When the Liberal Democrats took the decision to step up to the plate and enter government in May 2010, Britain’s economy was on the brink … It may not feel like it now but we could have been Greece. In 2010, their deficit was 11% of GDP, ours was 10%.
Nick Clegg, Deputy Prime Minister, speaking on March 9
Let’s start with the obvious. A comparison of the British and the Greek economies might not be entirely appropriate on any level, given the presence of large structural differences between the two countries.
First and foremost, Greece was accepted into the Eurozone in 2000, submitting itself to the common monetary policy set by the European Central Bank. This implies that Greece, like all other European Monetary Union countries, has given up the conduct of an independent monetary policy. This, of course, is not the case for the UK, where the monetary policy is set by the Bank of England.
Further interesting insights can arise from the government effectiveness index (compiled by The World Bank), which captures perceptions about the quality of the civil service and the degree of its independence from political pressures. This index isn’t the first port of call for economists when comparing nations, but it does reveal a vast difference between Greece and the UK. In 2010, and among 215 economies, the index ranked Greece in the 69th percentile. On the other hand, the UK was ranked much higher, in the 92nd percentile. In 2013 (last year for which data is available), the gap had held steady with Greece in 67th percentile and the UK in the 90th.
This isn’t just a bare ranking. It is important to emphasise that government effectiveness is priced by financial markets. One recent study on the determinants of global sovereign debt ratings looked at the credit scores from the three main international rating agencies – Standard and Poor’s, Moody’s, and Fitch – on 130 countries. They show that government effectiveness, together with other macroeconomic variables, are an important determinant of a country’s credit rating profile. And therefore of how much a country must pay to borrow money.
Looking at those other macroeconomic variables affecting credit ratings, it is true that in 2010 the UK had a high deficit, but, on the other hand, it presented a healthier overall economic picture than Greece. It is important to consider that in 2010 the UK debt accounted for 78.4% of the country’s GDP compared with 148.3% for Greece. Looking at the external position of the two economies, we note that in 2010 the UK’s current account deficit was approximately 2.7% of the country’s GDP, compared with a 10% deficit for the Greek economy. Such differences are observed and accordingly priced by the financial markets.
The raw numbers on the deficit comparison stand up to scrutiny, but the idea that the UK was at risk of a similar fate to Greece ignores a host of structural, and macroeconomic differences. The divergence is starkly obvious when you look at the World Bank’s government effectiveness indicator, one of several key factors which the market uses to price debt.
It is impossible to answer conclusively the kind of “what if?” question posed by Nick Clegg’s comments, but I share the author’s view that it is very difficult to believe that the UK could have ended up in a similar position to Greece. The author rightly notes that the UK has its own central bank which could, if necessary, stabilise the UK bond market, and has the kind of superior institutional performance that soothes market nerves.
Having said so, Britain faced significant fiscal challenges back in 2010, and decisive action was necessary to deal with the fallout from the global financial crisis. One function of the crisis has been that markets have made it much more expensive for countries to borrow money if they carry fiscal imbalances. Therefore, without the coalition’s post-2010 fiscal consolidation, it is very likely the UK would have seen a spike in its debt costs which in turn would have forced even more aggressive measures further down the line. Inflation may also have become a danger if the Bank of England was forced prop up the gilts market.
Overall, despite substantial differences in the scale of the fiscal challenges, both Greece and the UK were in need of bold fiscal consolidation back in 2010. In the case of the UK, this, on the whole, seems to have been successfully delivered.
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