestroika” told the world that the Soviet Union had ceased exporting revolution. The future was clear to see if one chose to see it. Sometimes the catch is that things actually are as they appear to be.
Everyone knows that governments do a lot of things that their citizens would be happy for them to stop doing. They do even more things which are, in theory, desirable but do them extremely badly and expensively. Everyone knows what food or clothing would be like if it was supplied by the State. Every developed country is on a journey of discovery about the privileges and work practises of their public servants. Their citizens will not like what they see.
Globalisation has transformed work practises and productivity in the private sector. To a large extent the public sector has been insulated. The disinflationary trend enjoyed by the developed world has largely consisted of falling prices in internationally traded goods and services combined with inflation in administered prices and state provided services. There is no good reason why this should have been the case. A large part of what governments do is data processing. In the private sector, data processing dependent businesses, retail banking for example, have seen a big fall in headcount and a step change in productivity over the last fifteen years. Nor is it universally true that the public sector has seen poor productivity growth. The German state sector has seen headcount fall by 20% and has lowered prices of a number of State provided services.
The effect of restructuring the state sector is not in anyone’s model. How could it be ? It hasn’t happened before. Nevertheless it is possible to make some informed guesses. It would be a second disinflationary wave at least comparable to the corporate restructuring which began in the wake of the credit collapse of the early 1990s. Firstly, poor labour productivity in the state sector represents a lot of spare resources potentially available to the economy. Secondly, a lot of the costs are borne directly by the private sector and reducing prices [and bureaucracy] would raise private sector productivity further.
There is no doubt that, even if victory is secured , the battle will be bitterly fought. The reduction in UK public spending after WW1, the so called “Geddes axe” achieved only about half of its objectives. However the state sector was very much smaller then and the scope for reducing its activities correspondingly less. The UK government is currently running an extensive TV advertising campaign encouraging its citizens to use handkerchiefs. Even a decision to cease transmitting the message would improve welfare as advertising breaks would be shorter.