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Hague: The British economy in an uncertain world

In an address to the Centre for Policy Studies at the Institute of Directors in London, the Leader of the conservative Party, the Rt Hon William Hague MP:

"This weekend the Chancellor travels to Washington for the G7 summit at a time when the world economy faces its most testing circumstances since the Government took office. No-one knows whether the international economy is on the brink of a major downturn, or is experiencing merely a temporary patch of turbulence, but Gordon Brown admitted for the first time this week that the British economy is likely to be hit by global instability.

When it came to power, the Government inherited a golden economic legacy, and during the last four years it has also been blessed by an unusually benign international economy. The Chancellor has often spoken of pursuing a policy of prudence, but we are only now reaching the time when prudence can be assessed - whether Britain proves to be adequately prepared for more turbulent economic times ahead.

A more exacting set of economic conditions exposes not only the competitiveness of businesses, but the adequacy of government policies. Policy differences between governments that are all but submerged when the tide is high are often revealed when high water recedes. We have to be sure that Britain is properly prepared for slower worldwide growth.

Outside Asia, the international economy has been healthy for the last four years, and our principal trading partners have experienced prosperity. Between 1997 and 2000 the main European economies enjoyed growth averaging 3.7 per cent a year, while the US economy has powered ahead with 4.6 per cent growth.

Britain has profited from this phase of international stability and prosperity, albeit less so than either our American or European competitors, with growth averaging 2.85 per cent between 1997 and 2000.

But as finance ministers gather in Washington this weekend they cannot help but notice the threat to this period of relatively uncomplicated prosperity.

I see at least four causes for concern for the British economy. It would be a mistake to assume that they all portend disaster. But it would be a greater error not to take the opportunity to assess how well prepared we are to cope with unforeseen circumstances.

The first of these is the position of the American economy, which in many ways sounds the keynote for the rest of the world. Last year the US economy is thought to have grown by a remarkable 5 per cent. But this year, the speed at which confidence is being lost is alarming. Six months ago the consensus estimate for US growth in 2001 was 3.6 per cent. By three months ago forecasters had revised this figure down to 2.6 per cent. One month ago the expectation reached 1.9 per cent, and the most recent view is that growth will be only 1.7 per cent for the current year. The IMF's World Economic outlook, published this week, is widely expected to marked US growth down further still - to 1.5 per cent. That is a precipitous collapse in economic optimism to occur within a matter of months. The response of the Federal Reserve, which has reduced interest rates from 6½ to 4½ per cent since the beginning of the year, shows that no-one there underestimates the seriousness of the situation, and no-one else should either. And evidence is now emerging that the slowdown in the American economy is affecting British businesses. Trade figures released this week for March show that our exports to non-EU countries, a category dominated by our trade with the US, plunged by 10 per cent in a single month.

The second cause for concern is the response of Europe to global difficulties. America may set the tone for the world economy, but a vigorous European economy is essential to the prosperity of many British companies. Many people are concerned that the ability of the continent to withstand the knock-on effects of lower economic growth in the US is likely to be hampered by the reluctance of the European Central Bank to lower interest rates. The ECB is now the only major central bank in the world that has not eased its monetary stance since the beginning of the year. Of course, the task of the ECB is literally impossible: it has to choose a one-size-fits-all interest rate which cannot possibly be right for all countries all of the time. And the problem is compounded by the need to synthesise the different political agendas of countries from Ireland to Italy; the need establish a reputation for rigour; and pressure to shore up a weak currency. In times of prosperity, economies may be able to withstand the handicap of the wrong interest rate. But when times are tough it can make the difference between stability and recession.

The third potential source of turbulence is the stock market. No-one, least of all a politician, can know how stock markets will move in the months ahead. But we do know that stock markets all over the world have run into a period of real turbulence. Tech stocks are sharply lower, with the NASDAQ having lost nearly 60 per cent of its value since its peak. But we are not witnessing simply the bursting of the internet bubble. The indices that comprise our biggest businesses across the international economy have seen their values contract. The FTSE100 has fallen 15 per cent from its peak, the S&P500 on Wall Street is down 19 per cent, the CAC 40 in Paris by 21 per cent and the DAX in Frankfurt by 24 per cent. Whether or not these movements represent a temporary blip, a completed and overdue correction, or are part of a longer-term decline, it is clear that confidence has taken a blow. Listings are being postponed, and deals deferred.

