The polls were right and France rejected the EU constitution 55%-45%. That should mean, after all the niceties, that the constitution, and the prospect of a UK referendum, are dead. Blair will prevaricate for a while, not least because he still sees winning a European vote in Britain as his coup de grace.

He should, however, try a different tack. European voters are turning against integration because of economic failure. The Lisbon agenda for economic reform in Europe has been a damp squib. The referendum verdict in France should be a wake-up call to Europe's political elite that, rather than wasting their time on working-time directives or EU presidents, they need to get on with the urgent task of boosting Europe's competitiveness. Like Nero, they're fiddling while Rome burns.

(0)

By Wednesday we could have a triple no in Europe, or rather nein, non and nee. Last Sunday voters in North Rhine-Westphalia said no to Chancellor Gerhard Schröder. Today they seem likely to say no to the European Union constitution in France, and again on Wednesday, in another constitution vote in the Netherlands.

We cannot take all these votes for granted. The polls point clearly to referendum rejections of the constitution in today’s French vote and — even more emphatically — in the June 1 Dutch poll, but these things do not always follow the script.

There is, however, a common theme to all three elections — disappointment with slow growth and high unemployment. In Germany a decade of weak economic growth — partly blamed on the legacy of the unification of east and west Germany in 1990 — has sapped confidence and led to widespread angst. A weak opposition and deft politics allowed Schröder to hold on to office three years ago, but now his days are numbered.

In France the constitution looks set to be rejected for straightforward economic reasons, most notably high unemployment. But built on that is a fear that the old economic order is changing and that France’s place in it is under threat from the new entrants into the EU, and from prospective new entrants such as Turkey.

Similar fears abound in the Netherlands. Until recently the Dutch experience was atypical, an example of a successful adaptation of the European social model into a high-growth, low-unemployment economy. But the last three to four years have been pretty grim. Growth has been weak and unemployment has virtually doubled, admittedly from a rate of less than 3% of the workforce. The Netherlands has picked up the malaise that has long been affecting its larger neighbours.

What’s ailing the old core economies of Europe, and to what extent is the euro to blame? It is striking that the European economies doing worst at present are the original six members of the European Economic Community; Italy is in an even poorer state than France or Germany. These countries should have been better placed to adjust to the regime of the single currency than other, newer members.

There is no simple explanation for the malaise. Some would put it down to the European Central Bank (ECB). Since taking charge of European monetary policy on January 1, 1999 it has been too cautious and inflexible, worrying too much about inflation and not enough about growth.

My story would be slightly more complicated. Since 1992, when France narrowly approved the Maastricht treaty in a referendum and the European exchange-rate mechanism almost collapsed, the priority for the EU establishment became achieving the single currency.

That meant reining back budget deficits and, for high-inflation countries, taking tough action to converge with Europe’s low-inflation economies. It also meant, crucially, giving a low priority to making the EU economy more flexible and adaptable, notably by making labour markets work better and cutting red tape and regulations.

That reform, however, was vital. Lord Layard of the London School of Economics has demonstrated clearly the difference in the unemployment record since the early 1990s between those countries that did reform their labour markets and those, such as France, Germany and Italy, that did not.

By the time the euro came into being in 1999, Europe had suffered a big economic disadvantage. America’s productivity revival of the 1990s, built on information technology, passed Europe by. Since then, and following the switch to euro notes and coins in 2002, that disadvantage has been compounded. Euroland’s sustainable economic growth rate is now 1%-1.5%, half the rate in America and Britain and a fraction of China’s 9%-a-year expansion.

Euroland and its politicians are caught in a catch-22. Sustainable improvements in economic and job-market performance require far-reaching reforms. But voters will reject those reforms as long as economic performance is disappointing.

Thus Schröder’s political woes are a rejection of his so-called Agenda 2010 reforms. France’s likely “no” vote comes in spite of President Jacques Chirac’s successful kicking into touch of the EU services directive, which was seen as a threat to jobs.

Does this mean we can write off economic reform in Europe? Julian Callow, European economist at Barclays Capital, rightly points to the experience of Germany, where the corporate sector is introducing its own flexibilities, using the threat of transferring jobs to eastern Europe. But reform also requires political momentum. Schröder has lost it and Angela Merkel’s Christian Democrats are unlikely to provide it. I knew Margaret Thatcher, vaguely, and Merkel is no Thatcher.

The other possibility is that instead of EU-wide reforms such as the services directive, the emphasis will switch to national efforts. The EU’s Lisbon agenda has been a failure so far. Perhaps, when looking down the barrel of a gun, countries will see the need for reform or face prolonged economic stagnation. That is what happened in Britain a quarter of a century ago. There is not much sign of it yet in core Europe.

