Sunday, April 03, 2005
Labour's record under a cloud
Posted by David Smith at 11:00 AM
Category: David Smith's other articles

Having promised last week to return to the subject “If Britain is doing so well, how come it doesn’t feel like it?”, first aired here on February 27, I had not expected a gift from the Institute for Fiscal Studies.

The IFS, as many will have seen, produced figures — based on government statistics — showing that average real household incomes, after taxes and benefits, fell 0.2% in 2003-4 compared with a year earlier. This was the first annual drop since 1992 and, as the Treasury’s reaction has made clear, about as welcome to Gordon Brown as another invitation from Tony Blair to dine at Granita.

The figures, which showed in graphic terms the impact of Labour’s post-election tax hike during this parliament, were also a reminder of the probable consequences of further increases (denied by the chancellor) during the next.

To be fair to the government, not everything in the figures was bad. Median, as opposed to mean, incomes rose 0.5% during the year in question. The difference between the two, as every schoolboy knows, is that the mean is simply the arithmetic average of all incomes, while the median is in the middle of the income distribution, with an equal number of households above and below.

The IFS exercise also shows the Blair government in a relatively good light compared with its predecessor, led by John Major (1990-97). Under Labour, mean after-tax real household incomes have grown by an average of 2.5% a year, compared with just 0.8% under Major. The recession of the early 1990s took its toll. But mean incomes grew faster, 2.9% a year, under Margaret Thatcher (1979-90).

How does this fit in with our story of an economy that does not feel as good as it should after 50 quarters of growth and with unemployment at its lowest for three decades? And how does it square with the latest evidence of retailing woes and a cooling housing market? There were two elements to the political calculation underlying Labour’s tax hit highlighted by the IFS. The hit, in the form of the higher National Insurance contributions announced in 2002 but implemented in 2003, was judged by Labour to be saleable as a price worth paying for extra spending on the NHS (although the money went into the general public spending pot). It was also thought it would be forgotten, as a one-off, by 2005.

Whether or not a permanent tax hike should ever be viewed as a one-off hit is debatable, but even after its maximum impact had passed, another force was taking over. The Bank of England, having cut interest rates to a modern low of just 3.5% in July 2003, began to hike them in November of that year, and continued to do so until last August.

These things take time to feed through, but a large part of the explanation for the absence of any genuine feelgood factor is the cumulative impact of this and other tax hikes and higher interest rates, albeit from a low base. Tied to this, however, are some longer-term “downers”, some of which leave people with a feeling of mere disquiet, and some of which create outright misery. Feedback from readers, for which I am grateful, has confirmed which of these are most important.

Pensions/financial insecurity
Britain’s occupational pensions were the jewel in the crown in 1997, and the envy of Europe. Eight years later, after Brown’s tax raid, the bear market and the apparent revelation to actuaries that people were living longer, and the spell has been broken. Trust, most obviously squandered in the case of Equitable Life and companies that have failed and left beneficiaries penniless, has been dissipated, as has access to many final-salary schemes. Without trust, pensions are nothing.

Tie that to the general loss of public confidence in even the most solid names in financial services, a legacy of mis-selling and inept management of funds, and it is hardly surprising people do not look forward with confidence.

Borrowing fit to bust
The jury is still out on whether public borrowing will fall in line with the Treasury’s projections. It clearly has already significantly overshot and is making people understandably nervous about their future tax bills. We should not be surprised by this; the great classical economist David Ricardo predicted such an effect. It is also true, however, that there is a lot of nervousness about private borrowing. That £1 trillion (£1,073 billion to be precise) of consumer debt has its counterpart at the micro level. Everybody, it seems, knows somebody who is about to be made bankrupt by credit-card or mortgage bills. That overstates it a great deal, but it explains why many think this long upturn has been built on sand.

Housing madness
You don’t have to expect a house-price crash to believe there has been something unhealthy about the trebling of prices since the mid-1990s. Lower interest rates could have had an enormous feelgood effect on people’s free incomes (although balanced by the losses to those dependent on interest for their income). Instead, much of the benefit has been squandered in the scramble to trade up, via larger mortgages, in the housing market. Has this created much economic benefit or consumer satisfaction? I think not.

I could go on. Squalor in public places, poor public transport, roads unnecessarily clogged by inept traffic management, the petty legacy of Callaghan-era industrial relations (everybody has an airport story to tell) add up to an economy that still feels more like an old banger than a well-oiled machine. None of this will do much harm to Labour which, as I noted last week, is miles ahead of the Tories when it comes to public perceptions of economic competence. The trouble, perhaps, is that we don’t expect any better.

