State of Play #8: A New Dark Age
Analysis of the economic and political outlook for the country and Conservative party
Crisis? what crisis!?
The Bank of England has confirmed a recession is imminent, with a predicted five quarter downturn for 2022-23. What has seemingly occurred every 40-50 years in modern times is a severe economic downturn — based more on a fundamental flaw in economic foundations, rather than ‘flash’ crashes or mere blips. The first in modern politics was the 1920s/30s recession and depression, leading to a general strike in 1926 and the new formulation of Keynesian (Interventionist) economics, led by then President Franklin D Roosevelt’s ‘New Deal’.
History repeated itself 40 years later in the 1970s crisis, with a three-day-week under Heath (1973) and the Winter of Discontent under Callaghan (1978-79). What followed was a further new economic settlement, this time in the form of Thatcherism and the promotion of neo-liberal economics; designed to break union power and stagflation (Individualism and free-market capitalism).
40-50 years later, are we in the midst of yet another crisis? As seen in the 1920s/70s: unions are back in force, an oil / energy shock (Russia) is fuelling high-inflation and growth is negligible – verging on non-existent. Resultantly, notable commentators like Rory Stewart are proclaiming a 10 year recession equivalent to that of the 1970s. While this prediction may be excessive, the seed of his argument could be correct. Crucially, the two pillars of the current capitalist framework are, once again, broken: persistent growth and low inflation. The question is, will a new economic settlement be found to fix it, and, if so, who will be its author? But to understand what comes next, it’s important to explore what is broken first…
The UK: Broken economics
Current Treasury orthodoxy relies on growth in order to redistribute wealth and keep inflation down — i.e., grow the UK’s pie, then worry about sharing it; don’t bother sharing out our current pie. Or, in a simpler analogy, as the tide rises everyone is lifted up. The redistribution of wealth over the past 40 years, especially under more individualistic governments, is hardly out of morality (bar possibly New Labour). Instead, it is designed to maintain economic efficiency. Middle and lower classes are stimulated with disposable income in order to consume (buy), and thus fuel the domestic economy. This usually takes the form of tax cuts, minimum wage increases, investment attraction, tax credits or stimulus.
However, as seen with this current crisis, low or no growth destroys the government’s room to practise this type of ‘growth’ redistribution without a political cost. When growth is high, its politically pain-free to spend more as the UK government can rely on higher tax receipts and increased consumer spending (from growth) to stimulate and maintain the economy. Therefore, hard political choices of redistribution or austerity can be avoided. When growth is low, however, a government (especially a Conservative one) cannot rely on this formula; as low growth makes intervention politically risky as it can’t simply be funded by QE-enabled cheap borrowing or the classic grow the pie / lift everyone up formula of the past. Funding, instead, must come from the existing pie either through tough austerity or unpalatable (for those on the right) redistribution.
Low inflation allows UK consumers to keep confidence in the economy and to continue to spend without worrying about cost of living, loans, mortgages, or the security of their jobs. Put simply: a country needs consumers to feel secure in spending so businesses remain profitable and continue to employ workers — who in turn pay taxes and keep the government's budgets flowing. This is why high inflation hurts, as a reduction in consumer confidence and an individual/ family’s disposable income both lead to less spending in the economy. As The Independent predicts, 45 million in the UK will be plunged into fuel poverty this winter — which translates to spending more than 10% of your income on fuel (with the effect of greatly reducing disposable income). High inflation is a key component in causing recessions through underconsumption.
High inflation rates also creates something called ‘fiscal drag’ where individuals are dragged into higher tax brackets (forced to pay more tax) through superficially increased incomes, even if their increased earnings are actually real-terms pay cuts as they remain under inflation (See chart below). Fiscal drag is essentially a form of submarine austerity, and will affect many lower-to-middle class consumers. Sunak’s decision to freeze the tax brackets until 2025 is the main cause of a predicted £30bn in fiscal drag, adding yet more pressure on the consumer.