The fourth force for uncertainty in the British economy is the continuing Foot and Mouth crisis. No-one who lives in our countryside, as I do, can fail to be shocked by how far-reaching are the economic effects of the crisis. Not just our farms, but businesses of every kind in our rural areas are on their knees. While the epidemic still rages it is too early to assess the full economic impact of Foot and Mouth. But there are already signs that it will prove a very significant burden on the economy as a whole. Early City estimates indicate that Foot and Mouth will depress GDP by 0.3 per cent this year, and there have been warnings that the figures could be much higher still.

These are just four of the difficulties that the British economy faces in the months ahead. There are others that could be mentioned, such as our pitifully low savings ratio - which has halved since 1997 - and the worrying signs that oil prices may once again be on the rise. But they suffice to make the point that we are facing a critical period of uncertainty.

Beyond all of these new threats, Britain's manufacturing industry has been suffering severe problems for several years now. Over 350,000 manufacturing jobs have been lost since 1997, and the CBI expects another 50,000 to go this year. On present trends that looks set to be an underestimate. On Tuesday, the mobile phone manufacturer Motorola announced the closure of its Bathgate plant with a loss of more than 3,000 jobs. Earlier this year the steelmaker Corus announced over 6,000 job losses across Britain. Eight hundred of these are in Ebbw Vale, in the middle of which the Labour Party has chosen to put up a poster bearing the slogan 'The work goes on'.

In recent days we have seen a welter of forecasts ranging from the reassuring to the pessimistic. It's no good the Government putting a spin only on the ones it likes. The range of forecasts emphasises the degree of uncertainty that we face. That is why we need to follow a policy that is truly prudent: one that would be right and sustainable even if things worked out worse than we might like.

A global slowdown would be a testing time for Britain's businesses. Lower worldwide growth means more competition for less demand, resulting in intense pressure to be internationally competitive.

Increased price competition and output that is reduced to below capacity will both tend to squeeze firms' margins. And tighter margins make the level of government-imposed costs and regulations businesses must carry a more critical factor in whether they can survive. Already, some firms are being forced to close excess capacity, and global businesses, which have to choose where in their worldwide operations the axe will fall, will be especially sensitive to the level of costs incurred in different countries and the direction in which they are heading over the long-term.

Businesses will make the same assessment of the current and future level of government spending and taxation. Global businesses will think twice before committing themselves to a country in which businesses and consumers are clubbed with higher taxes at the very time they are under pressure to survive.

So global competition applies as much to government policies as it does to business strategy. Economic downturns see the policies of governments fall under a revealing light as global investors are forced to decide where their investments will work hardest. A slowdown can lead to instant, and sometimes brutal, verdicts on the future prospects for an economy.

It is at times like these when the mettle of chancellors is tested. No chancellor deserves to be called prudent if he has failed to prepare for tough times ahead.

For the British economy to be considered adequately prepared for a more difficult economic climate, at least four conditions need to be met.

First, Britain needs interest rates that are right for the conditions we face.

Second, taxes should be heading down to avoid crowding out the private sector.

Third, burdens on business must be brought down to allow British businesses to remain competitive.

Fourth, we need a welfare system that keeps people off benefits and in work.

Let's have a look at how Britain is doing.

The first thing we need is interest rates that are right for the conditions we face. We have got a more independent Bank of England, and we support that. The Monetary Policy Committee has had a good start, and comprises good people, although it is fair to say that its ability to cope with harsher economic conditions is only now being tested for the first time. I would like to enhance its independence from the Chancellor, for example by making its members' terms of appointment non-renewable and lasting for longer than a single Parliament.

But this independent British monetary policy is not set to last. Labour intend to transfer the power to set interest rates from the Bank of England to the European Central Bank. Interest rates which are now set according to prevailing British conditions, would in future be determined according to the conflicting demands of every member of the euro. By jettisoning the pound for the euro, Labour would permanently blight the competitiveness of British businesses because they could never again rely on interest rates being set which are right for the conditions they face.

