Gordon Brown, leadership, GDP, strategy

Into the red with Brown

30.09.2005

by James Ferguson

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Not so long ago, most commentators were impressed with Gordon Brown’s handling of the economy. Now, the economy is struggling. Just how much of this is down to Brown? And will it do irreparable damage to his leadership bid?

Is Gordon Brown’s party nearly over? It’s beginning to look like it. His current “mood music” isn’t good, says Gary Duncan in The Times. Only a year ago, most commentators still appeared to be impressed with his management of the economy, but today when they think of Gordon Brown, they think of “grim Seventies-style images of oil shocks, soaring inflation, faltering growth and that period’s failed chancellorships”. Worse, it rather looks as though Brown is going to have to continue to sleep in the bed he has made so badly. At the beginning of this week, he was clearly hoping to take over from Tony Blair sooner rather than later, yet Blair’s speech this week was anything but one of resignation – instead, it was flamboyant, forward-looking and followed by a comment from Cherie Blair that her husband’s departure from Downing Street was “a long way in the future”. So it seems that for the next few years at least there’ll be no handing the poisoned chalice of the UK economy on to anyone else, something that will surely come as a grave disappointment to the chancellor.

Still, that doesn’t mean Brown can’t find an external factor or two to blame for the UK’s current difficulties. Having just been forced to say that things are already looking rather less rosy than he had previously claimed, and that his target of 3%-3.5% GDP growth in 2005 is far too high (the IMF is anticipating a rate of just 1.9%, meaning the UK is likely to grow less than Japan this year), he is claiming that it’s just not his fault. The chancellor should be eating a “large helping of humble pie”, says The Guardian, but instead he is passing the buck to oil and a sluggish Europe: he is doing what all politicians do when things go wrong – saying that “it is due to global forces”. But that isn’t quite true. It may be the case that oil prices have been hitting all-time highs, but only in nominal terms: the price still isn’t nearly as high as it was in the 1970s, once you adjust for inflation. Higher oil prices may not be helping the consumer slowdown, but they are not the core cause: falling house prices and debt overload have much, much more to do with current conditions. Indeed, anyone tempted to believe Brown’s protestations should note that economic danger signs have been obvious for a long time. Oil can hardly be to blame for the fact that, since 1999, Brown has watched over a “bigger deterioration in the underlying budget deficit” than has been seen in any other leading industrial country, says Robert Chote, director of the Institute of Fiscal Studies, in The Guardian. Unemployment also started to rise before the big leap in oil prices (it’s now risen for seven months in a row), as did inflation. At the same time, productivity is stagnant, public-sector spending has exploded, house prices (the biggest driver of consumption in the UK) are at best flat and consumer debt is still at record highs. It isn’t a pretty picture.

However, perhaps worst of all for Brown’s reputation is that it now looks as though it will be impossible for him to meet his so-called golden rule on borrowing. In order to gain the trust of the British people – and in an attempt to reassure them that the Labour Party was reliable on the economy – Brown created a ‘golden rule’ back in 1997, which stated that he would only borrow to invest (in infrastructure and the like) over the course of an economic cycle. This means that falling growth is really bad news for Brown – all his spending plans are based on his growth predictions and on how much tax will be raised as a result of them. If growth doesn’t hit its targets (which it won’t), then neither will the tax take – making it more likely he’ll break his own rules. Having already moved the goal posts by changing the beginning and end dates of the cycle and changing the meaning of ‘invest’, lower growth means that “tax rises now look inevitable”, says Trevor Kavanagh in The Sun.

This state of affairs is going to be irritating enough for the electorate, but of more immediate concern to most of us is probably the matter of where on earth all the money Brown has already spent has gone. The public sector has seen a massive inflow of cash, but you’d have to ask a lot of people in order to find someone who thought any services had improved as a result. There have been a lot of new jobs created (940,000 since 1997), but very few seem to be for new teachers, doctors and policemen. Indeed, to the external eye, the most useful role all this hiring has had has not been to improve public services, but to stop unemployment rising too fast: private-sector employment peaked in mid-2003 and with the manufacturing and retail sectors both in trouble (manufacturing is officially in recession), that isn’t going to change any time soon.

