Keith Marsden: Gordon Brown has not learnt from his past economic mistakes

Keith Marsden is a member of the Council of the Centre for Policy Studies and a former adviser at the World Bank and senior economist in the International Labour Organisation.

Following the G20 Summit, Gordon Brown has been posing as the saviour of the world economy. He claims to have master-minded an effective action plan to tackle the global recession. But he continues to deny any responsibility for Britain’s economic downturn. He blames it on the collapse of the U.S. sub-prime mortgage market, its repercussions on other financial activities and sectors in the U.S. and elsewhere, and the consequent contraction of world output and trade. He also refuses to admit the role played by Britain’s lightly-regulated banking sector in creating high-risk and little-understood financial instruments, and with his encouragement, purveying them around the world.

Independent data, and his own speeches, show that he was far from blameless. While Chancellor of the Exchequer, he failed to take action to prevent or restrain the bubbles that had formed in Britain’s housing market as early as 2004. In an op-ed article published by the Wall Street Journal Europe (“Gordon Brown’s Boom and Bust”, May 28th, 2004), I pointed out that house prices had risen by 55% in London, and by 40% in the UK as a whole, since 1997. These rises compared with increases in average earnings of just 10% and 12% respectively. These widening gaps were unsustainable, and must eventually be narrowed by a bursting of the house price bubble, or by a more rapid increase in nominal earnings. The latter would inevitably lead to a faster overall inflation rate, I suggested.

Writing in the Daily Mail on 26th July 2004, I also drew attention to an IMF study published in its World Economic Outlook, April 2004. This study of 14 countries found 20 cases of house price booms being followed by house price crashes since 1970. The median price contraction was 27% and the duration of the crash, from peak to trough, ranged from four to five years. Moreover, house price busts were associated with substantial output losses in the overall economy, averaging 8% of the level that would have prevailed with average GDP growth rates before the bust. Real private consumption and investment in machinery and construction were adversely affected.

Gordon Brown chose to ignore these facts and warnings. To admit the existence of a house price bubble would have contradicted his oft-repeated claim to have restored stability to the British economy.  In his Mansion House speech in June 2004, he told the assembled City of London (financial sector) leaders: 

“I am determined to ensure that we can lock in greater stability not just for a year, or for an economic cycle, but in this generation”. 

Speaking to the same audience a year later, he repeated his pledge:

“I assure you that nothing this government does now or in the future will put at risk the fundamental stability that we have achieved”.

Government action to dampen house price inflation (by lifting mortgage rates and imposing stricter eligibility criteria) would also have raised doubts about the effectiveness of Brown’s reform of the Bank of England in 1997. He gave the Bank sole responsibility for setting interest rates, but excluded housing costs from its operative inflation index.  And he created a new regulatory body, the Financial Services Authority, with a weak mandate and staffed by civil servants with little inside knowledge of the banking sector.

Government intervention would also have run counter to another of Gordon Brown’s political objectives. In a speech introducing a government document entitled “Homebuy:  Expanding the Opportunity to Own”, he spoke about:

“this Britain of ambition and aspiration is a Britain where more and more people must and will have the chance to own their own homes”. 

Brown’s encouragement of the rapid spread of home ownership, ignoring the incapacity of many borrowers to service their loans at inflated house prices, was even more pronounced than the promotion of sub-prime mortgages by a Democrat-controlled Congress in the U.S.

So nothing was done to halt the continual swelling of Britain’s house price bubble.  The OECD reported that the average house price-to-average household income ratio, expressed as an index number in relation to the long term average equals 100, soared from 79.2 in 1997 to 149.3 in 2007. This was a much steeper rise than occurred in the U.S., where the index went up from 87.5 to 109.7 over the same period.

Total U.K. household debt, including mortgage liabilities, also exploded at a faster pace and reached a higher relative level than in the U.S. It went up from 104.8% of household disposable income in 1997 to 153.1% in 2004 and 176.9% in 2007 in the U.K. The corresponding figures for the U.S. were 64.3%, 92.3% and 105.8%.  So it should have been no surprise that Britain experienced the first run on a major mortgage lender, Northern Rock, in September 2007. This required a capital infusion from the Bank of England, and its subsequent nationalization in February 2008. Northern Rock was brought down by soaring delinquency rates among its sub-prime borrowers, the withdrawal of deposits, and its inability to obtain wholesale funds from other banks. This took place before the U.S. Government was obliged to bail out its major mortgage lenders and guarantors, Fannie Mae and Freddie Mac, in September 2008.

Although in his Budget speeches Gordon Brown often emphasized his prudence in handling the Government’s finances, he threw caution to the wind when promoting the rapid expansion of Britain’s financial sector. His successive Mansion House speeches were replete with exhortations, or words of support, for more flexibility, innovation, and less regulation. In 2004 he announced:

“measures - both for the City and beyond - to tackle unnecessary and wasteful bureaucracy and red tape... All new FSA rules would be subject to scrutiny by our competition authorities; and the Office of Fair Trading is now specifically examining the impact of the financial sector regulatory framework on competition”.

His 2005 Mansion House speech praised the City’s “innovative skills”, and promised that it would “advance with light-touch regulation”. In 2006 he boasted of the fact that London was the world’s “leading banking centre with more foreign banks than any other city”, was the “home for 20% of all cross border lending, 40% of over-the-counter derivatives trade, 70% of the global secondary bond market”, and was responsible for “50 per cent more foreign equity trading than New York”.

He continued in the same vein in 2007. He bragged that “over 40% of the world’s foreign equities are traded here”, and that “while New York and Tokyo are reliant mainly on their large American and Asian domestic markets, 80% of our business is international”. 

Gordon Brown had strong political and personal reasons for promoting the rapid growth of Britain’s financial sector. Because Britain’s industrial sectors had experienced stagnant or declining output and employment levels since he took office, he needed rapid expansion of financial and related business services to achieve respectable overall rates of GDP growth and job creation. The rise in consumer debt also contributed, by boosting the growth of the retail trade, communications, and transport sectors above the levels that would have been generated by increases in employment incomes alone.  High salaries and fat bonuses paid to financial sector employees, and the inflated fees charged by City institutions, boosted Brown’s tax revenues and enabled him to fund a more rapid increase in public services.

Against this background, Brown’s claim that all the troubles now afflicting Britain’s financial sector (and the wider economy) originated abroad is not sustainable. On the contrary, some of the new-fangled financial instruments created and/or marketed by London-based financial institutions have caused havoc in countries which maintained more prudent domestic financial policies, and curbed the formation of house price and household debt bubbles. Countries which are heavily dependent on exports, such as Germany and Singapore, have been badly hit by the global squeeze on trade finance and trade volumes. They deserve an apology from Gordon Brown, or at least an admission that his hubris played some part in provoking the current global recession.

On the question of whether he merits the title of saviour, it is too early to judge whether the action plan agreed by the G20 will prove to be effective in tackling the global recession. In any case, it was a compromise solution combining the different approaches of the world leaders present, not the blueprint proposed by the host. His support for a U.K. budget that projects a massive increase in public debt suggests that he hasn’t learned from his past mistakes.