High inflation rates, however, has a third key side effect: higher interest rates. The Bank of England has continually raised interest rates by 0.25 bps in an attempt to reduce inflation (by suppressing spending / lending and thus growth / inflation). However, as many economists will tell you, high interest rates are quite a blunt economic tool, and while they do reduce inflation the effect is usually delayed and obtuse (3-6 months), almost always plunging the economy into a recession. A further, and possibly worse, effect of higher interest rates is that they ensure government borrowing is more expensive by raising the level of interest paid on its debts.
Quantitative Easing (QE) — essentially the government rebuying their own bonds to create new money by fuelling it into large financial companies / funds, and in doing so suppressing interest rates — is also set to end in the Autumn. The end of QE will add to the price of government borrowing, as without the suppression of bond yields (interest rates), it naturally becomes more expensive — for both government and consumer. Without the economic headroom or borrowing conditions to fund intervention it’s unlikely the next PM will have the political will or courage to do so, leading to an isolated and diminished consumer. This will result in less liquidity in the market or support for individuals, and thus harsher conditions for economic expansion as more businesses and individuals fight over smaller amounts of investment and consumer spending.
Finally, as if UK economics wasn’t catastrophic enough; wages have now stagnated for a decade since the 2008 financial crash and private pay is continually outpacing public sector pay (resultantly increasing inequality and pressuring union action). The UK government has no credible plan for growth, nor a strategy to fight inflation. The RMT strikes led by Mick Lynch are just the symptomatic beginings of a deep economic crisis. Industrial action will rapidly increase as fuel prices rise over winter and inflation peaks at what will likely be the mid-teens (around 13-16%). As the relative security of low inflation, low interest rates and steady growth has evaporated, fiscal policy and the economic settlement of the UK state is collapsing. The question now is: how will the politics respond?
Enter stage-right: PM Truss
The incoming Prime Minister, Liz Truss, is an unlikely candidate in a time of economic crisis and party disunity. Originally a Liberal Democrat raging against the monarchy – fighting the likes of Paddy Ashdown in an attempt to push the Lib Dems further left – Truss has since transformed politically. Now, instead of yellow-livered liberalism, Truss has embraced a diehard new-right combativeness, rooted in the (perceived) desire to bring about a continuous Thatcherite revolution. As she argued in her co-authored polemic Britannia Unchained, only the market can save our souls.
While this astonishing U-turn in belief may not seem traditionally ‘conservative’, some of the most canniesty Conservative politicians have relished in their elusive political affiliations, much to their personal preservation and furthering of their own careers (Churchill, Macmillan, Johnson).
The question that confronts Truss, however, is one not of ideology or vision, but reality. Truss comes into office expecting at best a 5 quarter recession, surging double-digit inflation and negligible growth. To break this deadlock of economic decline, Truss proclaims a Reaganite solution of £30bn in unfunded tax cuts to stimulate the economy and ‘unleash Britain’s potential’.
For several reasons this is unlikely to happen, here are three:
1. Playing politics.
Truss is preaching to the converted. To win Tory party members, Truss is likely pandering. While she may truly believe in large tax-cutting action, Truss will also want to remain PM for longer than Alec Douglas-Home. If she has any governing sense, then the policy is likely to be watered down when it enters government. Remember, Tony Blair won his leadership contest arguing for rail nationalisation only to U-turn instantly by repealing the infamous Clause IV – which promised to nationalise the commanding heights of the economy.
2. An unwinnable war
Even if Truss does desire to enact her huge tax cuts, she will need to win a key fight. Treasury orthodoxy will attempt to quash what, in their view, is rampant and illogical stimulus. Truss’s economic vision is so radical because, as noted previously, her plan doesn’t face the dilemma of ‘how to actually fund spending’ (through higher taxes, spending cuts or funded borrowing). Instead, Truss promises to upend Treasury policy for the last 40 years by ‘unfunded’ borrowing – i.e., with no fiscal basis to repay said debt apart from the nebulous ‘growth’ formula (translating to: ignore it now, we’ll pay it back later).
