How Brown's Budget could muck up Britain's economic experiment

On why demand is not a worry

BRITISH Budgets are not nearly as important as they are billed to be, but the one next Tuesday will be more important than most. It will be Gordon Brown's chance to muck things up.

The Budget last year was introduced when we were already three months into the financial year and was inevitably limited in the scope of the changes that could be made. It would have been difficult to have done anything that would have been seriously damaging to the economy, or indeed materially helpful to it. The budget deficit was narrowing in a satisfactory way, the economy was growing at a decent clip, unemployment was falling, there was very little inflation and the current account was in modest surplus. Not since the before the First World War has a new chancellor inherited such an evidently agreeable combination.

Now the picture is slightly different. The deficit is still narrowing, actually a little faster than before thanks to some modest tax increases and slightly faster-than-expected growth. Growth is still solid, unemployment still falling, inflation still under control - only the current account seems to be heading sharply into deficit.

So, over the last nine months, while the Chancellor has been pondering what he should be doing to make his mark on the job, most of the numbers have been improving. Borrowing is so low as to be almost non-existent. The top graph shows the way this has been falling, but the forecast there may be overly pessimistic. It is possible that - on present trends - the government accounts will show a surplus in the financial year starting this April. That is thanks to the virtuous circle which occurs when there is decent economic growth: the growth increases tax revenues while cutting demand for government spending, for example on unemployment benefit - see bottom graph.

So the number one concern of any chancellor - are the books balanced? - is not an issue. Number two concern is the state of the economy. Here the warning bell from the current account does show that we are close to the present limits of capacity utilisation. The warning bell might have come from inflation but it hasn't, partly because of the strength of sterling, which holds down import prices and puts pressure on exporters to hold down their costs, but mostly because of the change in culture which has taken place in wage bargaining. Inflation everywhere - in economies which are close to capacity and those which have lots to spare - remains very low.

So how worried should Mr Brown be about excessive demand? I am sure he will be seriously concerned for one simple reason. Ignoring the similar dangers signals was the key mistake made by Nigel Lawson in the late 1980s. I am not sure, however, that he needs to be so worried for two simple reasons. One is that he cannot do anything about it. The other is that he doesn't need to.

He cannot do anything about excessive demand because the sort of level of fiscal tightening needed to make any material impact on demand is so enormous as to be not worth contemplating. Changes in interest rates and other factors affecting consumer confidence are vastly more important that the odd few billion of changes in the government's taxing and spending. And he does not need to do anything to check demand because either it will taper down of its own accord, or interest rates will whack up to such an extent that they will knock the boom on the head.

But if there is no problem on the accounting side and nothing much that can be done on the macroeconomic side, why did I start this column by saying that this is Mr Brown's opportunity to muck things up?

Because Britain has become an economic experiment, a forerunner of what more and more developed economies will tend to become during the next 25 years. Our macroeconomic position is boring: satisfactory, but boring none the less. Our microeconomic position is very interesting indeed.

Unusually, and in an unplanned way, we have concentrated the main weight of our economy in a small number of sectors. These include international finance (of course), telecommunications and media, a cluster of hi-tech industries including defence and pharmaceuticals, and a few "brand-name" consumer industries. There is, in addition, still a significant conventional manufacturing business, but that is not large by international standards.

No one decided 10 or 20 years ago that we would sell the entire British motor industry to foreign interests. No one decided that we would create enormous pharmaceutical companies or sell virtually all our merchant banks to foreign banks. On the other hand, no one also decided that we would establish as large a venture capital industry as the whole of the rest of Europe combined. All these changes have been in response to market signals, which rightly or wrongly, we have accepted.

Question: will the myriad, detail changes in the Budget - and this is Mr Brown's main shot at these - allow and encourage these market signals to continue to shape our economy? Or will they start to lean towards command and control?

The worry of the more thoughtful people in the business community is not that the Chancellor will make some specific mistake in macroeconomic management. Rather, it is that he will make lots of small mistakes because he came to office with a rigid blueprint and hasn't a flexible enough mind to realise that this needs to be changed.

For example, the Individual Savings Accounts plan outlined at the end of last year is fine in principle but as presently constituted a clear disaster: cumbersome, expensive to administer, unfair. Will he change it? Is he aware that the only net creators of new jobs in the country are very small firms? Will, in practice, he make tax changes which tilt the balance of advantage against small companies and in favour of large? In his (perfectly proper) zeal to close tax loopholes, will he simply encourage people to move even more of their activities offshore? Will he allow profitable businesses like our fine art salerooms to be damaged by EU-imposed VAT levies? And so on.

The devil, this Budget, will lie in the detail. Fingers crossed.

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