WASHINGTON, Dec. 6 (UPI) -- British prime minister Tony Blair is said to be aiming Britain's General Election, (which must be held before June 2006), for May 2005, about the earliest he can reasonably hold it without attracting a storm of criticism. For the sake of his re-election, he'd better not delay it -- because the British economy could be looking pretty sick by the end of the year.
On the face of it, Chancellor of the Exchequer Gordon Brown's mid-year financial statement Thursday was a positive one. The Treasury expects the British economy to grow by 3.25 percent in 2004 and 3 to 3.5 percent in 2005, with inflation of 1.75 percent in 2005 and 2 percent in years to follow. Government borrowing in the year to April 2005 will be 35 billion pounds ($65 billion); it will then decline to 34 billion, 33 billion, 29 billion and 28 billion in successive years, while the ratio of public debt to gross domestic product inches up from 34.3 percent in 2004 to 35.4 percent, 36.2 percent, 36.8 percent and 37 percent.
Even so, Brown was able to distribute about 2 billion pounds of handouts, 1 billion of subsidies to local authorities (so council tax bills, which come out next April, will not be excessively high) a new 1 year subsidy for single parents, an increase in winter fuel payments and an increase in the minimum wage.
It all sounds too good to be true. Which is the problem: it is.
Since the Blair government took office in 1997, Britain has had a number of good years. British economic growth was steady in 1997-2000 and since 2001 has been higher than most other countries in the EU, and among the highest in the world. Nevertheless, the current account has been consistently in deficit, to the tune of about 3 percent of gross domestic product, and the public sector borrowing requirement has swung from a substantial surplus to a deficit that even the Chancellor is estimating at well over 30 billion pounds per annum, 3 percent of GDP. Both the current account deficit and the budget deficit are relatively smaller than in the United States, but not by much, so the question must arise; is this sustainable in the long run?
The British stock market, like most other stock markets around the world, underwent a substantial run-up in the 1990s, talking it far beyond traditional valuation levels; since 2000 it has however dropped rather more than the U.S. stock market, and so is only moderately overvalued currently. However, the British housing market tells a different story. As followers of Britain will remember, British house prices reached an unsustainably high level in 1989, then spent the next half decade in sharp retreat, causing a huge wave of consumer bankruptcies and great economic hardship. The British recession of 1990-1993 was much more severe than the U.S. recession over the same period, and affected the south of England and the middle class, who had been relatively unaffected by the prolonged northern industrial recession of the early 1980s.
This time around, it's much worse. The house price to earnings ratio, calculated by the Office of the Deputy Prime Minister, which peaked at 140 in 1989, is currently standing at 180, so house prices are as much as 30 percent more overvalued in relation to average earnings as they were at the peak of the 1980s bubble. Prices have risen by more than 2.5 times since the Labor government came to power in 1997.
Recent visitors to London can confirm this; house prices in central London are astonishingly high by U.S. standards, even compared with the overpriced markets on the East and West Coast. While this has allowed consumer spending to increase rapidly, on the back of mortgage re-financings, it has not been reflected properly in consumer price indices. Since nominal earnings, even at today's elevated exchange rate (the sterling/dollar exchange rate is currently at its highest point since 1992) are considerably lower than in the U.S., this brings genuine hardship for those compelled to work in London who are not already on the housing ladder -- their real earnings buy very little.
The problem is more severe than in the United States, where in most occupations, if you find house prices too high in New York or Los Angeles, you can always move to Chicago or Dallas. In Britain, many professions, particularly at the top end, are completely concentrated in London, and so young people are trapped by absurdly priced real estate, and compelled either to live in ghetto areas with very high crime rates or to endure multi-hour commuting on Britain's appallingly inefficient public transport.
The real flaw in Brown's budget arithmetic lies in his growth assumptions. In the 2002 and 2003 budgets, Brown assumed real growth rate in British GDP of 2.5 percent, somewhat above the long term average but in line with the country's improved performance since Margaret Thatcher's reforms of the 1980s. In 2004, Britain's economic growth will be around 3.25 percent, good news for the national exchequer, one would think. However, Brown has assumed that this higher growth rate will continue into the future; this has allowed him to increase public spending significantly, even beyond the levels of his previous budgets, and still produce a budget outlook that looks plausible, albeit close to the edge of fiscal plausibility. The City of London, whose consensus forecast for 2005 growth is 2.5 percent, doesn't share Brown's optimism.
