Labour in office could surprise us all

When I present to my clients on the economy, the most frequent question is: 'How would the prospects change if there were a Labour government?' Tony Blair's remarkable popularity in the opinion polls makes this especially pertinent.

Before the last election I predicted that if Labour won, we would see higher public spending with extra taxes and borrowing, that the pound would be forced to pull out of the European exchange rate mechanism, that the flow of inward investment into Britain would slow and that there would be some extra inflation caused mainly by the knock-on effects of a minimum wage.

Not all the predicted effects were negative - withdrawal from the ERM was forecast to lead eventually to a revival in growth. But the most damaging conclusion was that the combination of a minimum wage and acceptance of European social legislation meant that, even with an economic recovery, few extra jobs would be created.

Since then the international economic environment has improved. For Tony Blair this has a number of effects. Continued export-led economic revival means that no one can write off the Conservatives' election chances yet.

On the other hand, if he wins he is unlikely to have to cope with the international economic crises that derailed Harold Wilson's government in 1974 and Mrs Thatcher's in 1979. But the investment requirements of economic development in Eastern Europe, South- east Asia and Latin America, combined with low levels of savings in the developed world, will probably cause a capital shortage worldwide. This means that higher expenditure will need to be financed mainly by higher taxes. There will not be the scope, like last year, to run a pounds 45bn borrowing requirement.

The increased influence of the Bank of England on monetary policy is critical. Although an aggressive economic expansion in the run-up to an election is unlikely, an incoming Labour government would find itself forced to raise interest rates if its policies appeared inflationary. On the other hand, foreign investors, knowing there was a long-stop for economic management, would be less likely to speculate against Labour. It would not be in Labour's interest to change such arrangements.

Conservative policy has also advanced, mainly by stealing Labour's clothes. Both public spending and taxation are now planned to be about pounds 15bn higher than was envisaged at the time of the last election.

Although Labour's 'wish-list' at the last election might have cost anything up to pounds 40bn, the level of expenditure that has emerged under the Conservatives is, I suspect, close to that which Labour would have implemented. Labour would have put up income tax, whereas the Conservative tax increases have mainly affected expenditure.

Meanwhile, the prediction that Labour policies would force the economy out of the straitjacket of the European exchange rate mechanism has come true even under the Conservatives, though not as a deliberate act of policy.

Finally, the Labour Party has changed. It believes that it lost the last election because of the proposed tax increases for those on middle incomes or more. Now the focus for tax increases is on the 'very rich' and through 'closing loopholes'.

These won't raise much revenue - the 'very rich' can move between tax regimes and there are no obvious loopholes to be closed without damaging the economy. Taxes might be imposed on activities that damage the environment, but experience of extending VAT to fuel shows the practical difficulties.

There is not much extra tax revenue to be grabbed by even a left-wing government. Although British taxes are lower than in Continental Europe, the trend in Europe by the time of the next election will be for expenditure cutting and ultimately tax cutting, and everywhere else taxes are already lower than in Britain.

With little scope for higher taxation or borrowing, how could a Labour government finance higher spending? One answer is private finance for infrastructure, freeing resources to be spent elsewhere. But the present Government is already gung-ho for using private finance and would try to commit as much as possible before the election.

The difficulty with private finance for public projects is that such projects need to jump through two sets of hoops. They have to satisfy the private sector's need for profitability besides the public sector's traditional tendering procedures.

I suspect a new administration that was less in awe of the Treasury might be more prepared to relax procedures that constrain the use of private finance. But I doubt if this would generate more than pounds 2bn- pounds 3bn. And the Conservatives would hope to have committed at least as much as this from further privatisations, an option that would be ideologically difficult for Labour.

So it would be difficult for Labour to finance extra spending. This will disappoint supporters who assume that the reason why the Tories restrict spending is ideological hard-heartedness rather than the laws of economic gravity.

Whether a Labour government would try to spend more despite the difficulty in financing it is, of course, uncertain. It is a problem of the increasing professionalisation of politics that when a party has been, like Labour, out of office for as long as 18 years, its leading members suffer from a serious shortage of experience in running anything much more complex than a student union bar. But ministers do learn in office and Tony Blair has the advantage of owing few debts to the spending wing of his party.

Labour does remain committed to two measures that are generally thought to be bad for competitiveness, employment and inflation - the imposition of the European Social Chapter and of a minimum wage. In addition, there is the possibility of pro-union legislation.

The effects of a minimum wage depend crucially on the level at which it is imposed. There is a minimum wage in the US, but it is so low that it has little impact. But a minimum wage at, say, half average male earnings would bite, creating some unemployment and adding to inflationary pressures. It was the raising of the French minimum wage in 1982 that created the inflationary pressures that plunged the first Mitterrand government into financial chaos.

Meanwhile, changes in the distribution of employment opportunities mean that in future those who lack good fortune or skills will increasingly face the uncomfortable choice between low-paid jobs and none at all. If a minimum wage destroys the opportunities of low-paid jobs, even that choice may disappear.

The European Social Chapter is as yet undeveloped, and I suspect that eventually competitive pressures will limit the rights which workers can expect to have guaranteed under it. Padraig Flynn, European Commissioner for employment and social affairs, believes that has an unfair advantage in attracting international investment as a result of its opt-out. He may be exaggerating, but Labour's commitment to cancel the opt-out looks a transparent own goal for jobs.

So a Labour government might surprise everyone. International investors and British businessmen, who have traditionally feared Labour policies, could well find that they can live with them. But the less well-off and the unemployed, who have the greatest hopes of Labour, could equally find that misguided social policies create unemployment and make them worse off.

The writer is chief executive, Centre for Economics and Business Research.

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