Storm clouds over UK as US emerges from sub-prime

Economically speaking, the US and UK are often lumped together. Obviously, the two nations' genealogical, political and military ties are long-standing and strong. But in recent decades, and particularly since the Reagan-Thatcher era of the 1980s, America and Britain have been seen as economic first cousins too.

Until the sub-prime debacle, both the US and UK boasted seemingly robust, low-tax economies. They were seen, at least in their own eyes, as the West's economic stars.

Since the credit-crunch, of course, the Anglo-Saxon nations, with their lax regulatory culture, have rightly been painted as a major cause of the most serious global financial crisis in 80 years. Given their toxic waste on their banks' balance sheets, they were also predicted to take the biggest economic hit.

But now the economic fate of the Trans-Atlantic partners is diverging. The US will recover from sub-prime and return to growth reasonably quickly. But the UK is in much deeper trouble - and could struggle for longer than any other major Western economy.

Last week, the OECD forecast that US GDP will contract by 2.8pc this year. Just three months ago, the rich nations' think tank was predicting America's economy would shrink by 4pc. The US growth outlook is improving, then, with the OECD foreseeing a relatively buoyant 0.9pc expansion in 2010.

The UK's prospects, in contrast, are getting worse. The OECD now forecasts a 4.3pc contraction for 2009, downgrading its previous 3.7pc prediction. Britain is unlikely to grow next year either, the OECD says.

Much of the British political and media establishment assumes the UK's economic future is tied to that of America. Despite the deep cultural affinities, such assumptions are wrong. Only around 15pc of the UK's trade is with the US, while the Eurozone accounts for more than 50pc. The OECD's growth forecasts for the single currency area, incidentally, aren't much better than for the UK.

But the main reason the US and UK will now diverge economically is that their economies are very different. The UK is heavily exposed to financial services - accounting for almost a fifth of the economy and an even bigger share of taxation. That's why the OECD is forecasting a UK budget deficit equivalent to an eye-watering 14pc of GDP this year.

While home to Wall Street and some of the world's most powerful financial institutions, the US economy is far more diversified - with financial services accounting for less than 10pc of national income, making America's economy less exposed to the ravages of sub-prime.

The US has other enormous advantages. The dollar, for now, remains the world's reserve currency, giving America far more economic room for manoeuvre than the UK, not least greater scope to sell sovereign debt.

The US also remains the world's biggest destination for migrant labour, retaining the physical and political ability to keep absorbing wave-after-wave of new citizens, adding to the size and vibrancy of the world's biggest economy. While high net immigration has boosted UK commerce over the last decade, political realities will now curtail that source of growth.

But the real advantage America has over the UK is demographic. The US remains a relatively "young" country. Across the industrialized world, over the next thirty years, "dependency ratios" escalate. Our ageing societies mean the share of the population supported by working tax-payers rises from around 50pc today to 68pc in 2040.

While America isn't immune to this ageing mega-trend, it's in a far better position than the UK - not least due to its ability to keep its population relatively young via immigration.

An astonishing report, to be published tomorrow, provides a stark illustration of this reality. As this column has often pointed-out, the vast majority of the UK's public sector employees - a fifth of the workforce - enjoy taxpayer-funded final salary pensions, payable from 60 years of age.

In the private sector meanwhile, as the demographic pressures crank up, workers face the reality of much lower pensions, payable much later, with this public-private "pensions apartheid" getting worse all the time.

Authoritative research from the British North-America Committee shows the extent of the fiscal burden public sector pensions are now imposing on Britain. Even using official assumptions, the bill for such pensions, over and above the relatively tiny investments put aside to fund them, amounts to an astonishing 64pc of GDP. More realistic assumptions push that total to 85pc of GDP - all of it off balance sheet but to be paid from future taxation.

In the US and Canada, where such pensions have been reined-in and the population won't age so quickly, these totals are far smaller. This BNAC report is impeccably sourced and backed by an advisory panel full of distinguished, non-partisan experts. Once again, I implore Messrs Osborne and Cameron to tackle this issue of massive political and fiscal importance.

KING REMAINS REGAL AS MINISTERS SNIPE

The politicians just don't get it. First, the House of Commons chooses a speaker whose only qualification is that his own party didn't want him. Amidst intense public anger, our MPs have shown us two fingers - treating election to the hugely symbolic Speakership as a political parlour game.

Base politics is now rearing its ugly head within another important area of public life - the relationship between the government, the Bank of England and the Financial Services Authority.

Appearing before the Treasury Select Committee last week, Bank Governor Mervyn King suggested interest rates will likely stay at 0.5pc through 2009 and well into 2010. The Bank's Monetary Policy Committee is also keeping an open mind on whether its £125bn "quantitative easing" programme - where it creates money to buy back sovereign debt from the market - will need to expand.

I disagree with the MPC on rates. In my view, inflation will burst through quite quickly in the coming months - not least due to price pressures caused by QE and the unprecedented pace at which the government is now issuing debt. That's why I think rates could rise sooner, and more steeply, than the MPC predicts.

But King's testimony will be remembered because, under intense questioning, it emerged he hasn't seen the government's upcoming white paper on how the UK's regulatory landscape should change post "sub-prime". An "unnamed Cabinet Minister" then accused him of striking an "unholy alliance with the Tories", just because he has the temerity to express a view.

As a senior UK economic policy-maker who, amidst our woeful recent performance, still commands respect on the world stage, King is almost unique.

He also happens to be right on our new regulatory order. Gordon Brown's "tripartite" reforms have been a disaster. Splitting authority to supervise banks between the Bank, the Treasury and the FSA has meant no-one did the job properly.

Responsibility for bank supervision should return to Threadneedle Street - where it long-resided before 1997. The FSA should remain in place - it has other important work to do. But powers to monitor banks, raise reserve requirements and stop over-leveraging should lie with the Bank of England.

Why? Because such decisions are politically painful - and, while the FSA is a Treasury off-shoot, the Bank is robustly independent.

The government's failure to show King its white paper is pathetic. Even worse is the current attempt to use tribal politics to undermine him - and stop him winning the argument.

But it's precisely because King is willing to stand up to the government that the Bank should regain its supervisory role. By sniping at the governor, cowardly ministers are inadvertently illustrating why the institution he runs should regain the supervisory powers which Brown took away. 

Liam Halligan is Chief Economist at Prosperity Capital Management