WHATEVER HAPPENED TO THE GOLDEN LEGACY? THE ECONOMIC BACKGROUND TO THE 2005 BUDGET Ruth Lea THE AUTHOR Ruth Lea is Director of the Centre for Policy Studies. She is on the University of London Council and is a Governor of the London School of Economics. She has served on the Council of the Royal Economic Society, the National Consumer Council, the Nurses’ Pay Review Body, the ONS Statistics Advisory Committee, the ESRC Research Priorities Board and the Retail Prices Advisory Committee. She is the author of many papers including The Price of the Profligate Chancellor: higher taxes to come, The Essential Guide to the EU, Tax ‘n’ Spend: no way to run an economy and Pollyanna, not Prudence: the Chancellor’s finances. She was Head of the Policy Unit at the Institute of Directors (IoD) from 1995 to 2003 before which she was the Economics Editor at ITN, was Chief Economist at Mitsubishi Bank and Chief UK Economist at Lehman Brothers. She also spent 16 years in the Civil Service in the Treasury, the Department of Trade and Industry and the Central Statistical Office.

The aim of the Centre for Policy Studies is to develop and promote policies that provide freedom and encouragement for individuals to pursue the aspirations they have for themselves and their families, within the security and obligations of a stable and law-abiding nation. The views expressed in our publications are, however, the sole responsibility of the authors. Contributions are chosen for their value in informing public debate and should not be taken as representing a corporate view of the CPS or of its Directors. The CPS values its independence and does not carry on activities with the intention of affecting public support for any registered political party or for candidates at election, or to influence voters in a referendum.

 Centre for Policy Studies, March 2005

ISBN No: 1 903219 94 9 Centre for Policy Studies 57 Tufton Street, London SW1P 3QL Tel: 020 7222 4488 Fax: 020 7222 4388 e-mail: [email protected] website: www.cps.org.uk

Printed by The Centre for Policy Studies, 57 Tufton Street, SW1. CONTENTS

1. INTRODUCTION AND SUMMARY 1

2. THE POLICY BACKGROUND 9

3. ECONOMIC ANALYSIS 14

4. THE PUBLIC FINANCES 23

ANNEXES

CHAPTER ONE INTRODUCTION AND SUMMARY

“These are fantastically good figures”, the official concluded. “The state of the economy is much better than predicted.” Eyes swivelled to Brown. “What am I supposed to do with this?” he snarled. “Write a thank-you letter?”

Tom Bower, Gordon Brown, HarperCollins, 2004.

1.1 INTRODUCTORY COMMENTS The starting point for this paper is the “fantastically good” economic figures, referred to by the anonymous Treasury official. They represent, without doubt, a true “Golden Legacy” that was handed over from the outgoing Major Government to the Labour Government under Tony Blair in May 1997. There is little doubt that the economy was, at that time, performing very well indeed. The Treasury official was not exaggerating. The question that this paper seeks to answer is how the Labour Government’s eight years of stewardship has affected the performance and health of the economy they inherited from the Conservatives. In order to analyse this question quantitatively, the economy’s performance under the full Major Government (from 1992 to 1997) 1 is compared with that under the Labour Governments (from 1997). For the Major Government, 1992 is taken as the “base” year for calculations, and 1997 is taken as the year the “legacy” was handed over to the Labour Government.

1 For the Labour Government 1997 is taken as the “base” year for calculations, running on to 2004 (or 2003, if 2004 data are unavailable). Annex 1 elaborates on this basic methodology and annex 2 lists some of the main economic events over this period. All the major economic variables are assessed in this paper: economic activity, balance of payments, the labour market, inflation, interest rates and the public finances. The analyses are covered in chapter 3 (for the general economy) and chapter 4 (for the public finances). Doubtless the Chancellor, in his upcoming budget (16 March 2005), will be boasting about the British economy. No one wishes to run the economic performance of this country down and it has performed very creditably over the last 12 to 13 years. But the British economy’s performance under Labour should be qualified in at least two respects. Firstly, the Labour Government was fortunate to inherit a “Golden Legacy” from the Major Government in 1997, not that the Chancellor has ever had the courtesy to acknowledge this. On the contrary, he is keen to inform the electorate that he has transformed the economy since 1997; and he likes to give the impression that the country was floundering in a swamp of economic chaos prior to 1997. Nothing could have been further from the truth. And, secondly, the economy is not currently performing as well as it did when it was under the Major Government. This is because the current Government’s policies have hindered rather than helped business and have undermined competitiveness. And when the Chancellor refers to the fact that the economy has technically grown every year since 1991, it is worth remembering that for the first 5½ years of this period there was a Conservative Government. A final point to make: the official above made the point that the state of the economy was “much better than predicted”. It is instructive to note the degree to which this was the case. The July 1997 Financial Statement and Budget Report (FSBR) 2 contains a table outlining the changes to the PSBR forecast between the November 1996 budget and the July1997 budget. The main data are shown on the next page.

2 CHANGES TO THE PSBR FORECAST (£BN) BETWEEN NOVEMBER 1996 AND JULY 1997 FY1997 FY1998

PSBR in November 1996 budget 19.2 12.2 Effects of: Changes in assumptions & LA capital receipts initiative 0.8 3.9 Forecasting changes (including higher corporation tax -3.3 -6.7 revenue, and beneficial effects on revenue of higher money GDP*) Budget tax changes (including the effect of the -3.4 -4.1 removal of the tax credit on dividend payments) PSBR in July 1997 budget, excluding the windfall tax 13.3 5.4 and associated spending Net effect of windfall tax and welfare to work -2.4 -1.4 spending PSBR in July 1997 budget, including the windfall 10.9 4.0 tax and associated spending

Source: HM Treasury, Equipping Britain for our long-term future, FSBR, July1997, HC85. For the definition of the PSBR, see annex 3, the glossary. * The forecasts in July 1997 for money GDP were £752bn for 1996 and £798bn for 1997. The equivalent forecasts in November 1996 had been £746bn and £787bn.

The PSBR had, therefore, been “over-forecast” by the Treasury by £3.3bn for FY1997 and £6.7bn for FY1998 in November 1996. If one believed in conspiracy theories, one could even believe in a conspiracy.

1.2 THE POLICY BACKGROUND (SEE CHAPTER 2) Before discussing the comparative economic performance of the Major Government and the Labour Government since 1997, this paper looks at the policy background. There are, without doubt, two main reasons for the economy’s relative strength: ! the supply-side reforms of the 1980s including trade union reform, privatisation of the utilities and the reform of the tax system; ! the post-ERM transformation in macro-economic policy designed to deliver low inflation and economic stability. Chancellor Norman Lamont introduced inflation-targeting and the first steps towards an independent Bank of England. He also began a programme of fiscal consolidation, which transformed the public finances. These “Lamont reforms” were radical. His successor, Kenneth Clarke, consolidated Norman Lamont’s innovations. By 1997 the Conservatives “low inflation stability” policies were very effective and had succeeded admirably in reducing inflation and delivering sustainable growth.

3 Chancellor Gordon Brown built on the Conservatives’ policy framework for delivering “low inflation stability” in 1997. He gave the Bank operational independence in setting interest rates and introduced a more “rules based” approach to fiscal policy. His policy was, however, by no means revolutionary, whereas the “Lamont reforms” were. Brown’s policies were consolidatory. This is not to condemn or criticise Brown’s policy. But it is to put it in perspective. Gordon Brown’s fiscal reforms were not revolutionary. They merely consolidated the Lamont reforms which had succeeded in reducing inflation and delivering sustainable growth.

1.3 ECONOMIC ANALYSIS (SEE CHAPTER 3) The Major years were a remarkably successful time for the British economy. The official quoted at the beginning of this chapter was not exaggerating. Specifically, for the period 1992 to 1997: ! GDP growth averaged over 3% compared with about 2¾% since 1997. Manufacturing output performed quite well compared with a flat performance since 1997. The growth of business investment was also superior during the Major years. The household saving ratio was 9.5% in 1997, by 2004 it had dropped to 5.5%; ! the current account of the balance of payments improved significantly and was almost in balance in 1997 as resources were shifted from the domestic sector to the overseas sector. Last year the Labour Government clocked up the worst-ever visible trade deficit, which at £57bn, was £10bn higher than 2003’s deficit (which had been a record visible trade deficit); ! the labour market showed substantial improvements. Unemployment, including youth (16-24 year olds) unemployment, fell sharply and workforce jobs picked up. The fall in unemployment has slowed since 1997 with the drop in youth unemployment especially disappointing. The number of workforce jobs has undeniably picked up since 1997. There has been a rapid growth in jobs associated with the public sector but a sharp fall in manufacturing jobs; ! annual average productivity growth, whilst relatively modest at just over 2%, was noticeably better than since 1997. The picture on industrial disputes has also worsened; ! the “Lamont reforms” were extraordinarily effective in controlling inflation. By 1997 average earnings inflation was just over 4%, RPIX inflation was under 3% and CPI inflation was under 2%. Chancellor Brown’s “no more boom and bust economic stability” was achieved

4 under the Major government of 1992 to 1997. He was extraordinarily fortunate to inherit this gem of the “Golden Legacy”; ! interest rates were falling quickly – the official base rate was down to 6% by May 1997. And yields on long-dated gilts were already beginning to fall in response to the lower short-term interest rates and the lower inflationary expectations; ! according to both the WEF and the IMD the British economy was one of the most competitive in the world when it was transferred from the Major Government to the incoming Labour Government. This, therefore, represents international acclaim and recognition for the handling of the economy between 1992 and 1997 and the “Golden Legacy” handed over to the Labour Government.

