When determining the fiscal strategy for a Budget, one question Treasury officials will often ask the chancellor is “who are you trying to please?” Is it the electorate, is it Tory MPs or is it the markets?
Today’s Autumn Statement was delivered in immensely difficult economic circumstances. Growth has been downgraded, borrowing increased. There is no good news to distribute, only pain. The question for Jeremy Hunt was who he could least afford to displease.
The answer to that question was fairly simple, thanks to the actions of his predecessor. Kwasi Kwarteng’s disastrous “mini-Budget” created a run on the pound, an increase in gilt yields, international ridicule, his sacking and the subsequent resignation of the prime minister. Keeping the markets onside had to be Hunt’s priority.
There has been some talk of any fiscal tightening being voluntary, a political choice not an economic imperative. It is certainly true that there were choices that had to be made between tax increases and spending cuts, and choices as to when these occurred, but the wider point is that fiscal plans that are unsustainable risk a negative market reaction. This point applies regardless of whether one approves of the reason behind the cause of unsustainable borrowing (such as high spending on public services) or not (lower taxes on the wealthy).
The government’s fiscal target (reducing debt as a share of GDP after five years and keeping the budget deficit below 3 per cent of GDP in that fifth year) is hardly an extreme one – and represents a significant loosening from previous rules. We know that we will suffer recessions from time to time and that this will put up debt levels; it is not too much to expect that debt generally falls when we are not in recessionary years.
Having made the decision that he needed to keep the markets onside, Hunt then needed to work out how to do so. This is where keeping MPs onside becomes difficult. It would be wrong to think that there is just one view among Conservatives. Plenty worry about the state of public services and the implications this will have for their chances of re-election. But a sizeable number consider that the purpose of Conservative governments is to deliver low taxation, and notice that tax levels are higher than at any time since the Second World War (37.1 per cent of GDP by 2027-28).
Some of these MPs were cheerleaders for Liz Truss and it might be hoped that they would be a little sheepish in offering their advice on fiscal policy, but that is not how these things work. They will grumble about the tax rises announced today – nearly all coming from the windfall tax on energy companies and frozen income tax thresholds – but the fear of a revolt by MPs (and the wider Tory party) has meant that the Chancellor is also relying heavily on public spending cuts to make the sums add up.
In the circumstances, spending was always going to play a role. There must be a big question as to whether £30bn of cuts (albeit not until 2027-28) is deliverable. In 2010, it was possible to find savings by freezing public-sector pay, which had risen faster than private-sector pay in the preceding years. That is not the case today. This week we saw the biggest differential in favour of private-sector pay rises since records began. Public services are struggling, and it is hard to see how the current public-sector pay policy is going to be maintained without crippling staff shortages and widespread industrial action. The cash terms settlement for the next few years, which remains in place, is predicated on 2 per cent pay increases. It is not obvious why the markets consider this to be credible.
The third audience is the electorate. The Conservatives are doing dreadfully in the polls and the Rishi Sunak bounce has been limited. Some of the reasons for the economic mess we are in are external – Covid-19 and the war in Ukraine – but the Conservatives will have to take some of the blame for Truss and Kwarteng.
It is also dawning on the public that many of our economic woes flow directly from the hard Brexit that the Tories so enthusiastically endorsed. A fall in living standards of 7 per cent over the next two years – the biggest since Office for National Statistics records began in 1956-57 – is going to hurt the public and, in all likelihood, the government’s popularity. Where the government is on much stronger ground than previously is that it can argue the distribution of pain is broadly progressive.
How do the Conservatives recover? Their best chance is to deliver sensible, responsible government and acknowledge the challenges the country faces. They can then fight the next general election with some economic credibility. It probably won’t work (and their backbenchers might not let them) but they have little other choice. And it is what they should do anyway for the good of the country. This was not a perfect statement, but at least the Tories are now trying.