Now comes the harder part. If you say – and it is a crude tally – that the coalition managed to do half the job of bringing the public finances on to a sustainable basis, the other half is still to be done. There is a clear mandate to do it, and that is a start. The economy is growing strongly, even if the official data has not yet reflected that, and this gives a following wind. But the promises made in the campaign will make things harder, and there will be a double squeeze. There will be the fiscal squeeze as we all know. But there will also be more of a monetary squeeze, for rising interest rates will increase the cost of funding the national debt. As Gordon Brown used to remind us when he was in his prudent mode, money spent on interest was money not available to spend on services. There is a long way to go.
None of this should take away from the core economic message, picked up so strongly by the markets on Friday. Stability is better than instability. The positive reaction was a function of that sense of relief, for investors did not expect the pollsters to make such an ass of themselves. So sterling went up; share prices went up; gilt yields went down. But to put that in context, though the FTSE100 share index was up 2.3 per cent on Friday, the German DAX and French CAC were up slightly more. There are bigger things going on than our general election.
One of those bigger things will have a direct bearing on our new government. It is the shift in sentiment that has taken place over the past month about inflation and interest rates. Fears about falling prices across Europe have receded, and long-term interest rates have started to rise. The oil price seems to have bottomed out. The different eurozone countries face such divergent conditions that it is impossible to generalise, but here we are starting to see wages and salaries climb. We get new labour market figures this week that are likely to show employment continuing to rise at a rate of a million a year, and it is plausible that unemployment may be down to 5 per cent by Christmas. Forward-looking surveys suggest pay will be rising well above inflation through the autumn. Most important of all, the US Federal Reserve seems likely to make its first increase in rates later this year. That would underpin a move by the Bank of England here.
We need higher interest rates, or at least we will soon. We also need tighter fiscal policy. I know many economists, including Nobel prize-winner Paul Krugman, say we don’t, but the harsh truth is that policymakers do not take much notice of academic economists. Fiscal orthodoxy rules, and to judge by these results, voters accept that. George Osborne, heading into his second term as Chancellor but without the support of an able Liberal Democrat chief secretary, has been set a huge task. He has to get from a projected deficit of 4 per cent of GDP this financial year (and 5 per cent last year) to a balanced budget in four years’ time. He will not by law be able to increase rates for the three biggest revenue-raisers: income tax, National Insurance or VAT, and he cannot do anything on the fourth biggest, corporation tax.
You can see why the Tories made these commitments, but the effect is that the only additional sources of revenue will be general tax buoyancy from faster growth, and little tweaks such as closing loopholes and increasing tax on the banks. Governments always try to do the first and the second won’t look very bright if it pushes HSBC to move its headquarters to Hong Kong. He also has to find money from pension tax relief to fund a cut in inheritance tax; the proposed pension tax changes are a real mess, and will have to be rethought. So the only way out of all this is faster growth.
Well, maybe we will get it. If so it would be most helpful, but even then there will have to be a continuing squeeze on spending – except that more money is promised to the NHS and other protected areas, and there is the little matter of financing HS2. So for the unprotected areas the squeeze goes on and on, including the squeeze on welfare payments. (You may recall in his last Budget the Chancellor promised to end the squeeze a year early; that was because the projected cuts in the first four years were even tighter than previously billed.)
Actually I don’t think there is much point in fussing over the detail of public finances four years ahead; the numbers will change. I doubt that the Tories will be able to meet the fiscal targets they have set themselves, and as in the 2010-15 period, everything will happen more slowly than predicted. That would be acceptable were it not for one question: can the Government assume that global growth will continue for five years? The roof, to pick on George Osborne’s phrase, is not yet fixed and he will need a full five years of sunshine to finish the job.
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