1.4 THE PUBLIC FINANCES (SEE CHAPTER 4) The public finances deteriorated rapidly in the early 1990s as the recession hit revenue and increased public spending. A programme of fiscal consolidation began in 1993, which “transformed the public finances”. Between 1992 and 1997 the Conservative Government got a real grip on public spending (so that it was growing slower than GDP) and made some painful but necessary decisions in order to increase revenue. By 1997 the public finances were sound and moving towards balance. They were a vital part of the “Golden Legacy” handed over to the incoming Labour Government. Chancellor Gordon Brown was a prudent custodian of the public finances until FY2000 (his “prudent period”) but he has proved an old-fashioned “tax ‘n’ spend” Labour Chancellor since. The public balances are now nowhere as near as healthy as they were in 1997. There is a structural “black hole” in the current budget balance and this will have to be addressed at some point by either taxes or slower spending growth. The Conservatives have already announced that they would slow spending growth (by eliminating waste), Chancellor Brown is almost certain to raise taxes. In the meantime the ONS is dancing to the Chancellor’s tune by redefining parts of current government spending as capital spending so that the Golden Rule can technically be met. But the Golden Rule is very tarnished and one of today’s conundrums has to be why the gilt-edged market still retains so much confidence in the conduct of British fiscal policy.

1.5 CONCLUSION: WHAT HAPPENED TO THE “GOLDEN LEGACY”?

“These are fantastically good figures”, the official concluded. “The state of the economy is much better than predicted.”

“…Brown sought to present himself as the Chancellor dedicated to cleaning up the Tories’ mess. He would describe his inheritance as ‘instability, under-investment, unemployment and a waste of

5 talent’, and would pledge that under Labour Britain’s rate of growth would increase, taxes would be as low as possible, savings and investment would be higher, red tape would be cut, and training and productivity would increase.” Tom Bower, Gordon Brown, HarperCollins, 2004. The quotation from the Treasury official encapsulates the “Golden Legacy” that the Conservative Government handed over to the incoming Labour Government in 1997. The fact that it has never been acknowledged by today’s Labour Government is a distortion of the truth. Worse still, Chancellor Brown has insisted that he was the man who was clearing up the Tories’ “mess”.

The fact that the Golden Economic Legacy has never been acknowledged by the Labour Government is a distortion of the truth. Worse still, Gordon Brown has insisted that he was the man who was clearing up the Tories’ “mess”.

To sum up the economy in 1997: ! GDP had been growing by over 3% (annual average) since 1992. It has grown slower since; ! the current account of the balance of payments was to all intents and purposes in balance. Last year the visible trade deficit was a record £57bn (over 5% of GDP) and Britain’s net external liabilities increased significantly; ! jobs were being created in the dynamic private sector and unemployment, not least of all youth employment, had been falling rapidly. Job creation has continued under Labour, but the growth of public sector jobs has well outstripped growth of private sector jobs. Productivity growth has, unsurprisingly and despite the best attempts of the ONS to massage the public sector productivity data on behalf of the Treasury, fallen; ! earnings inflation and prices inflation were under control. The Bank of England, given operational independence to set interest rates in 1997, has efficiently and effectively maintained control; ! short-term interest rates were down to 6%. The Bank of England, reflecting its success in maintaining low inflation, has managed to push interest rates down a little further. They are currently 4¾% with the prospect of rising to 5%, as of 9 March 2005; ! the British economy was one of the most internationally competitive. This is no longer the case;

6 ! the public finances were improving significantly and heading towards surplus. There is now a “black hole” in the current budget balance that, if it is to be corrected, will have to met by either higher taxes or slower public spending growth. This was not the case in 1997. The following table demonstrates how, on most key measures, the economy is now performing less well than it was in 1997.

Some “mess”! There is no doubt that the economy handed over to Labour was a Golden Legacy. As the following table demonstrates, on most key measures the economy is now performing less well than it was in 1997. There is no doubt that it is also losing international competitiveness. In a world of ever-increasing competitiveness this is simply not good enough. It augurs ill for the future of Britain.

7 LABOUR AND THE GOLDEN LEGACY: A CHECKLIST Performance grade (see below) Economic activity: GDP growth rate – Manufacturing output growth rate – – Business investment growth rate – Households saving ratio – –

Balance of Payments: Visible trade balance – – Current balance – –

Labour market: Reduction in unemployment – Reduction in youth unemployment – – Change in workforce jobs + Change in workforce jobs excl. education, health & public admin. – Change in workforce jobs in manufacturing – – LFS employment rate = Productivity growth, whole economy – Industrial disputes, working days lost –

Earnings and prices inflation: Rate of reduction in earnings inflation – Maintenance of low earnings inflation + Rate of reduction in prices inflation – Maintenance of low prices inflation + +

Interest rates: Rate of reduction in short-term interest rates – Maintenance of low short-term interest rates + + Reduction in & maintenance of long-term interest rates + +

International competitiveness: Performance on the WEF index – Performance on the IMD index – –

Public finances: Performance from FY1997 to FY2000 + + Performance since FY2000 – –

Grading system + + Consolidating gains and significant improvement in performance + Consolidating gains and modest improvement in performance = Consolidating gains, performance maintained - Modest slippage in performance – – Significant slippage in performance REFERENCES 1. 1992 was chosen for the Major Government (rather than 1990) to retain the integrity of individual parliaments. 1997 was chosen as the legacy year because the economy’s performance was well established when the Labour party won the election in May 1997.

2. HM Treasury, Equipping Britain for our long-term future, FSBR, July1997, HC85.

8

CHAPTER TWO THE POLICY BACKGROUND 2.1 INTRODUCTION The economy has performed very creditably over the past 12 to 13 years. This is all a far cry from the feeling of defeatism and decline that coloured debate about the British economy in the 1970s when British industry was strike prone and poor industrial relations were known as the “English disease”. In 1979 (including the “Winter of Discontent”) there were nearly 30 million working days lost due to industrial action; in 1997 there were just 237,000 working days lost. In the 1970s and 1980s there grew up in British university departments of politics a subject devoted to the relative UK economic decline.1 There is little doubt that there are two main factors behind the transformation of the economy from the “sick man of Europe” in the 1970s to one of the more successful global economies of today.2 They are: ! the microeconomic supply-side reforms of the 1980s, including trade union reform, privatisation of the under-performing utilities, reform of the tax system and the deregulatory reforms of the financial sector. These reforms are widely acknowledged and understood; ! the post-ERM transformation of macro-economic policy, initiated by Chancellor Norman Lamont (the “Lamont reforms”) and developed by his successor Kenneth Clarke. This was designed to deliver low inflation and economic stability. It succeeded admirably. This transformation is all too often unacknowledged and misunderstood. When a Labour 9 Government was returned to office in 1997, Chancellor Gordon Brown built on the Conservatives’ macroeconomic policy foundations. But his policy reforms were by no means revolutionary, whereas Norman Lamont’s were. The rest of this chapter discusses all the developments in macro-economic policy post-ERM. The Lamont reforms were designed to deliver low inflation and economic stability. They succeeded admirably. This transformation is all too often unacknowledged and misunderstood.

As Gary Duncan3 wrote in The Times:

“…economically it [Black Wednesday] led the Conservative Government to lay the foundations of the successful economic regime that Britain now operates, with the introduction of inflation targeting and the first steps towards Bank independence. Certainly, Gordon Brown has built solid, credible institutions on those Tory foundations. But without the groundwork laid by Kenneth Clarke [sic], as well as the supply-side reforms to the labour and capital markets forced by through by Mrs Thatcher, it is doubtful that Labour’s economic record would look nearly as strong as it does.”

2.2 THE TRANSFORMATION OF MACROECONOMIC POLICY POST BLACK WEDNESDAY After Black Wednesday in September 1992, Chancellor Lamont and the Treasury moved extraordinarily quickly to establish a new framework for macroeconomic policy.4 Lamont’s successor, Kenneth Clarke, consolidated and built on Lamont’s pioneering work. Specifically the following reforms were introduced: ! the first crucial reform Norman Lamont introduced in October 1992 was a policy of “inflation-targeting”, in which there was to be a quantitative inflation target. Specifically a target range of 1% to 4% was introduced for RPIX inflation (retail prices inflation excluding mortgage interest payments). The important point for policy was that there would be a specific target to focus policy measures and a clear definition of success and failure. This policy of “inflation-targeting” replaced exchange rate targeting (which had been adopted by Chancellor Lawson in the mid 1980s and culminated in ERM membership) and the earlier monetary targeting (operational in the late 1970s and the first half of the 1980s). See annex 3 for more details. ! the second crucial reform introduced post-ERM was the establishment of regular meetings between the Chancellor (initially Norman Lamont) and the Governor of the Bank of England (initially Robin Leigh-Pemberton) 10 and the requirement for the BoE to publish a quarterly inflation report. The first inflation report was published in February 1993. ! Norman Lamont also set up a Panel of Independent Forecasters to advise him. The Panels’ first report was in February 1993. ! Kenneth Clarke, who replaced Lamont in May 1993, agreed in April 1994 to the publication of the minutes of the meetings between himself and the Bank Governor to improve the transparency of policy making.5 ! there was also from 1993 a programme of fiscal consolidation, which transformed the public finances. Chancellor Lamont, in his final budget in March 1993, announced fiscal measures to boost revenue by £6.7bn in FY1994 and £10.3bn in FY1995. The fiscal data will be discussed in chapter 4. ! together these reforms were a formidable package designed to deliver low inflation economic stability. And they were, by any standards, remarkably successful (as is shown in chapter 3). Sir Alan Budd, who was Chief Economic Adviser to the Treasury between 1991 and 1997, has described the period post-ERM up to 1997 as follows:6

It was a highly successful period for the UK economy. Inflation stayed below 4% and fell to 2½%. Growth was helped by the lower exchange rate and stayed strong. Unemployment fell steadily. Also from 1993 there was a programme of fiscal consolidation which transformed the public finances.

