In Liz we Truss(t)

Three years and 43 days ago, I asked “If Johnson is the answer, what is the question?” I never did get an answer to that question. As the blond bombshell moves out of Downing Street to be replaced by Liz Truss, a similar question can be asked of her. But whereas Johnson “only” had to deal with the difficulties of Brexit, Truss has two problems to contend with. On the one hand, she faces arguably the most toxic combination of economic circumstances in living memory. On the other she leads a fractured and fractious party which seems in many respects to have lost its way. How she deals with these issues will not only define her premiership; it may well determine the future of the current incarnation of the Conservative Party.

Over the summer, as the Tory Party devoted its efforts to matters other than governing, there was a distinct sense that many voters felt abandoned as the cost-of-living crisis intensified. This has been reflected in polling data which give Labour an 11 point lead – not by any means terminal for Truss but not a good position from which to start. Aside from the cost-of-living issues, there are a whole lot of other matters in her in-tray which her predecessor singularly failed to tackle (indeed, probably made worse): the increasing strain on the NHS; generally low morale amongst public sector workers and the dreadful state of the criminal justice system to name but three domestic items. Added to this are international matters such as maintaining relationships with the EU and dealing with Russia and an increasingly assertive China. Perhaps Rishi Sunak can console himself that the leadership contest was a good one to lose.

Big government is back

However much Truss may profess her love of a small state and associated low taxes (her campaign pledges included unfunded tax cuts), all western European nations now realise that the state will have a big role to play in keeping the economy – perhaps even the wider social fabric – intact. Nowhere is this more evident than in the debate over how to provide support to consumers whose energy bills will spike sharply this winter in the absence of intervention.

Despite her opposition to “handouts” Truss really has little choice – politically and economically – other than to cap household energy bills which would otherwise rise by 80% in October, with the average household paying £3549 per year (150% more than in winter 2021-22). The prospect of a further 50% rise in January 2023 would mean that the average household would be required to pay 17% of its net income in the form of energy costs. To get a sense of how big this increase is in real terms, see the chart below based on calculations by the Resolution Foundation. This would make its presence felt in inflation, which the BoE estimated in August would hit 13% at the end of 2022 and would feed through to affect other prices where energy is a significant input cost. The fact that the price cap is likely to rise even more than the BoE assumed suggests that inflation would rise even further with Goldman Sachs suggesting that this could push inflation above 20% in the early months of next year.

On the basis that many businesses would go to the wall if the full costs of energy were passed on to the consumer, the government is believed to want to limit the rise in energy bills to around 27% (restricting average household bills to a still-significant £2500 per year). But this will not come cheap. It has been suggested that freezing household energy bills at current levels could cost up to £100bn (over 4% of GDP) as the government subsidises the difference between the price paid by the distributor and the consumer, with another £50bn expected for business support. What then becomes important is how the subsidy is funded. 

One option would be to levy a windfall tax on the profits of energy distributors. Since the cap is designed to limit the amount that distributors can charge per unit of energy such that their profit margin is limited to 1.9%, if the wholesale price of energy were to double, so profits also double. The case for a tax on these excess profits is appealing on social justice grounds. However, Truss takes the view that levying higher taxes sends the wrong signal for a government that wants to support enterprise. Consequently, it is likely that the government will fund the subsidy by increased borrowing. This will of course raise debt levels, and the idea that a future generation of taxpayers should fund the energy needs of today’s consumers may strike some as distasteful.

Suggestions that the Truss government will reverse the recent rises in corporation taxes and NICs in a budget later this month at a time when the public sector is desperate for additional funding does strike me as bad policy. As I have noted previously, the UK (in common with other western European nations) does not have the favourable demographic profile that will prevent tax cuts from putting a significant hole in public finances – in contrast to the 1980s. Back in 2010, Bill Gross described the Gilt market as resting on a bed of nitroglycerine. What was an inaccurate portrait of UK public finances in 2010 may be more apt description of the current situation.

The political dimension

We should also not overlook the political challenges that Truss will face. Although she won 57% of the votes cast in the leadership ballot, this was on a turnout of 82% implying that only 47% of those eligible voted for her. The fact that 53% of party members voted for her opponent or did not vote at all, is hardly a ringing endorsement. It should not be forgotten that Rishi Sunak polled more votes than Truss amongst MPs in each of the five ballots prior to the final one amongst party members. Although the Tories will present a unified face  in public – at least for a while – there is little doubt that the Tory party remains split along ideological lines with the Brexit fissures continuing to run deep.

The ultras in her cabinet and on the backbenches continue to see the EU as the bogeyman responsible for many of the UK’s ills. Truss herself has become a convert to the Brexit cause. Despite having supported Remain in 2016, she has had to continue to sound hawkish on Brexit in order to appeal to the party faithful. However, as every PM has found to their cost, tough talking is not the way to achieve success in EU negotiations. Worse still, with the global geopolitical situation increasingly unstable, it is incumbent on the UK to find common cause with the EU on a range of economic and political issues. Truss knows only too well that the EU issue has played a role, directly or indirectly, in the downfall of her three immediate predecessors. 

Whatever one’s views on Truss – and her approval ratings are not exactly stellar – voters will be hoping that she can deliver them out of the dark place into which Boris Johnson led them. Surely she cannot do worse. Can she?