No it won't hurt, no it won't work

Poor economic results may prompt Kenneth Clarke to fuel a pre- election consumer boom. Yvette Cooper explains why he shouldn't

This was supposed to be the bit that worked, following the bit that hurt last year. With a general election no more than 10 months away, the Conservatives would love a bit of economic optimism.

Instead, on Tuesday in his Summer Economic Forecast, the Chancellor of the Exchequer will have to revise his forecast for economic growth downwards and his forecast for borrowing upwards. But despite the apparent gloom in this week's figures, the long-term risk is the reverse: that Kenneth Clarke will fuel a consumer boom in pursuit of a feelgood factor.

The Organisation for Economic Cooperation and Development expects growth in Britain to be 2.2 per cent this year, rather lower than the Chancellor's cheery Budget prediction of 3 per cent. On government borrowing he was over-optimistic too. His hoped- for pounds 22.5bn Public Sector Borrowing Requirement looks to be more like pounds 27bn.

This won't be the first time that a Chancellor has been forced to admit his earlier forecasts were wrong. Before the 1992 election, Norman Lamont said government borrowing would be pounds 28bn - it turned out to be pounds 37bn.

Such "mistakes" are not confined to pre-election periods. In last summer's economic forecast, the Treasury underestimated borrowing by pounds 9bn. The lesson? Beware Chancellors bearing borrowing forecasts and take Mr Clarke's words on Tuesday with just a pinch of salt.

Few economists believed that the UK economy would grow as fast this year as Mr Clarke hoped. Recession in Europe has squeezed demand for our exports. Manufacturing firms in particular have felt the pinch - output actually fell in the first half of this year, while the rest of the economy was growing.

David Walton, an economist at investment bank Goldman Sachs International, believes manufacturing growth may remain slow for the next few months as companies reduce their stockpiles of goods. And Mr Walton points out that, so far, "companies have made little progress reducing stocks." Goldman Sachs estimates that growth this year will be only 1.9 per cent as a result.

These are the "downside risks" the Bank of England refers to when projecting the future course of inflation: de-stocking and European recession. But these risks don't last forever. Most economists agree with the Chancellor that activity will start picking up later in the year.

The signs are that we consumers are already active. We are certainly borrowing with enthusiasm - on credit cards and through personal loans. Consumer credit is rising by about 14 per cent a year. Consumer spending is already strong and the OECD thinks consumption will grow this year at 3 per cent.

In theory this should be good for Mr Clarke's political fortunes. But will it be good for the rest of us? A consumer-led recovery - rather than an investment-led or export-led one - is not ideal. For Martin Weale of the National Institute for Economic and Social Research (NIESR), it is simply further evidence that "the British economy still suffers from the fundamental problem that we don't save enough."

Growing consumer demand on its own is not the problem. Difficulties arise when supply cannot keep up - exacerbated by low investment and skills shortages. At that point inflation starts to take off: if too much cash is chasing too few goods, prices start to rise.

Most economists appear to agree with the Government that inflation will stay low in the short term. In fact we seem to be on course to meet the Government's inflation target of 2.5 per cent by the end of the year.

But what will happen after that? Stewart Robertson of Lombard Street Research argues that inflationary pressures will start to build towards the end of next year. "We may be storing up trouble for ourselves in the future," he says.

Of course 1997 is slightly beyond Mr Clarke's political time horizon. The trouble is that interest rates - the standard remedy Chancellors use to control inflation - need around two years to take effect. So if you are worried about inflation rising in two years' time, you had better start raising interest rates now.

But Mr Clarke will not want to raise interest rates before an election in anticipation of a problem that voters won't see for two years, especially when he has so little room for manoeuvre on taxes. Lower growth, lower tax revenues and higher spending have all left Mr Clarke with a higher government borrowing requirement than he had hoped for.

Of course, Chancellors have cut taxes and massaged borrowing figures in election campaigns before. Norman Lamont pulled that trick in 1992. However, the City and voters will be more sensitive to such moves this time round.

Irresponsible monetary policy on the other hand is much easier to get away with.

As the NIESR's Martin Weale explains: "If I took the Government's inflation target seriously, I would have put interest rates up by now. What we have seen is the Government hiding behind the lags."

Pursuing the economic feel-good factor rather than going for tax cuts may, however, not pay off politically. In the United States, politicians are finding that voters are no longer prepared to give governments credit for economic recovery. They believe their own hard work and endurance, not government policy, pulled the country out of recession.

If the same thing happens in Britain, a patronising slogan like,"Yes it hurt, yes it worked" may be the last thing a Conservative Chancellor needs.

The forecasts so far

Treasury Average independent

Nov 1995 forecasters May 1996

GDP 1996 3% 2.3%

1997 3% 3.1%

RPI* 1996 2.5% 2.7%

1997 2.25% 2.7%

PSBR 1996/7 pounds 22.5bn pounds 26.2bn

1997/8 pounds 15bn pounds 22.3bn

*Excluding mortgage interest payments

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