What about the euro, one of the sources of the malaise? It will struggle, except in the unlikely event of a yes vote in France or the Netherlands. Will it break up? A few years ago I wrote a book called Eurofutures, in which I said that an unsuccessful single currency would not last beyond the generation of politicians committed to EU integration and monetary union.

The euro will still be around, in its present form, in a year’s time. In 10 years, barring an improvement in Europe’s economic fortunes, I’m not so sure.

PS: Is Gordon Brown turning the Treasury into the ministry of silly ideas? The chancellor’s mortgage wheeze has drawn a cool response, with good reason. His scheme for joint equity loans, in which eligible borrowers will raise 75% of the value of a property and the remaining 25% of the equity is split between the government and mortgage lenders, will help between 20,000 and 30,000 first-time buyers over the next five years.

The government seems determined to “do something” about the shortage of housing, whether it makes economic sense or not. Desperate measures don’t usually work.

From The Sunday Times, May 29 2005

(1)

What has been the most remarkable thing about Britain’s economy over the past decade or so? There are several candidates, but high on the list, undoubtedly, has been the performance of the labour market.

Employment has risen and unemployment fallen, year in, year out. The claimant count stands at 839,000, 2.7% of the workforce, equivalent to “full” employment on the traditional definition used by economists. Employment, measured by the Labour Force Survey, has risen by 3.3m to 28.6m from its low point, which was as long ago as 1993.

It has, then, been an astonishing success story, attributable to the combination of better macroeconomic policies from the early 1990s on, in combination with the labour market flexibilities won during the 1980s.

The job market also tells us a lot about why Britain’s economy has managed to keep going through 51 quarters of continuous growth while competitor countries have faltered. Rising employment has maintained consumer confidence through thick and thin, giving people the ability and the comfort to borrow and spend.

It has also, I would concede, been a big factor in supporting the housing market. My “no crash” view on house prices relies in part on the argument that the economy avoids recession and a sharp rise in unemployment. The crash of the late 1980s and early 1990s only really got into its stride once unemployment, which had been falling, began to rise with a vengeance. A big rise now would not necessarily mean all bets were off concerning house prices, but I would certainly think about wanting to hedge them.

I know, by the way, that there are certain caveats to be applied to the figures on jobs. There are, for example, 7.9m “economically inactive” people of working age, nearly 2m of whom say they want a job. The numbers of economically inactive have, however, been between 6m and 8m for decades and the latter figure, those who say they want work, has dropped by about 400,000 over the past five years.

I know also that there are many more public-sector workers than there used to be. John Sunderland, president of the CBI, told its annual dinner last week that one reason The Guardian could never go tabloid was because even as a broadsheet it had grown too fat on public-sector job advertisements. He upbraided Gordon Brown for the 900,000 increase in state jobs since 1997.

That may overstate it. Official figures show, in fact, 583,000 additional public-sector jobs between 1998 and March 2004, after an 815,000 fall between 1991 and 1998. Taking the two periods together, and allowing for some growth in public-sector employment since March 2004, the net effect is that the 3m jobs created since the early 1990s are overwhelmingly in the private sector.

Is that now coming to an end? Has the “business goose”, to use Sunderland’s phrase, been plucked and squeezed so much that it is incapable of creating any more jobs? The Chartered Institute of Personnel & Development, in its latest quarterly labour market outlook, based on a survey of 1,300 employers, finds that while 49% expect to increase employment over the next quarter, a net 23% think they will be employing fewer people in a year’s time.

Add to that the latest official figures which showed that the claimant count, while low, rose by 8,100 last month, its second successive rise. Bring in, too, the fact that manufacturing jobs have slid to a record low of just 3.2m, that retailers are warning of their most difficult year for at least a decade, and that public-sector jobs growth is starting to be reined back by a chancellor determined to meet his fiscal rules, and it would be easy to get gloomy.

A sustained rise in unemployment, particularly after such a prolonged fall, would hit hard. As Richard Layard, Stephen Nickell and Richard Jackman point out in a new edition of their book Unemployment (Oxford University Press), the effects go beyond the economic. Becoming unemployed is one of the worst experiences a person can have — “similar to divorce or bereavement”, they point out, citing new research.

So how worried should we be? The two-month rise in the claimant count should not trouble us greatly. Such short-term increases have happened before during the long unemployment fall. The wider jobless measure, based on the Labour Force Survey, showed a 15,000 drop over the latest three months.

Not only that but employment showed a pretty healthy 87,000 increase in the three months to March. That was split between a 146,000 increase in full-time jobs and a 59,000 drop in the number of part-timers. Rising full-time employment is normally a sign of strength in the job market.

Where are the jobs coming from? Apart from the continued, if soon to be slower, rise in public-sector employment, the latest 12 months saw a rise of nearly 80,000 in construction jobs, 30,000 in financial and business services and a similar amount in distribution, including retailing. Retailers may be downbeat but they plan to increase their floorspace in the coming years. Those new shops have to be staffed.

