Old Snake Oil in New Bottlesby robert looney
bob looney teaches economics at the Naval Postgraduate School in California.>
Published October 19, 2022
On occasion, governments tire of orthodox economic policy — typically, when the results are less than politically satisfactory. Instead, they may let ideology dictate, or revert to an unconventional economic strategy that has gained cult status somewhere or that once showed a glimmer of promise. Newly elevated UK Prime Minister Liz Truss’s quasi-libertarian economic policy — Trussonomics, as it was inevitably dubbed — is the latest example. And her adventure with the unconventional has already cost her a key cabinet member, and may yet cost her her own job.
Truss inherited the job when Boris Johnson’s ethical challenges became too much. But with real wages falling at a record pace and the economy in free fall, one might have expected an unelected PM to hunker down, accepting a recession as the price of containing scary double-digit inflation. Instead, she announced a supply-side policy on steroids meant to force an economic upturn and demonstrate the benefits of “getting Brexit done.”
The core elements of Trussonomics first appeared in a 2012 treatise, Britannia Unchained: Global Lessons for Growth and Prosperity, co-authored by Truss and Kwasi Kwarteng (PhD in economic history from Cambridge), along with several other ultra-conservative Tory MPs. Britannia Unchanged is a no-holds-barred “free-marketer” battle plan for an assault on taxes, regulation and what the authors describe as the “perks” of the welfare state — things like food, shelter and health care.
To American readers, the book comes across as a Social Darwinian version of Reaganomics lacking even a Laffer curve to justify its grandiose expectations. It proposes cutting taxes for the job creators along with a wholesale scrapping of business regulations to reverse the UK’s decades-long economic torpor and turn the country, or at least London, into Singapore-on-Thames.
With Trussonomics, the beauty part is the near-elimination of the need for detailed planning. It’s simply assumed the markets will respond favorably and force the economy in the right direction, reversing the weak economic growth the UK has experienced since the 2008-09 global financial crisis. Those trusty markets, alas, proved untrustworthy from day one, however — more on that in a minute.
Conservative Party economics before Johnson more or less centered on fiscal issues and the wonders of separation from the European Union, with budget austerity invoked as a means to reduce the deficit and somehow accelerate growth. Britannia Unchained argues that such a focus on short-term macroeconomic matters diverted attention from a much more serious problem: the stagnation in productivity.
On its face, that’s not dumb. UK labor productivity growth averaged a solid 2.5 percent in the 1980s and a bit squishy 2.0 percent in the 1990s. Thereafter it flattened, managing a pace so slow it might have been a rounding error. And while all advanced economies had a hard time restoring vigor after the financial crisis, the UK experience was more extreme than most.
This declining labor productivity partly explains the recent stagnation in the country’s wages and disposable incomes. The average annual increase in real hourly wages was 2.4 percent from 1980 to 2007, but since dropped to 0.2 percent. Real growth in personal income (after taxes and deductions) fell from 3.1 percent in the 1980s to 2.7 percent in the 1990s, 2.6 percent in the 2000s, and 1.5 percent from 2010 to 2021. And while nominal pay picked up in early 2022, inflation far outpaced it, making the decline in real wages the steepest since 2001.
The basic premise of Trussonomics as described in Britannia Unchained is that the UK’s productivity problems stem directly from large segments of the population being lazy slackers. This laziness is apparently facilitated by unions that are still too strong and massive public pensions that both undermine the supply of labor and raise the cost of capital for businesses.
For orthodox economists, increasing productivity requires improving broad-based education and training, increasing competition and creating a stable macroeconomic environment to facilitate increased investment. In contrast, the basic premise of Trussonomics as described in Britannia Unchained is that the UK’s productivity problems stem directly from large segments of the population being lazy slackers. For example: “For many students, sipping coffee in the common room, clubbing or lazing around appeals more than poring over a test tube or doing complicated sums.” This laziness is apparently facilitated by unions that are still too strong and massive public pensions that both undermine the supply of labor and raise the cost of capital for businesses.
To escape the resulting slow-growth trap, Trussonomics proposes using the tax system to shift resources from the hands of the unproductive (translation: the poor) to the productive (translation: the rich). Never mind there’s no evidence (really, none) that the supply-side tax cuts at the heart of Trussonomics can generate sustainable growth in an overheated economy. By no coincidence it resembles the faith driving Brexit, where ideology and disdain for elites and experts prevailed.
Trussonomics first came into play in September when freshly appointed Chancellor of the Exchequer Kwarteng presented his mini-budget, labeled a “growth plan” in vain hope that it would escape systematic analysis. At its core, was £45 billion (about $50 billion) in tax cuts — a lot of money in an economy about one-sixth the size of the U.S. economy. The wealthy and the financial industry would be virtually the only significant beneficiaries, with the windfall coming in the form of elimination of the top income tax bracket and of the current cap on bankers’ bonuses imposed after the financial crisis, not to mention reducing the tax on stock dividends. As a consolation prize, the mini-budget also promised an energy price guarantee, unfunded subsidies limiting the average annual household energy bill to £2,500 for the next two years.
For Trussonomics tax cuts and unfunded fiscal deficits to stimulate growth, a continuation of low-interest rates and a stable pound sterling were needed to accommodate a surge in investment. However, in an already inflationary environment, markets reacted as orthodox economists predicted with the pound falling to its lowest exchange rate against the dollar and euro in memory. Government bond prices plunged, and the consequences spread through the housing market — and more immediately, through fears that pension funds (which own a lot of bonds) would collapse.
While the Bank of England stepped in to support the bond market, the resulting turmoil prompted the IMF to rebuke the UK government in stinging terms usually reserved for emerging-economy basket cases. The IMF announced it was “closely monitoring recent economic developments in the UK” and was “engaged with the authorities.” Chief among the Fund’s objections was that the “untargeted” fiscal package risked working “at cross purposes to the Bank of England efforts to stamp out soaring inflation.”
As one IMF insider summed it up: “It’s the worst thing you could imagine.” Days later, Chancellor Kwarteng withdrew the initiative to abolish the top tax bracket that had galvanized public anger — but not other measures that will balloon the deficit unless pigs learn to fly.
Britannia Unchained cautions that “the key is ensuring that failure is survivable” and reassuringly notes that, “in the early stages of a project, failure need not be a disaster.” The UK isn’t going anywhere. But whether the PM can survive the recent embarrassment (as of this writing) is unclear. Truss ended September with lower poll ratings than her predecessor when he was forced out of office, and only 12 percent of those polled said the mini-budget was “good.”
Truss blamed the policy’s rocky start on adverse global developments (Ukraine, supply-chain chaos) and on the pushback from antigrowth opposition parties, trade unions, Brexit sour-grapers and environmental groups — which in her words do not understand “aspiration.” But last week, under imminent threat of losing Parliament’s confidence (and her job), Truss tossed Chancellor Kwarteng from the back of the metaphoric bus and pulled back some of the proposed tax changes that have fed the budget deficit as well as the securities markets’ panic.
Jeremy Hunt, the new, new chancellor of the exchequer, and formerly a contender for the prime minister, is less ideological than Kwarteng and certainly more experienced in government. But the UK economy is in bad shape – and nobody has a painless formula for managing what ails it.
Could this story have a happy ending? Perhaps the aforementioned pigs really will learn to fly.
related topics: Tax Policy