Inside Politics – The Policy Exchange newsletter (London), 26 October 2007

It has been a week of bad news for the British economy. Just when we thought that we had weathered the worst of the turmoil after the US sub-prime mortgage crisis, a series of worrying predictions were published over the past few days.

Alliance & Leicester, the mortgage lender, suggested that UK families were feeling squeezed by higher mortgage repayments and that Britons were scaling back on the amount they save. Barclays cut back its forecast for the UK’s economic growth while Bank of America predicted a weakening pound against the US dollar. To round off the bad news, the Bank of England warned that the fallout from the global credit crunch is likely to continue to impact on the UK economy with risks to both commercial investments and equities.

If the predictions turn out to be true, it could have significant political consequences. Gordon Brown’s reputation is largely built on Britain’s economic track record since he became Chancellor, and if that track record becomes tarnished, so will he. Historians may judge that he missed a window of opportunity when called off the Autumn election.

There is no doubt about it: UK economic circumstances appear increasingly fragile. In a way, it is quite normal for an economic upswing to be followed by an economic downturn. What is not normal, though, is the fact that the UK economy is so unprepared for this downturn.

After 15 years of continuous economic growth, public and private finances are, ironically, in a worse state than they were before. 2007 is the year when private debt overtook annual GDP for the first time. Furthermore, current budget deficit levels suggest that the UK is now in worse fiscal shape than almost any other major Western country.

What we have experienced is an economic boom driven by rising house prices, enabled by low interest rates and supported by high levels of immigration. But built on these foundations, it was an unsustainable boom from the beginning. It was like an economy put on speed. This created a comfortable illusion of wealth for some time, but it will also cause a hangover when the party is over.

Britain’s economic success story now turns out to be ‘more mirage than miracle’, as we called the assessment of the UK economy which we published on Tuesday.*

Meanwhile, the true foundations of long-term economic success have been eroded and gradually forgotten: Fiscal discipline, lighter regulation, lower taxes, better infrastructure and, yes, saving.

While the boom lasted, economists calling for a return to such policies have often been treated like party-poopers. Now the party is over, will politicians start listening to their advice again?