We should not forget, either, that there is a built-in self-regulating mechanism in Britain’s job market. The economic migrants who have been attracted here by job vacancies will no longer come if the jobs dry up. The size of the workforce is more variable than it used to be.

This is a downbeat time. Miserable spring weather and a depressing general election campaign mean the feelgood factor is lacking among employers and employees. But things are not that bad. An optimist would say the labour market has cooled enough to head off the need for higher interest rates but not sufficiently to produce a significant rise in unemployment.
There is plenty of gloom around. But now is not the time to get overly gloomy about jobs.

PS: There appears to be a small unit in the Bank of England working on footballing analogies for Mervyn King, the governor, to put in his speeches. I have a similar unit working on Star Wars’ analogies but the best they have come up with so far is Revenge of the Smith.

There is, however, a limit to how long the MPC can keep going in a straight line before people get wise to its tricks. The longest period of unchanged rates in the period since independence in 1997 was the 15 months from November 2001 to February 2003. The last time the MPC adjusted rates was in August last year, so matching the record would take us up until November. The way things are going, we should have a cut in rates about then.

From The Sunday Times, May 22 2005

(0)

The big story of the week was the Bank of England’s change of tone on interest rates. Its latest inflation report does not signal an imminent cut in rates, as some suggested, but it does mean that a hike has now all but disappeared from the agenda.

More on that in a moment. This week’s minutes from the May meeting of the monetary policy committee (MPC) will be fascinating. Two members have been voting for higher rates: Paul Tucker and Sir Andrew Large. Any sign that they have changed their minds, or are in the process of doing so, would reinforce the Bank’s new dovishness.

The Bank’s inflation report is important because, as noted last week, it holds the key lever of economic power, interest rates. But its publication is also an occasion, one of the few in Britain, when policymakers put themselves up for detailed questioning by economics journalists. Mervyn King, the governor, has been presenting the report each quarter since it came into being, under his direction, in 1993. He doesn’t usually put a foot wrong.

In contrast, and this might surprise you, neither the chancellor nor his senior officials submit themselves to such detailed questioning by specialist journalists after big Treasury events such as the budget or pre-budget report. The nearest the Treasury gets to it is an impromptu official briefing for lobby journalists in the Commons press gallery as soon as the chancellor sits down after making an important statement.

It hasn’t always been this way. I remember when Sir Peter Middleton and Lord Burns told a small group of us one Friday afternoon in October 1990 — after the markets had safely closed — that Britain would be entering the European exchange-rate mechanism the following Monday.

Gordon Brown summoned everybody to the Treasury a few days after the 1997 election to break the news of Bank independence from Treasury control. At first the penny didn’t drop. The first question, from a television journalist, was: “You’ll be sitting on this new monetary policy committee, and presumably your deputy will, too. But who else will be on it?”

So the Bank’s openness, for an organisation that used to be as closed as the freemasons, is very welcome. What did we learn from the Bank last week?

The first thing is that, after poring over the data and reports from its agents round the country, it cannot quite work out whether the recent weakness of consumer spending is temporary — following the example of America, which produced an unexpectedly strong bounceback in retail sales last week — or likely to be long-lasting.

Despite near suicidal reports from retailers, and the depression of much of the consumer sector, this is not yet armageddon. Consumer confidence has not collapsed. All that has happened is that people aren’t spending so much. There could be an innocent explanation for this — the weather, the timing of Easter, even the general election — or it could be rather more sinister.

The Bank’s inclination is that spending will pick up, though at a slower rate of growth than it previously expected. But it admits to doubts. “It is also possible that the deceleration in house prices and the cumulative impact on highly indebted households of past increases in interest rates may be associated with a more prolonged slowdown,” the inflation report said.

It has no such doubts about the outlook for government spending. After an election campaign that included a bizarre kind of beauty contest, based on whose pledges were the biggest, the Bank thinks public spending will continue to “grow strongly” in the coming years.

What is the effect of that? “The public sector can contribute to inflation by using resources that would otherwise be employed in satisfying private-sector demand,” it says. “Given the government’s nominal spending plans, its demand for resources is likely to grow quite quickly during the next few years.” It is a coded message but what it means is that the chancellor’s largesse will lead to higher inflation and interest rates than would otherwise be the case.

It could also, if the gloomier alternative for consumer spending turns out to be true, mean that public spending will be just about the only thing growing strongly.

The best the Bank can say about exports is that, after nine years in which their growth has been easily outstripped by imports (in the jargon, net exports are negative), their contribution may be slightly less negative in the future. That’s a long way from the export-led growth that chancellors dream of.

