Sunday, January 22, 2006

When and not if

As Alan Greenspan finally leaves the US Federal Reserve, it is hard not to feel that some fundamental economic realities are changing across the world. The continuing economic imbalances in the US economy are not fully understood, but the scale of military expenditure that "big government Conservatism" implies can not be sustainable over the long term. George W. Bush is driving his country into some serious economic problems- can a US retrenchment be long avoided? And what does that mean for the wider world?

In Britain, the failure of yet another PFI- the new St. Barts hospital project- confirms the strain on public finances that seems more evident every week. As the United Kingdom overtakes Germany in the percentage of economic activity devoted to taxation, an air of gloom is settling over the UK Treasury. The economic forecasts so confidently put forward by Gordon Brown are about to be trashed from all sides. The Labour government will finally have to make some genuinely "tough choices": what expenditure programmes must they cut? British public finances no longer obey any kind of golden rule and unless there is a radical change in policy, then Britain too has run out of room for maneuver.

Worse may be yet to come, according to Houseprice - click on link above. The persistent house price inflation of the last decade has probably come to an end, and may well now go into reverse. The ratio of house prices:average earnings has now reached an historic high. There are two schools as to what may happen next. The first is that the market has undergone a fundamental shift and will now settle, but that owning a house will not be as universal as it has been over the past thirty years. The pattern of most of the twentieth century included a large rental market, both private and social- council- housing and this more mixed market will now return. The alternative is that the prolonged boom will be followed by a sharp and dramatic bust, as took place in the early 1990s. The chances are probably higher for the second than the first, but in any event the growing insecurity of the housing market should certainly give pause for thought.

Given the various bear signals, it is hard not to conclude that "events" are about to move beyond the ability of even this government to spin them. Even the rumoured return of the much feared Alistair Campbell will avail Labour nothing if the growing pressures in the energy market finally force an economic down-draft upon the spendthrift American economy. Britain too is potentially on the bring of being forced into a government retrenchment that may be as protracted as it would be painful. Yet the policy mix on offer from the Tories is certainly not the radical Liberal approach that could reduce the role and cost of the state. Clearly ,the Liberal Democrats too will have to revisit their whole approach to the economy in the face of a major shift in economic fundamentals. That we should cap the size of the state is not in question, where we should cap it clearly is in question.

More to the point, the very basis of improved global prosperity over the past decade- freer trade- may now come under threat. The growing protectionism in Latin America may yet spread, and should the USA succumb to this false hope of "protection" the consequence could be a return to the beggar thy neighbour policies of the 1930s.

We face major threats- global financial instability, the stalling of the housing market in the UK, the consequences of profligate government expenditure, protectionism. Some may say I am being alarmist, that in fact we can handle these problems. My reply is that we should not underestimate the utter foolishness of our political class- as today's sordid and ludicrous revelations about Mark Oaten underline- I do not see leaders with economic understanding and vision. As that controversial classicist, J. Enoch Powell once said: "History is littered with wars which everybody knew would never happen."

In the face of a more uncertain future, the temptation is to vote for Menzies Campbell as the new leader of the Liberal Democrats. However, having rejected Simon Hughes, I am more intrigued than ever about Chris Huhne's ideas. Between those two candidates, I now slightly favour the more literate economist- as indeed does "The Economist", I hear from friends.

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