Changing of the guard

For once the pollsters got it right. Unlike in 2017 and 2019 when they predicted, respectively, a handsome and narrow Conservative victory, the 2024 election produced the landslide Labour win that was long expected. Back in 2021 it did not look likely that Keir Starmer would be leading a government in Downing Street, particularly after Labour lost one of their safest seats in a by-election. Not for the first time, I was proved wrong, but at least it offers a chance for a policy reset after years of fractious governance.

Labour’s position less secure than it looks

The 2024 result was a rejection of the Conservatives rather than a ringing endorsement of Labour. Indeed, while it won an overwhelming majority of seats, the roots of Labour’s win were not deep. A large parliamentary majority, which gave them two-thirds of the seats, was achieved with just one-third of the votes on a very low turnout slightly below 60%. It is not the lowest turnout of recent times – that occurred in 2001 when it dropped to 59.4% – but things are different today. In 2001, the electorate voted for an incumbent government and was expecting more of the same. In 2024, however, the electorate is voting for change and it matters whether they are simply voting against the previous government as a protest or in favour of the alternatives on offer.

Without wishing to strike a discordant note after one of the least popular governments of modern times has been banished into history, the narrow foundations of Labour’s win do matter. Although Labour appears to have a strong mandate, which many advocate as a reason to set out bold policy prescriptions, unpopular measures will simply encourage those who sat out the election last week to vote against them next time around. And there is no guarantee that Reform UK and the Conservatives will split the vote as they did on 4 July. Indeed, the combined vote of the Tories and Reform UK was larger than that of Labour.

This makes it all the more imperative that Starmer’s government gets the big things right quickly. Making voters lives better is the one thing that will raise the chances of a second term in office – a second term that will undoubtedly be required to properly fix many of things in the economy that require improvement. At least the new government is comprised of members that share the experiences of the people they represent. For example, only 4% of the cabinet was educated at a private school vs. 63% of the previous one. If accusations of being out of touch plagued the Conservatives, it is not an accusation we can so easily level at Labour.

What next for the Conservatives?

After a chastening defeat, which produced the worst result by the Conservatives since their foundation in 1834, and the worst by either of the two main parties since 1931 (when Labour won just 52 seats), a period of soul-searching is in order. Not only does the party need a new leader following the resignation of Rishi Sunak, it needs to decide what it stands for. The party has become increasingly out of touch since the Brexit referendum in 2016, burning through five prime ministers and spending more time pandering to right-wing MPs than listening to what voters want. It failed to improve public services – indeed their deterioration can be traced back to the austerity policy introduced by George Osborne in 2010; it failed to reach its immigration targets and it failed to make Brexit work.

At least the more reflective MPs recognised that fact as they trooped out of office yesterday (Sunak and Chancellor Jeremy Hunt among them). But is that shared by the 172,000 members of the Conservative Party, who will be responsible for choosing the next leader? The Tories made a mistake in tacking to the right after their defeat by Blair’s Labour Party in 1997 which kept them out of office for 13 years. Although circumstances are different today, the general view is that elections are won from the centre ground. A tie-up with Nigel Farage, as proposed by many excitable political commentators recently, would probably be a mistake. If Labour are smart (and they are), they will know that reducing NHS waiting lists and improving the quality of public services will draw the sting out of the immigration debate. The Tories would be well advised not to go too far down that path.

The fate of the smaller parties

The Liberal Democrats returned after three drubbings to record their best performance in terms of seats since 1923 (72). The Greens outperformed expectations to win four seats in parliament – a record for them – while Reform UK came from nowhere, grabbing the headlines with five seats and a 14.3% vote share. This was largely down to the charisma of Nigel Farage – love him or loathe him, he knows how to whip up the populist vote. Farage and his band of fellow travellers will be noisy and consume a lot of political oxygen in the months ahead. They are too small to be politically relevant but they will have an influence at the margin by influencing the debate in parts of the Tory party as it ponders its future.

The SNP had a bad day in Scotland, going from the dominant political force holding 48 of the country’s 59 seats in 2019 to just 9 of 57 today. This is the result of many domestic factors, including allegations of corruption at the top of the party, but the truth is that independence is no longer the burning issue it was a decade ago. This will at least make Starmer’s job a bit easier as he will no longer have to contend with demands for an independence referendum for the foreseeable future.

Stacked in-tray: What to do?

