The Budget 2011
March 24, 2011
Disparity in the central London property market The potential impact of the election result on the Brexit negotiation strategy My view on the proposed Conservative-DUP arrangement DISSOLUTION OF PARLIAMENT DISCLAIMER Bring it on: How Britain can master the long journey out of the EU
March 24, 2011
At its heart, this Budget acknowledges that a brighter economic future for our nation will be forged only by embracing avenues of sustainable growth. We have a proud history as an outward-looking trading nation. By liberating our smallest, start-up businesses from stifling regulation and convincing the world beyond that we are ‘open for business’, this nation will thrive as the global economy recovers.
But there is no room for complacency. Most of the UK’s economic competitors are desperate to break into developing markets. Not only in China and India but also in Vietnam, Indonesia, Brazil and Columbia to name but four. Financial services and its vast array of associated service professions has provided this country with an enormous competitive advantage in this regard, not least as the increased wealth and propensity to save from people in these new markets will ensure that this sector will continue to grow rapidly in the decades ahead. Whatever the current distaste for the banking fraternity, it is firmly in the national interest that the City of London and the UK maintain its global pre-eminence in this highly mobile sector.
Looking ahead, what the financial services fraternity now needs is greater certainty that we truly are moving beyond the ‘banker bashing’ debate. The City broadly accepts that things cannot in future be the same as they were – indeed many bankers would point to the increased levels of capital held by their organisations since the tumultuous events of autumn 2008. Unfortunately with the Banking Commission (whose work will include an examination of whether to break up our biggest banks) not due to report until September, there remains the perception that the banks are still fair game. Many financial businesses are now spending huge sums trying to second-guess what regulations might be coming over the horizon in this environment of damaging uncertainty. When such uncertainty encourages the holding rather than lending of capital, regulation becomes a problem not just for the banks but for the wider economy, as businesses seek to borrow and grow.
Naturally free trade is promoted best by a competitive, transparent and certain tax system. We have already seen vision and leadership on corporation tax (which will be reduced in each of the next four years) and entrepreneur’s relief, but the same must also apply to our income tax rates which are now amongst the highest in the developed world. It is encouraging to see the Chancellor making the case for economic efficiency and maximised tax-takes, even when most of us can appreciate the political difficulties in reducing higher-rate taxation levels at a general time of austerity and rising living costs.
Open trade must apply to human capital too. Sustained growth in this difficult era will only be promoted by private sector commerce and global businesses based here will want to recruit the most talented people. This should be encouraged, not restricted, if the UK is to be truly open for business. Similarly students who come to study here will return to their homelands as lifelong ambassadors for this nation. If the UK is to be home to global leaders in all business sectors it needs to be open to the brightest and best talent internationally and I am delighted that the government has been open minded on this issue and rethought some of the draconian measures originally put in place to restrict the flow of international students.
Closer to home, it is worth mentioning some of the concerns from business people coming through in my constituency work. I fear there is the continued perception that we politicians have no real understanding of the risks and sacrifices taken by business people in trying to generate wealth.
We must be mindful too of the unintended consequences on small businesses when, in a bid to reduce the deficit, government contracts are cancelled. A constituent operating a small financial services business recently advised, ‘I have faced a ruthless, largely unintelligent and exceptionally unpleasant series of demands from the Inland Revenue for tax. This has drained my energy, wasted my time and severely hampered my ability to restore my business to profitability as well as exposing the Inland Revenue as incompetent. The underlying problem was this: the IR, part of the government, was demanding a large sum of money, which I could not pay, because another part of the government had reneged on one contract, cancelled another and delayed payment on a third’.
In essence, we must always make sure that our rhetoric on the liberation of businesses is grounded in reality. Our wealth creators must not just be told we are on their side – they need to feel it with demonstrable action. We must relentlessly pursue our task of giving British businesses, large and especially small start-ups, all the tools they need to repair our confidence-battered economy – for it is only their energy, innovation, enterprise and freedom in the global market place that will provide the growth essential to recovery.
I accept, however, that part of that task entails creating the underlying economic conditions in which commerce can flourish. Here the government faces an immensely difficult balancing act.