Nor is there much investment-led growth. Business investment is picking up, but at a slower rate than in previous recoveries. There may be a statistical explanation for that but it chimes with anecdotal evidence, which is that firms remain reluctant to spend heavily.

Where does that leave the economy and interest rates? One of the features of the Bank’s running of monetary policy in the past eight years is that consumers have been grateful recipients of interest-rate cuts. Often those cuts have been due to events outside Britain, such as the September 11 terror attacks or the uncertain global economy at the time of the invasion of Iraq. But the aim has been explicit, to keep consumer spending going in order to compensate for weakness elsewhere.

What happens, though, if the weakness comes from consumers themselves? If spending continues to be depressed over the summer months, past experience would suggest that a modest cut in interest rates in the autumn would be enough to perk up shoppers in plenty of time for Christmas.

But what if something more fundamental has changed and that, in response to a flat housing market, high levels of personal debt and worries about higher taxes, jobs and pensions, the reluctance to spend goes deep? It could be that in these circumstances big cuts in rates would be needed to shake consumers out of their torpor. Even then, as discussed here two weeks ago, we could be in for a prolonged period of subdued spending. The housing market is not, I think, going to spring quickly back to life.

Interest rates, then, are at a crossroads and the most likely route ahead will be flat for quite some time, followed by a drop downhill. Consumers hold the key to when that dip comes, and how steep it is.

PS: Sipping my Horlicks the other evening after a day spent mulching the roses, I began to wonder whether I am getting old. When shop assistants call you Sir without apparent irony you get worried. It can only be a matter of time before a heavily pregnant young woman offers me a seat on the Tube.

Most of all I was struck by the tumultuous (if not spontaneous) welcome the chancellor got on returning triumphantly to the Treasury after the election. The gathered ranks of applauding young officials, dressed in polo shirts and chinos, looked like a university golf society outing. Some of the Treasury’s crustier former mandarins, who never entered the building without a suit, starched collar and tie, will have been turning in their graves.

From The Sunday Times, May 15 2005

(3)

Imagine, for a second, that the new Labour project had never happened. Rewind 13 years. Neil Kinnock, rather than stepping down immediately after the party’s narrow 1992 election defeat decides to stay on.

He is the political beneficiary of the Tories’ economic woes in the run-up to the 1997 election; the humiliating “Black Wednesday” collapse of sterling’s membership of the exchange-rate mechanism of the European Monetary System, the tax hikes that John Major said would never happen and, of course, deep Tory divisions over Europe. He, rather than Tony Blair, still plugging away at Michael Howard as shadow home secretary, leads Labour back into government after 18 years in the wilderness.

How, a few years on, would you have expected Britain to be voting? Labour, one would be fairly sure, would have huge leads over the Tories in its heartlands of Scotland, Wales, the northeast, the northwest and Yorkshire. The two main parties would be pretty close in the Midlands and London.

But Labour would be well behind in the southeast, the southwest and East Anglia, areas represented on the political map by a swathe of blue. Party loyalties established for decades under “old” Labour would have continued.

Look a little closer at how Britain voted 10 days ago and that, pretty much, is how things turned out in the 2005 general election. Looking at where Labour got its support, it is indeed almost as though Blair and the new Labour project never happened.

“I’ve never been entirely convinced by the idea of new Labour as a political earthquake,” said Professor David Sanders, of Essex University, one of the authors of the forthcoming British Election Study. “What was different in 1997 and 2001 was the destination of the middle-class vote.”

A comparison of Blair’s performance on May 5 and Kinnock’s in the April 1992 defeat is instructive. Blair, with just over 9.5m votes, got 2m fewer than Kinnock’s 11.6m, admittedly in a higher turnout election (78% versus 61% this time). Labour’s 1992 share of the vote was just over 35%, excluding Northern Ireland, compared with just over 36% this time.

Damningly, Blair did worse in the southeast (with just 24% of the vote) than Kinnock, who secured 27% of the southeast vote. Blair in 2005 and Kinnock in 1992 got similar vote shares in London (39% versus 37%) and East Anglia (30% versus 28%). Blair did somewhat better than Kinnock in the southwest, although Labour remains the third party, and in the east Midlands and West Midlands — where Margaret Thatcher had successfully brought skilled manual workers into the Tory fold.

Blair retained small leads in both regions. Kinnock failed to overhaul the Tories in either region, which was why he remained a political bridesmaid.

If regional voting patterns have not changed that much, it is also the case that party support remains firmly class-based. Although the lines between white-collar and manual workers are much more blurred than in the past with the rise of the service-sector economy, YouGov’s campaign polling pointed to a consistent Tory lead among so-called ABC1s but a big Labour lead among C2DEs.

