Coalition's first 100 days: The economy

Economy presents coalition with its biggest challenge
Economy presents coalition with its biggest challenge

All this week will be examining the state of the coalition as it marks its first 100 days, beginning with the biggest headache of all: the economy.

By Alex Stevenson

The Conservatives had pledged to hold an emergency Budget within 50 days; it came with a week to spare. For many it was the moment when talk of spending cuts turned from unpleasant anticipation to grim reality. Benefits were slashed and plans to increase VAT, which rises to 20% in January 2011, were announced. The atmosphere in the Commons could not have been a more unpleasant mix. Angry Labour MPs shouted in impotence as queasy Lib Dems sat next to their cheering newfound Tory colleagues.

Labour's warnings that spending cuts would hurt the recovery appear to have been vindicated. Last week the Bank of England's August inflation report lowered its predictions for 2011 growth from around 3.5% to around 2.5%, a huge reduction. It's the rapid pace of the reductions which proves so worrying to Patrick Stevens, vice-president of the Chartered Institute of Taxation. "The speed of it is clearly not going to help the recovery," he warns.

The Bank blamed the VAT hike. But it's the 'quicker and deeper' logic to Tory cuts which makes them so potent, going far beyond any one measure. Labour wanted to put off the process of cutting until the economic recovery became a certainty. The Tories, by contrast, are in a hurry.

Tony Dolphin, senior economist at the Institute for Public Policy Research thinktank, believes the rhetoric in the run-up to the Budget has probably had "more of a negative effect on confidence than George Osborne and co were expecting". Consumer confidence indicators and the like have not been nearly as impressed as the coalition might have hoped. They had argued cuts would provide uncertainty and boost confidence in the private sector. Instead, Dolphin suggests, there has been more of an "oh my God" reaction - in which businesses fear demand for their product might be dampened so they prefer to "hunker down for a bit".

"It is tentative, it's only two months in from the Budget," Dolphin says. "But clearly it's not looking good. The gamble so far doesn't seem to be paying off."

Muted banker-bashing

Not everybody is dismayed. In the City many are breathing a sigh of relief after the bank levy imposed in the emergency Budget proved significantly less stringent than many had feared. Nick Clegg told before the general election: "I think it's a complete economic and moral outrage the way the greed of the bankers of the City of London has basically held a gun to the head of the rest of the British economy." How would this rhetoric impact on the traditionally close relationship between the Conservatives and the City?

"At the moment, my impression is you're getting quite a good best of both worlds," Stevens, who is also vice-president of accountancy firm Ernst and Young, says.

"I have the impression that because they need to work with each other it means the more extreme elements of each party are being sidelined a bit. And that gives us possibly a better chance of having a government for the benefit of the whole country."

Stevens is upbeat; it looks like the Lib Dems haven't stuck to their guns on a tough response to the financial sector. With that potential crisis laid to one side CIOT is free to focus on its main goal - a simpler, working tax system. Corporation tax plans are laid out for the next four years, helping businesses plan ahead. VAT may be going up, but at least the hike is delayed so retailers can work out pricing strategies to cope. Capital gains tax has avoided complex indexation or tapers. And then there's the big review of tax reform. "It's early days, but we're quite pleased."

Initially, at least, the feeling is one of relief that more draconian measures have not been quickly rushed through. There are still plans within the coalition agreement for a crackdown on bonuses. A commission will work on how to separate retail and investment branches. And there has been "no decision to act just yet" on a threat to introduce net lending targets. All these will provide challenges. But no drastic steps have been taken in the coalition's first 100 days.

"I've been a bit surprised," Dolphin says. "Taking Cameron and Osborne at their word, they were interested in a fundamental review of the way the City operated. It seems they've hived that off into reviews which they may quietly forget about."

As he admits, in the long history of the Conservative party it's no surprise they're reluctant to take on the City. But "with a few Lib Dems in there to stiffen spines" it might still be different. "Maybe we're being too early to judge. You can come in and have a budget within a month or two and raise VAT - it takes a bigger decision to say we're going to break up Barclays."

Even in the key sector of financial regulation, where Osborne has announced plans to return significant oversight powers to the Bank of England, analysts are more nervy about a culture change than direct action by ministers. "There's going to be a lot more willingness by regulators to go for it - they don't want to be caught napping again," Stevens adds. "That will be more important than changes in top-level laws."

A comprehensive spending nightmare

The City may be getting ahead of itself. There is a sense the coalition will turn its attention to addressing the bigger-picture systemic risks to the economy which caused the 2008 financial crisis only after it has set public spending back on what it views as a sustainable footing.

This is no easy task. The pain of the emergency Budget is nothing to what can be expected on October 20th, when the final results of the comprehensive spending review are unveiled by Osborne. But there have already been rebellions from the left wing of the Lib Dem parliamentary party. In the weeks following the emergency Budget the mood among many marginalised Lib Dem MPs was less than happy; many complained about the rushed nature of the coalition agreement and the lack of wider consultation. A senior Lib Dem member of the government told before the break that MPs were fractious simply because they needed a holiday. It sounded a lot like excuse-making. To what extent are the minor rebellions indications of deeper discomfort?

"Clearly there is a portion of the parliamentary Liberal party that are quite nervous and upset," Dolphin says. "But the ministers, Clegg and Alexander, seem to be very much on message. Whether that's through the general genuine change of view, in favour of deficit reduction, or whether it's slightly more cynical and just playing to the collective Cabinet responsibility, I don't know."

Stevens agrees. His positive view is that coalition governments "could be quite a good thing".

But he adds: "Whether the people at the more extreme ends of the parties would go along with that, and whether politically that will be able to continue, is of course another matter."

For now, at least, the line is holding. But Andrew Lilico, chief economist at centre-right thinktank Policy Exchange, fears the full impact of the comprehensive spending review has not yet fully sunk in.

The first mistake Lilico identifies is the failure of the Tories to use the opportunity offered by coalition negotiations to drop their NHS ringfencing pledge. Protecting health and aid spending means departmental budget cuts which would have amounted to 20% will now be 25%, Osborne said in the emergency Budget. "They've got it all wrong on that," Lilico says. "By not cutting the NHS they're imposing much larger burdens elsewhere." If the defence budget is only reduced by ten per cent, reductions elsewhere could be forced up to 33%.

Have politicians really grasped the full implications of this? Lilico is full of scorn for our elected representatives and their extremely high levels of "paranoia". The recent row about free school milk for under-fives ended when No 10 intervened to save the totemic issue. All major cuts will now be scrutinised by Downing Street for an assessment of their political acceptability. This, Lilico says, is "not a good sign".

"He doesn't get it. You need a prime minister that's absolutely resolutely behind the process of saying there's tough decisions to be made.

"People aren't going to like it - that's tough, that's just the way it is. That kind of approach is going to get you hated, get you infamous. But as I've been saying - if you didn't want to do this, you should have got a different job."

Politicians aren't, as a rule, in the job to get hated. Any minister reading this could be forgiven for gulping nervously. Yet it is precisely that nervousness which makes the next few months so uncertain.

The grimness of the emergency Budget is nothing to what lies ahead. The first 100 days have seen the coalition take the first steps towards the big leap which is to come. It's also contained the seeds of self-doubt and a lack of resolve which could, still, undo the coalition.


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