But in an age of soaring inflation and low growth, it’s difficult to ascertain how taking on £30 billions worth of debt is a ‘safe’ move due to such harsh borrowing conditions (as noted previously): hence the Treasury’s disgust. The task to push this tax cut through will be near impossible at best. The Treasury has spent weeks preparing for a constitutional fight over preventing Truss from enacting economically illiterate plans. Truss would have to be ready to fire numerous senior civil servants and entirely reformulate the No.10/11 relationship if she wishes to truly cut billions in tax. At a time when No.10 and 11 need to unify to solve the economic crisis, it’s unlikely to happen.
3. Inefficient effect
The effects of said tax cuts, as Truss’s team knows, will be ineffectual in dealing with the Cost of living crisis. Bill capping (like Labour / Lib Dem policy), temporary nationalisation or stimulus handouts are all much more targeted or beneficial. The politics of cutting tax (especially corporation tax), which inevitably helps larger incomes / companies due to percentage, will become untenable in the face of opposition and the return of strident left-wing politics. One only has to look at the launch of the Enough is Enough campaign to see what a possible return of Corbynite left-wing populism could look like moving into the harsh 2022/23 winter. In this climate, as in 2017, these ideas may once again have an opportunity for popularity – especially with Andy Burnham at the heart of the project.
A party divided
But the opposition, left-wing populism or the treasury are not the main obstacles for a Truss government. The leadership campaign has thoroughly divided the Conservative party between the two camps of: unfunded borrowing for growth or book-balancing (or arguably reopened this unanswered divide which was thawed by Johnson’s ascension). Sunak and Truss’s briefings and counter-briefings have been vicious, while policy desires and governing style couldn’t seem more distant from one another. Central to Truss’s problem, however, is the arithmetic of MPs and ministers. Truss having 152 MPs to Sunak’s 125 splits the party down the middle. Prominent cabinet ministers have split for either candidate, rather than staying neutral to act as unifying government figures. The declarations of Wallace for Truss and Gove for Sunak sets up a parliamentary fight that few would want to fight, with impressive organisers and popular ministers inevitably left stranded on the backbenches as they fume and plot.
Importantly, Sunak remains admired as the Treasury’s star boy. Around Whitehall he is respected, even if partly tainted by his old green card or partygate penalty. His campaign team also includes four powerful ex-chief whips, as well as several prominent ministers. To pretend that their parliamentary strength will stand by passively as Truss (potentially) attempts to revolutionise treasury and government orthodoxy is unlikely. Dominic Cummings is right to argue that this is the most dangerous policy divide in Tory party politics since the Peelite divisions in the 1850s , when the party split in two over the Corn Laws. Unlike Johnson, Truss isn’t being voted in as a cakist ‘winner’, instead for her neo-liberal approach to policy and government. The foundations of her victory based on policy, and not power, are significantly shakier, which opens up the parliamentary divide further.
In addition, Johnson himself remains a nuclear wildcard in Tory politics. If he survives his inquiry, Johnson will likely remain prominent in politics – either in cabinet or on the backbenches. This is extremely dangerous for Truss as, unlike Sunak or Gove, Johnson’s support among Tory party members and in parliament is incredibly strong, especially considering his status as an ex-PM who was brought down by coup, scandal and mismanagement.
Johnson also had few policy areas as Prime Minister that he focussed on — which is both a blessing and danger. A blessing in the form of his large disinterest (and thus passivity) on tough detail, complicated legislation or economic policy. A danger because Johnson holds dear the few areas he does have a passion for, particularly: Levelling Up, the environment and foreign policy (Ukraine). These are possible landmines for a Truss premiership. An attack on one of these policies could be interpreted by Johnson as an attack on his own legacy, which could subsequently trigger his resignation from cabinet and/ or the beginning of a Johnson-led backbench anti-Truss rebellion.
If Sunak and Gove are bold enough, Johnson pissed off enough, and their parliamentary allies united enough, then Tory party politics could produce yet another bloody civil war of attrition and economic depression – but this time with little scope for the party’s recovery. The main loser will be the 56th Prime Minister. The main winner? Starmer.
As the nation dives into recession, the crisis facing Truss is just as political as it is economic.