Good and evil of electoral uncertainty

Leaders' election debate Image copyright Getty Images

Here is a funny thing. Uncertainty about the outcome of the general election is currently a good thing for the economy, but could turn into a very bad thing.

Think of it as a performance-enhancing drug that could become highly toxic if taken for more than a few weeks.

How so?

Well, it is likely that some of the recent weakness in sterling is attributable to the only unambiguous prediction of the polls - that a weak minority government or coalition, led by Tories or Labour, is the likely outcome.

Which means it is difficult to forecast with any certainty whether the government will want to get the deficit down faster (the Tory policy) or slower (the Labour approach), whether it will want to tax the banks more and break them up (the Labour commitment), or whether it will hold a referendum on membership of the European Union (the Tory pledge).

Equally, it is difficult to say whether UKIP and LibDems will be wagging a Tory government dog, or whether the SNP (and maybe LibDems) will be wagging a Labour one.

In those fluid circumstances, it was inevitable that sterling would weaken against the dollar and euro. And so it has come to pass - with the pound having fallen 3% against the euro in just under a month, and 2% down versus the dollar.

In relation to the euro, all that droop does, of course, is slightly offset the massive rise of sterling against the currency of our most important region for trade: the pound is still 11% stronger against the euro than it was a year ago, though more than 13% lower against the US currency.

That tells you that the biggest determinant of the price of sterling remains differing evaluations of the strength of the eurozone, UK and US economies - with the eurozone seen as weakest, the UK quite a lot stronger and the US stronger still.

Or to put it another way, UK electoral risk has caused a mild deviation from the more important judgement - which is that the UK economy and sterling look healthier than the euro and less healthy than the dollar.

But the short-term weakness of sterling has had a benign consequence: the edge has been taken off the deflation we've been importing from the stagnating eurozone (a falling pound pushes up the price of imports) and the competitiveness of British exports has improved a bit.

Or to put it another way, it could and should improve Britain's never-very-sparkling trade performance and mean UK inflation will be zero or less for fewer weeks than otherwise would be the case. So the risk should be cut of wage settlements trending back towards zero and reinforcing a potentially dangerous deflationary cycle.

In other words. electoral confusion has arguably turned up at just the right time for the UK, in providing just the kind of mild stimulus to domestic prices and trade that the Bank of England would love to give, but is powerless to do.

That said, and to state what is perhaps the blinding obvious, uncertainty about who governs us would probably be less benign if it were to persist for some time after 7 May's general election.

Weeks of wrangling about the composition of the government, an extended period of uncertainty about the policies of a minority government dependent on the support of smaller parties, could do serious economic damage.

How so?

Well, recent figures show there has already been something of a hiatus in business investment, and businesses have a habit of postponing and cancelling big investments till they are in a position to assess a government's direction.

So any prolonged weakness in investment would lessen the momentum of our economic recovery, would make our recovery more dependent on household consumption and thus reinforce its unbalanced character, and - perhaps more worryingly - would hold back a longed-for productivity revival.

And it is that stagnation of productivity, of output per hour worked, which is the rotten heart of our economic rehabilitation.

Without a return to growth in productivity, the two glaring flaws in our economic recovery - the record deficit on the money we earn from trading and investing internationally, or the current account deficit, and the government's still-big deficit - would become much harder to mend.

Just to remind you, the current account deficit was £97.9bn in 2014, equivalent to 5.5% of GDP or national output, which was the biggest annual deficit since records began in 1948.

And the deficit turned from being annoyingly negative to worryingly negative in the middle of 2013, when our persistent inability to earn a surplus on trade was seriously exacerbated by a collapse in what we earn on our overseas investments.

To put it another way, the rest of the world is increasing its loans to the UK at a record rate, at a time when the indebtedness of the UK is also at a record - equivalent to around 500% of GDP, according to McKinsey (that is the sum of household, business, City and government debts).

Now in the absence of a productivity resurgence that led to a rise in the UK's earning capacity, questions would at some point be asked about the ability of the UK to repay its debts - including government debts that rose at a rate of 5% of GDP last year and are forecast to reach a peak of 80% of GDP (the point is that when productivity is low, earnings tend to stagnate, so tax revenues are lacklustre).

At that ill-starred juncture, sterling would weaken, not because the UK economy was thought to be a little less robust than America's, but because of rather more profound anxieties about its (our) ability to pay for the standard of living we take for granted.

And as the Bank of England acknowledged in its so-called stress tests last year of UK banks, after a fall in sterling of some unspecified magnitude, the Bank's monetary policy committee would have to significantly increase interest rates - to ward off the seriously inflationary consequences of a collapsing currency.

At that point, house prices would plummet, as would the spending of households still shouldering debts that are very high by historic standards.

The UK would be back in the recessionary poo.

Now for the avoidance of doubt, the probability of this kind of calamity is low, though not negligible.

It would become a bigger risk, the longer it takes for investors to understand and put a price on the policies of a new government.

So here is the painful pincer of globalisation: it may have contributed to the fracturing of traditional party allegiances, as voters worry that global forces trump national policies; but if rudderless government in Britain were the consequence of those fractured allegiances, then in a globalised world, capital would flee the UK and leave us significantly poorer.

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