As the British Conservative (Tory) Party leadership race nears closure amid gleeful media predictions of a Tory wipeout at the next general election, due in 2005-06, it’s worth looking at what the economic background to that election is likely to be, since it can determine whether the Tory leadership is worth fighting for.

In British politics, with the exception of 1997, it has since World War II been “the economy, stupid.”

If, by the time of the next election, the difficulties of 2001 are just a distant memory, then Tony Blair’s Labor Party, (whether or not Blair has been succeeded by Gordon Brown), is likely to cruise to another victory. The only question would be whether Charles Kennedy’s Liberal Democrats can advance further and beat the Tories into third place.

Tony Blair is clever enough to finesse the Euro referendum issue if he needs to, holding an election only if he appears likely to win, or if the Tory leader, Kenneth Clarke, is more pro-Euro than he is himself, thus politically marginalizing the opposition. The Blair government is also sufficiently competent not to allow a rash of minor scandals to overwhelm it, as they did John Major’s luckless 1992-1997 administration. Thus absent a major war, if the economy in 2005-2006 looks good, with only a minor recession receding rapidly into history, Labor should be a shoo-in.

A good economy will also fund many of Labor’s spending plans, which are much larger than in Blair’s first term, and prevent the escalation of the inner-city decay that is causing crime rates to soar, above U.S. levels in many cities, and anti-immigrant feeling to re-emerge. With enough cash thrown at them, all problems can be papered over.

It will not surprise regular readers of this column to learn that I regard the above economically optimistic (if, from a Tory standpoint, pessimistic) scenario as highly unlikely. The reasons, however, deserve examination, as they differ significantly, at least in emphasis, from my reasons for pessimism about the U.S. economy.

Britain, like the U.S., enjoyed a phenomenal stock market boom in 1982 to 2000. In fact, the British boom actually began a couple of years earlier, in the overvalued-pound, embattled-Thatcher recessionary gloom of 1980. By December 1982, after the Falklands victory, the stock market was already 27 percent above its level in December 1979.

From December 1979 to December 2000, the market value of British equities listed on the London Stock Exchange rose from 67.7 billion pounds to 1,796.8 billion pounds, a rise of 811.8 percent after taking account of inflation, compared with a mere 55 percent rise in real gross domestic product. This is somewhat more than the rise in value of U.S. equities, which at the peak was around 700 percent from the 1982 low after taking account of inflation.

However, it is important to note that unlike in the United States, the British rise was not concentrated in the last five years; in Britain, in real terms, the market rose by 288 percent from 1979 to 1989, and by only 85 percent in the seven years from December 1993 to December 2000. The volume of initial public offerings, too, peaked at 8.8 billion pounds in 1986, and was only a little higher, 11.5 billion pounds, at its 1990’s peak, which was reached as far back as 1994.

Thus the overvaluation in London is less extreme than in New York.

The FTSE-100 share index is already down 23 percent from its January 2000 high, compared with 11 percent on the Dow Jones Industrial Index. The FTSE index bottomed at 986.9 on July 23, 1984, in its first year of existence; on that day the Dow was at 1096.62. If the Dow were to drop to 5,000, as I have predicted, in order to restore its historical valuation levels, the FTSE 100 Index, on this analogy, would have to drop to 4,498, only 17.8 percent below its current levels. In actuality, the Dow in July 1984 was still close to its bottom, whereas the FTSE had already been rising for five years, so a drop to 3,500 on the FTSE might be an appropriate comparison with a drop to 5,000 on the Dow. Even so, the London market, while still overvalued, by historical standards is currently nothing like as overvalued as New York, and its return to historical valuation levels would thus be correspondingly less deflationary.

As in the United States, the U.K. is currently running a balance of payments deficit that is unsustainable, in Britain’s case at a forecast 18 billion pounds in 2001, around 2 percent of gross domestic product, significantly below the 4 percent of GDP in the U.S. Escaping from a U.K. balance of payments deficit of 4 percent of GDP caused a severe recessionary effect on the U.K. economy in 1989-1992, and it is likely to have a similar but more modest effect this time around.