The second thing is that taxes should be heading down to avoid crowding out the private sector. When faced with more intense global competition and reduced earnings, businesses and consumers need to be reassured that they will not face higher costs through indirect taxes, and are not expected to pay over to the Government more of their income and wealth in direct taxation.

Indeed, as the global bank HSBC points out, tax is playing a central role in determining which countries will prosper and which will struggle in difficult times: 'there is now a greater incentive to find other means of improving competitiveness. One such way is to cut taxes in order to aid existing businesses and encourage investment from overseas.'

Governments across the world, and increasingly across the political spectrum, are doing exactly that. They share a common view that high and rising levels of taxation are fatal to enterprise.

One of the first steps George W. Bush took as President was to present Congress with a tax reform bill that will cut $1.6 trillion off the nation's tax bill.

In Germany, Chancellor Schröder has introduced a programme of tax cuts that will take as much as 2 per cent off the tax burden there.

Socialist governments all over Europe are waking up to the need to cut taxes. The socialist government of France has announced sweeping tax cuts, described by the Finance Minister as the 'biggest in half a century', which would reduce the tax burden by 1.5 per cent of GDP between 2001 and 2003. The socialist Italian Government has announced tax cuts worth over £6 billion.

Unfortunately, socialist Britain is taking the opposite route.

Labour wants to hitch up to Europe's unwise monetary policy, but they refuse to follow continental countries' lead in cutting taxes.

The Chancellor makes much of two stated rules of fiscal restraint: the so-called Golden Rule, whereby over the cycle the Government will borrow only to invest and not to fund current consumption, and the target of maintaining a stable ratio of debt to national income.

These principles sound as if they impose discipline on the Chancellor, but in fact their reassurance is worthless because they leave him free to increase government spending and tax to any level he chooses, crowding out the private sector.

The Chancellor regards himself as free to spend without limit taxpayers' money as long as he raises taxes to pay for it, and that is exactly what he has done.

This Government's appetite for spending knows no bounds. In the three years ahead planned growth in expenditure is 3.7 per cent against prospective growth rate for the economy of around 2½ per cent. Currently, Government spending is nearly 40 per cent of national income. But if, as the Government assumes, over the long term the economy grows at a rate of 2½ per cent and public spending grows by 3.7 per cent, what does this imply for how much is left for the private sector? It can only mean that the Chancellor plans for it to become a diminishing presence in the economy.

More Government spending means more taxation. The tax burden under Labour has risen by 3 per cent of national income - from 35.2 per cent of GDP in 1996/7 to 38.2 per cent in 2000/01. Between 1997 and 2001, tax receipts, after allowing for inflation, rose by 5 per cent a year - a swingeing increase: the biggest rise in taxation in any British parliament in peacetime. The Chancellor's tax increases have hit people and businesses in their pay packets, their mortgages, their pensions, their petrol tanks and their bottom line.

A recent CPS study identified 45 separate increases in tax which have been introduced over the last four years. And new ones are appearing all the time. This month, for example, businesses all over the country are opening bills for the new Climate Change Levy. Every business in the country, whatever size, has to pay this new tax. The Director General of the CBI has said this tax is 'seriously damaging UK competitiveness'.

Taxes on fuel - central to the livelihood of businesses - have soared. The cost increases arising from the global rise in oil prices are damaging enough, but in Britain, the Government has exacerbated the impact. Taxes on petrol have increased by 13 pence a litre since 1997. These taxes hit businesses as well as consumers, destroying the competitiveness of any firm that relies on the road.

Relentlessly raising taxes is the opposite of prudent preparation for economic difficulties. If it is misguided, on the verge of a potential sharp downturn, to be raising taxes on struggling businesses, it is all the more destructive to be doing so when the rest of the world is going in the opposite direction.

According to OECD figures the tax burden of the EU excluding Britain last year was 41 per cent and falling. If the present direction is maintained, under four more years of a Labour Government, taxes as a share of national income in Britain could breach the 40 per cent barrier at the same time as taxation among our principal European competitors approaches the same barrier. But the crucial difference is that in Britain, taxes are heading upwards through it, while on the continent taxes are heading downwards below it. The consequences for our competitiveness are obvious and profoundly depressing.

