26
Examination of witness
Dr Mohamed El-Erian.
Q66 The Chair: Good afternoon and welcome to this hearing of the Economic Affairs Committee and our inquiry into the UK’s national debt sustainability. I am delighted to welcome Dr Mohamed El-Erian. Mohamed, would you like to introduce yourself to the committee?
Dr Mohamed El-Erian: Thank you for having me. I am the president of Queens’ College, Cambridge. I am an economist by training, and I have spent time in both the public sector and the private sector. Right now, I sit on a couple of corporate boards, and I have been advising some companies and governments.
Q67 The Chair: Thank you again for joining us. There is a lot to get through. I will start with a big, broad question. The lights are flashing red on debt in a number of developed economies, not least here in the UK. How worried do you think we should be—big picture?
Dr Mohamed El-Erian: We should be worried, but we are not at the panic stage yet. We should be worried because three things are happening. First, as you pointed out, the stock of debt has increased significantly, mainly due to some major shocks to the economy. Secondly, particularly in the UK, and less so in the US, the growth and productivity dynamics are weak, so the ability to grow out of debt is less available than it has been before. Thirdly, there are a number of secular headwinds facing us that will claim more of our resources going forward. It is something we should be worrying about, but it is not panic stations yet. There is time to do something about it.
Q68 The Chair: That is brilliant. Thank you for that. That leads me straight into a follow-up question. How much time do we have to do something about this? We were told, I think by the OBR, and others, that we need to look at the next parliamentary cycle here and that action may therefore need to be taken in the next three to five years. We can come on to talk about what form of action, but how long do you think we have before we move from a state of being worried to one of panic and options for action start to close down?
Dr Mohamed El-Erian: If you are as old as I am, you will have learned that tipping points are very difficult to predict. I doubt many of us predicted the October/November tipping point in the UK under the Liz Truss Government. It came as a shock to us all that the markets could lose confidence so quickly and that the pension system could be threatened. I want to say that because tipping points are really hard to predict, because they are a function not just of your initial conditions but of how markets receive your intentions, what is happening around you, and what is happening to the broader neighbourhood, if you like, of the global economy.
We have time. The most critical element is how we use this time to deal with excessive debt. There are four ways: one good way, and three ways that are a lot less favourable.
The good way, and I will keep on stressing that, is to grow out of debt. It is to achieve the sort of economic growth that allows you to maintain and improve living standards while also lowering your debt burden over time.
The second way of doing it is through austerity, but we have found, over and over again around the world, that there is a limit to austerity. If you are not careful, austerity becomes counterproductive because it undermines future growth.
The third way is something we have experimented with, which is called financial repression. You artificially find ways to tax creditors and subsidise debtors.
The fourth way is restructuring debt or defaulting.
When you look at the alternatives to growth, they are not very appealing. So it is really important to put the issue of debt into the broader context of achieving high, sustainable and inclusive growth. I would agree with the OBR: we have a number of years, but we have to get going quickly, because it gets harder and harder to turn the ship around the further in you go in the next few years.
The Chair: That is, again, very clear. Thank you. I take your point that there is the unknown unknown and things happen, but there are also the known long-term challenges that we face. I am thinking here of the demographic challenge and the challenge of decarbonisation and the green transition. You may want to cite others. Which of them concerns you the most and is the one that we should really be focusing on as policymakers and politicians, or are they all equally concerning?
Dr Mohamed El-Erian: It is all of them, and I would add a third one. First, demographics is a big issue. Second, decarbonisation. Third fragmentation; the global economy is fragmenting, and I suspect that this is not a short-term phenomenon but a longer-term phenomenon. These three elements all serve to make it harder to deal with excessive debt, because they impose extra requirements on your resources. They are equally hard. This is not addition—one plus one plus one. They compound each other, which is why it is really important to get going.
Q69 Lord Verjee: Thank you for being with us, Mohamed. My question is a follow-up from the first one. Several Governments are looking to borrow record amounts in 2024. How do you see this affecting the UK in particular from the perspective of debt sustainability? Do you expect refinancing to be undertaken in an orderly fashion? How do you see the market’s appetite for UK debt changing?
Dr Mohamed El-Erian: That is a wonderful question, because it reminds us that this is not just an absolute game. It is also a relative game, because the markets are consistently comparing us to others and will continue to do so.
Relative to other countries, UK bonds are still attractive. Yes, there will be many countries borrowing, but, unless we shoot ourselves in the foot again, I do not think we will see a discontinuity in availability of funding. We may see a higher cost of funding, but market availability should not be an issue.
This changes if one of two things happens. One is if we repeat a policy mistake. The lesson that should have been internalised by now is that policy mistakes are punished by markets, and punished in a significant way. The other thing that can be complicated is that, away from government debt, there is a whole stock of other debt that was taken on at artificially low interest rates and that needs to be refinanced. The refinancing of that can be disorderly, if we are not careful.
Those are the two things that I would keep my eye on. The baseline scenario is that the refinancing of debt will be done in an orderly fashion, but, like any distribution of potential outcomes, there is a nasty tail, and that one is not as thin as we would like it to be.
Q70 Baroness Noakes: Could I explore this idea of a disorderly refinancing? What would you categorise as disorderly refinancing? There can be small difficulties en route that do not affect the overall issue of how you finance or refinance your public debt.
Dr Mohamed El-Erian: If I may, I will take you back to my days at PIMCO, which was a major buyer and seller of government debt. It was a very large bond management company, and it still is. I will give you an example. In May 2013, the then head of the Federal Reserve, Ben Bernanke, said that the Fed would taper—that was the word—the purchases of securities. I remember being on the trade floor and people saying, “What does taper mean?” It was such a shock to the system.
When we realised that that meant that the Federal Reserve would be less supportive of the bond market because it would be buying fewer securities, we thought that we should reduce our stock of debt. The phone was not picked up by the investment bankers because they themselves were trying to figure it out, so there was a sudden stop because the paradigm had suddenly changed.
This is what happened in the UK just over a year ago when the news hit the market that there would be large unfunded tax cuts. That was a shock to the functioning paradigm, and people in the marketplace simply stepped back to try to comprehend what the new paradigm was. The minute you step back, you get discontinuity. If I step back, the probability of you stepping back increases.
That is what I mean by discontinuity. It is a shock to the system that is unexpected, and the system has to adapt and figure out what the new conditions are. It risks what economists call multiple equilibria, path-dependency. Every bad equilibrium can make the next equilibrium even worse. That is why circuit breakers are very important. You will remember that, during the Truss episode, the Bank of England had to come in and start buying gilts.
The Chair: Thank you for these great answers.
Q71 Lord Londesborough: Can I come back to the term “relative game” that you used, I think in relation to the market’s appetite for UK debt? The UK has slid down the international G7 table on growth from being second fastest to second slowest. Today, the IMF has put the boot in again in predicting that we will be the second slowest-growing economy this year.
Particularly in relation to the cost of borrowing, how concerned are you about the relative performance of the UK? At what point does it become a pinch point and elevate our cost of borrowing?