Aside from the high profile issues of tackling the NHS, and overcrowded prisons which Starmer mentioned in his first press conference yesterday, reform of the social care, welfare and benefit systems are areas where the government will have to act quickly. It has long been recognised that the rollout of the Universal Credit system has been plagued with difficulties, particularly as people migrate from legacy benefits to the new system. Access to welfare benefits is increasingly wrapped up in red tape as claimants are subject to conditionality requirements, while there are mounting problems in accessing disability benefits as regulatory changes are introduced. In 2019 I advocated reducing the taper rate on Universal Credit as a gesture of goodwill to those voters who lent their votes to the Tories (which in fairness the government introduced in 2022 but more can be done here), and reducing the time between claiming benefits and receiving payments. If the government wants to improve the lot of the poorest in society, there are low cost wins to be had.

Final thoughts

As parts of Europe swing to the right of the political spectrum, notably France which goes to the polls today, the European landscape will become more fractured. As a result the UK may stand out as a beacon of stability after a tumultuous few years. That does not mean that the UK should expect a huge wave of foreign investment immediately but it may at the margin become less unattractive vis-à-vis other EU markets. Building some bridges back to the EU will definitely help.

Undoubtedly, the new government will have to prioritise on policy and it says that one of its primary tasks is to boost growth. In truth, this will be hard to achieve – there are so many factors which impact on performance that are outside its control. Not having made many tangible economic promises, it will be difficult to underdeliver, but that is not enough – voters want a bit of stability, and a return of the feelgood factor. Don’t we all?

The (un)changing face of politics

Although I have tried hard to steer clear of politics on this blog over the last year or so in order to focus on the economics, in many ways the two subjects are intertwined. The onset of the global financial crisis in 2008 raised a number of questions that politicians have failed to answer, with the result that the discontent which was already bubbling under the surface spilled out in ways that mainstream politicians have been unable to counter. Populists and authoritarians have had a field day, giving us Orban in Hungary; the Law and Justice Party (PiS) in Poland, not to mention Trump in the US and the Brexit crowd on this side of the pond. But the complexities of real life conspire to confound the simple appeal of many populists, with the result that PiS is a diminished (though still important) force in Polish politics; Trump is out of office (for now) and the gang of zealots that inflicted Brexit upon the UK seem to be fading away into the background.

Indeed, for a long time the British government has appeared to be drifting inexorably to the right, engaging in culture war rhetoric rather than attempting to tackle some of the bigger economic and social problems facing the UK. The sacking of Home Secretary Suella Braverman (the reasons for which you can read here) perhaps marks a watershed as Prime Minister Rishi Sunak realises that the further towards the fringes his party goes, the less likely they are to escape a major trouncing at the next general election, which is expected to be held anytime in the next 6-12 months. The surprise return of former PM David Cameron as Foreign Secretary is the big news, both at home and abroad, and is a sure sign that Sunak is attempting to drag his party back towards the centre before it is too late. If nothing else, it may reassure Tory voters in the shires who have increasingly found the current incarnation of the party unpalatable.

Whether or not Cameron will be the right person to convince the electorate is moot. After all, he is widely blamed for losing the Brexit referendum and ushering in a series of prime ministers who proved themselves more inept than their predecessor (Sunak broke that trend, although he did follow Liz Truss, whose main claim to fame in the eyes of many voters is that she was outlasted by a lettuce). And in an irony that has not gone unnoticed on social media, since Cameron is no longer an MP, he can only enter government by sitting in the House of Lords and cannot be held to account by the House of Commons. Remind me again, but wasn’t one of the benefits of Brexit that we could get rid of unelected bureaucrats?

While it is certainly possible – indeed likely – that changing the composition of his government will allow Sunak to eat into Labour’s polling lead, which has averaged 19 points over the past year (chart above), will voters be sufficiently pacified to draw a line under the last seven years of chaos? If the evidence which is emerging from the Covid inquiry is any guide, Conservative politicians of recent years have a lot to answer for. The tales of incompetence which emerged under Boris Johnson’s leadership will not easily be forgiven or forgotten, highlighting the extent to which governance has been compromised. The Truss government’s short-lived but chaotic tenure severely damaged the Conservatives’ reputation for economic competence while politically contentious decisions such as the cancellation of the northern leg of the HS2 rail project will do little to convince voters in the north that the Conservatives deserve another term in office.

