Sunday, March 18, 2007
Brown slams on the brakes at the 11th hour
Posted by David Smith at 11:00 AM
Category: David Smith's other articles


On my desk is a yellowing cutting from 1992, just ahead of the election that year. It is about the “captains of industry” survey conducted by Mori (now Ipsos-Mori), the polling firm.

These captains, at the helm of Britain’s biggest firms, were asked how they ranked leading Conservative and Labour politicians. John Major, then the prime minister, was preferred to Neil Kinnock, the Labour leader, by an embarrassing 93% to 1%.

Gordon Brown, then shadow trade and industry secretary, lost out to Peter Lilley by 45% to 33%, while Tony Blair — then still a couple of years away from greatness — was not business’s choice for employment secretary. Michael Howard was preferred by 69% to 13%.

Among top Tories, only my old sparring partner Norman Lamont, chancellor, lost out. His shadow, the late John Smith, was preferred, by 46% to 39% — his prawn cocktail offensive on City dining rooms appeared to have worked.

That aside, at the time business’s suspicions of Labour chimed with the views of voters in general. The Tories, despite it all, were regarded as a safe pair of hands on the economy.

All that was to change. A few months later Britain’s Black Wednesday expulsion from the ERM (exchange-rate mechanism), followed by big tax rises, shifted public opinion against the Tories. Owner-managers of small businesses also turned against the party. Big business was slower to lose the faith, but by 1997 it was on board for the new Labour project — the “captains” survey showed a significant majority believing that the new government had the right policies for improving the economy.

But, as the chancellor’s reputation has waned among voters, so it has plunged among business leaders. Ipsos-Mori’s latest “captains” survey, published recently, shows that only 15% think the government’s policies will improve the economy, with a huge 63% saying they will not.

The public is not quite as dismissive. Our own YouGov polls show that the Conservatives, after long being behind Labour, have just opened up a lead in terms of economic competence. That is a far cry from the big leads Labour enjoyed even relatively recently.

You might think that the economic stability I wrote about a couple of weeks ago might count for more in Britain’s boardrooms. Britain has grown faster than Europe and matched America more or less stride for stride since 2001 (the IMF thinks UK growth will exceed America’s this year, hence Brown’s upbeat tone).

Against that you have to set the complexity and uncompetitiveness of the business tax regime, described here last week; the explosion in red tape, particularly employment legislation; and memories of acts of treachery like the 2002 hike in employers’ National Insurance contributions.

Underlying all this, however, is what seems to me to be the most straightforward explanation. The figures show that business disenchantment with Brown began at just about the moment when he began his big relaxation of public spending at the turn of the new millennium. People in business recognise waste on an epic scale when they see it (they are not immune to it themselves) and reacted accordingly.

That is why this week will be interesting. Brown’s eleventh and final budget, we are told, will be built round the forthcoming comprehensive spending review. It has been known for some time that the spending review will mark an abrupt change of gear, but Wednesday’s budget will set that in stone by publishing the “envelope” — the amount total spending will rise.

That envelope had been expected to be 2% real growth in spending (1.9% for current spending, rather higher for public investment), compared with an average of 4.8% in the six years to 2005-6. Now, as I reported last week, the envelope is likely to be even tighter than that; somewhat below 2%.

In real terms, spending from next year will rise at a third of its rate of recent years. After the splurge of the past few years, the public sector will be on iron rations. There will be scepticism about whether this can be achieved, it being heavily reliant on cost and efficiency savings throughout government. Peter Spencer, economic adviser to the Ernst & Young Item club, points out that turning round the public-sector juggernaut is easier said than done. But that is the aim.

I should say at this point there will be plenty of other things in the budget. It will have a green tinge, clamp down again on tax avoidance and announce a range of measures that will make headlines but soon be forgotten.

Last year’s headline-makers from Brown included promises of extra spending on education, extra road tax on “gas guzzling” 4x4s and a cut in Vat on condoms (for which The Sun christened him “the love Gord”). Some of that will be repeated this year — Brown will make room for his extra education spending by selling the student loan book to the private sector.

What we will not get, unless something remarkable has changed, is tax cuts, though Brown hinted on Friday that business might have something to be pleased about. A new assessment by the Item club points out that Britain is still on course for a record nonNorth Sea tax burden of 37% of gross domestic product.

The Item club calculates that the burden of tax and National Insurance contributions on households rose from 33.6% in 1997-8 to 38.3% in 2005-6. It is still rising and the usual suspects are to blame.

As Spencer says: “Disincentive effects are most clear in middle-income brackets, where fiscal drag and stealth taxation have been working with a vengeance.”

So, as the chancellor puts the finishing touches on his eleventh and final budget, we face the prospect of a juddering slowdown in public spending as he slams on the brakes. Meanwhile, there is little relief in sight from the high tax burden. Business is unlikely to be won over by that. I doubt whether many voters will be either.

PS: You can’t keep housing out of the news, be it American sub-prime lending’s impact on global markets, or whether British prices are being slowed by higher interest rates. We had Martin Weale, director of the National Institute of Economic and Social Research, apparently suggesting in the Daily Mail that rates need to hit 8% to cool things.

Weale is an unlikely generator of a Mail splash. Sure enough, he was speaking hypothetically — where might rates be if controlling housing was the sole aim. His view is that it is touch and go whether rates need to rise again to meet the Bank of England’s inflation target and that the housing market requires a combination of supply-side (more houses) and tax measures.

