In response to British Prime Minister Liz Truss’s “mini-budget”, financial markets have pushed the pound to an all-time low, with no bottom in sight. While talk of an outright UK default is exaggerated, it is not unreasonable to anticipate a painful reckoning just before such an outcome.
CAMBRIDGE – In response to British Prime Minister Liz Truss’s “mini-budget” (a hodgepodge of policies ranging from Reaganomics-style tax cuts on corporations and the rich to old-fashioned socialist energy price caps), commentators have reacted with increasingly flowery exaggerations. Many wonder if the UK is beginning to look less like an advanced economy and more like an emerging market that has lost its way.
Incidentally, the financial markets slammed the pound to an all-time low (relative to the dollar) and there’s no telling how far it might go. Its status as a reserve currency (the last vestige of the UK’s once acclaimed centrality in the international monetary system) has been left in doubt. Although in his case to speak of a plain and simple default would be exaggerated, it is reasonable to foresee a painful settling of accounts that would not be very far away.
And remember that the United Kingdom received several bailouts from the International Monetary Fund from the 1950s to the 1970s included (which makes it its most loyal client). It would be naïve to think that it cannot happen again, especially if global interest rates for long-maturity instruments continue to return to their (very) long-term trend. Not surprisingly, the IMF is already taking issue with the UK’s dubious economic package, as it often does with emerging markets that may need access to their resources.
But the blood has not reached the river (at least, for now). Notably, at the end of September, the yield on 10-year UK government bonds was roughly half a percentage point above that on US Treasuries. In other words, still far below that of emerging markets such as Indonesia, Mexico and Brazil, whose governments must pay interest rates that exceed those of the United States by three, five and eight percentage points, respectively. Still, interest rates can rise very quickly, especially if markets lose confidence.
The two most problematic policies of the Truss government are tax cuts for the rich and energy subsidies. Although the conservative press has applauded them, they are difficult to understand, especially the tax cut. It is true that the scarcity of private investment may have been the main obstacle to growth in the UK since the financial crisis of 2008, and that in principle, a reduction in marginal tax rates should encourage investment.
But that is only true if the companies expect the downgrade to be permanent: there is little point in starting to build a factory that will take three years to complete, if one believes that in that time a Labor government can return to power and reverse the downgrade. taxes (and many other things). And of course, the more incoherent a policy package is, the more likely it is to be reversed, whoever is in power.
Energy subsidies are an even worse idea. As well as adding some 100 billion pounds ($108 billion) to the UK’s already high debt load, they will also distort incentives to cut fossil fuel consumption at a time of high demand. And although the measure was presented as “temporary”, energy subsidies are very difficult to eliminate once they are adopted (as many developing and emerging countries know).
It is true that other European countries are also resorting to desperate measures to deal with the enormous price increases that consumers have had to face since the Russian invasion of Ukraine, but Truss’s plan, due to its scope and scale, seems typical of the markets. emerging. It is common for these countries, particularly fuel exporters, to try to limit what consumers pay for energy, often at enormous fiscal cost.
There are also similarities between the Truss tax package and US President Joe Biden’s attempt to implement a host of progressive economic policies that far exceed what he promised on the campaign trail. But at least those policies were also on the platforms of other Democratic contenders in the 2020 presidential election, notably Bernie Sanders and Elizabeth Warren. Furthermore, it is not impossible to imagine a Democratic presidential candidate winning on a similar platform in 2024, especially if the Republican opponent is Donald Trump.
But Truss’s policies are not something that has been talked about. The prime minister won the job after a brief campaign among the 180,000-odd active members of the Conservative Party. No one outside this group had a say in the matter, and there was no good reason to believe that Truss’s program could win an election.
Furthermore, even assuming that the mini-budget was pure political theater, then it is not a very effective performance.
Voters tend to pay more attention to the economy and state largesse in the year before an election, and there is evidence of “political budget cycles”: in election years, governments push high-profile spending projects and cut back. longer-term investments not so visible. But the next UK election may not be before January 2025. By then, it should be clear that the tax cuts will not have spurred economic growth to offset them, and any initial positive reaction from voters will have faded. dissipated. Truss could call a snap election to get more policy mandate from him, but he would be extraordinarily risky.
It is true that radical policies (particularly those of conservative politicians) often receive furious criticism from the press until they turn out to be much more successful than previously believed.
Margaret Thatcher in the UK and Ronald Reagan in the US are two great examples of this trend, and Truss makes no secret of her admiration for the Iron Lady. But Thatcher and Reagan at least had a consistent policy framework and had communicated it clearly; so far, the same cannot be said of the Truss government.
Truss and his Chancellor of the Exchequer, Kwasi Kwarteng, are correct in saying that the UK’s biggest economic problem in the last two decades has been anemic productivity growth, and that the solution lies in implementing supply-side reforms. In addition, there is still time to devise better plans and explain them better to the people. The Bank of England will also be instrumental in this. But until then, the pound will take hit after hit and things will continue to go from bad to worse.
The author
Kenneth Rogoff, a former chief economist at the International Monetary Fund, is a professor of economics and public policy at Harvard.
Translation: Stephen Flamini
Copyright: Project Syndicate, 1995 – 2022
www.projectsyndicate.org
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