PS The debate over whether interest rates should rise, and when, had me bemused even before the latest figures for retail sales and house prices (although the Nationwide figures, showing a 0.6% March fall, were not nearly as scary as some reports suggested). Now, even more so, it seems to me that higher interest rates are the last thing the economy needs. But I am here to report as well as opine and that is by no means a universal view.

Two members of the Bank of England’s monetary policy committee, Paul Tucker and Sir Andrew Large, think rates should be rising. So do four members of the “shadow” MPC, which operates under the auspices of the Institute of Economic Affairs and has a monthly vote on rates for this newspaper.

The four, Tim Congdon, Andrew Lilico, Gordon Pepper and my namesake David Smith of Williams de Broë, are all concerned about continued rapid rates of money-supply growth, with the M4 measure growing at more than 9% in February compared with a year earlier. Lilico is also troubled by high oil prices, while Smith thinks the Bank should worry about the damage to the supply side of the economy through the public sector’s rapid expansion.

Economists do, however, frequently disagree. Patrick Minford, another member of the shadow MPC, argues for an immediate rate cut from 4.75% to 4.5% on the back of weakening demand. The other four, Roger Bootle, John Greenwood, Kent Matthews and Peter Warburton, vote to keep rates on hold but one, Greenwood, thinks it is only a matter of time before there is a rise. That is also, just, the verdict of the latest Reuters poll, with 29 out of 47 City economists expecting a further hike at some stage.

What will the real MPC be thinking this week? Not about an immediate rate hike; it would be surprising if anybody else joined Tucker and Large at this stage. Longer-term, a significant split will remain between those who argue that the case had already been made for a pre-emptive increase, and those who will not be budged until the data justify it.

From The Sunday Times, April 3 2005

Comments

Two linked points and one statistical one.
Firstly, the IFS figures based on the HBAI analysis show stong distibutional changes - so anyone in the top fifth of the income distribution (like many of your correspondents, and a proportion of your readers - likely larger than one-fith) would feel smaller growth than those lower down the income distribution.

Linked to this, strong regional factors - the South East and London has done worst while the North, Wales, Scotland have done best - feeding through to house price patterns.

So if your correspondents arepredominantly in the south and east of England, and in the upper end of the earnings distribution, they are likely to be a biased sample.

Statistical point - the HBAI figures on the self-employed are simply not believable - apparently about every child in poverty whose parents are not on benefit has a self-employed parent. The distributional figures are therefore hugely sensitive to the amount of fibbing done by the self-employed. National Accounts figures based on statutory tax returns are likely to be preferred as a source to voluntary survey returns for this reason. These show rising real personal disposable income up the scale (even if smaller at the top).

Posted by: Paul Bivand at April 4, 2005 10:23 AM

Paul, if you read the original article of Feb. 27th you’ll see that it’s not just based on reader comments (always a self-selecting group) but on a national, monthly Mori poll of economic optimism. There’s a very good graph of the poll results here:

http://www.mori.com/polls/trends/economy.shtml

In the period since mid-1991 (50 quarters ago) the peak of the economic optimism index occurred in May 1997 at +28.

May 1997 was also a peak for the percentage of people that thought the economy would improve: 40%.

In Jan. 2005 those two figures were –19 and 12% respectively.

You will recognise May 1997 as the time of the last election. Economic optimism in the population at large was at a peak then but it has been going down ever since.

Things did not get better.

Posted by: David Sandiford at April 4, 2005 12:20 PM

(Sorry, it was the last but one election).

Posted by: David Sandiford at April 4, 2005 12:25 PM

There was something puzzling about the IFS figures, particularly since such a big hit to personal incomes would normally have had a much larger overall economic impact. Consumer spending and the housing market continued to rise quite strongly during 2003-4.

On the point about self-employment, without going into the details of the data, I think we have seen an element of "involuntary" self-employment - in a period of weak private sector employment, some people have been forced into self-employment by redundancy, generating much lower incomes than when they were employed. I'm not saying this accounts for what the IFS data showed about self-employment incomes but it is a point to consider.

Also, you may have seen that the HBAI analysis shows a two-year fall in incomes, before housing costs, for the bottom 10% of the income distribution. Finally, I thought the IFS numbers were a useful reminder that tax increases are not costless.

Posted by: David Smith at April 5, 2005 02:17 PM

Just a quick point on the HBAI figures on income trends for the lowest 10%: year-to-year changes in this decile are apparently particularly uncertain, and the 3% drop from 2002/03 to 2003/04 isn't really statistically significant. If you look at three-year averages to remove some of the noise in the data, incomes for this group have been rising fairly steadily since the mid-1990s (although slower than every other income decile).

Posted by: Jim at April 6, 2005 12:23 PM