Why Trussonomics imploded
The depth of Britain's economic crisis can no longer be ignored.
As the Conservative Party descends into chaos again following Liz Truss’s resignation, can we draw any lessons from the failure of her plans for the economy? How should we understand the now-abandoned ‘Trussonomics’? And could it have made any real economic difference, if it had been given the chance?
Given the speed of Truss’s u-turns during her short stint as PM, it may be too charitable to assume that there ever was a distinct and coherent programme that could be called ‘Trussonomics’. Yet this is still a useful term. Both the advocates and critics of Truss’s plans described them as ‘tax-cutting’, ‘free market’ and ‘small state’. These tired labels say more about the poverty of intellectual thought today than they do about Truss’s specific economic policies.
For a start, there was not much actual tax-cutting, even in the first mini-budget. About four-fifths of the measures announced were just to reverse recent tax increases or planned future ones. Furthermore, there was nothing ‘free market’ about the market-distorting energy package shielding households and businesses from increased gas and electricity prices.
There is also nothing ‘small state’ about plans that involve the government spending more than four out of every 10 pounds produced each year. In truth, it is not possible for any government to circumvent the role the state now plays in advanced industrial economies, no matter how much it might talk up its ‘small state’ credentials. The role of policy, whether it is restraining or facilitating economic growth, simpy cannot be ignored.
If there has been a silver lining to the chaos of the past few weeks, it is that politicians are now having to face up to the reality of Britain’s economic stagnation. This at least makes a more honest debate possible about the challenges facing us as a society, and what we need to do to overcome them.
Politics is about more than ‘delivery’
Whoever emerges as the next prime minister is unlikely to solve our problems. This is not just a reflection on the individuals involved. Any new leader, regardless of their economic insights and thoughts, is likely to be caught in the stranglehold of Westminster. Over several decades, the political class has absorbed the undemocratic notion that governance is a process of delivery, rather than of leading and persuading people about how things might be changed for the better.
Truss herself encapsulated this problem. She rightly argued that there needs to be a focus on economic growth, and that without it ‘we cannot deliver better lives for people, whether it is higher wages or money able to go into public services like the NHS or the education service’. This made a refreshing change from the usual delusional claims from politicians that the British economy is ‘fundamentally strong’.
However, Truss’s repeated use of the word ‘delivery’ revealed a key problem with her approach. She seemed to imagine that her government could simply ‘deliver’ economic change from above. This was to fundamentally underestimate the scale of the problem.
The underlying economic problem that has dominated Britain’s recent history is productivity – that is, the amount of output produced in every hour. In the long run, productivity growth, or the ability to produce more with less, is all that really matters for rising living standards. This depends on business investment in technology and innovation. The challenge, therefore, is to identify and overcome the barriers that have been holding back this investment.
Overcoming these barriers will require a comprehensive programme of restructuring businesses and industries across the UK. Because this will affect everyone, this programme needs the active backing of the public to carry it through. Economic renewal is not something that can be simply ‘delivered’ by the government. Ministers must explain what it could mean for people’s lives and win the majority over.
That the Truss administration had underestimated the challenge of economic renewal was further exposed by the mini-budget’s growth plan. It contained nothing new. It was just a mishmash of deregulation, hyped-up ‘tax cuts’ and plans to implement supply side reforms.
Whatever the pros and cons of her plan, Truss’s fundamental error was to fail to make a plausible case for it. She and her then chancellor, Kwasi Kwarteng, did little to show how the plan would overcome the barriers to investment. Indeed, they refused to even debate the plan’s effectiveness in public, let alone answer the long-standing criticisms of some of the measures proposed.
Take its emphasis on deregulation. We’ve heard plenty from politicians about deregulation since Brexit, but seen little in the way of actual action. Truss should have at least tried to address people’s scepticism.
Likewise, the so-called supply side reforms, from slashing planning legislation to introducing better and cheaper childcare provision, were welcome in and of themselves. But Truss’s government failed to show how these particular changes could overcome the low productivity growth paralysing the economy. How, for example, does more housing, as important as that is, address productivity stagnation?
