Is Gordon Brown the economic magician?
Nigel Aitkins - Mon 02 May, 2005
"...Dear Prudence inherited an economy in good condition. Then global deflationary pressures allowed for a sustained period of falling interest rates, which in turn triggered several rounds of asset-price inflation, making everyone feel richer. That facilitated debt-financed consumption...which in turn sustained UK economic growth for 32 consecutive quarters of the Labour Partys administration..."
According to an ICM poll last week, 46% of UK voters believe Labour has the best policies on the economy, versus only 22% who believe the Conservatives do.
Can it really be true? Is Gordon Brown the economic magician everyone seems to think he is? The answer is no.
Dear Prudence inherited an economy in good condition. Then global deflationary pressures allowed for a sustained period of falling interest rates, which in turn triggered several rounds of asset-price inflation, making everyone feel richer. That facilitated debt-financed consumption...which in turn sustained UK economic growth for 32 consecutive quarters of the Labour Party’s administration.
Unfortunately, however, hubris appears to have set in. Brown has taken the credit for much of what has been a global phenomenon. Equally unfortunately, he has also taken the economic record for granted and set the stage for some nasty surprises.
So just how bad are things? Let’s look at the eight crucial areas of Gordon Brown’s performance to date, and assess the risks now looming for saver and investors.
Firstly, economic growth. The IMF recently dared to suggest that if the UK didn’t cut spending, taxes would have to rise. Brown, hubris intact, was furious. “The staff of the IMF have been wrong before about British growth,” he said, and they’ll be wrong this time too, he stated. Stronger growth will provide the tax revenue necessary to cover any shortfall.
Yet in the last year alone, the Government has added 146,000 new public-sector jobs, which can easily enough obscure the fact that in the private sector the number of jobs has actually fallen. The staff at the IMF were looking at the workings of the private-sector economy, not the wholly discretionary - and rather less economically positive - contribution of the Government’s payroll. As the public sector grows and the private sector shrinks, it’s hard to see how the economy can grow above trend.
Is Gordon Brown the economic magician?
Public spending is thus the second area where, sadly for private enterprise, productivity is plunging. Private-sector jobs are forced by competitive pressures to keep driving efficiency. There is no such pressure on the public sector.
The Centre for Policy Studies calculates that productivity in the economy as a whole grew by 1.2% in 2003 and 2.1% in 2004, yet in the public sector it shrank by 1.3%. “The non-jobs being created by Labour have a doubly damaging effect,” says Ross Clark in The Sunday Telegraph: “they add to the taxation burden at the same time as they create scarcity”, making it harder for “the wealth-creating private sector” to recruit.
Indeed, Sir Christopher Gent, chairman of the advisory board of the independent think-tank Reform, reckons that “if public-sector productivity matched that of the private sector, annual economic growth would be lifted by half a percentage point”. A productive economy will grow faster and a bigger economy can afford more services with a lower tax burden. Potentially a real win-win scenario, but not one we’re going to see. The forecast is for public spending in 2008 to be 40% higher in real terms than it was in 2000. The consequences for growth will become apparent later.
Thirdly, unemployment. New Labour realised in the mid-90s that, thanks to the deindustrialisation of the UK in the 1970s and 1980s, the economic focus was inexorably shifting away from manufacturing...with their unionisation and jobs-for-life...and towards services instead. This transformed the party into an electable alternative to the Thatcherite Conservatives. But without industry, where would jobs come from? The public sector, of course, with the beneficial consequence for Gordon Brown that hiring people to work for the State keeps them off the dole queue. No mean feat when one million manufacturing jobs have been lost since he took over at the Treasury.
But surely Gordon Brown can’t employ everyone, can he? Well, he’s having a damn good go. Labour may no longer nationalise ailing manufacturing industries, but it is effectively nationalising their workforces today.
In a speech in the City two weeks ago, Tony Blair confirmed the New Labour message, emphasising the need for “policies to foster enterprise and the knowledge economy upon which future wealth creation depends”. This knowledge economy requires a major investment in human capital. However, this emphasis is not without irony. While it has been Labour that has overseen the demise of manufacturing, most of the often subsidised jobs lost have merely reappeared directly on the public payroll.
To pay for this public-sector hiring binge, of course, the tax burden has risen and continues to increase. According to Sir Christopher Gent, “the last Budget planned for the tax burden to increase in each year of the next parliament, reaching its highest level for 25 years in 2009-2010”. For all Blair’s talk of “our development as an enterprise society”, the old habits of tax and spend seem harder to break.
Apart from his infamous 66 stealth taxes - 68 if you include the increased burden of parking and speeding fines - all independent observers believe tax rises are inevitable under Gordon Brown after the election. The tax-take is already 36% of GDP, up from less than 33% in 1993-1994. Reform argues that currently planned public spending “will rise by 40% in real terms and by five percentage points of gross domestic product” between 2000 and 2008. By then, the tax-take is forecast to exceed 38% of GDP, just shy of 1985’s record. And yet, this rising tax burden still won’t provide enough cash to fund Brown’s spending plans.
You see, recent GDP growth hasn’t really been growth at all. In the same way that you don’t measure your wealth by the size of your credit-card bill, deficit-financed growth is illusory and must be paid back at a later date. The Government has a budget deficit - or at least it would have if it wasn’t for some last-minute statistical jiggery-pokery by the Office of National Statistics - while household-sector debt has breached the £1 trillion mark...and the nation’s trade deficit of £58bn is one of the worst on record. Much of this is the Chancellor’s fault.
Brown gave the Bank of England freedom to set interest rates, but he still sets the parameters for their decisions. When the Retail Price Index inflation measure looked in danger of crossing its 2.5% threshold at the start of last year, which would have triggered an abrupt end to the low interest rates then fuelling the housing boom, Brown shamelessly switched the measure to the significantly less rampant Harmonised Consumer Price Index (HCPI) - or CPI for short.
The very clear and present danger now is that delayed action raising rates in the past, having allowed house prices to rise too far, will now necessitate higher rates for a longer period to bring the housing market back into equilibrium. And the economy has never sustained a period of falling house prices without that being reflected in much slower consumer expenditure, or without triggering an increase in savings patterns.
Even the new CPI jumped to 1.9% last month, just 0.1% shy of its 2% inflation threshold. This makes further hikes in interest rates more likely not just in the near term, but probably throughout the rest of this year. The risk is that, having forced the Monetary Policy Committee (MPC) into delaying their response to inflationary pressures, Brown has pushed the MPC into incubating a classic wage-cost push inflation spiral.
Finally, there’s the strength of the pound. Trade deficits usually mean weak currencies. The US dollar is already three years into a downtrend caused by twin Government and trade deficits. What makes Gordon Brown think sterling’s so different?
Whoever wins this election is likely to preside over a significant drop in the pound’s value. And as that would mean all our imports would become more expensive in sterling terms, it would also mean more inflation...rising interest rates...an acceleration of the housing slump...and a slowdown in the economy that threatens recession.
In fact, why the Tories would want to win this election and then take the blame for the trouble stored up ahead, is beyond me. If I were Oliver Letwin, I’d be happy to make a virtue of a necessity - and sit this one out, ready to watch New Labour reap what it’s sown.
Regards,
James Ferguson
for The Daily Reckoning
P.S. Pensions are in a real mess too, of course. Again, the main blame for this can be laid at Brown’s door. First, he in effect destroyed private-sector final salary schemes when he abolished corporate-tax breaks. Now, only public-sector employees, like MPs, get final salary schemes. Government interference has also caused excessively low savings through low rates and encouraged debt-financed consumption.
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