Liz Truss’s relentless advocacy of large permanent tax cuts in her bid to be elected has created a rod for her own back. While she has the opportunity now to row back and embrace a more considered position on the UK’s economy, the likelihood is that she believes her own flawed rhetoric and the advice she’s being given by a small group of right-wing, Brexit advocate economists, the foremost among them being Patrick Minford, professor at Cardiff Business School and one-time adviser to Margaret Thatcher.
Minford is providing the professional ballast for so-called “Trussonomics”.
In a throwback to the Reagan-Thatcher era, he believes the UK needs a big change in economic policy thinking, and that economic growth rather than spending rules and stability should be the lodestone of economic strategy.
In his view, UK institutions such as the Treasury, Bank of England and Office for Budget Responsibility are barriers to change that must be countered.
No one would dispute that a big change in policy thinking is needed, given the parlous state of and dark prospects for the UK economy. But is Minford’s vision right, or even relevant in the 2020s? The stakes could not be higher, because if his way of thinking is flawed, then Truss could wreck the economy and the currency, and cause egregious damage to the country’s social fabric. She might even lose her job in the two years before the next general election.
To put the economic challenge into perspective, consider the awkward philosophical position of the current Conservative Party, which Minford’s ideas are being used to address.
It is a low-tax party that is preaching tax cuts to a country where most voters now accept that higher taxes are necessary and are deeply concerned about the quality and availability of their public services.
It is a small government party, in contrast to a national consensus in favour of larger government. Public health and welfare, ageing-related issues, educational attainment, and national security matters spanning energy, food, defence, technology and climate change are almost universally seen as things the government should have more influence over. Joe Biden’s America, for example, looks to have embraced this reality.
It is a free-market party facing down a consensus in which more managed markets are seen to be necessary through the use of regulation, state funding and financing of key projects and infrastructure, and government industrial policy.
It is also a party that wants to reduce debt, but which has presided over an expansion in public debt from 74% of GDP in 2010 to 103% at the end of 2021. Although the Office for Budget Responsibility expected earlier this year that the deficit would slip back to about 2% of GDP by 2024/25, changing circumstances, especially inflation, and Trussonomics are expected to blow a £60bn hole in the budget by then, which is equivalent to nearly 3% of GDP. This will keep the country’s debt to GDP ratio on an inexorable upward trend.
This philosophical quagmire matters, because Minford and his supporters believe, naturally, that their political agenda should prevail, regardless of the consensus. This agenda is similar, by and large, to the 1980s, though there is an important difference. Back then, Thatcher was adamant about fiscal conservatism and the country’s debt ratio was much smaller. Today, the economic advice to the new government is that while the “long-run goal” should be to bring down the deficit and public debt, this should occur not via higher taxes but through economic growth. That means fiscal issues should be sidelined, if not ignored. In other words, the deficit doesn’t matter… until it does.
It’s quirky, because this idea is what Jeremy Corbyn’s Labour Party campaigned on in 2019. Then it was regarded widely with great scepticism, but now it could become the central economic policy of a Conservative government. Minford would argue, though, while the Labour Party’s version of this idea would be accompanied by tax rises which would suppress growth, and create a vicious cycle with debt expansion, Truss’s version will feature tax cuts and promote growth and a virtuous cycle. Or so the theory goes.
You can see why Minford has Truss’s ear. She wants to cut taxes for political reasons, but knows that she must remain committed to expensive projects and programmes, including the highly sensitive triple lock on pensions, and the pledges to subsidise old-age care home costs, resource the NHS and old-age care systems, supply new rail projects, boost defence, build out energy capacity and deal with the current energy cost crisis. For Truss, the key to cutting taxes and maintaining high levels of public spending is growth.
This is a variation of what is nowadays called Modern Monetary Theory (MMT), and it was initially advocated by economists with a left-wing bias. Now it is embraced by their political opposites. MMT is a curious phenomenon: it is not modern, monetary or a theory, but argues that fully sovereign countries with credible central banks and well developed and deep capital markets need not worry about the deficit. Not in the short term, at least. Politicians can be relied upon to raise taxes when the time is right, or when inflation rises to a point where action is necessary. If you believe that, I have a very long bridge to the Arctic to sell you, but be that as it may, it offers us a glimpse about the thinking that is guiding the new prime minister.
All of that said, if you are going to slash taxes, allow the deficit to rise sharply, and preside over a further drop in the pound, you have to make sure that the Bank of England is on your side to deal with the consequences. Minford and company think the Bank of England has been too slow to raise interest rates, and in fact, Truss and her camp have stated that the government might want to review the Bank’s remit, that is, the terms under which it pursues its mandate from the Treasury. The suspicion is that she wants to bring it back under No 10’s control.