Above all, it was Trussonomics’ tax cuts that raised the most questions. Truss’s key contention was that tax cuts would automatically increase businesses’ willingness to invest. Yet a comprehensive review of multiple studies earlier this year concluded, on balance, that corporate tax cuts do not have a definitive effect on business investment. Neither Truss nor Kwarteng made any effort to explain to people why this time would be different. For instance, we heard no answer to the question as to why Britain has long had one of the lowest corporation tax rates among the G7 leading economies and yet has the lowest business-investment levels.
There was also a conceptual flaw in the overall tax-cutting approach. Truss assumed that providing extra incentives would be enough to get businesses investing and driving up productivity. Yet this approach ignores the fact that only offering incentives for investment has not worked and will not work – because the disincentives to investment from a stagnant, congested, zombified economy have proved to be more powerful. Without removing these disincentives, any incentivising approach will fail.
Indeed, the suffocation of the creative-destruction process has been a huge and under-addressed factor behind Britain’s economic stagnation. Too many low-productivity businesses have been clogging up the economy – ranging from barely alive, debt-dependent zombie firms to the ‘long tail’ of mediocre businesses that have been unable to invest very much. Those firms surviving on state life support, hoarding workers and resources, also inhibit the development of the strongest companies.
Disruption or stability?
Our low-productivity economy is a result of weak investment in years past. But it also blocks future investments. This is the real reason we have a ‘vicious cycle of stagnation’, as Kwarteng described it, and that has to be broken.
Any attempt to break this cycle is bound to be disruptive. Governments should not minimise that reality. Overcoming stagnation is not possible without clearing out the old economy and removing the disincentives to business investment. It is just not possible to build a high-productivity, faster-growth economy when most of the UK’s businesses are slow-growing, low-productivity ones. The harsh truth is that the bulk of these low-productivity operations won’t be able to regenerate themselves. They need to be replaced. There are no easy solutions or painless routes to a better economic future. Every economic policy decision will create tensions somewhere.
Truss did initially seem to acknowledge this reality, when she said that restoring economic growth would be disruptive. Unfortunately, her idea of disruption did not mean disrupting the existing network of businesses. Hence, in her Conservative Party conference speech, Truss said that she would ‘back businesses to the hilt’. Like its predecessors, Truss’s government seemed to believe that supporting today’s businesses in the name of stability – no matter how unproductive they are – is the best way to bring about extra investment.
This was confirmed in Truss’s press conference after she sacked Kwarteng – she referenced the need for ‘economic stability’ multiple times. And new chancellor Jeremy Hunt has since emphasised that the ‘most important objective’ is now ‘stability’.
But as history tells us, economic renewal comes not from continuity and stability, but from change. And this could involve the destruction of some businesses. Consider the higher productivity-growth decades of the 1950s and 1980s. Both followed periods of business restructuring – the first through the upheavals of the war economy and the second after the deep recession and business closures of the early 1980s. Contrast those periods with the past two decades, in which struggling, low-productivity businesses have been sustained through cheap-and-easy credit facilities underpinned by central-bank policies. Productivity has flatlined as a result.
The disruptions needed for economic growth will affect more than just the financial markets and the Conservative Party’s poll ratings. To get the economy growing, it is the existing business landscape that will have to be disrupted.
Economic renewal needs a popular mandate
Truss’s government failed to understand that the only audience that it should be accountable to is the electorate, not the fetishised ‘financial markets’, the International Monetary Fund (IMF) or the Office for Budget Responsibility (OBR).
Not that Truss or her legion of critics understood this. If only, the critics claim, Downing Street had allowed the OBR to publish its ‘independent’ forecast on the public finances alongside the mini-budget, then maybe the financial turmoil could have been avoided.
There are two delusions here. First, the OBR is not on par with God. It is an unelected ‘fiscal watchdog’ with a short history, having only been established in 2010 by the then chancellor, George Osborne. For centuries, his predecessors had been happily presenting their budgets without the need for assurances from this ‘executive non-departmental public body, sponsored by HM Treasury’.
The OBR was not created because the Treasury struggled with its fiscal arithmetic. Rather, it was designed to operate as yet another unaccountable body through which an elected government could dilute its political responsibilities and avoid democratic accountability. The fact that the government’s opponents have in recent weeks bestowed even more authority on the OBR as an ‘independent’ gatekeeper is a further blow to democracy.
