Jeremy Warner's Outlook: Even house price bubble can't harm Blair now

"It's the economy, stupid". This was the catchphrase coined by the political strategist James Carville, who hung it on a sign in Bill Clinton's office during the 1992 US presidential election campaign to remind everyone that though President George Bush might be soaring in the polls after a victorious war against Iraq, it was the economy that in his view would ultimately determine the outcome of the election. He was proved spectacularly correct. The economy was recovering by November 1992, but not by enough to have an effect on employment, and Mr Bush was duly defeated by a substantial margin.

"It's the economy, stupid". This was the catchphrase coined by the political strategist James Carville, who hung it on a sign in Bill Clinton's office during the 1992 US presidential election campaign to remind everyone that though President George Bush might be soaring in the polls after a victorious war against Iraq, it was the economy that in his view would ultimately determine the outcome of the election. He was proved spectacularly correct. The economy was recovering by November 1992, but not by enough to have an effect on employment, and Mr Bush was duly defeated by a substantial margin.

It has been conventional wisdom ever since that governments stand or fall by their economic performance. OK, so John Major managed to win an election while in the middle of a recession, when negative equity was lapping at householders' feet, and then lose one when the economy was growing strongly again, having be then laid down many of the policy foundations necessary for successful macroeconomic management.

Yet even with Mr Major, the link is a stronger one than it might seem. Mr Major was able to win the election of 1992 by arguing that Labour under Neil Kinnock would be even worse for your pocket than he was. This was topped off with a substantial pre-election bribe in the form of deep tax cuts.

He lost the 1997 election, on the other hand, in part because Britain's ignominious exit from the European Exchange Rate Mechanism gave him a reputation for economic incompetence - never mind that this was actually the best thing that could have happened to the British economy at that time. Efforts to put the public finances back on an even keel through a rolling series of tax increases further damaged any remote chance he might have had of re-election. The economy may not be the only deciding factor, but in most elections it is the most powerful one.

For this reason if no other, nobody really believes Labour is going to have any difficulty winning a third general election victory next year, notwithstanding the debacle of the Iraq war. The British economy remains the showcase of Europe, and though there are plenty of reasons to doubt the durability of our economic miracle, Britons today have never been so prosperous. People are not going to vote against what appears to be a winning formula. Mr Blair's personal rating is at an all time low, but when push comes to shove, economic buoyancy should ensure that Labour support remains sufficiently solid to win.

Michael Howard, leader of the opposition, has long recognised the economy as his biggest obstacle - a curious position for a Conservative Party leader to be in, as historically Labour could always be relied upon to demolish any economic success Britain managed to achieve. Mr Howard has landed some punches, particularly with his criticisms of the growing burden of tax and regulation, but he's always lacked the evidence of economic mismanagement to be able to deliver a knockout blow.

Rising tax and regulation will in the long term always have a corrosive effect on economic performance, but it is on a long fuse, and to most people it doesn't seem so far to have harmed us at all. Despite the carping, Britain is still one of the most tax advantageous jurisdictions in the world to have your corporate head quarters, never mind its other attributes. Mr Howard is on a hiding to nothing in condemning the Government for economic mismanagement.

With GDP per head now higher that any other major economy in Europe - an almost total reversal of the position ten years ago - most of the hard evidence points the other way. As it happens, the economic success Britain has achieved over the last ten years doesn't really have a lot to do with Labour, much as Gordon Brown, the Chancellor, likes to take credit for it, but at least the Government has been wise enough not to get in its way.

In fact it is largely down to our timely transformation from industrial to service based economy. With rapid economic development in the Far East and now India, the terms of trade have moved decisively against established manufacturing nations such as Germany and France. By contrast, the British economy has come to rely ever more heavily on financial and business services - brain rather than brawn power - where the reverse of the world glut in manufacturing capacity applies. The price of goods is generally deflating. The price of high value added services has never been stronger.

To its credit, the Government has recognised these trends and ridden with them. That in itself is an achievement. Ministers seem intent on undoing all this good work with unsustainably high levels of public spending, yet for the time being this is unlikely to damage their election prospects. The adverse consequences won't become apparent this side of an election.

If there is an Achilles heel in Labour's armour, it has always seemed to me to lie in the housing market. This has been the other big ingredient in Britain's economic success this past ten years. Again it has been powered more by factors beyond the Government's control than by public policy. Indeed, there is a general conviction among ministers that the housing boom is not an entirely healthy thing. Yet by making us feel wealthier, it has sustained consumption right through the most serious stock market slump of the post war period.

Imported price deflation from the Far East in combination with the US productivity miracle has allowed central bankers around the world to sustain a regime of extraordinarily cheap money, driving up property prices and further supporting consumption through easy credit. The phenomenon has perhaps been more marked in Britain than anywhere else.

With interest rates now rising again, and the world economy slowing, there has been another outbreak of shock headlines predicting an imminent property crash. This week seemed to bring unambiguous confirmation that the housing boom is at an end, with new mortgage approvals last month plunging more than 20 per cent. Recent house price surveys have also pointed to a marked slowdown in house price inflation, with an outright fall in prices in some areas.

If house prices have helped support demand on the way up, the reverse would apply on the way down. A serious property crash would almost certainly be accompanied by a profound demand shock to the economy as a whole bringing with it rising unemployment. Unfortunately for Mr Howard, this seems quite unlikely to happen in the nine months left before the expected date of the next general election. Indeed it seems quite unlikely to happen at all.

The Bank of England's gradualist approach to monetary tightening, together with some carefully worded warnings from the Governor about the dangers of the housing bubble, seems so far to be working in bringing the market to heel. The evidence from Australia, an economy not unlike our own, is that given the correct policy action, a housing bubble can indeed be let down gently without completely pole axing the rest of the economy, though even in Australia is is perhaps still too early to say for sure. Personally I wouldn't expect average house prices to be any higher in five years time than they are now, even in nominal terms. They might even be a bit lower, as there is a big correction to be made to bring them back into line with their long term relationship to earnings.

The still unanswered question is how big an effect this might have on overall economic growth. The optimists say the UK recovery is already well enough established to be self sustaining, regardless of what happens to house prices. I wouldn't be so sanguine, but nor do I think it remotely likely that a slowing housing market will lead to economic catastrophe. For the time being, Mr Blair can afford to keep James Carville's words - "it's the economy, stupid", hanging on his own office wall.