Kansas?

Market Report

• Focus remains on next steps from UK policymakers with investors pricing u-turn
• History – some of the challenges of its use
• Outlook for the week ahead

CIO view

Another week spent staring slack-jawed at the Bank of England and bond investors body slamming each other in the Octagon, not quite knowing who to cheer. Meanwhile, building rumours of further changes to a budget already approaching ‘-gate’ status, helped to fuel wild moves in UK-related assets. Outside of the UK, those looking for signs of a peak in inflationary pressure in the US were disappointed. Inflation and employment data will only speak in hindsight of the world we need to get to. However, neither are providing much to cheer yet. The resulting steep rises in interest rate rises seen around the world, particularly the US, and attendant US dollar surge, are putting huge strain on the joints of the global financial system – the feeling that ‘something is going to break’ fed by the recent creaks in UK pension land.

Many clients have understandably wondered when we plan to make more material changes to the multi-asset class funds and portfolios we offer. The world has changed, while the mixes of assets we are currently deploying on behalf of our clients were implemented early last year. The sharp falls of various government and other IOU prices has pushed the corresponding yield to more eye-catching levels – easy money for those able to hold these bonds to their maturity. For some, that may be appropriate. However, in here are both an illustration of some of the difficulties of UK policymakers and a lesson in how and why we do investment.

One’s framework for how to interpret the messages of history is vital in assessing what works and what doesn’t in terms of policy, investment, and more besides. There is an understandable bias to stick to the familiar here – either in time frame or geography. Much political ideology naturally gravitates towards the ebbs and flows of the domestic economy and how various policy shifts can be seen to interact with them. For the UK, a brief tour through the last century or so is necessary…

History

By the turn of the millennium, real GDP per person in the UK was more than six times the 1870 level.?Someone born in 1870 could expect to live to the early forties, while a child born today could expect to live past his/her eighties. These bald statistics mask an incredible equalisation of personal welfare too. Back in 1870, the wealthy would expect to live for many more years than the poor. Now, in the 21st century, life expectation has become more equal across the income distribution. However, in spite of these dramatic improvements, the UK has spent much of this intervening period underperforming its competition, both near and far.[1]?

Some of this underperformance was unavoidable – the US overtook Britain, in terms of output per head, in the years running up to World War I – an inevitable byproduct of the vast advantages in raw materials per head which the US enjoyed (Figure 1). However, the UK also underperformed its European peers throughout the post-war decades, up to and including at least some of the 1970s (Figure 2). The earlier part of this underperformance can perhaps be explained by the UK starting from a higher initial level of income and productivity. However, the fact that the economy continued to lag behind its European peers even after being overtaken, hints at a more avoidable period of relative decline, one that is central to the debate on the path ahead today.

What part did politics actually play?

The temptation to commandeer chunks of economic history to support one ideological leaning or other is of course strong. However, the real world is routinely messier, with politicians often in yoke to the underlying economy and its pre-existing idiosyncrasies and eccentricities, rather than the other way around. Admittedly, some of the UK’s poor productivity growth during this period can be chalked up to the nationalisation of industries in the immediate aftermath of World War II by the Attlee Labour government. There can be little doubt that this curtailed innovation and competition within those industries. During this time, the state also had an unhealthy tendency to try and fine tune the economy, a lingering legacy of the necessities of the wartime economy. We can now see more clearly that such meddling served to destabilise the economy by accentuating, rather than attenuating downswings.

However, other structural flaws also played an equally significant, if not dominant, role. For example, cartelisation, which had proliferated during the 1930s and 1940s, characterised the greater part of the manufacturing sector. Inefficient plants and businesses were kept alive, leading to poor productivity growth as the incentives to innovate were diluted.[2] The absence of competition in much of the economy was further reinforced by the legacy of inter-war protectionism and the UK’s initial refusal to join the European Economic Community (EEC), prompting British firms to concentrate their exports on the less competitive Commonwealth markets.[3]

Accompanying all this, UK industrial relations had become increasingly dysfunctional throughout the post-war years. Britain entered the post-war era with an unreformed system characterised by multiple unionism, craft-control, legal immunities for trade unions, and plant bargaining with shop stewards. Disproportionately powerful trade unions, amidst the full employment of the era, contributed to an inflexible and expensive workforce, which itself acted as a serious deterrent to investment and innovation.[4] It is worth noting that these structural factors were present under both Conservative and Labour parties throughout the post-war years, and they can (and do) exist in nations that are governed under all shades of the political spectrum.

Thatcherism to the rescue?

The supply-side policies implemented by Margaret Thatcher’s Conservative government between 1979-1990 were certainly helpful in reversing the UK’s relative decline. With a sweeping range of policies which included reforming industrial relations, privatising state-owned businesses, encouraging foreign investment, and deregulating the economy, it is clear that supply-side reform stimulated much needed competition among British industries, leading to higher productivity growth. By the end of the 20th century, UK income levels had surpassed those of its European peers, thus putting an end to economic decline.[5]

However, it is important to note that Thatcherism wasn't the only reason for this turnaround. The UK was already opening its markets up to foreign competition before Prime Minister Thatcher came to power, with its entry into the European Economic Community (EEC) in 1973. Some plausibly argue that the UK’s EEC membership, and the faster productivity growth brought on by greater competition from more technologically advanced European firms, was the dominant factor in ending the UK’s relative economic slumber.[6]

Grand historical shifts are more often than not the product of multiple interacting variables, rather than a single overriding cause. Britain’s relative economic decline and revival throughout the post-war years is a good example. Previous drags on UK economic performance had arguably less to do with the reigning political ideology of the time, and more to do with long-standing institutional flaws within the economic structure itself. Similarly, the cure to Britain’s decline was rooted in greater competition, something that can (and should be) implemented by any political party straddling either side of the political spectrum.

And for investments…

A country’s history is full of noise and misdirection. Apart from the fact establishing cause and effect is often significantly more difficult than much glib commentary suggests, it really is different this and every single time. Often these differences can be subtle, sometimes much less so. However, transplanting the perceived successes of one policy package into another era is always a tricky business. One tactic historians use to try and locate winning policies is comparison with other countries and time frames. This comes with problems of its own of course, too many to list here. However, often this process usually softens ideological clarity and (over)confidence. That doesn’t have to be a bad thing, even if it moves us away from the comfort of a joined up global economy/geopolitical philosophical framework.

Our teams of specialist investors do the same in many ways. The asset allocation team don’t just look to the last decade for information and they don’t just imagine the past that lies behind us is the only one that could have happened. At all times, there were myriad roads ahead, just as there are now. Calling these uncertain times feels trite – we all clamour a return to some form of Kansas. However, the point to get across here is that we are always living in uncertain times, whether the newspaper headlines of the moment reinforce it or not.

The best weapon to deploy is humility. Its investing equivalent is diversification. This is why we retain teams of highly trained specialists who think of little else. The value of their obsession is very visible today in the multi-asset class funds and portfolios they help forge. Next week, you will hear from them on the plans afoot for the next major asset allocation refresh and what they are doing in the short term amidst these tragically turbulent times.?

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*This article is for information purposes only. It is not intended as a product offer or investment advice

[1] Britain’s Relative Economic Performance, 1870–1999 – Crafts, 2002

[2] Competition and Innovation in 1950s Britain – Broadberry (2001)

[3] From empire to Europe: the decline and revival of British industry since the Second World War – Owen (1993)

[4] Industrial Relations and the Economy 1939-1999 – Brown, 2003

[5] British Relative Economic Decline Revisited – Crafts, 2011

[6]How EEC membership drove Margaret Thatcher’s reforms – Campos, Coricelli, 2017