Be warned: it could all end in tears

All businesses need financial, market and political stability in which to prosper. The general election result and its economic background are plainly not good for business. The vital questions now are how our politicians adapt to the circumstances and how they, and other G20 governments, see the world economy through the second phase of the crisis that began in 2007.

It seems that the political situation at Westminster is not all doom and gloom. The pilot ‘chancellors’ television debate and the three subsequent leadership debates showed that, Cleggmania aside, the three parties were in a sombre and mostly agreed mood about the need to steer the economy to safer ground. The aftermath of the election also saw a powerful overlay of rhetoric about doing what was right for the country over what was right for the party.

However, the reality is that the UK is not practised in coalition government. So, however robust the Liberal/Conservative coalition seems today, the expectation is that it will not last four or five years. That uncertainty will play on whatever minds lie behind ‘the markets’, and we can expect early and repeated tests of the resolve of politicians to exercise strong government in implementing unpopular decisions. Moreover, the inevitable pressure to reform the electoral system may also cause uncertainty to no good short-term effect.

The central and complex problem the new administration must manage is how to get through the current sovereign debtor crisis, while leaving the economy and businesses in reasonably good shape. The UK is now running a public sector deficit roughly the same as that of Greece. That has not precipitated a crisis here because the markets perceive the UK as being better managed and with a strong taxpayer covenant (that is, governments can raise taxes efficiently when necessary to manage the debt). The markets appear to have held fire, waiting for the election result. We can now expect an early test of the new government’s resolve.

The immediate problem is that half the deficit is structural, some £80bn or so. That means it will not go away ‘through the cycle’ as the economy recovers. We must reduce public spending and increase taxes by that amount or face the markets repricing sterling and UK government paper at ruinous levels.

Reducing public spending takes time. Abandoning Crossrail and Trident, for example, would save money over the next ten years. Raising taxes is pretty immediate. Direct taxes are already set to rise, so the focus must be on indirect ones. None of the parties ruled out a VAT rise. For the insurance industry, it follows that the insurance premium tax (IPT) will most likely rise by an equivalent amount.

There are plenty of arguments against taxing insurance premiums, but they pale into insignificance against the pressing need to persuade markets that the UK is not Greece, and does not give in to sectional interest when it comes to running the economy. Moreover, the last Conservative government, which introduced IPT, considered the insurance industry to be under-taxed. No doubt Treasury officials think so too. The insurance industry will surely be better off with stable asset prices and exchange rates than shouldering a smaller tax burden and seeing the UK’s stock fall internationally.

How the coalition goes about its contribution to solving the wider global crisis will depend partly on its institutional arrangements. Clearly, the euro crisis and the Dow Jones falling 1,000 points in 15 minutes means we are not out of the woods. The unloved Conservative proposals to break up the FSA are now watered down. Making the Bank of England responsible for banking supervision again may strengthen its credibility but, in reality, it did not cover itself in glory when it had the job before. The practicalities of the plan may not have dawned fully on the Tories.

The boundary between macro and micro-supervision will be full of arbitraging opportunities, and who would want to be a micro supervisor when you can be a macro one? Let us hope that this coalition government works. IT

Richard Hobbs is director, regulatory consulting, at Lansons Communications