2.3 THE LABOUR GOVERNMENT When Gordon Brown became Chancellor in 1997, he consolidated and built on the Conservatives’ macroeconomic reforms for delivering “low inflation stability”. His policies were sensible but not revolutionary. And they did not transform the British economic landscape. After all, the Conservatives had already delivered low inflation sustainable growth (see chapter 3). The main aspects of his policies were: ! he gave operational independence to the Bank of England, establishing a Monetary Policy Committee (MPC) with the responsibility for setting interest rates and publishing the inflation report (with forecasts for inflation). He also redefined the RPIX inflation target to be 2½%, with the Governor required to provide an Open Letter of explanation to the Chancellor if RPIX inflation fell outside the range 2½% plus/minus 1%; ! he introduced a more “rules based” approach to fiscal policy (the “Code for Fiscal Stability”) with the introduction of two fiscal rules, which will be discussed in chapter 4; ! the Golden Rule: which states that, on average over the cycle, the government will borrow only to invest and not to fund current spending; 11 ! the Sustainable Investment Rule: which states that public sector debt as a proportion of GDP will be held over the cycle at a stable and prudent level. In his December 2003 Pre-Budget Report, the Chancellor changed the inflation target for monetary policy to one based on the Consumer Price Index (CPI), previously known as the Harmonised Index of Consumers Prices (HCIP). The CPI inflation target was set at 2.0%, with the Governor required to provide an Open Letter of explanation to the Chancellor if CPI inflation falls outside the range 2% plus/minus 1%. This move, introduced as a move towards preparation for euro membership, was criticised on the grounds that the CPI is a less comprehensive measure of inflation than the RPIX and, therefore, a poorer indicator of inflationary pressures.7 Specifically the CPI excludes housing costs, including the Council Tax, whereas the RPIX includes them. “It [the establishment of the Monetary Policy Committee] has been a brilliant success, but I want to repeat my point it was able to build on a very good foundation.” – Sir Alan Budd, member of the MPC, 1997 to 1999.

It is widely agreed that the Bank of England has proved proficient at setting interest rates (though, arguably, it has not really been tested as the period since 1997 has been relatively benign in economic terms). Sir Alan Budd, who was a member of the Monetary Policy Committee between 1997 and 1999, has judged this policy development as follows:8

After the election of May 1997 we saw the establishment of the Monetary Policy Committee with the responsibility for controlling inflation and with the power to set interest rates for that purpose. That has been a brilliant success, but I want to repeat my point it was able to build on a very good foundation. Sir Alan’s balanced and fair acknowledgement of history is very different from the history-rewriting “year zero” (i.e. 1997) story that the Treasury published in 2001, which was little more than a party-political tract.9 Quoting Gordon Brown’s Foreword to the Treasury’s book:

My first words from the Treasury… were to reaffirm for this government our commitment to the goal first set out in 1944 of high and stable levels of growth and employment, and to state that from 1997 onwards the attainment of this goal would require a wholly new fiscal and monetary framework. A wholly new fiscal and monetary framework? Hardly. The foundations had been built several years previously and the Conservatives’ “low inflation stability” fiscal and monetary reforms were already delivering “low inflation stability”. But this was not a truth that the Chancellor wanted to tell.

12 REFERENCES

1. Sir Samuel Brittan, “Britain’s very modest miracle”, Financial Times, 6 December 2001.

2. Anatole Kaletsky, “Our new wealth is built on three great changes”, The Times, 26 August 2004 added a third “tributary” of economic change that contributed to the reversal of Britain’s relative economic decline. This was the shift in relative prices whereby the things that the UK imported (especially mass-produced manufactured goods) had got cheaper whilst the knowledge-intensive goods and services (financial services, scientific research, education, entertainment and so on), which Britain has an advantage in exporting, had risen in price. In other words, the “terms of trade” had improved.

3. Gary Duncan, “Election war clouds the economic truth”, The Times, 14 February 2005.

4. David Smith, economics editor of the Sunday Times has written that the Treasury and Lamont were “magnificent” in developing the new macroeconomic framework post-ERM. See Smith’s “The seven ages of monetary policy” available on his personal website, www.economicsuk.com.

5. Kenneth Clarke received a “1994 Freedom of Information Award” for publishing the minutes of his monthly meetings with the Governor of the Bank of England. See www.cfoi.org.uk.

6. Sir Alan Budd, “Economic policy after 1992”, The Europaeum Lecture, Geneva, 25 March 2004, www.queens.ox.ac.uk.

7. “Steering by a faulty compass”, The Economist, 26 February 2005. This article argued that the CPI was too narrow a measure of inflation for monetary policy- making, asset prices also needed to be considered.

8. Sir Alan Budd, “Economic policy after 1992”, The Europaeum Lecture, Geneva, 25 March 2004, www.queens.ox.ac.uk.

9. HM Treasury, editors Ed Balls and Gus O’ Donnell, Reforming Britain’s economic and financial policy: towards greater stability, Palgrave, December 2001. It should be noted that Mr O’Donnell is a career civil servant and therefore paid by the taxpayer.

13 CHAPTER THREE ECONOMIC ANALYSIS

3.1 INTRODUCTION This chapter analyses the economy’s performance under the 1992 to 1997 Major Government compared with that under the Labour Government from 1997. For pragmatic reasons annual data are used. For the Major Government, 1992 is taken as the “base” year for the calculations and 1997 is taken as the year the “economic legacy” was handed over to the incoming Labour Government. (By May 1997, when the Labour party won the election, the economy’s performance for the whole year was well-established and well-entrenched.) For the Labour Government, 1997 is taken as the “base” year for the calculations, which run on to the latest year for which data are available (mainly 2004, but sometimes 2003). Annex 1 elaborates on this basic methodology. As explained in chapter 2 the “Lamont reforms” were designed to deliver “low inflation economic stability” and the figures in this chapter show just how successfully these objectives were achieved.

14 3.1 ECONOMIC ACTIVITY GDP growth resumed in 1992, after the recession year of 1991, and has grown ever since. But, as the table below demonstrates, GDP growth was stronger in the five years of the Conservative Government than between 1997 and 2004. And this makes no allowance for the fact that some commentators feel that the ONS’s recent methodological revisions, especially to the measurement of government output, are highly suspect and overstate recent growth performance.1, 2, 3 If some allowance were made for this, then the Conservatives comparative performance would be even more impressive. Manufacturing output performed reasonably well between 1992 and 1997, benefiting from a weak currency, but has suffered since from the competitive pressures of China as well as from a stronger currency. Business investment also performed better under the Conservatives, despite a fall in 1993. The households saving ratio was 9.5% in 1997, by 2004 it had dropped to 5.5%. GDP, MANUFACTURING OUTPUT AND BUSINESS INVESTMENT Conservatives (5 years) Labour (7 years) 1992 1997 1997/1992* 1997 2004 2004/1997* (base) (legacy) (base) GDP at market prices, 76.1 88.8 1.167 (3.1%) 88.8 107.2 1.207 (2.7%) volume, 2001=100 Manufacturing 88.2 97.6 1.107 (2.1%) 97.6 98.6 1.010 (0.1%) output, volume, 2001=100 Business investment 66036 86321 1.307 (5.5%) 86321 117058 1.356 (4.5%) (£m), constant 2001 prices Households saving 11.6 9.5 0.82 (-3.9) 9.5 [5.5] 0.58 (-7.5) ratio (%)

* average annual growth rate in brackets. Source: ONS. Note: data for the Households saving ratio are currently available for the first three quarters of 2004 only. The figure for 2004 is an average of the data for the first three quarters. Not merely has GDP growth been weaker under the Labour Government than under the Conservatives, but, since 2001, it has also been weaker than the Chancellor has forecast. There is, however, a complicating factor with the GDP forecasts because the Chancellor, since his November 1997 Pre- Budget Report, has presented the forecast growth rates as ranges such as 2 to 2½% (for example), with his “central case” referring to the mid-point. To add to the complications, the Treasury sometimes refers to “central case” forecasts and sometimes refers to the “bottom of the range” forecasts. There are, of course, several ways of comparing forecasts with outcomes. But one way that is fair, if not rather generous, to the Treasury is to compare the Treasury’s Pre-Budget Report forecast of, say, November 2000 for the year 2001 with the outcome for 2001. This is a very short-term forecast indeed – a mere year ahead.

15 Starting with the “central case” forecasts, the Treasury’s growth forecasts have been missed in all four of the years from 2001 to 2004. This was even true of last year, when there was a late growth spurt in the final quarter of the year. In 2002 and 2003 the growth targets were missed by about ½ of a percentage point, which was considerable. It is quite amazing that this poor forecasting record is commented on so little. Annex 4 provides the detailed figures. The current account is well and truly in the red and needs to be financed either by building up overseas liabilities or running down overseas assets.

The “bottom of the range” forecasts for GDP are used for public finance projections. But even on these “bottom of the range” forecasts the Treasury undershot in 2002 and 2003, and this undershooting would have contributed to the especially poor forecasts for the public finances in those years.