In the U.K., however, there is another recession-producing factor that is present to a much greater degree than in the United States, and that is the high and rising level of public spending. Public spending at all levels of government has been rising as a percentage of gross domestic product in Britain since 1999, when the Blair government abandoned the public spending “caps” set by the previous Tory government. In 2001 it is expected to amount to 39.68 percent of GDP, far above the 2001 U.S. level of 29.56 percent of GDP.

Of that total, 37.4 percent of GDP is represented by central government expenditure. However, by 2005, according to H.M. Treasury’s official forecast produced in April 2001, expenditure by central government is expected to have increased to 39.3 percent of GDP, an increase of 1.9 percent of GDP, largely because of a sharp increase in public sector “investment.”

Socialism, which was largely absent in Blair’s first term, can be expected to be more apparent in the second.

The Treasury’s April 2001 estimate, however, assumes steady economic growth with no recession. In the 1990-1992 recession, central government spending, which had declined from 48.6 percent of GDP in 1983 to 39.7 percent in 1990, shot up again to a peak of 44.2 percent of GDP in 1993.

In other words, under a government which was still trying to contain public spending, a moderate recession (albeit more severe then the contemporaneous U.S. recession) drove public spending up by 4.5 percent of GDP. If a similar rise were to happen under the pressures of a world recession in the next four years, then central government spending by 2005 would be 43.8 percent of GDP, up by a full 6.4 percent of GDP since 2001. In such circumstances, swinging tax increases would be inevitable. Socialism rampant.

However, apart from the discomfort which the tax increases will cause to the British middle classes, the sharp increase in public spending is likely to intensify greatly the depth of the recession. As demonstrated in this column a few weeks ago, high and rising public expenditure each have a severe depressionary effect on an economy, with the combination of the two being responsible for around 50 percent of long-term differences in economic growth rates.

In Britain’s case, total public spending will be around 46 percent of GDP in 2005, relatively high even by European standards, and it will have risen very sharply, by around 1.5-1.6 percent of GDP per annum, in the preceding four years. In such circumstances, the rise in public spending is bound to cause a severe economic contraction, with accompanying high unemployment and increase in social tension and crime, just as it did in 1974-1976, the last time Old Labor had its hands firmly on the tiller of the British economy.

From the above analysis, by 2005-2006 Britain is likely still to be in the tail end of a long and deep recession, accompanied by sharp increases in taxation. If Kenneth Clarke leads the Tories into that election, he is unlikely to be able to take advantage of this.

For one thing, as chancellor of the exchequer his record was also one of tax increases, accompanied by a notable lack of spending restraint. For another, he will have been led by Blair through an entry into the Euro, an abandonment of sterling, and increased involvement in a centralized European federation, which will itself constrain Britain’s freedom of economic movement. Thus Clarke’s credibility in running a campaign on a “Set the People Free” platform, the one likely to win in these economic circumstances, will be severely compromised, and his chances of electoral success, even in such favorable (or, for the country, unfavorable) economic circumstances correspondingly diminished.

And what of Iain Duncan Smith? We know very little about him, after all. Yet there is a precedent, in fiction — those who remember the Michael Dobbs series of political thrillers, shown on the British Broadcasting Corp. and Public Broadcasting Service in the 1990’s, will know what I mean. Scottish, military background, upper class, relatively unknown, from the right of the party — aren’t we talking about Michael Dobbs’ hero/villain, so brilliantly played by Ian Richardson, Francis Urquhart?

For lovers of a Tory Britain, who believe that in 2005-2006 the economic picture will be grim, and that Duncan Smith, if he is indeed a capable man, can use this to ride to victory, this is extremely encouraging.

Francis Urquhart, in Dobbs’ fictional Britain, apart from an unfortunate tendency to murder his opponents, was a damn fine prime minister, who outlasted Lady Thatcher’s record of 11½ years in office.

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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)

This article originally appeared on United Press International.