Sunday, January 08, 2006
Dear Tony, I'm afraid we've run out of steam
Posted by David Smith at 11:00 AM
Category: David Smith's other articles

Two e-mails landed in my inbox the other day. One was from Tony Blair, addressed “Dear supporter”, which to me is almost first-name terms. The other was from Michael Saunders, chief UK and European economist at Citigroup.

Tony’s message was full of optimism. “Britain in 2006 will continue to be one of the most successful countries in the world, with a strong economy and good public services,” he told me in his note. “Despite a more challenging context, our economy is enjoying its longest period of growth. While employment is high, interest rates and inflation are low.”

Michael’s, however, was downbeat. Called The Fading Star, it listed a series of reasons for Britain’s disappointing performance of last year to continue this year and beyond, including high household debt, weak business investment and rising taxes.

He is no Jeremiah. Until recently he was a champion of Britain’s economic performance. Now he has become disenchanted, not least with the government’s addiction to public spending, highlighted by Tony in his note, and red tape.

“We expect that the UK will remain with fairly high public spending, a rising overall tax burden and a stubbornly high fiscal deficit — in contrast to the trend of falling tax rates and lower tax burdens in many other industrial countries,” the Citigroup report says.

“The UK’s rising tax/regulatory burden may already be starting to hit business investment, erode the UK’s supply-side advantages and prompt households to save more.”

So who’s right, Tony or Michael? This is an interesting juncture in Britain’s economic and political fortunes.

Politically, Gordon Brown’s previously smooth passage into 10 Downing Street is looking much bumpier. He is having to put up with the indignity of impertinent attacks from what Charles Crawford, Britain’s ambassador to Warsaw, described as “the scary new teenage Tory opposition” at a time when his political touch seems to have deserted him. Blair has plenty of problems but, in contrast to the run-up to last year’s general election, Brown no longer looks the stronger of the two.

Economically, Britain appears to have reached a turning point. Either last year’s slow growth was a blip, in which case things need to speed up soon, or it is the shape of things to come. Plenty are starting to think the latter. For the first time in years Britain may no longer be able to claim economic superiority over Europe. Manufacturing in the euroland economies has started at a fair clip, easily outpacing growth in Britain, according to the latest purchasing managers’ surveys.

Manufacturing, of course, has not been a source of strength for the British economy in recent years, and the service sector is doing rather better. But forecasters are starting to think that this won’t lift growth in Britain above that in euroland.

HSBC, for example, has Britain at 1.8% growth this year, exactly the same as in euroland and well behind Japan (2.7%), America (3.3%), fast-growing India (7.5%), and China (8.9%). Oxford Economic Forecasting is more optimistic but sees British growth of 2.1%, behind that of euroland’s 2.2%.

According to the OECD, the last time Britain’s growth rate fell behind the weighted average of the 12 economies that make up the single currency was in 1992.

Why is this happening? Europe is perking up a bit. But the main reason is that Britain has lost the economic motor that has powered us through the Blair-Brown era. When consumer spending is not growing strongly, the British economy looks very ordinary indeed.

As recently as 2004, consumer spending was growing by nearly 4%, but the spell has been broken. The indebted consumer, worried about pensions and seeing his tax burden rising, cannot be blamed for deciding enough is enough. The consequences are a slowdown, probably prolonged, and the good run of economic growth that has characterised the new Labour era starts to look more like a mirage than a miracle.

What can be done? In a paper for Lombard Street Research, Time for a New Economic Policy, Christopher Smallwood proposes a radical solution. The current approach to policy, he says, has run out of steam. Consumers have reached the limits of indebtness and another growth factor — the £50 billion swing from surplus into deficit on the public finances since 1997 — cannot go any further.

Smallwood proposes reviving a policy that worked well after sterling’s exit from the European exchange-rate mechanism in September 1992. Interest rates were cut sharply and taxes rose to slash the budget deficit. The result was strong and balanced economic growth.

In 1994, because of this policy and the lower pound that followed the ERM exit, Britain achieved growth of nearly 4.5%. This was led by exports and investment.

Could history repeat itself? Smallwood argues that cutting interest rates dramatically and consolidating Britain’s fiscal position (cutting the budget deficit) by raising taxes on consumers would kill two birds with one stone.

It would ensure speedy restoration of growth — growth biased in favour of exports and investment rather than consumer spending. And by boosting business investment from near-record lows, it might help to turn round the abject productivity growth under this government — a full percentage point weaker on an annual basis than in 1990-96.

Smallwood argues that, as in the early 1990s, higher taxes balanced by lower interest rates would boost growth and leave the economy stronger in the long run. I don’t suppose, however, that Brown would want to take that risk, or face the political flak of another tax increase.

In the absence of anything so radical, a dull year is in prospect. I see 2% growth, below-target (1.75%) inflation by the end of the year, a further rise in claimant unemployment to 1m and a £25 billion current- account deficit.

What about base rates? Recent figures have been mixed, with strong mortgage approvals (and broad money supply) but weak consumer credit. That guarantees no rate cut this week but should mean at least one soon. My cautious view is 4.25% at the end of the year.

PS: Thanks to the many people who entered the Economic Outlook seasonal competition. The answers were: 1. On the basis of published figures Britain has had 53 successive quarters of economic growth.

2. The maximum and minimum level of base rate (the Bank of England’s repo rate) since independence in May 1997 were 7.5% and 3.5%.

3. Robin Leigh-Pemberton preceded Eddie George as Bank governor, and Paul Volcker came before Alan Greenspan as Fed chairman.

The winner, from a large field, was John Daly of Bolton, who pointed out that Leigh-Pemberton was originally named Robert before he became the distinctive Robin.