3.2 THE BALANCE OF PAYMENTS It is not fashionable to discuss the balance of payments but recent developments in Britain’s accounts with the rest of the world should not be ignored. The current account is well and truly in the red and, therefore, needs to be financed by either building up overseas liabilities or running down overseas assets. (Either way this involves a deterioration in the net assets/net liabilities position.) The most recent data on Britain’s international investment position relate to 2004Q3,4 and they showed net external liabilities of over £120bn at the end of 2004Q3 compared with net external liabilities of £75bn at the end of 2004Q2. As net liabilities rise then clearly the potential for a favourable balance on investment income will decline (even though recent balances on investment income have been very favourable). Running persistent, and worsening, current account deficits should not be simply swept aside as irrelevant. The Conservative record on the current account was creditable. A deficit of £13bn was recorded in 1992, but in 1997 the current account was almost in balance, mainly owing to an improved services account. There was even a modest improvement in the visible trade balance as exports growth outstripped imports growth, helped by the weak pound. In comparison Labour’s performance has been extraordinarily poor. Britain clocked up a record visible trade deficit of £57bn last year (over 5% of GDP), a record that the Chancellor does not boast about. The oil surplus is disappearing. The transfers balance has worsened – Britain’s net deficit with EU institutions is now around £5bn annually. The saving grace has been the greatly improved investment income balance – but one that most certainly cannot be guaranteed to continue as the country’s net overseas liabilities increase. 16 CURRENT ACCOUNT OF THE BALANCE OF PAYMENTS, £BN, CURRENT PRICES Conservatives Labour 1992 1997 1997/1992* 1997 2004 2004/1997* Exports, goods 107.9 171.9 1.593 (9.8) 171.9 190.7 1.109 (1.5) Imports, goods 120.9 184.3 1.524 (8.8) 184.3 248.4 1.348 (4.4) Exports, services 36.2 61.1 1.688 (11.0) 61.1 94.4 1.545 (6.4) Imports, services 30.7 47.7 1.554 (9.2) 47.7 76.1 1.595 (6.9)

1992 1997 1997 minus 1997 2004 2004 minus 1992† 1997† Balances: Visible trade -13.0 -12.3 0.7 (0.14) -12.3 -57.6 -45.3 (-6.47) balance Services balance 5.4 13.4 8.0 (1.60) 13.4 18.3 4.9 (0.70) Income balance 0.1 3.9 3.8 (0.76) 3.9 [22.2] 18.3 (2.61) Transfers balance -5.5 -5.9 -0.4 (-0.08) -5.9 [-10.9] -5.0 (-0.71) Current balance -13.0 -0.9 12.1 (2.42) -0.9 [-28.0] -27.1 (-3.87) * Aerage annual growth rate in brackets. † Average annual absolute change in brackets (£bn). Source: ONS. Note: There are no 2004Q4 data for the income and transfers balances yet available. The author has accordingly annualised the data for the first three quarters of 2004. The 2004 current account total was summed from components.

3.3 THE LABOUR MARKET, PRODUCTIVITY AND INDUSTRIAL DISPUTES There are many data relating to the labour market but only the main aggregates will be considered here. Between 1992 and 1997, strong economic growth stimulated the labour market (though with the inevitable lag) and unemployment fell sharply – indeed more sharply than during the period from 1997 to the present. The drop in young people’s unemployment was much more impressive during the Conservatives’ period of office than since 1997. Indeed the improvement in the figures for young people’s unemployment since 1997 has been especially disappointing, despite the money spent on the New Deal.5 There is little doubt that workforce jobs have increased at a quicker rate since 1997 than between 1992 and 1996, but the make-up of the “job creation” should give cause for concern. Manufacturing jobs have dropped sharply reflecting the state of manufacturing industry whilst public sector jobs (for which education, health and public administration are taken as a proxy here) have risen buoyantly. It is now estimated that a quarter of all jobs are now in the public sector.6 Transferring employment from the dynamic and competitive private sector to the undynamic and cushioned public sector has inevitably served to undermine the productivity and competitiveness of the economy. Since 1992 the employment rate has risen fairly steadily. 17 THE LABOUR MARKET: UNEMPLOYMENT, WORKFORCE JOBS AND THE EMPLOYMENT RATE Conservatives Labour 1992 1997 1997/1992* 1997 2004 2004/1997* Unemployment: Claimant count, total 2778.6 1602.4 0.577 (-10.4) 1602.4 866.1 0.541 (-8.4) (thousands) Claimant count, % 9.3 5.4 0.581 (-10.3) 5.4 2.8 0.519 (-9.0) LFS unemployed, total 2796 2045 0.731 (-6.1) 2045 1438 0.703 (-4.9) (thousands) LFS unemployment rate, % 9.8 7.2 0.735 (-6.0) 7.2 4.8 0.667 (-5.6) LFS, unemployed, 16-24 year 789 489 0.620 (-9.1) 489 421 0.861 (-2.1) olds (thousands)

Workforce jobs (thousands): Total 27571 28426 1.031 (0.6) 28426 30440 1.071 (1.0) Manufacturing 4543 4516 0.994 (-0.1) 4516 3569 0.790 (-3.3) Education, health & public 6483 6517 1.005 (0.1) 6517 7415 1.138 (1.9) administration Excluding education, health & 21088 21909 1.039 (0.8) 21909 23025 1.051 (0.7) public administration Employees in employment 23282 24320 1.045 (0.9) 24320 26264 1.080 (1.1)

LFS employment rate: 16-59/64 71.2 72.7 1.021 (0.4) 72.7 74.7 1.0275 (0.4) * Average annual growth rate in brackets. Sources: ONS. Notes: (1) LFS stands for Labour Force Survey. (2) LFS unemployed for 16-24 for 1992Q1 are not available, the 1992 figure taken as average of Q2 to Q4 data. (3) Workforce jobs measure jobs rather than people and include part-time jobs. (4) The employment rate equals those in employment as a % of all in these age groups (16-59 for women and 16- 64 for men). One of the key objectives of the current Labour Government has been to raise productivity growth but, as the data below show, it has only succeeded in slowing it. Annual productivity growth averaged over 2% in the Major years, but now struggles on at 1½%. This is another statistic that the Chancellor does not boast about. But, of course, productivity growth struggles under the current Government’s policies of increased regulation and an ever-larger public sector. In the words of Professor Nicholas Crafts of the LSE, when discussing the problems of productivity growth:7

These [problems which are specific to the Labour party] include a reluctance to accept that government regulation potentially acts both as a disincentive to innovative effort and a barrier to entry, a failure to acknowledge that economies with large public sectors financed by direct taxation suffer a significant growth handicap, a faith in the monolithic state provision of public services and a reluctance to take cost-benefit analysis seriously in the public sector. The final statistic considered here is that measuring industrial disputes. In 1979 (including the “Winter of Discontent”), there were nearly 30 million 18 working days lost due to industrial action, but in 1997 there were just 237,000 working days lost. Suffice to say that by 2003 the picture had worsened, though thankfully, the number of working days lost through industrial action were still relatively modest at half a million. PRODUCTIVITY AND INDUSTRIAL DISPUTES Conservatives Labour

1992 1997 1997/1992* 1997 2004 2004/1997*

Productivity index, 82.7 92.2 1.115 (2.2) 92.2 102.0 1.106 (1.5) 2001=100 1992 1997 1997-1992† 1997 2003 2003-1997† (6 years) Industrial disputes 528 237 -291 (-58) 237 499 262 (44)

* Average annual growth rate in brackets. † Average annual absolute change in brackets. Source: ONS. Notes: (1) The productivity data refer to whole economy output per filled job. (2) The industrial disputes data refer to thousands of working days lost.

3.4 EARNINGS AND PRICES INFLATION There is little doubt that Britain had an inflation-prone economy post second world war and especially so in the 1970s and 1980s. The consequent “booms and busts” were a major drag on economic performance and it was widely recognised during the 1970s and 1980s that there was a need to establish macro-economic policies that would deliver low inflation stability – hence the policies targeting monetary variables in the late 1970s and early to mid 1980s, during the high noon of monetarism, and the policies targeting exchange rates later in the 1980s and in the early 1990s, culminating in ERM membership. ERM membership certainly brought down inflation but the experience was very painful indeed – the costs were very high. Post-ERM the radical “Lamont reforms” were introduced, which involved explicit and direct inflation-targeting (see chapter 2 for more). And they were very successful indeed. As the table and chart below shows, earnings and prices inflation pressures were very effectively contained between 1992 and 1997. By 1997 earnings inflation was at a sustainable rate of just over 4%, RPIX inflation (excluding mortgage interest payments) was under 3% and CPI inflation was under 2%. Inflation had been conquered. And there were no signs that inflation was about to “take off again”. Sensibly Chancellor Gordon Brown locked in the successes of the “Lamont reforms” by transferring interest rate setting decisions to the Bank of England. The Bank of England has succeeded in continuing to contain inflation (though, arguably, it has been operating during a relatively benign period). But it has been consolidators – not radical innovators. The innovator was Norman Lamont. 19 EARNINGS AND PRICES INFLATION Conservatives Labour

1992 1997 1997/1992* 1997 2004 2004/1997*

AEI, whole economy, 73.0 86.8 1.189 (3.5) 86.8 116.7 1.344 (4.3) index 2000=100 AEI, annual inflation (%) 6.1 4.2 0.689 (-7.2) 4.2 4.4 1.048 (0.06)

RPI, index Jan 1987=100 138.5 157.5 1.137 (2.6) 157.5 186.7 1.185 (2.5) RPI, annual inflation (%) 3.7 3.1 0.838 (-3.5) 3.1 3.0 0.968 (-0.5) RPIX, index Jan 1987=100 136.4 156.5 1.147 (2.9) 156.5 184.0 1.176 (2.3) RPIX, annual inflation (%) 4.7 2.8 0.596 (-9.8) 2.8 2.2 0.786 (-3.4) CPI, 1996=100 90.9 101.8 1.120 (2.3) 101.8 111.2 1.092 (1.3) CPI, annual inflation (%) 4.2 1.8 0.429 (-15.6) 1.8 1.3 0.722 (-4.6) * Average annual growth rate in brackets. Source: ONS. Notes: (1) AEI, stands for Average Earnings Index; earnings data include bonuses. (2) RPI stands for the Retail Prices Index, RPIX stands for the Retail Prices Index excluding Mortgage Interest Payments. (3) CPI stands for the Consumer Prices Index.

Trend of falling inflation rates from 1992

5 4.5 4 3.5 3 2.5 2 1.5 1 0.5 Annual rates of inflation (%) 0 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

RPI RPIX CPI

3.5 INTEREST RATES The Bank of England’s base rate (then the “official rate” used for lending to the money markets including the commercial banks) was 10½% at the time of the April 1992 general election. It was reduced to 10% in May 1992. On 16 September 1992 (“Black Wednesday”) rates were swiftly increased to 12% and an announcement was made that they would be increased further to 15% from the next day. The increase to 15% was never implemented following the pound’s withdrawal from the ERM and on 17 September the rate reverted to 10%. Interest rates rapidly fell post-ERM. The base rate was reduced from 10% in September 1992 to 6% by January 1993 and down to 5¼% by February 1994. (See annex 2 and the chart below for details.) Following several policy moves, the base rate was 6% at the time of the 1997 election.

