From bitter experience: Lord O’Donnell on the next recession

Lord O’Donnell, pictured at GGF’s 2019 Global Government Summit, has questioned ministers’ decision to abolish the UK’s public health agency

The world economy is in trouble, former UK Cabinet Secretary Gus O’Donnell told the 2019 Global Government Summit, and governments must become more effective – repairing their economies, and reshaping public services around prevention rather than reaction. Matt Ross reports

“We’re going to have a global recession,” said Lord O’Donnell. “I’ve no idea when: we’re very poor at predicting them. But it’s overdue.”

“And what’s different about this next recession is that we’ll be going into it after a global financial crisis,” he continued. “That means that interest rates globally are much lower than they have been on previous occasions, so we have much less ammunition left to fight it with traditional monetary policy.”

O’Donnell has more experience of recessions than he’d like. A former academic economist and HM Treasury permanent secretary, he was Press Secretary to UK Prime Minister John Major during the 1990-91 recession, and Cabinet Secretary throughout the Great Recession of 2008-‘09. Since leaving office in 2011, he’s served as chair of consultancy Frontier Economics, a visiting Professor at the London School of Economics, and a trustee of the Economist Group.

Asked to speak on the global economy and developing governments’ capacity at the 2019 Global Government Summit – which brought together top civil servants from nine countries for informal discussion of their shared goals and challenges – O’Donnell began by pointing to a number of ominous dynamics in trade, finance and business confidence.

Less trade = less growth

“Trade growth has tended to drive economic growth,” he pointed out – but following a brief bounce-back after the Great Recession, world trade growth has slowed. “From 1999 to 2007, it was an average of 6.5% a year. Since the global financial crisis, it’s been 2.8%,” he said.

And trade faces strong political headwinds. If Brexit goes through, O’Donnell commented, the UK will have “thrown away the biggest, most fantastic trade deal on earth in favour of a much more restricted deal.” Meanwhile, US President Trump is sinking ever deeper into a trade war with China.

Globally dominant countries do tend towards protectionism as their pre-eminence fades, he noted. The UK introduced tariffs in 1932, as its international heft was eclipsed by that of the USA: “Now the US is being overtaken by China – and, in time, by India – and the [US is] starting to go protectionist.”

Meanwhile, O’Donnell argued, the combination of low interest rates and ‘Quantitative Easing’ – the injection of cash by central banks into the financial system, in order to prop up the banking system – has left large amounts of capital floating around the system, looking for a lucrative home. So assets may be over-valued, and there’s plenty of “money chasing crazy schemes, which offer ridiculous rates and at a very high risk.” If confidence takes a knock – perhaps due to a worsening trade war – that money could flee the markets quite quickly, prompting a recession.

Further instabilities lie rooted in growing inequality. For though globalisation has produced huge wealth, “you get big winners and big losers,” he said. “Technology is rewarding high-productivity economies and people and labour much more; the net result is that inequality is rising.” The proportion of national income taken by the top 10% of earners in the US has risen from 37% to 47% since 1980, whilst the top 1% have increased their share from 10% to 20%. “So what are we failing to do, from a civil service and government policy point of view?” he asked. “Quite simply, the winners are not compensating the losers. We’re not finding ways to get the benefits of globalisation, whilst dealing with its problems.”

The toolbox isn’t empty

What tools can governments use to combat these risks? For one, O’Donnell suggested that they could be more willing to borrow to invest. In January, macroeconomist Olivier Blanchard – a former IMF chief economist – argued that if public sector interest rates are lower than a country’s expected rate of growth, then it makes sense to increase borrowing. The caveat, O’Donnell added, is that you “have to be doing it for a good reason” – such as infrastructure investment, or to compensate for “the distributional consequences of globalisation and technology” – rather than “to give tax cuts to people who already have lots of money.”

Passing some economic decisions from ministers to autonomous bodies can help improve policymaking, he said – citing the UK’s 1998 decision to put the Bank of England’s Monetary Policy Committee in charge of setting interest rates. “The inflation target is set by the politically-appointed Chancellor, democratically accountable for that decision; and then the technocrats, given an inflation target, decide what interest rates need to be,” he explained. There is room, he suggested, to extend this model: “You get the politicians to define the outcomes – not intermediate inputs, but final outcomes – and then get the technocrats to deliver on that, using all the evidence from around the world as to what works.”

O’Donnell also advocated strong market regulation and competition authorities, challenging the perception that technology markets can’t be regulated. The Californian model views the internet as “open, free, unregulated and unregulatable,” he pointed out; but the Chinese, whilst happy to leave the commercial internet largely free, decided to “regulate it in the political sphere. And all those people who said that was impossible turned out to be wrong.” In O’Donnell’s view, intelligent regulation could help counter some of the inequities fostered by today’s technology-fuelled economic growth.

