Gordon Brown has stuck to his ‘golden rule’… but only by using statistical jiggery-pokery. Has this damaged his reputation? Or more importantly, the country? Simon Nixon reports.
Is the UK economy in trouble?
Not yet. But there’s no doubt it faces difficult times ahead. House prices are falling, retail spending is slowing, fuel costs are rising and manufacturing is in recession. Perhaps most worryingly, unemployment has now risen for five months in a row. With UK households currently struggling with unprecedented levels of debt, even the fear of unemployment could be enough to trigger a collapse in consumer spending. The result is that economists are slashing their growth forecasts. The respected Ernst & Young Item Club has just cut its forecast from 2.7% to 2.1%. The Bank of England is sufficiently worried that it is now widely expected to cut interest rates next month.
Is this a problem for Gordon Brown?
Not any more. During the election campaign in May, most economists predicted that if the slowdown continued, the Chancellor would have little option but to raise taxes or cut spending if he was to meet his so-called ‘golden rule’ that the Government’s finances should be in balance over the course of an economic cycle. They warned that the slowing economy had left him with a £10bn ‘black hole’ in his budget. There is no doubt that the public finances are deteriorating. In the first three months of the current financial year, the public sector was an alarming £13bn in the red, up from £2bn a year ago and the budget deficit is now running at more than 3% of GDP. But with one flick of his statistical wand, Brown has made the black hole disappear.
How did he make it disappear?
His trick was simply to put back the starting date of the current economic cycle by two years to 1997. This earlier start to the cycle allows him to include an extra £12bn of surpluses to meet the golden rule. If he hadn’t made this change, he would have been in deficit over the cycle, which is predicted to end next year, and would have needed a surplus of £3.5bn in the last nine months of the year to make his sums add up. Nobody believed that was likely. Brown argued that revisions to the national statistics showed that the new cycle began two years earlier than thought when it returned to its long-term trend following the trough of 1992. Critics pointed out that there was little point in having rules if Brown could interpret them as he pleased.
Has this damaged Brown?
It has certainly damaged his credibility. The golden rule is at the heart of his economic policy-making, which he claimed was the key to Britain’s economic performance. Indeed, for eight years he has hardly stopped boasting about his much-trumpeted “prudence” and how he had abolished “boom and bust”. Lately, he has even started lecturing other European governments on how to run their economies. But the truth is that the golden rule was never much more than a political device, designed to reassure the City that Labour would not be profligate in office. The real test is whether his attempt to move the goalposts will damage his reputation in the City.
How have the markets reacted?
They don’t seem to have cared at all. That’s partly because the move was widely expected. Nobody really believed Brown would cut spending or raise taxes just as the economy was turning down. Besides, so far as the City is concerned, Britain’s national debt, at less than 40% of GDP, is not a particularly alarming problem. Certainly, it is modest compared to most other industrialised countries. The national debts of Japan and Italy, for example, are both more than 100% of GDP. True, Brown’s sleight of hand will allow Britain to sink further into debt, but at least it won’t reach these levels.
Will he still need to raise taxes?
The Treasury says not. It is still sticking by its forecast that GDP will grow this year by 3%-3.5%, in which case tax revenues should hold up enough to pay for all Brown’s public spending. But that forecast looks increasingly unrealistic. Preliminary figures show the economy grew by just 0.4% in the second quarter. If Brown is to achieve his forecast, output will have to grow at twice this pace. That looks improbable. Instead, the Item Club forecasts that Brown could miss this year’s borrowing target by £6bn. Even so, he looks to have left himself enough wiggle room to avoid having to raise taxes to comply with the rule in the next two years.
What happens after that?
That depends upon what Brown decides to do about Government spending. The Chancellor was supposed to set out his spending commitments next year in his Comprehensive Spending Review. Conveniently, he has now decided to postpone his spending review until 2007, after the end of the current cycle, when he will set his commitments for the next decade. Cynics have speculated that he aims to use that spending review to set out his manifesto to succeed Tony Blair – that is, if economic events have not already sealed his fate.