Recovery position? By Peter Riddell

18 Sep 08
Against all the odds, Number 10 is banking on its latest economic rescue package to turn round the PM's and the party's fortunes. As Labour's annual conference convenes, Peter Riddell weighs up their prospects

19 September 2008

Against all the odds, Number 10 is banking on its latest economic rescue package to turn round the PM's and the party's fortunes. As Labour's annual conference convenes, Peter Riddell weighs up their prospects

It is not all gloom and doom. Sometimes in 10 Downing Street, late at night – or, more likely, given the prime minister's sleeping habits, early in the morning – Gordon Brown and his close allies talk about a way out of their current troubles. And, very quietly, some even whisper that Labour might still be able to end up ahead of the Tories at the next general election. All this might just be to raise their spirits ahead of this week's party conference in Manchester. But an optimistic scenario does exist in the Brown inner circle.

However improbable it now seems, such a recovery plan should not be dismissed out of hand. It is the strategy, if it can be so called, by which Number 10, if not the whole government, wants to be judged, and by which Brown hopes to rescue his premiership. Yet the question marks about its feasibility are as much political as economic. Has Brown the will, authority and clarity to see it through?

At its heart, of course, is the economy. Without at least the signs of a pick-up, Brown and Labour have no chance at all of remaining in office.

The Brown strategy at present is twofold: first, to alleviate the immediate worries of people, especially over the housing market and rising fuel prices; and, second, to argue that the British economy is better placed to withstand a downturn than many of its competitors and, indeed, than it was in the early 1980s and 1990s.

Brown claims this is because of a combination of Bank of England independence and control over interest rates; a flexible labour market sustaining employment; strong productivity growth in manufacturing; low public debt, at least relatively; and a willingness to take long-term decisions on areas such as nuclear energy, Crossrail, digital technology and streamlining the planning system to boost competitiveness.

As a result, he said: 'Once we are through this global crisis, we will continue to enjoy the opportunities that the global economy offers to us.'

This reassuring message was, of course, blurred by Alistair Darling's candid interview in the Guardian at the end of last month, when he said that economic times were arguably the worst for 60 years and the downturn could be 'more profound and long-lasting than people thought'. That warning has been borne out by an inflation rate double the Bank of England's target; falling house prices and rising repossessions; and predictions of a flat economy in the second half of this year.

The Organisation for Economic Co-operation and Development has forecast that the British economy will grow by just 1.2% overall this year, with all the expansion having already occurred. This compares with its projection of 1.8% only two months ago, and the 1.4% forecast by the International Monetary Fund in August. These forecasts are much gloomier than the Treasury's assessment in the March Budget and will mean a very sharp rise in public borrowing and overall debt.

Yet for all the current pessimism, a recession as deep as the two previous ones looks unlikely. The inflation outlook is not nearly as bad as in, say, 1980, when the annual rate of growth of retail prices exceeded 20%, or in 1990, when it was almost 10%. Retail price inflation has fallen to 4.8% and the official consumer price index is slightly less than that. Both are still unpredictable but not even the greatest pessimist believes that they will go into, or even approach, double figures. The Bank of England's quarterly Inflation report has suggested that the rate will peak over the next few months, then start coming down again towards the official target. The oil price has already fallen by well over a quarter from its summer peak of $147 a barrel. This does not mean that we are returning to an era of low energy costs, far from it, but the sharp upward pressures this year might not be repeated.

This is why interest rates are much lower than at the start of previous recessions. Rates have risen, and might be slow to come down until inflation does, but they are much lower than in the past.

However, a lot could go wrong. The crisis in the global banking system has got much worse this month, with the collapse of Lehman Brothers and the hurried takeover of Merrill Lynch creating worries about leading UK financial institutions. Apart from the risks of further failures and rescues, this will reinforce the credit crunch, with lenders even more reluctant to extend new loans. In turn, this could further dampen the housing market and consumer confidence.

No one can be sure, and this uncertainty means that the current mood of gloom and doubt is likely to continue. So the onus is on ministers to show how things will, and can, get better. Voters are no longer willing to give the government the benefit of the doubt. Hence the search for measures to reduce the short-term pain. There is a fine balance between raising expectations excessively and taking actions that will rebound in the long term.

