Now’s the time to get the public finances in order so the next recession won’t hurt as much as the last one

The house price boom really cannot continue and interest rates will inevitably rise

So what will the economic landscape look like for our next government – whoever forms it? We are now in the last round of political conferences before the election, giving us a feel for the pitches that the parties will make next year. But we know from past experience that the success or failure of any government depends on the economic climate it inhabits. A favourable tailwind, as Labour had for the first 10 years from 1997, gives it options to try and shape things. But if it has to butt into a strong headwind, as the Coalition has been forced to, those options narrow right down.

There are two parts to this. One, the more nitty-gritty, is the domestic outlook: how much longer it will take to fix public finances, the future of the housing and jobs booms, all that stuff. The other is the global climate: will the US carry on growing, what happens to Europe, is there another world recession looming? The two interact of course but while the first is somewhat within the government’s control the second is not. Some thoughts about each.

No-one gets the future direction of the economy right but there are some things that can be said with reasonable confidence. Factually, about half the job of bringing public finances back to a sustainable level is done, so the other half remains. That will be much easier if the present strong growth continues, though tax receipts at the moment are disappointing and the narrowing of the deficit seems to have stalled. There is a lot of momentum behind the present growth spurt, but common sense says that momentum is likely to ease over two or three years. The house price boom really cannot continue and interest rates will inevitably rise. How far they will go up – whether to 2 or 3 per cent or 4 or 5 per cent – I don’t think we can possibly say. The Bank of England is keen to push the idea that rates will not rise quickly, but central banks are not gods. Three years ago, no-one, as far as I know, in the European Central Bank saw the possibility of it having negative rates.

So, for the UK, there is likely to be reasonable growth over the next few years, strong for another year or two but probably tapering down after that. That quite benign prospect does, however, depend on a favourable global cycle.

The cycle, ah. If would be great if we understood it properly but we don’t. In the run-up to the last recession the conventional view was that while the business cycle existed, competent economic management was succeeding in diminishing its magnitude. How wrong that was. The very latest data does seem to show that for the UK at least, the 2008/09 downturn was no more serious than the early 1980s one if you allow for the fact that North Sea oil was growing in the 1980s and falling now. But the early 1980s were not great either, and for the developed world as a whole this most recent recession was indeed the worst since the Second World War.

That leads to a hopeful conclusion. These huge recessions don’t come along very often and accordingly it is improbable that we will experience anything like 2008/09 for a generation. The less hopeful conclusion, looking at past patterns, is that some sort of downturn is likely to occur during the life of the next Parliament. That is simply based on the observation that we have a cycle of around 10 years, so that some time around 2018 we should expect a dip. To say that is to say nothing about its possible severity, its likely triggers, or how to prepare for it. It is just what unfortunately seems to happen.

You can however point to inherent weaknesses in the world economy that may in some way be associated with the next dip. These include the extent to which the present growth phase has been puffed up by the central banks of the world, apart from the ECB, printing shed-loads of money. They had to do in the short term to get growth going – look at what has happened in Europe, where growth has stalled – but the long-term effects of a boom in asset prices are now evident. Other weaknesses include Europe, where there will probably have to be write-offs of sovereign debt if the continent is to avoid Japanese-style stagnation, and the dependence for global demand on China, where stresses are quite obvious.

There will be other weaknesses that we can’t yet see or simply don’t understand, just as very few people understood the mess that the banks had got themselves into. But I do suggest that there is a legitimate question to ask of any politician, here or elsewhere, who seeks to form a government. It is: what is your plan to cope with the next global recession? I have only heard it answered once, in Sweden about four years ago. The answer, incidentally, was to get the budget into surplus.

The trick that’s taxing Obama

The buzz word, or maybe the hate word, is inversion. This is when a company, usually an American one, inverts its legal domicile by buying a company in another, more favourable tax location and shifting its headquarters there. Usually the physical offices remain the same, and the top people go on living in their leafy US suburbs, but the company pays much lower taxes.

President Obama has just signalled his opposition to this and the US Treasury has announced a series of measures to combat the practice. Three things have driven it. One is the way in which headline corporate tax rates have fallen around the world over the past 30 years or so, whereas US rates have remained high.

A second is that some countries have deliberately sought to use a friendly tax regime to attract inward investment, Ireland being the prime example with its 12.5 per cent tax rate. (Note that the Scottish government wants to cut corporation tax and the UK plans to bring it down to 20 per cent).

And the third, maybe the most important, is that in a world of trading ideas and services, it is quite hard to see where anything is made. How much of the money you pay for a Starbucks coffee is for the coffee and location, and how much for the brand image and licence to sell the stuff?

Gradually this will change and it may well be that pecking away at the system, as the US is doing, will nudge along that change. But what is really needed is logical, orderly tax systems that raise money without distorting or damaging the underlying economies.

The OECD also did a study of that. The US is near the bottom, the UK about the middle, and at the top are countries such as New Zealand and Sweden – which should carry a lesson for our next Chancellor.

h.mcrae@independent.co.uk