Mori’s analysis breaks this down further. It suggests the Tories had a 37%-28% election-day lead among ABs, professionals and managers, and a 36%-32% lead among C1s, traditionally lower-grade white- collar workers. So much for Blair’s takeover of the middle-classes.

Blair’s continued success, compared with his predecessors, has been maintaining a significant lead (40% to 33%) among skilled manual workers, the C2s. These were traditional Labour supporters under, say, Harold Wilson but left the party in 1979. Labour’s lead remains massive, 48% to 25%, in the DE social groups; the unskilled and the unemployed.

If Labour’s vote has come almost full circle, and surprisingly Blair did better on May 5 than his left-wing predecessor in heartland areas such as the northeast and Scotland, a more detailed reading of the election results also underlines the mountain the Tories still have to climb.

The last three elections have seen the Tories with lower vote shares than in any previous elections, won or lost, since 1945. The party’s Great Britain vote share of just over 33% achieved this time was 10 points lower and 5.3m votes fewer (8.8m against 14.1m) than John Major received in 1992.

The Tories need comfortably more than 40% to form a government. They achieved that this time in the southeast (45%) and East Anglia (43%) but nowhere else. Even in the southwest, the Tories only managed 39%.

Major in 1992 got 45% of the vote in the West Midlands and 47% in the east Midlands. Howard in 2005 was exactly 10 percentage points down on these levels, at 35% and 37% respectively. Unless the Tories can win in the Midlands, they are doomed.

The party can comfort itself with the view that the UK Independence party may have prevented it from winning between 20 and 25 seats — in many marginal seats a straight switch of the UKIP vote would have produced a Tory victory. UKIP disputes this, saying its support comes from all parties.

Worryingly for the Tories the party did poorly among young women. Mori’s analysis suggests that Labour had a 43% to 22% lead among women aged 18-24, 44% to 20% against those aged 25-34 and 40% to 27% in the 35-54 age group. The gaps were smaller among men but this voting pattern reinforces the impression that the Tories are predominantly a male party appealing to older voters Was there a glimmer of hope for the Tories on polling day? Professor Colin Rallings of the Elections Centre at Plymouth University, points out that in May 5’s forgotten elections, for English county councils, the Tories gained 150 seats and Labour lost a similar number.

The Tories are now comfortably the largest party at local level, with nearly 8,200 councillors compared with 6,500 for Labour and 4,700 for the Liberal Democrats. Converting that to national support, however, is easier said than done.

From The Sunday Times, May 15 2005

(1)

It barely seems like any time at all since we were all abuzz with the question of Britain’s entry into the euro. The issue, often said to be at the heart of the long-running dispute between Tony Blair and Gordon Brown (although personal rivalry explains it better), was expected to dominate Labour’s second term in office.

As it was, that term was dominated by Iraq and the drive to improve public service delivery. That did not mean, however, that nothing happened on the euro. Before the 2001 general election the prime minister committed Labour to publishing a full assessment of whether Britain was ready to join the single currency; an assessment of whether the famous five economic tests were met.

Those tests, to remind you, were, first, are business cycles and economic structures compatible between Britain and Europe to permit the UK to exist comfortably in the euro; second, is there sufficient flexibility to deal with problems?; third, would joining improve the environment for long-run investment decisions in Britain; fourth, what would be the effect on financial services; finally, would entry be good for growth, stability and jobs?

That assessment, together with 18 accompanying studies, was published in June 2003. But the Treasury did not close the door completely. It conceded that progress had been made towards convergence with Europe. It announced a change to the Bank of England’s inflation target to the new, euro-compatible consumer prices index – a similar measure to that used by the European Central Bank (ECB). It also adopted the same target, 2 per cent, as the ECB.

Blair did not give up without a fight. He insisted that his entire cabinet was involved in the decision, and that all ministers were able to study the 18 technical studies in advance (whether they understood them was another matter). He made sure that the announcement was a full and separate parliamentary occasion, while Brown had wanted to get it out of the way in his budget. He also insisted that the Treasury review progress towards convergence with “euroland” and therefore entry into the single currency, each year.

So why has it all gone quiet? It used to be said that Blair’s ambition before he left Downing Street was to get Britain into the euro. It still is, but another European priority has jumped the queue. This is the referendum vote on the proposed EU constitution, due to take place next year. This presumes, I should say, Labour’s return to office in the general election.

While euro entry would involve deepening the degree of integration between Britain and Europe, a failure to approve the constitution could threaten Britain’s whole future in Europe. That may overstate it, but it would certainly represent a crisis in UK-EU relations.

How will the constitution referendum go? Until recently, the general view was that voters would overwhelmingly reject it, scared by talk of a giant step towards a federal Europe. However, recent polls conducted on the basis of the actual question that will be asked in the referendum have suggested a pretty evenly split vote. The question is: “Should the United Kingdom approve the treaty establishing a constitution for the European Union?” It sounds less than alarming, much to the disgust of the anti-constitution campaigners, A bigger fear than federalism may be the worry that Britain will be left behind, which the government will play on.

