As the Tories implode, do the holes in Labour’s position matter?

In my last post, published on Sunday, I suggested that the British prime minister Liz Truss and her Chancellor Kwasi Kwateng should have been pleased with how their budget was going down. The messaging was clear, and the opposition response muddled. By Monday, though, the story had moved on. Bond and currency markets were giving the statement a spectacular thumbs down, and there was a whiff of panic in the air. The panic has passed, but it is evident to almost everybody that the pair have dug their party into a very deep hole. Today the Bank of England announced that it would be forced to finance a portion of government debt through money creation. It’s not a good look.

The market rout begun on Friday, especially in the gilt markets – but on Sunday Mr Kwateng clearly felt things were going well enough to double down on his tax cutting plans, and suggest there were more cuts to come on. But by Monday he was forced to try and calm things down, with promises a proper plan for national debt. Faithful supporters have been doing their best to mount a rearguard action, though no minister has put their heads above the parapet. They have tried to deflect the currency problems onto the US dollar, which doesn’t explain the sharp devaluation since Friday, evident against even such currencies as the Turkish Lira. All suggested that there was more to come to make things better. Tory MP Andrew Bridgen suggested the government might like to cancel the flagship HS2 rail project; John Redwood, a veteran MP who is somewhat more economically literate, said that the government was about to reveal a tranche of supply-side reforms, so the markets hadn’t seen the full picture. These messengers were helped (on BBC radio at least) by the lack of economic grip of their interviewers, who did not press them on the obvious gaps in what they were saying. The BBC also helped when remarkable criticism came in from the IMF, by highlighting their comments on inequality -rather that the much more damaging criticism that the budget threatened to create a recession rather than head it off.

The darkening mood was no doubt caused by the prospects for mortgage rates. The reason that markets stabilised was that traders came to appreciate that interest rates would go up in reaction to the budget. Mortgage providers reinforced this point. Commentators quickly showed that increases to mortgage payments for homeowners would quickly overwhelm any extra cash coming from tax cuts. And this is a critical group to Conservative electoral prospects. The criticism by government supporters of the Bank of England not raising interest rates earlier (“asleep on the job” according to Mr Bridgen) doesn’t really help here. Once the government’s ability to finance itself comes into question it has no attractive option to dig itself out. Monetary financing at a time of inflation is hardly going to stabilise things. Reversing the tax cuts would be a humiliating retreat which could taint the Conservatives for a generation. Spending cuts on the scale needed would alienate a large part of the party’s base, as would letting interest rates rip (though a different part of that base). Supply side reforms would have to be big and spectacular to reassure markets. Release immigration controls? Re-enter the EU Single Market or Customs Union? Stop Russian sanctions and invite oligarch money back?

What makes things worse for the government is that they were warned well in advance. During his leadership campaign former Chancellor Rishi Sunak warned Conservative Party members that handling the energy crisis and making tax cuts did not go together. Ms Truss poo-pooed this as “Treasury orthodoxy” which had ended up in years of sub-standard growth. There is certainly a baleful aspect to Treasury orthodoxy that requires intelligent challenge – but the Treasury also has experience of navigating the treacherous world of government finance. FT columnist Janan Ganesh says that the government has fallen into the trap of trying to apply policies appropriate to the United States to a medium-sized archipelago whose currency is not used as a global reserve. Success in running British economic policy is a delicate balancing act which depends on maintaining confidence, not thumbing your nose at the rest of the world.

What of Labour? They can hardly believe their luck. The initial response was fumbled. They went on about the tax cuts for the rich (and the abstract idea of “trickle-down economics”) – leaving the much bigger charge of being reckless with the country’s finances muted. But by Monday, with their party conference in progress, they started to find their feet. Their shadow chancellor, Rachel Reeves, delivered a worthy speech, in which she gave emphasis to financial stability. She also started on an alternative growth narrative that did not depend on tax cuts – through green investment and such. It is important that the Tories are not allowed to win the growth argument by default, of which there was a distinct chance, so ruthless and repetitive has been their messaging.

