New Labour blows it

Do an honest health check of the economy and you’ll find that, however triumphant Gordon Brown is today, he has stored up huge problems for the future, says James Ferguson

According to an ICM poll this week, 46% believe Labour has the best policies on the economy versus only 22% who believe the Conservatives do. Can it really be true that Labour is no longer the party of tax and spend but is, as Gordon Brown claims, the true prudent guardian of stable, long-term growth? 

The answer is absolutely not. Labour’s first term saw Brown continue the reformist policies of the previous Conservative government and hold to a restrained new Labour tack when it came to spending. However, in the second term, spending restraint slackened off.  Stealth taxes allowed the promise of no increases in the basic or higher-rate of tax to be kept (just), but only because the economy continued to grow faster than most people expected. This in turn was because much of the growth came from (unsustainable) debt-financed consumption. Now, though, the Chancellor is running out of rabbits to pull out of the hat.

Gordon Brown inherited an economy in good condition. Then global deflationary pressures allowed for a sustained period of falling interest rates, which in turn triggered several rounds of asset-price inflation, making everyone feel richer and facilitating debt-financed consumption. That in turn sustained economic growth for 32 consecutive quarters of Labour administration. Unfortunately, hubris appears to have set in: Brown hastaken the credit for much of what has been a global phenomenon. Equally unfortunately, he has also taken the economic record for granted and set the stage for some nasty surprises.

“When the Chancellor inherited the economy from the Conservatives he was a very lucky Chancellor indeed and his fiscal policy was, initially, very sound,” says Ruth Lea, director of the Centre for Policy Studies. But that was then and this is now. Old Labour allegiances have crept to the fore and, concludes Lea, “under his stewardship economic and productivity growth have slowed, the balance of payments figures have worsened, private-sector employment growth has fallen, the fiscal situation has deteriorated and international competitiveness has fallen”.

So just how bad are things? Here we look at a nine-point check list of economic ingredients to assess Gordon Brown’s performance as Chancellor. We’ve given him a score out of ten for each one. Our conclusion? History isn’t going to give him the same accolades that he gives himself.

1. Economic growth (7/10)
The IMF recently dared to suggest that if the UK didn’t cut spending, taxes would have to rise. Brown, hubris intact, was furious. “The staff of the IMF have been wrong before about British growth,” he said, and they’ll be wrong this time too: stronger growth will provide the tax revenue necessary to cover any shortfall.

I wonder. In the last year alone, the Government has added 146,000 new public-sector jobs, which can easily enough obscure the fact that in the private sector the number of jobs has actually fallen. The staff at the IMF were looking at the workings of the private-sector economy, not the wholly discretionary (and rather less economically positive) contribution of the Government’s (Labour-voting) payroll. Private-sector jobs are real contributors to economic growth, public-sector jobs are funded from the tax revenue that comes from that real growth. Although they’re both jobs, in many respects public-sector jobs are just another form of Government spending, pure and simple. As the public sector grows and the private sector shrinks, it’s hard to see how the economy can grow above trend.

2. Public spending (4/10)
Another concern about the new public-sector jobs Brown thinks are driving growth is the damage such a strategy does to the economy’s future growth potential. Private-sector jobs are forced by competitive pressures to keep driving productivity growth. There is no such pressure on the public sector. The Centre for Policy Studies calculates that productivity in the economy as awhole grew by 1.2% in 2003 and 2.1% in 2004, yet in the public sectorit shrank by 1.3%. “The non-jobs being created by Labour have a doubly damaging effect,” says Ross Clark in The Sunday Telegraph: “they add tothe taxation burden at the same time as they create scarcity”, making it harder for “the wealth-creating private sector” to recruit.  Over time, by forcing the economy to direct resources into the less productive area of public-sector jobs, real long-term growth suffers. Sir Christopher Gent, chairman of the advisory board of the independent think-tank Reform, reckons that “if public-sector productivity matched that of the private sector, annual economic growth would be lifted by half a percentage point”. A productive economy will grow faster and a bigger economy can afford more services with a lower tax burden. Potentially a real win-win scenario. But not one we’re going to see. The forecast is for public spending in 2008 to be 40% higher in real terms than it was in 2000. The consequences for growth will become apparent later.

3. Employment (5/10)
It was New Labour’s realisation that, thanks to the deindustrialisation of the UK in the 1970s and 1980s, the economic focus in the 1990s was inexorably shifting away from the secondary sector (industrial and manufacturing) and the jobs-for-life demands of the past, and towards services that transformed the party into an electable alternative to the Thatcherite Conservatives. But without industry, where would jobs come from? These days, the answer is the public sector. Another beneficial consequence for Gordon Brown of the “creation of 583,000 public-sector jobs since 1997”, writes Ross Clark, is that “these jobs have kept people from the dole queues”. No mean feat when “one million manufacturing jobs have been lost” over the same period. Presumably the Government payroll will have little trouble soaking up the 5,000-odd jobs that are to be lost at Longbridge too. Or will it? Gordon Brown surely can’t employ everyone?