Would not a “yes” vote on the constitution enable an emboldened Blair to go for “one more heave” into the euro? After all, the Treasury probably cannot keep saying no to entry for ever. Privately, officials concede that the next assessment, if there is one, will have to come up with a positive verdict.

It could happen, so that by the end of the parliament Britain would have both signed up to the constitution and be happily ensconced in the single currency, the European Central Bank (ECB) taking our interest rate decisions.

But that seems unlikely, for several reasons. The first is that to secure a yes vote in the constitution referendum, the government will have to provide certain reassurances. One of those, most probably, will be that backing the constitution will not mean a rush into the single currency. Any suspicion among voters that this is the case could easily swing it towards a no vote.

Secondly, hostility to the euro goes deeper than to the constitution. There was a time when many British people thought the only argument about the euro concerned issues such as whether the Queen’s head would be on the notes, versus the convenience of not having to change currency at each European border crossing.

Things have moved on. There is now an implicit understanding amongst a large swathe of voters that adopting the euro means more than changing the currency you carry in your wallet. People are aware of the fact that Euroland appears stuck with slow growth and high unemployment. This many not be the fault of the euro and the ECB, but it is a reality, Voters may also be dimly aware that the euro’s fiscal rules, embodied in the stability and growth pact, have been flouted by Germany and France, and may never achieve credibility again.

All this is important. To argue the case for the euro, the government has to believe it. As far as the chancellor (who was once a believer) is concerned, that requires two things. One is a belief that the ECB and stability pact would be at least as good as his own fiscal rules and the independent Bank of England. He is a long way from believing that.

The second is that Europe is serious about increasing its flexibility, particularly in labour markets. A recent report by a high level group of experts under the chairmanship of Wim Kok, the former Dutch prime minister, concluded that this is far from the case, and that the EU is proceeding at a snail’s pace in this area. And as long as that is the case, the euro is off the UK agenda.

From Professional Investor, May 2005

(0)

General elections are a useful reminder that life is rarely as straightforward as models suggest. The final GB vote shares of the parties - 36% for Labour, 33% for the Conservatives and 23% for the Liberal Democrats - should have translated into a Labour majority of between 90 and 100.

But the swing was not even across the country. Labour held onto seats it would have expected to lose but lost others that on the basis of a 3% uniform swing it would have expected to hang onto. We wait to see what impact a reduced majority will have on economic policy.

Does it mean tax hikes are more or less likely? Will Labour be able to resist backbench pressure for even higher public spending? What will that mean for interest rates? Watch this space.

(0)

As I was watching the results come in on Thursday night, a thought struck me. If elections are usually won on the economy, and it is my firm belief that they are, does it require the Bank of England to mess things up for Labour to lose?

Before people write in, I am aware there are instances when the economic theory of elections does not hold. Kenneth Clarke delivered an economy in 1997 that was growing rapidly, with taxes coming down and interest rates low. But voters were keen to punish the Tories for earlier misdemeanours.

In 1970, Roy Jenkins thought as chancellor he had delivered the economic goods for Labour. That time it may have been the humiliating sterling devaluation of 1967 that did for the ruling party.

What struck me during the run-up to Thursday’s election, however, was how important Bank independence was for Labour. Despite its battering on most issues, Labour won, albeit with a reduced majority. But even those who attacked the government’s record in general, and Gordon Brown’s in particular, had to concede that handing over monetary policy to the central bank was a masterstroke. Labour is now firmly associated with economic stability, and as long as the Bank delivers that stability the party will be hard to beat.

The Bank, after all, is responsible for the most powerful weapon of short-term economic control, interest rates. Its alacrity in cutting rates in response to various crises, from Asia, Russia and hedge funds in 1998, to September 11 and Iraq war jitters, has been crucial.

Without it the economy would have sputtered to a halt long before racking up a record run of growth (51 quarters and counting). The Old Lady of Threadneedle Street is not given to boasting but could emblazon the cover of this week’s inflation report with the immortal words: “It was the Bank wot won it.”

Mervyn King, as governor, warned homebuyers last June that house prices could go down as well as up and that, as much as the monetary policy committee’s rate hikes, appears to have cooled things down. Even the rate hikes were out of the way by August, before people’s thoughts had turned to the election. I am not suggesting there was anything political in this.

The Treasury, while pleased with the Bank’s record, is keen not to be left out. Its officials stress the contribution of fiscal policy, and the chancellor’s rules, to the economy’s stability. Perhaps, but the government has taken greater risks with those rules than the monetary policy committee has — proof that you should never trust these things to politicians.