The sombre truth is that so long as the Bank of England maintains a virtual zero interest rate policy, our economy will remain on a taxpayer-induced life support machine. Implicit in our inability to lift ourselves from this economic coma is a hard-headed recognition that the recovery is simply too weak at this point to withstand tighter monetary policy. Indeed if interest rates started to rise significantly we should be under no illusion that this would precipitate an increase in bank foreclosures, as many businesses would quickly be regarded by lenders as no longer viable. Meanwhile the brutal truth is that collectively we continue to live well beyond our means and zero interest rates disguise that damaging fact.
In essence the continued solvency of many businesses and many thousands of individuals depends on their creditors (namely the banks) having little incentive to pull the plug whilst interest rates are near zero. Yet so long as we avoid such a scenario, the underlying economic problems will remain parked, not solved.
So I fear that as time rolls on, dark inflationary clouds gather. The Treasury and Bank of England are well aware that we are entering a very dangerous period. By rights given its express inflation targeting obligations, the Bank should already have raised interest rates well beyond 0.5% many, many months ago. Whilst it also has a less high profile duty ‘protecting and enhancing the financial system of the UK’, the inflation is now a serious issue to control.
At the end of last year Lord Young controversially observed that for the overwhelming majority the recession was ‘happening to someone else’. By contrast, nothing will bring home more to the majority of Britons that their own economic reckoning is underway than a marked rise in their mortgage repayments. The extra £20 or so taken up by the weekly shop or in filling the car with petrol will be as nothing to the impact of rising interest rates and the cost of borrowing returning to proper levels. Remember this would already have happened last year if the Bank of England was obeying its inflation targeting responsibilities to the letter.
So the story of 2011 as the year gets older will almost certainly be one of a rapid rise in the cost of living as both global commodity prices and taxation spike upwards. The cost of oil has been highly volatile in recent years, but the 75% rise in price over the past six months may prove more difficult to reverse. The exponential growth in demand from emerging economies (also affecting copper, steel, cotton etc.) may be compounded if political unrest in the Arab world persists or intensifies. Then there is a global shortage of wheat as a result of failed harvests in eastern Asia, the effect of the Queensland floods on the price of iron ore, coal and other minerals and the untold impact of the devastation in Japan and unpredictable future events – who knows what lies in store?
The impact of extraneous events would be compounded if interest (and mortgage) rates were to return to normal levels. Understandably policymakers are fearful simultaneously of the risks of stoking up inflationary expectations and choking off early signs of sustainable economic recovery if interest rates are raised.
The prolonged near-zero interest rate environment has enabled banks to continue holding toxic assets without realising their losses. Similarly, as I have suggested, there has been no incentive for banks to foreclose on many struggling businesses and indebted individuals. The impact of even relatively modest interest rate rises would undoubtedly be for creditors to cut their losses. The Council for Mortgage Lenders calculates that the impact on homeowners already perched on the edge of insolvency of a rise in base rate to 2.5% would be devastating to some three million borrowers. It would also lead to a confidence-sapping depression in both house prices (and more accurately still, house values, for those who have become accustomed to borrowing against the rising value of their main asset).
As I have said, the continued failure to raise rates is an implicit recognition by the Bank of the underlying weaknesses of UK plc after three years of patchy or negative growth. Yet the political pressure to keep rates down may test to breaking point in the year ahead the independence of the Bank of England over monetary policy.
The key challenge now is to tackle inflation without adversely choking off growth or economic confidence. I fear that in current circumstances it is nigh-on impossible to see how we can achieve both.
The calculated gamble by policymakers is that a little inflation in the system is now more desirable than the alternatives. Yet history teaches us that once in the system, inflation is difficult to control.
The Treasury has skilfully succeeded in persuading the markets of the government’s intent to control the deficit, in spite of public spending projected to be higher in 2014-15 than in the last financial year. As growth forecasts for the next two years have been slashed, so projected borrowing figures have been raised by £37 billion over the next four years.
The financial markets may soon need convincing of the resolve to keep the cost of living down. Especially as the biggest beneficiaries of the debasement of currency that comes with inflation are debtors…..and government is the biggest debtor of them all.