Stephen King: Rules are there to be broken as Brown's iron grip on the economy begins to corrode

The goalposts have not just been shifted a little across the pitch, but into a different stadium
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Indy Politics

Gordon Brown is not a man you would associate with uncertainty and contradiction. The pre-Budget report, however, suggests that the Chancellor of the Exchequer is facing economic and financial challenges that are making life at No 11 rather uncomfortable. This is a chancellor whose iron grip on the controls of the economy is showing the first signs of corrosion.

In line with his earlier efforts, Mr Brown's latest report is full of what could be called "the little stuff" - lots of policy tweaking, but not much in the way of a grand vision. That, though, is not surprising: the Chancellor is seriously short of revenues, a shortage that has both persuaded him to launch a raid on oil companies and circumscribed his room for policy action.

His problems, though, run deeper than a simple revenue shortfall. His whole framework is creaking under pressure from events beyond his control. Because of this, he is shifting the goalposts in ways that undermine the credibility of his "golden rule", the lodestar for his fiscal decisions.

Unsurprisingly, Mr Brown has placed a lot of the blame for his current difficulties on the global economic environment. Oil prices are one problem. Weak eurozone growth is another. Although world trade growth has held up nicely over the past couple of years, it is, like snow on the railways, the wrong kind of growth. The US may have done well. China and India are booming. These countries, though, are too far away: it is the poor performance of our near-neighbours that is giving the UK economy a nasty headache.

This story, though, doesn't stack up well. It's true that the eurozone has been weak. But it hasn't really been unusually weak in recent quarters. The puzzle resides more with the UK: why did our economy slow down so much more quickly than most others?

To be fair, the Chancellor has also highlighted the poor performance of the housing market and consumer spending in the light of 2004's interest rate increases. Whatever the reason, however, he's left with a less than triumphant boast. Previously, he could proclaim the UK's strong out-performance against all-comers: now he can only emphasise that, with higher oil prices, the UK has managed to avoid the recessions that laid us low in the mid-1970s and the early 1980s. That the UK economy has slowed down more than others is conveniently pushed to one side.

Like the rest of us, the Chancellor is clearly unsure about the interpretation of economic data. He doesn't quite say it, but the Chancellor, and the Treasury, clearly have a distrust of the official output data for the UK economy. Mr Brown would obviously like to argue that output has been rising more quickly than the official data suggest and that the UK economy has, therefore, not been so weak after all. That, though, would leave him with an even bigger problem with the public finances. If the level of activity is subsequently revised up, it would emphasise to an even greater extent the structural nature of his revenue shortfall.

Beyond measurement uncertainty, there is a more awkward issue. The Chancellor's golden rule works only so long as he has a reasonable idea of where the UK is within its economic cycle: he has, after all, promised to be neither a borrower nor a lender on his current budget through the cycle as a whole.

But economic cycles are not easy to define. And the latest pre-Budget report reveals a great deal of uncertainty about where, precisely, we are within the current economic cycle. In one section of the report, the Treasury talks about the unusually weak growth of wages in recent quarters and suggests that this could be a sign of depressed demand. This would leave the economy with a so-called negative output gap, implying that the level of activity was below the economy's potential.

In another section of the report, the Treasury suggests that weak wage growth may, instead, be a sign of globalisation. Greater competition within product markets, higher rates of labour migration into the UK and greater global capital mobility may have broken the link between, for example, oil price shocks and wage increases. Using this explanation, there is no direct implication for the cyclical performance of the UK economy. On this view, the UK economy would be experiencing a supply-side shock that could not easily be used as an explanation for a temporary revenue shortfall.

The first of these explanations is the more preferable for a chancellor short of cash. If he can argue that the economy is growing too slowly, that there is fuel in the tank for a renewed expansion, that revenues are cyclically depressed, he can claim that his budgetary arithmetic will, eventually, add up.

And that's exactly what he's done. He now thinks that the output gap in 2006-07 will amount to 1.5 per cent of GDP whereas, in the Budget earlier in the year, he thought that the output gap in 2006-07 would not exist at all. Within the space of nine months, therefore, there has been a radical revision to the economy's position within the economic cycle. It may be that, eventually, Mr Brown will be justified in making this decision. But the possibility that wages are weak because of global competitive pressures rather than weakness of domestic demand could easily come back to haunt Mr Brown.

All economists have problems measuring the output gap, so the Chancellor's decision to shift the goalposts is hardly a heinous crime. On closer inspection, though, it appears that the goalposts have not just been shifted a little way across the pitch: rather, they've been sent off to an entirely different economic stadium.

Over the summer, the Chancellor decided, on the basis of revised output data, that the latest economic cycle began in 1997. Up until then, the Chancellor had argued that the cycle began in 1999. The advantage of this redefinition is obvious: it provided the Chancellor with a couple of extra budget surplus years, thereby increasing his chances of meeting his golden rule over the course of the - now-lengthened - economic cycle. In yesterday's report, he went a stage further.

In the March Budget, Mr Brown's numbers suggested that the current economic cycle would come to an end in 2006-07. He's now suggesting that the cycle will come to an end in 2009-10. This decision - seemingly innocuous but hugely influential on his ability to meet his fiscal rules - gives him a few extra years in which to make up the revenue shortfalls that have left his budgetary coffers so short of cash. I have no idea of where we'll be cyclically at that stage. Neither has the Treasury. And nor has the Chancellor. But it's a neat trick: rules, it seems, are there to be bent, if not broken.

The contradictions within the report reveal a chancellor who is no longer enjoying an easy economic ride. He wants to argue that growth has not been as weak as the official numbers suggest. He wants to argue that the output gap is bigger than previously thought. He wants to argue that the labour market is benefiting from supply-side flexibility. And he wants to argue that the economic cycle will continue for another three years relative to the projections made nine months ago. On some of these observations, he may be right. It is highly unlikely, though, that he'll be right on all of them.

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