Honesty could be Brown's best election weapon

While politics is always unpredictable, one can be pretty certain that on Monday, at Labour's pre-election party conference, Gordon Brown will emphasise just how tough he intends to be in running the economy. No risks with inflation, no boosts in public spending, demanding targets for the debt/GDP ratio and no borrowing except for investment. In all probability he will mean what he says, for New Labour has discovered the truth that slack fiscal policy has little to do with being on the left - socialist or otherwise.

But imagine the scene at Mr Brown's first attempt to lay down this line in government. His maiden Budget speech might include something like this. "I can today announce our new forecasts. We have certainly inherited a mess in the public finances. But we are taking firm steps to counter this. The training policies that I am announcing today will boost growth. More important for the short term, I will unveil sharp cuts in our non-priority programmes so as to reduce public spending swiftly. With these measures I can tell you firmly that the fiscal position will be brought under control."

A stirring speech, but to what end? The key aim of such a hard-nosed policy would, of course, be to enable the rebalancing of the economy towards investment and away from consumption. And that requires being tough on fiscal policy, thereby allowing interest rates to stay low.

From one corner the response is predictable. Mr Brown will be howled down by the left and the public sector trade unions. There may even be Cabinet resignations. His policy, it will be said, is a sell-out to the powers of international capital and to monetarist orthodoxy. But what of the other corner, where the prowling menace of the City lies? Do they welcome this stance, confirmation that New Labour is no lover of fiscal imprudence and inflation? Does the "sell-out" pacify them?

The chances are that, despite his perseverance, the markets will be unenthusiastic with Mr Brown's Budget. Far from pushing interest rates down in response to the announced fiscal tightening, they will suspect that the figures are dodgy, that the growth forecasts are massaged and they will discount the idea that the fiscal position will improve. If anything, down will go the pound, and the pressure on Mr Brown will be to raise interest rates again. Tough on public finances - but to no avail. The nightmare scenario.

Why might this happen? The problem is that Labour has a credibility problem on the public finances. Life is not fair and good intentions are not enough. The markets start with a presumption that Labour will always be up to no good in this area.

Of course they have been given a pretty rough ride by Conservative chancellors over the years. They well remember (or do they?) the sheer nonsense they were fed about the fiscal position in the run-up to the 1992 General Election (see graph). They have witnessed a government that prides itself on "sound money" running a general government financial deficit (the Maastricht definition) that in each year since 1992/3 exceeded anything produced in the supposedly profligate years of the 1970s, with a new record set in 1993/4 (7.9 per cent of GDP).

They have observed a government that talks of not spending what you do not earn, that has been borrowing to finance consumption and tax cuts for some years now with the current expenditure exceeding current receipts in every one of the past five years. No wonder they tend to cynicism about government statements.

And yet the markets are still prepared to play along with the Tories' claim that it is OK for them to make tax cuts in the forthcoming Budget, as long as they offer some vague promise of further "efficiency" savings in the public sector, despite the fact that after 17 years, spending as a share of GDP has hardly budged.

The truth is that, however suspicious the markets are of Kenneth Clarke's PSBR forecasts, you can be sure that they will be even less likely to believe any projections put out by Mr Brown.

Indeed, facts barely noticed during the Tory years will suddenly come into focus. The PFI, shunting spending forward to future years rather than genuinely cutting it, will come under the spotlight; unaccounted for contingent liabilities on pensions will be worried about; the net worth picture, as bad as anything we have had for years, will start to be talked about in City wine bars.

What can Labour do about this prospective unpleasant situation?

The problems of market disbelief stem partly from the fact that it is very easy for the Treasury to present the forecasts for the PSBR in a light favourable to the chancellor of the day. It may be that they wilfully lie (and given the "porkies" around the 1992 election, this possibility cannot be totally ruled out). More fairly, it has to be said that forecasts on the fiscal position are very difficult to make.

All economic forecasts are uncertain and should have very big health warning. But the fiscal position is even more difficult. The relationship between growth and tax revenues may, and apparently has, changed sharply. The timings of tax receipts may alter if firms do not invest when expected. The tax avoidance industry can always muck up any forecast. Spending pressures are very cyclical but not always apparent or predictable.

Given this uncertainty the markets will always have reasonable grounds for assuming that the forecast of the fiscal position is too favourable. For this reason they will want real interest rates to be higher than they need be as an insurance policy.

The long-term answer will be for Labour in office to prove it does mean what it says, that it does not consistently give over-optimistic forecasts, that when it uses things such as the PFI, it is for honourable reasons. But an institutional change could help too. The key, but simple, change would be to have such economic and fiscal projections made by an independent body.

Professor Simon Wren-Lewis* has proposed that this body be called the Economic Forecast and Assessment Office (EFAO) and have the job of providing an assessment of future medium- to long-term trends in both the economy and public finances. The extra credibility that this would give such forecasts would mean that interest rates could be lower than otherwise. This idea will strike terror into many, especially on the left. At a time when the Bank of England has more and more power over interest rate decisions, and EMU offers the possibility of this power going abroad, are we now to give power over fiscal policy to an unelected agency as well?

But this is not the point. The EFAO would not decide policy, but give advice on the prospects and the likely consequences of alternative actions. The chancellor would still have the power to ask for different assumptions to be used for the forecast published at Budget time. But because these changes would have to be explicitly noted, he would have to explain to the world why he thought the EFAO was wrong.

Public scrutiny would be enhanced, credibility would soar and, with luck, interest rates would be lower.

Openness then should be Mr Brown's weapon in the fight for fiscal credibility. The same principle applied to the government accounts would also help. Accounts that reflected the true position of the public sector and were totally transparent may make nasty reading at times, but would start to gain a reputation for honesty that should lead to lower interest rates.

It is rare that what is morally right turns out to be good economics. Rarer still that it is also good politics. But in the fiscal case, honesty really is the best game in town.

Dan Corry is senior economist at the IPPR and editor of "New Economy".

* "Avoiding Fiscal Fudge", New Economy, Vol 3 no 3.