Kwarteng is risking serious economic instability


Great Britain, says Chancellor of the Exchequer Kwasi Kwarteng, is now “at the beginning of a new era”. He’s right. It is new in his willingness to scorn the last 12 years of Tory rule. It is new to the size of its game with economic stability. It is new in its promises of transforming the rate of economic growth. But the question is not whether this era is new. It is whether it will be an economic success, a failure, or an outright disaster.

The Chancellor has announced a “trend growth rate of 2.5 percent” per year as a medium-term goal. According to forecasts by the Office for Household Responsibility last March, the labor force is expected to grow by around 0.5 percent annually between the first quarter of this year and the first quarter of 2027. Between the first quarter of 2008 and the first quarter of 2022, trend output growth per worker was also 0.5 percent per year. Assuming the government has no plans to open the floodgates to immigration, the target suggests that productivity growth needs to quadruple over the next five years.

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The Chancellor also stated that “our plan is to expand the supply side of the economy through tax incentives and reforms”. Are the measures outlined in the speech suitable for achieving such a transformation? The answer is no”.

For example, Kwarteng proposes expedited approval of infrastructure projects. Over a long period of time, growth should accelerate a little. But it is inconceivable that today’s unauthorized projects will transform the economy within a few years.

The chancellor has also reversed tax hikes by his predecessor, Rishi Sunak. But, as Ian Mulheirn of the Tony Blair Institute notes, “It’s hard to see how a broad return of the tax system to where it was in 2021 now will boost long-term growth.”

Kwarteng also decided to lower the top rate of income tax from 45 percent to 40 percent. Is there reason to believe that this will trigger waves of entrepreneurship? Under Thatcher, the top rate was reduced from 80 to 40 percent. It’s debatable whether even that improved performance significantly. This mouse of variety certainly cannot. This applies all the more to the reduction in the base interest rate from 20 percent to 19 percent. For economic output, these changes are totemic, not real. For income distribution, however, they will be perfectly real and not totemic.

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If supply-side promises are a fantasy, the fiscal and economic risks are not. The permanent tax cuts amount to almost 2 percent of gross domestic product. According to Paul Johnson of the Institute for Fiscal Studies, the chancellor “announced the biggest package of tax cuts in 50 years without even the slightest semblance of an effort to bring public finance numbers into line”. There is also an emergency energy package that is expected to cost £60 billion in just six months.

Such generosity certainly raises questions about debt sustainability, especially in times of rising interest rates. In fact, the market is already demanding them. How might the government react? Probably due to spending cuts. We have no indication of where and how.

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Furthermore, this huge increase in the budget deficit occurs in a country that had a current account deficit of 8.3 percent of GDP in the second quarter of 2022 and has a declining exchange rate, low unemployment and already high inflation. Who could seriously blame this massive fiscal easing? The Bank of England will be forced to tighten drastically. The government could then blame her for the results of her own decisions.

All in all, this mini-budget will do next to nothing to boost medium-term growth, but risks serious macroeconomic instability. The failure to ask the Office of Budgetary Responsibility for an impact assessment is simply scandalous. This government may be indifferent to the painful reality. But in the end, reality usually wins out.

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