The fault, dear Brutus, is not in our stars,
But in ourselves, that we are underlings.
William Shakespeare (1564-1616), Julius Caesar, Act 1, Scene 2 (1599)
Future British historians will call 2022 the year of two monarchs and three prime ministers. Or will that be four?
Liz Truss resigned yesterday after an agonising six weeks in 10 Downing Street. The prospectus that she sold to the 160,000 members (we don’t know the exact number because they won’t tell us) of the Tory party had been reversed like a winter umbrella on Southend Pier. She was pushed out because the men in suits told her to her face that there was no way that she could ever regain the credibility required to hold office. No prime minister can survive the loss of a Chancellor and a Home Secretary within a week – especially if their programme lies in tatters. Her goose was cooked.
Truss kissed hands with a dying Queen Elizabeth II on 06 September. The late and esteemed monarch’s funeral will be remembered by many. Though the prime minister who read the Gospel at that service remained unrecognised by most observers – in contrast to her predecessor who is world famous. Soon, it will be as if her premiership never was.
This morning, the mainstream media has come to bury Truss, not to praise her. She was and is devoid of charisma; but she had her virtues, and keen supporters. The Tory members who voted for Truss to become PM were intent on a radical change in economic policy.
The arguments for Trussonomics were rational. Britain’s growth since the financial crisis has stalled. Our productivity is lower than that of our peers. There is a structural fiscal deficit which is deteriorating. We have a massive and widening trade deficit. The debt-to-GDP ratio creeps ever higher. The size of the state has been growing. The tax-take is at its highest level as a proportion of GDP since the early 1950s when we were still recovering from World War II.
Under Boris Johnson and his Chancellor, Rishi Sunak, there had been a trend towards a Brownite economic policy in which the state was always on hand to fix any problem that arose. That was partly due to the coronavirus pandemic, which monopolised government for more than two years and during which Mr Johnson promised “to wrap the arms of the state” around the individual. During this time any reforms made possible by Britain’s withdrawal from the European Union – supposedly Boris’s major success – were stalled. The man who did more than anyone else to get Britain out of Europe could not articulate what Brexit Britain would become.
Moreover, the economic weather has been worsening over the last year or more. Interest rates were already on the rise across the developed world even before Putin started to manipulate gas prices in the autumn of last year. Then he unleashed a full-scale brutal war in the heart of Europe: hydrocarbon prices soared, and so did food prices on the back of grain shortages and impossibly high fertilizer prices. That inflationary tsunami hit our shores early this year and will continue to cause havoc for at least another year. This week, the official inflation rate was reported at 10.1 percent. Double digit inflation poses both political and economic danger.
Thus, a reboot of economic policy was not a madcap scheme. Now, the left-wing media regards Mr Kwarteng’s kamikaze mini budget of 23 September as an illicit putsch by the libertarian extremists of Tufton Street. It was, in fact, entirely mainstream. It was the timing and the sequencing, plus the absence of supporting numbers, that were damning.
Under the New Labour government of 1997-2010, the maximum rate of income tax remained at 40 percent throughout – until Gordon Brown’s final months when the higher rate was hiked to 50 percent for people earning over £150,000. No one talked about “trickle-down economics” in the Blair years because the idea that the better-off should not be crucified was mainstream. Peter Mandelson was famously entirely relaxed about people becoming “filthy rich” (as he has now become). What was obnoxious about scrapping the higher rate now was that the relatively minor revenue loss of 2 billion would have to be paid entirely by new borrowing.
The scrapping of Mr Sunak’s hike in national insurance contributions was nominally Labour party policy; and Labour supported the proposed reduction in the basic rate of income tax to 19 pence in the pound. As for corporation tax, one of the greatest achievements of the Cameron-Osborne government was to reduce taxes on business to more competitive levels. It does not make sense to punish companies which invest in a more productive economy. The mini-budget, if implemented, would have lowered the tax-take from 36.5 percent to 36 percent of GDP – hardly a revolutionary manifesto.
