Thursday, March 06, 2008

Sterling blues

As Sterling hits further new lows against the Euro, the economic outlook for the UK seems more unstable than for some time.

Currency traders seem to be latching on to the structural problems of the British economy as a reason for selling. In short these problems come under four general headings.

Firstly, the UK has seen the largest increase in residential property prices over the course of the past 15 years. Average prices have more than doubled, but wages have not kept pace. The ratio of average house price to average earnings has gone from three times to more than six times. This is historically well out of line, and as inflation in food and energy prices nibbles away at spending power, the pressure on British consumers is intensifying.

Meanwhile, one major strength of the UK, which has been its ability to attract labour from such countries as Poland, is now also weakening. The weakness of Sterling has meant a stronger Zloty, and as wage rates have increased in Poland, the relative wage gap has fallen to the point where many Poles are now returning home- this a significant source of cheaper labour has now reduced. This may also have a marginal effect on house prices, as those who have bought to let find that rental demand has fallen.

At the top end, the cack-handed attempt by the government to tax non-doms is causing many to reappraise their commitment to the UK. Several investment firms are now considering relocation away from London. Although the income tax take may be small, the VAT and other taxes ARE paid by non-doms, whenever they spend money here, so should they move away, then economic activity will be slower and the tax take will be lower.

The fiscal burden in the UK is now quite high. The closing of various tax loopholes, especially on CGT, and a steady increase in the overall level of general taxation- although not the nominal rate of income tax- has increased the overall fiscal burden substantially. Although Gordon Brown was able, with some twisting of the figures, to stay within his pre set limits, it is practically impossible for his successor in the Finance ministry to do so. Government expenditure is high, and set to increase further. Yet the public sector continues to deliver poor quality services, even despite the substantial expenditure that has been laid out. Admittedly there has been a substantial waste in many projects. The NHS IT system has turned into a GBP 13 billion white elephant. The repeated crises in Agriculture have resulted in further lost billions, the PFI projects are also set to be far more expensive than was first mooted. The latest fiasco, that of Northern Rock is also set to cost the Treasury about GBP 7 billion, based on the fact that Northern Rock paper is being bid at 93 Pence on the Pound. All of this extra expenditure has brought little tangible benefit.

The NR affair has also brought home two further points of weakness- our dependency on financial services, including our regulators and our currency. The City has, in recent years, been challenging to be the leading Financial Services centre on the World. The relatively light regulatory burden was touted as a competitive advantage. However the failure of Northern Rock was massively amplified by the failure of the regulators to get to grips with the business until it was too late. The relatively smaller liquidity of the Sterling market has limited the options available, so that while there have been problems with both German and Spanish banks especially, these have been handled more effectively. The implosion of the global credit market will have a disproportionate impact on the UK, as jobs are lost from the City. It is now inevitable that Sterling will weaken still further, and one hedge fund manager said to me smilingly that he could see the real chance of Pound:Euro parity. "At that point", he said "Prime Minister David Cameron would be pleading with the ECB to let the UK into the Eurozone".

The situation in the British economy is complicated, with many pieces in play. However, the position is difficult, but not hopeless. It is essential that the state reduces dramatically it direct involvement in the economy. The burden of taxation must be reduced, and it is essential that the extraordinarily over-complex tax code is simplified drastically. I also believe that since the Poles are leaving, that we will need to find an alternative, and i suspect Ukraine or even Russia could be a good source of the kind of workers who have helped to maintain our economic momentum- at the moment this is down tacitly, but I believe that visa free travel from Russia and Ukraine might help the British gain a stronger economic foothold in these important countries, as it dis with the Baltic countries before.

Free trade, less regulation and a more open economy are all strongly liberal positions, and in the face of a protectionist clangour that is emerging in the US, we should not be afraid to speak out for these effective and important principles. I also believe that, although we should retain and develop our relationship with the US and with Canada, we need to engage further with the European Union. However, as with Britain, so with Brussels: we should explicitly state what the limits of European level decision making actually are. We should not be signing a blank cheque for ever closer Union. In that sense both the failed Constitution and the reform treaty that replaced it were significant improvements on the current position. In fact, since even David Cameron insists that he would not leave the EU, there is some general acceptance that the EU serves a positive purpose. It would not do our position in the EU any harm if this was publicly acknowledged by our political leadership.

The UK is headed for a period of economic weakness, which could be quite prolonged. The political fall out will be significant- to the point that the next election could well be the one to lose, rather than to win such is the scale of the poisoned chalice that the winners will inherit. However the crisis could become a catastrophe unless a disciplined economic policy, based on economic liberalism is adopted soon. This is the challenge for all political parties to rise to- I wish I had the confidence to believe that they will.

2 comments:

fh said...

What a thoughtful and intelligent piece. Thank you. Odd though isn't it that, in Westminster, one does not hear this kind of talk at all. Little about the fiscal burden, the dilemma of high costs and poor delivery, or the UK's extreme vulnerability to the downturn in financial services. Instead, it's all more for the NHS, more for education, more for transport. As if we could possibly afford it.

I agree that the next election could be one worth losing. I do occasionally wish it might be possible that all of them would do exactly that.

Newmania said...

Low taxes yes , unrestrained immigration no .It is a cost not a benefit by any reasonable calculation and a cost born by ordinary working people and their children suffering hopeless school conditions urban societal breakdown and swamped services...quite aside from changing the country in away the majority do not want. You would not understand.
EU membership on the beyond dubious basis that it would have helped Northern Rock absolutely not. Absurd. Northern Rock`s troubles had nothing to do with sub prime and the ability to borrow even more is the last thing we need. The regulatory bodies New Labour have imposed have of course been useless. can you think of one thing they have actually got right ...one ?
The FSA are the bane of my life and if the day should the day come when I do not have to teach unemployable thicko`s the right way to sit on a lavatory seat while they get paid twice as much as I do there will be bunting .
The European Union is dead in this country its a question of how to get ourselves out of the mess. Its protectionist expensive undemocratic and harmful to our security damaging to relationships with our real allies .The notions that we will be excluded from trading is ridiculous , we are a huge market for the EU and they can be replaced easily Others manage rather nicely and it would be amazing if they did not . This reminds me of the claim that the GLA is responsible for the prosperity of London. Onoly someone who has never created any money would say such a thing
Should we have to do without BMWs...I could learn to live with IT ....DO BE SERIOUS . The advantagesof freedom are considerable and developing relationships with countries to whom we can offer comparative advantage is the wise route. Remember 80% of economic activity is internal .
I think it is possible that if the whole vainglorious arrogant project was pared back to the single market a rapprochement might be available by the people to whom the political elite have been lying and continue to lie threaten and attempt to intimidate often with transparent fictions . Economic Liberalism in the world for the benefit of this country and its people out of Europe. Cicero..the Treaty of Rome was a Constitution,...that why you can achieve the same thing with a treaty. It has not failed it has been sneaked through against the express wishes of the people of this country which they have made entirely clear. It contains a ratchet for further removal of sovereignty and shifts a gear whereby the United States of Europe is a reality.






No-one cares what assorted foreigners say about us they are only a a light sprinkling of corrupt chancers justifying their endless waste .Our relations with Europeans are good we simply wish to be a free and democratic nation...if that’s alright . Meanwhile , the EU is now about to destroy Fireworks Parties with some new regulations about the loudness of Bangers and the distance from Fire. There will be a riot in Lewes and Norman Baker will be blamed rightly so, He lied .