The third thing we need is a light regulatory burden. If profit margins become tighter, companies are going to be forced to decide where to cut jobs. That is why the Government should be paring down the costs they impose on business to keep those jobs in Britain.

But the Government piles more and more new burdens on business every day. The British Chambers of Commerce estimate that the cost of new regulations on British business over the lifetime of this parliament is £10 billion. Our companies are becoming back offices for the Government.

Last year, the Government imposed 3,865 new regulations- over ten a day, and the highest number ever recorded.

As the British Chambers of Commerce have warned, 'despite all its rhetoric, the reality is that government has dramatically increased the regulatory burdens that threaten small business competitiveness. Excessive red tape is stifling the very enterprises the Government is seeking to promote.'

Fourthly, we need a welfare system that encourages people into work and off benefits. An unreconstructed welfare system is a force for ever rising levels of public expenditure, which calls forth higher taxes. This bites hardest in downturns, when increased welfare dependence can lead to a sudden escalation in the social security budget. And a rigid welfare system also prevents people moving quickly and seamlessly into new jobs, and risks them being trapped on benefits.

Before Labour took power, it came to recognise that continued reform of the welfare system was a crucial factor in maintaining Britain's competitiveness. In September 1997, Gordon Brown lectured the IMF on welfare reform, saying 'Every country will need to reform their welfare system with radical changes to ensure employability of work forces in the future'.

Labour promised to reform the welfare state. Tony Blair said that he would reduce the proportion of national income spent on the welfare bill, and he would create a more flexible labour market. It was a serious intention - he appointed Frank Field, a man with a record of generating radical ideas on welfare reform, with a remit to 'think the unthinkable' as a minister. They had the time, they had the majority, they had the need - but they lacked the willpower to do anything about it. The whole initiative has been abandoned never to be taken up again.

Labour's failure to reform welfare is a critical missed opportunity that would have made Britain much better prepared to face economic difficulties. As it is, despite conditions of continued economic prosperity, with falling unemployment and rising real incomes, social security spending has risen by over £20 billion, and has remained virtually unchanged as a percentage of national income. An indication of the failure of welfare reform is the number of people whose income comes from the state through means-tested benefits. Last week it was revealed that within two years, nearly 40 per cent of all British households will be in receipt of means-tested welfare payments. In 1999, the figure was only 24 per cent.

The Government is turning Britain's workforce away from enterprise and towards dependence on the State. Once again, Britain is sliding in the wrong direction.

I set out four conditions to be prepared for economic difficulty. The Government is failing to cut taxes, failing to reduce regulations, failing to reform welfare. For the moment we have interest rates set for British conditions, but even that the Government is preparing to throw out of the window by joining the single currency.

We're in bad shape to hold our own in an economic downturn. Rather than plotting a course for stability, Gordon Brown is following an imprudent path in an uncertain world.

It is a typical irony that Gordon Brown should choose to lecture the rest of the world this week on the need for "economic reform", at a time when other countries have been quietly, but radically, reforming their economies while he has been taking Britain in the opposite direction.

The country in greater need of economic reform today than many of the countries Gordon Brown lectures is Britain itself.

One of the conceits of this Government is that they like to see themselves as modern and international, whereas in fact they are taking us in the opposite direction of almost every other leading world economy. In its failure to prepare for economic difficulty Labour has shown itself to be not a modern government, but an anachronistic one.

The Chancellor claims to be prudent, but prudence is about preparing for a rainy day. As an American president once said "the time to fix your roof is when the sun is shining".

Real prudence requires being prepared for the unexpected. A Chancellor that has left Britain more vulnerable to international competition on the eve of a possible downturn cannot lay claim to the word prudent.

The Government has learned the language of reassurance, without having applied the policies that make it credible.

Prudence is like the various other mantras, catchphrases, principles, tests and rules on which the Chancellor has sought to place great emphasis during the last four years, but which, on closer examination, turn out to offer significantly less reassurance than is claimed for them.

