UK politics used to be dominated by the balance of payments figures. Governments would urge us to buy British, and to export to keep our jobs and maintain our living standards. Oppositions would pore over the small print of the monthly balance of payments figures, highlighting every weakness and warning of dire economic events to come if the figures were lacking in some respect.

In recent years under Labour and under the coalition the country has run large balance of payments current account deficits, importing more than it exports, with no apparent damage being done. So what has changed? Is this sustainable?

The main thing that has changed is the UK is now firmly wedded to having its own currency with a freely floating exchange rate. If we had surrendered the pound for the Euro we would have to put ourselves through tough austerity programmes to cut personal incomes, to curb our appetite for imports. That is exactly what happened in Greece and Spain, where they had substantial wage cuts in cash terms as one of the main weapons to correct their balance of payments deficit.

If we had kept to a managed exchange rate as we had in the 1960s and again under the Exchange Rate Mechanism then we would have to increase interest rates in an effort to hold up the value of the pound. This too would have enforced a kind of austerity on the country, hitting borrowers who are in the majority including the government. As rates rise so people with borrowings can afford fewer imports, and foreigners find it more attractive to deposit money and invest in the UK. Usually defending the pound proved to be both damaging and ultimately self defeating, as Labour discovered with their devaluation of the pound from $4 to $2.80 in 1949, and from $2.80 to $2.40 in 1967. In 1976 the pound fell to $1.63 under Labour as part of the IMF crisis. The devaluations then did cut UK living standards, making imports dearer and exports cheaper, to correct the balance of payments. It fell to $1.03 at its worst point under the Conservatives, but rallied strongly as more internal discipline was asserted over budgets.

So how does it work when you have a floating rate? In part it works by covert devaluation, making exports cheaper and imports dearer, as part of the adjustment. However, as we have seen, the pound has not fallen enough to correct the current account. It turns out the UK has been able to finance a current account deficit quite easily so far.

This happens by several means. Foreign buyers emerge who want to buy UK existing assets from UK people, government and companies who wish to spend more than they earn. Foreign investors also want to buy new assets which we produce to sell to them. I have commented before on the UK model of building lots of expensive flats in London to sell to foreign buyers, which has become one of our leading export industries rather like Germany selling such people top end cars. Our exports show up here in the investment flows, not the current account. Individuals and the UK government can also borrow from abroad to sustain higher consumption and investment. Some foreigners just want to deposit money in the UK banking system which helps finance us.

The present level of the current account deficit will doubtless generate both changes in the exchange rate and further substantial inflows of money from overseas. When considering changes to the exchange rate they are not necessarily all one way, as the relative valuations of paper currencies depends on considering the policies of both governments involved. The Japanese authorities and some in the Euro area wish to lower their exchange rate as a matter of policy.

In a rare moment of frankness, Permanent Secretary Dame Lucy was heard setting out some of her innermost thoughts about the current political situation to a colleague as we run up to the election. As a senior civil servant she is pondering how to prepare for the next government after May and did not know that one of my sources was recording her every word. Here is the gist of what she said:

“As you know, the civil service must prepare for every eventuality after an election. We normally prepare a detailed brief setting out the issues and requirements of the most likely next government, and a lesser brief on the manifesto of the main rival. We do not normally pay more than passing reference to the views of the other parties in a General Election.

This time may be different. If the current polls are to be believed and if they do not change much over the next few weeks, the electorate may decide to decline any party a majority, and indeed may decline any likely combination of two parties a majority. In such circumstances it is beholden on us, the official government, to ensure stability and continuity of policy, and to seek to help politicians of good will to form a majority to see through the necessary conduct of orderly business.

In such a situation We will need to remind those trying to form a coalition or other informal arrangement for a majority that they do not have the necessary strength or authority to undertake major constitutional change based on a balanced Parliament. According to current polls it seems that those wanting to disrupt our important nexus of relationships with the EU will not have a majority, so we will be spared an agonising attempt to renegotiate followed by a referendum on whether to stay in at all. It is an irony of the present position that the continued support for UKIP is denying the Conservatives victory to hold their referendum. The Foreign Office has anyway carried out a wide ranging study of our current relationship with the EU, explained its complexity and importance, and concluded that the current position is fine subject to a few tweaks on benefits and borders which the Germans are now likely to want as well. It will be important to explain this to any new government.

