It has been a hell of a month in the UK. Four weeks ago, the death of the Queen marked a symbolic shift in the institutional fabric, the implications of which we have yet to work out. Her funeral was an event televised around the world and confirmed that whatever else the UK does, it remains a world leader in pomp and ceremony and projecting its imperial past to relay an image of itself far beyond its significance as a modern global power. Four days after Her Majesty was laid to rest, the realities of modern Britain were highlighted by the government’s unveiling of what was described as the worst budget (sorry, not a budget – a fiscal event) of modern times – perhaps ever.
As an economic package it was gobsmackingly awful. For the full details, see here. But in short, the government (or perhaps we had better describe them as the latest collection of radicals to hold parliamentary office) outlined a Growth Plan with the stated aim of restoring the trend GDP growth rate to 2.5%. This entailed a series of supply side measures which amounted to unfunded tax cuts totalling £45bn or 2% of GDP. The rise in NICs announced last year will be reversed; planned increases in corporation taxes are to be scrapped; the basic rate of income tax will be reduced from 20% to 19% next April and it planned to abolish the higher rate of income taxation (45%) before it did a U-turn on the idea.
As a package of economic measures, it was always doomed to fail. First, the UK’s trend growth rate is hampered by unfavourable demographics so it will be hard to raise without a very big rise in productivity. The evidence does not support the notion that companies will boost investment in response to lower taxes, thus putting a hole in the productivity-enhancing rationale for lower taxes. In addition, an influential IMF paper in 2015 comprehensively debunked the notion that cutting taxes for the well-off has any impact on growth (“a rising income share of the top 20 percent results in lower growth – that is, when the rich get richer, benefits do not trickle down”).
As a political gambit, the fiscal event is probably the worst brand-destroying exercise since jeweller Gerald Ratner described his products as “total crap” and suggested that some of the earrings he peddled were “cheaper than a prawn sandwich from Marks and Spencer’s, but I have to say the sandwich will probably last longer than the earrings.” Ratner did not last long in the job after that. The findings by the Resolution Foundation that the richest 20% of earners will benefit from two-thirds of the gains from lower taxes may not directly have influenced voters, but they know well enough when they are getting a raw deal. This has contributed to Labour’s opinion poll lead widening from 12% four days ago to 24% today (chart below). Just as in 1992 when the perception of Tory economic competence was shattered by sterling’s ejection from the ERM, so the fiscal events of recent weeks could have the same impact on the current government.
Indeed, it was the pound that was initially the centre of attention in this fiasco as it briefly plunged to all-time lows against the dollar early last week. But it is the gilt market, where rising yields forced pension funds to scramble for cash to meet margin calls on their hedging instruments, where attention is focused and BoE action to calm the market (the merits of the BoE's actions are a subject for another day). To the extent that mortgages are priced off the gilt curve, rising yields imply that mortgage rates are likely to rise sharply, thus making life harder for households already facing a major cost-of-living squeeze. As it is, data from Refinitiv suggest that the 129 bps rise in 10-year gilt yields in September was the biggest monthly jump on record (chart below).
What’s next?
If the last few weeks have demonstrated anything it is that handing the keys to the kingdom to increasingly ideological governments is doing no favours for the economy or the majority of most of those dependent on it. Indeed as the excellent FT infographic (below) suggests, “out of 275 parties in 61 countries, the Tories under Trussonomics rank as the most rightwing of all” with the author concluding that “The Tories have become unmoored from the British people.”
Chaos is now the watchword in government and whilst the competence of the civil service is not in question, the firing by Kwasi Kwarteng of his most senior Treasury official sends a bad signal about the quality of advice the government can expect to receive. The fact that the OBR’s offer to provide an economic assessment of the government’s fiscal plan was rejected also calls into question the form of scrutiny to which the government is prepared to be subjected.
The fact that the government has back-tracked on cutting the 45% tax rate is a further forced error from both a political and market angle. It was slated to cost only £2bn and will not change the market’s view of the unfunded tax giveaway. The real error is failing to find ways to plug the revenue gap resulting from NIC cuts and income tax reductions. Markets will not easily be assuaged although the fact that yields fell following the announcement suggests that they expect more backtracking in the weeks to come. Politically, the government now looks weak because it has performed a U-turn despite Liz Truss’s assertion yesterday that she was committed to abolishing the 45% tax rate. Moreover, if market pressure does force the government to find savings, it may be forced to cut spending further. It is pretty certain this will not be a vote winner. Public services have been stripped to the bone in the last decade and voter appetite for further austerity is limited.
I concluded my last blog post more in hope than expectation by noting that “voters will be hoping that she [Truss] can deliver them out of the dark place into which Boris Johnson led them. Surely she cannot do worse. Can she?” A month in the job and she has more than lived down to expectations. Every prime minister it seems, manages to be worse than the last. This is not a cycle that the country can afford to continue. In the words of Martin Wolf in an unusually strongly worded FT opinion piece, “these people are mad, bad and dangerous. They have to go.”
