Politicians have a habit of under-rating the collective sagacity of the electorate. For most of my lifetime – with the exception 1997 – General Elections have been won or lost on which Party the electorate thinks, collectively, will be the better manager of the economy. The Conservatives lost in 1997, partly because of ‘sleaze’ but more substantially because there was a genuine feeling that it was a time for a change and, ironically, the economy was in good enough state to afford the risks of a change. While the ERM debacle had been a disaster for the Conservatives’ reputation as the better managers of the economy, the reality was that the Conservatives governed very well between 1992 and 1997, leaving the economy in a particularly healthy state.
While complacency is dangerous, it must be likely that Labour will lose the next election, heavily, come what may. The false reputation as good managers of the economy which Brown achieved for the 2005 General Election has been blown out of the water by the utter economic shambles Labour is seen to have created. There is clearly a pragmatic case for the Conservatives to say as little as possible, rather than getting dragged into a useless debate on minutiae, and to leave the Labour Government to “hang itself”.
In my judgement, however, this would be an unwise strategy. We have to face up to the fact that we will inherit a desperate situation where tough radical measures will need to be taken to avert national bankruptcy. Inevitably, we will be unpopular when we have to take the necessary measures, where we will be in a much stronger position if we have an effective mandate so to do. Moreover, the polling evidence is that 3 in 4 voters believe that public spending should be cut over the next few years and do not believe Brown’s irresponsible, electioneering platform that spending can continue to rise when the country is facing a multi-billion pound black hole in the public finances.
Where I believe the “Westminster village” misleads itself – no matter how many focus groups both main Parties may commission – is that, in aggregate, the electorate realises only too clearly that there is a terrible mess to be addressed. When it comes to the General Election voters will be looking for a government-in-waiting which tells them the truth and offers a convincing strategy to address our financial and economic problems, even though this will involve “pain”..
Here, as the Bank of England, OECD and IMF have all made clear, the Labour Government’s planned deficits and borrowings over the next 5 years – doubling the national debt without any war to finance – are unrealistic and un-financeable. A major difference between now and 1945 is that then the UK Savings Rate was high, because there was little people could buy and, therefore, a large public deficit was financeable out of domestic savings.
Today, even after the economic shock of the last 2 years, the Savings Rate is only some 5% of national income – nowhere near sufficient to finance the planned £700bn of additional government borrowing. What this means is that most of the finance has to come from overseas. Those that say, ‘don’t worry, China will buy the gilts to finance the deficit’ fail to realise that China is embarked on policies necessary to its own economy to increase domestic consumption dramatically to reduce its growth dependence on exports and so to reduce its Savings Rate and its external surplus. While, notwithstanding, China is likely to continue to run a significant external surplus, it has also made it clear that it will be much more choosy as to what it does with this and much less ready to invest it in either US Treasuries or UK Gilts.
Right now, Sterling is relatively stable, and although gilt yields have risen, the UK Government is still able to borrow. The major reason for this is that the international community expects the next Conservative Government to take tough measures to restore the public finances. The immediate risk for an incoming Conservative Government is that if it is perceived, on taking power, to disappoint expectations, there will be a vicious circle of Sterling devaluation and rising gilt interest rates threatening national bankruptcy. The most important political and economic imperative is that reasonable expectations are met here. This should lead to a virtuous cycle, where the exchange rate and gilt interest yields remain stable, enabling a much reduced borrowing requirement over the next 5 years to be financeable.
What, therefore, will need to be the planned borrowing requirements in a Conservative manifesto? To this there is no easy answer; first of all, until the economy is clearly recovering, there is no avoiding a huge fiscal deficit to keep it afloat. My only comment here is that in the short term, much of such borrowing requirement can, and should, be monetised. My suggestion is that there should be a plan from 2010 through to 2015 to get the UK government borrowing requirement down to less than £50 billion per annum by 2015, in progressive stages. What I suggest this means is that Labour’s planned fiscal deficits will need to be cut by something of the order of £70 billion per annum, which would also allow for the manifest underestimate of the borrowing requirement, in both the present fiscal year and going forward.
Gordon Brown made the disastrous mistake of assuming that the tax revenues at the top of the borrowing and credit bubble he created, represented ongoing tax income which could be relied upon: the reality is that something of the order of £50 billion of tax revenues arose from the temporary froth of the credit bubble. Brown had already planned a deficit of £37 billion when the economy was at the top of – or well over the top of – the cycle. Hence the logic that of the order of £70 billion of regular additional spending is not sustainable, based on tax revenues.
Secondly, and from a different angle, the reason why most of the near doubling of public spending under Brown has achieved so little, is that most of it went into public sector inflation which, from 2001 ran at 3 times the rate of inflation in the private sector. In simple language, most of the money went into pay increases and pension costs. If public sector inflation had been running at the same level as private sector inflation, the borrowing requirement would be of the order of £70 billion per annum less. The message here is very clear – that going forward there will need to be an effective freeze on public sector spending and public sector pay as a major strategy to reduce the borrowing requirement and to restore the public finances.
There are many areas where specific expenditure has run riot and public expenditure is simply wasted which, if addressed robustly, can also deliver significant savings. Put another way, the mismanagement of public expenditure in the UK is the worst of all the Western economies, where as a result, with the necessary will, the UK’s public finances are capable of being sorted out more easily than in some other economies.
What is clear, however, is that the Labour Government’s planned borrowings are simply un-financeable and will need a sudden and dramatic cut back in public spending at some stage to avert national insolvency. This is where Brown’s wholly irresponsible position on spending up to the Election and his cancellation of the public spending review is also dishonest. The debate about how much cut back Gordon Brown has hidden, albeit relevant to exposing his style of deceit – is essentially irrelevant to the bigger issue.
The Conservative Party will need to be brave and go into the General Election campaign with a credible plan to cut back Labour’s unrealistic borrowing requirements to what is reasonably financeable over the 5 year parliamentary term. The electorate knows that this is what really matters given Labour’s disastrous financial and economic management. The incoming Conservative Government needs to have the necessary mandate to take tough measures where I believe this is what the electorate is expecting of us and willing to give their support. To fudge this central issue could be both politically and economically disastrous.