UK Treasury: Picture by Carlos Delgado, CC BY-SA 3.0, https://commons.wikimedia.org/w/index.php?curid=19020165
Last weekend former British prime minister Liz Truss reentered the public sphere with an essay in the Sunday Telegraph, and an interview with The Spectator, publications that are both relatively sympathetic to her cause. This has occasioned much derision in the wider media. While I share much of this derisive view of her, I’m not going to join the chorus – it’s been said too well by others. Ms Truss has simply reminded most people why they dislike her so much. I want talk about the issues she raises, both in terms of economic policy, and how it can be implemented in Britain’s institutional environment.
Ms Truss’s starting point is what is widely seen as the UK’s dismal economic performance since the great financial crisis of 2008-09. Economic growth has been dismal, and if Britain has been able to maintain the pre-crisis trend of growth, then, according to Tim Harford in the Financial Times, it would be a staggering 40% better off. She attributes this to policy mistakes – a view that seems to be widely shared, even if not many agree on what those mistakes were. Personally, I differ from this – I think that the lack of growth is a reflection of adverse economic conditions, which started before the crisis – principally demographics and a changed world trade environment, made worse by Britain’s lack of a strong manufacturing industry. Liz Truss’s solution is to go back to policies popularised by the US president Ronald Reagan in the 1980s, and often attributed to Britain’s Margaret Thatcher too, though in fact she was much more cautious. These are mainly a matter of tax cuts, especially for businesses and the well-off, and deregulation. What she particularly favours is to proceed with tax cuts without regard to short-term effects on the public budget deficit, in the belief that an expanding economy will make things good in the longer run. She was always reluctant to talk about cutting public spending, and in the case of defence, advocated a substantial increase.
Her views on tax are largely magical thinking. Tax cuts might directly stimulate growth by increasing demand, but not as efficiently as many other policies, such as more generous state benefits, and not at a time when inflation is running riot. Lower corporate taxes might attract inward investment – but they are not widely thought to be a major factor, especially when the country’s politics seem so unstable. To her credit, though, apart from tax cuts, she advocated supply-side reforms that stand a much better change of promoting growth. These included easing immigration rules and making it easier for parents of small children to reenter the labour market. These weren’t popular in her own party, though. In her speech to the Conservative Party conference she decried an anti-growth coalition – which it struck many observers as being mostly her own party. However, her supply-side ideas had nothing like the heft to make more than a small difference to the country’s growth rate. Tax cuts (or forgoing tax increases) were her only big idea.
She has a second huge blind spot: inflation. She does not appear to understand that this usually arises from excess economic demand – and therefore that taming it requires deliberately crimping economic growth. She persistently seemed to think that inflation was somebody else’s problem – in particular the Bank of England’s. I find it astonishing that somebody whose degree course included economics (PPE at Oxford) can have thought this way. Everything interacts with everything else, and if you are the head of government, you are ultimately responsible for all the tools of macroeconomic management. What individuals do with their personal time may not be government’s problem; what public institutions do most assuredly is, even if they are run at arms length.
But amid all this foolishness and and failure to understand how things actually work, she did touch on something that is true. She railed against the “economic establishment” (the Sunday Telegraph unhelpfully added “left-wing” to this in their headline, but she neither said that nor meant it). She was particularly vehement about Treasury orthodoxy, which she saw at first hand in two years as a Treasury minister. The power of this orthodoxy undermines, usually fatally, any attempt to implement policy that contradicts it. That included her fiscal policies. They didn’t have her back when things got rough, and they forced an about-turn on most of them. What is a bit less clear is how Ms Truss fits the people controlling the world’s financial markets into this orthodoxy. She and her supporters are trying to blame the derivative based policies used by many pension funds for creating an unstable situation, about which nobody warned her or her Chancellor, Kwasi Kwateng. The Bank of England, also part of the orthodoxy, should have handled this better, they suggest. Rather interestingly, when she describes these polices as allowing the funds to invest more in businesses rather than bonds, they sound like just the sort of pro-growth idea she should be supporting. Of course the real problem here was the imperious arrogance with which she and Mr Kwateng treated financial markets. And as for the Bank of England, it was widely known that it was struggling to manage markets because inflation had caused a reversal of its loose-money policies, especially Quantitative Easing, upon which markets had come to depend..
I have some radical economic ideas of my own, though quite unlike Ms Truss’s. These are that Britain is far too centralised, and that responsibility for the many trade-offs required in financial and wider policy need to be radically decentralised. It’s not surprising that people oppose housing or industrial investments in their local area, when they will not be accountable for the benefits. The tough decisions are made in Whitehall, leaving with nothing else to do but complain. But this is part of the Treasury orthodoxy too – they don’t want a chaotic decentralisation, with corrupt nobodies taking decisions without the Treasury having ultimate sign-off. When the government wanted to distribute funding for its “Levelling Up” agenda, it didn’t distribute funds for disposal by the city regions and councils, it made these institutions put in bids for the imperious mandarins to pick from. To be fair, government leaders seem a bit embarrassed about this, and say there will be changes in future. But how did they allow this in the first place? And what credibility do their promises to do things differently next time have? The Treasury will undermine any effort they make to reform things. It is now reported that the Treasury is refusing to authorise any capital projects proposed by the Department for Levelling Up. The Treasury isn’t all in the wrong here: the levelling up funding was originally envisioned by former prime minister Boris Johnson as a politically directed slush fund to help win marginal constituencies. The power of the orthodoxy is that it is often right.
So the “economic establishment” would undermine my ideas for reform just as surely as they did Ms Truss’s. It’s a real thing. Any serious attempt at political reform therefore has to take on the orthodoxy and beat it. It can be done. Mrs Thatcher did it, and, to some extent, so did Tony Blair and Gordon Brown for Labour in the early 2000s, especially with their radical expansion of health funding (and it required both of the double-act to do it). It took these leaders years and all their political skill. The remarkable thing about Liz Truss is that she thought she could break the Treasury in an afternoon, based on a mandate she had won from 100,000 or Conservative Party members.
And that is the point. We need political leaders who understand the orthodoxies and how to challenge them – people with political skills high and low. The current government possess few, if any, people of that description. Do Labour? I really don’t know. I haven’t been that impressed with Sir Keir Starmer, their leader, or Rachel Reeves, his Shadow Chancellor. But I could be wrong – they are becoming more effective. One opposition politician I am sure has the necessary heft and skill is the Liberal Democrat leader Ed Davey, having honed those skills as energy minister in the coalition government of 2010-2015. Perhaps he will get another chance.
Labour shortages mean that the pay of refuse workers is advancing
It turns out that the leaders of Britain’s Conservative and Labour parties agree on quite a lot. The latter, Sir Keir Starmer, gave a quite a weighty speech to the Confederation of British Industry this week – which did much to help his gravitas as prime-minister-in-waiting. What has drawn most attention is his opposition to excessive immigration (not clearly defined, of course) and commitment to making Britain a high-wage, high-productivity economy. This was one of the main planks of Tory policy in at least the last two general elections, and still is – in contrast to integration with the European Union’s labour and product markets. Many in the CBI want a more flexible approach to immigration (to say nothing of more integration with the EU) – but they weren’t getting it from either leader.