20 The newly independent Bank of England tightened monetary policy during 1997 and the first half of 1998, raising its repo rate (the renamed official rate for lending to the money markets) to a “high” of 7½% by June 1998. Subsequently the Bank of England has actively amended the repo rate, the repo rate reaching a low point of 3½% in July 2003. The repo rate is currently 4¾% (as of 9 March 2005) and may rise further in this economic cycle. (See annex 3, the glossary, for more on repo rates.) Trend of falling official interest rates from 1992

14

12

10

8

6 Bank Base Rate 4

2

0 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Note: see Annex 2 for data. As the above chart shows, the Bank’s official interest rate fell from 10½% at the beginning of the 1992–1997 Major Government and was down to 6% by May 1997. The current repo rate, at 4¾% (as of 9 March 2005) and possibly set to rise again, is only modestly down on the rate operative in May 1997. The Bank of England’s official rates influence interest rates and yields throughout the spectrum of financial products, in general, and the yields on Government securities (“gilt-edged” or “gilts”, excluding Treasury bills), in particular. Yields on gilts are also influenced by inflation expectations. As the Conservative government brought down official short-term interest rates and brought down inflation the gilts market responded accordingly. Yields on 20-year gilts (long-dated gilts) were over 9% in 1992 but had fallen to around 7½% in the first half of 1997. This was another achievement of the “Lamont reforms”. When the Labour Government gave operational independence to the Bank of England for setting interest rates, the markets responded favourably and this fact, along with the continued control of inflation and apparent fiscal prudence of the Chancellor (though more in chapter 4), is currently holding yields on 20-year gilts below 5%.

21 3.6 COMPETITIVENESS INDICES There is little doubt that the UK is slipping down the international competitiveness league as the Labour government piles on taxes and regulations on the wealth-creating private sector. The World Economic Forum (WEF) calculated that the UK was the fourth most competitive economy in 1998 (i.e. before the current Government’s policies had had an opportunity to take effect); in 2004 it was the eleventh. The International Institute of Management Development (IMD) put Britain at ninth in 1997 and twenty-second in 2004. (See annex 5.) Britain may be holding its own with the increasingly uncompetitive economies of “core eurozone”, but it is not holding its own with the other major Anglophone countries and most certainly not with the emerging economic giants of China and India. The Chancellor, to give him credit, appreciates that there is the “China Challenge”. But his response, promoting British “world-class science, education and enterprise”, is simply not good enough. The policy response should be to lift the regulatory burdens from business, resist the endless tinkering, interfering and social engineering that has been the hallmark of his period in office and reduce the size of the state.8

REFERENCES

1. Allister Heath, “1984? Britain’s Big Brother statistics would call it 1498”, The Business, 6 February 2005, for example, was scathing. He wrote “George Orwell’s… Winston Smith, who worked for the Ministry of Truth, was in charge of “re-adjusting” official statistics, supposedly to rectify mistakes but in reality to rewrite history. Unfortunately it sometimes seems that nobody told the British government was a work of political fiction, not a manual for civil servants.” Heath went on to write “one of the ONS’s best kept secrets – it was buried in Sir Tony Atkinson’s 234-page, independent inquiry into UK statistics – is that since 1998 better exam results have automatically increased GDP. So if exam grades go up… GDP will go up.” Heath ended by saying “George Orwell’s Ministry of Truth would have been proud; the rest of us should be very angry. Never has a statistical service seen to be independent of government been more urgently required.” See next reference for the reference to the Atkinson inquiry.

2. ONS, Atkinson Review of Measurement of Government Output, ONS, January 2005.

3. According to Edmund Conway, “Public sector accounts are challenged”, Daily Telegraph, 20 July 2004, Sir Tony’s findings on “quality adjustments” had already been used by the ONS to upgrade health statistics, boosting Government productivity.

4. ONS, Balance of Payments 3rd quarter 2004, ONS, 23 December 2004.

5. For a critical assessment of the New Deal see Ruth Lea, Education and training: a business blueprint for reform, IoD, June 2002.

6. Allister Heath, “Yes Minister, a quarter of Britons work for you”, The Business, 27 February 2005, using data calculated by Williams de Broe.

7. Nicholas Crafts, “Why productivity growth is till a problem”, FT, 2 June 2003.

8. For more on this see Ruth Lea, Tax ‘n’ spend: no way to run an economy, CPS, June 2004. 22

CHAPTER FOUR THE PUBLIC FINANCES

4.1 INTRODUCTION This chapter covers the following issues: ! the public finances, including spending, revenue and the major financial balances, are analysed and a comparison is made between the 1992 to 1997 period, under the Conservatives, with the period since 1997, under Labour; ! analysis of the Chancellor’s fiscal rules; ! the Conservatives’ plans for the public sector finances.

4.2 THE PUBLIC FINANCES The public finances deteriorated rapidly in the early 1990s as the recession hit revenue and increased public spending. A programme of fiscal consolidation began in 1993, which, in the words of Sir Alan Budd, “transformed the public finances” (see chapter 2). Chancellor Lamont, in his final budget in March 1993, announced fiscal measures to boost revenue by £6.7bn in FY1994 and £10.3bn in FY1995. Between 1992 and 1997 the Conservative Government got a tight grip on public spending, so that it was growing slower than GDP, and made some painful but necessary decisions in order to increase revenue. By 1997 the public finances were sound and 23 moving towards balance, if not surplus. Even on the Treasury’s own forecasts at the time of the November 1996 budget, the PSBR was expected to return to debt repayment by FY2000. These forecasts turned out to be too pessimistic by a significant margin (see chapter 1). Gordon Brown’s early spending plans were prudent (he adopted the plans of the outgoing Conservative Government) and the public finances undoubtedly benefited from this. Brown’s “prudent period” lasted between 1997 and 2000. The public accounts were healthily in surplus, enabling a significant reduction in public sector debt.

Since FY2000, the spending taps have been well and truly turned on. The Treasury expects the tax/GDP ratio to be above 40% by FY2007, even on its current unrealistic forecasts of the public sector finances.

But since FY2000 the spending taps have been well and truly turned on and the surpluses had disappeared by FY2002. By FY2005 the Treasury expects the ratio of total spending to GDP to reach 42%. Partly reflecting the early prudence and partly reflecting the fact that revenue growth is falling behind spending growth (and therefore the financial balances are deteriorating), the tax/GDP ratio has been held down to date. But the Treasury expects the ratio to be above 40% by FY2007, even on its current unrealistic forecasts of the public sector finances. An earlier CPS paper discussed the Chancellor’s poor forecasting record for the public finances.1 The updated figures are shown in annex 6.

THE PUBLIC FINANCES TO FY2003: (A) SPENDING AND REVENUE Conservatives (5 years) Labour (6 years)

FY1992 FY1997 FY1997 FY1997 FY2003 FY2003 (base) (legacy) over (base) over FY1992* FY1997* Total Managed 271.6 321.0 1.182 (3.4) 321.0 454.7 1.416 (6.0) Expenditure (TME) (£bn) Total receipts (£bn) 224.9 314.4 1.398 (6.9) 314.4 419.3 1.334 (4.9)

FY1992 FY1997 FY1997 FY1997 FY2003 FY2003 minus minus FY1992† FY1997† TME as % of GDP 44.2 39.0 -5.2 (-1.0) 39.0 40.7 1.7 (0.3) Receipts as % of 36.6 38.2 1.6 (0.3) 38.2 37.5 -0.7 (-0.1) GDP

24 THE PUBLIC FINANCES TO FY2003: (B) BALANCES (£BN) Conservatives (5 years) Labour (6 years) FY1992 FY1997 FY1997 FY1997 FY2003 FY2003 minus minus FY1992† FY1997† Current budget -34.4 -1.4 33.0 (6.6) -1.4 -20.7 -19.3 (-3.2) surplus Current budget -34.4 [-6.9] 27.5 (5.5) [-6.9] -20.7 -14.8 (-2.3) surplus adjusted for July 1997 budget‡ PSNB 46.7 6.6 40.1 (-8.0) 6.6 35.4 28.8 (4.8) PSNB adjusted for 46.7 [12.1] 34.6 (-6.9) [12.1] 35.4 23.3 (3.9) July 1997 budget† * Average annual growth rate in brackets. † Average annual absolute change in brackets (£bn). ‡ The FY1997 figure is adjusted for the £5½bn of tightening in the July 1997 budget. Source: HM Treasury. Note: (1) The PSNB stands for Public Sector Net Borrowing. (2) See annex 7 for the public balances to FY2004. The data look a little better for the period since 1997 than in the above table.

4.3 THE CHANCELLOR’S FISCAL RULES The Chancellor has two fiscal rules: the Golden Rule and the Sustainable Investment Rule. The Golden Rule states that, on average over the economic cycle, the government will borrow only to invest and not to fund current spending. An earlier CPS paper 2 concluded that, assuming that the current cycle runs from FY1999 to FY2005, the Chancellor was likely to miss his Golden Rule for the current cycle by a whisker. But this was not the main problem with the public finances. A far more serious problem was that he would be entering the next economic cycle, starting in FY2006, with a “black hole” in the current budget balance of around £11bn to 12bn. This meant that, if the Golden Rule were to be met for the next cycle, there would have to be higher taxes or slower spending growth. This view is shared by many commentators including the IFS and NIESR.3, 4 As the current Chancellor is unlikely to slow spending growth then, if he stays in office after the next election and wishes to stick with the Golden Rule, higher taxes are inevitable. There is little to add to this analysis except to say that the ONS has recently announced that it will reclassify some public spending on road maintenance as capital rather than current spending. Given this reclassification, the Chancellor now looks much more likely to “meet” his Golden Rule for this cycle after all. But it could prove to be a Pyrrhic victory if the financial markets decided that this was one statistical “fiddle” too far and that British fiscal policy was really out of control. Then the much-prized fall in long-term rates, reflecting the Chancellor’s “prudent period”, could reverse quite uncomfortably. One of today’s conundrums has to be why the gilt-edged market still retains such

25 confidence in the conduct of British fiscal policy. And this is at a time when the EU Monetary Affairs Commissioner, Joaquin Almunia, has warned the Chancellor that he must act to get the budget in balance otherwise he risks breaking the 3% Maastricht deficit to GDP ratio ceiling - again.5 There have been many manipulations of the public sector accounts. These include: reclassifying some public spending on road maintenance as capital rather than current spending; classifying Network Rail as a private sector organisation; and changing the way in which the Golden Rule is presented.