Dr Mohamed El-Erian: It eats away at our cost of borrowing on a daily basis. High-quality growth is the answer to so many things. Unless you get growth, in order to pay your debts you will have to cut somewhere else or do something that is unpleasant to the marketplace. So I cannot stress how important growth prospects are for debt sustainability. It is absolutely critical. Without debt sustainability, you do not have much else. I remember, from when I was at the IMF for 15 years, the phrase, “Sustainability isn’t everything, but without it you have nothing”. It is really important. The issue is, and will always come down to, the ability to generate high, durable and sustainable growth.
Q72 Lord Turnbull: Thank you for giving evidence. Thank you also for your regular commentaries on the radio in Britain, which I find extraordinarily clear.
“We” is a very difficult word to get round. Sometimes it means we the UK, but let us broaden it to include the US. Supposing we are getting things broadly okay, what possible threats could come from the debt management policies of the United States?
Dr Mohamed El-Erian: Thank you for your kind words. If I understood you correctly, you are asking about the risk to the UK from the policies of the US.
Lord Turnbull: Yes.
Dr Mohamed El-Erian: The system operates as follows. I am telling you something that you know. After the Second World War, the Bretton Woods system put the US at the centre of the global system. The US provides key public goods. The two most important of the public goods are, of course, the currency—the dollar is a reserve currency—and the US financial system, which intermediates other people’s savings because it is so deep. Those are two public goods.
In return for that, the US gets what a French leader called exorbitant privileges. People essentially exchange goods and services for pieces of paper. That is what a reserve currency gives you. The more money you intermediate for others, the lower your interest rates. And, of course, the US has a very strong voice in international organisation.
The implicit contract underpinning this is that the US manages the system responsibly. We have had a series of shocks recently emanating from the US. The global financial crisis in 2008. The Trump tariffs, which weaponised tariffs in 2017, came from the US. We had the big mischaracterisation of inflation as transitory. That also originated in the US. Then we had one of the sharpest increases in interest rates, again led by the Federal Reserve. I am saying that, because the UK and others have been on the receiving end of every one of these shocks. So the ability of the UK to navigate an already tricky terrain is also a function of whether the system as a whole is stable.
The good news is that the US has shown economic exceptionalism. Compared to our low growth rates, it had a growth rate of nearly 5% in the third quarter and over 3% in the fourth quarter. US inflation has come down more quickly than UK inflation. The US is in a better place than many—in fact, I would say most—other advanced economies, certainly better than the eurozone when it comes to future drivers of growth. The question becomes whether it maintains this exceptionalism. If it does, this will facilitate our own adjustment, because it will keep the benchmark interest rates lower than they would be otherwise. It will keep funding flowing throughout the system. If the US starts repeating policy mistakes, of course it will be much harder for the UK.
Lord Turnbull: Is the so-called Biden Inflation Reduction Act, although it did not seem to really relate to either of those, a well-judged piece of policy, or do you have concerns about it?
Dr Mohamed El-Erian: Let me say that I believe that we are going through three major structural transformations. We have already mentioned one: decarbonisation and green energy. The second is technology, particularly generative AI, and the third is life sciences. Those three will be very important drivers of future economic growth and future productivity. Those three will not materialise without public-private partnerships, without the public sector crowding in private sector activities.
The US legislations that you referred to are a serious attempt to do so. It is probably the most serious attempt we have seen outside of China. Is it perfect? No, certainly not, but it is a lot better than not doing it. I think that the rest of the world, Europe in particular, has gone from viewing the legislation as protectionism to understanding that, in order to capture the upside from these major transformations, Governments will need to play an enabling role.
Q73 Baroness Noakes: You said at the outset that the best way was to grow ourselves out of debt. I think there would be cross-party agreement, certainly in this country, that economic growth is absolutely key to our future success. I wondered whether you would comment on the role of China in economic growth, given that China has been one of the major engines of global growth for some time, with very high growth rates, but now it has its own problems. In particular, it has negative population growth, which has arisen from a number of factors, including the massively falling birth rate. There have to be limits to the amount by which China can prop up its economy through investment, which is what it has done recently. I wondered what your take was on the role of China in global growth and therefore, eventually, the prospects of growth in this country.
Dr Mohamed El-Erian: As you know, Chinese economic development has been a miracle in the way it has brought people our of poverty and the Chinese authorities’ ability to course correct. I owe a lot of my thinking on China to Professor Mike Spence, a Nobel Prize winner who looked at the growth dynamics. He often noted that the model of China—politically it is able to do this—is to identify a destination far in the future, to have the confidence to get going on the first few steps, and then to learn very quickly from both its experience and the rest of the world’s experience. The course corrections have helped it tremendously.
Today, China has to reform, because the growth model that has served it so well is now like an old engine. If you keep on cranking it up through stimulus, monetary and fiscal, it becomes more and more inefficient. Then you have the image of oil spilling out everywhere. You start getting collateral damage and unintended consequences. China has this problem with its growth model. It also has a problem with pockets of overindebtedness in the property sector and beyond that.
To address these two things, China would need, first, to revamp its growth model. Secondly, it will need to deal with these pockets of overindebtedness without creating a general balance sheet recession. That is the challenge it faces right now. It is also why China has not opted for the sort of old-style stimulus measures that it used to. Going forward, it means that China’s growth engine will be a lot less powerful for the global economy than it has been in the past. It needs time to revamp its growth approach. During that period, growth will be in the 3% to 4% range. It sounds high to us, but it is actually low in terms of what China needs and has achieved. Also, there will be fewer positive spillovers to the rest of the world.
I have said all this without mentioning geopolitics. As I said earlier, one of the secular trends I believe we are in is that of global fragmentation. The system is fragmenting as countries look for more resilience than they have had in the past. That is really problematic for China, because it means that the global economy will go from a tailwind to a headwind. To put all that together, it is just to say that we should not expect China to be a meaningful engine of growth for the global economy in the next few years.
Baroness Noakes: That means that we will be looking at rather sluggish growth in the UK and Europe over the next few years.
Dr Mohamed El-Erian: Yes, if we do not pursue the sorts of pro-growth, pro-productivity measures that we desperately need. At the end of the day, everything we talk about boils down to three words.
One is agility—the ability to adapt your economic management approach and growth model to the realities of tomorrow.
The second is resilience; we live in a world of almost permacrisis, where there is one shock after the other and, if we stumble, we have to be able to get back up.
The third is optionality, which is the open mindset to think differently. In the world we are talking about, and given the initial conditions we enter with, such as sluggish productivity, high debt and inadequate public services, we will need this combination of agility, resilience and optionality. China’s low growth makes that need even more acute than it would be otherwise.
Baroness Noakes: Can I expand my question a little towards other geopolitical risks, the impact that they may have on global growth and therefore the kinds of growth opportunities that the UK will have going forward? Obviously I have in mind what is happening in various battlefields around the world.