CBI director general Richard Lambert warned in a recent speech that: 'There are no silver bullets to halt the decline in the housing market, or to shoot the economy rapidly back on to a growth path.'

In short, market forces and price adjustments have to be allowed to work their way through. Everyone agrees that the most vulnerable members of society need protection. The risk, however, is that interventions are counterproductive and damaging in the long term. As Lambert said: 'The test for every policy initiative should be: will it help to create more jobs and more investment when the recovery comes?'

The government has, so far, found it hard to avoid these traps. There has been muddle both over the contents and the presentation of the housing and fuel packages. The first instalment, on September 2, was a series of measures to help homebuyers at the lower end of the market: a year-long holiday from stamp duty for properties worth £175,000 or less (up from £125,000); a new share equity scheme for 10,000 first-time buyers; bringing forward funding of affordable housing schemes; and cutting the waiting period for income support for mortgage interest payments.

The general reaction was lukewarm: that the measures would not make much difference given the scale of the problem. For instance, proposals to support families who can no longer afford their mortgages are likely at best to help 6,000 families compared with the 45,000 expected to face repossessions this year.

The biggest criticism was reserved for the stamp duty holiday. This has been seen as largely symbolic since the real problem is the reluctance of banks and other lenders to advance new mortgages. So, overall, the measures are unlikely to halt the decline in house prices or to revive the near moribund housing market.

Meanwhile, discussions continue on extending the Bank of England's temporary mortgage swap facility – which allows banks to exchange their mortgage-backed assets for government bonds – to include new, as well as existing, loans. The Bank is resisting this.

There was even more controversy ahead of the announcement of the fuel package on September 11. Many Labour MPs and the unions had pressed for a windfall tax on energy companies to provide help for those hardest hit by rising fuel prices. The government resisted this since it is looking to these very companies, many now foreign-owned, to finance a £100bn investment in energy infrastructure and low carbon projects. In the short term, the companies are backing a £910m package of help on insulation and energy efficiency for pensioners and poor households. The aim is to cut energy demands and bills over the long term. Again, this has been criticised as not enough.

Beyond these packages, the government and the chancellor will have to announce a new fiscal framework in the Pre-Budget Report. The rise in public borrowing produced by the slowdown has bust the Treasury's much-trumpeted 'golden rules'. And no one in the public sector should expect any relief, with government pressure to hold down pay settlements and the certainty of a very tight spending round next year, with annual growth of no more than, and probably less than, 2% a year in real terms.

The immediate political problem for Brown, and Darling, is to try to shift media attention away from the all-too-evident immediate troubles to the long-term prospects for recovery and slower inflation. It is an exercise in survival, both economic and political. Brown is struggling to counter speculation about his future in Downing Street.

Ahead of the Labour conference, Brown's authority was eroded by disgruntled MPs calling for a leadership contest and by the departure of two obscure junior ministers. This did not amount to a credible plot or coup, and the Cabinet gave Brown conditional backing. Moreover, there was no agreement on an alternative leader.

The Conservatives are obviously in a very strong position, well ahead in the polls, at around 45%, against 26% for Labour. But the message from leader David Cameron is no gloating and no complacency. The Tories still have to show that they are prepared for, and can make a difference in, government. This has already led to a shift in tone on spending and taxes. While the Tories will honour current spending plans, there is no commitment for later.

Cameron and shadow chancellor George Osborne know that if they do form a government in late spring 2010, they will inherit a fiscal mess. Not only will it be near impossible to cut the overall tax burden in the short term, but it will be hard to keep spending growth down to the official limit of 2% a year.

Most in the political and media worlds assume that whatever happens now, Labour is bound to lose the next election. Even if the inflation rate does fall back next year, and the economy begins to recover, there might be little or no 'feelgood factor', and the polls suggest that voters believe that it is time for a change. However, much of the rise in Tory support has been a reaction against Labour failings rather than a positive commitment to back Cameron and his party.

Moreover, the Tories start from far further behind, in terms of votes and seats, than Labour in 1992 to 1997. Still, Brown has to manage an even greater recovery than any previous PM has ever managed – and that will only even be a remote possibility if the economy rebounds visibly and strongly by the spring of 2010.

Peter Riddell is chief political commentator of The Times


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