The economics of a hung parliament
Last week there were some graphic warnings from the Conservative front bench about the economic perils of a hung parliament. Ken Clarke warned:
"Bond markets won't wait. Sterling will wobble. We have seen even minor flickers in the opinion polls causing problems with interest rates in the recent past. If the British don't decide to put in a government with a working majority, and the markets think that we can't tackle our deficit problems, then the IMF will have to do it for us."
Since then I have been speaking to my contacts in the bond markets. Being self-proclaimed "bond-bores", preferring tweed jackets to the red braces and lap dancing image, they do not want to speak in public, but the message was clear: a hung parliament is already largely factored in to UK bond market.
It may sound prosaic but, as one explained, "the City takes the bookmakers as the best guide to the future, where politics are concerned". If you think about it, it's logical - even the hi-falutin' "global strategy analysts" inside the biggest banks don't have the kind of intelligence operation that could second-guess the UK electorate. Right now the polls and the bookies are signalling a hung parliament. William Hill has it at 4/7.
It's not that my interlocutors like the idea of a hung parliament. Indeed one professed to be amazed by the lack of market reaction to such a violent polling shock as the post Clegg-Thursday leap of the Libdems into second place. (Sterling is different, being tossed between the troubled Euro and the dollar)
On the basis of these conversations think the majority view in the bond market is that any government was going to find it hard to impose 38bn worth of cuts, especially when there has been no attempt to lay out where those cuts will fall during the election campaign.
Just to put this into context I've converted yesterday's 0.2% quarterly GDP growth into billions. One percent of GDP is £14bn; so 0.2% is about 3bn. The Conservative efficiency savings for this financial year potentially take £6bn out of demand; Labour's planned NIC rise in 2011 takes out roughly the same, but later - and there is a legitimate argument as to when and how to do it, and which stands the best chance of avoiding recession, which I will put to one side here.
But if growth is going to achieve 1.25% - let's say £18bn in notional money - then you can see the headwind that taking down public spending creates: £20bn of Labour pay/pension cuts plus efficiencies; £6bn of Conservative efficiencies plus whatever they find in the emergency budget. £38 billion envisaged in Budget 2010.
My own judgement if the 0.2% provisional figure turns out right is that unless something miraculously stimulates UK growth in the next 3 years, at some point the scale of public service cuts means a real danger of a public-sector-led double dip recession.
That's because we also know more about the way the UK economy is responding: it's been a jobless recovery so far - in which employment has declined and unemployment (OECD measure) has risen. Plus the worrying uptick in inflation makes it harder for the Bank of England to maintain its loose monetary policy.
For those in the bond markets who share this view, there are swings and roundabouts between a low-majority single party government and a big-majority coalition.
Provided there are advanced and swift negotiations between the parties (see below), and a clear common ground on deficit reduction in the medium term, there are even some who see the hung parliament scenario as positive. Moody's - one of those ratings agencies who were once thought to be about to plunge Gordon Brown into the abyss my slashing Britain's credit rating - said this:
"We do not think that a hung parliament will have a direct impact on the UK credit rating. If you had a fiscal plan agreed by a coalition, that could actually be quite positive, because it would imply broad popular support."
What the markets fear is a "chaotic hung parliament" - as one market participant put it to me - with "the DUP, Plaid, SNP - and maybe one each of Respect, BNP or the Greens holding the balance of power".
You can see why if you take into account the facts David Cameron referred to in last night's interview with Jeremy Paxman. Northern Ireland, Wales and North East England each sees more than 2/3 of economic activity driven by the public sector. Due to the recession the percentage of GDP accounted for by the public sector nationally has risen from 40 to 50% in just three years.
Even if there is no differential application of cuts to the high-public-sector regions - and there is no suggestion of this - it means any across-the-board cuts have a differential impact in these particular nations and regions.
This inevitably places pressure on MPs from these areas - and not just those from nationalist or Unionist parties. Once party loyalties are muddied by the creation of a coalition, there is temptation for MPs from any party to go native over local spending priorities. And this is true even if you buy the analysis that says rapid pending cuts produce private sector growth and eventual rebalancing.
When Ken Clarke sounded his warning this week, many heard only the frightening bits "sterling will wobble" etc. But there was another subtler implication to the phrase "the bond markets won't wait" - and that is that the parties may have to face the polling evidence and spell out what they would offer each other in case of a hung parliament.
And, by no coincidence at all, this seems to be what Mr Clarke has begun to do in today's Daily Telegraph.