Economics and the UK's Great Power Status

Economic pressures are biting hard into British ability to project power. The British have finally left Iraq, handing over security control to the US on April 30th, but are committed to Afghanistan. 179 British military personnel have died in Iraq over six years and the death toll is mounting in West Asia.

Competing Pressures on Budget

There a number of fiscal issues arising here.

The expense of operations East of Suez was presumed to be worthwhile because economic growth, derived from never-ending globalisation, would pay for the interventions necessary to stabilise the lands where the wild things are. That growth has come to a grinding halt.

Projection of power also involved high expenditure along three competing lines - boots on the ground to follow through on intervention, a bigger naval presence to protect trade and energy routes and participation as leading player in the projection of European power.

On top of this were Cold War hang-overs like the independent nuclear deterrent (Trident) and demands for more budget against insurgent and terrorist threats from the security services, not excluding GCHQ budgets for monitoring the Government's own electorate.

This is a massive and mounting sum - nuclear upgrades, better equipment for the army, aircraft carriers, the Eurofighter, hugely increased 'spook' budgets ...

Tough Decisions

... and yet there has been no recent Strategic Defence Review. Few take seriously the threat of a direct assault by any other sovereign state on the island of Britain and the threat of terrorism appears to be mostly talk with any likely annual death rate less than one severe bombing raid on civilians in 1940.

Expenditure entirely depended on increased tax revenue and a politically compliant population that would not mind the steady diversion of taxes into the toys of great power status because it was living it large on easy credit. Neither the revenue nor the compliance may now be taken for granted.

The constituency for worrying about child poverty or the state of care homes had been swept aside with union connivance but, as the mafia say, 'things change'. The state of the British economy has taken all the fun out of defence procurement and it will soon direct attention back to social problems

The Government's refusal to undertake a full Strategic Defence Review until after the next Election creates an illusion of business as usual until the crunch in government spending really takes hold from 2011. This is purely tactical - a hope against hope that New Labour can bluff its way back in 2010.

Government strategy has been reduced to stalling on big decisions wherever it can, kite-flying on the possibility of killing off big projects like Trident (in the context of some US-led wider nuclear disarmament treaty) and spending high now to achieve some short term objective and then get out.

West Asia - A Race Against Time

Take West Asia. UK policy has three components - don't upset the Americans, don't spend any more money than necessary and hope that the Americans can pull off their Iraq trick and allow the British to get out in 2010, preferably just before an election, with honour intact if not enhanced.

The UK has just published its new medium term strategy for Afghanistan and Pakistan to bring it into line with US policy in the area. It will send a temporary extra 700 troops to Helmand to help provide security for the presidential election in August.

But the Army is not happy. Gordon Brown vetoed any further UK involvement in the US troop surge in Afghanistan much to the consternation of commanders on the ground. Their immediate demand for 2,000 more troops was curtly rejected.

The issue of military anger ('incensed', according to the Financial Times) at the Government’s decision is an interesting one because there seems to have been a sustained campaign by the Army to embarrass the Prime Minister in the media.

To some extent, this military anger is a righteous irritation with a failure to resource it properly on mission. To some extent, it represents anger that lack of available force means that Helmand Province will soon become a wholly US command and that Brits will be ordered around as their juniors.

But behind this is the fear that the military may be cut back in favour of aircraft carriers and aircraft in the post-election Strategic Defence Review (probably undertaken by the Tories). If funds are committed to the big toys now, the incoming Government may be faced with a fait accompli.

The Old 'Guns versus Butter' Debate

Boots on the ground ensuring a victory might have been an argument for spending more on soldiers in the future, regardless of the fact that, if the UK can no longer afford a Blairite policy of global humanitarian intervention, there is really not much point in having much of a standing army at all.

The Financial Times sided with the military this week, criticising the Government for trying to conduct war ‘on the cheap’. This is a little naïve about a domestic situation where there is no stomach for massive transfers of funds and loss of lives at a time of economic crisis.

Extra funding was promised to help Pakistan’s counter-terrorism operations as well as education and economic assistance, with pledges of £665m over the next four years. Yet, privately, respected intelligence analysts are telling MPs that the UK should just scuttle from West Asia as fast as possible.