We may also face the position of an important block of SNP MPs. It is another irony that these socialist inclining candidates may well deprive Labour of a majority. Whoever forms the government will need to remind them that the country regards the issue of Scottish independence as settled by the last referendum. Any group of MPs forming a government is likely to want to honour the terms of the offers made to Scotland during the referendum campaign. We must be ready to assist, whilst pointing out that the offers were not detailed and in some respects were different between the parties. The Treasury will need to do more work sorting out how the new tax system will work, with different taxes being devolved in Northern Ireland, Wales, and Scotland. The most difficult part for us will be to get political guidance on the new grant settlements required by these new levels of devolved tax.
I suspect any weak coalition will wish to be particularly generous to Scotland, as it may need SNP support or abstention to conduct other business.

The issue of England will be raised by some, but the political imperatives are likely to mean deferring a solution as any coalition is likely to need support from MPs from the other countries and is unlikely to see the England issue as a priority or helpful. We should have ready alternative proposals for devolution to regions and cities which may command more support. We will need to caution against hasty moves to strengthen the largest country in the union. .

In such a balanced Parliament there will need to more guidance from civil servants. We will need to be strong in reminding Ministers of their duties under European law, which mercifully now covers so many areas. We should expect more progress in European integration under the new Commission, as they seek to buttress their great advance of the Euro. We will need to explain the realities of being a good European to our new political masters.

Whilst colleagues will have to look forward to rather more work in such difficult conditions, I feel sure we will be able to reverse the recent slimming of the civil service in the years ahead. We will be able to point out that there is far more work to be done when a government is based on several parties, and when the political situation in the Commons and Lords is fluid. Both the EU developments and the need to complete a new settlement of our own Union means much more detailed civil service work, which needs proper staffing levels.

An outright win by either of the two main parties is of course still possible, and we must cover those options, but the possibility of a balanced Parliament offers most scope for the civil service to rebuild and show its importance as the custodian of stability.”

Happy Christmas to all my readers. Today I have a turkey to cook and a family Christmas to enjoy.

Let me have one more go at explaining to all those commentators and opposition politicians who claim there have been massive cuts in the public sector. Overall the public sector continues to grow, led by the growth in real spending on important areas like health and education. Whilst some individual departments and programmes have been reduced, overall there has been real growth. So can we now have some accuracy in reporting, and an end to the lies based on no figures or garbled and selective numbers?

Yesterday the ONS produced the official figures for the year to September 2014. They said:

“Government final consumption increased by 0.3%,(Q3) following a 1.4% increase in the second quarter. Between Q3 2013 and Q3 2014 government final consumption increased by 1.9%”. These figures are in real terms.

The same official figures showed that growth in government consumption added 0.2% to the total economy in Q1 2014, another 0.3% in Q2 and an additional 0.3% in Q3. This follows the performance in 2013 when public consumption showed a small real increase.

The ONS revised down total growth of the economy for the most recent year to September to 2.6% from 3.0%, but it still leaves the UK as the fastest growing major economy apart from the USA. There are also signs now of rising private sector consumption, with more imports adversely affecting the balance of payments, along with a reduced balance on income from investments. People are saving less and spending more.

As a result of the better growth rate, the UK economy is now 2.9% above the previous peak, and has recouped all of the 6% crash in output recorded in the Great Recession at the end of the last decade.

The UK has assisted in a series of wars in Kuwait, Iraq, Afghanistan, and Libya. It has so far stayed out of Syria, though the government was keen to intervene there as well. It has stayed out of Gaza, Egypt, and other troubled or potentially dangerous territories. It has stayed out of Iran, though it has used diplomatic pressures and sanctions over the issue of nuclear weapons.

The overall experience of these conflicts has been very mixed. The most successful intervention came assisting the USA in liberating Kuwait from unwanted invasion at the request of the Kuwaiti government and people. The interventions in support of the USA post 9/11, to try to root out terrorists and to change regimes have been less successful.

The largest and longest deployment came to Afghanistan. There the western forces have helped engineer regime change, and have given extensive support to the democratic regime that now governs. The UK did not commit sufficient troops to Helmand province, leading to additional US commitment there to seek to control the anti government forces.

The west’s aims have varied. Sometimes they have just been to support the civilian power established. Sometimes they have been seeking regime change. Sometimes they have been fighting against various branches of militant Islam. Sometimes the west has been on the Sunni side, and sometimes on the Shia side, in the relentless religious war. The west has changed its stance on Assad in Syria, has allowed a military coup to replace the elected government of Egypt, has tried to establish an elected government in Libya but failed to help enforce its will on a war torn country, has been patient in Afghanistan, and is now modest in its involvement in the bitter struggle over Iraq.

