Stephen King: The UK has bigger worries than the next Budget

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The Independent Online

A few years ago, Budgets were really quite big events. The Chancellor, whoever he was (we've not yet had a she), could control the instruments of both monetary and fiscal policy. The UK's economic destiny was in his hands. People believed that the Chancellor was a man of both giveaways and takeaways. Some would win, others would lose. Budget day was a bit like the weekly Lottery draw, but with smaller prizes. And, for those who couldn't stand the idea of parting with a few extra pennies for a tank of petrol, there was always the option of a last-minute dash to the petrol station before the increase in fuel duties hit home.

Nowadays, Budgets are just a little dull. Monetary policy decisions no longer reside with the Chancellor, so it's difficult to draw any immediate conclusions for interest rates. There's hardly any room for manoeuvre on income tax because Tony Blair knows that higher personal tax rates are a vote loser. And the current Chancellor deliberately stuffs his statements with obscure statistics to make it that much more difficult to gauge what, in truth, is going on.

Indeed, these days, the truth emerges well after the event. Income tax rates may have hardly changed but the tax burden, nevertheless, has risen significantly in recent years (see left-hand chart). Despite big spending increases, overall improvements in public sector provision have been rather disappointing, in part because productivity gains have been limited. A big chunk of the money spent by the public sector has boosted pay. While this may lead to longer-term improvements in provision - the public sector begins to attract better quality graduates, for example - it won't deliver immediate dividends to today's consumers of public services.

More broadly, although the UK's cyclical economic performance has been impressive, pointing to good macroeconomic management, there's little evidence that this has contributed to a more efficient allocation of resources. According to the official data, the UK's overall productivity growth has been much weaker over the last four years than in the previous four years.

Put another way, Budgets these days have less relevance for the cyclical performance of the UK economy - the Bank of England has a bigger say in that area - and only limited relevance for its supply-side performance. And it's for these reasons that I think Budgets have become less interesting. Despite claims to the contrary from chancellors of all political persuasions, fiscal policy can play only a limited role in influencing the structural performance of our economy.

I say this because most of the major supply-side shocks - both good and bad - are coming from abroad and, hence, are outside the Treasury's control. The bad ones include, most obviously, the rise in oil prices. Investment decisions are typically based on a clutch of simple assumptions and, in recent years, it's likely that most companies invested on the basis of an oil price considerably lower than the current $60 per barrel. Paying more for oil may have reduced the efficiency of many industries and, by doing so, may have been associated with a loss in output. Not good news for the Chancellor's revenue assumptions.

The good supply-side shocks include moves towards greater economic openness. Trade, capital and labour flows across borders are now much higher than they were in the past, and the barriers to trade and to capital movements are a lot lower (see right-hand chart). Globalisation is partly a story about technology and, in particular, the collapse in communications charges around the world, but it's also a story about the collapse of economic nationalism. Nations have increasingly embraced their mutual interdependence and, in the process, have understood that, through easier movement of factors of production across borders, there are plentiful opportunities for a more efficient allocation of resources.

Obviously the UK can play its role in supporting these moves towards greater openness but the UK is, these days, a marginal player. Moreover, despite the Government's commitment to free trade and capital mobility, it's clear that the icy winds of protectionism are beginning to swirl around the global economy. We are, for example, reaching a pivotal moment in the trade relationship between the United States and China. This week, Senators Lindsey Graham and Charles Schumer are on their way to China. They will use their visit to help them reach a decision on whether to put Schumer's Congressional Bill, seeking to place tariffs of 27.5 per cent on the value of Chinese imports into the US, to the vote.

What the senators really want is a major revaluation of the renminbi, and they are using the Bill as a way of forcing the Chinese to do just that. China, for its part, has always emphasised that it will adjust its currency only gradually, fearing that a major change in the renminbi's value would be hugely disruptive for the domestic Chinese economy. So, whatever the rights and wrongs, the world economy is in danger of reaching a policy impasse that could all too easily lead to protectionism.

And it's not just in the area of trade that politics is beginning to matter in a big way for economic progress. The US, with a current account deficit of 7 per cent of GDP in the final quarter of 2005, needs huge inflows of capital from elsewhere in the world to maintain its lavish lifestyle. The US can either borrow from abroad - through the sale of Treasuries, agencies (like those of Fannie Mae) or corporate bonds - or it can sell off its own assets. In a free market, foreign investors would be able to make the choice themselves. But it now seems that not all US capital is up for sale. Last year, a Chinese oil company was prevented from buying Unocal. This year, Dubai Ports World has not been allowed to gain management control of six US ports, despite initial support from George Bush.

The justification for preventing the sale of these assets may have been national security, but it does leave the US in an odd position. Washington supports free trade and free capital flows, but only on its own terms. This approach has, of course, paid dividends in the past. In the 1971 Smithsonian agreement, the US forced other countries to revalue their currencies, using the threat of punitive tariffs as a catalyst for action. Similarly, Japan was forced to revalue the yen in the late 1980s. And, in the 19th century, the US benefited from the use of trade barriers to nurture its own infant industries, an approach that no doubt influences Chinese thinking today.

Political interference in the free movement of capital, labour and people is on the rise. We've been through 50 extraordinary years in which globalisation has worked mostly to our collective advantage. If we're about to see the process go into reverse, we really ought to be very worried. The renewed rise of economic nationalism may be easy enough to explain - the world is a more dangerous place, Western workers feel vulnerable in the face of newly-empowered Chinese and Indian labour - but economic nationalism is ultimately a disastrous philosophy. At the very least, it chokes off the spread of ideas and innovation, stultifying economic growth. At its worst, it leads to conflict. Economic nationalism was, after all, one of the preludes to the First World War.

So when Gordon Brown stands up on Wednesday to deliver his Budget speech, spare a thought for the rest of the world. The UK's future really lies with the global political changes that are beginning to affect economic progress, not with the few extra pennies that a litre of petrol or packet of fags might be costing you by the end of the week.

Stephen King is managing director of economics at HSBC

stephen.king@hsbcib.com

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