British citizens might legitimately wonder why £665m of their taxes are going to improve education overseas when everyone knows that there will be serious cut-backs in education and in other services at home within that same period to assist in a war that might be supposed to be none of our business.

Case Study in Crisis - The Eurofighter Programme

The end of the days of fiscal wine and roses is not restricted to its effect on overseas operations. The UK has declined to pay £1bn towards the Eurofighter Typhoon jet programme on demand amidst European anger. It will now come to a decision by May 15th and it is not an easy one to make.

Brown was personally called by Merkel, asking him to keep to a commitment for a programme conceived in the Cold War (mid-1980s) and probably of no real use to the UK compared to the more immediate requirement to balance the economic books.

There will be more European protests. Anxiety in Berlin relates to its own domestic politics and should not detain us. The bottom line for us is that the British were quite prepared to bung a £1bn wad towards the European attempt to be a strategic power in its own right as an entry price to the game.

Now the Eurofighter looks like a great white elephant, economically and potentially politically, a grand European project which is really a luxury item and, in fact, the pursuance of continental industrial policy by other means.

Its supporters are increasingly reduced to warning of the effects of a failure to proceed on an industry which provides 40,000 jobs. This is important politically when the main union involved is central to the New Labour project but the argument does not have a great deal to do with national defence needs.

A £1bn subsidy to the defence sector is going to upset a lot of people. Those seeing public spending cuts and future tax rises and those sectors who have not received Government help, notably the rival automotive sector which has had minimal assistance, are not going to be well pleased.

Political Tensions

The military, who would rather have the money spent on improved equipment for missions like Afghanistan, are opposed and have friends in the Tory Party. Drifting liberal and left supporters of the Government, many on the cusp of walking out of the Labour coalition altogether, will not see the point.

The decision affects the Treasury (public finances), the Business Department (industrial policy) and the Ministry of Defence (allocation of limited resources), while pressure from European partners involves the Foreign Office. Eurosceptics could have a field day in the run-up to the June 4th vote.

The UK defence industry is getting equally irritated with the Tory Party’s alleged plans (as yet very unclear) to cut expenditure on defence. Tories are giving private assurances that certain programmes are safe (presumed to be the aircraft carriers) but, in public, the opposite impression is being given.

The Tory Party has the same problem as New Labour. It likes to talk tough and has its own services constituency but it also needs to win and hold power amongst a population who will not take kindly to high taxes and poor services if taxes only mean funding the military.

Prospects

We now have the prospect of two years’ of struggle by the defence and security services and industrial interests to sustain the ‘guns’ budget against some increasingly desperate social demands from the 'butter' interest, with each defence interest squabbling, in turn, over access to what remains.

Unlike the Edwardian era when German dreadnoughts threatened an empire, the 1930s when fascism looked to conquer Europe or the Cold War when Cossacks with snow on their boots threatened to reach the Channel, there are no serious national enemies on the horizon other than a few terrorists.

All in all, unless the 'guns' lobby comes up with a really good scare, they are going to find it harder and harder to compete with any democratic mandate for sustaining the welfare state and resisting tax increases. And perhaps quite right too ... unless, of course, some extraterrestrials arrive on cue.

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The Gloom Budget

As a member of the G8, the state of the British economy is a matter of global interest. It is at the centre of the international services component of the world system but that facility cannot be divorced from its position within a nation state that has to supply the needs of around 60m people on a daily basis.

Within days of the Chancellor’s national budget, his economic calculations were thrown into doubt by news that the economy had contracted at its worst rate in 30 years (-1.9%: Q1 2009), faster than he had predicted.

This means that the economy is not leveling out (-1.6% in Q4 2008) but slightly worsening. The Treasury stood by its predictions although the suspicion must be that the Chancellor had his eye more on international investor sentiment than on playing it straight with the voters.

This is the essential tension within the British political system. The State has to sustain international investor sentiment, also on a near-daily basis, and yet its Government (the temporary holders of control of the State) need to win a majority in Parliament every few years. Democracy can be so inconvenient!