After all there have been other manipulations to the public sector accounts, which should concern the financial markets. They include: ! Network Rail is classified as private sector rather than public sector in the national accounts;6,7 ! the Government has a record (“previous”) of ensuring as much of its transport spending as possible is classified as capital rather than current spending. In the 2003 review of railway finances, the Department for Transport asked Tom Winsor (then the rail regulator) to pay the subsidies to the Train Operating Companies in the form of grants to Network Rail (which would be classified as capital spending) rather than as subsidies (which would be classified as current spending). Mr Winsor agreed.8 ! last year, the Treasury changed the emphasis in its presentation of the golden rule. Instead of simply subtracting deficits in one year from surpluses in another (as was previously favoured), the Treasury currently emphasises the calculation of these budget balances as proportions of GDP. This means the past surpluses, when GDP was smaller, gain relatively more weight than do the current deficits. The Chancellor’s second fiscal rule is the Sustainable Investment Rule, which states that public sector debt as a proportion of GDP will be held over the cycle at a stable and prudent level. The Government believes that, other things being equal, it is desirable that public spending net debt should be below 40% of GDP over the cycle. It is all too infrequently commented on. Public sector debt as a proportion of GDP fell quite sharply between FY1996 and FY2001 and was, very creditably, down to 30.2% in March 2002. The improvement reflected economic growth as well as the public sector surpluses generated during the years FY1998 to FY2001. Reflecting the return of the public accounts to deficit in FY2002, the debt to GDP ratio started to increase in that year and has been rising ever since. The debt to GDP ratio by December 2004 was 34.9% (the latest figure available). Even though this figure is still well within the 40% ceiling, the rate at which is rising should cause some concern. It is not compatible with “stability”. 26 4.4 THE CONSERVATIVES’ PLANS FOR PUBLIC SECTOR FINANCES In January 2005 the Shadow Chancellor Oliver Letwin announced the Conservatives’ plans for public sector finances.9 Briefly they comprised: ! a saving of £35bn in public spending waste, with £23bn reinvested, leaving an overall saving of £12bn in FY2007; ! of the £12bn, taxes were to be reduced by £4bn and a repayment of £8bn was to go towards the financing the “black hole” in the current budget balance. The IFS has analysed the Conservatives plans and has concluded that over the period FY2006 to FY2011:10 ! the Conservative plans would save 0.3% of GDP in FY2006 rising to 2.0% of GDP in FY2011, assuming their spending savings would moderate the current Government’s planned increases of investment and non-investment proportionately; ! by FY2011 the current budget balance under the Conservatives would be 1.7% of GDP stronger than under Labour. The Conservative plans would be equivalent in their net impact on the current budget balance over 6 years (from FY2006 to FY2011) to an upfront tax increase of 0.75% of GDP or £9bn; ! the IFS analysis assumed that the Conservatives would cut revenues by £4bn (0.3% of GDP) each year from FY2006 to FY2011.

REFERENCES 1. Ruth Lea, The price of a profligate Chancellor: higher taxes to come, CPS, March 2004.

2. Ruth Lea, Pollyanna, not Prudence: the Chancellor’s finances, CPS, November 2004.

3. IFS (editors Robert Chope et al), The IFS Green Budget, IFS, January 2005.

4. Simon Kirby et al, “Prospects for the UK economy”, National Institute Economic Review, January 2005.

5. George Parker and James Blitz, “Chancellor ‘must act to get budget in balance’”, FT, 17 February 2005.

6. ONS, ONS announces decision on Network Rail, ONS press release, 27 June 2002. This press released announced the decision to classify Network Rail in the private sector.

7. ONS, Classification of Network Rail, ONS press release, 27 February 2004. This press release announced that Network Rail’s classification to the private sector would be dated from April 2003, rather than from August 2002 as previously announced.

8. Scheherazade Daneshkhu and Chris Giles, “Spending policy rethink may save Brown’s blushes”, FT, 19 February 2005.

9. Conservative Party, Better public services, better value: Conservative spending plans, 2005-2008, January 2005. Available from www.conservatives.com.

10. IFS (editors Robert Chope et al), The IFS Green Budget, IFS, January 2005. 27

ANNEX 1

COMPARISONS BETWEEN THE CONSERVATIVE AND LABOUR GOVERNMENTS: BASIS OF CALCULATIONS

The following periods are taken for calculating growth rates and absolute changes.

Election dates Government Calendar years Financial years

10 April 1992 Conservative Government 1992 (base year) to 1997 FY1992 (base year) to (“the legacy”).* 5 years. FY1997 (“the legacy”).* 5 years.

2 May 1997 and 8 June Labour Governments 1997 (base year) to 2004 FY1997 (base year) to 2001 (final year). FY2003 (final year). 6 years. 7 years. Also use estimates for Occasionally use data for FY2004; 7 years. 2003; 6 years.

* Calendar year 1997 and financial year 1997 (FY1997) are treated as the “legacy”, which was handed over to the incoming Labour Government in May 1997. Any policy changes undertaken by the Labour Government that affected outcome (eg the fiscal tightening in July 1997 budget) are allowed for in the calculations.

ANNEX 2

KEY ECONOMIC EVENTS SINCE APRIL 1992

Date Events* From April 1992 9 April 1992 General Election: Conservatives returned to power. 5 May 1992 “The base rate” (the most frequently quoted base rate of the retail banks, linked to the BoE’s Minimum Band 1 Dealing Rate) changed from 10½% to 10%. 16 September 1992 UK left the Exchange Rate Mechanism (ERM), after strong downward pressure on exchange rate and large official intervention to support the rate. Base rate was raised to 12%. A further increase, to 15%, was to take effect from 17 September but never implemented. 17 September 1992 Base rate reduced to 10%. 22 September 1992 Base rate reduced to 9%. 8 October 1992 Chancellor Lamont set out framework for monetary policy outside the ERM, including the conditions for returning to the ERM, an inflation objective of 1- 4% and monetary policy indicators. 16 October 1992 Base rate reduced to 8%. 29 October 1992 Chancellor Lamont’s Mansion House speech: he announced his intention to set up a Panel of Independent Forecasters. This Panel was accordingly set up. It produced its first report in February 1993. 12 November 1992 Autumn Statement: base rates cut to 7% (with effect from 13 November). Measures to boost housing, investment and construction; tax on new cars abolished; public pay rises limited to 1.5%; introduction of a monitoring range for M4 (4-8% for the second half of financial year FY1992). 1993 26 January 1993 Base rate reduced to 6%. February 1993 The first Bank of England “Quarterly Inflation Report”. 16 March 1993 Budget (Lamont): set monitoring ranges of 0-4% for M0 and 3-9% for M4, for the period of the Medium Term Financial Strategy (MTFS, to end FY1997). Fiscal measures to boost revenue by £6.7bn in FY1994 and £10.3bn in FY1995. Extension of VAT to domestic fuel and power (from FY1994); mortgage interest income tax relief limited to 20% (starting April 1994); income tax allowances frozen (for FY1993). 27 May 1993 Ken Clarke replaced Norman Lamont as Chancellor. 1 July 1993 Eddie George replaced Sir Robin Leigh-Pemberton as the Governor of the Bank of England. The regular monthly meetings instigated by Norman Lamont with the Governor became the “Ken and Eddie show” (as dubbed). 23 November 1993 Base rate reduced from 6% to 5½%. 30 November 1993 Kenneth Clarke’s first Budget as Chancellor: first unified budget (combining the Budget and Autumn Statement). Fiscal measures to boost revenue by £1.7bn in FY1994 and £4.9bn in FY1995, in addition to impact of measures announced in March 1993 Budget. Mortgage interest income relief limited to 15% (from April 1995); income tax allowances frozen (for FY1994); commitment to raise tobacco duties by at least 3% pa in real terms; fuel duties escalator increased from at least 3% pa in real terms to 5% pa in real terms. 1994 8 February 1994 Base rate reduced from 5½% to 5¼%. April 1994 Chancellor Clarke agreed to the publication of the minutes of the “Ken and Eddie show”. June 1994 HMT’s Summer Forecast. PSNCR expected to be £36.1bn in FY1994 (£1.8bn lower than the Budget forecast). 12 September 1994 Base rate increased by ½% to 5¾%. 29 November 1994 Budget broadly neutral; PSNCR forecast for FY1994 reduced from £36.1bn to £34.4bn. Monitoring ranges for M0 and M4 unchanged. Landfill tax planned for 1996. 7 December 1994 Base rate increased by ½% to 6¼%.