Evan Davis’s excellent Radio 4 housing series also raised issues. It said there have been 16 annual price falls since 1945. But that is only for real (inflation-adjusted) house prices. Nominal (actual) prices fall rarely, the two big 20th century episodes being the 1930s and early 1990s. They do so in conditions of economy-wide recession. Prices are, as economists would say, “sticky downwards” — people don’t cut prices unless they have to.

The programme also asked whether rising house prices benefit owners. Or do they only gain when trading down, perhaps that final move into the old people’s home?

There are three things wrong with the question. On that basis there would be no wealth until it is turned into hard cash. We don’t apply that to other assets, so why houses? And housing wealth is real when people draw on it, as they have increasingly been doing. Finally, those with housing wealth are plainly better off than those without it. If negative equity is real, so is positive equity.

From The Sunday Times, March 18 2007


Hmm - David I'm not sure about the positive and negative equity comments. Both are pretty much hypothetical until you turn said assets into cash. The problem with negative equity is that it destroys liquidity. But if you can make the payments and have no pressing reason to sell then so what? Likewise my father's house is probably in the seven figure bracket these days. But again - so what? He doesn't want to sell it because that might mean giving up his chickens and his vegetable garden.
And with other supposedly assets - shares for instance - correct me if I'm wrong but they're not necessarily purely liquid (in as much as they can be instantaneously exchanged for cash at the prevailing market rate) - for instance if an institution owns a large chunk of company y it may not be able to put all its shares on the market without pushing that market downwards and I guess one could argue that currency speculators (such as Soros etc in 92) had the same effect with cash.
At some point a home is just a home - rather than an asset.

Posted by: jonathan at March 18, 2007 03:40 PM

Your argument that nominal house prices only fall when there is high unemployment was more believable last year before we had the example of house prices in the US declining over the past year at the same time that unemployment there is near record low levels (along with stable or slightly declining long term interest rates).

On the main point of the article, though, I'm wondering just how growth is going to be maintained in the UK if growth in government spending (about 1/3 of the economy) is cut in half. Do most economist believe that growth in the UK is going to decline significantly, or is another sector forecasted to take up the slack from growth in public spending?

Posted by: RichB at March 18, 2007 05:27 PM

In my view, once you stop regarding assets as wealth, you are questioning the whole basis of the economic system. Cash may be king but there is a lot more to wealth than liquid assets.

The US situation is interesting. But so far, at least, it is still following the script. Nominal house prices rose by 1% last year and have never fallen on a calendar year basis in the modern era. Existing house prices are currently down modestly on a year ago (3%), which is a long way from a crash. It remains to be seen whether that will continue or whether they will recover later in the year to continue that calendar year record.

Can the UK economy grow as fast if public spending slows? It is going to be an interesting challenge. The great rebalancing requires slower growth in government spending and household consumption to be offset by stronger exports and investment. Investment is in fact picking up quite strongly but the jury's out on exports.

Posted by: David Smith at March 18, 2007 06:47 PM

Actually David I am questioning the whole basis of the economic system, and questioning our fundamental assumptions is a worthwhile task. Otherwise, dare I say, we'd still all believe that the Earth was made in six days (or that the world economy had entered a 'new paradigm' with the dot com boom of the late 90s. Questioning can lead to reaffirmation as well as rejection - whereas taking the fundamentals for granted is dangerous.
You know a weekend at the odd rock festival or three weeks back packing in India or even a month in Tuscany if you're feeling past that sort of thing can all put a healthy space between oneself and the things one takes for granted.

Posted by: jonathan at March 19, 2007 01:27 AM

Being Devil's advocate, this definition of wealth can then be extrapolated.

If "wealth" includes all things that you have that are of value, then how about totting up the total value of your body parts and counting that as wealth ?

All you have to do is sell them when you want the cash.. !

I don't agree with your view, but I can see why some people would.

In my opinion, if you live in a nice house, you will feel "wealthy" because you live in a nice house, regardless of it's cash value. After all, if you want to swap it with another nice house, you will find that it's absolute cash value is irrelevant, it is it's relative cash value that counts.

If you want to swap your nice house for something other than property, then yes I guess you will be "wealthy", but what proportion of the population does that cover ?


Posted by: Nick Thorne at March 19, 2007 09:46 AM

It is right to question assumptions but I think you're in danger of going too far down the hippy trail. The boom was an over-reaction but the evidence is that we did enter a new paradigm and are still in it, in terms of technology-driven productivity growth and the way that the internet is transforming our lives.

I hope my body parts are as good as the Duke of Westminster's but on any reasonable measure he is wealthier than I am. If money matters, as it has done since man started to trade in cowrie shells, then so does wealth, which is stored-up money. Three weeks in India exposes you to a country determined to achieve rapid economic growth and, yes, a big increase in wealth.

Posted by: David Smith at March 19, 2007 09:58 AM

Anyone with more property than they need will indeed feel wealthy.A more normal case of having just enough property, is very different.
The Duke can sell a few acres of Park Lane, and still have half of Mayfair. i.e. it won't affect his lifestyle.

A retired teacher on a £20K pa pension living in a £450K 4 bed house in Surrey cannot liquidate his "wealth" because that would require a move to a £250K 2 bed flat in e.g. Southampton.
His £200K is being used to keep the lifestyle he expects.
I guess he could use equity withdrawal, but then he would be sacrificing e.g. ability to move later on.

On a similar subject, I have noticed a new form of "negative equity" emerging.
Here is an example: A BTL landlord buys a house in 2001 for £150K. In 2005 it has risen to £230K. He remortgages it, extracting £80K and lives off the money. Two years (2007) down the line he cannot sell the house because he cannot pay back the CGT he will owe. I have seen it happen.

Posted by: Nick Thorne at March 19, 2007 05:26 PM
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