Hamish McRae: They pull the levers but to little effect

Economic Studies

What does a hung parliament do to the economy? The popular perception is that this would be bad news. There has indeed been a knee-jerk reaction on the foreign exchanges to the apparently increasing probability of such an outcome: minority government equals weak government, which in turn equals weak financial management. So the pound goes down.

It is always perverse to dismiss the obvious, so anyone wishing for a minority government, whoever they would like to lead it, needs to be aware that the conventional perception that it would be an economic disaster may be right. But it is important to remember that it is only a government. When politics and economics clash, economics wins in the end.

We are seeing that in Greece at the moment. It does not matter who is in power there; there are certain inevitable financial actions that have to be taken and the government of the day has to do them. In any case, on past form minority governments in the UK do not last very long, and this one most certainly would not last long if the country plunged into some sort of economic disaster on its watch.

The real question then is not so much whether a hung parliament would be good or bad but the extent to which it will be in control of events.

Seen that way, the most pressing issue is whether the next government will be strong enough to exert control over the fiscal retrenchment that is inevitably going to take place. Either the government will be strong enough to bring in the spending cuts and tax increases that are inevitable or it will be forced to involve the International Monetary Fund (IMF). Indeed a minority government might be wise to involve the IMF in any case, to achieve independent validation of its policies. It would be obviously embarrassing to do that, given the memories of 1976 and the experience of Greece now. But the impact on both fiscal policy and business confidence might be better than a go-it-alone strategy. What looks bad in political terms might actually turn out to be good for the economy.

That leads to a second issue, the impact of a minority government on confidence. Here the concerns should be greater because the reaction to any such government will be that it won't last long. So decisions are postponed. The path of interest rates is uncertain. People don't want to take on additional mortgage debt so they don't move house. Domestic firms postpone investment. Foreign ones question whether it is really a great idea to invest in the UK anyway. The present uncertainty has already reduced the flow of inward investment and the possibility of a new government that was unfriendly to the international business community would inevitably cut it further.

Having said all this, though, we do need to remember that just as politicians do not have much control over economies, economies can and do soldier on without political intervention. The fact that a government is weak may reduce its ability to bring in positive economic policies, but it also cuts its ability to screw things up.

The next government, whatever its character, will inherit the worse fiscal deficit since the Second World War. But it also will inherit a world economy that has started to grow again, and with that, a British economy that is picking itself up, dusting itself down and figuring out how to make the most of the next growth phase.

That "phew, the corner has been turned" feeling is reflected in share prices everywhere. Though it is perfectly reasonable to expect some sort of double dip in the world economy in the next few months, it would really be extraordinary if, in say two or three years' time, the major economies had not made up most of the ground lost in the recession. We won't be back to the old growth trajectory but we will be back past the level of activity of the last peak.

It may even be that we need to experience a period of weak government to teach us the limits of political power. Politicians pull levers in Westminster and Whitehall: they bring in laws and regulations, they have "initiatives", they try and create incentives. But if the experience of the past two years tells us anything, it is surely that when they pull the lever, there may be nothing attached at the other end. If they could have stopped the recession, they would have done so. So if the economic power of governments is much weaker than it used to be, maybe it makes sense not to give our next government too much political power either.

And if, beyond that, we look to ourselves rather than government to fix things, then that too will be a healthy development. There is a sea-change taking place in the relationship between the individual and the state, and an awareness of the limits of politics is at the centre of that shift.

The fall from grace of Goldman Sachs has been sudden and swift on both sides of the Atlantic. But if in the US the investment bank supplied Treasury secretaries to both Democratic and Republican administrations, here they have merely been cheerleaders for Gordon Brown. In the final months of his chancellorship, a seminar held at the Treasury was packed with foreign bankers and business people, who successively praised British financial management in general and the incumbent chancellor in particular.

The then head of Goldman Sachs in London was given a special slot in which he explained that it was thanks to Gordon Brown's enlightened policies that Goldman based its international business in London, not New York. Other foreign business leaders banged on in similar vein, while the heads of the British businesses quietly fumed – then a couple of them buttonholed me to tell me how angry they were.

To his credit, Alistair Darling, who was also there, picked up these dissonant noises and asked the heads of companies that had signalled they were not members of the Chancellor's fan club to talk with him privately about their concerns. Looking back it is hard to credit the elevated status of Gordon Brown in foreign banking circles, but that was then and this is now.

By the way, the spell check on my last computer offered the alternative of Goddam when I typed in Goldman. The present one offers Gold mine.

h.mcrae@independent.co.uk

For further reading

"No overall control", edited by Alex Brazier and Susanna Kalitowski, Hansard Society; www.charter2010.co.uk

Tomorrow: International Studies