The economic trouble all around the UK means that “the pained calls for lower UK interest rates are getting shriller”, says Lex in the FT. This week, the head of retailer Next said “significant” rate cuts were needed for growth to return to the high street, for example. But can this really happen? We think probably not. Alongside falling consumer spending, there are also inflationary pressures on the UK economy. At 2.4%, the Consumer Price Index (CPI) is currently at its highest level since 1997 and well above the Bank of England’s Government-set target of 2%.

The fact is that “the Chancellor’s eight-year run of luck at the Treasury may be running out”, says Kavanagh. The UK has benefited from cheap Chinese imports, which have helped keep a lid on inflation. Now Europe is imposing quotas on China, the yuan has been revalued upwards and oil prices are hitting transport and production costs, China can’t keep saving our skin with cheap underwear. This leaves the Bank of England with a dilemma over which direction interest rates should move to achieve the inflation target of 2%. And “while he may have handed control of interest rates to the Bank, Brown would be unlikely to escape all blame in the eyes of the voters”, says Chote. If interest rates do end up having to rise in the face of inflation, then things can only get worse for the UK economy. The property market, which is already seeing price falls, will tumble further. Consumers will then cut back spending more than they have already; retailers will be hit again and the vicious circle will continue.

So where does this leave Brown? With the economy collapsing on his watch (second-quarter GDP numbers out this Wednesday showed that the economy grew at a mere 1.5% annual rate, the lowest for 12 years), he must want to move into Number 10 as quickly as he possibly can. But Blair is showing no signs of shifting – the new deal is apparently that Blair will move on in about three years’ time. Brown may object to this – but if he does, the Blairites are said to be planning to put up another contestant to stand against him. However, if he doesn’t start trying to find a way to take power earlier, he may find that, in three years’ time, his reputation has slipped so far that for Labour to keep winning elections an alternative candidate will have to be found anyway.

Has Brown led us from a virtuous cycle to an ever-more vicious one

Gordon Brown inherited a robust economy, low inflation, budget surpluses and the longest period of sustained global growth the world has ever seen – and yet according to him, he was almost single-handedly responsible for the good times. So it’s rather salutary that now he is having to lower his growth forecasts, from as much as 3.5% to nearer half that, he says it is not his fault. Good times, it would seem, are due to Gordon’s skills, but bad news is due to “global forces”.

It is true that Brown’s personal intervention sustained the economy’s growth last year. When everyone else thought that growth would slow, Brown knew he was going to throw huge amounts of money at the public sector and single-handedly boost employment. As a consequence, the economy did grow the 3.2% he had always forecast. However, private-sector employment fell and, without Brown’s huge spend, public-sector employment wouldn’t have grown either. Direct public spending wasn’t the only way the chancellor conspired to boost the economy in the short term. He needed a compliant Bank of England to set artificially low interest rates to keep credit-fuelled consumption booming. Unfortunately, the first thing he’d done as chancellor was give the Monetary Policy Committee its independence, hence, on the face of it, depoliticising interest-rate decisions. Still, to even this out all he had to do was politicise the inflation measure the MPC was instructed to track. When the RPIX went above target in late 2003, Brown just switched the measure to be followed to the new CPI, which was well below target.

Truman once said: “there are lies, damn lies and statistics”, but on Brown’s watch, nothing has been sacrosanct. The rate of inflation has been changed to sustain Brown’s boom. Inflation measures increasingly ignore any component that goes up through arcane fiddles such as hedonic accounting (which makes inflation look much lower than it feels) and substitution. The definition of maintenance in the highways budget has been changed to capital expenditure (or investment) to cover Brown’s overspend and the length of this economic cycle has been extended deep into the previous one to cover the trail. Perhaps irreparable damage has been done to the trustworthiness of the national statistics.

Unfortunately, Gordon Brown has also believed his own press. He believed that just by forecasting strong growth, it would happen and sustained strong growth would provide the tax revenues to finance his pet spending projects. But here we are, at the top of the best of all possible domestic and global economic growth cycles and the chancellor is already spending a good £10bn-£15bn more than he’s taking in. This already makes the whole ‘Golden Rule’ speech look like a farce and the old ‘prudent’ moniker seem like a bad joke.

