Dead Men Left

Monday, April 18, 2005

The Brown miracle revisited

Having had the occasional (if - ahem - slightly cautious) sideswipe at Gordon Brown's "economic miracle" on these pages, it's pleasing to see the myth given a good, honest smack in the mouth from Respect. John Rees and Graham Turner, in the Guardian:

...we should not lose sight of the fundamental flaw at the heart of New Labour economics. The squeeze on take home pay has been accompanied by a surge in borrowing, and Britain is more in debt than ever before. Private-sector liabilities have soared from 135.7% to 202.3% of GDP since the second quarter of 1997.

Actually, this is a point that needs developing a bit. Though both public and private sector pay have, on average, risen, the dispersion of pay has widened (PDF file). In other words, those already rich in 1997 have, on the whole, seen their pay rise faster than those further down the scale. In the case of the public sector, this is an entirely deliberate government policy: the most senior managers have their mouths "stuffed with gold" to compete with accelerating private sector pay, whilst those further down the hierarchy see their earnings deliberately restricted. For the private sector, the dispersion of pay is the side-effect of so-called liberalisation and the promotion of flexible working. The number of truly "flexible" workers on temporary and non-standard contracts remains minimal, but elements of flexible working have crept into a huge range of jobs, shifting the balance of power in workplaces in management's favour. The continued weakness of trade unions under Labour has exacerbated this trend.

The decision to grant dependence to the Bank of England, often touted as New Labour's most important policy success, has fuelled a boom in house prices, dividing Britain into haves and have-nots. "No more boom-bust" was the Brown mantra. But it is a Labour government that has stood back and watched this country being consumed by a grotesque speculative bubble. Japan's experience of the past 15 years shows the payback can be long and painful.

The consensus view on central bank independence is that it is always and everywhere a Good Thing. By taking key monetary policy decisions out of the hands of beastly elected politicians, it is thought that democracy's "inflation bias" will be reduced. The theory is simple, and depends on politicians' propensities to break election promises. Regardless of what they said before taking office about restricting inflation, there is a great incentive for politicians in office to pursue inflationary policies to win votes - boosting public expenditure, for example, or pursuing "easy money" policies to promote investment. The financial markets will therefore not believe government commitments, and expect higher inflation regardless of what politicians say; these expectations will then, through the operation of the money markets, turn into actual higher inflation.

The whole of the central bank independence argument hinges on a perceived trade-off between democracy, in the form of elected and vaguely accountable politicians responsive to public opinion, and inflation. It is fundamentally flawed for the reasons John and Graham hint at, namely that the central banks' major policy instrument, the interest rate, has to perform other tasks than combatting inflation. Critically, it is the closest capitalism generally gets to central planning mechanism for investment: through the operations of the financial markets, decisions about investment are made, hinged around the signal that the interest rate is presumed to be sending about future returns. Investors aim to maximise their returns with the minimum of risk, with the Bank of England's interest rate acting as a benchmark for other forms of investment.

Britain, for a developed, Western country, has an extraordinarily uneven economy. A train journey from, say, London to Liverpool will provide a graphic demonstration of how this unevenness has impacted on the environment, low-rise commercial services turning into evidence of substantial manufacturing investment. There are elements that cannot be seen: the heavily unequal distribution of wealth, the wide regional variations in unemployment, and the extraordinary dispersion of productivity across British firms.

The critical divide for us is between a manufacturing sector that has, after a post-Black Wednesday recovery, been squeezed by the high value of the pound; and a consumer sector that has, after successive liberalisations of the financial markets, an extraordinarily easy access to credit. Manufacturing requires a lower interest rate to promote investment and reduce the value of the pound; the consumer market, fuelled by easy credit, exerts a constant inflationary pressure requiring higher interest rates. The net results of this impossible balancing act are exceptionally high levels of private debt promoting a consumer boom at the same time as manufacturing remains in the doldrums. The expression of this tension is a growing trade deficit, with consumers effectively borrowing to spend cash on imports. There is a significant and growing weakness at the heart of the so-called "Brown boom":

The failure to control the financial system has also pushed the trade deficit up sharply. Britain's trade gap has now reached 5.2% of GDP, nearly matching the worst point of the Lawson boom. Capital inflows into debt instruments rocketed to £92.2bn in 2004 to finance this deficit.

But the debt-financed consumer boom has failed to boost manufacturing output, which has barely shown any increase over the past eight years. Virtually the entire rise in spending on consumer goods since June 1997 has been filled by imports. When the bubble bursts, sterling will fall like a stone. Policy flexibility will be compromised and we shall have a re-run of the early 1990s for many years.