Dr Mohamed El-Erian: In one word, they are stagflationary. At the margin, they reduce economic growth and increase the input costs for companies and what households face. So far, they have been relatively limited. However, there is a risk of escalation, as you know much better than I do, in the Middle East. The markets have been incredibly calm about the geopolitical risk premium. You hardly see any geopolitical risk premia priced in the marketplace right now. The explanation that a lot of people use for that is that we are on the cusp of lower interest rates from central banks and that is the one issue that the markets are focusing on right now. It would not surprise me if, in the weeks and months ahead, the markets become more sensitive to the geopolitical risk premia.
Q74 Lord Griffiths of Fforestfach: Going back to China for a minute, you talked about the growth model spluttering and coming apart, and oil coming out. What exactly does China itself have to do to sort that out?
Dr Mohamed El-Erian: First, it needs to go from relying on the outside world to relying on the inside world for growth, so going from an export‑oriented economy to a more domestically oriented economy. Secondly, domestically it should rely less on public sector-led investment and unleash the household sector more. Thirdly, and this seems to be politically most challenging, it needs to push down the initiative for growth, rather than pulling it up, as has been happening in the last few years. If it combines that with what it is doing on in generative AI and green energy, it would significantly improve its growth prospects.
Q75 The Chair: Thank you for such clear answers. Piecing them together, am I right in inferring from what you are saying that, given how the debt sustainability of other countries impacts on us, we should be thinking more and be more concerned about what may or may not happen in China than the US, given the US’s track record on growth in particular? Baroness Noakes makes the point about growth in those countries having an impact on us per se, but I am thinking about it through the prism of debt sustainability. Is that a fair characterisation of what you are saying?
Dr Mohamed El-Erian: If I may, I will just slightly reword it. We should be concerned with what we do and how we start generating productivity, growth and, ultimately, sustainable and durable economic growth. This has massive implications for how we think about deficits, taxes versus expenditure and within expenditure. We should not rely on the rest of the world to pull us up. If anything, we should worry that the rest of the world may pull us back. It is a challenge that is domestic in nature and it requires mainly domestic measures. We should be urgently moving on that road, because the world is not as friendly as it used to be.
The Chair: That gives us a neat segue into Lord Davies’s question.
Q76 Lord Davies of Brixton: I have a follow-up question to this question too, because you have made really clear the importance of growth. There are issues with growth, though, such as the extent to which physical and human resources are available to power it and ensuring that it is decarbonised. How optimistic or plausible is that?
Dr Mohamed El-Erian: I am worried that, if we are not careful, the low‑quality growth that we have been pursuing, which is also inconsistent with the well-being of our planet, will reach a tipping point. I am optimistic that, through a transition to greener energy, we can deal with both issues, which are stopping the damage to the climate and the planet while generating sustainable and inclusive growth. We have the tools. What is required is something that is very hard for all sorts of reasons, which is a long-term policy orientation and an ability to course correct as needed. Unfortunately, we tend to go for short-term measures, and often what is economically desirable is not what is politically attractive.
Q77 Lord Davies of Brixton: This is my question. To change the approach somewhat, we have all seen the history of public debt. We have all seen graphs going back to Napoleonic times, mountains and peaks, of course reaching 250% during the Second World War and consistently high above 100% during the 1920s and 1930s, and yet we survived. What do you think that teaches us about where we are now? Is it a brave new world where the old rules do not apply?
Dr Mohamed El-Erian: One of the most difficult things is to find a measure that tells you how close you are to the red zone. People tend to use debt to GDP, but debt to GDP is partial and problematic in itself, for both the numerator and the denominator. If you look at debt, you do not capture what the debt maturity profile looks like—“What sort of debt have I issued? Who’s buying my debt?” You do not capture those things. GDP has all sorts of issues, as you know, and yet there has been this quest for looking for the magical level of debt to GDP.
Then you have Japan. In modern history, Japan has been running numbers that people thought would be completely unsustainable, and it has had no issues at all. You have had countries with much lower debt to GDP than our 97.7% that have run into problems quickly.
Again, I go back to our own experience. The notion that the pension system almost collapsed is frightening, but it shows you what happens when you shock the system suddenly and buyers of your debt step back. I do not know what the magical number is for debt to GDP, but I know that, because we live in a world that is subject to a greater frequency and severity of shocks, we need buffers in the system—the notion of resilience—and we cannot build those buffers unless we continually generate sustainable growth.
Lord Davies of Brixton: Are you saying that the red zone where problems occur is time dependent? It varies by when you are going to hit that red zone. If you are going to hit it in 20 years’ time, it is different to hitting it next week.
Dr Mohamed El-Erian: Yes, totally. That is why my first response to the Chair was that we are not at a crisis stage . We are not going to hit it next week, but we would have hit it in 20 years’ time. Then it becomes this bid offer. If it is not next week and it is not 20 years, where is it in between?
It is one of those things that you do not want to find out, because, when it hits, you become an emergency doctor. An emergency doctor sometimes has to do things that are not the first and best things to do in normal times. The consequence of getting too close to that level is that you end up doing things that can make the recovery harder. In example after example in the developing world in the last 40 years, we have seen the problem that countries never fully exit from debt sustainability red zones. Then it becomes not just an economic and financial issue; it also has massive distributional effects. It is the most vulnerable segments of the population that get hit the hardest in this.
Q78 Lord Davies of Brixton: You mentioned earlier the issue of financial repression. Could you expand on that? Some of us are not quite as familiar with the process and the concept. Perhaps you could say a little bit about that to help us.
Dr Mohamed El-Erian: It is what we went through coming out of the global financial crisis, where the system had too much debt. There are different ways of dealing with that. One, unfortunately, is bailouts. Those were necessary but have all sorts of adverse consequences. The other is that central banks stumbled into a paradigm that the vast majority, if not all, of economic books did not foresee. That is lowering the interest rate to zero and, in the case of the European Central Bank, to negative levels.
Imagine this notion of negative nominal interest rates. You lend your money to somebody, take the risk of lending your money and pay for the privilege of lending your money. That would have been viewed as absurd before the last decade and yet, at one point, 33% of global government bonds was trading at negative yields, meaning that people were buying them and then paying interest to the issuer. That was financial repression. It allows the system to recapitalise the debtor by taxing the creditor. Inflation does the same thing. If you suddenly have an inflation shock, you will get the same effect. This financial repression of reducing interest rates and then central banks coming in and buying securities meant that, for a good 10 years, creditors were subsidising debtors. That is financial repression.
We have recognised today that this financial repression results in all sorts of longer-term distortions in the economy. It distorts financial relationships. It distorts the allocation of resources. When finally you get back to reality, to interest rates that are not artificially repressed, you have to deal with the stock of debt that was financed at artificially low interest rates and cannot be sustained that easily at high interest rates. We are living through part of that today. It is very painful for mortgage holders who have to refinance at significantly higher interest rates. Commercial real estate is another example of that. Financial repression is attractive until you have to exit. Then, when you start exiting, you realise all the unintended consequences that have been created.
Lord Davies of Brixton: Thank you. That is very clear.
