Economics: Harsh reception for a failing double act

NEITHER of our two leading economic policymakers is emerging from his present travails with laurels. By digging in his heels against an interest rate cut larger than a quarter percentage point, Eddie George, the Governor of the Bank of England, has revived old suspicions about whether he is - in his phrase - an 'inflation nutter'. Within a week of the decision, it was clear that inflation was better than the Bank had predicted. And the recovery was weaker.

But there is also some grumbling about Kenneth Clarke. Some of Mr Clarke's colleagues think he has badly mishandled the whole issue of tax rises in the Budget. Perhaps because he was lulled into complacency by the rapturous initial reception for his measures, he attempted to swot aside the Times story about the high tax burden as if it were no more than an irritating summer fly.

Instead, the story has run and run in a variety of guises so that there can be hardly a voter in the country who is unaware that the Conservatives are set to tax more than Labour did between 1974 and 1979. On Thursday, the Treasury's written answers confirmed that the average British family will pay pounds 1,160 a year more in tax from April 1995 than it does today.

Instead of attempting to accuse the Times and a leading accountancy firm of getting their sums wrong - which was not true - the Chancellor would have been wiser to argue the positive case for a tough Budget. Those tax rises reduce borrowing and allow interest rates to come down and stay low. That stabilises sterling at a competitive level and benefits exporters. And it is also true that most people have enjoyed huge rises in post-tax real incomes since 1979.

I suspect that the Chancellor is suffering from the lack of a special adviser who knows something about both politics and economics: this is the role Sir Adam Ridley and Peter Cropper respectively performed for Lords Howe and Lawson. Mr Clarke is adamant that he can manage without any such talent, relying merely on his own political skills and antennae. On present performance, he is wrong. He needs help.

The Chancellor may also have underestimated the political complexity of the Treasury. In most departments, the boss can handle the politics while the junior ministers handle the detail. Because the Treasury is the central department of Whitehall, with its fingers in every spending pie, every number has political implications. The Chancellor needs an alert team that knows what other members are doing.

The case of Mr George and the Bank of England is rather different. Mr Clarke and the Prime Minister both wanted a half percentage point cut in bank base rates to 5 per cent, but the Bank resisted tooth and nail. It argued both that the recovery had enough momentum to withstand April's tax increases and that the inflation outlook did not justify another rate cut.

The result was a messy compromise on a quarter-point cut, which failed to trigger any general reduction in mortgage interest rates and which therefore will have a negligible impact on the element of demand that will be most affected by tax increases. Moreover, the timing of the cut, immediately before a batch of key figures, suggested that politics motivated the decision.

If the Bank of England had moved more quickly or had waited until this week's data, the markets might well have cheered. The Bank had projected in its inflation report a January inflation figure (excluding mortgage rates) of 3 per cent. It was 2.8 per cent. This is the fifth occasion (out of six forecasts) when the Bank has been overly pessimistic.

True, there is always a large margin of error. Over the last 10 years, the Treasury has been one percentage point out on average in its year-ahead forecast for inflation. But that uncertainty surely argues in favour of using interest rates more flexibly: cutting today to offset the certainty of the tax rises in the spring, while raising interest rates tomorrow if the Government's 1 to 4 per cent target range is threatened.

The Bank's other central assumption also looks debatable in the light of last week's data. This was that the economy is expanding at such a rapid pace as to narrow the gap between actual and potential output, and by implication to continue reducing unemployment. Instead, unemployment rose by 16,000 in January, after the official seasonal adjustment.

The actual increase in unemployment was 107,000, a sharp rise that caused the Central Statistical Office to revise upwards its view of the likely seasonal effect. If we use last year's seasonal adjustment, the underlying rise is in fact 40,000, which is a lot. Taken with the fall in job vacancies in January, it looks as if the trend reduction in unemployment has slowed sharply if it is continuing at all.

That in turn must limit concerns about any inflationary upturn in pay settlements, the first signs of which have appeared in the Confederation of British Industry's pay databank and the official earnings figures for services. These series bounce around. But if unemployment is no longer falling sharply, any response of pay to the rise in the headline rate of inflation is likely to be muted.

The picture of an economy probably growing too slowly to sustain the reduction in unemployment was reinforced by the data for manufacturing output, which rose by a mere 0.5 per cent taking the latest three months over the previous three. An annualised rate of little more than 2 per cent is far short of what is required to stabilise employment when productivity has been rising rapidly. Retail sales volume was also more sluggish than expected.

The final support for a larger cut in British interest rates came with the Bundesbank's reduction of its discount rate by half a percentage point to 5.25 per cent. The official bottom of Germany's interest rate band is thus now in line with British money market rates, giving the Chancellor more room to move without any fear that sterling will weaken sharply and drive up import prices.

With German interest rates heading down to perhaps 4 per cent by year-end, it would be surprising indeed if Mr Clarke were not soon to prevail upon Mr George for the other half of the rate cut he wanted.

When British interest rates are down to 5 per cent, the going will be tougher. Unless the tax increases have an even bigger effect than I expect, or the inflation super-optimists are right, that may be near the bottom of the British interest-rate cycle.

ONE HOPES that the apparent success of recent peacekeeping efforts in Bosnia may encourage a more open-minded attitude to Russia's problems. In a front page article in the Financial Times, John Lloyd recently reported that life expectancy in Russia had fallen sharply to just 59 years for men, which compares with 72 in Britain.

The full horrors of what is happening in Russia were driven home to me by Professor Murray Feshbach, the leading Russian expert and author of Ecocide, who passed through London on his way back to Washington last week.

Professor Feshbach points out that male life expectancy fell in just 12 months in Russia by an astonishing three years. In the entire post-war period, there have been only three instances of falling life expectancy in the US, and they were by 0.6, 0.3 and 0.3 years.

The causes of the decline are a sharp increase in alcoholism, depression, stress, road accidents, pollution-caused illness and suicide. This is a symptom of the collapsing economy, but it is also aggravating Russia's problems as key workers simply disappear from the labour force.

Whatever your views about the desirability of economic aid to Russia, there is surely a prima facie case for humanitarian help with the public health problem. Indeed, Professor Feshbach argues that it would be in our own interests because of the increasing dangers of epidemics of killer diseases.

There is a serious risk of a diphtheria epidemic, because there is not yet a critical mass of vaccinated population. For similar reasons, there were 564,000 cases of Rubella (German measles) a year in the former Soviet Union between 1985 and 1989. There were just 427 a year in the US.

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