Political Economy Review writer Roland Kristo writes on the impact of Liz Truss’ policies on the British economy and Britain’s prospects for the future.
Shocked by the death of its longest-reigning monarch, the United Kingdom has woken up to a prime minister that is likely to break the record for the shortest time in office. As we all know by now, Liz Truss and her outgoing chancellor Kwasi Kwarteng recklessly introduced the fairy-tale mini-budget that crashed the pound, scared investors, and overwhelmingly lost the trust of the British public.
In a classic case of ‘have your cake and eat it too’, Lis Truss thought she could both cut taxes and increase public spending. By spooking precisely the market she dearly depended on to cover the fiscal deficit, she raised borrowing costs and put the UK in a trajectory of stagnation – the complete opposite of what she sought to do. The irony is even greater if we consider that Truss, a small-state ideologue, was defeated by the same free market she adores so much.
It has therefore long become clear that Liz Truss’s premiership is at an end. The question is not whether she will be replaced by the Tory leadership but rather when that will happen. The Conservative Party is in impasse not knowing which is the path of least pain. It can decide to stubbornly stick with probably the least popular Prime Minister, or it can choose to pick yet another Prime Minister not even two months since Boris Johnson resigned. The latter is much likelier; either way, the damage has already been done. Not only has the market lost all faith in the British government – something that the sacking of chancellor Kwasi Kwarteng has not fixed – but the electorate is also unlikely to forget the poor governance of the Tories.
Although Truss sought to reinforce its conservative base by reducing income taxes for the rich, she might have alienated the same voters the most. ‘Sensible’ economic policy and responsible ‘statesmanship’ used to be the main selling point of the conservatives. This may have been less of an issue under Corbyn’s Labour, but plain-old Keir Starmer may in fact prove to be more dangerous than any mass-exciting socialist. Boris Johnson briefly got away with reckless policy, no care for expertise and at times outright rejection of reality, but he was lucky to ride on the optimism of finally ‘getting Brexit done’ and then benefited from an aura of national unity in face of the Covid-19 pandemic and its aftermath.
Unfortunately for Liz Truss and whoever will be the next PM, the fairy tale is now over. We are now faced with a low-growth economy, seemingly persistent inflation, already high and still increasing borrowing costs, an NHS on its knees, and a cold winter ahead. Not long ago, in the aftermath of the Covid-19 pandemic, the British economy had an impressive rebound, and the future of Britain seemed much brighter. One could have therefore been excused to think that the UK not only ‘got Brexit done’ but also that it got away with it. This could not be further from the truth.
Estimates suggest that the introduction of trade barriers between the United Kingdom and the European Union have led to significantly lower levels of growth than the counterfactual of staying in, as illustrated by the higher growth of all other G7 countries. Even before Brexit, the UK economy had been stuck in a low productivity trap for more than a decade. Despite the best wishes of Liz Truss, cutting taxes does not seem to be the solution.
More worryingly, a less productive economy, with less trade with its largest economic partner, will likely mean quite the opposite. Given the same fiscal burden, a smaller economy will need even higher levels of taxation. Even worse, keeping government spending constant in times of high inflation in fact represent cuts in real terms – a type of silent austerity. On top of that, the Bank of England, despite its best intentions, will likely lead to further troubles as ever-increasing interest rates will lead to further rises in borrowing rates.
To avoid the slow and agonising death of the British economy, the new PM and Chancellor, whoever may they be, will have to stabilise the financial markets and lower government spending, or somehow increase revenues. It remains unclear whether the Conservatives are still fit for the job. Finding a replacement for Liz Truss – the necessary first step – may not be easy. Choosing any of the leadership candidates that were rejected by the vote of the conservative membership is not a wise choice – all to Rishi Sunak’s dismay. Currently it may seem that newly-appointed Chancellor Jeremy Hunt is the de facto leader, notwithstanding his official stance, so he might be in charge for the near future.
Regardless of who will have the tax to fix the public finances, there is no easy solution. Macroeconomic projections done by Citi and analysis done by the Institute for Fiscal Studies suggest that in order to balance public debt by 2027, the government would have to cut spending by around £62 billion – so the recently announced U-turn on Kwasi Kwarteng’s tax cuts will not be enough. Cutting public spending seems to be the option preferred by Chancellor Jeremy Hunt who, in addition to reversing all previously announced tax cuts, has chosen to scale back on energy bill support. The market’s reaction to Jeremy Hunt’s decisions seem to be positive for now, but it remains to be seen if any further fluctuations may follow and if the public will be satisfied with the difficult decisions taken by the new Chancellor.
Labour may therefore wish to think that it finally has a shot. After all, it has never been this popular, or at least the Conservatives have never been this unpopular. Unfortunately, between Keir Starmer and the PM’s office there is a clear obstacle – the unlikely scenario that conservative MPs will risk their seats by calling an early election. Yet Labour may still offer a glimpse of hope if it manages to convince the public that the path to growth is not the path of lower taxation, but of higher spending on health, education, and a greener future. Until then, the future is open, yet the present outlook is rather bleak.
This article is published in partnership with “The Political Economy Review”. You can find the full article here.