It has been a truly historic week in the UK. The passing of Queen Elizabeth II after an extraordinary reign of 70 years and the accession of her son to the throne as Charles III eclipsed in (symbolic) importance the third change in conservative Prime Minister since the Brexit Referendum. Whatever one thinks of the Monarchy, the passing of the Queen literally means the end of an era – namely the second Elizabethan one. One of the bridges that connected the 20th century Britain with 21st century Britain has disappeared. Given the tumultuous years the UK is going through, the Queen’s passing means another pillar of stability and familiarity is gone, making what lies ahead for the country a bit more uncertain and unnerving still.
In the meantime, life goes on and the week also brought us the first glimpses of what the new PM’s post-Brexit economic policy would actually look like now that it has to be stripped of the vitriolic rhetoric of the Tory leadership contest.
There are some signs that in some respects realism will trump rhetoric. Importantly, her attack on the independence of the Bank of England (BoE) has given way to more conventional reassurance about the independence of the BoE’s monetary policy mandate. Similarly, on the Northern Ireland Protocol (NIP), Truss had threatened during the leadership contest to trigger art. 16 immediately after taking office, it now seems like she will not do such a thing.
In most other respects, however, Truss and her new Chancellor Kwasi Kwarteng seem to continue the Brexiter tradition of being thoroughly grounded in fantasies. Indeed, it seems highly unlikely that their strategy of squaring the circle of tax cuts, spending increases, public borrowing, and inflation control will work.
Trussonomics: Dropping the conservatism from fiscal conservatism
Like I briefly wrote last week, at the heart of Trussonomics is a promised of deficit-financed tax cuts. These tax cuts include reversing the planned corporation tax increase from 19% to 25%, reversing the increase in National Insurance, freezing the energy levy, and possibly a 5% cut in value-added tax (VAT). Tax cuts are of course pretty orthodox Tory economic policy. Indeed, former Chancellor George Osborne – interviewed on the News Agents podcast – stated that it was Theresa May and Boris Johnson who were the ‘odd ones out’ in terms of Tory economic policies, while Truss consists a return to more traditional Thatcherite economics.
That may be true for the tax cuts bit of her economic plan, but here is the unorthodox – i.e. unconservative – bit of Truss’s economics: Contrary to the fiscally conservative stance of so many Tory PMs and chancellors before her, she is less concerned with balanced budget and reducing public debt in the short run. Instead, she suggests financing the tax cuts through increased borrowing, while maintaining (or even increasing) public spending. Indeed, she seems to consider that austerity after the financial crash was a mistake. That is perhaps one of the few remnants of Johnsonite populism in Truss’s economic plan.
Indeed, this mixed policy makes political sense. While tax cuts may assure Truss the support of the traditional Tory base, the 80 seat majority Johnson won in the 2019 GE was the result of a combination of votes from traditional Tory voters in affluent areas of the country, and the votes of pro-Brexit working class voters in the ‘red wall’ constituencies. Tax cuts alone will not achieve the goal of keeping those strange electoral bedfellows on board. Therefore, fiscal expansion and promises of public spending are key in electoral terms.
That insight also explains while another bit of leadership contest rhetoric has now given way to realism, namely her initial opposition to energy price caps, which has now turned into an expensive energy plan.
Energy Plan
Trusses energy plan, revealed on Thursday, consists of a two year freeze of unit energy price - more than most expected. Businesses will receive similar support, but only for six months after which point only still to be defined ‘vulnerable industries’ will be supported. The plan also comprises the idea of giving nuclear and renewable energy companies long-term contracts at fixed prices that are decoupled from the gas price, thus reducing prices compared to the current gas price (but possibly paying more over the long-term).
Keeping average household bills at an estimated £2,500 a year, compared to the projected £3,500 in October and £6,000 next year will make a huge difference to UK households. Yet, some critiques, like Green MP Caroline Lucas, say even those prices will be unaffordable for poorer households. Moreover, the estimated cost of £150bn* will not be financed through a windfall tax on energy companies’ excess profits – which polls suggest has wide support in the public even amongst conservative voters. Instead, Truss will ultimately have to ask taxpayers to foot the bill.
Most importantly though, in Truss’s energy plan there is absolutely no mention of any attempts to reduce energy consumption – the most important policy target one should think given the climate crisis we are facing. Rather than addressing that most urgent issue, Truss ditches the green energy levy, promises to increase oil and gas production and restart fracking, thus encouraging the burning of fossil fuels as if it were the 1950s. That part of her energy plan reveals the fundamentally ideological nature of Truss’s politics. Lifting the fracking ban is not only environmentally absurd, but also illogical from a purely pragmatic point of view. Indeed, experts consider that the UK simply does not have any good shale gas to make fracking viable. Furthermore, fracking is extremely unpopular in the UK (only 17% of the people support it). So, Truss’s lifting of the fracking ban is neither economically rational, nor justified by her populist leanings, but simply a two-finger salute to environmentalists by someone who has put a climate change denier in charge of energy policy.
