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The economic consequences of Liz Truss

The country is returning to a more normal life. But it won’t be that normal. Liz Truss will take care of that.

On Friday, Kwasi Kwarteng, Chancellor of the Treasury, will follow up his emergency energy package with a mini-Budget. The latter is expected to reverse the increase in national insurance contributions and halt a proposed increase in corporate income tax. It will also set a target of 2.5 percent annual growth. Should we take that seriously? No and yes. No, because the idea that a market economy government can achieve a growth target is ridiculous. Yes, because it will guide the policy. The question is whether it will lead to good or bad. My guess is on the latter.

Line chart of UK income tax rates (financial years ending in year shown, %) showing that the cuts in the highest income tax rates are unrepeatable

Neither Hayek nor Friedman would have thought a growth target wise at all. That’s planning. Hayek would rightly insist that we have neither the knowledge nor the tools to deliver one. In Britannia unleashed, published in 2012 (two authors of which were Kwarteng and Truss), Brazil was proposed as a model. Ten years later, that looks insane.

A growth target is not only unworkable, but also a danger. Suppose Kwarteng tells the Treasury and the Bureau of Fiscal Responsibility to include this target in their forecasts (if they are allowed to make one). If he is wrong, deteriorating public finances could trigger a crisis of confidence, as happened in the 1970s. He seems to dismiss such concerns as mere “managerialism.”

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So let’s put the objective aside and think about policy. Truss says: “The economic debate of the past 20 years has been dominated by discussions of distribution.” Yet, the OECD says, UK has the largest inequality after the US in the distribution of the disposable income of households of all high-income countries. George Osborne’s post-crisis austerity policy was also not at all focused on ‘distribution’. Her take on past British debate is a red herring.

We must instead recognize that Thatcherism, 40 years later, is a zombie idea, for two opposing reasons: both what has been accomplished and what has not.

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Thatcher did liberalize labor markets, restrict unions, privatize nationalized industries and lower the highest tax rates. Its policies (including the promotion of the EU’s internal market) and those of subsequent governments have also increased competition in product markets. Overall, today’s UK is a low-tax country by the standards of other high-income economies. It has a deregulated economy, where the successful are well rewarded, but those who do less well are punished. Such Thatcherite goals then became a reality.

So what have Thatcher and those who followed her failed to achieve? They have not liberalized the biggest disruption in the economy, land use. They have not changed the skills of the population, which has been complicated by the conditions in which many children grow up. They failed to address corporate governance flaws, which put spending at the expense of investment. They allowed the search for safety in corporate pensions to shift portfolios from providing venture capital to corporations to ownership of government bonds. This basically turned the plans into state-sponsored pay-as-you-go schemes.

Line chart of real gross fixed capital formation in the UK (Q1 1997 = 100) that peaked real business investment at the time of the Brexit referendum

Overall, the economic performance not lastingly changed for the better. In 2019, output per hour worked in the UK, compared to France and Germany, was virtually the same as in 1979. Productivity in particular has stagnated since the financial crisis. As a percentage of GDP, investment is the lowest of all large high-income countries. Business investment has remained below its peak in real terms since the Brexit referendum. The earlier implosion of the financial sector under ‘light touch regulation’ did not help. No more than the austerity measures after the crisis or the folly of Brexit itself. The uncertainty alone is bad for confidence and therefore for investments

Line chart of total investment, as a percentage of GDP, showing UK investment lagging behind other major high-income countries

The idea that further tax cuts and deregulation (such as lifting the cap on banker bonuses) will alter this performance is a fantasy. What is simple has already been done. What’s left is hard to do. To cite an example, higher investments require higher savings. Where do these come from? There are also the interconnected complexities of climate change and energy. In addition, there is evidence that both better economic performance and political stability may depend on: lower inequalityno more than the country has now.

The Truss government is not just committed to tax cuts and deregulation. It also continues to suggest the possibility of breaking with the EU over the Northern Ireland protocol, which would also be a violation of the US. This would undermine confidence in the UK’s sincerity, increase uncertainty, prove that Brexit has not been implemented and suggest that the government cannot live with the choices it has made regarding its own flagship policies. To add to all this, Truss also seems to be breaking with China. Her VK seems determined to be friendless.

The UK has not caught up with French or German productivity since 1979.  Relative labor productivity chart (GDP per hour worked, % above/below UK level) for US Germany and France

Moreover, the Tories won their majority under Boris Johnson by getting Brexit done, strengthening the NHS and ‘leveling out’ poorer areas. Thus they created a new coalition of traditional supporters with former Labor voters. Today, Brexit is not over, the NHS is in crisis and leveling out seems to be headed for oblivion. Only 81,000 members of the Tory party have elected as Prime Minister someone who was not even the first choice of their elected MPs. She has no mandate for the policies she wants to pursue. One can imagine little better designed to exacerbate today’s ubiquitous cynicism about politics and politicians.

Trust is easy to destroy, but hard to restore. That’s why it’s important to keep your word. Britannia is not “unleashed”. It is instead sailing in dangerous waters. Can the new captain and first mate even see the rocks ahead?

martin.wolf@ft.com

Follow Martin Wolf with myFT and further Twitter

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