The politics are obvious. Immigration is a touchstone issue in Britain, as it is in much of the world. The public thinks that the ruling elite were too relaxed about immigration and this was one of the main factors behind the populist backlash of the last decade, and the Brexit referendum result in particular. Labour are less trusted by the public on the issue, and so need to show a visibly firm line, or they won’t win back the voters that have deserted them since their last election victory in 2005. And the idea that choking off cheap labour from abroad will raise living standards is superficially plausible. In fact it was one of the more plausible claims made by the supporters of Brexit. And having done Brexit, I can understand how mainstream politicians feel the need to try and make the idea work.
But how does political necessity fare against reality? Most people seem to have very little idea of how the high-wage economy is actually supposed to work. It’s a bit like the “Australian-style points system” to manage immigration, which most people think is a jolly good idea, without having much clue about what it actually is, and how it compares to alternatives. The main target audience for economic policy ideas seems to be property-owning retired folk in the English North and Midlands (and in the English South and Wales, to be fair), who have little direct stake in a modern, functioning economy – which is all somebody else’s problem. Meanwhile they insist that there is “no room” for more immigrants – and fear that it erodes English national culture. There is therefore no particular need to explain the actual impacts of policy.
The overall economic theory is clear. If we can raise economic productivity, there is more money per head to go round to support higher wages. By choking off the supply of cheap labour from abroad, employers will be forced to use the available resources, i.e. local workers, more productively. There are two basic problems with this line of argument. The first is that higher income per head on average does not guarantee higher income for everybody. An imbalance of power in the labour market leads to high pay for the powerful at the expense of the powerless. The hope is that cutting immigration strengthens the bargaining power of less powerful. Academics argue about whether it is true – but it is not hard to find anecdotal evidence of just this. A shortage of lorry drivers following Brexit has recently driven up their pay – and with it incomes workers in related fields, like refuse collection. Still, we shouldn’t forget, as Tories sometimes do, that better wages depend on the bargaining power of workers.The second problem is that productivity is only part of the equation – the proportion of working people, or working hours per head of the total population, is critical too. In fact in a modern developed economy it is probably more important – and it has been falling due to demographic pressures, the propensity of older workers to retire on their savings, and (perhaps) lack of access to health care for longer term and mental conditions. Immigration raises the ratio of working people in the short and medium term – which is why so many people think it is a good idea.
Still, let’s put these problems aside, and try to imagine what a high-wage society looks like. It is in fact not too hard to find such societies. They are usually located in spots in the developed world with a low population density. These are often tourist hotspots and it is mainly as a tourist that I have visited them: in Australia, New Zealand, Western Canada, Norway and Switzerland. The first thing you notice is that there aren’t many workers. If you are on safari in Africa, you will get a tour guide and driver as a minimum. In Canada and Australia the same individual does both roles. Go into a shop and there are few people to serve you. And there aren’t many shops. At hotels you carry your own bags. You get something of the Tesco automated checkout phenomenon. Self-service amounts to higher productivity for Tesco, but all they are doing is making you do more work for yourself. An experienced cashier is much quicker. In a high-wage economy you may find yourself eating at home instead of at restaurants – or inviting friends for drinks at home rather than trying to find a bar. The cost of services involving human contact is relatively higher.
So where are the workers? Not so many in the tourist spots, though there will be people delivering high-end products or services at quite a cost. They are mostly somewhere else, delivering highly productive goods or services. In Australia and Canada there is mining; in Norway there is oil; in Switzerland there is sophisticated manufacturing (chemicals and such) and banking. These are linked to exports, so that high-wage countries tend to be high-exporting ones, usually running trade surpluses.
Here’s the key. Some gains to wages for the less well off can be made by reducing profits and cutting top-level pay. But not enough and not sustainably. A large proportion of workers need to be employed in highly productive fields. If businesses simply raised prices to pay for higher wages, we end up where we started by putting so many things out of the reach of less well-off workers. But high productivity industries in the modern era are very productive indeed. They don’t employ many workers and usually need exports to to be sustainable.
And so we can start to see the characteristics of a high-wage economy. Workers must have strong market bargaining power, generally by being in short supply. There must be a strong, highly productive core to the economy, generating a substantial export trade (overall trade doesn’t need to be in surplus in theory – though in practice this often seems to be the case). And most people will have to put up with doing more things for themselves, as the price of services is high – and especially in rural areas. Taxes are also likely to be quite high to to support public services such as health and education – as a strong state underpinning of these, and an effective social safety net, is all part of the ethos – and supports the strong bargaining position of workers generally.
In Britain the problem is obvious. Labour shortages are improving the bargaining position of workers. We are moving towards a self-service economy as these labour shortages sweep through the hospitality industry amongst others. But what of the highly productive core? Here we are faced with a fleet of ships that have sailed. Fossil fuels are depleted and anyway a problem in the zero-carbon future. The country’s manufacturing has been hollowed out – the trade deficit is of very long standing. Financial services provided a lot of punch in the earlier years of the 21st century, but are going through rough patch in the 2020s. Brexit is widely blamed, but in truth the problems are wider. A lot of the strength of the mid-noughties turned out to be fictional – and it was very centred on London. The country needs to look to the future, and not try to recreate old glories. Here the parties do differ a bit. There doesn’t seem to be a coherent Conservative strategy at all. Their basic idea is to create fruitful conditions for investment and sit back and wait. Liz Truss, Mr Sunak’s predecessor, did lend some coherence to this approach. She wanted to create a low-tax, low-regulation haven for footloose international businesses. This idea quickly collapsed, leaving Mr Sunak plying platitudes about innovation. His government looks increasingly paralysed by internal divisions and unable to implement any decisive strategy.
Labour’s big idea is the green economy (something promoted by the Lib Dems and Greens too). This entails a massive investment programme designed to transform the country’s infrastructure as well as develop export industries. This is a good idea, but a lot of the work involved (home insulation for example) is not high-productivity. And there is intense competition for the rest – batteries and wind turbines for example. Still, it doesn’t do to underestimate British inventiveness, and public-private partnerships in this area surely provide part of the answer. Also renewable energy does offer high productivity, without the need for exports. There are other ideas. I have often talked about health care and related services, where Britain has a promising base – and where the NHS offers world-class data for developing new treatments – as the covid episode showed.