In comparison, the EU’s plans, to be finalised next week is expected to combine price caps, with windfall tax on energy producers, and measure to reduce energy consumption.
Regardless, the announcement of the plan did cause a short term recovery of sterling, although that was short lived, as on Tuesday sterling hit a 40 year low against the dollar (Project Fear anyone?)
Dangerous optimism
Like I wrote last week, challenging some of the economic dogmas of the past decades is most definitely important. Even fiscally conservative economists acknowledge that short-term spikes in debt are not necessarily a problem if it remains sustainable in the long run. Yet, suggesting a borrowing-financed spending spree at a time when interests are set to rise from historically low levels to 3% or so by the end of the year makes one wonder whether Trussonomics will turn out to be sustainable.
The reason why Truss and her advisors think their plan will add up is down to the typical blind optimism and boosterism that has become the hallmark of the Brexit ideology. Indeed, Truss puts all her eggs into the basked of pro-growth economic reforms. Yet, what shape these reforms will take is currently still unclear. Indeed, here Trussonomics seems to rely on a two-pronged strategy, although the two prongs do not necessarily seem compatible.
The first on is an industrial strategy. Here the remarkable news this week was the appointment of Jacob Rees-Mogg as Secretary of State for business, energy and industrial strategy. What is remarkable is not so much his appointment to that post, which had been expected for some time. Rather, what is remarkable are two things: firstly, the fact that Rees-Mogg’s previous position as Brexit Opportunities and Government Efficiency Minister (BOGEMin) has disappeared. The clearest sign yet that not even Truss’s hardcore Brexiter government puts much hope in finding any benefits from Brexit. Secondly, despite Truss’s libertarian leanings, Rees-Mogg’s new jog title does seem to suggest that developing an industrial strategy, which the now Chancellor Kwarteng had ditched not so long ago, remains part of Truss’s economic strategy. This may not go down well with the hard-right of the Tory party, which has become Truss’s main source of internal support. For instance, Rand-fan Sajid Javid when he was business secretary warned that the words ‘industrial strategy’ should never come out of Tory mouths.
Yet, Trussonomics seems to combine an industrial strategy with another blindly optimistic policy, namely deregulation. That is clearly indicated by her proximity to the free market extremists of the Institute for Economic Affairs (IEA) and the role extremist economists play amongst her advisers. Politically controversial projects like radically deregulation the planning system to stimulate construction or privatising the NHS will not be possible without a democratic mandate and may hence have to wait until the next GE. Yet, there are already signs that a wave of deregulations will hit the country. Thus, Kwarteng has announced a Big Bang 2.0 for the City of London. Together with tax cuts for the rich, that may provide the intended economic sugar rush in the short run. In the long run, however, it will further spur asset price bubbles, the further financialisation of the UK economy, and – as economic history teaches us – most likely another financial crisis at the end of it.
The Truss government’s optimism is also dangerous in another respect, namely in its naïve view of the relationship between economic growth and the distribution of income and wealth in society. As I wrote last week, here all Truss and her team have to offer is the old idea of trickle-down economics, which we know will not work. The theory is that by taxing wealthy people and corporations less, they will invest more, thus stimulating economic growth, which in turn will benefit everyone in society. That sounds like a fairly compelling theory. Except, of course, that we have known for a long time that it does not work. In some sense, trickle-down economics is a theory about inequality, which states that increasing inequality in the short term (by reducing taxes mainly on the wealthier strata of society), will lead to absolute increase in welfare in the society even though relative inequality may remain high or even increase. The International Monetary Fund has moved away from that theory around seven years ago. An IMF report from 2015 has the following to say about the link between income inequality and growth:
“Our analysis suggests that the income distribution itself matters for growth as well. Specifically, if the income share of the top 20 percent (the rich) increases, then GDP growth actually declines over the medium term, suggesting that the benefits do not trickle down. In contrast, an increase in the income share of the bottom 20 percent (the poor) is associated with higher GDP growth”
The poorest 20% clearly are not the main target of Truss’s plan, which is based on an aversion for government ‘handouts’ and tax cuts that benefit the wealthier more than the poorer in society. In particular, cuts to VAT and income tax do not necessarily make the poorest 20% better of, because items that they spend a disproportionate proportion of household income on (food and children’s clothing for instance) are not subject to VAT and income tax does not help pensioners and the unemployed. Similarly, capping energy prices at a level where many poorer households will still be struggling will not do anything to increase the income share of the those who would contribute most to generate economic growth.