Where does the Bank go from here? A few months ago a strong view was developing in the financial markets that interest rates would be coming down in response to slower growth in the economy.

Some of that was built on a gloomier view of the housing market than mine but, as far as the broad outlook for the economy was concerned, it was right. The CBI’s distributive trades survey last week made particularly grim reading, recording the biggest year-on-year drop since the economy was emerging from the last recession, in July 1992. This is not a great time to be selling furniture and carpets.

The Bank has been keen in recent months to demonstrate that consumer spending has decoupled from the housing market, and that a drop in prices would not hit retail sales much. The housing market, if anything, has been stronger than it expected, but sales have been much weaker. I think this tells us that the linkages are powerful.

Housing affects some spending directly, such as carpets and furniture. But it affects a lot more indirectly. Mortgage equity withdrawal — the amount people are taking out of the housing market, usually when moving or remortgaging — has more than halved in the past year.

Consumer spending is not the only weak spot. MG Rover and Marconi — the latter in the kind of high-technology area that is supposed to be our industrial future — have provided timely reminders that things are tough for firms that actually make things.

But this is not just a British phenomenon, as the latest purchasing managers’ surveys make clear. Industry is struggling in America and euroland, as well as here. The global economy has entered a soft patch, because of higher oil prices and interest-rate rises, including another quarter-point hike from the Federal Reserve last week. It may last for a while yet, hence the jitters in equity markets.

What should the Bank do? Talk of spring rate cuts evaporated with the Bank’s February inflation report and the emergence of a minority vote in favour of higher rates. The March rise in consumer price inflation to 1.9%, the latest in a series of higher-than-expected numbers, closed the door on such talk. knocked remaining early-rate-cut hopes on the head.

This weekend, the MPC is ruminating over its next move. Its meeting started on Friday and will conclude at noon tomorrow. So I don’t have the normal four days’ grace between this column appearing and the decision being made.

A rise in rates, which until recently looked a serious possibility, is now highly unlikely, thanks to those weak retail and industrial figures. But the Bank’s May inflation report, which we will also get this week, is again likely to predict that inflation will rise above the 2% target over the next two years. That combination, a mild dose of “stagflation”, is not a comfortable one.

This is a time, however, to treat the forecast with some scepticism. The “downside risks” on consumer spending that some MPC members have been worried about are crystallising. A hike in rates would run the risk of tipping already cautious consumers over the edge. And there is not a lot of growth impetus coming from the world economy.

So the outcome this week should be no change in rates but with the inflation report signalling a so-called “tightening bias” — in other words rates may rise at some stage.

My long-held view is that base rate will stay at 4.75% for most of this year and that the next move will be down. Let’s hope this is not proved wrong tomorrow.

PS: I haven’t yet seen any figures on how stock-market investors voted, but I suspect it wasn’t with any great enthusiasm for Labour. This government’s first term wasn’t too bad — the FTSE 100 was about a third up on election day 2001 compared with its position in May 1997. Even then, however, it was nearly 15% down on its December 1999 peak.

The second term was much worse, with shares falling by a fifth. The net result was that by polling day on Thursday, their gain over the eight years since May 1997 was under 10%. Even allowing for dividends, you would have been better leaving your money in the building society.

Is the outlook still gloomy? One bright spot is that profits have grown pretty well over the past couple of years and the profits share of GDP has edged back up to 18.5% (still lower than average). That might suggest a cheerier prospect for the stock market — depending, of course, on if, or when, the chancellor decides to hit businesses with new tax rises.

From The Sunday Times, May 8 2005

(0)

Crunch time is near for the opinion pollsters. The final Sunday Times-YouGov poll has Labour on 36%, the Conservatives 33% and the Liberal Democrats 23%. This would produce a 92-seat Labour majority. This is similar to the authorative by-election model prediction from Professors Colin Rallings and Michael Thrasher, directors of the Elections Centre, University of Plymouth.

The by-election model, which has as its basis the votes cast in council by-elections every week, predicts Labour on 37%, the Conservatives 34% and the Liberal Democrats 21%, a Labour majority of 96. This model accurately predicted the parties' vote shares in the 1997 and 2001 elections.

Other polls, it should be said, point to far bigger Labour leads, and majorities. The word from the constituencies is that things are closer than the polls suggest. As I say, crunch time approaches.

(2)

An unseasonable chill has descended on the economy. Britain’s once-rampant consumers are minding the pennies, proof to me at least that there is a link between the housing market and people’s willingness to spend. The flatter the former, the more subdued the latter.

Businesses are also glum. Business confidence normally rises in the spring as the sap rises but, according to the Institute of Directors, it has fallen sharply since January. The CBI reports a slump in industrial orders in its latest quarterly survey, alongside the sharpest rise in costs for a decade.