But there is a gorilla in the room that the politicians don’t want to talk about. This isn’t Brexit (though they don’t want to talk about that either). This has created problems for developing export industries – but other EU members are further down the path of developing exports and British industries struggled to compete with them in the single market. Britain’s trading problems got worse within the EU, after all, even if there were compensations. The gorilla is public sector pay – especially if we include the issue of social care. High wages mean high levels of pay in the public sector. Not all public sector jobs are badly paid, but the pressure of a tight labour market is putting public services sector under pressure. Staffing shortages are rife in many parts of it. Meanwhile part of the government’s anti-inflation strategy is to hold back public sector real pay levels – which is making matters worse. The answer is either to shrink the public sector or to raise taxes. Of course the politicians hope that an explosion of high-productivity private sector jobs (with associated tax revenue) will come to their rescue. But it won’t happen in time, if it ever does.
This is a tough place to be in, so it’s no surprise that our politicians are slow to confront the truth of it. I have to admit that it is forcing me to rethink some of my assumptions. But I do think that the vision of a high-wage economy is worth pursuing. The main alternative being offered by those interested in social equity is a universal basic income paid by the state. I am deeply uncomfortable with that idea for a number of reasons. Given that, here are two things to be thinking about.
The first doesn’t involve any great rethinking on my part, but remains politically toxic. We need higher taxes. This is not just on various soft-spots and loop-holes in the wealthier parts of the economy – schemes that are predestined to disappoint. Higher taxes need to affect most people. This is because public spending will have to rise to accommodate higher public sector pay – and we need to manage down the level of demand in the rest of the economy to help stabilise it, to say nothing of limiting the need to borrow money on world markets. Of course public sector productivity can be improved (though I prefer the word “effectiveness” to “productivity” – as a lot of the solution is lowering demand by forestalling problems), reducing the need for spending. But our political class, our civil servants, and the commentators and think tankers that critique them, have almost no idea how to achieve this. They are stuck in an over-centralised, departmental mindset. What is needed is locally led, locally accountable, cross-functional, and client-centred services – an idea that is so alien to British political culture that most people can’t even imagine it. So we can’t count on that idea and must settle for replacing the dysfunctional with the merely mediocre, with no cost-saving.
The second idea is even more contentious, and I haven’t properly thought it through yet. It is that inflation is an essential part of the process of readjustment, and we have to tolerate it to a degree – provided that the source of that inflation is a rise in pay for the less well-off. As somebody who grew up in the 1970s, I hate inflation. I think it undermines trust between the state and the governed. I have never subscribed to the view of liberal economists that it can be a tool of economic management. But there have to be exceptions. One example was Ireland in the 2000s, as that country worked through its economic transformation as it integrated with the EU economy, which did involve a spurt in productivity. Wages rocketed, driving inflation up. Ireland was in the Euro, so there was no ability for the currency to appreciate to ameliorate the effect. This was the only way for the country to reach the sunlit uplands – which didn’t stop the European Central Bank from criticising it – something my economics lecturer at UCL said was absurd.
Britain’s position is different from Ireland’s. We haven’t had that productivity spurt. There is nothing to drive an appreciation of the currency. But we want wages amongst the less well-off to rise. Price rises are part of the adjustment – with inflation acting as a tax on the wealthy, as part of a redistribution process. Meanwhile we need to drive capital investment – most renewable energy is very capital intensive, for example – as are most of the ideas for developing higher productivity. That means keeping interest rates low. Which won’t happen if interest rates are jacked up to combat inflation. And, as suggested already, to the extent that inflation needs to be managed, higher taxes are a better way to do it.
This is quite a progression in my personal thinking (and thank you to regular commenter Peter Martin for helping me along the way – though doubtless we still disagree). But trying to get to the fairer, more sustainable society we seek is going to require many of us to change our thinking – and put up with some things we don’t like.
The Comet airliner was world-beating British design before a crash in the 1950s allowed US aircraft designs to dominate the market. The British aviation industry never recovered.
Our new prime minister, Rishi Sunak, says that Britain faces a profound economic crisis. I don’t disagree – few will. Neither do I disagree with his statement that hard choices lie ahead. I almost certainly will disagree with him what the right choices are. We are entering a period when politics matters. But we need to understand more about the mess and how we might progress.
Liz Truss, Mr Sunak’s predecessor, presented a clear narrative to explain the country’s economic ills. A timidity in the British ruling elite, abetted by the “abacus economics” of the Treasury, has stifled private enterprise, leading to a bloated public sector accompanied by low economic growth. She saw that a combination of lower taxes and deregulation could correct this, deliver economic growth, and that, thanks to the wealth thus generated, the country would be able to afford an acceptable level of public services and welfare safety net, together with improved state pensions. She thought that she could kick start the process with tax cuts. The overarching narrative may or may not have substance, but the timing was all wrong. The result was the shortest prime ministerial stint in British history.
Ms Truss was rare in offering us a clear narrative. Mr Sunak will not make that mistake. Clarity divides, getting in the way of the coalition building that successful politics demands. But a clear narrative helps the rest of us decide which policies to support. I will attempt one of my own.
My story starts in the middle of the last century. Britain was an industrial powerhouse, with a strong belief in free trade, though this regularly caused political controversy. Before the Second World War, though, this was marred by widespread poverty; the country had not found a good way of spreading economic (or any other) wellbeing across the whole of society. And then came the war. The necessities of the war ushered in a period of massive state intervention that followed a lot of the principles of socialism. Food was rationed, but people were amazed that levels of nutrition improved, as the diets of the poorest in society improved. Meanwhile the British war economy produced wonders of production and ingenuity, combining state direction with private initiative. People saw that a new way was possible, and this was brilliantly articulated by the Labour leader Clement Attlee, who reassured the middle classes with a particularly British slant on socialism, and Labour won an overwhelming parliamentary majority in 1945. He ushered in a period of profound welfare reform and the nationalisation of key industries. Labour lost power in 1951, but the landscape was so profoundly changed that most of the reforms were supported by a political consensus.
There followed two decades of what many regard in hindsight as a golden age. Economic growth was rapid, living standards advanced, poverty reduced and life expectancy dramatically extended. Many transitioned from working class to middle class. An expanding working population and an industrial revolution in the development of consumer products were the drivers. But all was not well. Other countries were doing better. Britain was steadily losing its place among the front rank of industrial powers, to America, to Germany, and even to Japan. Each of these countries turned into export powerhouses, while Britain, relatively, declined. What was happening? Poor management and a relative lack of investment were to blame, along with some bad luck (the crash of the Comet airliner in the 1950s dealt a body blow a world-leading aviation industry). A lot of this had to do with the fact that large parts of the industrial heritage was now under public ownership, and this increased as industries, notably the motor industry, started to fail and led to a clamour for government intervention. The government either starved nationalised industries of investment (the water industry for example), or squandered unbelievable sums on ill-conceived investment programmes (notably nuclear power). There were exceptions to this general mis-management, of course, such as the switch from coal gas to natural gas for domestic use. But by and large decisive management was replaced by consensus-building and political grandstanding, and the constraints of government financial management. By the 1970s nationalised industries were a by-word for bad management. Meanwhile the private sector was weighed down by high marginal rates of income tax (top rate 83%, or 98% for investment income by the mid-1970s) and corporation tax (52%).