Q79 Lord Griffiths of Fforestfach: I have one question on a number of things that you have been saying. If you take the UK at present, we have an election within a year or so. The Government say that they are concerned to make sure that tax cuts are made, because that at least shows some commitment to growth. On the other hand, we look at defence spending, the state of the NHS and a schools or skills budget. So much of that, from what you have been saying, is a medium-term problem—so five to 10 years—in order to avoid getting into the red zone. I believe that is the major challenge that we face. If that is true, do we need in a way to change the structure of our democratic system? Having elections every four or five years commits us to focusing on the short term, not the medium term.
Dr Mohamed El-Erian: I value greatly democracy, regular elections and the ability of people to go to the polls and choose. The problem that you refer to could be handled in a different way. Basically, we are looking for structure to do the heavy lifting and to stop us going for what is politically tempting but not economically sound.
We dealt with this on the central bank side by granting central bank operational autonomy. A target is set for inflation, and the political system does not interfere with how that target is attained but holds the central bank accountable for attaining it. That was to reduce the temptation of using monetary policy for political purposes. There has been an attempt to do so on the fiscal side with targets, the watchdogs and the Office for Budget Responsibility. There have sometimes been, as in Germany, constitutional brakes, debt brakes as they are called, that apply as an attempt to use structure to do the heavy lifting.
I would not go anywhere near something that is so valuable, critical and such a huge part of our society as regular elections are. I would not go anywhere near that, but I would think about how you get agreement on longer-term goals that should not be sacrificed in the short term. We have this issue today. Someone quoted the IMF report. The IMF came out today and revised down growth, and then warned the Chancellor not to use the fiscal space that is available in March for tax cuts, pointing to the inadequacy of public services. I myself wrote an article in Bloomberg Opinion a few weeks ago saying that, as tempting as it is to use the fiscal space—the headroom, as we call it—for tax cuts, it should be used for other things that directly generate the sorts of long-term growth and productivity growth that we need.
These are choices that Governments make. We will have one coming up in just over a month’s time where the OBR, I suspect, will say, “We measure that there’s so much headroom that can be used”, and then the Government will have to decide whether to use it for tax cuts or for improving public services, investment in infrastructure, and the sorts of steps we need to enable the growth drivers of tomorrow.
Q80 Lord Griffiths of Fforestfach: Thank you for that excellent response. You mentioned that the ratio of debt to GDP has so many weaknesses. What would you put in its place?
Dr Mohamed El-Erian: I do not think there is one perfect measure. It is a bit like a pilot in a cockpit. Some instruments are more important than others, but you need to look at all the instruments. There is a temptation to try to find a single measure that captures that sustainability, and that is a trap. You have to look at a broad set of measures that capture your ability to service debt going forward.
Q81 The Chair: What about assets and how we think about assets when we talk about this? There was a report from the Resolution Foundation that points out, “Asset holdings … appear nowhere in the main summary measures of government financial performance … This deliberate ignorance of the stock position seemed an anathema to anyone working in the private sector”. Should we just look at the other side of the ledger, so to speak? What do you think about that? Is that a fair criticism? Should we be thinking about this in a different way as well?
Dr Mohamed El-Erian: I certainly think we should take into account assets and the quality of the assets. Again, it is not a notion whereby, if we adjust debt for the assets and divide it by GDP, we have a measure of sustainability, because it raises all sorts of issues on all three of those measures. It is really hard, because we are very tempted to look for easy measures and it is not precise science. This is something where you have to look at a whole range.
I have worked on many countries and I can tell you that countries with similar debt-to-GDP ratios and assets have had different trajectories. Some had very short-maturity debt that had to be refinanced. Others had very long‑maturity debt and had a massive runway to pursue other things. As tempting as it is, it is very hard to come up with any single measures. There have been many criticisms. The IMF has a different set of sustainability measures. The Institute for Fiscal Studies has different metrics and the Resolution Foundation as well. At the end of the day, you should look at them all because it is a cockpit of many things you need to look at.
Q82 Lord Davies of Brixton: You have addressed the issues that arise from the question I had in mind. Would it be fair to say that, while you would not go as far as saying that the fiscal rules as they are used at the moment should be put on one side, you are saying that they should be seen very much in the context of everything else that is going on? Are you familiar with the paper produced by Peter Orszag, Rubin and Stiglitz, where they reject the concept of fiscal anchors and say that there should be a basket of issues? They put a lot of stress on automatic stabilisers and that sort of thing. Do you have a view on whether that is a sound approach? Is it one you would adopt yourself?
Dr Mohamed El-Erian: You need to give me the conditions for a few things. The first is the strength of our institutions. The second is how sound our debt management policy is. The third is how disciplined are we. It is a bit like parenting. We often use the shortcut of rules, some of which I, as a parent, would acknowledge are very rough and ready, in order to try to constrain certain behaviours. If you have strong institutions, sound debt management and responsible policy-making, Rubin, Orszag and Stiglitz are absolutely right. If, however, you are Argentina, which has shown a repeated failure on all three, we are going to have to apply certain targets that are not perfect but that constrain irresponsible behaviour.
I think we are much closer to the Orszag, Rubin, Stiglitz end than Argentina. Even our reality with rules is that a shock happens, the rule is not met, we recalibrate the rule to reflect the shock that has happened and then we move on from that. At the end of the day, these rules tend to end up being quite flexible.
Lord Davies of Brixton: Yes, it is about institutions.
Dr Mohamed El-Erian: It is. The strength, credibility, accountability and transparency of institutions are absolutely critical on these issues.
Q83 The Chair: Can I just pick you up on this, Mohamed? This is very interesting. Let us stick to the UK for the time being. Do you think that the rule performs any meaningful service as it is, or not really? It seems to be honoured in the breach.
Dr Mohamed El-Erian: It forces a certain amount of thinking. The system we have right now, with the OBR first looking at the projections, finding out how much headroom exists relative to whatever target is binding first and giving that as a parameter, plays a really important function. It is an anchor. I would certainly not do away with what we have now, but I would complement it with other things.
The Chair: To be clear, what might the other things be?
Dr Mohamed El-Erian: Within that there is this notion of dynamic forecasting, the ability to look at many scenarios and understand that the path to a certain objective in five years’ time can be attained in different ways and the quality of that path really matters. That is important. That goes back to the quality of spending and of taxation. We also need something that reflects that, every time we revise up a target, it should not be, “Don’t worry. If a shock happens, we’ll simply fully accommodate the shock”. Then we move up to a high level of debt and move forward again with more budget responsibility, only to have another shock.
We have had a tremendous increase in our debt to GDP in recent years. If you look at it, three-quarters of it has come because of shocks, such as the global financial crisis shock, the energy shock and the pandemic shock. What tends to happen is that we adjust everything higher, in terms of indebtedness and interest payments, and then move forward. At some point, we have to recognise that we have to adjust for what we accommodated, rightly, during the shocks. We should be flexible enough to accommodate a shock, but we should not then think that it is a free pass for the future.