Finally, the former civil service chief argued that nations must hang onto the international rules-based order. In the early ‘90s, he pointed out, the last global trade round generated huge tariff cuts and created the WTO. “Those rules have worked very well, with amazing benefits for trade and growth,” he said. “We risk that if countries are not abiding by those rules.”

Ministers do ends, officials do means

Turning to building governments’ capacity to address today’s challenges – social and economic alike – O’Donnell highlighted the need to focus on outcomes, and to strengthen preventive work.

“Throughout my time in government, it was very clear to me that what was nearly always missing was clarity about outcomes,” he said. Taking health services as an example, he pointed to politicians’ tendency to promise “to build more hospitals, or employ more doctors and nurses; but they’re all inputs.” It’s hard to get ministers to look past the means and focus on the ends, he added: “I had nine pensions ministers in five years: they weren’t there long enough to know anything about pensions, but they all had a very strong view about the right thing to do.”

Similarly, he said, the focus on exam results in education may be misplaced. “There is very little evidence that universities get the best people by using exam results, because they’ve never used anything else,” he pointed out. But research by Lord Layard of the London School of Economics suggests that “individual children’s wellbeing levels are good predictors not just of how well they do in exams, but also better predictors of how well they finally do in life – in terms of their wellbeing and incomes – than exam results.” So if schools damage children’s wellbeing by pushing them relentlessly to excel in exams, they may be doing more harm than good.

Even when governments establish central delivery units to manage performance in public services, he continued, they tend to rather miss the point. In the UK, the targets set by the central unit “were things like not waiting longer than four hours in an Accident and Emergency department. Actually, do we care about that? No! Our outcome should be ‘quality-adjusted life years’, which is the measure we use in a tiny part of our health service – when we assess the value of new drugs. Why don’t we use that for everything in health?”

Don’t respond; avert

When policymakers begin to focus on outcomes rather than inputs, that leads them towards preventive services: shifting away from intervening to address a problem, and towards averting the problem.

“In general, we are set up in the public services to cure problems,” commented O’Donnell. But in many fields, demand for such responsive services is essentially unlimited unless public servants can address the root problem: health professionals can keep on healing the injuries suffered by an elderly person who regularly falls at home, for example, but what’s really required is the equipment and home care that will avert those falls. “We’re curing, curing and curing again; we need to prevent,” he said.

“If you go to the hospital, that should be regarded as a failure,” O’Donnell continued. “We should prevent people from getting into those situations. And that’s massively worthwhile from a public expenditure point of view: the Treasury should be completely with us on this, because it’s much more efficient to prevent problems than to solve them.”

In part, he added, the solutions must lie in changing incentives structures. So in the UK’s National Health Service, for example, hospital trusts are paid according to the number of treatments delivered – not the health, quality of life or lifespans of their patients. And O’Donnell gave another example, regarding civil service compensation.

When O’Donnell was Cabinet Secretary, London-based civil servants were paid much less than their private sector counterparts – leading to high turnover rates and skills shortages. Meanwhile, they had very generous pensions: “We were giving people most of their money after they retired!” Yet because salaries are counted in departmental budgets whilst future pensions liabilities are not, O’Donnell struggled to get political support for shifting the balance. “We did manage to change it, but the politicians weren’t that bothered,” he commented. “Accounting changes could make a difference. Probably what we need is an international body, like the IMF or the OECD, saying: ‘This is the way you’re going to do it’.”

In praise of experts

Summarising, O’Donnell warned that “the next recession will be more difficult to deal with. There are deep divisions; we need to work out the right policies for ensuring the winners compensate the losers. And deglobalisation is becoming a reality, so how do we manage that?” In his view, having identified the desired outcomes, in suitable fields delivery decisions should be taken “out of politics and given to technocrats, who are trusted by the public to do these things.”

But trust in experts is also falling, pointed out one delegate, with the public debate increasingly dominated by the pick-your-facts, antagonistic forums of social media. “That does make it more complicated to get across evidence-based policies, because you’re working in a space where there are no arbiters on what constitutes right,” responded O’Donnell.

Yet there are ways to swing people behind hard evidence. When given the chance to question experts and the space to debate the issues properly, for example, ordinary members of the public tend to reach sensible conclusions: Ireland’s Citizen’s Assembly on abortion rights is an obvious example. And high-profile, non-partisan figures can make an impact: David Attenborough’s focus on plastics waste has made a real difference to government policy, noted O’Donnell.

Ultimately, he said, politicians, commentators and members of the public can’t be barred from making false or misleading statements: “I’d love to be the person in the audience who holds up a red card and says: ‘Sorry, that’s just not true – he’s lying.’ But we don’t have that kind of fact-checker.” So the ultimate answers may – in-keeping with O’Donnell’s over-arching messages – lie in a preventive, rather than a responsive approach. Public servants could, for example, focus on providing education services that give people the knowledge and analytical skills to intelligently assess the information they’re being given.

“Wouldn’t it be wonderful if we could be producing people who start to ask those questions?” concluded O’Donnell. “People who demand evidence; who say: ‘Prove it!’”

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