If the economy now slows, as seems inevitable (it is now growing at its slowest pace in 12 years), the Treasury will find itself committed to a hefty spending programme with no plan in place to fund it. Short term, borrowings will have to rise, which will push up interest rates and slow the economy. But because that won’t be sustainable for long, taxes will have to rise. An uncomfortable but unavoidable problem with economic slowdowns is that tax revenues slump, so a vicious cycle beckons, where higher taxes slow growth, which saps tax revenues and forces another round of higher tax.

This effect works in reverse too, as a virtuous circle. Higher growth spells higher tax revenues, which facilitates less borrowing and budget surpluses. This is the virtuous circle Brown’s profligacy threw away. For all his golden rules, Brown couldn’t even restrain himself to stay within his budget when times were good and he should have been building up a financial war-chest to tide the economy during harder times.

Instead, he blew it all away. As higher oil prices start to bite, as global growth slows, perhaps even as a domestic consumption collapse follows on from a slowdown in the housing bubble, what have we got saved up? Nothing. The budget deficit is already a European Union stability pact busting 3.2% of GDP. The only thing left in Britain’s war-chest is an overdraft statement.

Brown's record: the facts so far

Growth

While most analysts suggest the UK’s economy will grow by some 1.9% this year, and a more recent Capital Economics forecast predicts 2005 GDP growth of 1.7%, Brown stuck by his 3%-3.5% forecast, until last week, that is, when he finally admitted that the economy is “weaker than predicted”.

Public spending

Analysts reckon there could be a £10bn shortfall between what the chancellor spends and “what he receives”, says Ian King in The Sun. And he’s certainly spending a lot: the Treasury, for example, is currently paying £2bn per year on Whitehall consultants – the equivalent of adding 1p to the basic income-tax rate. As it is, the Government is reaching its borrowing limit, with the budget deficit now at 3.2% of GDP – a breach of the EU stability pact, which has a limit of 3%.

Productivity

Even Brown’s closest adviser, Ed Balls, has admitted that Britain’s productivity needs to be improved, saying in the Evening Standard that Brown needs to “reverse the decades of underinvestment in British skills”. British employees produced 10% less on average than other G7 workers in 2004 – and a full 24% less than the US, says the FT. Even French workers are now 11% more productive than their UK counterparts.

Employment

Unemployment may technically be near its lowest level since records began in 1971, but it is rising fast: in August, unemployment rose for the seventh consecutive month, the longest stretch of rises for 13 years, thanks to job cuts in the retailing and manufacturing sectors. According to the Office for National Statistics, the number of out-of-work Britons seeking employment rose by 12,000 to around 870,000 last quarter. But UK numbers simply count those on unemployment benefit. If you add in those not on benefits, but still unemployed, the number comes to more like 1.4 million. Add in the number of people on incapacity benefits, two-thirds of whom are thought to be able to work, and things look even worse.

Inflation

The Bank of England, tasked by Brown to keep inflation at around 2%, is struggling as consumer price inflation (CPI) rose to 2.4% in August. This is the highest level since the current records began in 1997. Meanwhile, retail price inflation (RPI, which includes housing costs) fell from 2.9% to 2.8% year-on-year in August – as house prices continue to fall and consumers check their spending habits. But while this may have fallen, it’s still well above 2.5%, the target rate for the Bank of England when it was the Government’s preferred measure of inflation.

Tax

With the UK economy slowing, Brown is left with two major options in order to make up for a fall in the Treasury’s revenues: either cut spending or hike taxes. And the latter option is looking the more likely. The National Institute of Economic and Social Research reckons there’s a £10bn shortfall that Brown will have to make up, potentially rising to £40bn by 2008. And thanks to the effects of fiscal drag, since May 1997 tax as a percentage of GDP has increased from 38.1% to 39.9%, while, according to the Daily Mail, we’re paying £2bn more tax per week than in 1997, when Labour came to power.