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Britain: If The Economy Ain't Broke...


In 1997, Mark Jefferies started Camel Construction Products Ltd., a business that sells heavy-duty stones for curbs that line roads in Wakefield in West Yorkshire. The company, which was formed when Tony Blair first became Prime Minister, has thrived under his Labour government. Revenue has grown more than 10% each year, jumping nearly 40% in 2004. Jefferies, 39, who began with just one assistant, now has five employees. He remains a dyed-in-the-wool supporter of the Conservative Party but concedes that the business environment under Blair has been far better than he expected. "Low interest rates are good for manufacturing and very welcome," he says.

Blair should give thanks for the robust economy. On Apr. 5, he asked Queen Elizabeth II to dissolve Parliament and schedule a general election for May 5. But Blair's popularity has been battered by his decision to take Britain into the war in Iraq. Many voters also say the Prime Minister is not trustworthy and that he has fallen short on promises to improve public services. His lead is down to an average of 1 percentage point in five recent polls, and Robert M. Worcester, chairman of pollsters MORI says "a hung Parliament with Labour in the lead is possible," although he still thinks Blair is likely to gain an outright majority.

If Blair holds on and wins, it will be thanks to Britain's position as the healthiest European economy. Under Blair, the economy has recorded growth every quarter. That takes the Tories' traditional election ace away from them. "The Conservatives are not able to claim the economy has gone to the dogs; no one would believe them," says Anthony King, professor of government at University of Essex. Labour has built on efforts begun under the Tories to curb inflation, notably by giving the Bank of England power to set interest rates.

Yet there are still profound differences between Blair and the Tories over how Britain's economy should be managed. Blair and his cohorts believe that government should be the major player in vital areas including health care and education. The Conservatives are skeptical of the public sector and want to trim it back. Although the traditional lines between the parties have been blurred by Blair's natural conservativism and the Tories' wariness of openly advocating deep spending cuts, this election will broadly determine which of these visions prevails in Britain.

BALANCING ACT

Blair and his partner, Chancellor of the Exchequer Gordon Brown, have had to juggle conflicting demands. Business and investors want to limit both taxes and government spending, while traditional Labour supporters prefer to see money transferred from the rich to the less well-off. Brown spent his first term burnishing his credentials with the first group. He ran a tight ship, cutting public spending from 40.6% of gross domestic product to 38% in fiscal 2001-02. But in the second term, public spending has climbed to a projected 42% for the current year. Brown wants health outlays to leap by 9.2% this year and education by 8.5%.

Blair gets blasted by Labour traditionalists for being a Tory in disguise. But under his government, income growth of the lower 40% of British households outpaced those of the top 40%, according to the Institute for Fiscal Studies (IFS), a nonpartisan London think tank. The main reasons: higher taxes on income and subsidies for low earners. The percentage of households below the poverty line has dipped from 24.9% before Labour took office to 20.5%.

Instinctively, Blair favors slashing the welfare rolls further and selling off public housing. He also wants to tackle pension reform. If he manages to hold on to a 70- to 100-seat majority, he will be able to do what he wants, and he may stay on until near the end of the five-year term. But if his lead is reduced to 40 seats or less, he may not be able to prevail over Labour rebels and the left-leaning Brown.

How different would a government led by Tory leader Michael Howard be? He promises to spend the same as Labour on schools and health in his first budget for 2007-08. His proposed tax cuts are small, just $7.5 billion, or about 0.4% of GDP. In an indication that Labour's big spending agenda rules the day, Howard recently sacked a Tory deputy chairman, Howard Flight, for suggesting in an off-the-record speech that the party planned deeper cuts than it was saying publicly. But it is a good bet that over time, a Tory government will spend and tax less than Labour.

Economic changes may well force change no matter which party wins. Blair and Brown have exploited strong growth to preserve much of the welfare state. But there are signs that the economy is slowing as higher interest rates and a leveling-off of housing prices bite into consumer spending, the main driver of British growth. Morgan Stanley (MWD) forecasts Britain's GDP growth will hit 2.1% for this year, in contrast to the Treasury's projected 3.0%.

WELFARE STATE: "UP FOR GRABS"

No matter who wins, the government may be forced to raise taxes, scale back its ambitions, or both. Public debt is about 35% of GDP, near the 40% limit that Brown holds sacrosanct. David Miles, chief economist for Britain at Morgan Stanley, estimates that if Labour wins, taxes may need to go up by about $18 billion, or 1% of GDP, per year, in order for Brown to fulfill his pledge to keep the budget in balance over the economic cycle. And with a less robust economy, the next Prime Minister will realize that the government can't continue to throw enormous sums at public services. "Somewhere down the road the whole model of the welfare state is going to come up for grabs," says Derek Scott, Blair's economic adviser from 1997-2003.

Businesses already are raising red flags. Brown has loaded a big chunk of his taxes on business, including a one-percentage-point rise in the national insurance rate on employees' income to 12.8% and tax hikes on energy use. While Britain's overall corporate tax rate, at 30%, still remains lowest in the Group of Seven industrialized nations, it is above the European average of 26.2% (excluding Britain), according to the IFS. Poland and the Czech Republic have much lower rates. "One of our biggest concerns is that the tax burden on business has gone up," says Steve Radley, economist for the EEF, an association of manufacturers.

Companies are also screaming about the blizzard of red tape that has fallen on them since Labour came to power. "Since 1997 more of my time has been spent on paperwork and regulations than on running the business," says Andy Willox, 61, who runs a contract cleaning company called Goldstar in Aberdeen, Scotland. Willox has good reason to complain. But he can thank Blair that Britain's economy is strong enough to generate good demand. If he lived in one of Europe's other large economies -- Germany, say -- he might not be in business.

By Stanley Reed, with Kerry Capell, in London


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