Economics: Clarke talks tough as he shifts course

THANKS to our valiant band of lobby correspondents, many people will be suffering from the delusion this weekend that the coming public spending round is likely to be the 'toughest for 15 years'. Even the Financial Times parroted this Downing Street interpretation on Friday, though it is wildly exaggerated.

This episode neatly illustrates the real problem with the political lobby at Westminster, which is not the secrecy or non-attributable nature of its briefings, but the impossibility of its members being well-informed about the gamut of issues they are expected to cover.

There is nothing personal about this. The best and brightest of British journalism head for the lobby. But it would be beyond the wits of an Einstein to be well-versed in every policy debate of every ministry of a Government that spends 45 per cent of national income.

Political correspondents repeatedly have to make judgements based not on knowledge but on whether they trust their contacts.

It is difficult to strike a balance between being led by the nose, or becoming so sour with the whole system as to presume everyone a knave. On Thursday, Downing Street clearly wanted to appease the Tory right by giving the impression that the spending round would lead to blood on the carpet, if not the streets. It succeeded.

The true position is set out in the bar chart, which shows the Government's New Control Total for public spending in real terms, after allowing for the general rise in prices throughout the economy (ie, the GDP deflator) projected in the Budget.

Over the past two years, there was a dramatic 8.5 per cent real increase in public spending. The modest objective now is merely to hold the present total steady for two years before allowing a little (pre-election?) growth.

The New Control Total strips out about two thirds of the public spending affected by the business cycle, notably social security. But it includes the financing requirements of nationalised industries and also housing benefit, so that some of its recent rise is due to the recession. But that cyclical component within the New Control Total means that the Government's task in holding spending constant in real terms should be easier over the next two years, because the cyclical components will be shrinking.

Moreover, the Government has a little headroom because inflation was lower in both 1992/3 and 1993/4 than was thought at the time of the plans. Given that real government spending was held flat in 1981 and 1982 despite the impact of recession, and given that it fell outright in 1977 and 1988, no one should be too impressed by the Cabinet's objective.

The Downing Street spin may be symptomatic of a wider shift in economic policy. In a sharp break with the rhetoric of the Thatcher years, the Chancellor said in his 'Mansion House' speech on Tuesday that the pursuit of low inflation on its own was not enough and pointed out that the ultimate objectives of economic policy are growth, jobs and living standards. We have come a long way from the old Thatcherite assertion, reiterated by a clearly worried Lord Lawson on Friday, that government macro-economic policy can only influence inflation.

Over time, this change in tone and in ideology will subtly affect the new Chancellor's decisions. He will probably be keener on capping sterling than his predecessor, because he will be more enthusiastic about encouraging manufacturers than about curbing the impact of higher import prices on inflation.

As a Midlands MP, he will remember the appalling effects of the overvaluation of sterling during the 1979-81 recession, when manufacturing fell by a fifth.

Indeed, the new Chancellor may be tempted to cut interest rates soon, if only by a half point, as we report today. Mr Clarke has a political motive. An interest rate cut would help him draw some credit for sustaining the emerging recovery. But there is also an economic rationale, which is that an interest rate cut would stop any rise in sterling.

This change of emphasis does not necessarily mean that the holders of fixed interest government debt (whose value is eroded by higher inflation) should despair. If the Chancellor waits for another continental move before cutting British rates, there would be no reason to accuse him of inflationary tendencies. But he would be wise to be cautious.

On the face of it, last week's inflation figure was better than expected at 1.3 per cent in April, holding the lowest rate since 1964. Even the underlying rate, excluding mortgage interest, edged down by 0.1 of a percentage point to 2.8 per cent. But this figure is flattered by the shift from poll to council tax, and there was a gentle warning against any further interest rate cuts in the figures for factory gate prices, which showed a rise of 4 per cent over the year.

Moreover, last week's other indicators suggest that the recovery is solidly based, and there are the first signs that it may have a beneficent pattern. Retail sales volumes continue to be flat, but this is as it should be if we are to curb our appetite for imports. Manufacturing output is powering ahead at an annualised trend rate of some 5 per cent, which means that exports are probably performing better than the dire recession in our European markets should have led us to expect.

The best news of all was on unemployment, which fell for the fourth successive month. The main reason for the decline is probably shrinking labour supply, particularly as 16- year-olds stay on in school. But there may also be a rebound in jobs growth after the excessive shake-out of last autumn, even though this has not yet been picked up by either the Labour Force survey (which finished polling in February) or the Government's employer surveys. There is little case for a rate cut just now.

The second key test of the Chancellor's policy will be how much he raises taxes in his autumn Budget. There is everything right with a relaxed monetary policy, low interest rates and a moderate sterling exchange rate, providing that the Government's decisions on taxes and public spending choke off any incipient inflationary pressures. The failure to take more of a tilt at public spending means that Mr Clarke will need to raisemore from taxes.

After all, the deficit is expected to shrink by only pounds 6bn in 1994/5 to pounds 44bn even with a spending target that is 'the toughest in 15 years'. Pace the Tory right, tax increases should be directed at incomes rather than spending, because a rise in income tax or National Insurance contributions does not directly add to the Retail Price Index.

Mr Clarke can privately hope that the deficit will go away, as it might if the economy grows more rapidly than now seems likely. But he should also reflect, whether in taking decisions about inflation or the deficit, that chancellors rarely fail because their intentions are bad. They fail because they succumb to wishful thinking about their own propaganda. This week's little episode about a 'tough' public spending round is just a touch worrying.

(Graphs omitted)