1995 2 February 1995 Base rate increased by ½% to 6¾%. 14 June 1995 Chancellor Clarke’s Mansion House speech: inflation target range (1-4%) reaffirmed. 28 June 1995 PSNCR Summer Economic Forecast for 1995/96 of £23.6bn (£2.1bn higher than the Budget Forecast). 28 November 1995 Budget: monitoring ranges for M0 (0-4%) and M4 (3-9%) remained unchanged in November Budget. PSNCR Budget forecast for FY1995 of £29bn. Basic rate of income tax cut 1% to 24% (starting April 1996). Tax on savings income cut 5% to 20% (from April 1996). 13 December 1995 Base rate cut by ¼% to 6½%. 1996 18 January 1996 Base rate cut by ¼% to 6¼%. 8 March 1996 Base rate cut by ¼% to 6%. 6 June 1996 Base rate cut by ¼% to 5¾%. 30 October 1996 Base rate increased by ¼% to 6%. November 1996 Budget: monitoring ranges for M0 (0-4%) and M4 (3-9%) left unchanged in Budget. PSNCR forecast for FY1996 revised downwards to £26.4bn. Further cut in the basic rate of income tax from 24% to 23%. 1997 1 May 1997 General Election: Labour won. 6 May 1997 Chancellor Gordon Brown announced Bank of England to receive operational independence over monetary policy. Decisions on interest rate policy to be made by a Monetary Policy Committee (MPC), which was to meet monthly. Base rate increased by ¼% to 6¼%. May 1997 M0 and M4 monitoring ranges lapsed. 6 June 1997 Bank of England increased BoE repo rate by ¼% to 6½%. 2 July 1997 Chancellor Brown’s first budget. PSNCR forecast for 1997/98 revised downwards to £10.9bn. Bank of England given inflation (RPIX) target of 2½%, with the Governor required to write an Open Letter to the Chancellor if inflation becomes one percentage point higher or lower than target. Increased estimated revenue (from an indexed base) of nearly £6bn for FY1997, £6.6bn for FY1998 and £5.2bn for FY1999. See also chapter 1. A windfall tax on the utilities was introduced to fund the “New Deal”. Stamp duty increased to 1.5% (properties £250,000 to £500,000) and 2% (over £500,000). Tax credits for dividends paid to pension schemes and UK companies abolished. Main corporation tax rate cut from 33% to 31% (April 1997). Mortgage tax relief reduced from 15% to 10% (April 1998). 10 July 1997 Bank of England increased repo rate by ¼% to 6¾%. 7 August 1997 Bank of England increased repo rate by ¼% to 7%. 6 November 1997 Bank of England increased repo rate by ¼% to 7¼%. 25 November 1997 In the Pre-Budget Report, the Chancellor revised the PSNCR forecast to £9.5bn from FY1997 from £10.9bn in the Budget. 1998 17 March 1998 The broadly neutral Budget contained proposals on the Government’s replacement for PEPs and TESSAs: the Individual Savings Account (ISA). The PSNCR forecast for FY1997 was again revised downwards to £2.6bn from £9.5bn in the Pre-Budget Report. The forecast for the PSCNR for FY1998 was £2.3bn. Announcement of tax credits. Stamp duty increased to 2% (properties £250,000 to £500,000) and 3% (over £500,000). Main Corporation Tax rate reduced from 31% to 30% and ACT abolished (April 1999) 4 June 1998 Bank of England increased repo rate by ¼% to 7½%. July 1998 Comprehensive Spending Review for FY1999 to FY2001. 8 October 1998 Bank of England cut repo rate by ¼% to 7¼%. 5 November 1998 Bank of England decreased repo rate by ½% to 6¾%. November 1998 The Pre-Budget report showed a revised forecast for the PSNCR for FY1998 as a surplus of £4.3bn (including windfall tax). 10 December 1998 Bank of England decreased repo rate by ½% to 6¼%.

1999 7 January 1999 Bank of England decreased repo rate by ¼% to 6%. 4 February 1999 Bank of England decreased repo rate by ½% to 5½%. March 1999 Budget: a new 10% starting rate of personal income tax (April 1999) and the basic rate to be reduced to 22% (April 2000). Married Couple’s Allowance and MIRAS abolished (April 2000). Introduction of the Minimum Income Guarantee for pensioners. Stamp duty increases announced: to 2.5% (properties £250,000 to £500,000) and 4% (over £500,000). NICs reforms to go ahead (April 2000 and April 2001). Climate Change Levy (from FY2001). 8 April 1999 Bank of England decreased repo rate by ¼% to 5¼%. 10 June 1999 Bank of England decreased repo rate by ¼% to 5%. 8 September 1999 Bank of England increased repo rate by ¼% to 5¼%. 4 November 1999 Bank of England increased repo rate by ¼% to 5½%. November 1999 Pre-Budget Report: end of automatic fuel escalator.

2000 13 January 2000 Bank of England increased repo rate by ¼% to 5¾%. 10 February 2000 Bank of England increased repo rate by ¼% to 6%. March 2000 Budget: large increases in public spending announced (ahead of the July Spending Review). Stamp duty: 3% of properties between £250,000 and £500,000 and 4% over £500,000. Aggregates levy (from April 2002). July 2000 Spending Review (FY2001 to FY2003): large increases in NHS spending. November 2000 Pre-Budget Report.

2001 8 February 2001 Bank of England decreased repo rate by ¼% to 5¾%. March 2001 Budget: increases in tax credits. 5 April 2001 Bank of England decreased repo rate by ¼% to 5½%. 10 May 2001 Bank of England decreased repo rate by ¼% to 5¼%. 7 June 2001 General Election: Labour returned to power. 2 August 2001 Bank of England decreased repo rate by ¼% to 5%. September 2001 Following the terrorist attack in New York (“9/11”) the Bank of England decreased repo rate by ¼% to 4¾% at an emergency meeting. 4 October 2001 Bank of England decreased repo rate by ¼% to 4½%. 8 November 2001 Bank of England decreased repo rate by ½% to 4%. November 2001 Pre-Budget Report.

2002 17 April 2002 Budget: large increases announced for the NHS spending; increases announced in employers’ NICs, self-employed NICs and employees’ NICs (from April 2003), estimated to increase revenue by £8bn. Changes to system of tax credits. July 2002 Spending Review (FY2003 to FY2005), confirmed very large increases in public spending, including the NHS. November 2002 Pre-Budget Report.

2003 6 February 2003 Bank of England decreased repo rate by ¼% to 3¾%. 9 April 2003 Budget: fuel duties frozen in cash terms until 1 October 2003. 9 June 2003 The Chancellor ruled that the UK was not ready to join the euro as four of the five economic tests not met. He announced that the inflation target would be changed to one based on the Harmonised Index of Consumer Prices (HICP) and not based on the RPIX. 30 June 2003 Sir Eddie George replaced by Mervyn King as Governor of the Bank of England. 10 July 2003 Bank of England decreased repo rate by ¼% to 3½%. 6 November 2003 Bank of England increased repo rate by ¼% to 3¾%. November 2003 Pre-Budget Report. 10 December 2003 Pre-Budget Report. The Chancellor changed the inflation target for monetary policy to one based on the Consumer Price Index (CPI), which was previously called the Harmonised Index of Consumers Prices (HCIP). The CPI inflation target was set at 2.0%. If inflation is either 1% higher or lower than this target the Governor of the BoE is required to send an Open Letter to the Chancellor explaining the reasons.

2004 5 February 2004 Bank of England increased repo rate by ¼% to 4%. March 2004 Budget: most alcohol duties increased in line with inflation only. 6 May 2004 Bank of England increased repo rate by ¼% to 4¼%. 10 June 2004 Bank of England increased repo rate by ¼% to 4½%. July 2004 Spending Review (FY2005 to FY2007), substantial increases in public spending, not least of all for the NHS. 5 August 2004 Bank of England increased repo rate by ¼% to 4¾%. December 2004 Pre-Budget Report.

* The budget information, in particular, is selective.

Sources include “Diary of events relevant to the interpretation of the monetary statistics” (source: www.bankofengland.co.uk) and The IFS, Green Budget, IFS, January 2005. The PSNCR data quoted in the above table were taken from this quoted Bank of England source, which can be considered to be reliable. ANNEX 3

GLOSSARY

Fiscal rules: Chancellor Gordon Brown’s rules are: ! the golden rule: which states that, on average over the cycle, the government will borrow only to invest and not to fund current spending; ! the sustainable investment rule: which states that public sector debt as a proportion of GDP will be held over the cycle at a stable and prudent level. The government believes that, other things being equal, it is desirable that public spending net debt should be below 40% of GDP over the cycle. Inflation targeting: is when monetary policy regimes are adopted that explicitly target inflation directly rather than an intermediate target such as money supply or the exchange rate. The pioneer was New Zealand (in 1990), followed by Canada (1991), the UK (1992) and Sweden (1993). Even though the ECB’s primary objective is price stability (with CPI inflation “close to 2%”), it monitors both inflation and monetary variables. It does not see itself as an inflation-targeting central bank. The Bundesbank’s primary objective was also price stability (with 2% inflation regarded as the norm) but its monetary policy involved pragmatic monetary targeting. The US Federal Reserve Bank (“Fed”) has the following goals: “maximum employment, objective of price stability and moderate long-term interest rates”. The Fed does not see itself as an inflation-targeting central bank, though it has discussed the possibility of moving nearer to inflation-targeting. Repo rates: the Bank of England derives its influence over interest rates in the wholesale money markets by having the monopoly of supply of central bank money, which is the only form of final settlement for sterling payments. Through its Open Market Operations, the BoE meets the demand for central bank money by buying financial assets, at a “price” (interest rate), from its counterparties (including the commercial banks) in the wholesale money markets. The “price” is based on the official repo rate. The BoE currently buys high quality assets (eg Treasury bills) either outright (with less than 14 days to maturity - though this is due to end from 14 March 2005) or through 2-week “reverse” repo transactions. (Repo transactions are “sale and repurchase transactions”, reverse repo transactions are “buy and re-sell transactions”. Reverse repos act as a short-term loan to the counterparties from the BoE.) Changes to the official repo rate influence the rates (or yields) on the all securities, but especially those at the “short end” of the market – in other words those securities that have short maturities (e.g. 3-month Treasury bills). Changes to the repo rate, therefore, have a very direct effect on all short-term interest rates. Long-dated securities, having a maturity of over 15 years, are, however, also influenced by changes in repo rates. “Long-term interest rates” are defined as yields on securities having a maturity of over 15 years. Public sector accounts: the key terms used in the public sector accounts are shown below.

