Hamish McRae: Gordon Brown may not like Brussels, but he can still learn something from Europe

The UK problem is the repeated shortfalls in tax revenue
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The Independent Online

Gordon Brown and Brussels do not get on. The Chancellor is in the dock for breaking EU limits on the budget deficit. After pointing out year after year how the UK has a stronger fiscal position than its continental counterparts, his own record is now under closer scrutiny. The European Commission regards the UK deficit as "excessive" and charges the Chancellor to cut it.

Big issue? No and yes. No, in the sense that there is nothing the EC can do about the UK deficit in terms of sanctions. We did, as part of our signing the Maastricht Treaty, agree to abide by the EU's rules on fiscal policy: a budget deficit of less than 3 per cent of GDP. However, the fact we are not members of the eurozone means the sanctions that, in theory at least, could be imposed on eurozone members cannot be imposed on the UK. Further, the EC has shied away from using its legal powers when it comes to transgressions by large countries, as the experiences of Germany, France and Italy show.

In any case, the 3 per cent ceiling is pretty arbitrary since it does not take into account things such as the age structure of a country's population and the growth potential of the economy. For some countries, 3 per cent is already too high.

However, the EC has focused attention on Mr Brown's failure to meet a target that he himself used to cite draws attention both to the gradual deterioration of the UK's fiscal position and the antagonistic relationship the Chancellor has with the EU hierarchy.

The deteriorating fiscal position is widely noted. To put it into perspective, the UK deficit this year looks like being better than that of the European big three but worse than that of the US (see first graph). But these projections are quite fragile because a country's fiscal deficit is the difference between two very large numbers. Last year, the US deficit was more than 4 per cent, but there has been a sudden surge in tax revenues in recent months, which has narrowed the gap.

For the UK, the problem has been the repeated shortfalls in tax revenue. You can see in the second graph how successive estimates of the deficit this year has proved too optimistic. This raises doubts about Treasury estimates in the future. You can control your spending but not your revenue - in the sense that while the Treasury can set tax rates, it cannot set how people will respond. You can cut the amount of duty you pay on petrol by switching to a more efficient car; or the amount of income tax by switching more income into a pension; or VAT by switching spending to non-VAT goods and services, such as a foreign holiday instead of a new suit.

There are signs, too, that the Inland Revenue is getting increasingly desperate to get revenue in. The worry for the Chancellor - and ultimately for the rest of us - is not the excessive deficit now but rather its stubborn refusal to come down in recent years and probably in future ones.

This leads to a broader issue: the general performance of the UK vis-à-vis other developed nations. Mr Brown is apt to harangue his fellow finance ministers about their nations' under-performance. This does not play well in Brussels. If it is mildly irritating for Britons to be told in Budget speeches that the UK has achieved a longer period of sustained economic growth than its competitors, it is seriously irritating for foreign finance ministers contemplating their armies of the unemployed.

Historically, the Chancellor and his predecessors have a decent caseYou can see the crude growth numbers since 1994 in the third chart. Eastern Europe has leapt forward, but of course it started from a long way back. The European big three have undoubtedly done very poorly. However, some other European countries have done well. Spain has grown faster than the UK and, if you take the 25 members of the EU as a whole, they have actually done a bit better than the US, despite the drag of the big three.

So seen in its wider context, the UK performance is pretty good but not exceptional. The adulation of the US, evident in some of the Chancellor's remarks, also appears a bit excessive. Yes, it has grown strongly, particularly given the high level of GDP from which it started, but the record is not that amazing.

As for the UK, there are some reasons to suspect the strong performance will not continue. There is a good new paper out from Christopher Smallwood at Lombard Street, which argues that the two main motors of growth since 1997 - a consumer spending boom and a £50bn switch of public finances from surplus to deficit - are cutting out. He thinks there will have to be a switch in policy akin to that in 1992 when Britain left the European Exchange Rate Mechanism, laying the basis for this period of growth. Policy will have to switch to promoting investment and exports. That will mean "fiscal consolidation" to make room for interest rate cuts and a lower sterling exchange rate.

That is broadly right. You can have a debate about the scale of the fiscal tightening that is required, and you can have another debate about the balance between increases in taxation and cuts in spending plans. But it is hard to defend a budget deficit stuck above 3 per cent of GDP, not because of some arbitrary Maastricht criterion but because it is damaging to the longer-term growth of the economy.

That leads to a further concern, the quality of UK public spending. The instinct of the Chancellor is to look to the US for policy initiatives, find something that seems to work and then apply it here. We have not looked much to the rest of Europe, while Europe to its credit has sometimes looked to the UK.

Given that the efficiency of UK public services is not high by world standards, this seems a narrow approach. There must be things we can learn from Europe as well as the US. That will have to happen because we are coming towards the end of the period of increased spending, even on the Chancellor's optimistic assumptions. If revenues continue to fall short, the squeeze will probably come sooner.

The big point here is not that UK finances are in dreadful shape. Rather it is that they are not as good as they were in the early years of New Labour and that they are in danger of deteriorating further. Being attacked by the EC for breaking the Maastricht Treaty does not of itself matter.

Neither the EC nor the provisions of the treaty are much admired in the world's financial markets, and it is those markets that have to finance the UK deficit. But if this attack encourages closer scrutiny of UK fiscal policy more generally then the EC will have done us a service. The big numbers matter of course, but so too so the ways in which those big numbers are being spent.

Greenspan deflates from hero to zero

What will happen to the reputation of the soon-to-retire Alan Greenspan? The economy the US Federal Reserve chief is about to hand over is none too healthy, says The Economist. "He is leaving behind the biggest economic imbalances in American history".

The core of the newspaper's criticism is that easy money has created an excessive consumer boom. While cheap imports held down the inflationary impact of that boom on current goods, the money pushed up asset prices instead. Unless consumer growth slows of its own accord, there will have to be further interest rate increases and "many American households will be shockingly exposed".

The US economy is suffering from huge imbalances. These will have to unwind and the only issue is their scale and the pace at which they will be tackled. George Soros reckoned last week that these might lead to a recession in 2007 or 2008.

Were that to happen, there can be little doubt that Dr Greenspan may catch some of the blame.

But fiscal policy must carry some of the can too. The US ran a huge deficit thanks to tax cuts that were introduced by the Bush administration. The President has turned a strong fiscal position into a weaker one.

More interesting still will be the questions raised about central banking in the future. Should the banks worry about asset prices? The Bank of England clearly does on house prices. Should the main policy guideline be inflation targets, which the US, unlike the UK and Europe, does not have? Or in an age of cheaper goods, are these a false friend? Should it simply be, as Dr Greenspan's predecessor, Paul Volcker, believes, long-term stability?

What is beyond doubt of course is that Dr Greenspan has been hugely influential, projecting the role of central banker as national - even global? - hero. But even heroes have their feet of clay.