When asked what would determine the outcome of the Presidential election in 1992, Bill Clinton famously said ‘it’s the economy, stupid.’ He was right on two levels. In the short term, financial security and perceptions of personal wealth are big determinants of how people vote. But in the longer run, too, the management of the economy influences how long a Government will retain the country’s confidence and stay in power.
This is why the economic policies of the major parties are among the first things to come under scrutiny in all elections. The current one is no exception but, as with everything else in Election 2019, the conventional wisdom is not a great starting point to understand what is going on. The glib verities about Labour profligacy and Conservative prudence don’t really apply this time around.
A fascinating report by the Resolution Foundation, a think tank, this week suggested that whichever party wins the election on December 12, the size of the state will return to levels not seen since the 1970s. And that is almost certain to lead to higher taxes for us all and will probably lead to wider deficits in the public finances. The currency, bond and equity markets will all be watching closely.
According to the research, spending will increase to 41.3% of GDP by the 2023/4 tax year under a Conservative government and to 43.3% under Labour. That compares with just 37.4% of GDP in the 20 years leading up to the financial crisis. This level of public spending is a reminder of the 42% of economic output that government spending represented between 1966 and 1984.
What is interesting about these figures is not just that they point to higher spending. After nearly a decade of austerity, an increase was always likely. Surveys of public opinion suggest that more people think spending cuts have led to an unacceptable decline in public services like the NHS. Fewer of us still argue that balancing the books was a necessary if painful part of the post crisis recovery.
What is more interesting about the research is that there is no longer much to divide Labour and the Conservatives on this key question. Both parties are seemingly bidding to out-promise each other when it comes to investing in hospitals, schools, the police and social care. In the fight for the hearts and minds of pro-leave constituencies in some of the more deprived parts of the country where the election will be determined, there are no votes in continued austerity.
The research derived its forecasts from promises that have already been made by the two parties in the government’s recent spending review and Labour’s 2017 manifesto.
The even more interesting question than how much the parties are planning to spend, and on what, is how they intend to pay for it. Here there really is a difference between Labour’s and the Conservatives’ plans. And it matters because one plan looks painful while the other might be unrealistic.
Labour has already said it will raise taxes to pay for higher spending. This is intellectually honest as far as it goes but the measures announced so far are probably not enough to fund the expansion of the state envisaged by the party.
The Conservatives may be on even shakier ground because their proposed tax cuts are at odds with the desire to spend more. They can only make up the difference by increasing the deficit, which is not a long-term solution in a country that has always relied on the ‘kindness of strangers’ to use Mark Carney’s description of our reliance on overseas investors.
It is a sign of the shift to a more populist style of politics, not just here in Britain but around the world, that the debate is no longer between a tax and spend party and a party of fiscal prudence. Rather it has become a contest to see who can promise the most while glossing over how it will all be paid for.
As investors, we don’t just need to decide which approach is right or wrong. We also need to make a judgement about what the implications will be - both at the overall market and asset class level but also as it affects individual companies and sectors. Even if government spending is excessive in the long run, there will be short-term winners.
These are likely to focus on the domestic side of the stock market and may well favour smaller companies rather than the internationally-focused mega-businesses in the FTSE 100.
The Select 50 list of our preferred funds has been designed to offer investors a wide range of UK-focused funds across the size spectrum, as well as different styles such as income and growth.
The Threadneedle UK Mid 250 Fund, as its name suggests, focuses on the UK’s second tier, companies that its managers say have ‘been through their adolescence’ and are on the cusp of significant development and growth.
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