Hidden Tax Rises: Labour should go into reverse

The Government should come clean and admit that its fiscal policies have misfired, writes Andrew Smithers

The Bank of England has the job of keeping down inflation in the context of output and employment. This used to be the Chancellor's role, but by granting the Bank independence he has changed his own job description.

Brown remains responsible for fiscal policy, but he is no longer in charge of the demand-management sector, where he has only observer status. His speech should therefore be less concerned on second-guessing the Bank about this year's economic outlook. Rather he should concentrate on his own responsibilities.

The key ones now are the euro, exchange rates, long-term growth and unemployment. New Labour's policies on all these issues have been damaging to Britain. In addition, the UK is running a massive trade deficit. Allowing for the fact that US gross domestic product is six times ours, the UK could complain with as much justice as the US of keeping the world afloat by being such a stout importer.

But the Government's silence on this issue is understandable, as it can blame no one but itself. It is clear that sterling is dangerously overvalued and it is obvious that this arises from the UK's stupid fiscal policy.

If Brown's Budgets had contributed less to overheating the economy, then interest rates and the exchange rate would be lower and output the same. Only the balance of the economy would be different, with more emphasis on manufacturing output and less on the service sector. Brown's errors have created a two-tier economy in which the South-east and services flourish while manufacturing and the other regions suffer.

The decision to join the euro means that the need to bring down the value of sterling has become urgent. So long as we have an independent currency, the bad consequences of the Chancellor's follies can be reversed. If sterling gets weaker, although UK wages don't fall in sterling terms they do get cheaper in euros. Once we have joined, cheaper UK labour costs can only go down if UK wages actually fall. This has been made far more difficult as a result of deflation in euroland and New Labour's decision to raise unemployment through the introduction of the minimum wage. When inflation was the norm, holding wages unchanged was enough to reduce costs. But with deflation looming, wages will have to fall to render Britain's regions competitive.

The need to dampen the economy in the South-east and boost it in the North is made more urgent by the way house prices in the South-east go up when rates fall. If we were to join EMU today, UK interest rates would fall by 2 per cent overnight. A sharp rise in house prices would be welcome to home owners in the South East, but it would only increase the North/ South divide and make it even more difficult for the unemployed to move to get jobs. The Government pretends to believe that housing demand can be satisfied by building new homes on brown-field rather than green-field sites. This flirting with the economics of absurdity will simply add to the problem.

Brown's policies have hit the regions hard and if he doesn't change tack, then joining the euro will make the damage permanent.

If growth could accelerate, then the misery induced by New Labour's negative regional policy would become less painful. Brown's policies have unfortunately been negative here too. He has been anxious to talk about Britain's poor productivity, because he can then put a negative slant on the Tories' good record on employment. Since the previous Labour government was driven from office in 1979 with cries of "Labour Isn't Working", the GDPs of France and Britain have risen at the same rate. The difference has been in employment. If the UK's experience had been as bad as that of France, we would now have another 1.9 million out of work. As the less easily employed are less productive, this success story can be given a negative slant. This Brown has sought to do, and it should be seen as the shoddy piece of spin doctoring that it is.

We do not need improved productivity at the expense of employment, we need higher GDP per head. There are only two ways to get there. Either investment must be made more productive or we must invest more. The second looks far and away the most promising, because UK investment is already very efficient and no likely action by Brown is going to improve it. The ways to improve the productivity of capital are things that the Government wishes to avoid, such as repealing labour legislation and abolishing planning restrictions.

Unless New Labour's policies cause capital productivity to collapse, more investment will lead to higher growth. To get higher investment, all that is needed is higher saving, because this would lower sterling and thus create and finance more profitable investment opportunities.

What Brown should do is simply reverse the policies of his previous Budgets, which have been too expansionary. He has chosen tax saving rather than consumption and made profligate promises for accelerating future government spending.

The benefits of a policy reversal are clear. Lower budget deficits would increase the national savings rate, which would finance faster growth. Lower interest rates would avoid a shock on euro entry and lower sterling would both provide increased opportunities for investment and halt the harrying of the North.

Brown must act promptly. We cannot afford to join the euro with current interest and exchange rates. It really is very simple. Profligacy is costly and it is no less costly when called prudence by the spin doctors.

n Andrew Smithers is the proprietor of Smithers & Co, fund management advisers.

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