Markets think Labour may revert to type
Sunday 05 May 1996
It is worth saying that starkly because this information, however self- evident it might be to ordinary people, is not yet priced into the financial markets. A handful of rich individuals might be quietly moving their business interests offshore, there may be some hesitation in overseas purchases of UK government securities, and the UK stock market may have underperformed slightly in relation to Wall Street; but the past history of financial markets at the time of elections suggests that it is only in the last three months before an election that the markets fully adjust for the probable outcome, and perhaps not even then. So it is worth trying to think through the consequences of a Labour victory not just because being better informed is worthwhile in its own right, but also because there are implications both for savers and for company executives which are not yet fully appreciated.
There are two key reference points when seeking to judge how a Labour government might operate once in office: what the leadership has said it will do, and what previous Labour governments have done in the past. To ignore the first would be dishonourable, for one has, surely, to assume that people of the personal integrity of Tony Blair and Gordon Brown mean what they say; to ignore the second would be naive, for it would be astounding if the deep-rooted instincts of the Labour party were not reflected in some measure once in office. It is time to use both these points as an anchor and to make a judgement as to the ways in which a change of government might change the economic landscape.
As far as general economic management is concerned there is a sharp distinction between the stated policy of the Labour leadership and the professionals' expectations of a Labour government. On fiscal policy Gordon Brown has said that a future Labour government would, over the economic cycle, borrow only for capital expenditure and not for current spending and that the overall public debt would be held broadly constant as a percentage of GDP. The first golden rule might be open to different interpretation (is spending on education investment or con- sumption?) but the latter would restrict public borrowing to about 2.5 per cent of GDP, for the underlying rate of growth of the economy is unlikely to be greater than that.
Yet under the last Labour government, from 1974 to 1979, borrowing averaged 6.7 per cent of GDP, while under the present government the average from 1979 to 1996 is only 2.6 per cent of GDP. So, if you believe Mr Brown, a new Labour government would follow at least as restrictive a policy as the Tories, but if you believe the lessons of the past you might conclude that it would not.
The professional investors take the latter view. A poll of people in the financial services sector carried out by Charles Barker showed that 85 per cent of respondents thought a Labour victory would result in higher government borrowing, while 75 per cent expected higher retail prices, and 78 per cent higher interest rates.
That is quite chilling, for it means that those whose whole livelihood depends on judging the economic performance of different countries reckon that UK performance on these key measures will deteriorate under Labour.
If the professionals believe there will be higher interest rates then they themselves will help determine that this outcome will occur. What happens in financial markets is as much a product of expectations as of reality.
This judgement also reflects a view of likely monetary policy under Labour. Here, on paper, a Labour government would seem to be just as orthodox as a Conservative one; indeed since it would be inclined to devolve more power to the Bank of England in setting short-term interest rates, it might turn out to be more orthodox. But if inflation and interest rates are expected to be higher, this suggests that the professionals simply do not believe what they are being told. The memory of the past, perhaps, is just too strong. It is not at all a fair comparison, for the general level of inflation in the developed world was much higher in the 1970s than in the 1980s, but under the last Labour government the rate of inflation was 15.7 per cent.
What about taxation policy? Last Friday, a new London Business School forecast suggested that taxes would rise under Labour. The useful working assumption should be that there will be some increase in the nominal rates of taxation on higher earners, little or no increase in those on average wages, and some new tax breaks for people who save. The problem with this is that such a plan would not produce much additional revenue, for there are too small a number of high-earners to up the total tax take by very much, and many of those high earners are internationally mobile, so raising rates might not increase revenues.
Company tax? Labour has yet to publish its ideas but it seems companies will face a sharp rise in taxation, with a target suggested by the Labour think-tank, the Institute for Public Policy Research, of 7 per cent of GDP, as a realistic goal. Tax revenues from companies did rise sharply following the Lawson reforms of 1984 (see left-hand graph), but the IPPR target would bring revenue from company taxation above even the peak tax take of 1989-90. And tax rates in the UK (see right-hand graph) are quite high by international standards. Besides, Labour has sought to reassure companies that there would be additional tax incentives for investment, which will inevitably tend to cut tax revenues.
My one guess - and it is no more - would be that there will be some increase in the tax burden on companies, but international competition will limit the practical extent to which such taxes increase and actual tax revenues will rise only by very little.
Other policies we know about include the minimum wage, and the introduction of a lower tax band (of 10 or 15 per cent) for low earners. The first will have a marginal effect of increasing unemployment, but probably not by enough to have overall significance, the second the (also) marginal effect of reducing the disincentive to take on paid work for those at present on benefit, but again probably not by enough to have overall economic significance.
The import of all this might seem more than a little dispiriting: not a lot of overall change in actual policies, and not a lot of impact on the performance of the real economy; but, partly because of adverse actions both of UK professionals and overseas money managers, some adverse impact on inflation and interest rates.
In fact I believe that the greater concern is not New Labour policies - for what it is worth I would err on the side of trusting the judgement of the present leadership rather than looking at the mistakes of the past - but the dynamics of the economy when they take it over.
Come the end of the year we will be enjoying a modest consumer boom. But the balance of trade will be deteriorating and there will be some inflation, maybe not a lot, in the pipeline. The trend of interest rates will be rising, and prices on financial markets, already looking over- valued, will be vulnerable. This is not a comfortable legacy. So disappointment is likely, not because of any error, real or perceived, by the new team. It is likely because of the swing of the economic cycle. That is unfair, but it is life.
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