The 1970s were a time of profound economic crisis, with many parallels to now. Energy costs rocketed with two Middle East crises following the Arab-Israeli war of 1973 and the Iranian revolution of 1979. Inflation took off, and policymakers struggled to respond, as this came alongside rising unemployment (which we don’t have now, or not yet). In 1972 the Conservative government of Ted Heath tried to break the deadlock with tax cuts and more public spending (I can still remember the party political broadcast promoting this – I was 14), in a move reminiscent of Ms Truss’s failed budget. This quickly collapsed into disaster, and the government was locked into a confrontation with the miners’ union, amongst others. Harold Wilson’s Labour government of 1974 did not make things much better. Unions were able to block any serious economic reform.
In 1979 came the election of Margaret Thatcher and the Conservatives. Mrs Thatcher brought with her a new economic philosophy of reducing the role of the state. She started to reform the nationalised industries preparatory to privatisation. She cut marginal rates of income tax (though putting VAT up to maintain the overall tax take). At first things seemed to be going very badly. Inflation persisted, unemployment climbed, and nationalised industries played havoc with government finances. But by 1982 things were getting better. She received a political boost from the Falklands war, while Labour seemed to be imploding. A new party, the SDP (which I joined and have never left), offered a diversion, but failed to break Britain’s electoral system, even in alliance with the Liberals. Mrs Thatcher won a landslide majority in 1983, and quickly became politically more secure. Inflation was tamed and economic growth returned. This period remains a matter of bitter controversy. Many say that her success was based on the exploitation of North Sea oil. This was clearly a factor but her economic reforms, especially the privatisations of the energy, telecoms, steel and motor industries, clearly helped. Another factor that proved of benefit, though perhaps more so later, was the development of the European Single Market, of which Mrs Thatcher was one of the architects. Prior to this European product and labour markets had been badly fragmented. The European Economic Community had tackled tariff barriers, but non-tariff barriers remained high. These were progressively dismantled, so that Europe could follow America in the benefits of a large domestic market for many goods – and labour. Britain became a favoured European base for American and other countries. But while this progress was happening a lot of industries, notably the coal industry, collapsed under foreign competition and changing production technology. This has coloured Mrs Thatcher’s memory ever since – as she saw no reason to soften the blow as swathes of the country went into industrial decline.
One of the driving forces of change was globalisation. Increasingly the Far East became a source of cheap industrial imports. This started with Japan, and then moved on to South Korea and Taiwan, amongst others. Falling import prices became one of the chief sources of improving living standards, but it hastened the decline of former industrial heartlands. By the 1990s we see taking shape some of the main outlines of the current British economy. The country became a major net importer of manufactured goods, only partially offset by a booming service industry. At this point the books were being balanced by net oil exports. But some areas of the country were doing much better than others.
Labour under Tony Blair took over in 1997. Mr Blair sought to maintain much of the Thatcher legacy, but with an important difference. After 2001 in particular he expanded the public sector, through expanding public services such as health and education in particular. In these years a powerful myth took over the British political class. You could solve the conundrum of getting Scandinavian-level public services and welfare with American tax levels though allowing economic growth to expand level of tax receipts. But the politicians failed to understand the source of Britain’s growth in the early 2000s. This was largely driven by three factors. The first was an acceleration of globalisation, enabled by internet technologies and driven by China. I remember looking at the components of Britain’s consumer price inflation, which was about 2% per annum. The prices of manufactured goods were falling; this allowed 4% inflation in many services to be balanced out. And pay tended to follow the services figure, staying consistently ahead of overall inflation, and so leading to improved living standards. The second factor was a dramatic increase in European immigration. By the early 2000s many parts of the country were experiencing labour shortages. The baby boom was over, and the process of bringing women into the workforce largely complete; pension schemes were only slowly catching up with increased life expectancy and the proportion of retired people was growing. But the European Union at this point admitted Eastern European countries with a workforce that wanted to improve its living standards by working abroad. Poles and others flooded in and the demographic crisis was averted. Inflation was kept at bay, the second major component of growth. The third factor was the rapid expansion of financial services, and especially the banking industry. Many banks made big profits, giving the City of London the air of a boom town, inflating the property market, and generating significant capital taxes. Pretty much all the increase in recorded productivity in the early 2000s came from the banking industry, alongside “business services” (management consultants, lawyers, accountants and others feeding off the banking boom, as well as juicy public sector contracts), and the now-declining oil industry.
None of this was sustainable, and the moment of truth arrived in 2007, when the world banking crisis developed. Those big banking profits, and the productivity gains that came with them, were exposed as fiction, and the industry experienced massive write-offs. Meanwhile the globalisation boom peaked, as China sought to improve its own living standards rather than those of westerners. The public increasingly turned against European immigration. And the decline of North Sea oil continued apace.
So in this account the slow growth that followed the crash arose not from a failure of government policy (be it austerity in the left’s account; or excessive tax and regulation in the right’s), but from the exposure of demographic forces that were always present, and the passing of globalisation into a new phase that was not producing gains in living standards. And two further things were added after 2015: the decline of North Sea oil turned precipitate, and Brexit, after the referendum in 2016. Brexit has raised the cost of imports (especially if you attribute the depreciation of the pound that coincided with it, though I’m inclined to believe that much of this was in the pipeline anyway), made exporting harder, reduced the attractiveness of inward investment, and caused many immigrants to go home and made immigration harder. On that last point it is worth observing that the country has made up the shortfall in European immigrants with people from other countries, and in any case the European labour market is becoming tighter. But the labour market for immigrants became much less responsive to short-term demands. All round Brexit has added to the friction of running a business, rather than causing an immediate catastrophe.
To these troubles we must now add two more. Firstly the gas and oil price spike, exacerbated by the war in Ukraine, and secondly the rise in world interest rates. The energy price rise is a double whammy. It is helping to stoke up inflation, which causes economic damage in its own right, but also causes nominal interest rates to rise, which disrupts the economy in further ways; and the public expects the government to shield at least some of us, or even all of us, from the effects, causing a massive outlay in government spending. Rising interest rates make mortgages more expensive, which causes further hardship, and also disrupts a finance sector that has grown complacent on low interest rates.
The problem is this. Britain has a deep structural deficit in the trade of manufactured goods. We are heavily dependent on imports for our standard of living, and exports are nowhere near enough to cover this. We now have a substantial trade deficit on energy too, made worse by the Ukraine crisis. We still have a trade surplus on services, but nowhere near enough to cover the gap. Inward investment is sluggish, and anyway broader troubles in the world economy limit the possibilities. This means that the country as a whole has to borrow heavily from abroad – whether this is to fund the national debt or the private sector. Rising interest rates makes that more expensive. Crashing the pound would help exporters, maybe, and inward investment, almost certainly – and since nearly all the debt is denominated in sterling. would not make those debts any harder to maintain. But that would feed through to consumer prices, and destroy the economic strategy of the last few decades of consuming cheap imports.
