The great British economic bet

So much for a “mini-budget”. Just two weeks into his new position as UK chancellor, Kwasi Kwarteng announced the biggest tax cuts in half a century. This will be a government of tax cuts, regulation and energy subsidies on a historic scale — financed by borrowing and the hope of future economic growth. Fiscal discipline will come second to stimulating the economy. With growth sluggish since the 2008 financial crisis and inflation near 40-year highs, Britain’s economic model needs a refresh. However, this initial leap into “Trussonomics” represents a heavy political and economic gamble.

It is true that the development plan was pro-business, offering lower taxes, improved investment relief and reduced red tape. The Liz Truss government aims to build on Britain’s strengths in financial services and accelerate infrastructure development and recognizes the importance of simplifying the tax system. Striving for higher growth is a good thing. However, relying entirely on achieving such growth to fix the hole in public finances that the overall economic strategy will create carries huge risks.

Some fiscal easing was necessary to tackle the cost-of-living crisis, but the chancellor’s excess is bordering on wasteful. Britain’s economy is fragile. Debt as a percentage of economic output is at its highest level since the early 1960s. Upward pressures on borrowing costs are worrying: the Bank of England this week signaled further rate hikes — partly in anticipation of higher borrowing — and will sell female gold, through the quantitative tightening program. The recently announced £45bn of tax cuts, together with the package already unveiled to help consumers and businesses with rising energy costs, will leave the debt-ridden country on an unsustainable path.

Strict adherence to fiscal orthodoxies in a crisis is not always wise, but boldness must be balanced with the need to maintain confidence in the UK’s financial credibility. Sterling retreats, portending more imported inflation. It fell again, to a 37-year low against the greenback below $1.09, after Kwarteng’s statement. Gold yields also rose. Covering Britain’s record current account deficit also depends on international financiers buying British assets or lending to it. The presentation of such a radical plan without independent forecasts from the Office for Budget Responsibility is not reassuring.

This makes the specific measures in the development plan all the more crucial. A significant increase in trend growth is one way to get public finances back on a solid footing, but the odds are stacked against achieving this. In the short term, the tax cuts will boost demand in an already supply-constrained economy. This will fuel price pressures, which the BoE will push back, creating potential tensions with the government.

Measures that increase the supply capacity of the economy will be more important. New investment zones could boost capital spending, but they will take time to develop – and may simply displace activity elsewhere. Accelerating infrastructure projects and supporting business investment is laudable, but it will also take time for potential growth to grow. The plan contains little to boost skills and reverse the rise in economic inactivity since the start of the pandemic.

While the details are yet to be finalized and policies may evolve, it will now be up to the government to demonstrate that it can deliver on its development ambitions. The need to meet other spending commitments — including expanded public services and defense — will only further test the strategy. Financial markets will continue to pile on the pressure. This fiscal statement has put the British economy on a dangerous course.

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