If, on top of everything else, if interest rates rise faster and further than people currently expect, that could torpedo both the government’s fiscal position through higher debt interest costs, but also the wider economy, principally through the housing market.
One particular area of interest is what happens to the pound. It has already fallen almost to levels against the US dollar that have not been seen for 40 years, and many analysts expect it to fall to parity with the US unit. That still seems a likely prospect, given the likely trajectory of Trussonomics.
Yet, if nothing else, volatility is guaranteed. If the Bank were to raise interest rates as described, the pound might even rise temporarily. This would be a blow to exporters, who are already facing strong post-Brexit and global economic headwinds, but a boon to people buying imported goods or travelling abroad. Even in this case, however, the ensuing downturn in the economy and possible exodus of capital would pressure the pound eventually.
For all the focus on taxes, deficits, interest rates and the pound, three important considerations are missing from Minford’s publicly available comments and what we believe to be Truss’s thinking.
First, although they think that UK institutions, such as the Bank of England, Treasury, and Office for Budget Responsibility have been either resistant to change or slaves to economic orthodoxy, they could be courting grave danger by interfering with the big economic institutions. This is not to say that there is no case for changing how they operate in some respects, but it is questionable whether anything is so drastically wrong with them that our problems can only be addressed by “taking back control”, rather than by well thought-out leadership from the prime minister’s office. In other words, the problem may not be institutional rigidity but the last 12 years of inconsistent and poorly framed leadership.
Second, Minford’s economic advocacy, similar to that under Thatcher, is not appropriate to the UK in the 2020s. Back in the 1980s, there was a feisty argument about cutting taxes and about monetarism, aligned with other important policies involving regulation, competition, privatisation, the power of unions and the role of labour markets.
Yet, at the time, while it was true that the supply side of the economy had succumbed to decay and needed strong therapy, there was little risk of excess demand or, in the context of the monetary and exchange rate policies of the time, of an overheating economy.
For a long while, Thatcher’s Britain had abundant spare capacity in the system, meaning the economy could be stimulated without triggering inflation. For example, the UK had over 10% unemployment, and there was time and opportunity for structural reforms to take effect.
Today, we have an economy with less than 4% unemployment, record numbers of job vacancies and next to no spare capacity. Business investment this year, even though it is higher than during the pandemic, is no higher than it was in 2015, or the pre-financial crisis peak in 2007. Further, deregulation isn’t the burning issue that it was 40 years ago, and none of the other “to do” items under Margaret Thatcher have real significance today.
Minford says that Sunak’s policies to increase national insurance and corporation tax would have damaged the supply side of the economy, but this is just a political cover for not liking higher taxes. Look at this another way. Cutting national insurance taxes might cause a rise in the demand for workers, were it not for the fact that we are already at full employment, and wages are rising. The reasons that people who could work are not in employment are mostly to do with long-term Covid or other ailments, as well as the impact of the pandemic in inducing people to leave the workforce, and societal ageing. Cutting tax is going to fuel demand without moving the supply dial.
The same reasoning applies to the idea of cutting corporation tax. Company investment is typically determined not by tax but by demand, which means investment is derived from what people choose to spend and why. Cutting corporation tax won’t change that investment picture.
Cutting VAT will lower the consumer price index in the month it takes effect, and so make it seem as if inflation is falling – but this is not really tackling inflation. A fall might get people to spend more, but spurring demand (which we don’t yet need to do) without stimulating supply (which we do need to do) is a waste of money, and regressive.
The cost of energy crisis will require the government to inject more money into the economy, or borrow a lot more, in order to assist those at risk from fuel or food poverty, but temporary or targeted tax cuts would be far more cost effective and relevant than broad, universal, headline-catching cuts.
Third, and of huge significance, the rhetoric from Minford and Truss is silent when it comes to our most important medium-term challenge, which is how to promote more sustainable growth in GDP and productivity, the holy grail of all political parties. This cannot be done simply by cutting taxes and hoping for the best. It needs a properly thought out strategy on systemic issues like the overall structure of the tax system, pension reform, infrastructure provision, and how we want to develop industrial, technological, social and education policies to allow investment and productivity to rise.
Truss will probably not be in power long enough to make any material positive difference to these outcomes. But she could, if the prime minister were minded, get her new cabinet to draft a programme for 2020s Britain and at least begin the task. For that though, she’d need to listen to a different group of economists from those who now have her ear.
The author is a research associate at Oxford University’s China Centre and at SOAS, former chief economist at UBS and author of Red Flags: Why Xi’s China is in Jeopardy.