The parallel assertion that Downing Street should defer to the ‘financial markets’ is also misguided. Indeed, it is a category error to allow the markets to determine anything. They do not set goals or have a purpose. Markets are simply places where people and institutions sell or trade with each other. They can reveal the outcomes of multiple exchanges conducted by people, but they are far from an omnipotent, intentional power – Adam Smith’s ‘hidden hand’ was a metaphor, not a description. Markets should certainly not be given the authority to decide how governments act.
Besides, while the mini-budget did trigger turmoil in the markets, it did not create the underlying instabilities of the British economy. For many years, knowledgeable observers of Western financial markets have been warning of the disarray to come. They have been particularly worried about what would happen when central banks in the US, Europe and Britain began to reverse years of super-easy monetary policies. Established in the aftermath of the 2008 financial crash, these policies involved low interest rates and quantitative easing, whereby state banks directly buy financial assets including government bonds (the IOUs that finance public expenditure in excess of tax revenues).
In the immediate aftermath of the 2008 crisis, these policies shored up financial institutions. But the longer they continued through the 2010s, the more they have distorted our economy. This has led to inflating price bubbles not just in government and corporate bonds, but also in other assets, including shares and property.
Meanwhile, what seemed to be permanently low interest rates encouraged greater indebtedness across households, businesses and governments. In short, the gap widened between these financialised asset prices and debt liabilities and the production of genuine value in the economy. And the larger the gap, the greater the eventual implosion in the financial markets.
There were occasional, often limited, attempts to tighten monetary policies during the 2010s. But what effect they had was more than reversed again in the 2020s, by the heavy central-bank interventions in response to the pandemic lockdowns. Central-bank balance sheets became even more laden with government bonds, swelling price distortions, while corporate and public indebtedness were ratcheted up again.
Asset markets, including those for UK government bonds, were therefore precarious well before Truss became PM. From the end of last year, central banks had begun tightening in response to higher inflation, interest rates had started rising, and it was expected that state banks would begin offloading their bond holdings. The war in Ukraine merely exacerbated what observers saw as the ‘vulnerabilities’ in financial markets.
The greater volatility in financial prices has extended into currency markets, with the safe-haven dollar rising relative to the falls in most other currencies, including sterling. Unsurprisingly, financial traders have been taking advantage of these fast-shifting prices to trade on behalf of their clients, sometimes reinforcing price movements. The car-crash mini-budget merely offered a great trading opportunity. Brexit-bashing types, from domestic Remainers to the IMF and various American and European economists and politicians, were then on hand to blame it all on Truss, the Tories and, ultimately, the UK’s decision to leave the EU.
Truss and Kwarteng could have been savvier in anticipating these attacks, as well as the yo-yoing financial markets. But this only means they should have flagged up these possible reactions and warned people about them in advance. It does not mean, as their critics maintain, that they should have kowtowed to financial traders.
And this brings us back to the fatal flaw of Truss’s brief administration. Having sensed that a growth plan would be disruptive, Truss and her team failed to lead the UK through those great upheavals. They failed to bring the people with them. This was a dereliction of democratic duty. People aren’t going to put up with ‘disruption’ as an edict from Downing Street. They can’t be expected to just go along with it. They need to understand the reasons for the economic tumult. Ultimately, they need to understand why it is necessary to reorganise and rebuild production anew.
A principled government that is serious about pursuing a radical productivity programme has three simultaneous responsibilities. First, it has to be honest and spell out to people why there is no pain-free path out of our economic malaise. Second, it has to help the families of workers losing their poor-quality and insecure jobs by supporting them with money or public-works schemes. This support may have to be in place for a long time, as society acts to bring about the conditions for creating better-quality and higher-paying jobs. And third, the government needs to initiate a national public conversation about the changes required to bring about the faster productivity growth that sustains these better jobs. Out of this deliberative exercise, people’s ideas for local economic renewal would turn the productivity plan from an aspiration into something concrete. The government’s task is then to argue publicly for this growth plan and fight to secure a popular mandate for it.
If the next PM ducks this challenge and pretends nothing big needs to change, then we should demand a General Election and get the debate started ourselves. Then we might finally be able to get started on the road to economic renewal.
Pictures by: Getty.
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