Q84 The Chair: That was very interesting. Can you give us your views on the debt brake in Germany? Just today I was reading that there are proposals afoot for a wide-ranging reform of the German debt brake. Is that something we should be looking to, or would you say that we should stick with what we have and do what you have just suggested, i.e. add more measures to the current rule?
Dr Mohamed El-Erian: The debt brake is a perfect example of when some rules can be counterproductive. For those who have not followed this closely, what basically happened is that the constitutional court ruled on spending that was deemed to be unconstitutional, so the Government had to find savings to compensate for what was deemed to be excessive debt. It did that at a time when Germany was going into recession and major investment was needed for the drivers of tomorrow’s growth. As a result, Germany has become even more the sick man of Europe, even though its balance sheet—going back to the notion of balance sheet—is among the strongest in the advanced economies. It is a self-inflicted injury that comes from being overcautious.
I am sorry I keep on repeating myself, but, ultimately, we should be waking up every morning and asking, “How much resilience do we have? How much agility do we have? Is our mindset open enough to recognise that the world is changing around us?” Germany has built a tremendous amount of resilience, but, in the process, has sacrificed the agility that is needed to navigate the world we are living in today.
Lord Griffiths of Fforestfach: My reading of the Swiss experience with something very similar is that that has been successful, whereas the German one has not.
Dr Mohamed El-Erian: I do not know enough about the Swiss one, but knowing the Swiss it would not surprise me if it has been successful.
Q85 Lord Turnbull: You mentioned with approval the OBR’s projections as helping to condition the debate, but is it hamstrung by two complaints? One is that the Government say, “These are our spending plans and these are our tax plans”. If neither of them has any credibility, the OBR is lumbered with producing projections that do not really fit the bill. It probably does not even believe in them itself.
Dr Mohamed El-Erian: My understanding of the OBR process—please correct me—is that there is a pre-measure assessment and then the Government supplies a list of possible measures on both the tax side and the expenditure side. The OBR then opines on what the fiscal implications will be. That is what it feeds back to the Government. The Government then decides on the actual measures. Is my understanding incorrect?
Lord Turnbull: I thought the Government said, “We’re going to constrain the growth of public expenditure in real terms to 1% a year”—that would be more than swallowed up simply by the health service—“and we’re going to index road fuel duty, having promised that for 10 years and never done it”. Both of those leave us with a position where, if the OBR incorporates stated government policy into its projections, it does not get projections that really tell us what the debt position is.
Dr Mohamed El-Erian: Yes, I understand. You are referring to execution risk; that is, I tell you that I am going to do a certain thing, but it is unlikely that I am going to do it.
Lord Turnbull: Yes.
Dr Mohamed El-Erian: That is clearly there and has been for 14 years now. It is hard to think of an alternative. Should the OBR be opining on whether the Government intends to carry through on their promises? That puts the OBR in a really hard position.
It is interesting that you say that, because the IMF today, in updating its assessment of the UK, said it does not believe the UK can deliver the expenditure cuts that have been indicated. There are independent bodies that can and do make such judgments in very public ways. I am not sure you would want the OBR to do it, but I leave that up to you, because it reports to you.
Lord Turnbull: We talk about the OBR as an independent commentator, but you are clearly indicating that it is not, whereas the IMF is not subject to the same constraint. If the IMF does not believe what the Government are going to do, it can put in a different number. The OBR cannot.
Q86 Lord Londesborough: Can we come back to the good way, as outlined at the beginning, which is sustainable real growth? Putting external shocks to one side—as you explained, that is a pretty major aside—is it fair to say that the key reason the UK is saddled with debt the size of our annual GDP is our anaemic growth rate and low productivity over the last 15 years? Government receipts are about £150 billion short of our spending needs principally because the economy is too small. Is enough attention paid to the structural slowdown in growth as a source of our deteriorating dynamics?
If I can add a secondary question to that, you came out with this interesting expression about the quality of growth. Would you describe the growth that the UK has had in the last 15 years as low-quality growth or is that unfair?
Dr Mohamed El-Erian: First, thank you for bringing in the word “structural”, because that is key. It explains outcomes that have consistently disappointed on both productivity and growth.
If you remember, in the run-up to the global financial crisis, the UK was among the countries that fell in love with finance. I remember two particular transitions. One was a linguistic transition. We used to call it “financial services”, but we started to call it “finance”, as if it were the next level of capitalism. You had agriculture, industry, manufacturing and services, and if you were really good you could get to finance. The value added keeps on going up as you go up that ladder. We somehow fell into the trap of forgetting that the financial services sector serves the economy and finance got very big relative to the underlying economy.
The second transition that was made is that people started competing to be the financial centre of the world. If you were not big enough—if you were Iceland, Switzerland or Dubai—it did not matter. You could borrow someone else’s financial sector, and you could grow at a multiple of your GDP.
In the process of all this, most countries, Germany being the exception, stopped investing in what really promotes economic growth: people and infrastructure. Come 2008, we realised that we overdid this romance with finance. But then we substituted the public balance sheet for the private balance sheet. Over the next decade, central banks became—I wrote a book on this in 2016 with this title—the only game in town. They became the major policymakers, and they invented and evolved their tools, as we discussed earlier.
Again, we did not invest in the fundamental drivers of economic growth. We have had this whole period where we were tricked by finance. We fell into this romance, and we stopped doing what is really important, which is to structurally enhance our growth engines.
We have an opportunity now to make up for our mistakes because of the big three transformations that I talked about. They allow us to leapfrog certain stages that we have already missed. That is the good news. The bad news is that we are starting from a situation that is worse than it otherwise could have been. Yes, there absolutely has to be investment in the structures that allow for growth.
Why has growth been low quality? First, it has been debt driven. Secondly, it has not been inclusive enough. It has left people out. People felt alienated and marginalised. Thirdly, it has not been of the type that builds on itself. Because of that—I go back to the image beforehand—we had to throw more and more money at it to get growth out of the system.
It is the result of a lack of focus on the structural drivers of proper and genuine growth and this excessive romance with finance. That is the legacy that we are trying to overcome right now. I keep on going back to being optimistic. We have these opportunities that have opened up, which can fundamentally change our growth and productivity paradigm.
Lord Londesborough: Being an optimist, what rate of productivity growth is a realistic goal for the UK over what time horizon? Part of that question is whether you feel the Treasury should play a stronger role in target setting for growth, on which it seems to have little to say.
Dr Mohamed El-Erian: First, it goes beyond the Treasury. It is one of these things where, to use the American phrase, you need a growth tsar. You need someone who co-ordinates the different agencies and ministries and always asks the question, “What is that doing to growth?” You literally need someone to be the common denominator on a lot of these things. Otherwise, people tend to get distracted by other issues.
I see no reason why our productivity growth cannot be pushed from where it is now well towards 2% or even a little bit more. It is absolutely feasible, but it requires us to invest in those future growth engines.
Lord Londesborough: You mention a productivity tsar. Earlier, you suggested that one problem of the political system is mainly short-term decision-making on the economy, when, particularly on the structural side, these are long-term issues. Do you have in mind a productivity council that is outside the political system? What are your thoughts there?
