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The two main political parties have nailed their colours to the mast for dealing with the recession, as Robert Hill explains Rarely in recent years has there been such a clear policy and political divide between the main parties. Over in the red corner, we have the Government arguing that the threat posed by the banking crisis and the looming recession is so grave that it demands bold measures. So it acts to shore up and take control of the banks, followed by big cuts in interest rates, followed by sizeable drop in the value of the pound, followed by tax cuts – even though the budget deficit is worsening – followed by a boost to infrastructure projects. Meanwhile, in the blue corner, we have the Opposition arguing that the Government is largely to blame for the crisis because of its imprudent spending legacy and weak regulation of the financial sector. It warns of the pound going into free fall and says the fiscal stimulus in the pre-Budget report (PBR) is irresponsible because it will pile debt upon debt. Who is right? Most economists would argue – as does just about every government in the developed world – that such is the dire state of the world economy that a stimulus is needed. And in the short term, governments normally and inevitably borrow to fund a stimulus package. The 1980s showed the destructive limitations of trying to rely only on monetary policy, through the setting of interest rates, as the main lever to counter a recession. This is even more the case today, as the full effect of interest rates cuts is not yet getting through to businesses and families because of the banks' ultra-cautious approach to lending. And if you don't make the stimulus, then borrowing ends up rising anyway as the economy contracts, tax revenues fall and the costs of unemployment rise. So, in economic terms, it makes sense to inject money into the economy at this point – and to combine that with lower interest rates, easier access to credit for home-buyers and businesses, and a more competitive pound to help our exporters. The Conservatives are, therefore, taking a massive political risk in opposing such common sense economics. They risk reviving memories of their stewardship of the 1980s, and they lay themselves open to Gordon Brown's charge of them being the ‘do-nothing' party. Why are the Tories doing this? They are going for an each-way bet. If the stimulus fails, they can say, ‘We told you it was foolish'. If it works, they will highlight the cost of paying off public debt and argue that it needs a new government to plan for a new ‘peace-time' financial strategy and slimline state, now that the war of the credit crunch is over. But the Government is also taking big risks. First, is the stimulus big enough? A lot of attention has focused on the seemingly-paltry nature of the 2.5% cut in VAT. In fact, it will help ease retailers' margins and maintain demand for big ticket items, such as cars, washing machines and holidays. In addition, the PBR contains a lot of unheralded measures – such as the increases in the personal allowances and tax credits. But, overall, the stimulus package is only worth 1% of GDP, when the IMF is calling for countries to think in terms of 2%. And it is far less than Barack Obama's new administration is contemplating for the US. The second gamble was the decision to pre-announce tax rises from 2010/11 to repay the borrowing and balance the government budget. This is, essentially, politically not economically driven, since the level of the tax rises actually required will be determined entirely by the speed and scale of the recovery. The Government has told us about the pain that is to come in an attempt to blunt the Conservative attack, and demonstrate its commitment to fair taxation at a time when a lot of banking fat cats are perceived to have walked away from the financial carnage unscathed. But will this high stakes politics undermine faith in New Labour and frighten off high-aspiring middle class voters? These are strange times indeed. Both main political parties have shown their cards. Which party has got its political strategy right? Only time and the economy will tell. Robert Hill is a former adviser to ex-PM Tony Blair and works as an independent policy analyst

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WHITEHALL

Parties split over the economy

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