This has been complemented by an orderly conference, with its leader, Sir Keir Starmer, clearly in control. Dissent has been modest. I listened to two interviews by senior members of the party’s socialist wing: John McDonnell and Diane Abbott. Neither created trouble (and Mr McDonnell was distinctly more in command thad than Ms Reeves). The party was able to develop a narrative of a government-in-waiting.

Still, there are two big problems with Labour’s stance. The first is that they lack an alternative fiscal policy. They only said that they would reverse the higher rate tax cut, which has little fiscal impact – and said would not reverse the national insurance and basic rate income tax reductions. So how would they try to fill the evident gap? We just got obfuscation. When challenged about how the party was would maintain spending on the NHS and social care, Ms Reeves suggested that there was no problem because Mr Kwateng said so. They are trying to accept the fiscal package and disown it at the same time. To be fair, they did not say anything about not increasing Corporation Tax, and they have suggested higher windfall taxes on energy companies. But surely they are going to need something more. Tony Blair and Gordon Brown, who the leadership would like to emulate, solved a similar problem in the mid 1990s by adopting an austerity stance on spending – shadowing the Conservative government’s spending plans. This would take the party out of its comfort zone – but something like this will surely be necessary.

The second big problem is engagement with the European Union, as pointed out by Danny Finkelstein in The Times. The party understandably does not want to reopen the Brexit debate. But how to create a credible path for the country outside the union while shadowing so many EU policies on worker protection and the environment? This surely creates a competitive weakness. Mr Finkelstein thinks that the party, once in power, would surely be forced into a closer trading relationship, sacrificing many of the sovereignty gains as a result.

So Labour is trying to have its cake and eat it. Boris Johnson could get away with that, but it is harder to see that Sir Keir can. However the hole that Ms Truss has dug for her party is so deep that it probably doesn’t matter.

UPDATE, 30 Sep 22. The first quarter’s current account deficit was reported by the FT as being over 8% – compared to the 3% figure which I took from The Economist. According to the FT report (which dated from before the statement), this was making gilt markets nervous. This makes sense, though I would prefer to know exactly where the funding vulnerabilities are rather than relying on these broad aggregates. All this shows that there was lots of evidence that Mr Kwateng (and Ms Truss) were skating on very thin ice before the statement, but they chose to ignore it. Mr Kwateng’s decision to keep on digging the hole deeper in Sunday media interviews is quite astonishing.

The budget isn’t a gamble: it’s Russian roulette

The British prime minister, Liz Truss, and her Chancellor of the Exchequer, Kwasi Kwateng, must be pleased with how things are going following the “fiscal event” last Friday, otherwise referred to as a “mini” budget. They cannot use the word “Budget” because it was not accompanied by independent forecasts from the Office of Budget Responsibility (OBR). Whatever one thinks of the content, the media narrative is going well. The lack of the OBR forecast has clearly helped the government to shape it, and the Opposition is failing to divert it.

The word generally used to describe the fiscal policies set out in the statement is “gamble”. You can make a case for this word for the politics – but it is also being used to refer to the economics. The government’s central message is that it is implementing massive tax cuts, without corresponding spending cuts, with the aim of increasing economic growth. This is exactly how most commentators are describing it – and they say it is a gamble because the growth (targeted at 2.5% per annum over a period of years) may disappoint. That suits the government fine – it suggests bold and decisive leadership – which presents a striking contrast with the chaos of the previous administration led by Boris Johnson. Difficult times need bold leadership is the sub-text. Meanwhile the Labour Party are mucking up their response, talking about something called “trickle-down economics” which few outside their own activist circle will understand, and not taking about the game of Russian roulette being played with the nation’s finances.

There are two problems with the government narrative. The first is that the measures are nothing like as bold as is being suggested. The second is that there is zero chance that they will lead to a sustained increase in growth. This may not matter politically, because the next election could take place before its failure becomes clear. But the government is also taking a big risk with the state’s finances – for no discernible economic benefit except to a lucky few. This is the Russian roulette. This isn’t gambling – it is a form of torture.

