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Public spending conundrum must be solved whoever wins the election - John Redwood Comment

April 07, 2010

At last the much heralded UK election campaign is officially started today. Markets are watching the frantic movements in the polls and listening carefully to the statements of the main parties involved. This column will cease to be the John Redwood column from today for the campaign- it is the Pan column and as always reflects the Pan view, not any particular party or candidate's view.

Over the last week the issues affecting sterling and the bond markets have proved to be a little more subtle than previously thought. Whilst the markets want a plan to cut the public deficit before bonds can be relied on and sterling gains a surer footing, that is not necessarily the same thing as markets welcoming higher taxes.

For market participants understand the dynamics of an economy. If a government raises tax rates on trading, saving, earning and enterprise too much it may not maximise revenue. It may deter effort, encourage people to emigrate or discourage new people from coming with their businesses. The market participants tend to be the people who will have to pay the higher tax rates, so it is not good for sentiment either.

Over the last week the battle ground between Conservative and Labour has been the issue of the proposed increase in National Insurance. Labour says it is an important part of its deficit reduction programme. The Conservatives say it will destroy jobs, thereby increasing spending on benefits. They favour more efficiency savings to "pay" for the tax reduction, whilst Labour say these efficiency gains are illusory. Labour, however, do include efficiency gains of their own within their deficit reduction plan.

The sums involved are not large compared with the size of the economy or with the scale of the deficit. They have, however, become symbols of two differing approaches. Labour's approach is based more on maintaining public spending- the so called fiscal stimulus. The Conservatives are moving more towards incentives for more enterprise, jobs and business, the private sector growth oriented approach to cutting the deficit.

The Evercore Pan view is that in practise any party winning power is going to have to hold a serious public spending review and will have to take tougher decisions than so far they have spelt out to curb spending and cut the deficit. For the moment sterling rallies a little on news that the Conservatives might win, in the belief that their deficit reduction programme is fuller and more convincing. So far no party has spelt out the detail necessary to reassure the markets that spending and the deficit will be brought under control.