Money is blind, but can Labour hear?

It Is gradually dawning on the Labour leadership that if it does win power at the next election it will be even more strapped for cash than it had thought. Deteriorating public finances may be bad news for the Tories, for it reduces the scope for making tax cuts this autumn. But in a way it is even worse for Labour. A new Labour government would at best be faced with no money to carry out any additional spending plans; at worst it might either have to cut spending or raise taxation just to maintain existing levels.

On Friday Gordon Brown, the shadow chancellor, urged the Government to be honest about the shortfall in revenues:

"It is now clear", he said, "that there is a hole in the Treasury's book- keeping, a hole in the public finances about which I believe they are not being honest."

Honest or not, it is certainly clear that the projections of last November's Budget (which showed a deterioration on those of November 1994) are already too optimistic. The fiscal year just ended showed an overrun on borrowing and just last weekend Kenneth Clarke, the Chancellor, acknowledged that the 3 per cent growth forecast for this year was "on the high side". On Friday we also got the Public Sector Borrowing Requirement for April, which showed that although the tax take had recovered a bit (a recovery in growth?), public spending was running well above Government forecasts.

The deteriorating fiscal inheritance is one of the themes explored in a new paper by the broking side of the Union Bank of Switzerland - the old Phillips and Drew - published today. The London financial community has now started in earnest to assess the likely impact of a Labour government, the results ranging from the optimists who reckon there will not be much change, to the pessimists who see a significant deterioration in economic performance.

While no forecast expects the sort of economic disaster that overtook the last Labour government - runaway inflation and a rescue by the International Monetary Fund - it is slightly depressing that there does not seem to be any City forecaster who expects a significant improvement in economic performance under Labour. (Lest anyone think that is simply a City bias, note that there are several Labour advisers, past and present, who have worked as economists in the City.)

Two particular aspects of this UBS paper deserve a wider audience, because they quantify two very important economic variables: where Labour is starting from in fiscal policy; and what effect its proposed minimum wage might have on unemployment.

The starting point is shown in the graph on the left. The projected steady fall in the PSBR comes from the forecasts at the time in the last Budget, and as you can see suggests a move into surplus in 1999. But that is already wrong: instead of the 1995/96 PSBR at 3.5 per cent of GDP, it looks like being about 4.3 per cent.

Now look ahead and all the variables are on the wrong side. Add in the fact that tax revenues are undershooting and spending overshooting, the probable tax cuts of the forthcoming Budget, a rise in public spending were it to grow at the same trend as in the recent past, growth already running at its long-term trend, plus extra interest, and the figures look instead more like the top line.

In other words, Labour would not inherit a steadily falling borrowing requirement and the prospect of a balanced budget before the end of the century. Instead it would inherit a PSBR stuck at its present level of more than 4 per cent.

This level is not acceptable. There is a lot of argument about the potential growth rate of the economy, but no one suggests that it is as high as 4 per cent. If it could manage close to 3 per cent that would be very good. It may be that UBS is being too pessimistic in these projections, for it has assumed that everything that might go wrong will go wrong. They are not, UBS stresses, forecasts. But even if the deterioration were only half as bad as this, the fact remains that Labour might well find itself increasing taxation just to maintain the present level of public services. The prospect, as the brokers say, is decidedly grisly.

If this is inherited grisliness, there is also some grisliness of Labour's own making. This is the impact on jobs from the introduction of a minimum wage. UBS calculates the effect of two levels of minimum wage, pounds 3.25 an hour and pounds 3.80 an hour, and traces through the impact on the economy. You have to remember that it is not just people who at present receive less than the minimum wage who will get higher pay - assuming they keep their jobs. Other, slightly higher-paid workers will also seek to restore their differentials. So the additional impact on the wage bill will depend on the extent to which these people are able to do so.

The graph on the right shows the UBS calculation for two levels of restoration: if they get back 25 per cent of the differential, and if they get back 50 per cent. As you can see, the job loss ranges between under 100,000 and more than 250,000. (If you assume the full differential is restored, the loss is higher still, but mercifully that does seem unrealistic.)

A scare story? I wish I knew. Intuitively the 250,000 number feels to me to be too big. There have been other calculations which show a much smaller impact, and there are enormous imponderables. The tally will be affected by the government's fiscal and monetary correction: obviously there will be some inflationary impact from a minimum wage and to some extent this will be offset by higher interest rates or tighter fiscal policy. But we have no idea how big this offset will need to be.

Nor do we know how many jobs will be displaced abroad, the time-scale of the shift, nor to what extent the people who are displaced will be mopped up by general economic growth. But it is certainly useful to have some hard numbers on the table, even if they do turn out to be overly pessimistic, so we should be grateful to the UBS team for that.

The Labour leadership should be particularly grateful, even if much of the response is disagreeable. Remember that no one, repeat no one, in a future Labour cabinet would have any memory of government. People can have ideas, set up think-tanks, write policy papers. But this is all a game until these ideas come under professional scrutiny. That is what is starting to happen now. Quite suddenly Labour is being taken seriously by people whose job it is to assess the economic policies of a score or more developed countries around the globe and advise investment funds on where to allocate their assets. Britain is one possible recipient, among many. It is quite important (last year we overtook Italy to become again the fifth largest of the Group of Seven developed economies) but not that important.

Money is politically blind - international finance has little compunction about investing in any country whatever the politics of the incumbent government, witness the way funds are now flowing into China. But it is also cowardly - it is ready to run. Having professionals suck their teeth at the legacy which Labour might inherit is fine - Gordon Brown is sucking his teeth too. Having them warn that a minimum wage could cost up to 250,000 jobs may seem less fine - but it is absolutely the sort of cool, dispassionate advice to which Labour needs to listen. This is not the think-tank of like-minded people. It is real.