So why do I say that the budget is not nearly as bold as billed? Firstly, a lot of the tax cuts are in respect of changes that have been implemented recently (the National Insurance changes) or not yet applied (Corporation Tax) – so don’t represent a change on the situation that applied a year or so ago, when Ms Truss says the growth performance was inadequate. That leaves the planned cut to basic rate of income tax of 1%, and the abolition of the top rate of income tax (reducing the rate by 5% for a very small number of earners), together with a reduction in stamp duty. But this needs to be set against a significant amount of “fiscal drag” – extra tax revenues pulled in because tax allowances and thresholds are not being adjusted for inflation, while incomes are being driven upwards. That is why the Resolution Foundation has suggested that the bulk of taxpayers will be no better off in real terms. There is a game of snakes and ladders – with the government is only talking about the ladders.

This is one reason that the measures will not have a sizeable impact on growth, but there is more. There are two ways that tax cuts can increase economic growth – one is by increasing consumption by allowing people to spend more. But that can only work if the economy is showing slack – otherwise all that happens is that the country imports more and the benefit goes to other countries. Or the gains are lost to inflation. There is no visible slack, and indeed the Bank of England will be obliged to neutralise any effect by raising interest rates – like a car being driven with a foot on both the brake and accelerator. The other way that tax cuts can help is if they change behaviour and either draw more people into the workforce or encourage them to work more hours (though as first-year economics students are told, tax cuts can have the opposite effect), or increasing productivity by, for example, creating a more positive environment for investment. It is hard so see that the odd percentage point off tax here and there will change behaviour by much. The exception may be the freezing of Corporation Tax – as the change to marginal rate is more substantial. Of course the actual increases to the rate haven’t been implemented – but the proposed changes may have influenced corporate investment plans, and these might change again. There were other “supply-side” changes in the budget too – infrastructure investments, special investment zones, and so on. But this is all small beer and will take time to have any effect. There is nothing radical here, like a root and branch reform of the planning system, major changes to technical education, or any of the other changes that people who worry about Britain’s supposed productivity problem suggest. Of course the government may move on to such action later – but the hype is being applied to the statement itself.

But even a more radical programme would struggle to make much difference. Economic growth fully developed economies (i.e. those without a significant agricultural workforce) is driven mainly by demographics – the proportion of people working in the economy. Here the country is facing a severe headwind as the baby boom generation retires. It is this population bulge that explains most of the rate of growth in the later 20th Century, and why it has slowed in the 21st. There is little on offer from the government, as yet, to address this, for example by freeing up immigration or encouraging more mothers (and fathers) into the workforce by making childcare more accessible. Both would be politically tricky (the latter because it would involve more public spending – “handouts” in Ms Truss’s language). At least pension reform and the impact of inflation on pension savings will discourage people from retiring, and bring retirees back into the workforce – but that is hardly a political bonus.

The scale of impact of demographics on growth in developed economies (which I have posted on recently) is still not widely understood, even by professional economists. Instead most of the focus is on productivity. There is a specific narrative that Britain is suffering from lower productivity than other similarly developed economies – and therefore that there is an opportunity to improve it and generate a bit of catch-up growth. This view is currently being promoted by The Economist newspaper, and Ms Truss and Mr Kwateng are clearly both believers. I am personally sceptical, as I don’t think the comparative productivity statistics are reliable. In particular I don’t think that proper account has been taken of the fact that Britain has deindustrialised faster than other economies, and so has a smaller manufacturing sector – which is where higher productivity measurements are concentrated. Britain benefits from cheap imports – but this won’t be captured by the productivity statistics (though a falling pound undermines this). Certainly there are a lot of things that could be done to make the economy work better, but it is easy to exaggerate their effect on overall growth, as they will often be neutralised by, for example, people retiring earlier, or by the gains being ploughed into less productive parts of the economy, like health spending.

What is certain though is that the government’s policies set out in the budget will have little or no positive impact on economic growth. The best that can be hoped for is a temporary boost from some unforeseen change to the workforce or energy market.

So is the budget much ado about nothing? Actually no. The main issue is what it did not address. A much more significant policy announcement came just before the hiatus caused by the passing of the Queen – the generous package of measures to support the public and businesses suffering from high energy prices. This came on top of generous government support during the pandemic, and promises to deal with backlogs in the NHS and social care. All this entails a huge fiscal outlay, and nothing was said about how this is to be financed – just a question of borrowing more. The budget has simply added to the strain rather than reducing it.

