[PEN-L:32608] England

["Ian Murray" <seamus2001@xxxxxxxxx>]

A chancellor still in control of events. But only just

Larry Elliott
Thursday November 28, 2002
The Guardian

Gordon Brown brazened it out. He stood up at the dispatch box and admitted
that his growth and borrowing forecasts made in the spring were wildly
optimistic, but adopted his normal Commons persona - self-confident
bordering on smug. There was, the chancellor insisted, nothing really to
worry about. The economy was going through a bit of a sticky patch but it
was all Johnny Foreigner's fault. And it was merely a temporary blip.

Beneath the surface, however, it is likely that Mr Brown is a lot more
worried than he appears. The fact that the rabbit pulled out of the Treasury
hat was the announcement that Mervyn King would replace Sir Eddie George as
governor of the Bank of England was meant to reassure the financial markets
at a time when the chancellor was announcing a doubling of borrowing.

Moreover, Mr King has made it abundantly clear in the past couple of weeks
what he thinks about the underlying state of the UK - an unsustainable
housing market and the weakness of manufacturing reflect an economy that is
dangerously unbalanced.

Mr Brown's analysis is that the recovery he anticipated in 2003 will now
take place in 2004. He has cut 0.5 of a percentage point off his growth
forecast for this year and next, but added the same amount to his prediction
for 2004. Growth is expected to be between 3% and 3.5% in 2004, and a robust
2.75%-3.25% in 2005, the date pencilled in for the next election. How likely
is this? There is one good reason for thinking the chancellor will be right,
but two important reservations that need to be aired.

On the upside, the chancellor's decision to let borrowing rise during a
period of weak growth is absolutely the right thing to do, straight out of
the Keynesian textbook. While much of the rest of Europe seems intent on
impaling itself on the sort of economic orthodoxy that went out of fashion
in the early 1930s, the chancellor is allowing fiscal policy to act as an
automatic stabiliser. Previous Labour governments have never had the luxury
of relaxing fiscal policy during a global downturn, but have instead been
forced to retrench, as in 1931 and 1976, with disastrous political
consequences. Mr Brown deserves credit for being able to increase public
spending at precisely the right time.

Should the global economy pick up next year, there is a chance that Mr
Brown's forecasts will come good. But that is the first concern.

The chancellor is correct to point out that the global economy is in one
heck of a state, even though the strong figures coming out of the US
yesterday may be a sign that the Federal Reserve's cut in interest rates is
working. To coin a phrase, there has been a global boom-bust of stupendous
proportions over the past five years, and most countries are still living
through the after-effects of the collapse of the bubble economy. The global
economy is awash with spare capacity, which is resulting in a freeze on
investment, falling prices and weak profitability.

Only the most heroic optimist would assume that this period of adjustment
will be over in a year's time. The US stock market still looks hideously
over-valued, the German economy is on course to be the new Japan. That is
without even mentioning a possible war against Iraq.

Since Britain had its last full-blown economic disaster a decade ago, the
global economy has had a succession of crises, from Thailand to Argentina
and from Russia's debt default to America's dotcom sector. To assume that
this era has come to a close and that the process of adjustment to all the
previous problems will be over in 12 months is heroic.

It is really not much comfort, then, to hear from Mr Brown that while the UK
has been doing badly this year, the rest of the world has been doing worse.
On that basis, should the rest of the world continue to struggle, so will
we. The chancellor is remarkably proud of the fact that Britain has the
lowest inflation and interest rates for 40 years, and says so at every
opportunity. What he never mentions is that the rest of the world has
historically low inflation and low interest rates as well. We are living in
a age of disinflation bordering on outright deflation.

The second cause for concern is what you see when you scratch below the
surface of Mr Brown's much-vaunted "stability". A mountain of consumer debt
shows that we are all shopping for Britain, but the fall in investment over
the past year was the biggest since records began in 1965. Productivity, for
all the chancellor's prodding, is growing half as fast as it was when Labour
came to power. Mr Brown's belief that the economy can grow rapidly in 2004
and 2005 is based on the assumption that productive capacity has risen; the
figures for investment and productivity hardly bear that out.

As a result, this statement showed the chancellor still in control of
events, but only just. The big increases in public spending have left him,
unlike in previous years, with little room for manoeuvre. He needs
everything to turn out right. The lesson of history - particularly British
economic history - is that it rarely does.