There is a striking comparison to be made between Britain and Japan. Both are island nations with challenging demographics. Both have an uneasy relationship with their continental neighbours, on whom there is a degree of economic dependence. Japan has long set its face against immigration, an attitude that is prevailing Britain too. Japan has also been suffering economic stagnation, but it is not so obvious that the people living there mind, as economic wellbeing is spread widely. Something like Japan is what many of Britain’s Brexit supporters aspire to. But there is a crucial difference. Japan remains an industrial powerhouse, and produces a substantial trading surplus. They do not depend on inflows from abroad to keep the show on the road. That means the government has a huge amount of flexibility in borrowing money to meet its needs. Abacus economics is dead. It is living proof of the Modern Monetary Theory (MMT) idea that the debate on government deficits and national debt is beside the point. Japan is in the position that Liz Truss seemed to think Britain was in when she promoted her tax-cutting and free-spending budget. But even under MMT consumption cannot outlast production forever, and inflation is admitted as a constraint. That is where Britain now is, and the government has little choice but to bring its budget position under control. The pressure is not extreme, as it has been for countries like Argentina or, in a rather different context, Greece in 2010 – but the trajectory needs to be clear or otherwise market interest rates will rise further than they otherwise would, with difficult repercussions.
That’s for now. But what should the country’s longer term strategy be? Ms Truss, and indeed Mr Sunak, subscribe to vision of what might be called a “buccaneer” strategy. They present a picture of the country being a haven for freewheeling businesses, attracted by low taxes and able to out-manoeuvre over-regulated competitors in Europe and elsewhere. But buccaneering has its dark side – the original buccaneers were licensed pirates, legal in their home domain and criminals elsewhere, after all. Britain would need to develop its already burgeoning function as a haven for grey and even darker money, from kleptocrats and criminals across the globe. The trick to this, as we have learned, is not so much lax laws on such things money laundering, but weak enforcement. Most Brexit supporters would likely connive at such a strategy, if not openly support it – on one condition: that public services are made more effective, and the state pension is improved – they are probably less fussed abut other aspects of welfare spending. This is where the main political battles are going to come in the next few years – as it is far from clear that such things can be maintained without increasing taxes.
Liberals recoil from such a strategy, but they will agree in principle to another strategic objective – that of energy security, and reducing the dependence on fossil fuel imports. There is a disagreement, of course, on whether that means developing the remaining domestic fossil-fuel opportunities. But, in principle at least, most can agree on the development of renewable energy, with the storage and grid upgrades that will be needed alongside it. One thing that helps is that this can largely be financed by foreign borrowing and equity investment – as the linkage of investment to financial returns is easy to make.
If liberals can agree on the need to turbo-charge the development of renewable energy, what alternative can they present to the buccaneer strategy? We can’t go back to being an industrial powerhouse with a strong export industry. That ship has sailed. We can make modest gains, but we can’t reverse more than half a century of decline.
I can’t see a single big idea, but a number of smaller ones might add up to a strategy. The drive for renewables should be tied to a more general mission to decarbonise the economy. This should drive a whole series of investments and reforms that will help renew life generally. The country should aim to ease trade with the European Union, which will mean accepting EU regulation in lots of areas. But we should be wary of relaxing immigration rules. The public seems to be happy with immigration by and large, if it is closely regulated. That means bureaucracy and friction, but in a democracy we have to work within the constraints of public consent. The government should also help develop industries where the country looks internationally competitive. Healthcare is the most promising area – I think the idea of cooperation between the NHS and private entrepreneurs to develop new treatments has much potential. The relatively unified state of health records is an opportunity, though bringing challenges with it. Also public services need to become more effective. That means shifting towards solving problems rather than simply repairing the damage after the event. This in turn means a stronger emphasis on prevention, and getting the various different services working together more closely. It is hard to see how this can work without more localised leadership and accountability – serious decentralisation and devolution. A further idea is political reform – through electoral reform, and reforming the House of Lords. This is as yet a bit of a long shot. For all public discontent about the state of politics, I see little groundswell for changing the system , as the was case in New Zealand in 1993, for example.
But we are going to have to get used to two two things alongside all of this. Taxes will need to rise, and economic growth will continue to be sluggish. This is the opposite to what Ms Truss was trying to achieve. That is not the end of the world. We can still achieve an improved quality of life and an environmentally sustainable way of being. That is a simple consequence of where the country stands as demographic forces assert themselves, and after the country’s mishandling of its industrial legacy over the generations.
Boris Johnson promised us that we could have our cake and eat it. So we ate the cake. When his successor, Liz Truss, went to the cupboard to look for it, she found that it was all gone. The transition from the bounty of tax cuts and energy subsidies promised by Ms Truss when she took charge to the austerity being promised just a few weeks later is one the most dramatic policy reversals I have ever seen in Britain.
During her selection campaign for the leadership of the Conservative Party, Ms Truss railed against “Treasury orthodoxy”. This, she said, was responsible for the country’s strangled growth since the financial crash of 2007-09. She knew what she was talking about since she had served as Chief Secretary at the Treasury for a stint in 2017-19. This was a widespread complaint. I heard it made by Lib Dems during the coalition years, especially as many ideas for long-term investment were shut down. The complaint was much more virulent from Labour supporters, for whom “Austerity” was the root of all evil. It is interesting to see these usual suspects being joined by the libertarian right, who have elevated high tax levels to the same heights of evil that the left has for austerity.
It is important to distinguish Treasury orthodoxy from economic orthodoxy – though most people seem to do just this. Treasury types are steeped in economic orthodoxy: you won’t get away with the “lump of labour fallacy” (the idea immigrants, for example, take away people’s jobs) if you talk to one of them. But it is tempered by an older belief, dating back to Gladstone and beyond, in “sound money”. They do not like to see high levels of government borrowing, leading to creditors being able to dictate policy. The divergence between Treasury and economic orthodoxy was especially evident in the coalition government of 2010-15. Many orthodox economists argued that austerity policies were at best overdone, or at worst completely wrong-headed. They suggested that there was significant slack in the economy, and that policies that reduced demand were a self-inflicted wound (whether there was as much slack in the economy as they thought, and whether the austerity policies were as destructive, are questions for economic historians). They produced as evidence more generous US policies at the time, leading to less economic hardship. The Treasury thought otherwise. In 2010 coalition ministers were scared witless by warnings of dire consequences in financial markets if austerity programmes weren’t followed. Both Tory and Lib Dem ministers accepted this basic premise, while quibbling with the details. The previous Labour government under Gordon Brown and Alistair Darling had as well. Almost all serious economic commentators now suggest that this was a serious mistake – and that the market position was not nearly as precarious as suggested.