Here we enter uncharted waters. The government has been able to borrow freely from domestic and world markets, financing itself in its own currency. It is now widely accepted that it panicked back in 2010 when the Great Financial Crisis caused a huge government deficit. They did not need to implement austerity policies – or not quite so hard – to prevent financing problems. The thinking is now that much higher levels of government debt are sustainable than previously thought. People used to be worried if overall public debt reached 60% of GDP. Now people are relaxed about it heading over 100%. Discussion of this is muddled by the politicians. There is a lot of confusing talk about piling up debt that later generations have to repay. But that confuses the financial economy with the real one. The wealth of future generations will be determined by the productive capacity of the future economy and not by how the government is currently financing itself. Unless, that is, there is a financial breakdown that has the effect of constraining that productive capacity. That has happened in Argentina, for example, but not here, unless you count the IMF crisis of the 1970s.

And yet the risks of just such a breakdown are rising. Because the currency is freely floating the risks are less than if we were part of the euro, for example, or if the gold standard applied, as it did in earlier eras. But the financial climate is becoming more hostile – and the country is running a significant current account deficit (3.1% of GDP according to The Economist). This means that the country’s finances are dependent to some extent on foreign finance. The country has been running large deficits for two decades now, without any major stress. I have seen no clear explanation of this remarkable performance. I can only speculate that the sale of residential property to foreigners has a lot to do with it. But since we don’t understand how this has been achieved, we also have little idea of when things will become more difficult. The symptoms would be the government struggling to sell gilts, and being forced either to finance itself through the money supply (causing inflation) or borrowing in foreign currency, or seeking help from the IMF. This would entail a major financial crisis, and the government being forced to raise taxes, cut spending, implement capital controls, or other such unthinkable measures.

Although the pound has depreciated badly I still can’t believe that the country is close to such a crisis. But the risk is rising. Much more likely is an intermediate sort of problem, with persistent inflation, rising domestic interest rates, and a weak pound. Ms Truss’s growth talk would be shown to be vacuous, and the government’s reputation for competence would be shattered. This is what I mean by saying that the government is taking a big risk with its finances. It really should be talking about higher taxes, not tax cuts. The timing is completely wrong.

So why has the government embarked on this suicide mission? The simplest explanation is that they believe their own rhetoric. They really think that doubling down on neoliberal economic policies will yield positive economic dividends. Mr Kwateng said that the government’s new turn in policy represented a new era. In fact it is the death throes of the old one.

Thank you Ma’am

Photo: Joel Rouse/ Ministry of DefenceDerivative: nagualdesign, OGL 3, via Wikimedia Commons

When I ended my last post nearly three weeks ago, I said that would be away for two or three weeks. How dramatic these weeks have turned out to be! The biggest event in news coverage terms, here in Britain, was the death of Queen Elizabeth II, who was buried earlier this week. Whether this is as important those many other stories in actual terms is harder to say. But I want to say something about it.

I am an apathetic republican. I don’t think that the head of state should be monopolised by one family, and decided by heredity. But I am open to more pragmatic arguments about the monarchy’s usefulness – and there is no perfect democratic alternative. This apathy, whether one is for or against the institution, seems to be widely shared. It is remarkable how many supporters use its attraction to tourists as one of their principal reasons – talk about damning with faint praise. A lot of our feelings are tied up with the holder of the top job. Like most I have been impressed with Elizabeth’s towering sense of public duty, and the way that she has preserved the institution’s dignity over the 70 years of her reign. And a feeling that I owe her thanks.

Many have reported being affected by association with their own families. This has affected me too. She was born about a month before my mother (who passed away in 2009), and about six months after my aunt, who is still with us. It is as if she was a distant member of the family – and her passing marks the disappearance of that generation. Which leads us to contemplate our own mortality.

