Undermining trust and credibility

Economic data out this week has highlighted the challenges the next government will face. Yet the latest Conservative election pledge on public finances further eroded what economic credibility they had.

The official preliminary estimate of British GDP for the first quarter of this year showed that the growth rate has slowed. The economy grew only 0.3 per cent. There was little growth in the production sector and the larger services sector disappointed. It seems growth has been affected by poor performance in the business services and financial areas, parts of the economy that may also be holding back productivity growth. It is one figure and an estimate subject to revision, but nevertheless it highlights the poor quality of this recovery.

The United States’ economy also appears to be growing at a slower rate, with official figures showing GDP grew only 0.2 per cent in the last quarter. Again, the figures are likely to be revised, but the Federal Reserve also suggested the recovery has slowed. Meanwhile, the Eurozone is relying on quantitative easing to boost its economy while it deals with difficult negotiations with Greece.

The Conservative party yesterday pledged that if it wins the election it will introduce a law to guarantee no tax rises before 2020, in income tax, VAT, or national insurance. It further stated that it would not increase the range of products or services covered by VAT. The announcement was an obvious attempt to portray Labour as the party of tax rises.

However, the Conservatives have probably over-reached. The core message of their campaign – insomuch as we can discern it – has been to cast themselves as the party of economic credibility. In government, they failed to eliminate annual government borrowing but the past couple of years of growth have helped bail them out, even if GDP growth remains well below the pre-crisis trend. The coalition government has cut spending severely and the Conservatives plan around £30bn or more cuts should they win, with no details about where the cuts will fall. It is here that they have undermined their own credibility. They have decided to spend some of the political capital they believe they have gained from their economic management. But rather than announced detailed pledges on tax and spending, they have instead opted for unfunded promises. We have seen this with pledges on health spending and tax allowances. The overall effect has been to undermine trust.

Perhaps that is why the latest announcement declares that rather than simply trust the Conservatives to keep taxes low, there would be a law to keep them honest. The problem with this is two-fold. First, sound economic management requires a chancellor to have a full range of options. He or she can outline what they intend to do but flexibility is required to respond to economic shocks. The growth projections for the United Kingdom’s economy from the Office for Budget Responsibility rely on some crucial assumptions. The OBR believes productivity growth will pick up, leading to higher wage growth. It also assumes households will keep on borrowing to higher levels than before the financial crisis, which could store up economic problems for the future. Should growth disappoint, then government borrowing would be higher than projected and households would be under more pressure – the Conservative plans to eliminate all borrowing by the end of the parliament would be in jeopardy. In these circumstances the Tories would have to cut spending by even more than they intend, or distort the tax system through tax rises elsewhere, if they were to meet their fiscal targets.

The second problem with the announcement is that any law can be over-turned by parliament if required. So either the proposal unnecessarily binds a chancellor to act against the public interest should economic conditions take a turn for the worse, or it is a meaningless pledge. Either way, Conservative credibility on the economy is undermined. Labour on the other hand has clear fiscal aims but with some built-in flexibility. There is a clearer contrast now than there has been for years between Labour and Conservative economic policy.
 
This article was first published by Progress, on 30 April 2015.