Doubtless this is what gave Ms Truss the courage to take on the Treasury, though her central idea that tax cuts can be paid for through the growth they stimulate, especially when unemployment is at a record low and inflation on the rise, was a challenge to economic orthodoxy as well. She noted the substantial “headroom” in forecasts by the Office for Budget Responsibility (OBR) earlier in the year – doubtless brought about by stealth tax rises through holding tax thresholds down. She also noted that government debt levels were not as high as other some other big developed economies. So she appointed her close ally Kwasi Kwateng as Chancellor of the Exchequer, and his first act was to sack the leading Treasury civil servant, with talk of replacing him with an outsider.
It fell apart with startling speed. In the popular telling the “Markets” struck back, causing mortgage rates to shoot up. This has wiped out any feelgood factor brought about by tax cuts and energy interventions amongst a key constituency of Conservative voters. The talk about the power of Markets is a convenient shorthand, but oversimplifies things a lot. Media coverage as been very muddled. At first a lot of attention was focused on the pound – which at one point nearly sank to parity with the US dollar. But it was the gilt (government debt) markets that caused the mortgage rate problems. I think this took a lot of people by surprise, including, perhaps, our political leaders. In the common understanding interest rates are determined by the Bank of England, which was not due to meet until early November – so people probably expected any crisis on the mortgage front to approach slowly. In fact Bank of England decisions are only one factor amongst many – and mortgage providers need to look forwards at potential future rises. Then a crisis blew up with the liability matching policies in certain pension funds. I have read two tellings of this crisis. In one the pension funds had been indulging in reckless speculation camouflaged as prudent management of future cash flows; in the other prudent management was caught short by a temporary liquidity crisis dictated by the way certain financial markets are structured. The Bank of England rode to the rescue, but a temporary tiding over of a technical crisis was presented by many as something much broader. The Bank’s attempts to communicate what it was doing and why didn’t really help. Neither did Mr Kwateng’s attempts to shrug the whole thing off.
The muddle made things worse. The pound recovered, but gilt markets have not made life for mortgage providers any easier. But what has now been revealed to the world is what the point of Treasury orthodoxy is. Financial markets are complicated things, and they can affect the public in a number of ways. As with any market, they are the meeting place of people with many different agendas. If mismatches occur they can be destabilised quite easily. The Treasury tries to manage things by making orderly, predictable demands, and not pushing its luck. It builds up a reservoir of confidence which means that it can respond to emergencies. The timing of Ms Truss’s attempted coup could hardly have been worse. Rising inflation, low unemployment (showing limited capacity to expand the economy) and the energy crisis, coming after the trauma of the pandemic and alongside the destabilising effects of the Ukraine war, all pointed to this being a particularly delicate moment. Ms Truss’s attempt to blame the demise of her strategy on the markets is a bit like the Captain of the Titanic blaming the iceberg for the loss of his ship. Except that this was no stray iceberg, the government was steaming full-steam ahead the middle of a known iceberg belt.
Now the government, having destabilised things, is having to work very hard to restore order. Treasury orthodoxy reigns triumphant. The new chief civil servant is an experienced insider; an experienced senior politician has replaced Mr Kwateng as Chancellor; most of the tax cuts have been withdrawn; public spending cuts are back on the agenda; the energy price intervention has been scaled back. There was even talk of not raising the level of the state pension in line with inflation – the Treasury has long hated the so-called “triple lock” on pensions.
The dust hasn’t settled, but the effect of this change is chilling. It isn’t just tax cuts that have been put on ice – but hopes by politicians on the left of raising spending on public services and benefits now look much harder to fulfil. Suddenly Britain looks like a lonely nation living beyond its means in a hostile world. Hard choices lie ahead.
The new Conservative leader and British prime minister, Liz Truss, has endured a spectacular collapse in public approval after only a month in office. Her party’s poll ratings have collapsed, and there is an expectation – unthinkable not long ago – that Labour will win by landslide at the next general election. A lot of people have drawn a parallel with a similar collapse under previous Tory prime minister John Major in 1992, after the pound fell out of the European Exchange Rate Mechanism, shredding his government’s reputation for economic competence. Ms Truss’s misfortune followed her government’s first budget, which rocked financial markets, causing a temporary breakdown, followed by much higher mortgage rates. Mr Major lost to a massive landslide in the subsequent general election, put off for as long as he could, in 1997. Ms Truss has only two years to go.
But the episode also puts me in mind of a similar political collapse, suffered by the Liberal Democrats when they entered a coalition with the Conservatives in 2010, led by Nick Clegg. Their polling support shrank to a fraction, and the party was nearly wiped out in the subsequent general election in 2015, and has only partially recovered since. I was a loyal party member at the time – and I still am. The current machinations by senior and not-so-senior Tories is very familiar. Exhortations that the party could turn things around, that it is all unfair, and other variations on denial – together with searing criticism from others, and a steady membership exodus, followed by the disappearance of most of the party’s council base (this last has yet to happen to the Tories, but it surely will). The public turned hostile; it became part of every current affairs comedian’s contract with the BBC that they should heap derision on the party and its leader. I also remember the personal opprobrium heaped on Nick – who evoked a loathing among many members of the public that he never overcame. He fled to America to make his subsequent career. Ms Truss is suffering the same treatment.
Does Ms Truss deserve this? I hate to see politics descending into such personal abuse. And in some ways she is a refreshing change from Boris Johnson, her predecessor. She is clear and focused. This is a little bit of truth that a lot of the misfortune to mortgage rates would have happened anyway. It is a mark of courage to do unpopular things for the longer-term good. Still, she has no electoral mandate to take the government in the direction she has – and she seemingly fails to understand this. And the precarious nature of financial markets was well known before the budget – which makes its content all the more reckless. Her approach to appointing cabinet ministers – reading loyalty ahead of competence – betrayed a complete lack of political skill.
There are lots of contrasts between Nick Clegg and Ms Truss. Nick was a much abler and more rounded leader. He subsequently took up a senior role with one of the world’s most important companies, Facebook (now Meta), and has held down the role successfully, securing a promotion. Few British politicians from any party have been able to pull off such a feat (the only one I can think of is Labour politician David Miliband, now head of International Rescue; he’s perhaps one of the best prime ministers we never had). It is hard to see Ms Truss being offered a senior management role in anything other than a political think tank. Her clarity and focus would equip her well for a number of middle-management roles, but an absence of market or customer awareness, and a blind spot on risk management, would disqualify her from most serious roles. For all his abilities, Nick could not shake off his collapse in popularity – though his high point, during the 2010 election, was much higher than Ms Truss ever achieved. If he couldn’t turn his fortunes around, what chance has Ms Truss?
There was also a striking contrast in what brought about their undoing. In Nick’s case it was because he broke a firm pledge: to abolish student tuition fees. Ms Truss’s problem was sticking to a very foolish pledge – to deliver tax cuts as soon as she took office, regardless of the cost of government intervention on energy prices. Of course the pledge was made to party members – the public had no say in her elevation. The public sees Ms Truss as ideological and incompetent; they saw Nick as sacrificing his political principles for the status of ministerial office – after he’d promised to be different.