Even with growth at 2.5 percent, the previous Budget assumption, a hole of 10 billion pounds ($19 billion) per annum or more opens up in Brown's budget arithmetic, and the deficit begins to spiral out of control. Britain's public spending has already increased from 39 percent of GDP to almost 42 percent under Labor, in a period of strong economic growth; any economic difficulty will cause it to spiral rapidly back to its record and economy-killing levels of the late 1970s.
With house prices at record highs, and the payments deficit also close to historic highs, it is likely that the Bank of England will be forced to raise interest rates further from their current 4.75 percent (in this context, one should give credit where it's due -- British monetary policy since 1997 has been far sounder than in the U.S., probably a result of Brown's giving the Bank of England monetary independence on coming to power in 1997.) If British house prices then begin to decline, as seems to be happening currently (the Halifax house price index was flat for the last 3 months, after a rise of more than 20 percent in the previous year) in an environment where most home mortgages are based on floating interest rates, the already excessive levels of consumer borrowing will start to exert a real squeeze. At that point, the house of cards is likely to fall, causing a prolonged period of economic misery similar to that in 1990-93, only with much larger budget deficits.
It is unlikely, however, that this unpleasantness will have become fully apparent by May 2005, which is why Blair, if he is wise, will take an election win while he can get it.
In the long run, if Blair indeed calls a relatively early election and wins it, there may be a major tectonic shift in the landscape of British politics. The Conservative party, under Iain Duncan Smith, had in summer 2003 looked quite well placed to win a 2005 election, leading Labor in opinion polls, with memories of the Conservatives' last disastrous years in power under John Major beginning to fade, and with the Iraq war, Britain's shaky public finances and the EU all playing into the Conservatives' strengths.
The sudden replacement of Duncan Smith with Michael Howard in November 2003, carried out by Conservative MPs on the basis of a thoroughly disreputable media campaign without any consultation with the party as a whole, was only too reminiscent of the replacement of Margaret Thatcher in 1990, and awakened old scars among Conservative loyalists. That, combined with a badly run campaign in the Euro-elections last spring, during which Howard concentrated his fire against the UK Independence Party, thus again raising memories of the unpleasant and deceptive euro-surrender of the Major years, caused a huge upsurge in the UKIP vote and a flat Conservative vote, in an election that should have been a Conservative landslide.
Since that time, Howard has replaced Howard Flight, the one Conservative shadow minister with real economic ability and experience, has sacked Boris Johnson for marginal sexual peccadilloes far less serious than the Labor Home Secretary David Blunkett appears likely to survive, and has promoted men in their 30s who might be plausible future leaders of the party in 2025 but today are no more than leadership poodles. Consequently, the Conservatives are still trailing Labor by several points, well behind their position under Duncan Smith, and appear likely to make little if any electoral progress in 2005.
This raises the possibility that a further Liberal Democrat surge in 2005, and a poor Conservative performance, may leave the Liberal Democrats as the leading alternative government when Labor becomes terminally unpopular. The Liberal Democrats are now left of Labor on economics, and strongly pro-EU, a position shared by almost none of the British public, but this may not be a problem for them. Capital punishment was consistently supported by 70-80 percent of the voting public after its abolition in 1965, yet the political class made sure that the public had no effective way to express that support, since no major party favored its restoration. The popular support for capital punishment was thus politically marginalized, so much so that now, if a government wanted to restore it, it would not be able to do so under the European Convention on Human Rights.
The same could happen on Europe. If Howard continues to surrender the Conservative position on Europe, and the Conservatives are weakened by another electoral defeat, then the Liberal Democrats and the Blair government may with the help of the massively pro-Europe broadcast media succeed in marginalizing Europe as an electoral issue, so that anti-Europeanism becomes seen as the refuge of the cranky and the ancient. Labor (minus Blair, whom the chattering classes have never really liked) and the Liberal Democrats can then divide the political spoils between them, perhaps cementing their power by a "constitutional reform" introducing proportional representation, ensuring that election of a majority Conservative government becomes impossible.
In that event, Britain's public spending, already moving sharply up towards the EU average, will rapidly come to match it or even exceed it, and Britain will take its place, with a sclerotic economy, a huge public sector, tiny armed forces and a neutralist, anti-U.S. foreign policy, securely within the ranks of Old Europe.
Half a millennium of British exceptionalism will thereby come to an end.
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(The Bear's Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that, in the long '90s boom, the proportion of "sell" recommendations put out by Wall Street houses declined from 9 percent of all research reports to 1 percent and has only modestly rebounded since. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)
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Martin Hutchinson is the author of "Great Conservatives" (Academica Press, 2005) -- details can be found on the Web site greatconservatives.com.
