Sunday, March 16, 2008
Send for the men in white coats
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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The government's advisers sometimes yearn for the "white coat" effect. The idea is that trust in politicians is so low that you need an expert, a man in a white coat, to convey information to the public.

I thought of the men in white coats when listening to Alistair Darling presenting his budget last week, and not to summon them to take him away. His task was to convince the public that Labour's economic management has left the economy "resilient" and well placed to cope with shocks like the dangerous credit crisis sweeping through the world financial system.

The Tories, on the other hand, were anxious to prove 11 years under this government has left the Treasury without a bean and that the economy is only a downturn away from becoming a banana republic. David Cameron, quoting the CBI out of context, used those words in his budget response.

Adjudicating in this debate is not easy, though given some of the over-the-top attacks on Darling in some of the dailies after the budget Attila the Hun often got a better press I am more than usually inclined to side with the underdog.

But if I side with the chancellor I will be accused of being a Treasury/Labour stooge, while if I take the Cameron line I will be attacked for being a Tory one. Don't worry, I've had both.

Part of the problem is that politicians are politicians, and never admit to any achievements by their opponents. So Darling referred in his speech to Britain's economy "growing continuously for over a decade". Over a decade, as he knows, is more than 15 years, 62 quarters, and started when Cameron was a callow youth advising Norman Lamont. The Tories, similarly, are required by convention to paint the Labour era as a disaster.

So how to settle whether the economy is well-placed or not? Let me turn to a man in a white coat, Andrew Gurney, Treasury official and author of a report, Resilience in the UK and other OECD economies, published alongside the budget.

Although a working paper rather than an official Treasury document, it has been passed around most senior officials for approval. I get the sense that the Treasury is fed up with all the criticism. Whatever happens now, after all, the record on growth, inflation and employment of the past 15 years is the best in living memory.

Gurney examined Britain's performance in two periods, 1982-93 and 1994-2005, in comparison with 13 other advanced-country economies. The conclusion, which followed an earlier OECD verdict that Britain has had the most stable growth and inflation of advanced countries in recent years, was that the UK was also the most resilient to shocks, such as the Asian, Russian and hedge-fund crises of 10 years ago, the bursting of the dotcom bubble, September 11 and so on.

The reason, though the paper does not say so explicitly, is the Thatcher supply-side reforms of the 1980s combined with much better macro management, in particular targeting inflation, from the early 1990s.

Is the man in a white coat right? There is a caveat, known to any- one who has ever seen a unit-trust advertisement, which is that "past performance is not necessarily a good guide to future outcomes".

But the paper does expose the nonsense of the Tory suggestion that somehow Britain is uniquely exposed to the dangers of the credit crisis. Do they really think that Japan, still to recover properly from the bursting of its bubble economy two decades ago, is better placed? Or Italy? Or over-regulated France?

Budgets, in terms of their impact on the economy, are much less important than they used to be. Chancellors can do damage, as Darling discovered with his pre-budget report in October. But the individual measures unveiled last week, which will amount to a fiscal tightening of 1.9 billion in two years' time, and sensibly none now, were inoffensive enough. We can debate whether higher taxes on alcohol and on gas guzzlers will change behaviour but it is hard to argue against them per se.

Where budgets are important is in the message they send out about the economy. Darling has decided that the credit crisis, which the Treasury does not expect to be fully over until mid-2009, will slow the economy but not derail it.

His predictions of 1.75%-2.25% growth this year, 2.25%-2.75% next, are in that context. He could have gone lower for 2008 but to have done so would have taken him below the consensus, which is 1.7% this year, 1.9% next (the lower number in the Treasury's forecast range is always the one it expects).

There is even a view among officials that some of the gloom may have been overdone. While emphasising the downside risks, it says: "With UK private business survey indicators pointing to the economy carrying momentum into 2008, and the possibility that GDP growth in the euro area may exceed current expectations, there are also upside risks to the . . . growth forecast."

What about the dire state of the public finances? Gordon Brown did indeed spend recklessly and leave little for a rainy day, as the Tories have said. I am not in favour of emergency fiscal action but targeted help for first-time home-buyers such as a lifting of the stamp duty threshold, as widely advocated (and proposed by the opposition) would have been timely.

The real problem for the public finances, however, is that Brown's beloved fiscal rules are not fit for purpose. There is nothing magic about a government debt ceiling of 40% of gross domestic product, which is low by international standards. But there is something wrong when the Treasury is obliged to move heaven and earth to keep the figure below 40% (it gets to 39.8% in the latest projections) when everybody knows the true figure is higher.

The bigger problem is with the golden rule, which allows too much borrowing at all times. Crudely, the golden rule means that public borrowing equals public-sector investment. The latter is scheduled to rise to 41 billion by 2012, implying that this becomes the "normal" level of borrowing.

Darling made a start to restoring the public finances when he sneaked in that next year's spending review would aim for tight growth in public spending, 1.9% a year in real terms from 2011. That, if achieved, will mean five years in which spending growth is held at roughly 2%; below the rate of growth of the economy. The Tories would call it sharing the proceeds of growth. I call it good housekeeping. And it is a much more sensible rule.

PS: Ask why Britain had such a long run of low inflation and many will mention the "China effect" cheap imports from the People's Republic. With Chinese inflation running at a 12-year high of 8.7% last month, perhaps we should be worried, particularly with Bank of England figures showing rising public inflation expectations.

But research to be presented to the Royal Economic Society's annual conference at Warwick University this week gives a different picture. It has been carried out by a Bank of England economist, Tracy Wheeler.

Looking at the China effect over the period 1997-2005 she calculates that switching to low-cost China has indeed reduced the price of goods in clothing, shoes, IT equipment and hi-fi. But this is balanced by another effect, which is that once the switch has been made, inflation in Chinese prices is higher (or the fall in prices lower) than in the country from which supply was switched. The net effect, says Wheeler, is that "imports from China put upward pressure on inflation in consumer goods over the 1997 to 2005 period". There was no downward China effect overall. Interesting and counter-intuitive.

As for the future, some businesses say China's inflation, though concentrated in food, could make them switch production elsewhere in which case we'll hear less about the China effect anyway.

From The Sunday Times. March 16 2008