Looking back on the period of mourning, it was a remarkable ten day storm – one that arose very suddenly, and which has passed just as suddenly. On the Saturday following her death I read a Guardian headline suggesting that BBC leaders were struggling to balance their coverage with other events. That puzzled me a bit, though not enough to read the article. I had not observed any balance in the BBC’s coverage whatsoever. On Friday night the BBC aired an extended programme referred to as “News and Weather” in the schedule, lasting an hour. We did get a short weather bulletin at the end. But not so much as a second of “other news’. We kept watching in anticipation that they would gives at least a little new, but nothing came. There was little enough actual news about the Queen’s death and the royal succession – just endless circling and dredging through history. And those royal correspondents dripping complacency. The BBC became pretty much useless and I stopped viewing or listening. Until the funeral – most of which I watched. The coverage of that was good – mainly because the commentators said very little, and allowed the ceremony to speak for itself. Funnily enough all that processing in and out was more moving that the service itself.

What of Elizabeth and her legacy? She held completely to the doctrine that the monarchy should be non-political. She simply stood for general goodwill to all. In practice that meant doing whatever her prime minister advised her to do. As a constitutional model, it is a weak one. Democratic systems work best when there is tension, forcing people to justify their actions, and creating a dialogue through which people can work through the issues. Instead, our system depends on the prime minister not asking for anything improper. Its failure was evident in 2019, when she appointed Boris Johnson as prime minister, simply on the advice of his predecessor (Theresa May), who followed Conservative Party rules. Mr Johnson did not have any parliamentary mandate until the general election of December that year. Meanwhile he inherited all the formidable executive powers of that role. This reached its climax when he decided to suspend the troublesome parliament without any clear constitutional reason. The Queen went along with this outrage – it was only stopped by the Supreme Court. But the Queen probably did not have a choice, as she had no democratic mandate of her own and was tied to a particular set of precedents – the culmination of the decades of her rule. A head of state should have forced Mr Johnson either to get his parliamentary mandate, through a confidence vote, or let somebody else try, or call an election. A serious flaw was exposed in Britain’s constitution.

I think that episode was the only serious political blemish in the Queen’s reign. Her interventions in the affairs of the Royal Family were less happy, from vetoing her sister’s marriage to a divorcee, to manoeuvring her heir Charles away form his love, Camilla, leading on to the disastrous marriage with Diana Spencer and its still reverberating after effects. All to no avail as Camilla is now the Queen Consort. In this, though, the Queen was following advice from her family and courtiers. It would have required immense will to resist these forces. That was not how she saw her role. Her one serious act of individual will – her choice of husband – was accomplished before she took the crown.

What happens next is hard to say. It cannot be the same with King Charles, even if he tries to make it so. We have been so used to Elizabeth as the sovereign that it is very difficult to understand how things have changed. The safest prediction is that the constitutional monarchy will go on. It will require a crisis to change it. The period of mourning showed a yearning from the bulk of British people (even the Scots) to stand together after the divisions of Brexit – and it will take a major crisis to bring the monarchy into doubt.

If the monarchy goes, it will be as part of a wider crisis in the British state. The main threat to the constitution came from Boris Johnson. That has been removed (though he has one potential last, damaging act in appointments to the House of Lords) – but other dangers lurk – not least the independence movement in Scotland. That is for the future.

Meanwhile I just want to record my thanks to Her Majesty for a long life of loyal service to my homeland, and, indeed, to the wider world.

The next election is Starmer’s to lose

Chris McAndrew, CC BY 3.0, via Wikimedia Commons

It looks certain that Liz Truss will become British prime minister this week, and British politics will take a dramatic turn. It is surely an act of political suicide by her Conservative Party.

We are, of course, urged not to underestimate Ms Truss – as so many of us have in the past. And yet, Matthew Parris in The Times tells us that this is a mistaken sentiment – just as it was for Boris Johnson and for Donald Trump – also politicians who won the top job against huge scepticism of their fitness for the job. She really is as shallow and dangerous as she looks.

I agree. During her bid to persuade first Tory MPs and then ordinary Tory members to vote her into the job, she has backed herself into a difficult corner. Her fiscal policies are inflationary; her economic ideas delusional, and she has shown little aptitude for the negotiation and compromise that are essential to any successful political leadership. She is also a stiff and awkward communicator. She enters the job in the middle of an economic crisis – it is hard to see that she has much chance of a honeymoon period longer than a month.