It is difficult to see that all this activity over more than a decade has either vanquished militant Islamic forces or established a series of peace loving democracies that share more of our values. The West has discovered that terrorist groups are many and various, constantly changing, and able to move across borders as Western force seeks to catch up with them. The West has learned the old lesson that you cannot establish a democracy by conquering a country. The impulse for democracy has to come from within the country itself and takes years to learn and bed down.

It looks as if US policy towards the Middle East is shifting. The response to Iraq and Syria this time round is much more modest than after 9/11. There seems to be more recognition that local politics matters and western troops are at a big disadvantage without knowledge of the local languages, religions and customs. I want the UK to lead the conversation in NATO and the UN against further military intervention, other than in a case like Kuwait where a Middle Eastern country asks for western help in resisting invasion and it is help we can give successfully.

The UK today faces just two formal threats from other states to the integrity of places we protect. Argentina refuses to lift her claim to the Falkland islands, despite losing a war following an illegal invasion, and despite the overwhelming wish of the islanders to stay with us. Spain lodges a claim to Gibraltar for no good reason, other than geographical proximity, and regularly seeks to disrupt life on the Rock.

Our diplomatic and defence forces have to be in a state of vigilance to ensure the safety and self determination of both the Rock and the islands. Both places have shown in referenda their overwhelming desire to stay with the UK. The Falklands showed the unfortunate need for the UK to possess an expeditionary capability to defend the islands. It also showed we cannot always rely on NATO and the US to assist us. Then our force was seaborne and successful, but with considerable hazard. Today a new airport would make it much easier to send forces rapidly should there be a new military threat. It is most important the UK shows permanent resolve in all it says and does, to avoid giving the impression that illegal acts by others would no longer be resisted.

The UK also buys into the US view of the threat from Al Qaeda/Taliban/Isil and other similar insurgent violent groups in the Middle East. Whilst it is true that the UK has to be vigilant to see off terrorist activity here in the UK by intelligence and police action, it is not necessarily true that going to war from time to time against some of these people in some of the Middle Eastern countries where they operate makes us safer at home or will lead to the end of such terrorist threats.

The UK public was very critical of Mr Blair’s Iraq war. There is considerable scepticism about the results of the intervention in Libya. The long war in Afghanistan was bravely fought by our troops, and may result in a better Afghanistan depending on how the local politics now work out. However, it transpired that the US went to the wrong country to track down Bin Laden. The US has discovered that the terrorist groups operate over the borders into Pakistan so they cannot be defeated just in one or two Middle Eastern countries.

Libya is now a broken country with warring bands competing for power and territory. Egypt’s democratic revolution led to a military coup. Iraq is split into three broad fighting groups, with its government shelling its own people, and the rebels killing both the government troops and civilian bystanders. Syria is also gripped by a long and brutal civil war. So far western intervention has not been able to stabilise the region, nor to help create several functioning democracies as hoped.

The main ways we can protect ourselves against terrorist threat are through proper controls of our borders, and through good intelligence and police action here at home. We need to develop our cyber capability, use access under warrant to the phone and internet connections of those we suspect to monitor and warn us of forthcoming trouble, and work through schools and colleges to tackle home grown extremism.

I wish to write some pieces over the next few weeks on the future of the UK’s foreign policy and alliances. I do so because the future of our relationship with the emerging integrated state of Euroland is up for reconsideration in the General Election, and because many people in the UK are now tired of the US approach to the Middle East under the long shadow of 9/11. That too may change during the forthcoming US Presidential election.

The UK’s current stance is based on a central folly or misleading proposition – that the UK as a member of the EU, NATO and the Security Council has power by virtue of its membership of those bodies, and therefore has to keep compromising its own interests or beliefs to stay in or justify its membership of those bodies.

The truth is of course the opposite. Those bodies draw strength from the membership of the UK, to the extent that the UK is and remains a large world economic power, and to the extent that it continues to spend substantial sums on military force which it is prepared to use when necessary. As someone who broadly supports our membership of NATO and opposes our membership of the EU under the current terms and treaties, I wish to see substantial changes in the UK’s relationship with most international bodies, and a redefinition of the UK national interest and what we will do.

Once the UK has a new idea of what its national interest is, then it is easier to decide what new relationship we need with the EU, which type of NATO interventions we will join, and what defence forces we need.