Take for example the famous five tests that the Chancellor says must be met before Britain can join the single currency. They were promulgated with great solemnity in 1997. The tests themselves are recited regularly. But if the tests are in any sense objective, why do we not have clear and regularly published assessments of progress against them? The fact is that no serious commentator today believes that the Chancellor's tests provide anything other than carte blanche for the Government to declare that the conditions are right to scrap the pound as soon as it is politically expedient to do so.

The Chancellor goes to international gatherings to lecture his fellow finance ministers on prudence, discipline and reform. But his is a masterclass in the use of language rather than the application of modern economics. For all his bluster, the Chancellor's policy relies more on day-to-day improvisation than he would like people to realise. The Chancellor talks the talk, but wants to retain the ability to walk a dangerous walk.

So we face a situation in which the economy faces difficulties for which Britain is inadequately prepared. This means that Britain will have to rely the quality of the Government's day-to-day response to events - how it can manage in a crisis.

Unfortunately, the Government's record of acting judiciously and decisively during periods of difficulty is one of its least impressive characteristics.

After four years in charge, the Government has form when in it comes to coping with crises.

Who can forget the fuel tax debacle last autumn? First, they plunged their head in the sand and pretended that nothing of any significance was happening. Then, they tried to get away with using soothing words rather than real policies. Then they panicked at the public reaction, and the Prime Minister announced that he was taking personal charge. But he found that his ability to make any significant proposal was stymied by the Chancellor.

Depressingly, the same cycle of spin and inaction has often been repeated in the Government's handling of the Foot and Mouth crisis.

We know only too well how the Government behaves when its mettle is tested. It bodes ill for the difficult times ahead.

We need a new approach if Britain is to be competitive in more uncertain times. We need a better policy mix that will serve us in good times as well as bad. That approach needs to be based on discipline at the macroeconomic level, and freeing businesses from state interference.

We will replace the Chancellor's meaningless mantras with a framework of real economic discipline. Michael Portillo has set out the five disciplines which will underpin the economic policy of a Conservative Government in the next parliament.

First, we will retain our own currency. It is fundamental to a clear economic policy for a Government that businesses and overseas investors should know for the course of that Parliament what currency they will be working in, and whether or not Britain will follow an autonomous monetary policy suited to domestic conditions

Second, we will maintain the Monetary Policy Committee of the Bank of England, but enhance its independence. I want to make sure that the Committee is able to be robust to political pressure, for example by making its members' terms of appointment last for longer than a parliament. I would like its role as a force for transparency to be enhanced by encouraging it to comment on any discrepancy it might perceive between monetary and fiscal policy.

Our third discipline will be to establish a Committee of Economic Advisers to act as a watchdog which will oversee the appropriateness of the government's fiscal stance. Monetary discipline is not enough to build an external reputation for sound macroeconomic management. There must be fiscal discipline as well.

Fourth, we will appoint a National Accounts Commission to draw up proper national accounts, including a proper presentation of the government's long-term liabilities; in my view there can be no discipline worth the name unless it is founded on transparency, and this includes absolute precision about the national accounts.

Fifth and finally, we will restrain the growth of public spending to within the trend rate of growth of the economy as a whole, so that there is a strong bulwark against the government crowding out private enterprise. This is the only genuinely sustainable policy that a government can pursue. Control of public spending is the essential pre-requisite for sustainable tax cuts.

Within this framework of five disciplines, a Conservative Government will pursue an urgently needed programme of reforms to help Britain survive in a more testing international economy.

We must rein back the long-term growth in public expenditure to within the overall growth of the economy and stop crowding out the private sector. We have identified £8 billion a year of savings in government spending that we can make by 2003/04.

We will return the savings in public spending we make as tax cuts to those who have been worst hit by Labour's tax increases. For savers and investors we will abolish taxes on savings and dividends; for families we will introduce a transferable married couple's allowance and increase the Children's Tax Credit for the under fives by £200 a year. We will take a million pensioners out of income tax altogether, raising their tax allowance by up to £2000. We will help people and businesses that rely on their cars by cutting taxes on fuel. And we will reduce business rates for our hard-pressed rural firms.

