Why she failed

Since Brexit and Osborne’s subsequent political demise, a consistent theme has been harder to find. The Brexit vote itself represented a multi-faceted, contradictory spasm: a rejection of free trade to pursue more of it somewhere else; a small-state vision, somehow sold – by libertarians – as the way to push money into nationalised healthcare. Under Boris Johnson’s chaotic, covid-dominated premiership, inconsistent improvisation was the rule. Cakeist boosterism from No10, stern vows of fiscal probity from the chancellor next door, and a bewildering mishmash of multiple economic theories from the Department for Levelling Up.

But there really has been a constant theme – the government’s steady disdain for economic institutions. This reached its nadir during the disastrous mini-budget of September 23. Its failure as an economic approach is what will damn this government to electoral defeat. 

The economic institutions I am directly referring to are the Office for Budget Responsibility, the Bank of England and His Majesty’s Treasury, the triple guardians of the economic orthodoxy. However, in using the term “institution”, one must distinguish its usual meaning from the way economists typically think about it. To an economist, an institution is not so much a physical “thing” as a set of rules, customs or laws that serve to constrain the behaviour of economic agents. The rule of law, stable property rights, the ways markets are allowed to work – these are all institutions. Brilliant economic historians such as Douglass North and Daron Acemoglu credit good institutions with enabling countries to achieve sustainable growth. Bad institutions are why they get stuck behind. 

The economy of today is defined by its institutions. Laws and rules ensure that our money is safe in our bank accounts, that our contracts are generally carried through and that there is recourse when they are not. Should you invent something new and valuable, the institutions of intellectual property law will help you to exploit your invention. Regulations make our products safe and reliable, and a thicket of rules and practices stop our own government from arbitrary acts of tyranny or confiscation. 

The best-known recent example of institutional reform is the granting of independence to the Bank of England in 1997. For decades before, monetary policy had been pursued in a chaotic way, chasing inconsistent goals and subject to constant political interference. Pick up the memoirs of Nigel Lawson, chancellor of the exchequer for six years in the 1980s, and his account of interest-rate setting is bewildering, complex and occasionally hair-raising. Lawson consults and bargains with a variable crowd of experts, sometimes the Bank, his Treasury team at other times, while engaged in a brewing theoretical argument with his prime minister’s economic adviser about what objectives should be pursued. The PM herself, Margaret Thatcher, looms over it all – persuading her of his decisions sounded nerve-wracking. At one point the chancellor even found himself weighing an interest rate move to react to the foreign exchange markets from a hotel on the Kent coast. This was no way to guide the most important variable in the economy. 

From 1998 onwards, in contrast, we have enjoyed an orderly system of carefully selected experts voting at regular intervals on the basis of solidly examined data, and in pursuit of an inflation goal set in agreement with the government of the day. Central bank independence is still seen as the best economic innovation of the New Labour years. 

Until recently UK governments of both left and right have generally bolstered institutions. Labour passed an Act to regulate how the government interferes in takeovers, for example. George Osborne brought the Office for Budget Responsibility into existence, to prevent the perceived or actual risk of the Treasury marking its own homework. And we must not forget the European Union – a supra-national system of institutional constraints enabling the operation of a single market across borders. Much of the EU’s operating software was written by British diplomats at the behest of Margaret Thatcher, a big fan of the Single Market. It helped to protect countries from the sort of damaging subsidy races that Conservatives generally deplored. 

The moment when this tide began to ebb was the Brexit referendum. At this point, it is important to emphasise that there is nothing inherently wrong with politicians taking a tilt at the institutional set-up of the country they are trying to run. Nothing dictates that every new government has to accept the constraints that were bequeathed by its predecessor. Many will have campaigned precisely on reforming what is in place. Thatcher, for example, inherited a National Economic Development Council from the preceding Labour government, a relic of the previous era’s corporatism. She disliked and sidelined it, and her successor John Major eventually scrapped it. Not doing so would have contradicted their entire economic philosophy. This applies to the question of membership of the European Union. Politicians can accept or reject the idea that a nation’s behaviour should be constrained within the structures of the EU, although they should be honest about the implications of the choice.

But Brexit marked more than that one rejection. The years after the vote saw a steady series of attacks upon the institutional constraints binding the government. Perhaps the most notorious was the “Enemies of the People” vitriol aimed at High Court Judges, who had ruled that Parliament should be allowed a vote on leaving the EU. The notorious Daily Mail article (written by a future media adviser to Number 10) passed with little in the way of condemnation from the then-lord chancellor, Liz Truss. Since then, other institutional constraints have come under fire.

In 2019 there was the prorogation of parliament, to evade scrutiny of the government’s Brexit deal. The following year, the government found itself defending the idea of breaking international law in a “specific and limited way”, as it tried to evade the dilemmas inherent in that same Brexit deal. More, smaller but significant shows of defiance continued. Cabinet ministers have been more willing to avoid select committee examinations. Boris Johnson ducked televised debates during the 2019 general election. Another obvious example is how Johnson ignored the advice of the independent adviser on ministerial standards in a case of bullying at the Home Office. All these can be seen as evasions that lighten the institutional constraints stopping politicians acting just as they please.

Liz Truss was called the “continuity Johnson” candidate in this summer’s leadership election, a label that confused those of us paying attention to her policies. Truss in fact is Johnson’s Tory opposite on economics – small state, uninterested in the key goals of her predecessor like “levelling up” or net zero, and dogmatically ideological. But in her disdain for institutional strictures, her start in Number 10 carries on right where Johnson left off. 