The Treasury is also moving towards significantly higher capital ratios which will mean cash hoards where banks are ‘too big to fail’. The timing of this is important but it means that the big quasi-nationalised banks will not be lending so easily which in turn must be a brake on future 'growth'.

The root of the Q1 collapse seems to be a sharp drop in the output of ‘other business services’. This is already the worst economic performance since Q3 1979, confirming our original analysis some eighteen months ago that we would be seeing a 1970s scenario with 1930s characteristics.

Public spending is now predicted to rise to levels higher than in the crisis of the 1970s when the Government had to be bailed out by the IMF. This is the timeline of national expectations, based on the Sunday Times prediction of two days ago…

2009 - The biggest budget deficit in UK’s peacetime history (12.4% of GDP) and the steepest downturn in the UK economy since the war.

2014 – The £60bn spending squeeze has worked its way through the system and public services are severely strapped for cash. The public is paying higher taxes and Government debt is close to 80% of national income.

2027 – China becomes the world’s largest economy. Both the US and UK are still feeling the effects of the crisis.

2031 – Government debt finally falls to 40% of GDP but the Government’s infrastructure is crumbling with taxpayers still funding expensive PFI projects from a different age. The Government has still not been able to privatise the UK’s sclerotic nationalised banks.

How true this scenario is is anybody's guess. The Sunday Times has a propensity to sustained hysteria. The optimists think that, in fact, other economists are being pessimistic and that recovery and growth may be faster than predicted – that, in fact, the Treasury is right and they are wrong.

The real pessimists think the financial crisis is far from over and that the UK will have a Japanese-style ‘lost decade’ of weak growth and falling prices with national debt rising from 50-60% to nearly 200%. The low point would then be a visit to Beijing with a begging bowl.

More positively, specialist commentators point out that various tax changes in the Budget, combined with pressure on tax havens, could make London more rather than less attractive as a financial centre compared to competitors in the rest of the EU like Dublin and Luxembourg.

Higher personal tax rates are likely to offset this to some extent but, again, the situation is uncertain. A vociferous 'bourgeois' lobby made up of editors and media figures used to the high life as much as anyone else is no guide to the effects in reality.

Our suspicion is that the tax did not go far enough and was set at too high a threshold to be meaningful in fiscal terms and that only a relatively few of those affected are in a position to scuttle the country, especially as tax rates are likely to rise across Europe as well.

One of the oddities in the situation is that it is business as usual in terms of public spending until 2011 when the brakes get slammed on. The only way to explain this is a combination of inertia and the downright political – no cuts in public sector employment permitted until the votes have been counted.

The graphs in the newspapers, however, paint a nightmare scenario placing tax levels up there with Japan and the Nordic social democratic economies, without Nordic (and indeed Japanese) social cohesion and effective infrastructural management.

It has to be said that this is painful but is still not yet at 1930s levels and it may never be that bad. Unfortunately, both the Great Depression and Second World War debt levels could be paid off with (in effect) Imperial assets flogged off to the Americans. Such assets no longer exist.

It gets a little worse because the plan was to replace the dwindling revenues of the North Sea with the tax take from a City of London at the centre of globalisation and from UK international businesses that would get massive dividends from investment overseas.

The North Sea asset is going to dwindle regardless of Government action but the replacement model of New Labour is looking decidedly shaky. UK assets overseas have plummeted in value. Sustained 'high' globalisation is in doubt and not just because of the difficulties of trade finance.

Pandemics and the problems of maintaining security on food and energy supply routes may raise questions of border control and of food and energy self-sufficiency within the decade or more of pain ahead. All in all, the UK seems to have gambled and lost on globalisation ....

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[Special Reports on the UK have been replaced by a regular twice a week summary note]

The Budget & The Bigger Picture

There is little point in pre-speculating on the content of the Budget tomorrow. Economic uncertainty has meant that Treasury officials have been ‘doing their sums’ right up until the last minute. You will read all about it in a little more than twenty four hours.