Dr Mohamed El-Erian: That again goes to the notion of using structure to do the heavy lifting. Could you have a structure, such as the one you just mentioned, that does this? The US uses councils, which tend to be public-private interactions. I chaired a global development council for President Obama, which was about people coming together and interacting with the different ministries to improve US global development efforts.
You can use such instruments, but ultimately this is something that politicians have to be convinced about. You can create all those bodies, but they have to be influential. In any system, you can inform outcomes, influence outcomes or impose outcomes. That is the range. Parliament imposes outcomes. Think tanks can inform outcomes.
You are looking for the middle: some sort of structure that can influence outcomes. It does not impose outcomes; it influences outcomes. Parliament imposes outcomes. Those outside bodies can go from just informing to influencing.
Lord Davies of Brixton: I have a quick follow-up on the idea that the economy fell in love with finance. Is this the same thing as overfinancialisation, which Andy Haldane has spoken about? Would you go as far as to say that it was a resource curse?
Dr Mohamed El-Erian: Yes, it is what Andy Haldane has talked about. This is a really interesting notion. I had never thought of it before, but it does have elements of a resource curse. That is really brilliant. Thank you.
Q87 Lord Blackwell: In a minute, I want to come on to the structure of the debt, but before that, I want to talk more about this growth issue, which, as you have said from the beginning, is so core.
The OBR has a very pessimistic view if you go right out into the future. Extrapolating on its view of the historic levels of productivity growth in the UK, it shows expenditure as a percentage of GDP going up from the 40s to over 60% and on an upward trajectory simply because of demographics, more spending on healthcare and social care, and the fact that the number of people in work as a proportion of the population will continue to decline.
That is an Armageddon scenario. If that is true, it is impossible to believe that we could continue to raise taxes to keep up with expenditure and have continuing growth. There has to be a way out of that.
There is also the optimistic view, which you were just putting forward. Is it possible to believe in a scenario that says, over the last 10 years certainly, our productivity growth, which has been dismal overall, has been masked by the bursting of the financial services bubble and all the value added that was in the economy from that? That meant a significant decline in GDP and therefore a drag on productivity over the last 10 years. If you extract it from beneath that, maybe the productivity growth of the rest of the economy has been higher than the OBR has said.
Going forward, the UK is a heavily service-dominated economy. There are lots of debates about AI, but one ought to think that AI would be a huge boost to productivity in the kind of services that the UK excels in. Are those the kinds of things that lead you to your 2%-plus growth scenario, which would get us out of the doldrums?
Dr Mohamed El-Erian: There is so much there. My understanding is that the OBR takes existing policies and economic trends, projects them forward and says, “This is the path that we’re on right now”. Of course, you can change paths. That is what policy is about; it is about changing paths. It is similar to when Andrew Bailey, the Governor of the Bank of England, came out and said, “Given what I see right now, inflation could peak above 13%”. Inflation did not peak above 13% because measures were taken.
The OBR is saying, “This is the path we’re on. If we continue on this path, this is what it probably leads to”. It is a bit of a fan chart. There is a central scenario and there are alternatives, but that is the direction of travel. We can change the direction of travel. In our case, we certainly should change the direction of travel.
On your question on AI, there is this notion of labour- augmenting AI. It is one step advanced from whether it will take jobs away. A lot of AI potential is labour enabling and labour enhancing. We see this in education. There can be a world in which students have in their pocket a tutor who understands the student’s ability to absorb information and delivers coursework in an accessible manner, and then the teacher migrates up the value added to solving problems more of the time. The teacher goes from providing information to solving problems. That is higher value added and allows for better educational outcomes.
Just to make it very personal and to show you how old I am, I remember the day when I walked in and found my 10 year-old, who is now 20, doing her homework. She had her computer open where she was working. She was using her iPhone to call a friend on FaceTime, and her friend was also doing her homework. She had her iPad on with Netflix. I looked at this configuration and I asked, “How can you possibly concentrate? This is ridiculous”. She responded, “Dad, judge me by results, not by old-fashioned approaches”.
I say that because we will go to a world in which the way we teach or do other things is going to evolve because of AI. In medicine, it is very clear that we are heading in this direction. It can be productivity enhancing in a significant manner. That does not mean there are no risks—there are major risks that need to be managed—but most transformations and innovations involve risks. We just have to manage them. Again, this has a component of private-public partnership.
Lord Blackwell: Let us hang on to that source of optimism. Can I move on to the structure of the UK’s national debt and the implications of that for sustainability and funding? There are certain characteristics of the UK’s debt that are potentially concerning. It has been increasingly short-term under quantitative easing; a lot of it is index-linked; and a lot of it is owned by non-UK entities. All those characteristics potentially add to the risks. Do you see the structure of the national debt as an issue for its sustainability and long-term funding?
Dr Mohamed El-Erian: Yes. All three make you more vulnerable to shocks. Shorter maturity means you have to refinance more often. Being index-linked means that, if there is a shock to inflation, you immediately see your debt service deteriorating.
There is then the tourist versus resident issue. Foreign holders of debt are very often the equivalent of tourists visiting a certain country. Think of us in wintertime. We pick up a brochure and look at somewhere warm and we are attracted to going there. The minute something goes wrong there, we act like tourists and not residents. We head to the airport and get out. Home bias comes in very strongly. That is what tends to happen during shocks. Investors tend to be subject to home bias.
That is amplified by some structural aspects of investment management. Often, the UK position can be what is called off-benchmark—it is not part of the benchmark for some; it is more of an opportunistic exposure. Therefore, not only do you worry about your return; you worry about reputational risk as well. There are lots of factors that contribute to the home bias tendencies of international investors. If you rely, as the UK does, on foreign investors, you are also subject to a withdrawal of funding. Tt can be for shocks that have nothing to do with you at all. It could be a shock outside.
Yes, maturity, being index-linked and the pattern of ownership make the debt more challenging to manage well on a consistent basis.
Lord Blackwell: If we want to improve sustainability, should we have clearer policy objectives around the structure of our debt?
Dr Mohamed El-Erian: The answer is yes. We should certainly lengthen its duration—its average maturity. That comes at a cost. The cost of doing so right now is not that high because of the way that the yield curve is shaped. In general, one should look to lengthen maturities in a cost-effective way.
Again, there are structures that can be used to do that. The US has something called the Treasury Borrowing Advisory Committee. That is a committee of participants in debt financing that come together with the US Treasury once a quarter. That provides the US Treasury with a feel for what the appetite is in different parts of the yield curve and what the implications of different maturities are. Slowly, you can start moving the average maturity and composition of your debt, whether it is inflation-linked or not, to where you want it to be. You do that after being informed by what the market conditions are. You do not shock the market without understanding what the initial conditions are.
Lord Blackwell: The move to shorten the debt structure here because of the Bank of England’s role in quantitative easing happened without, to my knowledge, any serious commentary, opposition or policy debate that said we should be doing something to prevent this shortening of the debt. Would the US system have challenged that?