Alongside Kwasi Kwarteng, her supremely self-confident future chancellor, she planned a handbrake turn on economic policy during the leadership election in August: a programme of enormous, unfunded tax cuts, despite weak public services and the looming necessity to spend billions on supporting energy bills. The only constraint she appeared to face was the accusation of pursuing “fairytale economics” from her opponent, Rishi Sunak, until recently the chancellor and, compared to Truss and Kwarteng, the very embodiment of Treasury thinking. 

Perhaps Sunak’s impeccable sound money credentials acted as a provocation to the winning side. The leadership campaign was characterised by aggressive talk from Truss about how she wanted to assault “Treasury Orthodoxy”, which she anticipated as a major obstacle to her tax-cutting plans. Rather absurdly, she implied that Treasury analysis and its “abacus economics” just couldn’t grasp the dynamic effect of a tax cut. Of course, over the years they have produced any number of studies examining that issue. 

These were only words, and although UK bond markets suffered a bad August while they awaited the new team, it was not markedly worse than elsewhere. The problems really started when it became clear that the words meant action. Kwarteng sacked the top Treasury official Tom Scholar, refused the offer of an OBR examination of his plans, and barrelled ahead with the biggest programme of tax cuts in 50 years – at a time when markets were already anxious about how to fund energy bill support. To universal surprise, the 45p top rate of tax – for people earning five times the average income – was abolished. The volume of accompanying analysis was as minimal as the scale of new tax giveaways was vast. 

Even the most implacable opponents of Truss’s policies were astonished by the swiftness and brutality of the market reaction. Sterling has plumbed an all time low, and government borrowing costs soared relentlessly. On the day in early July when Johnson resigned the premiership, 10 year borrowing costs stood at around 2.0%; in late September they had shot up to 4.5%. The Bank of England was forced to step in to calm a bond market so disorderly that it threatened the viability of large chunks of the pensions industry. According to the Institute for Fiscal Studies, the government’s annual debt interest bill is forecast to be £23bn higher than was expected in March. 

The effect on the real economy will be harsh. Thousands of mortgage deals were pulled from the shelves, and returned far more expensive. The typical two-year fixed rate is well above 6.0%, almost triple the level of a year ago. For millions of households, this means monthly bills hundreds of pounds higher. Transactions are being cancelled, housing chains are likely to break, and a slump in the housing market is a strong possibility.

The political fallout is equally brutal. Conservatives poll numbers have dropped to levels not seen in 30 years. At the most miserable party conference in living memory, the chancellor was forced to U-turn on his abolition of the top rate of tax. 

Both chancellor and prime minister now show an apparent humility before the high priests of the orthodoxy. The OBR has been summoned and listened to, and its forecasts brought forward to the end of the month. Scholar’s replacement will be someone just as marinated in Treasury thinking as he was. While some of the government’s outriders still aim veiled criticisms at the Bank of England, its relationship with Whitehall has been flipped around entirely. Far from being threatened by the politicians, now we watch anxiously for whether its governor, Andrew Bailey, does enough to calm the gilt market and take the pressure off the chancellor. 

This leaves two questions. First, is this pro-institutional pivot enough to pave the way for the Bank to help the government out of this mess? Probably not. The phrase Bailey and colleagues fear above all is “fiscal dominance” – the situation where the central bank is forced to deploy monetary firepower to support the policy of the government. The Bank’s apparent determination to draw a line under its gilt market interventions is an explicit attempt to rule that out. 

But even if Bailey chose the short-term safety option of more generous support – risking the longer-term inflationary consequences – it would do little to help the more fundamental problem: making the government’s sums add up. Kwarteng has left a £62bn gap in his future budget, according to the Institute for Fiscal Studies. The markets are telling him to close it. Bailey can do little to help. Only an actual reversal of much of the mini-Budget can do that. Few fiscal experts think there are credible spending cuts available on a remotely adequate scale, and certainly not any that might get past a mutinous House of Commons. This would almost certainly mean the loss of the chancellor, at the least. At time of writing, pressure on the government or this even greater reversal is extreme; even George Osborne has joined in. Humiliatingly for the government, this coincides with a marked improvement in bond yields. 

The second question is whether the hammering taken by Truss and her economic philosophy will mark a turning point in the broader relationship between the Conservatives and the institutions they so unwisely disdained. My fear is that it will not. A disturbing aspect of the recent anti-institutional turn was the way the battle became so personal. It was nasty to pin “Treasury orthodoxy” on one person, Tom Scholar, just as it was disturbing to pick on actual judges for interpreting the law. Persistent efforts to staff institutions with the “right” people show the same tendency. 

Bailey’s performance has often appeared erratic, and it is easy to imagine the failure of the government’s economic plan being blamed on the Bank – for doing too much, too little or even both. When the OBR finally gets to opine on the growth-boosting nature of Kwarteng’s Growth Plan, there is bound to be a think tank that questions its workings and proposes something ludicrously optimistic instead. It is easy to guess which ministers will be touring the studios, waving these figures about. 

By attacking or ignoring our economic institutions, the Conservatives undermine the most enduring driver of our long-term prosperity. Ultimately this is very bad for their economic credibility. I know more than a few leading lights from the party now in a state of utter despair, wondering where their political home is any more.

There is one sliver of comfort. For too long populist, institution-bashing has proven a powerful narcotic – but never and nowhere has it so quickly been proven so inept, unpopular and damaging. Maybe the sheer scale of Truss’s defeat – and a spell in opposition – will be enough to wean Conservatives off the drug.

Giles Wilkes is a former adviser to Business Secretary Vince Cable, and Prime Minister Theresa May, and now divides his time between consultancy Flint Global and the Institute for Government.