What We Are Led To Expect

The Government is expected to claim that things will be worse than expected in 2009 but that we will see growth again in 2010. The recent predictive track record of the Treasury has been pretty poor for some time now so it might be best just to take any of their prognostications with a big pinch of salt.

The Chancellor is also expected to indicate that the Government will now not recoup the full costs of the banking intervention and that its costs to the taxpayer could be as high as £60bn. A provision will be added to 2008’s public borrowing totals and public debt.

A huge increase in public debt is likely to be headline news tomorrow although we are getting rather used to problems being talked up while the good news is kept back for the day. Currently, the peak deficit is touted as £170-180bn.

If public debt is to be this large or nearly this large, then it is likely that the (projected) £147.0bn gilt issuance target is likely to be revised upwards. It is hard to see how this cannot affect sterling.

Expected global demand for sovereign recapitalisation in the coming months creates the worst conditions possible for the UK’s plan to finance its debts in the market. Major tax rises and public spending cuts, in this context, are almost certainly not negotiable.

There is another problem bubbling up – this time with seven building societies who are said to be ‘in crisis’. A slew of credit-rating downgrades on bonds have forced them into talks with the Bank of England about their funding.

No, they are not going to go bust but they are likely to have to cut back on mortgage lending at precisely the wrong time, from the Government’s perspective, without more help.

So What Happens To Gordon Brown's Economics?

There is one big question that needs answering, if not now then soon – does the British economic model stand up to scrutiny in the wake of the credit crisis?

Two years ago, the economy was booming on lines that may now seem illusory but which were touted by the Government as a model for the rest of the world. Some overseas leaders were so entranced by it that they were on the cusp of following its credit-fuelled, free market, light government approach.

The liberal economic consensus today seems to be that the financially near-busted state of the State must inevitably result in public sector retrenchment and so in private sector growth as well as a new insularity in global affairs. So far so likely.

But we have our doubts that it will all be so simple. The analysis takes no account of ‘politics’ – the reactions of those whose services will be cut or who will be horrified by the effect of cuts on others, as well as of those who find high taxes intolerable and a ‘bloated’ public sector something to be axed.

The Politics of Crunch

The ‘British model’ was not quite as people imagined it. It was touted as 'free market'. Not quite. It was not a light hand Government but a Government acting in partnership with finance capital, regulating it to the demands of an economic model that poured credit into the economy and privileged toxicity.

Decisions not to use executive and legislative power are not negative but positive. New Labour chose not to intervene for ideological reasons and it must take responsibility for the consequences.

The inter-relationship of ‘big’ globalising business and government was intimate. This alliance now faces massive populist pressures from both Right and Left simultaneously. On the one side, a resentment of taxation and regulation and, on the other, anger at poverty and unemployment.

Can these two pressures be squared or will they even themselves out to allow the old system to survive, the lesser of three evils compared to one or other populist resistance model? On the face of it there seems to be no alternative to 'business as usual' but we are not so sure of this either.

The politics of post-crunch Britain could be very new, both libertarian and demanding on the political centre, apparently impossible to square but with both Right and Left tending, in practice, to the diminution of state power in favour of either smaller national business or community and protest politics.

For example, how can a Eurofighter at around £100m a shot (let alone Trident) be seen as a sound investment when small businesses want lower taxes and while care homes descend into abuse and scandal for lack of funds. It doesn’t stack up. Both sides might agree that we don't need any more guns.

Some Fundamentals

There are fundamentals here that need to be reviewed. Household debt as percentage of annual disposable household income has increased dramatically since 2001.

At 90-110% levels, it could be argued that having a whole year of your disposable income designated for debt was unwise but the ratio has moved on from these pre-2001 levels to something over 160% in just seven years.

Such debt levels require continued high growth to service or a nice dose of hyper-inflation to be resolved – no or low growth means serious family and personal pain for many, regardless of job prospects.

The private sector (excluding the dimwits in banking) has probably never been better managed in our history but, as manufacturing has fallen in importance, the slack has been taken up by a services sector that has depended on both disposable income and on full, i.e. increased public sector, employment.