All this could be temporary, a reflection of the soft patch the global economy appears to be experiencing, itself the product of the gradual removal of an extraordinary policy stimulus — ultra-low interest rates and huge budgetary expansions — and $50-a-barrel oil.

But it is possible, too, that we have reached a turning point, and that this general election will mark the end of the period of apparently easy economic success that Britain has enjoyed since the early 1990s.

I am not making a party-political point. On broad economic policy there is not enough to choose between the three main parties — deliberately — to make a difference. All have assumed that the economy continues on its untroubled growth path, and have built their tax and spending plans around that assumption. That leaves no room for error and the worry is that a rise in unemployment, coupled with the discovery that most of the supposed savings on government waste are a fantasy, will leave the public finances badly exposed.

Why might we be on the cusp of a change? One reason, described here last week and developed in more detail elsewhere in these pages, is the prospect of a much more subdued outlook for consumer spending.

The seven fat years in which spending has grown faster than the economy as a whole may be followed by seven lean years, as financial insecurity, tax increases and the need to service the debt built up over the past few years hits home. Mervyn King warned of this two years ago, in his first interview on taking over as Bank of England governor. He may now be proved right.

It is hard to overstate the importance of the consumer in Britain’s recent growth story. In the past 10 years, gross domestic product has risen by an average of 2.8% a year, consumer spending by 3.6%. Contrast that with the lumbering giant of Europe’s economy, Germany, where GDP growth has averaged 1.3%, consumer spending 1.2%. Germany, it should be said, has a far superior record over the period when it comes to exports and industrial growth.

It would be an exaggeration to say that more reluctant consumers could cut economic growth in Britain to Germany’s paltry rate, revised down again last week by leading research institutes. But a spending slowdown to more normal levels would make growth here look very ordinary.

But the big worry comes not on the demand side but on the supply side. Britain’s tax burden is fast converging with Europe’s, as the Engineering Employers’ Federation points out in its business manifesto. In 1997 there was an eight-point difference between Britain’s tax burden (revenues as a proportion of GDP) and the EU average. By next year, according to OECD figures, it will be down to three points, and closing.

Some might say that the economy was taking this extra taxation in its stride, without any discernible effect on its ability to grow. That, however, ignores two things. Most of the increase in the tax burden has yet to come through; Treasury figures suggest that only 40% of the planned rise in the burden between 1996-97 and 2007-8 has so far occurred.

The other problem is the “petrol on a bonfire” argument, which should be familiar to economic policymakers. You add another dose of tax or business red tape — of which the running total since 1998 is £39 billion and counting, says the British Chambers of Commerce — and nothing much seems to happen. Then suddenly, with a “whoosh”, the economy goes up in flames.

The National Institute of Economic and Social Research, in a new assessment of Labour’s economic record, finds much to praise. But in comparison with France and America, the two other countries it looks at, the record is not that special. Britain has had the highest inflation rate of the three; growth has been slightly higher than in France but weaker than in America; productivity growth has merely matched France but, again, has lagged America.

And, according to another recent report, longer-term prospects for Britain are far from bright. Deutsche Bank in Frankfurt, in a report entitled Global Growth Centres 2020, says the top five emerging-market economies between now and then will be India, Malaysia, China, Thailand and Turkey.

The top five among OECD countries, it says, will be Ireland, America, Spain, Canada and France. Where’s Britain? Limping along in 21st place in Deutsche’s 32-country table, with a growth rate averaging just 1.9% a year, well below those of Ireland (3.8%), America (3.1%) and France (2.3%).

Britain, according to the analysis, is running out of “growth-positive” factors, the job-market flexibility and other supply-side measures introduced in the 1980s, and is running into a series of “growth- negative” headwinds. They include, as well as higher taxes and the re- regulation of the economy, factors such as education, openness to migrant workers and the degree of dependence on imported energy.

Some argue that economic prospects are so poor that Thursday’s election will be a good one to lose. I don’t agree with that, although I am sure we will hear it from somebody come Friday morning.

But the outlook, plainly, is more sombre than the politicians are letting on. Consumers have picked that up, and know they face the need to save more, or be taxed more heavily, or both. Businesses and the financial markets have also picked it up. Did somebody say things can only get better?

PS: The shadow monetary policy committee (MPC), which meets or communes by e-mail each month under the auspices of the Institute of Economic Affairs, has a more hawkish bias than the actual MPC. It is encouraging then, that in its vote this month its members do not yet see the case for a rate rise.

Last month’s rise in inflation to 1.9% means the new forecast will begin from a higher base, but the weakness of consumer spending and industrial activity provides a clear steer in the opposite direction. My guess, on balance, is that the forecast will not provide the MPC with a clear-cut case for shifting rates, putting the onus back on the data. And the figures, with one or two exceptions, are weak.

From The Sunday Times, May 1 2005

(1)