Still, there is something the two have in common: a lack of connection with the public at large. Neither had much in the way of a serious contested public elections on their rise to power. They didn’t have careers as councillors; they achieved their ambitions through appealing to party members instead. Nick first became a member of the European Parliament by getting to the top of the list for a list-based proportional election system; he then got elected to the national parliament by getting selected in a safe Lib Dem seat at the only election, in 2005, when such a thing existed. Ms Truss did have a run at being a councillor (in the London Borough of Greenwich), standing twice before being elected in 2006, and standing down in 2010, when she stood for parliament in far away Norfolk. These council elections were all in different wards – there was no sense of building a serious council career. She was just doing her bit while searching for a safe parliamentary seat. I don’t think either she nor Nick expected that the public would react as deeply as they did to their first steps in power. So far as Nick was concerned, going into a coalition is what politicians in minor parties should do, as happens so often in other countries; the reversal on tuition fees was just one of the compromises you have to make to achieve other objectives. Ms Truss seems to think there would be widespread public support for her vision, where it not for all those silly lobbyists and talking heads. And that you implement policies by declaring your objectives loudly and railroading them through with loyal but inexperienced subordinates, regardless of practical difficulties. In both cases they caused a profound breach of trust, both with specific promises – but more generally with what they had claimed to stand for when originally elected. Such breaches of trust are impossible to come back from.
Apart from the fact that Ms Truss achieved the top job in British politics and Nick didn’t, things look bleaker for Ms Truss. Many ambitious Lib Dems MPs in 2010 suspected that they would only get one shot in government in their careers, but accepted that it would be worth it – though I don’t know whether these included Nick. The Lib Dem parliamentary party remained disciplined, the government lasted a full term of five years, and the party had a pretty decent record of achievements within it. Looking back, the most important of these was turning the corner on the promotion of renewable energy. The Lib Dem pupil premium policy also made a profound difference in education. There were other, negative achievements – vetoing or softening Conservative policies. I am, though, probably alone in thinking that the overall balance on austerity policies was right (as implemented rather than as planned), or at least justified based on what was known at the time – apart from excessive restraint on capital spending, which the party argued against. Against this admittedly modest record, Ms Truss stands to achieve very little of her agenda. Her party is divided; the government’s financial position is weak; she doesn’t have enough time.
One thing I think we can learn from the experiences of Liz Truss and Nick Clegg is that it is dangerous to be led by politicians whose careers are built purely on appealing to party members – and not on direct voter appeal – or even a record of achievement in the world outside politics. What to do? Electoral reform could make things worse if the wrong system were adopted. It is one reason that I favour the single transferable vote system – which avoids this pitfall better than any other. But Britain’s politicos don’t want to change the system that has been the basis of their careers. If there is change – which remains unlikely – it is likely to be for a system that includes a role for party lists, which are just as bad as safe seats in the current system. Still a proportional system would do something to constrain the power of those that reached the top – by forcing compromises between parties. A Truss moment would be nearly impossible, and a Clegg moment probably less shocking.
Meanwhile, political parties should reflect on whether it is wise to let their memberships choose their leaders – which they all do – and especially if they are leading the government at the time. Surely this is best left to MPs?
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 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.
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.
This week’s Bagehot column in The Economist suggests that Labour’s policy of freezing energy prices is bad policy (actually “silly”) but good politics. It says that Labour has been too tied to “wonkery” – the design of policies that are clever enough to solve problems without the need to confront awkward choices. Their new policy is a welcome break form the current Labour leader, Sir Keir Starmer. But I don’t think the policy is quite so silly – even if Labour’s suggestions about how the costs will be managed mainly are.
The challenge is huge. British energy prices, especially for gas, have shot up this year. But that is just a foretaste. Further steep rises are in the pipeline: the graphic above, showing annualised costs, culled from the New Statesman (featuring widely quoted projections from Cornwall Insight – who seem to be the only people making them) shows the problem. The median annual household income is estimated to be £31,400 after tax – so costs are rising from 4% to maybe nearly 14% of income for the median household, and it could be double this for the bottom quartile. Other costs are rising too, and, for most people, pay is not keeping up (many senior executives and our local refuse collectors excluded). The media has little difficulty in finding cases of extreme hardship – of people choosing between energy and food for example – and, apparently, not even being able to heat that food up. In one case publicised by BBC News, somebody was selling their furniture to pay their bills. And that is before the forecast price rises have gone through, and before winter brings in the need for heating. Overwhelmingly the public feel that the government should step in to relieve hardship – although how many Conservative Party members share this feeling, while they choose their next leader, is not clear. So far, so clear.
This is where The Economist‘s wonkery comes in. The view amongst Britain’s policy wonks is that help needs to be concentrated on those that need it most. Trying to cap the price for everybody, a policy widely favoured in other European countries, is regarded as a bad idea. For two reasons: first it wastes public funds on people that don’t need it, and second it blunts the market signal that people should reduce energy consumption, and so ease the imbalance between supply and demand that is causing the problem in the first place. This thinking has guided government policy to date. British energy prices have been allowed to shoot ahead of those in the rest of Europe – while the government is trying to target the bulk of its help to the neediest. But this bumps into a major problem. How can the government tell who to help, and who can get along without it? They have two main ways of trying to do this. The first is to help those already entitled to other help, such as Universal Credit – and the second is to ask people to apply for help, and then to assess whether they actually need it.
Both solutions are badly flawed. A problem on this scale is going to hit many people not entitled to benefits, which have become notably stingier over time. I have seen this problem in a different context: the supply of free school meals to struggling families. Many families need the help but are just above the threshold for entitlement. The problem with asking people to come forward is that many will refuse to as a matter of pride, while others who don’t need the help will try their luck, and need to be weeded out in some way, or else the system will subject to allegations of widespread abuse. This last has been the case with help for businesses in the pandemic. This problem is what I have called the Information Gap. The state does not know enough about individuals or businesses to tailor its policies to specific need. It either creates universal entitlements, helping those who are not in need, or resorts to a number of very blunt instruments, which often create political backwash.
The Information Gap is not just some technical problem that can be left to policy wonks to solve. It is one of the central problems of the modern state, and everybody in politics, wonk or not, should be aware of it. There are three general philosophical approaches to dealing with the Gap. One is to use the best efforts of the state to gather information and close the gap, compelling disclosure as required. This is the approach we associate with the Chinese Communist Party; it is highly paternalistic, and seamlessly moves into the state intruding into our private lives in unexpected ways. And the state never gets enough information to solve the problem properly. Its opposite is the libertarian approach. This suggests that the state should not involve itself in helping individuals at all. It should establish a system of security and property rights, and not much else. This thinking is popular n the political right, though not amongst populists. The third approach is solve the problem through a combination of universal entitlements and high taxes. This has recently been popularised through the advocacy of Universal Basic Income. Of course nobody, or almost nobody, advocates taking any of these three approaches to the extreme. Practical statecraft involves balancing all three approaches. Politically, though, we need to develop a sense of in which direction is the site needs to tilt at the current time.