It's the economy stupid

It is only four years since the last election and a lot of water has since flowed under the bridge. But one of the great consistencies of the intervening period has been the Conservative government’s failure to interpret the electorate’s mood in 2019. It did not win a huge mandate because the electorate was concerned about immigration or “wokeism” but rather because it wanted an end to the Brexit wrangling, which Johnson promised, and because Jeremy Corbyn was viewed as an unelectable leader of the opposition.

Matters have been compounded by the fact that the government has failed to deliver on its levelling up agenda – not altogether a problem of its own making, since the pandemic drove a coach and horses through that policy. It has also presided over the fastest rate of inflation in four decades – again the result of forces outside its control. However, it has doubled down on Brexit despite evidence that this is an increasingly unpopular policy, and voter satisfaction with the NHS has fallen to record lows, which is increasingly blamed on government policy (some of which is fair criticism, some of which is not).

Brexit is not to blame for many of the economic ills that the UK now faces, although it does compound them. Dissatisfaction over the state of public services is to a large extent the consequence of the austerity policy introduced by the Cameron government, which resulted in a two percentage point decline in the central government contribution to local authority financing (chart above). Increased unhappiness over the provision of services by public utilities is partly due to a lack of private sector investment following the privatisation of many of these utilities in the 1980s and 1990s. A policy of less government and more private sector involvement is thus not perceived by voters to be acting in their best interests. The debate is obviously more complex than that, but as I have pointed out many times before, the UK cannot afford to operate the same economic model as it did between 1979 and the onset of the GFC in 2008. Demographics are increasingly a headwind and there is no North Sea oil to fund tax cuts. Like all western economies, the UK looks set to experience a sharp slowdown in growth and a commensurate slowdown in the pace at which living standards improve.

As we look ahead to the next election, the party that does best will be the one that has a credible plan to tackle many of the UK’s underlying economic ills. How this will be done is a subject for another time. But changing government personnel does not sound like the game-changer that the UK needs. Forget culture wars and wokeism – the next election will be fought against the backdrop of the economy. Or as Bill Clinton’s strategist James Carville put it in 1992: “it’s the economy stupid”.

Farewell Liz, we barely knew ye

It is becoming increasingly difficult to know where to start in describing the political implosion at the heart of Westminster. A catastrophically-timed mini budget which attempted to kick-start growth by cutting taxes has proven to be a catalyst for a collapse of the Conservative government – perhaps even the party itself. In the last week alone, we have seen the departure of the third Chancellor since July (we are now onto our fourth in the shape of Jeremy Hunt) a second Home Secretary and we are now about to have the third prime minister in less than two months. Fans of political fiction could never have dreamed that they would be able to watch such drama unfold in real-time. It would be funny if it were not so serious.

How did it come to this?

Historians will undoubtedly have a field day in analysing Liz Truss’s shortest prime ministerial tenure on record. They will likely conclude that the Tory party implosion was a long time in the making. Tempting though it is to date the start of the rot to the Brexit campaign in 2016, the split within the Conservative party on the twin questions of Europe and the role of free markets in the economy – both of which played a key role in the recent shenanigans – dates back to at least the 1970s. More recently, the huge antipathy towards the EU demonstrated by large parts of the Tory party during John Major’s tenure as PM in the 1990s never quite spilled over into the mainstream at the time but it did poison the well. We have since been drinking from it for too long.

Undoubtedly, the Brexit campaign was an accelerant in the process. One of the potential benefits that Brexit offered was the chance for the UK to revamp its economic model – a deregulated model, free from the perceived constraints of the EU. This was never a realistic option: Putting up barriers to trade with the UK’s main trading partners could never be compensated for by trade with other nations. As the howls from small companies dependent on exports became louder it was increasingly clear that the economic costs of Brexit were mounting. Undaunted, the Truss administration doubled down with a policy of unfunded tax cuts that in their view would unleash the UK’s growth potential. We should perhaps not have been too surprised given that both Truss and Kwasi Kwarteng were authors of the infamous book Britannia Unchained which argued that Britain suffered from “a bloated state, high taxes and excessive regulation." It went on to suggest that “The British are among the worst idlers in the world. We work among the lowest hours, we retire early and our productivity is poor. Whereas Indian children aspire to be doctors or businessmen, the British are more interested in football and pop music."

When it came to putting the policy into practice, markets understandably took fright. Big, unfunded tax cuts at a time of slowing growth and rising interest rates were never going to fly. Had the policy been introduced more stealthily, it is possible that the Truss government could have made more progress towards its goals. It might have given Truss more time in office. But a big bang approach was the wrong strategy at the wrong time. With the Tories having warned for years that the economic plans of the Labour opposition would result in markets taking fright at eye-wateringly high public deficits, it is ironic that it took a Tory government to blow a huge hole in public finances and spook the markets. The likelihood that a UK government will attempt a similar policy of gambling with tax cuts to boost growth in the near future is low. The Singapore-on-Thames model espoused by many Brexiteers looks dead in the water.

