Economics: A government that can't decide for itself

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The Independent Online
"I think, if Labour get into power," said a British bureaucrat working in Brussels, "that they will be appalled at the extent to which they will have to refer any decisions they make to Brussels."

That comment was made last year, long before the beef crisis blew up, but it perhaps explains the Government's apparent lack of awareness of the need to bring the European Commission on-side before announcing its original plans for coping with the disease. If the Tory cabinet, with many years of experience of dealing with Brussels, could fail to spot the danger of a collision, how much worse it would be for a Labour administration, with no actual experience of government, and just a folk-memory of what government was like in the 1970s when the European Commission had far less power than it does today.

The level at which public policy decisions are made - or to put the point more contentiously, the extent to which the UK government is subservient to Brussels - is going to be one of the great political issues of the next decade. Some decisions - including quite possibly the crucial one of setting short-term interest rates - seem likely to move up from national authorities to a supra-national body. On the other hand, there are suggestions that other forms of decision could be pushed down from national government to a local body.

But the process is more complicated than that, for the driving forces are not just political. There are also increasingly powerful international market forces that are narrowing the scope for individual governments to take decisions, particularly in taxation. And there is a global momentum behind deregulation, also pushed by international competition, but in addition encouraged by the European Commission on the grounds that such regulations impede competition within what is supposed to be a single market.

So the assault on national sovereignty is coming not just from Brussels but from international competitive forces. It is an astonishing, seismic change in the nature of government, which has not been properly charted. Many people are intuitively aware that the scope of government has narrowed, but perhaps because there have been few studies of the process, the political rhetoric has yet to reflect this. So a couple of recent research papers by OECD staff deserve attention.

One, Fiscal relations within the EU, looks at the interaction of EU members' national tax policies and those of the EU as a body in its own right. The EU could soon become the only economic union where monetary policy, at least for a core of members, is to be set centrally but fiscal policy set nationally. This begs the question, therefore, to what extent it will be possible for countries to have individual tax and spending policies. The left-hand chart shows one form of taxation where competition is particularly evident: corporate tax rates. These have tended to decline in the cross- section of selected countries, not just in the EU but elsewhere. Spain is the rare exception. Tax competition must have something to do with this, although the fact that the overall level of company tax receipts as a proportion of GDP did not fall between 1960 and 1990 suggests competition may not be eating away at the tax base as much as some fear. (Remember, too, that this is despite the fact that some governments actually encourage tax avoidance by companies, by granting them special tax concessions if they locate new plants in particular areas, or by setting up special tax- free zones.)

For personal taxation there is less evidence of competition: top tax rates everywhere have come down, but people, certainly within Europe, do not seem to be as mobile as companies. Still, the OECD reckons that while tax competition may not have cut tax revenues, it has reduced the power of governments to increase taxation. As a result, increased spending has tended to be financed by higher borrowing, rather than higher taxation.

A similar pattern is evident in regulation. An article in the latest OECD Economic Studies, Deregulation and privatisation in the service sector, looks at the way deregulation has swept through a string of different industries, ranging from distribution and construction through to airlines, telecommunications and railways. The right-hand chart has been drawn from some of its findings. Remarkably, every country has moved in the same direction. Some have moved further than others, and the English-speaking world has moved further than the rest. But you would expect a few countries to have increased the level of regulation, and the OECD does not identify a single one that has done so.

There are big questions here for the next British government - on relations with Europe, on taxation and on deregulation. In the event of Labour winning the election there will be pressure to co-operate more closely with Europe. But co-operating with Europe may well mean more regulation. Governments have two main methods of exerting their power: taxing and spending on the one hand, and regulating on the other. The EU budget is tiny in relation to the GDP of its members: 1.25 per cent of GDP. So much of the impact of the EU is through regulation. It is very hard to see EU-generated regulation declining in the future.

As for taxation, there will also be an instinctive desire to increase taxes on companies: the one new tax that has been advanced is a tax on the privatised utilities.

There will also be a desire to reverse or at least halt the process of deregulation. A series of statements by shadow cabinet members show distaste for the process of deregulation, although the extent to which regulation will in practice be increased is not clear.

But what is the most powerful driving force behind both taxation and deregulation? If it is principally the power of ideas - the fact that governments worldwide became prisoner to a set of market ideas - then it is theoretically possible for a government with different ideas to reverse the process, at least for a while.

If, however, the driving force is competition - that international competition is cutting both tax rates and regulation - then there would be immediate costs in trying to swim against the tide. Increasing company taxation would not simply put UK-based companies at a disadvantage vis-a-vis those of other countries, it would also encourage relocation. Increasing regulation would, if the regulation were inappropriate, similarly shift activities offshore.

What does not really exist at the moment is a detailed analysis of this narrowing of scope for action by national governments: there are many essays, articles and pamphlets on bits of the jigsaw, but nothing that assembles what has happened in one place. Worse, there is very little forward-looking analysis. We do not know, for example, whether tax competition will increase rapidly in the coming years, so that government revenues will not just be contained but actually cut away. Nor do we know how far the process of deregulation might go. There is some evidence of discontent with the process but no evidence yet of retreat. And of course we do not know how much longer the process of European integration will travel, and when it ceases to advance, whether it will stay on a plateau or fall back.

What is clear is that the narrowing of the scope for individual action by national government is a trend that has a long way to run. The beef war has taught the country that much, and more besides.