Kwasi Kwarteng’s disastrous mini-Budget was due to more than his own hubris. It was, admittedly, extremely foolish to sack the Treasury’s top civil servant, to brush off the Office for Budget Responsibility forecasts, and then to throw in the surprise 45p tax cut on the day of the Budget itself. If the plan was to maximise the chances of an immediate market panic, Kwarteng succeeded dramatically. U-turns have undone some, but not all, of the damage: the pound is trading at around the same level against the dollar as immediately before the debacle of 23 September. But the government’s cost of borrowing remains almost a third higher.
Tremors from the end of cheap money – brought to a halt by the Federal Reserve’s interest rate rises over the summer – are being felt around the world. The near-collapse of many British pension funds last week, rescued only by a £65bn injection of funding into bond markets by the Bank of England, was a glimpse of the strains that the past decade of ultra-low interest rates have disguised. If Labour wins the next general election, it will inherit a rotten economy in a creaking world-system.
The fundamental weaknesses of the British economy are now being revealed. Kwarteng’s mini-Budget inadvertently provided a vertiginous end to our collective suspension of disbelief. Britain remains a major economy, but one with low growth, low wages, low investment, substantial debts and a large dependence on imports for essential supplies, such as natural gas.
The irony is that the true believers around Liz Truss understand those fundamental economic weaknesses. They merely believe that the solution is something like a Maoist act of will by government – tearing down the barriers to the flowering of the entrepreneurial spirit, from the 45p tax rate to planning laws to labour regulations to benefits payments, in a Great Leap Forward for free enterprise. Investment will boom, wages will rise, and growth at precisely 2.5 per cent a year will return (one day!) to these benighted islands.
But reality usually intrudes on utopian schemes, in this case in the form of immediate market panic, public revulsion and a scolding from the International Monetary Fund. By the time senior Tories were voicing their disquiet at the opening of the Tory party conference, the government’s position had become untenable. Arriving with the backing of few MPs, a smaller-than-expected majority of Tory members, and no general election, Truss is a weak prime minister, attempting to reach far beyond her mandate. The upshot is internal political revolt. Like weak leaders the world over, Truss and her chancellor are borrowing heavily, adding an extra £45bn to the government deficit at a stroke in the mini-Budget – with many billions more to follow through the energy price guarantee, which seeks to keep energy bills at manageable rates.
But unlike other weak governments, Britain’s major institutions can push against, and often through, the difficulties. The perceived strength and credibility of the Bank of England, especially, has allowed the country to run on fumes for some time. The Bank acted to patch over the prolonged disaster of austerity through quantitative easing, intervened on the morning of the Brexit vote, and issued enough new money to cover the costs of the pandemic in 2020. The Bank’s hasty purchase of bonds last week followed this pattern.
But that amounted to a U-turn by the Bank, reversing its planned sale of government bonds to control inflation. The Bank has chosen instead to prioritise financial stability over inflation-targeting, two of its responsibilities that the government is now placing in tension. There are limits to how far even the venerable Bank of England can stretch to cover both government stupidity and economic failure, and with the current round of bond-buying support due to end on 14 October, there is a chance we will see the strains later this month in renewed pressure on the pound and further pension fund instability.
Politically, Labour is enjoying stratospheric poll leads and there are few signs of a Tory recovery any time soon. Yet the chaos and fundamental weaknesses of the British economy mean the route to anything like the “fairer, greener future” that Labour promised at its party conference is narrowing. Inflation will remain high for the foreseeable future, and increased government borrowing rates will impose billions of pounds of extra costs on a future government. Promises to borrow £28bn a year for green investments suddenly look more costly. The value of the pound is unlikely to seriously recover in the next few years.
The solitary real economic advantage the UK holds, ironically, is its inequality. We live in a poorly performing economy that happens to contain some very wealthy people and institutions. British companies hold £950bn in their bank accounts, up from more than £400bn a decade ago. The top 1,000 richest people hold £700bn between them. A smart government could put these hoards to good use, turning idle wealth into active investment and spending. But this will involve Keir Starmer’s Labour not only confronting vested interests in the form of obvious baddies – such as energy producers’ superprofits – but focusing on the structural and historical barriers to taxing wealth fairly, and making the political case for doing so – something it has been unwilling to do. The shadow chancellor Rachel Reeves has begun to offer some hints in this direction, but with expectations for a new Labour government now rising, the party will need a bolder and more determined approach.