Britain’s new government on Friday announced surprise tax cuts costing about 1.8% of GDP, with no explanation as to how they would pay for them, other than a few gestures on the subject of “growth”.
Unlike President Ronald Reagan’s debt-sponsored tax cuts, investors reacted by dumping the pound and selling government bonds or gilts. Benchmark 10-year gilts have been the strongest sellers since at least 1989, when Margaret Thatcher, the heroine of new Prime Minister Liz Truss, was Prime Minister.
There are three very big problems with the new approach. The first is the starting point. Unlike in the early 1980s, Britain’s economy is not being strangled by government bureaucracy, blackmailed by powerful unions (with the exception of a few key industries) or paralyzed by high corporate taxes. Almost all badly run state-owned companies have been privatized, and those that remain state-owned have improved greatly. The major supply-side reforms have already been implemented.
Sure, there are worthwhile reforms out there, and the government announced some on Friday: looser rules on building new infrastructure, lifting special restrictions on onshore wind farms, scrapping rules on banker bonuses, which the UK tried and failed to block when it was still in the European Union. But they will not allow growth, as did Mrs Thatcher’s union busting, her privatization program and the desegregation of many workers’ segregations – including the City of London’s ‘Big Bang’.
The biggest supply-side changes needed in the UK are reforming the building permit rules that slow or prevent the expansion of homes and businesses, and securing or enhancing key free trade agreements, notably by removing the red tape that Brexit will mean for trade introduced with Europe. Both stay off the table.
The second is Britain’s shaky position as a global borrower. At the dawn of Thatcherism and Reaganomics, both the UK and US were running small current account surpluses and the UK had a debt of only about 40% of GDP. There was plenty of scope for foreign borrowing to be turned into a deficit as foreigners helped fund a surge in domestic borrowing, consumption and investment.
At the start of what’s been dubbed ‘trussonomics’, the UK has a record current account deficit and debt in excess of 100% of GDP, both of which are worsening on additional borrowing for tax cuts and a massive energy subsidy package.
The third problem is politics. Mrs Thatcher had a strong mandate to push through unpopular policies that enabled her to make large cuts in government spending to partially fund tax cuts, while Ms Truss has none. After a decade of post-financial crisis austerity, made worse by the pandemic, many of the country’s public services are already crumbling, making larger cuts even more difficult.
Ms Truss also faces an election two years from now that she widely expected to lose, at least before the tax cuts.
Politics will become even tougher if the country goes through hard times instead of the promised growth. The Bank of England believes Britain may already be in recession, thanks in part to two royal holidays. The boost in demand from the unfunded tax cuts means the BOE must hike rates even faster to bring the country’s double-digit inflation under control, potentially deepening and widening the recession. Both Thatcherism and Reaganomics began with bad recessions as interest rates soared, but both leaders weathered them and waited for better times. Ms. Truss doesn’t have the luxury of time.
To mitigate all these problems, the government should have been careful to prepare the markets, explain its position and project a bright future for the country’s finances. Instead, it has merely promised that its independent forecasting panel will show the impact of all the additional borrowing by the end of the year.
Investors were left with the impression that the government either didn’t care or didn’t understand the impact that retro-’80s politics was having on their finances. This was reflected in what appeared to be a larger risk premium for the UK, as the pound fell 3.66% against the dollar on Friday, even as two-year yields rose 0.42 percentage point, a huge move that would normally attract money.
When markets lose confidence, it becomes even more difficult for an already risky fiscal policy to succeed.
Write to James Mackintosh at [email protected]
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