Apocalypse at No 11 - no one dead

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The Independent Online
DON'T spend it all at once! Today the basic rate of tax goes down lp to 23p as a result of Kenneth Clarke's Budget measures announced last November. Along with changes in tax allowances, it means that average taxpayers will be some pounds 200 a year better-off.

But what the Chancellor gives with one hand he takes with another. Increases in insurance premium tax, council tax and indirect taxes make sure that the Treasury's coffers are not too depleted. The Government, of course, is hoping that the bigger bottom line in people's pay packets this month will translate into an improvement in the Conservatives' rating in the opinion polls. It is certainly possible but the pollsters have already noticed that the relationship between the so-called "feelgood factor" and the Government's approval ratings has been a lot looser since 1992.

Either way, there is no doubt that the economy is in better shape though talk of it overheating is a long way wide of the mark in my view. Nevertheless, last week's distributive trades survey from the Confederation of British Industry sounded an upbeat note on spending in the high street and sales growth is expected to accelerate this month. Already, the Government's own statistics show that retail sales volumes expanded by 4.4 per cent in the year to February. Consumers have extra cash in their pockets and are willing to borrow more, as recent statistics make clear.

Having said that, debt levels are a long way from the heady heights seen during the Lawson boom in the late 1980s. Consumers are also a lot cannier now and have no wish to end up with a debt millstone round their neck.

Likewise in the housing market, a significant recovery is under way with some areas, especially in London, recording double-digit price increases over the past year. Nationally, though, the picture is more subdued, and there were fewer house transactions in February than January, according to the latest statistics.

But this is a recovery that is primarily driven by consumer spending. And good economists know that a reliance on consumer spending can end up in a worsening trade balance, a sterling crisis and higher interest rates if the government of the day does not do the right thing on policy. In addition, investment remains stagnant in contrast to the American economic recovery, where investment played a very large role in bolstering competitiveness and raising long-term productive potential.

A cursory examination of the latest press release from the Office for National Statistics shows that capital expenditure by manufacturing industries amounted to pounds 11.5bn in 1996 in real terms. This is way below the level of pounds 15.0bn recorded in 1989 just prior to the last recession. And it is not just investment in manufacturing that is unsatisfactory but also the well- documented weaknesses in skills and vocational training.

Of course, we should be grateful for small mercies. On most comparisons with the continental European economies, at the moment the UK comes out with flying colours. Economic growth is higher, unemployment is lower, and the flexibility of the economy continues to attract the lion's share of foreign direct investment. This is not surprising given the growth- deadening policies that have been mercilessly pursued by continental European economies over the past decade in their quest for the Holy Grail of European Monetary Union. In this regard, Tony Blair is to be congratulated for holding back from any commitment to joining up in 1999.

In the meantime, City economists like myself spend a lot of time cogitating what the economy will look like under a Labour government. The financial markets are quite relaxed about an impending change of government. During the election campaign, the pound has actually gone up while the FT-SE 100 share index has performed better than other major stock markets. Those who believe that a Labour government means the end of civilisation are a small minority. The "smart money" recognises that Labour's economic policies are orthodox and mainstream.

A return to "tax and spend" policies is off the agenda for good, it would seem. Gordon Brown's plans to cap spending and hold the income tax ceiling are hardly the stuff of apocalypse. Indeed, Mr Brown might find himself enjoying a longish honeymoon period if he takes possession of No 11. He is likely to inherit an economy that is in reasonable shape with relatively low inflation and a minor current account deficit. Sterling is a strong performer on the foreign exchanges, reflecting the attractive rates of return available to international investors in the money markets. The Bundesbank also recently acknowledged that sterling has a safe-haven status among the European countries in contrast to the German mark, which has taken a battering over the past two years.

Of course, predicting currency movements is a hazardous business and the forecasting ability of some market professionals, never mind government advisers, would make even Mystic Meg embarrassed. Currency volatility aside, the main issues are taxation, spending and borrowing. The latter is something Mr Brown will not be keen to accept as a legacy from his predecessor. This financial year it is expected to be around pounds 26bn while the national debt has doubled since 1990. In the 1995-96 financial year the general government financial deficit was 5.0 per cent of Gross Domestic Product - one of the highest in Europe.

Not surprisingly, a number of commentators argue that whoever wins the election will have to cut the deficit by a combination of higher taxes and reductions in spending. The Conservatives' manifesto seems oblivious to this fact and promises of more tax cuts will not only guarantee Lawson- style overheating, but also a sharp slide in the fiscal position. In Mr Brown's first Budget, we already know that he intends to stick to Mr Clarke's spending plans. My guess is that Mr Brown will surprise the cynics with his commitment to ensuring no fiscal slippage.

Hidden agenda theorists who believe the trade unions will present Mr Brown with a shopping list of spending increases and that Mr Brown will meekly cough up the cash have got it completely wrong. I wouldn't mind betting that, as a result of this tough fiscal policy, public-sector borrowing falls a lot faster over the next few years than many pundits are currently predicting. Of course, a lot depends on economic growth. If this collapses, all bets are off, but this looks very unlikely.

However, the Bank of England is already preparing its case for higher interest rates after the election, and Mr Brown will probably go along with this. A speedy response would establish his credentials with the City.

But there is no need for a return to double-digit interest rates. We should heed what is happening in the US where a much stronger economy recently triggered an increase in interest rates to only 5.5 per cent, compared to 6.0 per cent here. Most reputable forecasters expect US interest rates to peak at 6.5 per cent by the end of this year. Ours should be no more than 7.0 per cent.

q Neil MacKinnon is an economist with Citibank in London and is writing in a personal capacity.

q Hamish McRae is on holiday.

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