4. Education (5/10)
In a speech in the City last week, Tony Blair confirmed the New Labour message, emphasising the need for “policies to foster enterprise and the knowledge economy upon which future wealth creation depends”. This knowledge economy requires a major investment in human capital. However, this emphasis is not without irony. While it has been Labour that has overseen the demise of manufacturing, most of the (often subsidised) jobs lost have merely reappeared directly on the public payroll. Labour may no longer nationalise ailing manufacturing industries, but it is effectively still nationalising their workforces.

Future plans also look ill-considered. For example, Labour emphasises science and engineering qualifications – the sorts of skills that are often best suited to that same manufacturing and industrial job market that even Labour admits is now lost forever.

5. Taxation (3/10)
According to Sir Christopher Gent, “the last Budget planned for the tax burden to increase in each year of the next parliament, reaching its highest level for 25 years in 2009-2010”. For all Blair’s talk of “our development as an enterprise society”, the old habits of tax and spend seem harder to break. Apart from the infamous 66 stealth taxes (68 if you include the increased burden of parking and speeding fines), all independent observers believe tax rises are inevitable after the election. The tax-take is already 36% of GDP, up from less than 33% in 1993-1994. Reform argues that currently planned public spending “will rise by 40% in real terms and by five percentage points of gross domestic product” between 2000 and 2008. By then, the tax-take is forecast to exceed 38% of GDP, just shy of 1985’s record (see chart to left). If the recent super-charged rate of economic growth stumbles, these figures would swiftly look much worse.  

6. Deficits (2/10)
There’s a very good case to be made that recent GDP growth hasn’t really been growth at all. In the same way that you don’t measure your wealth by the size of your credit-card bill, deficit-financed growth is illusory and must be paid back at a later date. The Government has a budget deficit (or at least it would have if it wasn’t for some last-minute statistical jiggery-pokery by the Office of National Statistics) while household-sector debt has breached the £1trn mark and the nation’s trade deficit is £58bn, one of the worst on record. Some of this is the Chancellor’s fault. Brown gave the Bank of England freedom to set interest rates, but he still sets the parameters for their decisions. When the Retail Price Index inflation measure looked in danger of crossing its 2.5% threshold at the start of last year, which would have triggered an abrupt end to the low interest rates that fuelled the housing boom, Brown shamelessly switched the measure to the significantly less rampant Harmonised Consumer Price Index (HCPI) – or CPI for short.

The very clear and present danger now is that delayed action raising rates in the past, having allowed house prices to rise too far, will now necessitate higher rates for a longer period to bring the housing market back into equilibrium. And the economy has never sustained a period of falling house prices without that being reflected in much slower consumer expenditure, or without triggering an increase in savings patterns.

7. Inflation (5/10)
Even the new CPI jumped to 1.9% last month, just 0.1% shy of its 2% inflation threshold. This makes further hikes in interest rates more likely not just in the near term, but probably throughout the rest of this year. The risk is that, having forced the Monetary Policy Committee (MPC) into delaying their response to inflationary pressures, Brown has pushed the MPC into incubating a classic wage-cost push inflation spiral. MoneyWeek covered this in detail last week, but suffice to say, once started, such inflationary spirals are almost impossible to control. This late in the cycle is always a dangerous time, what with the twin threats of economic slowdown and late-cycle inflationary pressures, but the trade deficit makes us especially vulnerable.

8. Sterling (7/10)Trade deficits usually mean weak currencies. We’ve yet to see that this time round, but note that the US dollar is already three years into a downtrend caused by twin Government and trade deficits. What makes us think we’re so different? Whoever wins this election is likely to preside over a significant drop in the pound’s value. And as that would mean all our imports would become more expensive in sterling terms, it would also mean more inflation.

9. Pensions (1/10)
Pensions are in a real mess. So much so that Oliver Letwin is happy to blow most of the £4bn of savings David James has identified in his review of public spending on what The Times called “a tax boost for pensions”. The main blame for this can be laid at Brown’s door. First, he in effect destroyed private-sector final salary schemes when he abolished corporate-tax breaks. Now, only public-sector employees, like MPs, get final salary schemes. Second, Government interference has caused excessively low savings through low rates and encouraged debt-financed consumption.

Brown’s overall score is a fairly lowly 39 out of a possible 90, or 43%. Back when I was at school, that would actually have been classified as an ‘F’. However, under New Labour, standards have naturally slipped. At least in the Chancellor’s mind, then, he’s still top class.

Yet for all the criticism, and there aren’t many areas where Brown’s policy has been an unqualified success, there are few who feel truly poor or angry. At least not yet. Blair’s command of what he calls the “progressive centre-left” position has left Oliver Letwin with little radical to say about his party’s economic plans. But this won’t last. Labour’s third term will prove interesting, particularly as the one thing we can say for sure is that taxes will have to go up. The restraint of the first term gave Labour the platform to spend in the second. And it did: up by 1.6% a year in the first term, spending increases have averaged 4.4% since 2001. If I were Letwin, I think I’d be happy to make a virtue of a necessity – to sit this one out and watch Labour reap what it’s sown

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