The new British government announced surprise tax cuts on Friday costing about 1.8% of GDP, with no explanation of how to pay for them other than some hand-waving at “growth.”
Unlike with President
debt-funded tax cuts, investors reacted by dumping the pound and selling government bonds, or gilts. Benchmark 10-year gilts sold off by the most since at least 1989, when new Prime Minister
was prime minister.
There are three very major problems with the new approach. The first is the starting point. Unlike in the early 1980s, British business isn’t being strangled by government red tape, held to ransom by powerful unions (a few critical industries excepted) or crippled by high corporate taxes. Almost all the badly run government businesses have been privatized, and those that remain in government hands are much improved. The big supply-side reforms have already been done.
Sure, there are worthwhile reforms, and the government announced some on Friday: looser rules on building new infrastructure, removal of special restrictions on onshore wind farms, scrapping rules on bankers’ bonuses that Britain tried and failed to block when still in the European Union. But they won’t allow growth the way Mrs. Thatcher’s breaking of the unions, privatization program and removal of many worker demarcations—including the City of London’s “Big Bang”—did.
The biggest supply-side changes needed in the U.K. are to reform building approval rules that slow or prevent expansion of housing and business, and to secure or improve major free-trade agreements, especially by removing the bureaucracy Brexit introduced on trade with Europe. Both remain off the table.
The second is Britain’s shaky position as a global borrower. At the start of Thatcherism and Reaganomics, both the U.K. and the U.S. ran small current account surpluses, and the U.K. had debt of only about 40% of GDP. There was plenty of scope to borrow from abroad by turning it into a deficit, as foreigners helped finance a run-up in domestic borrowing, consumption and investment.
At the start of what’s being called “Trussonomics,” Britain has a record current account deficit and debt above 100% of GDP, both to worsen due to the extra borrowing for the tax cuts and for a massive energy subsidy package.
The third problem is politics. Mrs. Thatcher had a strong mandate to push through unpopular policies, allowing her to make big cuts to government spending to part-fund tax cuts, while Ms. Truss has none. After a post-financial crisis decade of austerity worsened by the pandemic, many of the country’s public services are already crumbling, making major cuts harder still.
Ms. Truss also faces an election in two years that, at least before the tax cuts, she was widely expected to lose.
The politics get even harder when, instead of the promised growth, the country hits hard times. The Bank of England thinks Britain might already be in a recession, thanks in part to two royal holidays. The boost to demand from the unfunded tax cuts means the BOE will have to raise rates even faster to bring the country’s double-digit inflation under control, perhaps deepening and extending recession. Both Thatcherism and Reaganomics started out with nasty recessions as interest rates soared, but both leaders were able to ride them out and wait for better times to follow. Ms. Truss doesn’t have the luxury of time.
To mitigate all these problems the government should have taken care to prepare the markets, explain its position and project a confident future for the country’s finances. Instead it has merely promised that its independent forecasting body will show the effects of all the extra borrowing by the end of the year.
Investors got the impression that the government either didn’t care or didn’t know about the impact on its finances of its retro 1980s policies. That showed up in what looks like a bigger risk premium for Britain, with the pound down 2.8% against the dollar even as two-year yields jumped 0.37 percentage points, a huge move that would usually attract money to flow in.
If markets lose confidence it will make it even harder for what was already a high-risk fiscal policy to succeed.
Write to James Mackintosh at email@example.com
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