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