1 Total current receipts Taxes on income & wealth + taxes on production (including VAT) + other current taxes + taxes on capital + compulsory social security contributions + gross operating surplus + interest & dividends from private sector & RoW (rest of world) + interest & dividends (net) from public sector + rent & other current transfers

2 Total current expenditure Current expenditure on goods & services + subsidies + net social benefits + net current grants abroad + current grants (net) within general government + other current grants + interest & dividends paid to the private sector & RoW

3 = 1-2

Saving, gross plus capital taxes

4 Less depreciation (conventionally shown as negative in the accounts)

5 = 3+4

Surplus on the current budget (current balance)*

6 Total net investment Gross fixed capital formation (GFCF) less depreciation + increase in inventories & valuables + capital grants (net) within public sector + capital grants to private sector + capital grants from private sector

7 = 6-5

Net borrowing (NB)**

8 Financial transactions Net lending to private sector & RoW + net acquisition of company securities + determining the net cash accounts receivable/payable + adjustment for interest on gilts + other financial requirement (NCR) transactions

9 = 7+8

Net cash requirement (NCR)***

* The surplus on the current budget can also be defined as: current resources minus current uses (= net saving) plus receipts of capital taxes.

** Public Sector Net Borrowing (PSNB) is the net borrowing for the total public sector. It is the balance between income and expenditure in the consolidated current and capital accounts and is measured on an accruals basis.

*** The Public Sector Net Cash Requirement (PSNCR) is the net cash requirement for the total public sector. It is measured on a receipts basis. The PSNCR can also be defined as public sector cash receipts minus public sector cash outlays. It was previously known as the Public Sector Borrowing Requirement (PSBR). ANNEX 4

GDP GROWTH FORECASTS

ANNEX 4(A): TREASURY GDP GROWTH FORECASTS, SHOWN AS RANGES

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Jul 97 2½ 3 ¼ 2 ½ Nov 97 2½ 3½ 2¼ - 2¾ 1½ - 2 2¼ - 2¾ Mar 98 3 2-2½ 1¾ - 2¼ 2¼ - 2¾ Nov 98 3½ 2¾ 1-1½ 2¼ - 2¾ 2¾ - 3¼ Mar 99 2¼ 1-1½ 2¼ - 2¾ 2¾ - 3¼ Nov 99 2¼ 1¾ 2½ - 3 2¼ - 2¾ 2¼ - 2¾ Mar 00 2 2¾ - 3¼ 2¼ - 2¾ 2¼ - 2¾ Nov 00 2¼ 3 2¼ - 2¾ 2¼ - 2¾ 2¼ - 2¾ Mar 01 3 2¼ - 2¾ 2¼ - 2¾ 2¼ - 2¾ Nov 01 3 2¼ 2-2½ 2¾ - 3¼ 2¼ - 2¾ Apr 02 2¼ 2-2½ 3 –3½ 2½ - 3 Nov 02 2 1½ 2½ - 3 3 –3½ 2¾ - 3¼ Apr 03 1¾ 2-2½ 3 –3½ 3 – 3½ Dec 03 1¾ 2 3 –3½ 3 – 3½ Mar 04 2¼ 3 –3½ 3 – 3½ Dec 04 2¼ 3¼ 3 – 3½ Sources: successive Budget reports and Pre-Budget Reports. Note: first outturns are underlined.

ANNEX 4(B): TREASURY GDP GROWTH FORECASTS, TAKING THE MID-POINT FIGURE AS THE “CENTRAL CASE”

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Jul 97 2½ 3 ¼ 2 ½ Nov 97 2½ 3½ (2½) (1¾) (2½) Mar 98 3 (2¼) (2) (2½) Nov 98 3½ 2¾ (1¼) (2½) (3) Mar 99 2¼ (1¼) (2½) (3) Nov 99 2¼ 1¾ (2¾) (2½) (2½) Mar 00 2 (3) (2½) (2½) Nov 00 2¼ 3 (2½) (2½) (2½) Mar 01 3 (2½) (2½) (2½) Nov 01 3 2¼ (2¼) (3) (2½) Apr 02 2¼ (2¼) (3¼) (2¾) Nov 02 2 1½ (2¾) (3¼) (3) Apr 03 1¾ (2¼) (3¼) (3¼) Dec 03 1¾ 2 (3¼) (3¼) Mar 04 2¼ (3¼) (3¼) Dec 04 2¼ 3¼ (3¼)

Out-turn* 2.2 1.8 2.2 3.1 Na PBR forecast (Year of PBR in brackets) 2½ (00) 2¼ (01) 2¾ (02) 3¼ (03) 3¼ (04) Out-turn minus PBR forecast -0.3 -0.45 -0.55 -0.15 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 * Latest ONS data. Notes: (1) The mid-point, the central case, is in brackets. (2) The Pre-Budget Report (PBR) forecasts used to calculate the accuracy of the forecasts are shown in bold. (3) First outturns are underlined. ANNEX 5

COMPETITIVENESS RANKINGS

ANNEX 5(A): IMD (INTERNATIONAL INSTITUTE OF MANAGEMENT DEVELOPMENT) WORLD COMPETITIVENESS RANKINGS

1997 1998 1999 2000 2001 2002 2003 2004 Change: 1997- 2004 Eurozone & the UK France 22 22 23 22 25 25 23 30 +8 Germany1615121313172021+5 Italy 3931303233344151+12 UK 913191517161922+13

Anglophone Australia 15 12 11 11 12 10 7 4 -11 Canada681089763-3 New Zealand1117172021181618+7 UK 913191517161922+12 USA111111110 Sources: IMD competitiveness yearbook 2004 (for the years from 2000 to 2004). Rankings as of April 2001 from website: www.imd.ch (for the years 1997 and 1999). Back data are subject to revision. The number of countries tends to increase over time. There were 60 in 2004. The lower the number, the better the ranking.

ANNEX 5(B): WORLD ECONOMIC FORUM (WEF) GROWTH COMPETITIVENESS INDEX (GCI) RANKINGS

1997 1998 1999 2000 2001 2002 2003 2004 Change: 1997- 2004 Eurozone & the UK France 23 22 23 21 20 30 26 27 +4 Germany2524251417141313-12 Italy 3941352926394147+8 UK 748812111511+4

Anglophone Australia 17 14 12 11 5 7 10 14 -3 Canada4556381615+12 New Zealand 5 13 13 19 10 16 14 18 +13 UK 748812111511+4 USA33212122-1 Sources: Global Competitiveness Report 2004-2005 (for 2003 and 2004; website: www.weforum.org), “World competitiveness reports” (for 1997 to 2002; from website: www.maaw.info). Back data are subject to revision. The Growth Competitiveness Index (GCI) (referred to as the Competitive Index prior to 2000) is based on estimates of each country’s ability to grow over the next 5-10 years. Please note the number of countries considered tends to increase over time. There were 104 in 2004. The lower the number, the better the ranking. ANNEX 6

FORECASTS FOR THE PUBLIC FINANCES

ANNEX 6(A): CURRENT BALANCE FY2000 ONWARDS

FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09

Nov 98 3 8 10 11 Mar 99 4 8 9 11 Nov 99 11 13 13 12 11 Mar 00 14 16 13 8 8 Nov 00 16.6 16 14 8 8 8 Mar 01 23.1 17 15 8 9 9 Nov 01 25.1 10.334789 Apr 02 21.6 10.6 37979 Nov 02 7.7 -5.7 -5 3 5 8 10 Apr 03 9.9 -11.7 -8 -1 2 6 9 Dec 03 -11.8 -19.3-8-50 4 8 Mar 04 -12.3 -21.3 -11 -5 0 4 9 Dec 04 -21.1 -12.5 -7 1 4 9 12 Sources: successive Budget reports and Pre-Budget Reports. Note: first outturns are underlined.

ANNEX 6(B): PUBLIC SECTOR NET BORROWING, £BN, FROM FY2000

FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 Nov 98 5221 Mar 99 3134 Nov 99 -3 -3 1 4 6 Mar 00 -6 -5 3 11 13 Nov 00 -10.1 -6 1 10 12 13 Mar 01 -16.4 -6 1 10 11 12 Nov 01 -18.8 2.51215131313 Apr 02 -15.9 1.3 11 13 13 17 18 Nov 02 1.2 20.12419191920 Apr 03 -0.4 24 27 24 23 22 22 Dec 03 22.5 37.43130272724 Mar 04 22.9 37.53331272723 Dec 04 34.8 34.23329282422 ANNEX 7

THE PUBLIC FINANCES TO FY2004: BALANCES (£BN)

Conservatives (5 years) Labour (7 years) FY1992 FY1997 FY1997 FY1997 FY2004++ FY2004 minus minus FY1992* FY1997* Current budget surplus -34.4 -1.4 33.0 (6.6) -1.4 -16.0 -14.6 (-2.1) Current budget surplus -34.4 [-6.9] 27.5 (5.5) [-6.9] -16.0 -9.1 (-1.3) adjusted for July 1997 budget+ PSNB 46.7 6.6 40.1 (-8.0) 6.6 34.2 27.6 (3.9) PSNB adjusted for July 46.7 [12.1] 34.6 (-6.9) [12.1] 34.2 22.1 (3.2) 1997 budget+ * Average annual absolute change in brackets (£bn). + The FY1997 figure is adjusted for the £5½bn (approximate) of tightening in the July 1997 budget (see chapter 1 for details). ++ The Pre-Budget Report (December 2004) forecast a current budget deficit of £12.5bn and a PSNB of £34.2bn. The CPS forecast for the current budget deficit is £16.0bn, and this allows for the better-than-expected January public sector data. (The current budget deficit for FY2003 was £20.7bn.) The Treasury’s forecast for the PSNB for FY2004 looks plausible.