Talk to anyone who works in the City for more than a couple of minutes and you will find a metaphorical black cloud of gloom will descend over the conversation. Your companion will be telling you he or she has looked into the future and before you his or her face will indeed appear to have been affected by the experience. For such has been the shift from high optimism to high pessimism (the outcome is of course uncertain). Into this atmosphere was launched the UK's Pre Budget Report (PBR) on Monday 24 November.
A week has passed and some of the dust has settled. It has been clear to me that this was onlyt the first fiscal stimulus - Alistair Darling appears to suggest the same in the Observer today. That is a reflection of reality, not failure. The UK will not be alone. In any event, the measures in the PBR must be given time to work before we can know for sure.
The Chancellor announced in the PBR statement that over a year and half, the government plans to inject £20bn into the economy. This will be in the form of various measures, the most headline-grabbing being the cut in Value Added Tax (VAT) from 17.5% to 15%.
Other measures include bringing forward increases in pensions and child benefit payments to January. In fact, this measure should not be underestimated because it will effect those with a relatively high propensity to consume (rather than save) increases and those rises will be based on an inflation adjustment which itself is taken from the Retail Prices Index as at September, which saw a level above 5% which we will not see again for some time.
The government will also bring forward some spending plans.
But the PBR has not had a sudden positive impact on sentiment, nor on Labour's opinion poll position. In part this has been because the plus points were leaked in advance of the statement, so focusing attention on the negatives. Moreover, there is some scepticism about the efficacy of a VAT rate cut, which appears rather insignificant compared to 10%-plus discounting by retailers. That does ignore the fact that it amounts to a £12bn injection into the economy but that will not be experienced on an individual level.
The PBR also contained a road map for paying for this stimulus. It does not make for happy reading. Taxes will have to rise when growth resumes (which the government forecasts will be in 2010 and beyond, at reasonably high growth rates). The new upper rate tax of 45% for incomes over £150,000 will contribute, as will the 0.5% increase in National Insurance (effectively income tax). What also makes for grim reading is that government spending growth will be at much lower levels than previously forecast. In addition, the government plans to make savings; if these cannot be found some hard choices will have to be made about spending priorities. It is by no means certain that the full implications of this have sunk in around Whitehall.
But where the PBR chimes in with City pessimism is that the start position of the economy has been revised. It is not just that we might wish we hadn't started from here. It is that we are starting from somewhere completely different to where we thought we were. The Treasury has revised upwards its estimate of the structural deficit - ie some of the deficit that was assumed to disappear with higher growth (some of the 'cyclical' deficit) turns out to be permanent. Structural changes are required to remove it. This means we need to relearn how the UK economy is structured and rethink what we should do to chart its direction in future.
There are great challenges. There are also great opportunitities. And it may well not be as bad as many now believe. If the banking system recovers, the UK economy being financially focused could see a geared upside to growth which may put us in a better position than many other economies.
However, Labour now needs to continue thinking about the politics of this economic situation and consider what the challenges may be in 2009. That will be covered in my next post.