12 Jul 2010 | UK

Coalition Government - New Beginnings for Investors? 

 Will the coalition be in investors’ interests, asks David Smith?

Some people reading this will remember Britain’s last coalition, the Churchill-led wartime government that came to an end in 1945. Some may even remember the last peacetime coalition, Ramsay MacDonald’s national government of 1931-35. For many of us, however, the new Conservative-Liberal Democrat coalition, led by David Cameron in partnership with Nick Clegg, is something we have not previously experienced. We will have plenty of time to get used to it. If things go according to plan the two parties will be running the country for a five-year fixed term, the next election being due on 7 May 2015.

Any new government takes time to find its feet. This one has, however, hit the ground running, recognising the need to act quickly to reassure the markets and preserve Britain’s AAA sovereign credit status. So George Osborne, the Chancellor, announced a new Office for Budget Responsibility (OBR), under the economist Sir Alan Budd, which will have independent responsibility for producing growth and budgetary forecasts, taking them out of the Treasury for the first time in Britain’s history.

Budd’s job is to approve the government’s ‘fiscal mandate’, of eliminating most of the budget deficit by the end of the parliament and ensuring public sector debt is falling as a share of gross domestic product, as a consequence of higher taxes and spending cuts. This he duly did as part of the June 22 budget.

Comparisons have been drawn between these announcements and Labour’s 1997 decision to give the Bank of England independence. Certainly it is a bold thing for a Chancellor to give up his right to produce economic forecasts. This does not mean the Treasury will be disbanded: it will continue to provide forecasts, research and analysis and staff, from which the new body will also draw. As for the Bank, it will have more responsibility to oversee the banks and the financial system, effectively taking over regulation from the Financial Services Authority, which Osborne said would cease to exist in its present form. The changes will take 2-3 years.

How should investors react to this? Nobody would have benefited from economic instability and there was clearly a danger that, in the absence of firm, early action, Britain could have been on the slippery slope, with the loss of the country’s totemic AAA rating and risk of a so-called debt spiral, in which government inaction leaves the budget deficit becalmed at record highs and international confidence ebbs away.

The new government has recognised and responded to this danger. The first item on the coalition agreement between the Conservatives and Liberal Democrats was headed ‘Deficit Reduction’, showing how much this is regarded as a priority.

Investors responded relatively calmly to the government’s decision to (quickly) bring Capital Gains Tax rates on ‘non-business assets’ into line with Income Tax rates, which has meant an increase for most higher rate taxpayers from 18 to 28 per cent, on, for example, gains from shares owned by ordinary investors and from second homes. When it comes to tax rises more generally, those with the broadest shoulders tend to be the middle classes, not the very wealthy. This is where the rise in VAT to 20 per cent from January will hit significantly.

We should, however, be grateful for small mercies. There was a danger, following the inconclusive ‘hung parliament’ election, of a long period of squabbling between and within the parties and months if not years of policy drift. Things have turned out much better than that. In an unstable world, an element of political stability is welcome. 

This article was written and based on information correct as at June 2010.
 

Author: David Smith
David Smith is economics editor and an assistant editor and policy adviser for The Sunday Times and a visiting professor at Cardiff University. His latest book is The Age of Instability: The Global Financial Crisis and What Comes Next.