Lower taxes will help restore the competitiveness of the British economy that Gordon Brown has damaged. We will also take urgent steps to scrap burdens on business and restore flexibility to the economy. We will abolish IR35, and the Climate Change Levy. We will set regulatory budgets which limit the burden of red tape that each Government department can impose on business, and make sure they come down year after year. All new regulations will have to be scrutinised by an independent commission, and will only be implemented if they are time-limited or minimal in their impact on business costs and proportional to the objective that they have. When I am Prime Minister, I will only promote ministers who get rid of more regulatory burdens than they add. And as far as EU regulations go, we will not enforce them any sooner or more zealously than other countries.

But Britain can do so much better than merely survive in difficult times. I want Britain to once again lead the world in new policies that build prosperity. To do that we need to rekindle the spirit of reform that animated previous British Governments and which has been taken up around the world.

My central argument today is that we must lower taxes and free our businesses to compete. If we do not, the foundations on which prosperity is based will be progressively undermined to the point of collapse.

And the same applies to our communities and the institutions that shape who we are. Government that grows year after year after year does so at the expense of families, communities and institutions.

So when we say we want to cut taxes, that is not only an economic argument, but one that goes to the heart of the difference in philosophy between us and Labour.

All of our policies spring from a passionate belief that people should be free to make their own choices and live their own lives. We trust people to do that. Labour doesn't trust people, which is why they want to take more of their earnings and more of the decisions out of their hands completely.

This drags down our businesses, destroys our economy, nationalises our communities, and replaces responsibility with dependence.

When the election comes we will publish our manifesto for government, and it will be the most ambitious Conservative programme for a generation.

Our policies, every one of them, will support the values, such as responsibility for ourselves and others, that are vital for a strong economy, strong communities and strong institutions.

On the economy, we will take fundamental steps to allow people and businesses to choose to spend more of the money they have earned. The £8 billion of tax cuts that we have announced is not the end of our tax cutting agenda, but merely the beginning.

With proper control of Government expenditure in the next Parliament we can cut taxes further. Among our priorities will be to reduce taxes on enterprise such as by simplifying and reducing Capital Gains Tax and increasing threshold at which people begin to pay the higher rate of income tax.

We will let people take responsibility for themselves and others. For example we will give young people the option of paying their National Insurance contributions into properly funded private pensions, rather than force them to pay them the State. For decades the State has failed to invest people's hard-earned contributions and so can therefore only provide a miserly income in retirement. Our way will allow people the chance of a comfortable retirement and relieve the welfare burden on our children.

We will strengthen our institutions by giving them real independence from the deathly embrace of Government.

We will, for example, use revenues from asset sales progressively to endow our universities. They will be free, like the best American universities, to develop their own character and specialisms, competing with the world's best for students and research funding. Just imagine what heights of excellence they can scale if they are free from Whitehall.

We will give every head teacher the budget and the authority to run their own schools in the way they judge will best deliver the kind of education parents want for their children. Why should inspirational heads be treated as branch managers for the Government? Why should parents not have the same choices of excellence for their children's education that they expect in every other area of their life?

We will strengthen our public services by making sure the money we spend is not wasted in bureaucracy but is spent efficiently on the things that people want. The £8 billion of savings we have identified already will not diminish any one of our public services - in fact they will be strengthened.

This spirit of choice to be independent of the state pervades every aspect of our policy, from economics to public services. It represents a return to a bold agenda for this country, and an agenda based on real policy innovation rather than spin.

It is fashionable to think that there are no longer any significant issues that divide the parties, but that could not be less true.

We have a Government bereft of ideas. Not a modernising government but one of the most complacent, unimaginative, rootless governments Britain has ever had. They inherited a country in unprecedentedly good condition, but they have squandered our hard-earned competitive advantage through a retrograde, imprudent economic policy. And this overweening Government is destroying our civic society by smothering the institutions and the personal responsibility that are at its heart.

At the next election Britain will have an alternative. A party that will be innovative, not complacent. A party that will be prudent, not reckless. A party that trusts people, not government.

Britain has the chance once again to be an example, not a warning, to the rest of the world. It's time to take it."

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