Simon Rubinsohn, chief economist at Gerrards, explains the effect he believes Labour will have on...
Simon Rubinsohn, chief economist at Gerrards, explains the effect he believes Labour will have on UK business and the economy if re-elected for government.
From the moment the starting gun was fired in this general election campaign, there has been little doubt about the outcome. Such certainty, in part at least, helps to explain the reluctance over the last four weeks of UK financial markets to let their attention drift too far from events on Wall Street. It also highlights a diminished sense of political risk in the UK; for all the rhetoric, the two main political parties are actually in broad agreement on most of the key areas of economic policy.
However predictable or not, the election outcome and the collection of policies that go with it impact investors and, consequently, the approach to investment. Attention on the next term's agenda as it emerges is inevitable. However, far from the clearly set out ambitions of the Labour Party in 1997 (with such major proposals as devolution to Scotland and Wales and reform of the House of Lords on the cards), the details of the 2001 agenda are not so clear. Markets will be watchful for any early surprises reminiscent of the unexpected speed with which, following the 1997 election, the new Government gave the Bank of England its independence. This time round, with its reputation for economic competence established, there is rather less need for the government to implement any headline grabbing, demonstrably confident, measures to provide reassurance for investors.
Despite the expected result, there are a number of important areas of policy where questions remain unanswered. Tony Blair will be under some pressure to provide clear guidance before too much longer.
One issue which surfaced briefly during the election campaign is that of Labour's medium term plans for public expenditure. Having stuck to the previous Government's spending projections for the early years of the first term, the Chancellor then announced a substantial increase in resources for the three year period 2001/02 to 2003/04.
Most striking was the 6% plus real annual growth planned for health spending and the 5.5% plus real rise in education spending. The Government has argued that these increases are affordable because of its 'prudent' handling of the economy; this has curbed debt interest payments and capped social security spending. If these key services have not visibly improved by 2003, there will be pressure on the Government to throw more money at the problems. As things stand, the Treasury envisages the overall budget moving back into deficit, in a modest way, in the next financial year (2002/03). It is then expected to deteriorate a little further over the following couple of years while, importantly, still always meeting Gordon Brown's fiscal rules.
A big package of spending increases would certainly jeopardise the Chancellor's carefully crafted reputation for prudence, ringing alarm bells in the gilt market. On the other hand, the failure to meet the electorate's expectations in key public services could seriously damage the prospect of a third term in power for Labour.
It is conceivable that, in such difficult circumstances, the Government could be bailed out by a re-invigorated American economy. This would set a positive tone for growth elsewhere around the world, not least in the UK, quite possibly enabling the Exchequer's revenues to continue rising rapidly. This, in turn, could facilitate a further period during which the happy combination of higher spending levels and budget surpluses can be sustained.
Significantly we suspect that Labour is already recognising the risks associated with the worst case scenario in its recent proposals to introduce greater private sector participation into the provision of public services. Schools and hospitals are both seen as areas where the injection of more dynamic management could help to bring the best out of the additional resources being committed. Although bond investors may need some convincing, and the government has yet to be tested in this area, we doubt that having invested so much in building up a reputation for economic competence that either Tony Blair or Gordon Brown would willingly jettison this.
More troublesome still could be the issue of business taxation and regulation. Although the government has been happy to boast of its success in creating a healthier environment for business, it clearly remains reluctant to ease the tax burden on the corporate sector further. Its decision to stick to the plans to implement both the climate change levy and the aggregates tax, while disguised behind an environmental mask, is indicative of this. Similarly, it is hard to see the mounting concerns over the increased burden of regulation being assuaged.
At best, the Prime Minister seems determined to resist the pressure from Brussels to implement further workplace rules. However, whether he can withstand the overwhelming demands for consultative committees looks doubtful. Closer to home, the most that can be hoped for is that the government proves sensitive to the request from smaller businesses for some assistance in helping to implement the Working Families Tax Credit.
Possibly more encouraging for the equity market are the indications that Labour could be willing to shift the goalposts for mergers and acquisitions. In its business manifesto it suggested that in future "they will be judged by whether competition and the consumer are harmed, taking account of globalisation's impact on markets". This appears to signal a clear break with the approach to take-over policy seen in the UK over the last thirty years. From recognition of the role of global market movements in competition should follow the relaxing of attitudes towards UK to UK acquisitions. This could mean that in future fewer eyebrows would, for example, be raised by Lloyds TSB's current attempt to acquire Abbey National.
At some point during the lifetime of this Parliament, the UK's membership of the European single currency is likely to raise its huge head. Although largely accepted as keen to move the UK into the Eurozone, so far the Prime Minister has only made a commitment to re-examine the five tests established by the Treasury back in 1997. These were designed to assess whether the economy had converged sufficiently with the Eurozone to make participation in monetary union desirable. As the debate moves forward we are likely to see more Cabinet ministers making pro-Euro speeches, something which the Government has hitherto avoided.
In truth, the Treasury's tests are fairly subjective and could be used to justify whatever outcome the government wishes. Of course, even if the conclusion reached is that membership would be in the best interests of the country, the bigger hurdle of the referendum would still have to be jumped. With opinion polls showing a huge majority in favour of remaining outside the single currency it will take all of New Labour's marketing skills to turn things around.
The prospect of Euro membership is unlikely to do very much for the gilt market, with benchmark yields now trading pretty close to those in Germany and France. Equity investors could, however, view such a prospect with greater relish. One reason for this is quite simply the downward pressure that, as things stand, would result on base rates. The other is that it is improbable the Government would wish to lock Sterling into the single currency at current exchange rates. Something 10% lower is the least that is likely to prove acceptable. Any depreciation in the Pound would naturally not only enhance the competitiveness of exporters but also provide a welcome boost to the value of overseas profits.
Putting the issue of the single currency to one side, financial markets tend to benefit most from a stable economic backdrop and this has been a key reason for the generally healthy performance of both gilts and equities during the first term of a Labour Government. More of the same would almost certainly do very nicely for the next four years. However, in seeking to achieve this the Government will, as all Governments do, need a healthy slice of luck.
Simon Rubinsohn is chief economist at Gerrard, the private client investment managers.
If you have any comments about this article or anything else, either email the editor through the hyperlink (see right) or go to IFAonline's opinion pages and discussion boards.
Lack of innovation for solutions
Some 2,000 consumers affected
Achievements, charity work and other happy snippets
Appetite has suffered since Brexit vote
'Failure to pay attention can result in enforcement'