I’ve been reflecting a little more on the debate around the Chancellor of the Exchequer’s statement last Friday and what is now becoming referred to as “Trussonomics.” You will remember that my assessment was that it was economically illiterate and politically stupid. Perhaps you thought that harsh. Perhaps not given the even stronger assertions from some that the Chancellor’s actions were immoral, worthy of condemnation from our pulpits.
So, here’s a reminder of why I think the statement was economically illiterate. It’s important at this stage to understand why the markets have reacted so badly to the statement and why confidence in the pound has crashed even further. The reaction was not to the axing of the 45p tax band (however we feel about that), nor was it out of the blue. The Government didn’t manage to cause an overnight devaluation of what had been a strong pound. The City was already nervous about that. Why?
Well, there seem to be two factors at work, one completely outside of the UK’s control. The first factor is that generally in times of trouble and uncertainty, there’s a go to currency -the dollar. That’s where everybody is investing at the moment and the US have significantly pushed up interest rates to counter inflation, further strengthening the dollar. So, the pound was already weak against the dollar. Now, that’s not necessarily a bad thing. In fact, Governments in the past have intentionally decided to devalue the pound, or at least to allow it to devalue.
In 1967, the then Prime Minister Harold Wilson famously said
“The pound in your pocket has not been devalued.”
You see, he had made an active decision to allow the pound to lose value against the dollar. There were reasons for that. When your currency is lower against other currencies, it makes your exports cheaper and that’s good for manufacturing and should encourage economic growth. However, it isn’t a strategy without its downside. It also makes imports more expensive and so can lead to higher inflation. Now, if you devalue at a point in time when inflation is already under control and suppressed, for example, just coming out of a recession, as Norman Lamont in effect did in 1992 when he took Britain out of the EU Exchange Rate Mechanism (ERM), then you might get away with it. That was the point of Wilson’s claim. He was trying to reassure people that domestically, the pound would still have the same buying power. You would still be able to buy a pint of milk and a loaf of bread for the same price. Of course, inflation did increase, though not by the alarming amounts seen in later years.
The second factor, is the UK domestic situation. There are two parts to this. The first is that with inflation increasing, the markets have been watching to see if action will be taken to get it back under control. The primary tool for controlling inflation is interest rate policy. You increase interest rates to slow supply of new money into the economy and in effect force people to live within their means, this dampens demand and so suppliers have less scope to up their prices. The perception of the money markets is that the Bank of England have been a little slow and remain cautious about increasing interest rates here. Do they have the will-power to tackle inflation? Their hope seems to have been that higher prices were a temporary consequence of COVID and the war in Ukraine. Others are not so sure.
The second part relates to Government spending. Is this a Government living within its means? Now, a couple of things are worth noting here. The first is that it isn’t unusual for countries to increase borrowing during tough times, nor is there anything economically wrong with cutting taxes. The problem is that this is happening here against a backdrop of a country where spending and borrowing is already high. The country had not, despite the language of austerity, really got close to tackling the debt and deficit problem following the financial crash and then on top of that, there was substantial spending to support the economy through COVID. Britain has as a nation maxed out its credit cards.
It is worth saying at this point that, the reaction we are seeing in the markets is not to the specific decision to scrap the 45p tax rate, nor to get rid of the cap on bonuses. Rather, it was to the whole package -yet there are no plans by the Labour to reverse the other measures. By the way, this is a helpful reminder that the Government aren’t relying on trickle down economics. If they were, in fact if they had just scrapped the top rate, then I doubt we would be seeing such a panic.
My view then is that the announcement was economically illiterate for two reasons. First of all, as I’ve written previously, I don’t think it was the most effective way of making a significant financial difference to those who most needed help and secondly because the measures were announced without due consideration to the wider economic context. It may not be the present Government’s fault that we cannot afford these measures but that still doesn’t mean that they can simply ignore th situation.
Secondly, I’ve argued that the announcement was politically stupid. Why? Well to answer that we need to recognise a crucial point. The Chancellor of the Exchequer was answering a different question to the one that we all were asking and thought he was answering. We believed that this was part two of the Government’s response to the energy and cost of living crisis. This was going to do two things. It was going to help us to see what further help was coming beyond the price freeze and how the Government intended to pay for the help now.
If that was the Government’s aim, then the question could have been answered in two parts -and in fact had I think been answered in the Prime Minister’s statement. What further help was coming? The answer is that the reversal of the National Insurance increase. The combination of this with the price freeze and the £400 pay out amounts to a substantial level of help for many families. The other side of the question was I think answered by Liz Truss. The Government’s expectation, rightly or wrongly, is not that the energy companies will pay for this with an increased windfall tax, nor that we will pay it back in higher fuel bills later. Rather, she believes that it will be paid back by reduced fuel bills in the longer term.
So, what was the Chancellor’s statement all about? Well, he actually told us. It was about how the Government intended to pursue longer term economic growth. This was not in fact a response to the energy crisis. The context of course is how do you encourage economic growth outside of the Single Market which we were members of as part of the EU. One way of doing that is by signing your own free trade agreements. However, if that isn’t possible, then you want to do other things to make your economy competitive. So, the Government wants to do things to make sure that businesses stay in the UK and to maintain the City as a world leader in financial markets in the face of competition from Frankfurt. That’s why corporation taxes have been kept low and bonus caps scrapped. It also affects the decision to remove the top income tax band. This was meant to be a signal to the world, that Britain is a low tax economy.
There is a strong view among Conservative politicians and conservative leaning economists that the top rate of income tax didn’t actually do much in terms of bringing revenue in and so have wanted to remove it sooner than later believing that this will actually increase tax revenue over the longer term.
Now, here’s where the Government showed a lack of political intelligence. It seems, I think that they thought that the removal of the top rate would be kind of lost in the focus on the price freeze and the other tax cuts. Instead, because we like to see people paying tax when the likelihood of us ever having to pay it is far removed, they have managed to drown out all the other measures without getting any political capital from this one. It seems that they have been in such a rush to put forward their agenda that they have forgotten the political basics.
The better approach would have been to start to prepare a strategy and to win political support for the longer term. There was a fantastic opportunity for Liz Truss and Kwasi Karteng to do this next week at the Conservative Party Conference. It would have meant that the Labour Party would have gone into their conference perhaps still grumbling about a windfall tax but being landed with the trap of several tax cuts they did not want to reverse and with their membership generally taking the attitude of “we were told by the last two leaders that those currency traders were the bad guys anyway. So who cares what they think?” The Chancellor could have then offered red mat to activists next week and tested the response in focus groups, opinion polls etc before deciding which measures to specifically include in an Autumn budget.
Some people are describing the 45p tax band decision as Liz Truss’ poll-tax. I don’t think it is because it isn’t about imposing an unpopular burden and its not likely to lead to rioting on the streets. Further, the Poll Tax was in principle popular with Tory voters and activists. Thatcher’s problem came when people saw the disorder on the streets and when they began to experience the pain of how the tax was implemented. The reality is that we won’t experience any cost in our own house hold budgets from this. In terms of political comparisons, I suspect it is closer to Theresa May’s miscalculation in springing the social care announcements mid General Election in 2017. It’s an unforced, error. Truss and Karteng did not need to do this now and the result is that they have probably alienated their own voter base and delivered a policy that their own MPS don’t believe they can get behind. I suspect that part of the problem will be that the PM has not included Sunak supporters in her cabinet and so the announcement never got properly tested there.
Two big lessons for us then.
- Don’t surround yourself with compliant “yes-people”. Challenge and critique is your friend.
- Context matters. Nothing happens in a vacuum.