It gets worse for the Conservatives. They have built their political appeal on the basis of being a safe pair of hands with the economy. Whether this claim has been justified is another matter: while the austerity policies with which the party was associated from 2010 until 2019 struck most voters as being careful and sensible, most economists regarded them as being inappropriate at best. Now that reputation for economic competence is under water. Recent polling shows a Labour lead on handling of the economy, as its does in overall voting intentions. This is very dangerous territory for the Conservatives – and Ms Truss is going to do nothing to improve it. The sort of tax-cutting fantasies that are popular on the American right do not play so well with floating voters here. And it is hard to see that inflation is going to improve much under her stewardship – not without a recession, which she is claiming that she can avoid.

Still, many observers think the Conservatives can pull things back. Ms Truss will hit the ground running, as she has had plenty of time to prepare. A new cabinet will be put in place quickly – and the current government lethargy will be replaced by energy and optimistic talk. There is bound to be a honeymoon bounce. Ms Truss might even go straight into a new general election. This would be perfectly justifiable, to give her a fresh mandate, rather than the flawed manifesto of 2019. The Conservatives have been planning for this possibility for some time, as new, and more advantageous constituency boundaries come into effect. They will likely be better prepared than they opponents. But the polling looks dire – and she and all her hangers-on will be dismayed at the idea of throwing away their coup so soon. Opposition is a dismal place to be for those used to government. Still there is a certain recklessness about Ms Truss, and I wouldn’t rule it out.

The main reason that people seem to think that the Conservatives might win the next election is a lack of belief in Sir Keir Starmer, the Labour leader. He is uncharismatic and cautious. It is hard to say what he stands for, and his polling is weak. But is this a Westminster bubble thing? Activists on the left like their leaders to be charismatic and radical – and so do the journalists and others who follow them. It is easy to see their disappointment. But FT columnist Janan Ganesh warns that this bias against the uncharismatic, also applicable to US President Joe Biden, leads us to underestimate them. Floating voters like their leaders to be reassuring and middle of the road – and, I would add, especially if those leaders are from the left. Radicalism is not a positive attribute. The Conservatives are walking into a trap.

The main equation for Labour is whether they will win the next election by themselves, or alongside the Liberal Democrats. The Lib Dem leader, Sir Ed Davey, is no more charismatic than Sir Keir, though he is more experienced. He has made a lot of the political running in the last few weeks on the energy crisis – a subject he knows well as a former Energy Secretary. Like Sir Keir, he is relentlessly un-ideoligical. He is not trying to move the debate to the areas that his activists want to talk about – such as Brexit – but focuses on the areas that are close to floating voters top concerns. The other issue that the Lib Dems have been able to run with is the water companies’ disposal of raw sewage into rivers and the seaside. The Lib Dems are doing well in many Tory heartland seats where Labour is weak. The public ground is being subtly prepared for a coalition – or cooperation at least – between the two parties – in a way that it wasn’t before the Lib Dem coalition with the Conservatives in 2010, which saw Lib Dem support collapse.

It is reported that the Conservatives are preparing a campaign based on defeating the “Coalition of Chaos”, compared with strong and stable one-party government. This follows the successful deployment of this line of attack in 2015, which nearly wiped out the Lib Dems – though it failed in 2017, to the extent that the Tories are likely to avoid the slogan “Strong and Stable”, the basis of the 2017 flop. This line might gain traction if it looks as if a Labour-Lib Dem alliance will not gain enough seats to prevent the Scottish Nationalist Party from holding the balance of power. The SNP will not want to let in a Conservative government, but they will demand another referendum on independence. Labour and the Lib Dems are going to need to think through their strategy on that front with care, and not just hope that the issue won’t come up. But will the prospect of another Scottish referendum scare English floating voters? Probably not enough.

Sir Keir’s strategy was a risky one. He has done nothing to motivate his own activists – and gone out his way to insult the socialist left, the source of Labour’s most energetic supporters. He is unable to project the flair of Tony Blair, who previously made a floating-voter strategy work for Labour. But the Conservatives are playing into his hands.

I am going to be offline for two or three weeks.