At the high level, the UK’s first national interest must be to promote the prosperity, peace and happiness of UK citizens. This should mean we wish to promote free trade, democracy and peace around the world. Our second national interest must be to protect and ally with those of like minds and those who are formally under our defence umbrella. We need to recognise the limits to our military power, and make sure we have sufficient military might to deter aggression against us and those we wish to protect, and to carry out expeditionary interventions where appropriate. We also need to strengthen the potential of our political and moral influence, by avoiding conflicts which make us too partisan or compromised by those we would ally with.

I am no apologist for Russia. I do not support illegal invasions nor fuelling civil wars in third countries. Russia has not behaved well in Ukraine.
That does not make me a fan of the EU’s approach either. It takes two to make a conflict. The EU has helped destabilise Ukraine by its approach to the previous elected President and by its offers to the new government in Kiev. The EU has not clearly condemned shelling and bombing of civilians by the Kiev government in the way it has condemned Russian military support to the rebels or the bloodless occupation of Crimea.
Policy before the EU and Russian interventions in UKrainian politics was based on a long term rapprochement of Russia and the west, following the unpleasant cold war. That was a good policy, and the world will be a worse place if diplomats and governments are unable to get back to positive working together between Russia and the west. The west’s interests are not best served by a poorer and angry Russia, locked out from western financial markets.
I read that Russia and the west still do co-operate to some extent on Middle Eastern policy, where both sides have important interests in stability but have different reach and influence depending on the country concerned. The Middle East needs Russia and the west to work together for stability in that troubled and war torn area.
In Europe, the EU should seek to reassure Russia that it is not following ambitions to encircle Russia in any threatening way. NATO is a defensive alliance in Europe. Ruling out adding more countries to NATO would be a good idea. In Ukraine we need an agreement to leave Ukraine as an independent country, where both the EU and Russia can have access and some influence without either side seeking or gaining control or untoward influence over policy. We need to find a way to get rid of sanctions with promises of no further military interventions by Russia. It is time to talk to see what is on offer. Those who are sure Russia is out to invade other countries will dislike this approach. Perhaps the best way to tip Russia into a more militaristic foreign policy is to carry on isolating her.

I will be on the panel of BBC Radio 4’s Any Questions this evening at 8pm. It will be repeated just after the 1pm news tomorrow lunch time, for anyone interested.

All the main parties believe in equality of opportunity. There are various policies pursued to try to give people from disadvantaged backgrounds a decent chance in life. There is no disagreement about the aim.
All the main parties also agree that the tax and benefit system should narrow inequalities of outturn. All believe in taxing the rich more, and giving more benefits to the worse off. The political argument again is not about aim, but about the means and extent of the transfers.
The left like to portray the UK as a uniquely unequal society. The traditional method of measuring it, the Gini coefficient, shows the UK within the typical European range for inequality. We are more equal than Italy, Spain or Greece, but less equal than the Scandinavian countries. Our rating is almost the same as Switzerland’s, the richest European country.
If a country is too unequal or becomes more unequal because the poor are getting poorer, then it has a serious social issue which it needs to address. In the decade up to the financial crash under Labour there was a serious problem, with the lowest 10% of incomes not joining in the general advance in living standards enjoyed by all other income groups. If a country becomes less equal because it attracts some very rich people at the top, that is less of a worry. Compare the following two models:

In Group A the 9 people with an average income of £25,000 and an income range of £10,000 to £50,000 are joined by a tenth person with an income of £1 million. Income inequality has risen from a multiple of 5 to a multiple of 100, a huge rise in inequality. Average incomes have also increased, and no-one is worse off.Indeed, the nine can look forward to increasing their incomes by offering goods and services to the rich new comer.

In group B with 9 people on an average income of £25,000 with a range of £10,000 to £50,000, the poorest member of the group experiences an income fall to £8000. Income inequality goes up from 5 times to over 6 times. This does matter because the poorest has just got poorer. Average incomes fall.

Tackling inequality should be mainly about trying to get more people into jobs and once in a job into better paid jobs. The position in 2012-13 in the UK was far from satisfactory for the bottom tenth of income earners. This bottom decile earned on average just £3875 a year in income, and received £5868 in benefits to top up. This group of course included many people unable to work or unable to find a job, or on a pension. The importance of welfare reform is to get more into jobs, and I trust then to be more generous to those who are unable to work. All should participate in the general advance of real wages in the country through the tax and benefit system. Many more people are now in jobs, and wages are now moving up a bit. As the economy grows and as productivity rises, so real wages can improve more, and there will be more opportunities for people to move into better paid jobs. Both right and left should be able to agree on this.