The first test of life under Labour

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But has the earth moved for economics too? It is always hard to foresee the linkage between political change and economic change. The 1979 election is a good example. Most people would see that election as an economic watershed - the start of a series of market reforms which, for better or worse, then swept the rest of the world.

But you can see the roots of many Tory economic reforms in the policies of the previous Labour government. It was Denis Healey who started the decline in public spending as a proportion of GDP and established monetary targets; the first big government share sale, that of the first tranche of BP, was carried out by Labour; even the trade union reforms, carried through by the Tories, had their antecedents in the attempted reforms of previous Labour governments.

So the main elements of the Conservative economic platform of the 1980s - in monetary, fiscal and structural policies - echoed policies that were put in place, or had been attempted, by the previous government.

To say that is not to pretend that had Labour won in 1979 all the Tory market reforms would still have taken place. But many of them would. The timing and the rhetoric would have been different, but since the backcloth against which the governments of the 1980s operated would have been the same, broadly similar economic policies would have eventually been adopted. Nevertheless, the difference in timing is important. Moving early in any of these areas - monetary and fiscal policy, or structural reform - confers long-term benefits. Moving late carries costs. Countries arrive at the same place in the end, but the speed at which they get there does matter a lot.

There are now a number of reforms in the pipeline in each of these three areas. It matters whether these reforms are maintained, speeded up, or slowed down. At the moment we have only words on which to make an assessment, but in the next six to nine months we shall see a series of practical tests, the outcome of which will help us to judge the nature of the new political animal.

The first and most obvious test comes next week. There will be a meeting between the Chancellor and the Governor of the Bank of England at which there will have to be a decision: do interest rates rise, and if so by how much? The test here is not, as is popularly supposed, whether the rise is 0.25 points or 0.5 points, or for that matter 0.75 points. It is whether the new Chancellor accepts the Bank's judgement. Does he trust them?

The reason is that the odd quarter percentage point on base rates is neither here nor there. What is vital is whether the new Chancellor accepts professional advice from people who know. When we know if he does - and we will from the minutes of the meeting, to be published in July - we have a clue to the general conduct of monetary policy over the next five years. If advice is accepted, expect the plans to give greater independence to the Bank on monetary policy to go smoothly. If not, expect bumps.

Then, as the months unfold, there will be other tests. The Conservatives have started a process, giving the Bank greater authority in monetary policy by a series of detailed procedural changes such as the publication of minutes of meetings between the Governor and the Chancellor. Labour has a new structure in mind which will take this process further, though it falls just short of full independence. The speed at which Labour moves will give us a feel of the extent to which it accepts the new global orthodoxy that central banks should have primary responsibility for setting short- term interest rates.

The second set of tests applies to fiscal policy. There will be a Budget in July, and the question here is: do taxes go up, and if so by how much?

Of course, the lead-in to that question is: do they need to go up? There are two views on this. The majority view among professional economists is that they do, by something like 1 per cent of GDP, or another pounds 7bn in taxes. The argument here is that though the government borrowing requirement is falling and will be below 3 per cent of GDP this year - the Maastricht limit - that is largely because of faster-than-trend growth. Even when the economy is at full capacity, the argument goes, it will still be about 2 per cent of GDP, which is rather high. If you believe that public sector debt ought to decline slowly, over the economic cycle this 2 per cent level ought to be the average - growth at, say 2.5 per cent, borrowing at 2 per cent - not the best achieved when the economy is at full tilt.

There is, however, a minority view on this, best articulated by Gavyn Davies, chief economist at Goldman Sachs, who explained this position in his column in the Independent last Monday. His view is that the increases in taxation under the outgoing Tory government and the tight hold on public spending are sufficient to enable Labour to meet its fiscal objectives. There will be some slippage from Kenneth Clarke's policy, but that policy was "overkill". Mr Davies's view matters because he is close to the Labour leadership, and is also a possible candidate for the next Governor.

For what it is worth, I agree with Mr Davies, because I think the trend growth of the economy may be higher than presently estimated by most commentators. A bit of support for this view comes from some new work by American Express, which estimates that the trend growth of the economy is now 2.7 per cent, compared with the 2.25-to-2.5 per cent of popular estimates. Amex drew attention to the latest OECD estimates (see chart) for growth for the current five years, which show us at 2.8 per cent. This is way below the "tigers", but better than that being achieved by other developed economies. Amex reckons that taxes have to go up, but the faster the growth and the closer to capacity the economy can be run, the less of a problem there is on the fiscal side.

Anyway, whatever view you take about the fundamentals, we will know more about the Government's general intentions come July. Is it inclined to err on the side of fiscal caution, or is it inclined to a more relaxed view? Wait and see.

Finally, there are a host of structural issues. The big question here is this: to what extent should the market be allowed to allocate resources and to what extent should its decisions be modified by government?

There are two big areas in these structural questions. One concerns established micro-economic policies. Does the privatisation programme continue, or does it stop? Is there a substitute for privatisation in some form of partnership with the private sector? What happens to government intervention in labour markets beyond the minimum wage and the signing of the social chapter? What happens to pension reform, given that Labour is interested in some kind of compulsory savings scheme, but also given the fact that it attacked the Tories in the election campaign for supposedly planning to end the state pension?

There will be no revelations here; expect a series of measures, emerging over the next two to three years, each of which will build our knowledge of the Government's mind.

The other structural area concerns the single European currency. Does the large Labour majority mean it will be more inclined towards such a scheme? Or will the plan fall to bits before we are called on to decide? Would they have us in anyway? I do not think it is possible to say anything sensible about this issue at this stage, except that I suspect this is not a decision which the British people will be called upon to make. The big decisions will be in Germany and France, and they are simply too close to call.

In one sense nothing has changed. The world economy is the same as it was a week ago. The British economy is the same too. We have a government which has said it will continue the same broad economic policies of its predecessor. And there is in any case a natural continuity of policy despite political change. But a lot of experienced (and decent) people in the world of finance are troubled, and that in itself is worrying.