Sunday, March 21, 2004
Brown is gambling on growth
Posted by David Smith at 09:02 AM
Category: David Smith's other articles

SOME budgets are like champagne; they sparkle and bubble immediately, though they can leave you with a hangover. Others are like a fine wine; they mature nicely with age and their full importance becomes clear only later.

Gordon Brown’s eighth budget was not very bubbly. It had elements of fine wine about it. Some of its announcements, such as the merger of Inland Revenue and Customs and Excise, were historic and will have implications for decades to come.

But the budget also had a strong taste of Monty Python’s legendary Australian table wine, Perth Pink: “This is not a wine for drinking. This is a wine for laying down and avoiding.” The chancellor is certainly doing his share of avoiding tough decisions.

It is touch and go whether Brown will meet his famous golden rule (borrow only to invest) during this economic cycle, let alone the next. Barclays Capital, the National Institute of Economic and Social Research and Price Waterhouse Coopers all said he will not. The Institute for Fiscal Studies said the rule will be broken on the way he defined it a year ago.

But he still found room for a budget “giveaway” of 700m. That is neither here nor there in the grand scheme of things, but it tells a lot about the politics that drove the budget. The City was at least expecting a nod in the direction of fiscal tightening.

The chancellor was also being disingenuous when he claimed that the choice he faced was whether to cut taxes, cut borrowing or boost public spending. His new borrowing figures, 37.5 billion this year and 33 billion in 2004-5, are slightly higher than before.

The public spending “envelope” for the two years from 2006 (2.5% real spending growth) was probably the least he could have got away with, particularly when the NHS is promised 7.2% annual real growth.

The promise of more money for front-line services through efficiency savings, building to 20 billion a year, is implausible. Cutting a net 40,000 jobs, even if achieved, would save 2 billion a year at most.

So the black hole was there before this budget, and it remains. Most independent economists say that, to be sure of meeting his golden rule in the next cycle, Brown will need to raise taxes by 10 billion.

What has changed, however, is the strength of the chancellor’s denials that there is a problem. When, after the years of prudence, the big borrowing started to emerge, Brown lost some of his bounce. There were murmurings in Downing Street that the iron chancellor was starting to rust.

But no hint of that emerged last week, when he dismissed suggestions of a black hole in an even more forthright manner than in December’s pre-budget report.

Could he still raise taxes substantially in the next parliament after all that? Perhaps, but it would be difficult. He is relying on strong growth to square the circle.

The question mark over the public finances is a pity. It detracts from the fact that the economy is enjoying an extraordinary run.

The growth that Britain embarked on in spring 1992, which has lasted since, is the longest continuous period of growth for more than 200 years, as Brown said. He might have gone further. This may be the longest non-stop period of growth ever.

It did not all start in May 1997. It reflects a combination of the supply-side reforms of the 1980s and the better macroeconomic management of the 1990s. But things have got better, largely by dint of avoiding recession and spikes in inflation.

The Treasury’s “red book”, its main budget document, goes in for some politics by comparing the period since May 1997 with the 10 years before that.

Average inflation has halved, while average growth is about half a percentage point higher. More important, perhaps, the volatility of both inflation and growth is sharply down. When Brown talks about stability, he is backed by the data.

That still leaves a fundamental question, as posed by the Tories. If things have been going so well, how come government borrowing is so high? There are three answers. One is that all countries are borrowing more because of the global downturn. Another is that if the government had not borrowed, and put so much into public spending and recruitment, the economy’s recent performance might not have looked nearly as good.

A third answer would be that Britain’s public services and infrastructure badly needed rebuilding, and if this was not done during a period of strong growth it might not happen at all.

The Treasury’s longer-term projections suggest that growth will eventually slow to 1.5% a year as a result of population ageing.

That’s all well and good, but it does not alter the basic facts of the arithmetic underlying this budget. The chancellor is relying on strong growth in the economy and an even faster rise in tax revenue.

He said that he can deliver more cash to front-line public services while increasing government budgets at a slower rate.

The prudent Brown used to provide himself with a cushion against things going wrong. The new risky version is placing all his bets on everything going right.

PS: The Bank of England’s monetary policy committee (MPC) voted 9-0 to hold interest rates earlier this month, last week’s minutes revealed, and the new measure of inflation showed a fall from 1.4% to 1.3%. Does that mean base rates can stay at 4%?

Probably not. Retail sales were flat last month compared with January but up 6.5% on a year earlier. Average earnings, boosted by City bonuses, are rising by 4.4%, close to the Bank’s tolerance limit. Sterling’s strength has been partly reversed.

So the odds are on further rate rises, with the next most likely in May. But these things are never set in stone.

Events in Madrid showed the ability of terrorism to change the course of an election. We have seen, most notably in the aftermath of the September 11, 2001 attacks on America, that terrorism can change the course of monetary policy.

From The Sunday Times, March 21 2004

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