Economic management is not a party political issue. True or false?
One thing may come right. The UK may be able to sustain a lower unemployment rate than it has in the past
Tuesday 21 January 1997
There has been an undercurrent of opinion in recent months that, once the election is out of the way, both taxes and interest rates will have to rise. This, it has been argued, would occur whichever side won the election, the import being that pre-set policies are not sustainable. If you believe this, then neither political party has credible policies: the Tories did not have them, and now Labour has fallen into the same trap. But if you believe what Gordon Brown says and the broad shape of British fiscal and monetary policy will be much the same under either party, at least the first question has become very clear: is that undercurrent that Britons face higher taxes and interest rates right?
On interest rates the answer is easy: yes. The UK interest rate cycle is heading upwards and will do so for the next couple of years. Remember that only very short-term interest rates are set by the authorities, and that a rapidly growing economy will put pressure on the available resources, real and financial. So we will have higher interest rates this year and the only issue is how high they will go.
Now taxes. Taxes in aggregate only have to rise if either public spending is not held to present targets, or the present tax levels narrow down the Public Sector Borrowing Requirement insufficiently slowly.
On the spending side the current fashion is to say that the Government's spending plans are not credible, for two reasons. One is that they are based on short-term policies which cannot be sustained through the life of the next parliament: that they are holding down public sector pay in an unrealistic way, and have cut some long-term spending programmes, particularly on infrastructure, to an unsustainable level. The other reason is that there are structural demands on public spending - more obviously from the ageing population, but also from higher expectations from an electorate accustomed to quality services from the private sector - which any new government will have to meet.
There is a problem here on both fronts. The short-term criticism is at least partly true, and a continued squeeze both on public sector pay and on infrastructural projects would probably be more difficult to sustain under Labour than under the Conservatives. As for the demand for quality services, Labour would face just as much demand as the present government. Indeed during its years of opposition it has contributed to the idea that the prime problem of the quality of public sector services has been "Tory cuts".
But none of this need mean that Labour would be unable to deliver the same spending total as the Conservatives. In the short term it could do it if it wanted to simply by saying no; in the long term it could do so by putting even more pressure on the public sector to improve its efficiency. Question: is Labour likely to be a more competent manager of public sector services than the Conservatives? On past performance the answer would have to be no, but the 1970s were a long time ago.
Finally, is the Government narrowing the PSBR sufficiently quickly? Here is surely the best news for the winner of the next election. The PSBR is declining quite fast. Have a look at the graph. The blue bars show the government deficits (in our case the PSBR) for 1996, 1997 and 1998 for the UK, Germany and France. The forecast comes from a respected market source, Deutsche Bank Research - you have to take a market forecast, for you cannot trust governments when it comes to projecting fiscal out-turns. The actual percentages may bewrong but the direction is very clear: the PSBR is whizzing down. And it is projected to go on coming down when that of both France and Germany are stuck at around the 3 per cent of GDP level.
Is that because the UK economy is closer to capacity than France or Germany? Well, in the case of France, yes, but not really in the case of Germany. The red bars show output gaps as calculated by the OECD. These too are coming down but there is still a little slack from the UK in 1998. It would be difficult to run an economy with zero slack, and all these OECD output gap calculations may be wrong, but we are clearly within a percentage point or so of having a balanced budget if the economy were running close to full output. And a deficit of 1.5 per cent of GDP would be low enough to start cutting back the national debt as a proportion of GDP, for growth ought to be able to average 2.5 per cent. We are, on those figures, closer than Germany at stabilising the debt burden, while for France the problem is getting to full output in the first place.
To be clear: the UK fiscal position is not wonderful. A new government would have to accept that, unlike France and Germany, there will be relatively little scope for further privatisation to bolster revenues. But the position is not dreadful, either. There is no absolute necessity for increasing taxation in order to speed up the correction of the PSBR unless there is some unforeseen and expensive disaster.
In any case one very important thing may come right. The UK may be able to sustain a lower rate of unemployment than it has in the past. No-one knows the minimum level of unemployment that the economy can manage to run without leading to higher inflation. But if it were, say, the same as the US, now at 5.3 per cent, instead of the OECD guestimate of 6.5 per cent, then the capacity of the economy would be higher and demand on public spending would be lower. Get unemployment down and all sorts of other things come right. Mr Brown is committed to such a policy, though whether he fully understands the need for flexible labour markets (and the element of insecurity associated with them) is not clear.
If this line of argument is right, then there are important implications for British business and for investors in the country too. Suddenly, with Mr Brown's statement on tax and spending policies, UK economic management is no longer a party political issue. There is, within broad limits, a new stability of policy. A new government would carry on the broad path already set. That path is more or less credible. So the question is simply: "Do we believe what politicians say?"
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