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Text File | 1994-05-02 | 19KB | 378 lines

<text> <title> United Kingdom: Economic Policy </title> <article> <hdr> Economic Policy and Trade Practices: United Kingdom </hdr> <body> 1. General Policy Framework The economy of the United Kingdom is based on free enterprise and open competition. Throughout the 1980's, it has undertaken a methodical privatization of government-owned enterprises and has eliminated virtually all controls on the flow of capital into and out of the country. It has an open financial services environment. The few barriers to international trade and investment which do exist include preferential treatment for U.K. firms in oil and gas, telecommunications and electrical equipment. Economic policy in 1990 and 1991 has been dominated by continuing efforts to reduce inflation and new concerns over the recession that began in the last half of 1990. Core inflation (as measured by producer prices and the GDP deflator) still remains around six percent, even though the headline, retail price indicator of inflation has dropped from 10.9 percent in October 1990 to 4.1 percent in September 1991. With core inflation still high, and given the discipline of the European Monetary System Exchange Rate Mechanism (ERM), interest rates have only been reduced in a very cautious, step-by-step fashion since the advent of the recession. As of October 1991 the base interest rate was 10.5 percent, high by G-7 standards, though well down on the 15 percent of a year earlier. In the meantime, GDP fell by 3 percent from peak to trough. The forecast for 1991 GDP is for a fall of about 1.9 percent from the full 1990 calendar year. With the current recession and prospects for weak growth in 1992, the unemployment rate has risen from 5.6 percent in early 1990 to 8.7 percent in September 1991. It is projected to approach 10 percent in late 1992. Fiscal Policy: With strongly rising GDP producing handsome increases in tax revenue, a tight fist on expenditures, and big proceeds from privatization, the central government and public sector ran surpluses from 1987 through 1990. In 1989 the public sector surplus was 7 billion pounds, or about 1.5 percent of GDP. In 1990 the surplus fell 2 billion pounds, and in 1991 it has shifted toward a deficit of 10 billion pounds. In 1992 the deficit is likely to approach 20 billion pounds, or 3 percent of GDP. Personal income taxes have been simplified, with just two rates of 25 and 40 percent. The Conservative government has a long-term goal of reducing the basic rate on personal incomes to 20 percent "as and when prudent to do so". If the Labor Party wins the next election, due sometime before July 1992, the top rate would go to 50 percent. Capital gains are adjusted for inflation and are generally taxed at regular income tax rates. Gains from the sale of a primary home are exempt. Corporate tax rates are 25 percent for smaller companies and 35 percent for larger ones (with incomes over 200,000 pounds). As the government has kept a tight lid on public sector outlays, real public expenditures have grown more slowly than gross domestic product. They declined to 37.5 percent of GDP in financial year 1988, and have hovered in that region since. With the slowdown in the economy, it is likely that this figure is now closer to 40 percent. The privatization (sell-off) of government enterprises has strongly affected budget balances. Privatization has not only provided revenue from asset sales, it has also reduced the drain in the form of subsidies. Monetary Policy: The U.K. manages monetary policy through open market operations by buying and selling in the markets for overnight funds and commercial paper. There are no explicit reserve requirements. For the past two years, broad money has ceased to be targeted, although the monetary base (circulating cash, coin and reserves in the Bank of England) has been targeted at 1 to 4 percent growth. The two main indicators of monetary policy for the past few years have been the exchange rate and the base interest rate. The Bank of England controls the base rate indirectly by establishing the cost of short-term funds in the money market. For one year, from October 5, 1989, the Bank of England maintained a base rate of 15 percent. On October 5, 1990, it cut the rate to 14 percent, and the U.K. simultaneously entered the ERM. The high interest rate regime clearly cooled domestic demand, so much so that the economy shifted to recession. Because of the Gulf War, no further cuts in the interest rate were made until February 1991. Since then, cuts have been made on a month by month basis, and rates are expected to drop to 10 percent at the end of 1991. It will be difficult to cut base interest rates much below 10 percent. First, core inflation is still running close to 6 percent. Second, wage settlements exceed 6 percent. Third, the pound is at the bottom of the ERM ladder, so the U.K. can hardly cut interest rates before others in the system do so. 2. Exchange Rate Policy Until October 5, 1990, when the U.K. joined the ERM, the British pound was officially floating. Now it is pegged to the European Currency Unit (ECU) at a central rate of 0.6969 pounds per ECU, which is equivalent to a rate of 2.95 Deutsche marks per pound. Like the Spanish peseta, the pound may float 6 percent above or below its central rate as long as it does not appreciate or depreciate more than 6 percent against any other currency in the ERM. (Other ERM members are limited to fluctuations of 2.25 percent either side of their central rates.) U.K. authorities have made it very clear that they intend to defend their peg in the ERM vigorously, even if that means having to increase the base interest rate again. 3. Structural Policies Over the past 12 years, Conservative governments have promoted structural reform to increase the efficiency and growth potential of the British economy. They have deregulated financial services, telecommunications, and transportation. They have also ended capital controls. Mortgage regulations have been liberalized and much of the public housing stock has been privatized. They have privatized producers of motor vehicles, aircraft and steel, the water utilities, and electrical power. Electric power generators and distribution companies in Wales, England and Scotland were privatized. The electric company in Northern Ireland may be sold before summer 1991. Subsidies designed to give British firms dominance in the market, and therefore, to keep out imports, have been slashed. In the past eight years, the government has passed four employment bills to increase labor market flexibility, democratize unions, and make unions accountable for the industrial acts of their members. These fundamental structural reforms have stimulated investment, employment, economic growth, and demand for domestic and foreign goods alike. There still remain structural problems that impede the U.K.'s capacity to grow and consequent ability to trade. Clogged roads push up operating costs. An educational system which allows more than half of its students to leave school at age 16 amd which provides a relatively weak technical training program inhibits growth in high technology areas. And the fact that most privatized enterprises are just now beginning to feel the winds of real competition means that they still have many inefficient habits that will take time to correct. Her Majesty's Government is aware of most of these shortcomings and is intent on eliminating them. As a consequence, the medium and longer-term future of the British economy is relatively bright, though an economic downturn has occurred in 1990-91. U.S. exports to Britain should soon resume steady growth. 4. Debt Management Policies As a government, the U.K. has no meaningful external public debt. Because London is one of the foremost internat