So much for a “mini budget”. Barely two weeks into his new job as UK Chancellor, Kwasi Kwarteng announced the biggest tax cuts in half a century. This will be tax cuts, regulatory cuts and energy-subsidizing government on a historic scale – financed by borrowing and the hope of future economic growth. Fiscal discipline will take second place to burning the economy. With growth sluggish since the 2008 financial crisis and inflation near 40-year highs, Britain’s economic model needs a revamp. Nevertheless, this opening salvo in “Trussonomics” represents a fierce political and economic investment.
True, the growth plan was pro-business, offering lower taxes, improved investment relief and reduced red tape. The Liz Truss government aims to build on the UK’s strengths in financial services and accelerate infrastructure development, recognizing the importance of simplifying the tax system. Striving for higher growth is a good thing. But relying entirely on achieving such growth to fix the hole in public finances that the overall economic strategy will create involves major risks.
Some fiscal relief was needed to tackle the cost of living crisis, but the Chancellor’s splurging borders on waste. Britain’s economy is fragile. Debt as a percentage of economic output is at its highest level since the early 1960s. The upward pressure on borrowing costs is worrying: the Bank of England this week signaled further interest rate rises – partly in anticipation of higher borrowing – and will sell gilts via its quantitative easing programme. The £45 billion of recently announced tax cuts, along with the package already unveiled to help consumers and businesses with skyrocketing energy costs, will leave the debt-ridden country on an unsustainable path.
Clinging to fiscal orthodoxy in a crisis is not always wise, but boldness must be balanced with the need to maintain confidence in Britain’s economic credibility. Sterling has fallen, suggesting more imported inflation. It fell again, to a 37-year low against the dollar of below $1.09, after Kwarteng’s statement. Gilt crops also jumped. Closing the UK’s record current account deficit also relies on international financiers buying or lending to UK assets. Presenting such a radical plan without independent forecasts from the Office for Budget Responsibility is not reassuring.
This makes the specific measures in the growth plan all the more central. Raising trend growth significantly is one way to put public finances back on a solid footing, but the odds are stacked against achieving this. In the short term, tax cuts will only stimulate demand in an already supply-constrained economy. This will increase price pressure, which the BoE will push back on, and set up potential tensions with the government.
Measures that raise the economy’s supply capacity will be more important. New investment zones can boost capital spending, but will take time to develop – and may simply displace activity from elsewhere. Accelerating infrastructure projects and supporting business investment is commendable, but it will also take time to lift potential growth. The plan does little to boost skills and reverse the rise in economic inactivity since the outbreak of the pandemic.
While the details are yet to be finalized and policy may evolve, it will now be up to the government to prove it can deliver on its growth ambitions. The need to meet other spending commitments – including on stretched public services and defense – will only test the strategy further. The financial markets will continue to increase the pressure. This fiscal policy statement has set the UK economy down a dangerous path.