Dr Mohamed El-Erian: The US fell into the same trap. Part of that is because, when central banks embarked on QE, they thought they were building a short-term bridge. That is honestly what they were thinking. No one thought that QE would last a whole decade. Once you fall into the trap of QE, it is very difficult to exit. That was the history.
We finally had to exit when inflation became unacceptably high. Part of the problem was that we simply did not recognise early on that we were going into a multiyear regime of QE.
Lord Blackwell: Can I just ask about Japan? Japan is held up as an outlier in terms of its debt-to-GDP ratio of 250%. Are there any lessons we can learn in terms of the structuring of our debt from the way Japan is handling it?
Dr Mohamed El-Erian: In the economic profession, there is a lot of discussion going on about how that very high debt has contributed to deflation and to the private sector being too risk averse. It is an issue. Japan went one step further than other central banks in implementing what is called YCC or yield curve control. It has put a ceiling on the 10-year government bond. That ceiling was zero, then 0.5% and now 1%. That has massively distorted the financial system. There were days last year when Japanese government bonds never traded.
We should learn from Japan that, even though it was able to sustain a high debt‑to‑GDP ratio, it came at a cost that now is also limiting its ability to normalise monetary policy as other central banks have been able to do.
Lord Blackwell: I have one last question. The equation around sustainability contains both growth and the interest rate on government debt. The former Governor of the Bank of England, Mark Carney, argued some years ago that interest rates would be structurally low in the world for decades because of a surplus of savings and that, given that our interest rates are tied to US and global interest rates, we were permanently in a low interest rate environment. Do you agree with that? Do you have a view on what the equilibrium long-run rate of interest in the UK might be?
Dr Mohamed El-Erian: That view was dominant in the last decade. It was absolutely dominant because there was a feeling that there was insufficient demand in the global economy. We had had massive positive supply shocks, such as the entry of China and the former Soviet Union countries into the global system. After the global financial crisis, there simply was not enough demand in the system. That meant equilibrium interest rates were much lower. It also meant you could flood the system with fiscal and monetary stimulus and not pay the cost in terms of inflation.
You had a whole theory that came up saying that there is essentially no binding speed limit. Modern monetary theory. Today, my own view—I have said this consistently for the last two years—is that we have gone from a world of insufficient demand to a world of insufficiently flexible supply. It is the supply side that is governing outcomes. It is not just because of what happened in the pandemic.
We have come out with four supply-constraining realities. The first is something that we have talked about. We have to go on an energy transition. It is not easy to replace something with something else that is not fully developed as yet. It is more costly. It requires a rewiring of the energy infrastructure. It is a negative supply shock. It is absolutely necessary, but we will have to accept that it means less flexible supply for a while.
Secondly, there is the geopolitical dimension we talked about. The notion of nearshoring and friend-shoring means that you will go from commercial determination of trade to geopolitical determination of trade. That means international trade will be costlier.
Thirdly, there are companies that have realised that they overdid it in the run-up to the pandemic in terms of efficiency and they now need more resilience. They need more back-up supply chains. That is also impacting the supply side in a manner that is inflationary.
Finally, there is the functioning of the labour market and the skill mismatch that we face.
If we put those four things together, it suggests to me that we will no longer live in a world of insufficient demand but in a world of insufficiently flexible supply. If you believe that, as I do, the interest rate—R‑star, as they call it, the natural level of interest rate—will be higher than what a lot of people thought in the last decade.
It would be interesting to ask Mark Carney today whether he still thinks low interest rates will continue for decades or whether that period is behind us and we are now back to a period where interest rates will be higher than what we have seen, certainly since the global financial crisis.
Lord Blackwell: Can you put a figure on R-star?
Dr Mohamed El-Erian: I cannot. It is really hard to put a figure on R-star.
Q88 Lord Turnbull: You spoke earlier about the adverse effects of flooring interest rates for 10 years. What alternative policy, admittedly with hindsight, should have been followed in those 10 years?
Dr Mohamed El-Erian: Two pivots were missed. Again, I feel strongly about this. In 2016, I wrote a book about it, because I was worried that we were getting ourselves into a trap. It was called The Only Game in Town.
The first pivot was from temporary support for the economy, which was monetary policy, to genuine investment in future drivers of growth. I will give you an example. In August 2010 at Jackson Hole, the annual conflab of central bankers, Ben Bernanke signalled a change in the use of the Fed’s balance sheet. Previously, it had been directed only at normalising markets, so you intervened with your balance sheet—the most powerful balance sheet in the world—to normalise the functioning of private markets. People do not trust each other; banks do not trust each other. You say, “Don’t worry. Trust me, the Fed”, and you restore the functioning of the market.
In 2010, the use of the balance sheet went from normalising markets to pursuing macroeconomic objectives. That came at a time in the US when the Tea Party was on the rise, Congress was completely paralysed, and the Government could not take any action at all. It was viewed as a short-term measure to later hand off to Governments to pursue those macroeconomic objectives.
There is an inherent problem in using the balance sheet, as you know. How does it work? I, a central bank, come in and buy securities. I push the price of the securities up. That pushes the price of other securities up. It then hope to trigger the wealth effect. That is, when you open your retirement account or investment account, you feel wealthier because asset prices have gone up. As you feel wealthier, you spend more, so you trigger the wealth effect. As you spend more, companies’ animal spirits get stimulated. They invest more, and then through the asset channel, all this raises growth.
We found out prettyearly on that the asset channel was very good at increasing asset prices but not so good at promoting growth. That was the first pivot that was missed.
The second pivot that was missed was when central banks realised that they needed to exit, but got held hostage by the markets. We have several episodes of new central bankers coming in, trying to exit, and the market bringing them back in. When Christine Lagarde of the ECB came in, she made the right remark that the ECB was not there to bail out Italian investors. Two days later, she had to change that phrase because of what happened to Italian spreads.
In the fourth quarter of 2018, because the economy was doing fine, Jay Powell tried to pivot away from very accommodating policies. He was forced into a U-turn by disruptive markets in January 2019. The same thing happened to Ben Bernanke in May 2013 when he announced a taper. In July, he had to take it back because market functioning got problematic. The second pivot that did not materialise is the ability to tell the markets, “We’re not your best friends for ever. We’re not there to repress volatility for you. We have other objectives”.
The co-option that happened was broken only when inflation got to levels that were unacceptable. We fell into two distinct traps that made us overreliant on QE and artificially low interest rates.
Q89 The Chair: I am going to come back to tax. The UK tax burden is historically high, but it is below the average across other advanced economies. At what point does the overall tax take have a detrimental impact on growth?
Dr Mohamed El-Erian: At a certain level, it certainly has a detrimental impact. It has negative incentive effects. It can crowd out investment. It can do all sorts of things. There is a level out there. I do not think we are there.
We have a problem in the quality of spending, which means that we end up having the highest tax burden that we have had for many decades and yet the spending side is totally unsatisfactory. I cannot stress enough the importance of investing in infrastructure and public services, because they contribute to productivity. If you do not have a healthy and well-educated population, your productivity will be lower. If you do not have proper infrastructure, your productivity will be lower.
