Why Brown's grand plan may exceed his grasp

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The Independent Online
"GORDON BROWN warns US and Europe over economic turmoil," said the newspaper headline yesterday. To this end he has proposed a three- point plan to save the world economy, calling for greater "transparency" in the accounts of financial institutions, a global regulatory agency and better crisis management.

Um, yes. Nothing wrong with those ideas, but these grand plans are not within his domain. The key players are the US and Germany: if they agree, things will happen and if they don't they won't.

Indeed, Mr Brown's calls for a cut in German interest rates seem to have been swiftly rejected by the Bundesbank. What we really need to know from Mr Brown is how he will handle the two things which are directly in his bailiwick: UK payments to the European Union; and his ambitious UK public- spending plans, now undermined by the Treasury's slower growth forecasts.

More of that in a moment; first the global outlook. The past week has been a fascinating one for anyone who follows the twists and turns of economic forecasters. Until the summer most forecasters pitched too high. It took the collapse of share prices to trigger a rapid re-thinking of their earlier optimism, but until the last week there was a reluctance to "call" a true recession.

Then, 10 days ago, came the downgrading of the growth forecast of the IMF, followed by the gloomy IMF/World Bank meetings in Washington. Now the various private-sector forecasters are coming up with unvarnished forecasts. I have just been looking at the latest ones from JP Morgan in New York. Its global view is shown in the chart: something worse than the early 1990s downturn, but maybe not as bad as the early 1980s one. It believes that inaction by the US and Western Europe has helped turn what was a regional recession into what will become a global one.

But not every bit of the world will actually experience recession. Overall, as the chart shows, the world did continue to grow through the previous low points of the cycle. And some bits will do so this time too. Thus, while the US is forecast to experience a mild recession in the middle of next year, over the year as a whole the economy will be up just 0.1 per cent. The "euro" area is expected to keep creeping forward, with 1.7 per cent growth. The UK, however, is forecast to have a recession in the first half of the year and not to recover until the final quarter.

These forecasts may or may not be right. My own instinct, for the UK economy at least, is that the problem will not be so much in the first half of next year but rather later, perhaps in the second half of the year and maybe not until 2000. My reason for this is the present momentum in the economy, the recent decline in sterling, and the ability of the Bank of England to stimulate domestic demand by cutting interest rates. But what seems to me abundantly clear is that the revised Treasury forecast for the UK economy, unveiled only last week, may have to be revised down again.

So what will Mr Brown do? There is a big question and a small one.

The big question is whether he will protect his public spending plans. He said at the weekend that he wouldn't cut spending but instead would borrow and tax more. No, I am fibbing. He didn't make that statement in its entirety - all he said was the first part, that he would protect public spending. But if you are going to keep spending, you either have to increase taxation or increase borrowing, or both. Increasing tax rates in a recession is liable to deepen that recession, so there are limits to the extent to which that can be done. And since a recession tends to reduce the tax base and to increase public spending (largely because of higher outlays on social security) the amount of additional borrowing can be very large indeed. That is, after all, what happened under the previous government.

Conclusion? I suspect when push comes to shove, the Chancellor will do all three. He will cut spending a bit, but try to protect the main priorities of health and education. He will increase taxation a bit, but try not to break the specific manifesto promises. And he will increase borrowing a bit, but try not to break his "golden rule" about not borrowing for current spending but only for investment. If he cannot make the numbers add up, then expect the definition of "investment" to broaden a bit to cover things that otherwise might be considered consumption.

Cheating? No, not really. I think that voters would be reasonably mature in their response to a squeeze of this sort, provided that they felt that (a) the Government was taking a fundamentally responsible line on the taxation/borrowing equation, and (b) the public spending was getting value for money.

The bigger trap, in political terms, is surely the smaller one in financial terms. It is the possibility of having to pay much more towards the costs of running the EU at a time when public spending as a whole is being squeezed. It is this issue that opened up yesterday.

Now that there is a new government in Germany, the EU's largest net contributor is determined to cut its bill. For many years the UK was the second-largest net contributor on a per capita basis, after Germany, despite the rebates negotiated by Mrs Thatcher. Now The Netherlands contributes more on a per head basis. Nevertheless if Germany is to pay less, other countries will have to pay more and present net contributors like the UK will be in the firing line.

The numbers are not enormous in public finance terms - three or four billion a year. But they do have to be paid across the exchanges and have in recent years often been enough to tip us from surplus to deficit. And they are funds which are not scrutinised in the same way as they would be were they spent by the Government in the UK.

If Mr Brown were wise, he would be worrying less about the world economy (about which he can do nothing) and more about the UK contribution to the EU (where he can, like Mrs T, always say no). Politically it is just this sort of issue that bites politicians in the backside.