Get down from the international stage, Mr Brown, and attend to taxes at home

`If we carry on pushing up interest rates, the Bank of England will hurt everyone in all income groups'
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LAST WEEK, Lynton Charles MP posted his report from Brighton, where he was speaking at a think-tank fringe meeting at the TUC with "that slightly odd gingery bloke, Charlie Leadbeater", who is the Prime Minister's favourite guru. For the uninitiated, Lynton Charles is the fictional Labour minister who writes a diary column every week in the New Statesman. He is not what you would call Old Labour.

This week's target was the trade unions: "One of the most enjoyable aspects of being New Labour is thinking the unthinkable in front of comrades who find any kind of thinking painful," writes our Charles. "You tell them that old ways must alter to take account of whatever the change was. Now they furrow their brows because `old ways' means them. Finally you hit them with all the ways in which they must change, and they see all their favourite nostrums, their comfortable practices under assault. Oh, the squirming!"

Funnily enough, I went to the TUC last week too, but I didn't find what Lynton found. I was addressing a London GMB [General, Municipal and Boilermakers Union] fringe meeting on globalisation. From what I heard the delegates saying, there is a lot of serious discussion going on about Britain's economy and where it fits into the global market-place.

The international economy has now passed the bottom point in the business cycle and is moving into an upturn. That's obviously good news for all of us, but the issue is how big the upturn is going to be. No doubt those advising The Treasury will agree with the commentators who think we are set for a return to the stable boom conditions of the Fifties and Sixties. The Financial Times (17 September) clearly thinks so: "With the global economy setting back to normal, and signs of recovery apparent in the euro zone's largest economy, Germany, the European Central Bank has found the confidence to endorse a fairly upbeat growth forecast."

Unfortunately, the upturn is likely to be weaker than generally expected. The continuing decline in investment in the most advanced industrial economies is holding back growth, and putting constraints in the way of a more sustained upturn. In each business cycle since 1973, the level of investment in the economy has failed to reach the highest level of the previous cycle. In the OECD [Organisation for Economic Co-operation and Development] economies as a whole, the peak level of investment in the business cycle, that culminated in 1973, was almost 24 per cent of GDP; in today's cycle it was under 20 per cent.

So the bad news is that the upturn will probably see inflationary pressures emerging, fuelled by the capacity constraints caused by a lack of investment, unless the expansion is reined back. The shortage of savings, that underlies low investment, means a shortage of capital, and, so, higher than expected interest rates. Long-term interest rates are already rising sharply even at the cyclical expansion's start.

The only way out for the international economy is to increase the supply of capital, but that would mean reversing the policies pursued globally throughout the last three decades when capital was dissipated through high dividends and the consumption of income at the expense of savings. Such an internationally dissolute trend was fuelled by reductions in taxation on the highest income groups.

Just as the world economy is preparing for its shaky upturn, constrained by the international policies which have deprived it of the capacity to expand effectively, so the British economy appears to be doing well. In the South and South-east all the talk is of the feel-good factor. But a significant part of this is based on an international borrowing binge. The balance of payments has deteriorated from a surplus of pounds 1.9bn in the third quarter of 1998 to a deficit of pounds 3.7bn in the first quarter of 1999. In the 12 months to the first quarter of 1999 exports of goods and services shrank by 1.1 per cent while imports grew by 5.7 per cent. But like all good parties, it'll give way to a hangover when the debts have to be paid.

Feeding this situation is (as usual) the overvalued exchange rate, which worsened again in the first half of the year. The pound's effective exchange rate rose by 3.5 per cent between the fourth quarter of 1998 and the second quarter of 1999. The over-valued pound is a major obstacle for manufacturing, which accounts for two-thirds of our exports of goods and services. The over-valued pound has led to a fall in manufacturing employment by 150,000 over the last year.

What is called for in order to lower the exchange rate and revive manufacturing is a sharp reduction in interest rates. The Bank of England, however, has started to move in the opposite direction.

The decision by the Bank of England, on 8 September, to raise interest rates - when manufacturing industry has spent the last year in the doldrums; the pound is over-valued already, and the most optimistic projections for economic growth this year are around 1.5 per cent - came as a heavy blow to industry. It was a serious issue in Brighton last week, where a succession of leading trade unionists urged the Government to address the high interest-rate, high-pound stranglehold on manufacturing.

The BoE's decision is no doubt motivated by the "bubble" that has appeared in house prices, particularly in the South. The bubble will inevitably mutate into higher consumer demand. This house price boom is the British equivalent of the share price bubble in the US. It is a by-product of the same expansionary monetary policies adopted in the US, Japan, and Europe to avoid a financial crash last year.

The problem is that a reduction in interest rates would inflate the house price bubble even further. So interest rates cannot be reduced in isolation. This dilemma has emerged because The Treasury has not increased taxation on either high incomes or grossly inflated dividend payments.

We now need an increase in taxation on higher incomes, balanced to sustain the economic recovery by using the Government's budget surplus to boost health, education and pensions, as well as lowering interest rates to bring down the exchange rate.

Increasing taxation on higher incomes would also have the helpful effect of pricking the housing boom bubble at the very highest end of the market, while maintaining its positive effect for mortgage payers in the middle income range.

If we carry on pushing up interest rates, the Bank of England will begin to hurt everyone in all income groups through their mortgages, while simultaneously hammering manufacturing industry. Perhaps it is not the trade unions who are stuck in their old ways but Lynton Charles MP.