A sea-change in austerity: what does it mean for investors?

June 16, 2017

John Redwood, Charles Stanley’s chief global strategist, looks at the investment environment now that governments’ attitude to austerity may be changing.

Wealth managers and their clients often feel uncomfortable with insurgent political movements. Around the advanced world, parties that highlight inequalities of income and wealth and demand better for the less well-off are doing well.

Sometimes they come from the so-called right, as in the US, but more often they come from the left, as with Syriza in Greece, Labour in the UK and Five Star in Italy. The conventional parties of centre-left and centre-right have been squeezed on the European continent by populist movements from both sides of the spectrum.  Should investors be worried?

There is an understandable impatience amongst many electors about falling real incomes, or real incomes rising at a glacial rate in much of the West. The eurozone has experienced mass youth unemployment in the south and west. There is anger about the high cost of homes for younger people with no foot yet on the property ladder.

In the UK, which has done better with employment, many young people still feel badly done by. Many of them build up a large initial debt to pay for their higher education. They may encounter delay or difficulty in getting from university into a well-paid job.

With many more graduates, just getting a degree no longer guarantees a management or professional role. They often do not see the opportunity to buy a home or to accumulate financial assets. They end up dependent on the bank of Mum and Dad well after leaving home and getting a job. Those with well-off and friendly parents are greatly advantaged compared to those without.

Income and wealth inequality are more of a problem when there is little or no growth to create more opportunity and a sense of hope. Advanced country governments of right and left try to tackle it. All believe in progressive income taxation to transfer money from richer to poorer. All have complex benefit systems designed to give more income to those with stretched budgets.

Centre right parties tend to accent tax cuts, centre left parties higher benefits, but the aim is similar. The political debate is not about the desirability of attenuating income differentials. It is about the magnitude of the desirable intervention, and the best means.

The biggest difference of view is over taxing the rich. Conservatives tend to the view that taxing the rich is necessary to pay for benefits and public services, but you should not overdo it, as the rich can and will avoid tax or leave. Socialists want to tax the rich as a moral cause and do not mind so much if the rich leave the country as a result.

Inequalities of assets are more marked than inequalities of net income. The rapid rise of house prices has done most to create a divide between those who own and those who rent. The favourable background of bond and share prices in recent years has also generated more portfolio wealth for those with financial savings through pension funds, Isas and personal portfolios.

There is no consensus to tax wealth and redistribute it, in the way there is over income, but there is a general acceptance of taxes on transactions when people buy and sell assets, and some agreement on taxing gains made on assets sold.

In the UK the two biggest sources of personal wealth, home ownership and pension savings are free of capital gains tax. There is disagreement over the desirability of imposing a levy on wealth. Both the US and the UK have resisted such a tax.

In the recent UK general election there was a hostile response to the idea that elderly people in need of social care (in their own home or in a care home) should have the costs registered as a charge against their property value, to be paid on death. The UK does already have a system where an elderly person moving into a care home has to pay the bills out of the proceeds of their former home where they owned one.

Governments are edging towards spending a bit more and borrowing a bit more in the US and UK. On the continent the budget disciplines of the euro make that more difficult. President Trump and the Republican majority in Congress want to cut taxes. They want to promote higher real incomes by taxing less.

The UK government will find it difficult to tax more: it had to drop a recent proposal to impose a higher rate of national insurance on the self-employed. Austerity, to the left, means insufficient public spending and too few public sector jobs. To the right, it means higher taxes and a more restricted private sector.

The mood has shifted on austerity on both sides of the Atlantic. Electors want more growth, not less; more spending power, not less.

That is the background to markets and government decisions. It means a climate where people expect accommodating policies to speed the recovery. This in turn remains a favourable background for share investment.

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