So, even with Brexit government number 3, the pattern in terms of economic policies is the same as under May and Johnson, namely the economic policies that are being adopted will continue to aggravate rather than solve any of the economic problems that caused Brexit. Indeed, the history of the past forty years teaches us the following: Libertarian, market fundamentalist economic policies make the rich richer. Yet, rather than investing in productive activities, they spend their money on luxury goods like yachts and invest in asset markets, while the rest of us are waiting for the trickling down to happen. Combined with the opening of global markets and the off-shoring of blue-collar jobs, these policies translate into deindustrialisation and job losses in formerly industrialised areas, followed by declining living standards (also cauasing wide-spread drug abuse) and then votes for nationalist populists like Trump and Johnson. The tragedy is of course that those alleged populists then adopt right-wing economic policies that make things worse for the working classes.
Inflation and the battle between Treasury and BoE
A key question regarding just how bad Trussonomics will be for working class people concerns its impact on inflation. The downside of Trusses tax cuts and expansive fiscal policy will almost certainly be higher inflation in the long-run. Truss claims her £150bn energy price package will help tackle inflation. Indeed, forecasts suggest that the two-year energy bill freeze will reduce peak inflation by about 5%, meaning we are facing 10% rather than 15% inflation in January . However economists expect that in the longer run the increase in government borrowing and spending will add to inflationary pressures, which will make further interest rate rises necessary.
Inflationary pressures will in turn increase pressure on the Bank of England, which will find itself in a tough spot having to choose between resolutely fighting inflation that might reach 20% next year according to some forecasts and a recession. If interest rates do increase, as most observers expect, the effects on mortgage and credit card-payments fore already stretched households may be severe. They will also affect the costs of government debt. Truss will certainly blame the BoE for it. Indeed, Trussonomics seems a recipe for increasing tensions between the Treasury and the Bank of England. While her aggressive rhetoric against the BoE has already been tuned down since her appointment, the expansive fiscal policy that the Treasury is expected to follow will clash with the BoE’s priorities and monetary policy, making tensions inevitable. Indeed, it would seem that the BoE considers the UK economy going into recession to be inevitable to bring down inflation. That is not something a PM facing criticism for costs of living and an election in two years’ time will easily accept.
Towards 2024
The country is now governed by the most ethnically diverse cabinet in its history. Yet the visible diversity hides the homogeneity of the government in terms of socio-economic class. In fact, what unites the members of the Truss government is the fact that the vast majority of them attended private schools and went through the same educational institutions as so many politicians before them. Despite its seemingly progressive composition, this is the most right-wing government Britain has had in decades, which combines a lack in competence with an oversupply of ideological zeal.
Yet, some in the British public still do not seem to take the warnings about the direction we are going into (e.g. by Anette Dittert or myself) seriously. The otherwise very good The News Agent podcast for instance concluded on the cheerful note, that the Truss government was going to be ‘entertaining.’ There is nothing entertaining for the people in this country who are facing fuel poverty or massive debts to get through the winter. There is nothing entertaining either about this government for those running companies that IEA-backed extremists in government call ‘Zombie Companies’ – which are in reality nothing else than companies that employ millions of people up and down the country but are struggling with debt after two years of pandemic, Brexit, and now massive inflation and rises in energy prices. Oxford Professors and successful journalists will face entertaining two years…the rest of us will face a trickling down of pain from an elite who is making constantly the wrong economic policy decisions.
In two years’ time when the next GE is due, the country will look back on 16 years of economic disasters – including a massive financial crisis, austerity, declining living standards, and inflation. If Trussonomics do not work, Truss, more than Thatcher back in 1983, will then need a serious rally around the flag to get people to vote for her. That will encourage her to rake up English nationalism and jingoism, which in the hands of someone known to love provocation and clearly reckless enough to put her career above the good of the country and its people is nothing short of scary. Indeed, her inclination to not do the readings she was meant to do as a student and her provocations may see quirky in a 20-year-old student, they are a whole different matter in a PM running the country in a context of the most febrile international situation in at least a quarter century. What saved Thatcher in 1983 was a war – let’s hope the same is not true for Truss in 2024.
*Depending on wholesale energy prices, the cost could be higher than this. on the other hand, the short-term impact on reducing inflation will save the government money on its inflation-linked debt payments.