Taxpayer funds (logically from the private sector) have been siphoned off to increase employment in the public sector by over 20% since 1998 to meet New Labour's main promise to its union backers in 1996 that full employment would be a strategic aim of its Government.

Think about it – if we are to have public sector cuts and increasing reluctance to spend freely on services, this means that full employment strategies are at threat. Working people are going to be faced with more uncertainty and worsening conditions to match middle class dimunition of wealth.

So the perfect storm is that a chunk of the middle class and a chunk of the working class are going to be aggrieved at the centre and at each other ... instead of leading a coalition of workers and bourgeoisie, the Government faces a war on two fronts. New Labour's political strategy is dead.

The Centre Holds With Difficulty

This brings us back to politics. In the last week or so, we have seen some downright filthy behaviour by New Labour senior officials. Attention has shifted from Parliamentary expenses to a ‘smear operation’ run by Damian McBride from Number Ten which has degraded both Party and Government.

The Sunday Times implicated Education Secretary, Ed Balls, Brown’s closest ally, but this seems to us little more than a continuation of the war between Blairites and Brownites by other means. What we are really seeing is a political and media class that is completely detached from the crisis in the street.

It may seem unimportant that former MP, Alice Mahon, has left the Party in disgust but, although retired, she is a significant figure in the now-aged traditionalist Left. For such a tribal loyalist of the old school to leave the brand she has given her life to, indicates just how far the official British centre-left has sunk.

Of course, growing criticism of a ‘bloated’ public sector is triggering the usual populist measures designed for the headlines. The Government has used this sector as a vote creation scheme over a decade, just as it has pump-primed the outer regions and small nations with Southern cash.

What it has to do now is get the public sector to 'be more efficient' rather than follow through on the logic of its economic mismanagement - those job cuts and reductions in pay and perks. Hence, the clamp-down on one easy target – the pay and perks of executives in the over-padded Quango sector.

Private Sector Opportunities?

This general trend towards talk of ‘efficiency savings’ (aka penny-pinching) and ‘asset sales’ is being undertaken both for its own sake and to send a political signal.

Current interest is in the cost of back office functions, implying an opportunity for private business in offering outsourced services not only to Whitehall but to local authorities, police, the health service and the public sector in general.

Much of this is kite-flying but the unions won’t like it. A political and PR battle is about to start up between a private services sector hunger to get hold of this new market and a public sector resistance to changes that will cost jobs and benefits and force through more onerous terms and conditions.

However, there is an alternative model in which the public sector sorts itself out through comparisons and indicators that compare worst practice with best practice and drive improvements and service sharing through strategies of example, fear and punishment.

Managerialism is very much more politically feasible than privatisation. It fits in better with the sentiments of New Labour. Private sector vultures might, therefore, have more of a fight on their hands than they had hoped.

So To The Future ...

This leads to the big political question – if a busted centre-left, following moderated right-wing policies, is about to be ousted (though this is not certain?), what precisely will it be ousted by?

Evidently a Tory Government or conceivably some Tory-Liberal coalition or even some National Government concoction involving right-wing Blairites are on the cards.

But what will their policies be? How will they respond to a devastating failure in a model that has been touted globally for over a decade?

Cultural changes of which we still know little may suggest that a new mix of the libertarian, in its anti-State aspects,and the paternalist, to deal with social crises that will fill the newspapers in the months to come, will emerge. Maybe we may term this anarcho-conservatism or conservative anarchism!

Without adequate resources to meet demands, knowing of mounting resentment at 'nannyism', a new Government will be ‘nudging’ the public into becoming more sensible and not expecting too much of the State. 'Tough choices' will mean what they can get away with.

Does this now mean a new centre-right Government following moderated left-wing policies? We think that this is a possibility, not by choice but by circumstance.

A section of the Tory Right, otherwise libertarian, is already deeply engaged with the crisis in the council estates and this means intervention of sorts.

An election in 2010 may represent an ideological revolution– a new, more insular yet increasingly European, less strident but mildly nationalistic, more communitarian economically and yet socially libertarian Britain, led by English Tories, even if in coalition, is now on the cards.

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