The Chair: Just coming back to what the IMF is saying today, it is warning the Chancellor against cutting taxes. There are tax cuts that are beneficial for growth—I am sure we would all agree on that, would we not? If we had the choice, is that where we should put our emphasis in terms of policy prescriptions for addressing the growth dilemma that you are highlighting? Should we look instead at spending and infrastructure in the way you have just outlined? Should it be both? Where would you focus?
Dr Mohamed El-Erian: I would put growth-promoting and productivity-promoting expenditure as a high requirement. The tax cuts run the risk of pushing on a string, because you are not sure whether they are going to lead to a permanent increase in growth or just a burst of growth. That is the judgment that needs to be made. They will certainly lead to a short-term burst of growth, but will it be repeatable?
Certain health-related and infrastructure-related spending, certainly with the transitions that we talked about, can deliver repeatable growth. That analysis has to be made. The hurdle for using a tax cut as a way to promote growth is that you do not just promote one-round growth; you promote multi-round growth.
Lord Davies of Brixton: When you talk about the impact of the level of tax, do you distinguish between tax that is used to make transfer payments and tax that is used to purchase goods and services?
Dr Mohamed El-Erian: I do. I would also distinguish between taxes on households and taxes on businesses.
Q90 Lord Verjee: Thank you so much for all your answers so far, Mohamed. I have two very diverse questions. Going back to our core theme of debt sustainability and the risks of excessive debt, can we just go back to the geopolitical crisis? It seems to me that in the last decade we have had a profound change in geopolitics. Previously, policy was pro-China and we were all investing in China. Now there is huge disinvestment.
Can you talk a little bit about who the borrowers and the lenders are? It seems to me that the borrowers today are the western world and the lenders are the eastern world, in particular China. Is that a big risk? Can you quantify that risk or talk about that big change between the borrowers and the lenders—tourist debt as opposed to domestic debt?
Dr Mohamed El-Erian: Analysis has been done of the vulnerability of the buyer base. The worst thing that can happen to government issuance is a buyer strike, when buyers just do not turn up.
There are four types of buyers. There are those who have no choice. Think about banks that have to own regulatory capital of a certain type. You then have discretionary institutional investors, who normally look at the whole world and then compare and contrast. You then have areas that have surpluses to invest all the time. The list is the sovereign wealth funds, Japan and China. That is where geopolitics comes in. If you are China and your tensions with the US are not coming down sustainably, you will naturally question the wisdom of investing the extra dollar of reserves that you have into the US.
Increasingly, there is also this notion, as you know, of political swing states. Governments in certain countries want to diversify their geopolitical bets. Again, that means geopolitics gets in the way of all sorts of commercial activity. That is why I used the word “fragmentation”. Before, the system went through the middle for financial intermediation and back out. The US and, to a lesser extent, the UK and Germany were in the middle. It was US-dominated, but they were in the middle too. Capital would come in and then get redistributed.
Now, you are starting to see little pipes around the centre. The good news is that you cannot replace something fully with nothing. There is nothing that can wholly replace right now the core, which is western-dominated, but we should keep an eye on the pipes that are being built. China’s belt and road initiative is a perfect example of little pipes. It comes with funding. It comes with building infrastructure and workers. These are little pipes that are being built.
You can question whether some of the newwst institutions need to exist. The Asian Infrastructure Investment Bank borrows and redistributes capital. It does not do something that the Asian Development Bank or the World Bank do not do. The big difference is that the US is not a member of the Asian Infrastructure Investment Bank and the West does not dominate that bank as it does the World Bank, for example.
So we are seeing little pipes being built that are fragmenting the system, meaning that, over time, the core is going to attract less of the surplus capital that is created elsewhere in the world.
Lord Verjee: I find that whole scenario quite scary. It is a huge paradigm shift. I wonder whether we pay enough attention to that. Pivoting and asking another key point, could you comment on the UK’s debt sustainability with respect to the transition to net zero? What risks does the transition pose and can policy mitigate those?
Dr Mohamed El-Erian: Policy certainly can and must mitigate those. That policy is costly, just to be clear. It is one of those secular burdens on debt sustainability, but the alternative is much worse. If we were not to facilitate a green transition, the bill would be absolutely astronomical in terms of the consequences.
Q91 The Chair: We are very close to the end. Thank you very much for such fulsome and comprehensive answers. Can I just ask a final question? We are in the run-up to an election, sooner or later this year. If you were to scroll forward, say, four years from now, to come back to where we began, and if you were to be comforted that we were on a path to address some of the issues regarding our debt sustainability, what two or three things would you want to see ticks against in terms of government policy?
Dr Mohamed El-Erian: It would be the things we talked about. I would need to see that debt-to-GDP was not only moderating and starting a downward trend but doing so because it was powered by the denominator, by growth, rather than by some sort of austerity that would not be maintained. That is the first issue: to see a reduction in the debt burden because of growth.
The second issue is about reducing the vulnerability in the composition of our debt. You spoke to the three elements: the maturity; the extent to which it is linked to inflation, which has become more likely because of the supply-side issue that we talked about; and the need to develop a broader buyer base and lock them in for longer.
The third element will be the quality of spending. We need to shift spending in the direction of enabling investments and productivity. Those are the things that I hope will happen.
The UK has tremendous potential. It is just a question of removing the obstacles. The work that I have done with colleagues suggests that three factors have consistently contributed to disappointing outcomes. The first—I am sorry that I keep on repeating like a broken record—is the inability to grow in a durable, inclusive and sustainable manner. That has been an important contributor. The second contributor has been repeated policy mistakes. We often make the same policy mistakes over and again. The third one, which is much harder, is the lack of international co-operation. A lot of the problems we face are common to many countries. Certainly, the solution requires international policy co-ordination. The last few years, in particular, have been characterised by a lack of international policy co-ordination. We now celebrate when the G20 agrees on a communiqué, regardless of how meaningless it is. There was a time when we celebrated the G20 coming up with measures; now it is a question as to whether they can even agree on a text.
We need sustainable, inclusive and high growth; we need to stop repeating policy mistakes; and we need a higher level of international collaboration, if we are to manage what is ahead.
The Chair: Can I abuse my position? One thing that was not mentioned in your excellent checklist—you may have implied it—is whether we need action to address the demographic pressures that we are under. In particular, what does the state do to support people in old age, how are individuals encouraged to support themselves in old age and what do we do about things such as the pension age? How important is it to think about and address that during the next Parliament?
Dr Mohamed El-Erian: They always say, “Be careful of the last question”. I really need to think about that. It is important, but I really need to think about it, if you do not mind.
The Chair: That is absolutely fine. You have given us excellent answers to a wide range of questions, and you have spoken incredibly lucidly. I am speaking on behalf of everyone here in saying that this has been an extremely good session, Mohamed. Thank you very much for your time.
Dr Mohamed El-Erian: Thank you for this honour. Thank you very much for your time.