It is also worth noting in passing that the MMT model of public finances does not come out of this episode unscathed. As I pointed out in 2019, “whilst it is true that governments will always be able to repay their local currency debt, it does not justify continually expanding the deficit without limit. In what can be thought of as the ‘when you’re in a hole, stop digging’ theory, governments have to be aware of the extent to which there will always be willing buyers of debt. If one government expands its deficit without limit but another is more prudent, bond investors will always favour the more prudent debt issuer.” If there is any silver lining to the clouds of recent weeks, it is that governments have been made aware of the existence of the budget constraint that proponents of MMT told us did not exist.

What happens now?

We should be in little doubt that the Conservative Party’s economic strategy lies in ruins. Announcing a radical tax-cutting policy, only to be forced to backtrack under market pressure, has blown the government’s credibility. The markets are thus likely to continue to demand a risk premium to hold UK assets for some time to come (memorably described by the economist Dario Perkins as the “moron premium”). This has raised howls of anguish in certain quarters that UK economic policy will increasingly be subject to market approval. But it did not have to be this way. So long as the UK continued to respect the domestic constraints imposed on policy actions by the OBR, the Civil Service and the Bank of England, markets would probably have continued to fund the UK’s mounting fiscal and current account deficits. Sacking the Permanent Secretary to the Treasury because he did not buy into Kwarteng’s plans; ignoring the OBR’s offer to assess the mini budget and calling the independent BoE’s mandate into question served to undermine trust in the UK’s solid institutional base. No longer can the UK rely on the kindness of strangers: It will come at a price.

The fiscal austerity unleashed under David Cameron dramatically hollowed out public services to the point that by 2019 their performance in many instances was already worse than in 2010. The hit resulting from the Covid pandemic has pushed many of them over the edge (see chart below). In its latest Performance Tracker, the Institute for Government notes “these are not isolated problems in individual services, but interconnected structural failures – particularly in the health and care and criminal justice systems … Governments since 2010 may have been seeking efficiency over resilience but achieved neither.” 

Viewed in this light the policy of cutting taxes was always a non-starter. It would become impossible to deliver even basic public services by lowering taxes, and the breathtaking inequity of the strategy beggars belief: Those whose taxes were being cut were not those most reliant on the crumbling public services infrastructure. As it is, the government is likely to have to find more savings. Having rolled back much of its plan to cut taxes, with the proposal to cut corporate and income taxes now off the table, the government has maintained that it will not raise NICs which leaves an £18bn hole in the public finances on a 5-year horizon (0.8% of GDP). This is not a propitious inheritance for the new PM, whoever they may be.

On that note, the UK continues its descent into an irony-free political zone with news that Boris Johnson has considerable support amongst Tory MPs should he wish to return to 10 Downing Street. This is the same Johnson that MPs turfed out over the summer due to his chaotic government style. Were he to make a return, and it is far from certain that he will, this could be the straw that breaks the camel’s back and splits the Conservative Party, with many MPs potentially siding with the opposition to trigger a general election. In any case, if he has any sense Johnson will steer well clear of the premiership, for he cannot possibly hope to gain. The economic situation is far worse even than when he left office and his style of government is not suited to the austerity which is increasingly demanded by markets (indeed markets took fright on the news that Johnson was in the frame). He cannot play the Brexit card as he did in 2019 and he faces a far more credible Labour leader in Keir Starmer than he did when up against Jeremy Corbyn.

Over the past 50-odd years the UK has faced down a series of economic crises with each one portending an end to the face of Britain as we knew it. Invariably, however, it rebounded and demonstrated a resilience that surprised the doomsayers. But this time, as they say, is different. The UK has not faced a political crisis such as the current one in well over 60 years (since the Suez Crisis of 1956). What makes this worse than any other episode in living memory is that the country’s institutional framework is dramatically impaired after years of neglectful governance which will reduce the UK’s resilience in the face of shocks. In 1975, a Wall Street Journal  editorial observed the reduced state of the British economy and concluded ‘Goodbye, Great Britain, it was nice knowing you.’ The events of recent weeks certainly feel as though something has been broken that will not easily be put back together again.