What undid the mini budget was not Labour’s onslaught but the reaction of the markets. Financial markets rely on a flow of data crunched by geeks. The geeks were given precious little data to crunch – and therefore assumed the worst: that the Truss-Kwarteng government was about to go on a borrowing splurge before securing supply side reforms to the British economy, the benefits of which are in any case impossible to quantify.
We now know that what I called recently the “gilts market wobble” was much more serious than we realised at the time (that is, during the week of 26 September). The Bank of England has let it be known that some pension fund managers were on the phone talking about a “full-scale liquidation event”. The doom loop – whereby funds were forced to sell gilts to generate liquidity, thus putting further downward pressure on gilts prices – was only just avoided by the Bank of England’s intervention.
One explanation of the gilts wobble is that, over the weekend following the kamikaze budget, Mr Kwarteng told a group of businessmen in private that further tax cuts were on the way, at a time when the markets had already been spooked. My own view is that the management of those flagship pension funds showed themselves to be manifestly unprepared for a hike in yields which had been foreseen for the last 18 months or more. Everybody could see that the Fed was raising rates remorselessly and that the Bank of England and the ECB would have to follow from behind. If the liability-driven investment (LDI) vehicles on which funds had become dependent were unable to withstand a sudden hike in gilt yields, that was not necessarily the fault of the Truss-Kwarteng government.
But the fact is that Labour and others have been able to score an easy political point: people are being forced to pay more for their mortgages because of crazy Tory economic policy. Mortgage rates have risen faster and higher in America than in the UK – but no one talks about that.
If there was one man who sealed Mr Kwarteng’s fate it was the Governor of the Bank of England, Andrew Bailey. He it was who issued an abrupt warning to the bond markets on the evening of 11 October in Washington that they had just three days left to “get this done”. Gilt yields began to rise again, and poor Mr Kwarteng was summoned back to London to be fired.
Mr Kwarteng’s replacement, Jeremy Hunt, then set about trashing all that remained of the mini budget. The OBR estimated that a gap of around £60 billion had opened up between government tax revenues and expenditure, even without the impact of the mini budget. So, Mr Hunt, who presumably took the job on the condition that he (like Gordon Brown) would have sole control of the economy, was able to make the case for both tax rises and spending cuts. The Bank of England Governor proclaimed a “meeting of minds” with the new Chancellor. The unfortunate prime minister was left to preside over a government which was to pursue policies totally at variance with those she had championed as her own. Her position had become untenable – and still she did not resign until her Home Secretary walked away.
Because there is fundamental disagreement on the direction of economic policy within the Tory party, it is difficult to foresee that Ms Truss’s successor will be able to bring about a consensus. There are the Tories who believe in free markets and letting entrepreneurs prosper unmolested by the state: their watchword, as with Truss, is “growth”. And then there are the “compassionate Conservatives” who want to spend to mend. Both pay lip service to “fiscal responsibility”. The first are relaxed about removing restrictions on planning and immigration; but most Tories on the ground resent house building on greenfield sites and large-scale immigration. It is difficult to reconcile such fundamentally different views.
If the Tories are incapable of cutting taxes to create a more dynamic economy, then who can? And indeed, as have I asked before: what are the Tories for? The reality is that spending cuts of almost any kind would be politically toxic. The state retirement pension accounts for about 12 percent of government expenditure. It used to be seen as a benefit but is now regarded as an entitlement. Pensioners have fared better than young people, economically speaking, since the financial crisis; and yet the issue of whether to maintain the “triple lock” on state pensions is political dynamite.
But if the Tories are in a pickle, consider that any incoming Labour government would have very limited room to manoeuvre too. Even swingeing tax hikes on “the rich” would not make sufficient difference to tax revenues to finance all their spending dreams. Gordon Brown famously stuck to Tory spending plans for three years after 1997; Rachel Reeves would probably have to do the same. The revolution has had to be postponed.
The last Tory leadership election – which self-indulgently wasted an entire summer at a time of economic and geopolitical crisis – was a choice between a radical growth agenda and more of the same. The Tories chose the growth agenda. That blew up. This time, they are likely to plump for more of the same. And if they choose Boris, as is rumoured this morning, that really would be back to the future.