Alas politicians rarely succeed by being honest about the difficult choices involved. Tory leadership contender Rishi Sunak seems to be suggesting that we take the more paternalist approach – but without being clear as to how the information gap is to be closed. His past behaviour in the pandemic suggests that we will accept a high degree of failure and try to shrug it off. His rival, Liz Truss, is suggesting a more libertarian approach – but without being honest about the widespread hardship and business failure that is likely to result. And now Labour is suggesting the use of universal entitlements – but without being honest that this will lead to higher taxes. All three are displaying a dependence on magical thinking. Labour’s “costing” of its new policy is laughable – but the economic illiteracy it is showing is the rule amongst serious politicians, not an aberration.
Personally I think Britain needs to move further along the universal entitlements and high tax route – an approach derided by Ms Truss, but one which the better-run European states favour. That does lead to further problems. Public services will require more discipline to improve their effectiveness, which I believe will have to come alongside decentralisation – with political accountability moving in parallel. That will require deep reforms that people may support in theory, but will resist in practice. Without reform, services will simply gobble up resources without becoming more effective. A further problem, shown in other European countries, is that tensions over immigration have to be managed. If entitlements are high, the public resents people it sees as freeloaders – and there is political mileage in stoking up that resentment, whether fair or not.
So that’s two cheers for Labour – and indeed the Lib Dems whose policies Labour seem to be copying. Alas I don’t see any sign that either party is going to be honest about taxes. But the public, surely, will start to see the need for hard choices. The careers of the two British politicians most egregious in suggesting that no hard choices are required – Boris Johnson and Jeremy Corbyn – have both ended ignominiously.
Hardly for the first time in my life, I have got something wrong. In my recent post on the Conservative leadership contest I suggested that Rishi Sunak would prevail over Liz Truss. This was based on the thought that Conservative members were more sensible than they are usually portrayed to be, and that they would react against the apparent recklessness of Ms Truss – t and favour Mr Sunak’s better presentation skills. I have badly underestimated Ms Truss, as I now think she is unstoppable, but I’m hardly the first person to do so.
Monday night’s TV debate showed why. Mr Sunak badly needed to portray Ms Truss’s economic plans as reckless (an opinion which I share), and especially that they could send inflation and interest rates up. He got his point across pretty successfully. In the process we found him talking over his opponent repeatedly with the confident male assurance that far too many of us have seen senior men do with female colleagues. Would he have done that with a male opponent? You bet he would – he was desperate to convey his message. So it probably wasn’t sexism – it was the opposite, not making concessions to Ms Truss’s sex. But it was a very bad look, and looks matter. Ms Truss held her line firmly; the waves broke over a rock. She had ripostes prepared, and she used them. Mr Sunak’s plans were contractionary (er… that goes with taming inflation); it was all Project Fear (a clever reference to the Remain campaign’s warnings of the economic consequences of Brexit – which have largely been proved right, but which Mr Sunak could not point out); it was all Treasury conservatism and “bean-counting” (true enough – but not actually relevant in this context). She surely did enough to cast doubt in Conservative members’ minds about Mr Sunak’s plans. Meanwhile Mr Sunak’s behaviour neutralised his actually rather impressive confidence and command.
This is a race between the tortoise and the hare, that we have so often seen played out in politics. The patient plotter quietly and relentlessly pursuing their ambitions, while their flashier opponents fall apart one by one. John Major; Gordon Brown; Theresa May – (you can go back further – Jim Callaghan; Ted Heath; Clement Attlee). Like all of these, Ms Truss has endured massive amounts of sneering criticism on her journey upwards. Apart from Attlee, though, none of them were particularly successful once they achieved the summit of their ambitions.
I have in fact met Ms Truss. It was before she was an MP, when she was attending a Lib Dem conference in the later 2000s on behalf of Reform, a think thank devoted to new ideas for public services. We exchanged pleasantries, but I don’t remember much beyond that. Reform’s ideas were (and still are) definitely centre-right – and more to the right in those days of New Labour. They favoured the conversion of state schools to academies, for example – something of a red herring in policy terms. As I remember they had better ideas elsewhere – they had a god line of constructive criticism. This part of Ms Truss’s career tells us two things. First is that she is fluent in the world of think tanks and policy debate. She is repeatedly portrayed as being a bit dim: this is far from true – but it is harder to shake the accusation of shallowness. The second thing this tells is us is that she is a professional politician, and knows no other trade. She was in her late 20s at this stage – was elected to parliament in 2010 and quickly became a junior minister (in 2012), reaching the cabinet in 2014. To be fair, she did train as a management accountant (i.e. a qualified bean-counter, like me, though working in business rather than in the profession) – but she did not take up any serious professional or management role. Her whole life seems to have been political – with politically active parents, and active with the Liberal Democrats at university, before taking up with the Conservatives. She paints this as a political journey, rather than opportunism – and I’m happy to take her word on this. I’m told she was never a left-wing Lib Dem, and the Conservative Party is in the long run a happier place for economic liberals – though deeply out of fashion in the 1990s. But a political career was clearly always on her mind.
Where does this leave us? We have no reason to doubt her conviction to a particular political philosophy (unlike Boris Johnson, for example) – that of being an economic liberal. But her attachment to particular policies never seems to be very strong. She knows all about how to win power, but her ideas about how to exercise it have less “bottom”. This isn’t all bad – disaster can happen when a particular politician has an idée fixe, which they pursue obsessively regardless of evidence. A particular disaster was Andrew Lansley, the first Health Secretary in the coalition government of 2010, who implemented an over-engineered reform of the NHS when it was already suffering reform fatigue. Ms Truss might have the flexibility to change course when things go wrong. The danger is that her yardstick of success is less about actual achievement than the political mood. She is not a conviction politician like Margaret Thatcher. If she was, she would have been completely thrown by Brexit, which she energetically opposed, and now supports with equal energy.
Getting the top job, if she succeeds, is going to be a big shock for her. You can’t get away with sleight of hand. If the economy goes seriously wrong, for example, she can’t simple vanish and blame somebody else. She may be comfortable with rapid changes of course, but she would then find it harder to persuade people to trust her. She is a poor public speaker, verging on disastrous. This was one reason that many people, including me, never took her chances of rising to the top seriously. She simply did not look the part.
As my readers will know, I think her ideas for tax cuts will be disastrous. They will hinder the fight against inflation, which will lead to increasing interest rates. They are a gamble that you can fight inflation without damaging economic growth. Given the obstacles the country is experiencing international trade and labour markets, not least by Brexit, this looks unrealistic. She may well be forced into austerity policies, including public service cuts just as an election looms.
So if I was a Conservative member I would choose Mr Sunak. But Ms Truss has been running this race for much longer than him. And it shows.