As for new indicators to supplement the skip index, Sir David Nicholas suggested reviving an old one: the number of times Tower Bridge is raised, these days reflecting Thames traffic in cocktail cruisers rather than cargo ships. Peter Breck offered loft conversions as a better indicator than skips.

On the high-tech theme, Turan Ahmed suggested take-up of satellite-navigation systems for cars — a sign of prosperity or necessity? But the prize goes to Rohan de Silva of Solihull for three high-tech offerings. These were: sales of HDTV televisions, per capita active mobile-phone ownership, and the proportion of retailing carried out online. Keep them coming.

From The Sunday Times, January 8 2006


Cutting interest rates would encourage more consumer borrowing by some as well as the desired less saving by others. The more a substantial segment of the population is in debt, the greater the threat to the economy. I believe the Bank of England is walking an increasingly narrow tightrope when it comes to interest rate flexilibility.

Posted by: David Goldfinch at January 8, 2006 09:51 PM

As Victor Meldrew would say 'I do not believe it!'

The 1990s after the boom went bust, and the currency collapsed, taxes were raised, was a period of great technological growth in the operations of business - especially english speaking businesses.

This English speaking world led, series of IT innovations is what I believe gave the UK, as well as many other countries who share the same culture, such a huge leading edge in productivity and innovation, a rapid rising service sector, RISING REAL WAGES, thanks to non unionised flexible IT workers, and lead to great investment, as real returns on capital rose strongly, and exports rose as we beat on price non english speaking inefficent competitors who caught on slowly to the technological breakthroughs.

Yes, we are weighted down with insane red tape, Just tommorow I have to fill in pages of forms which have changed yet again this year, and have grow more complex. It will probably cost me 3-4 days to sort out again.

Reams of confusiong regulation and complience, big business allowed to crush smaller cheaper businesses, massive tax burdens ;

Why have such perversions not had a nasty effect on profits,and a nasty effect on employment by now?

Through it all there is still growth keeping the bad ship Brown afloat.

Where is it coming from?

This economy relies on massivly high levels of immigration, which I see barely meantioned in economics columns - this acts to lower real wages, but also raise productivity, (The sad state of UK productivity would have been much worse without these very cheap workers).

As the bank prints money, the returns on capital, instead of through technology, seem to be at the expense of workers as thier wages can never catch up, and are falling in terms of houseprices and other real resources.

We are at a totally opposite extreme to the period when low interest rates and rising taxes, a collapsed undervalued currency encoraged RISING WAGES, capital inflows and investment in risk and profit and jobs, with no printing of money the BOE.

Property now represents 60% of UK wealth, from under 20% in the 1990s. In the 1990s most wealth was in savings and businesses.

If the bank lowers interest rates now, houseprices will storm, but peoples real incomes will carry on falling under taxes. Each job in the public sector is already looked on enviously by a weighted down private sector. There is little to spur rising wages, without inflation or more labour force competiton and displacement from more immigration.

Can you see serious capital ready to invest in UK companies, developing real returns and innovation, not connected to the credit industry, property or real resources like oil? Under the fumbleing mountain of regulations, taxes, public sector jobs and stuper inducing property boom, our innovation and competitve edge so prevelent in the 1990s has gone!!

Cutting interest rates and raising taxes further, expecting a investment boom, may result in the opposite - capital flight.

Posted by: Mr M Micaber at January 8, 2006 11:28 PM

From a personal standpoint, I find Smallwood's suggestions alarming.

Higher taxes would leave me with even less in my pocket at the end of the month, after steep recent rises in council tax and other taxes.

Lower interest rates would not only reduce the return on my savings, but the inflation they would cause would erode their value too. House prices would zoom out of view again, and the weakness in sterling that lower interest rates would cause would inevitably cause prices of goods like petrol to rise. Yet it is unlikely that wage inflation would follow suit, given the dampening effect of new EU immigration and the lack of labour organisation to push for pay rises. So personally I would be a lot worse off.

The recipe for any economic planner - be it in a capitalist system or in another system like communism - should be to reward hard work and frugality. Yet Smallwood's suggestions would see myself and many other worker/savers in a far worse position. While debtors would see their interest burden eased and the value of the principal diminished by inflation. Those who live within their means are punished, those who live beyond them are rewarded. In these circumstances I would leave the country, and I am sure I would not be the only one. Why stay here and work if work is not rewarded?

What really needs to be done is for interest rates to be RAISED and for government spending to be CUT. This would for a period bring about a recession as the economy is rebalanced. But it is the only remedy for the imbalances in our economy - consumer debt mountain, bloated public sector, trade deficit, the parlous state of government finances. The longer the cure is put off, the worse the medicine will taste.

Posted by: El_Pirata at January 9, 2006 12:26 AM

Rates & Productivity
The UK has had a very good period of growth in prosperity. the tail of that period has however created a lot of slack.Instead of doing little to obtain a lot, a long period of doing a lot to obtain little might be just starting.( Its productivity.....STUPID !)

p.s We could of course make it much more complicated in making things unintelligble... cound't we ?

Posted by: Arik Schickendantz at January 9, 2006 08:10 AM

Cut rates and raise taxes? Well OK, but won't that just mean that consumers, faced with lower real incomes, will borrow this still cheaper money to facilitate spending, thus making the debt imbalance in the economy worse? Our problem is that our economic growth has been substantially funded by government and consumer borrowing, and whatever the way to correct that, it surely can't be done by making the consumer part of it worse. The relatively modest growth achieved in the last decade was achieved by living beyond our means as a nation. We have to start living within our means, and that is going to mean pain.

Incidentally, I thought businesses invested at times when they thought prospects were going to get better. We already have massive service and retail capacity in the UK (and of course manufacturing is a busted flush); why would any business want to invest now, when it looks as if harder times lie ahead?

Posted by: bears all at January 9, 2006 10:31 AM