How should Labour and progressives react to the astonishingly rapid collapse of Liz Truss’s economic agenda? The temptation will be to rejoice. Rejoice at the crushing rejection of trickle-down neoliberalism, the humiliation of the Conservative party and the growing likelihood of a Labour majority.
But these will be pyrrhic victories if “Trussgate” leads to a re-embracing of the fiscal conservatism that has dominated British politics for most of the last quarter-century, together with an unquestioning faith that markets know best. The new chancellor, Jeremy Hunt, has committed to public spending cuts across government departments, alongside reversing Truss’s tax cuts. In other words, it’s back to austerity. Hunt has even appointed Rupert Harrison to his new council of economic advisers – the architect of George Osborne’s austerity strategy in the early 2010s and currently adviser to American investment management firm Blackrock.
Unfortunately, the conclusion most will take from the past weeks is a simple one: the government cannot borrow its way out of economic crises. Already the danger signs are there, with Labour determined to reclaim the mantle of being the party of “sound money” (ie getting the deficit down) and FT journalists proclaiming the victory of “orthodox economics”.
Once the markets are calmed, Hunt will seek to reposition the Conservatives as the party of fiscal discipline by reducing spending and daring Labour to say it would do otherwise. The punishment meted out by financial markets to Truss’s borrowing plans will be held up as the ultimate example of the limits of the state’s fiscal power in the face of market forces: Britain’s “Greece moment”.
But Labour and the left must avoid falling into this trap. Instead, it must learn the right lessons from the crisis and carefully shape the narrative that follows it.
The first lesson: this isn’t Britain’s “Greece moment” because we are not facing a Greek-style sovereign-debt crisis. Indeed, a sovereign currency-issuing nation cannot default on its debt denominated in its own currency. Rather, it is facing an inflation-expectations crisis, in which investors lost confidence in the government’s ability to bring down prices. High inflation reduces the real value of government debt and will lead to higher interest rates that will push down their price. This is bad news for the investors who hold such debt, hence the sell-off of bonds.
The related lesson is that the type of fiscal policy intervention matters more than the size of it. Yes, its true that the mini-budget did involve an enormous expansion in government borrowing (around £160bn when you include the energy cap). But it was the £45bn of tax cuts on top of already rising inflation that the market didn’t like. Even bond traders understand that making rich people richer is likely to stoke inflation and won’t on its own increase growth.
Labour must thus not shy away from making the argument for major public investment that ultimately can help reduce inflationary shocks, in particular from energy prices. The obvious short-term target for such investment should be a national home retrofitting scheme that would reduce energy bills, create skilled jobs and support the transition to a greener economy. In the medium term, the state needs to provide a direction for growth with an overarching industrial policy framework – Labour’s Great British Energy proposal is a good start – so firms have the confidence to invest. Some of these investments can be supported by tax rises but borrowing on a large scale will still be needed.
A second lesson is that inflation needs to be tackled by the Treasury and not just left to monetary policy. Dealing with it inevitably requires some groups in society losing out: it is a distributional problem. By cutting taxes, the Treasury was handing over responsibility entirely to the Bank of England, which has just one blunt tool in its armoury: raising rates. This generally hurts those with the most debt and the lowest incomes the hardest.
A fairer and more economically credible approach is to remove demand in the economy from those who can most afford it: the rich. Labour needs to reimagine tax policy not only as a means to ensure social justice, but also to control prices and steer the economy in a more productive and less inflationary direction – most obviously, by taxing unearned wealth, including from property, and environmentally damaging activity. This can help provide the headroom for continuing to spend on public services.
A third lesson is: ensure better coordination between fiscal and monetary policy. The day before the mini-budget, the Bank committed to actively selling off government debt by shrinking its QE gilt portfolio by £80bn over the next year, including, in contrast to other central banks, outright sales of bonds before they matured. Markets were suddenly faced with both a central bank and a government that were selling huge quantities of government debt. This suggests a serious lack of communication between the UK’s two great macroeconomic policy institutions. The Bank was forced to U-turn and recommenced buying gilts to prevent a financial meltdown in the pensions sector.
The pension crisis brings us to a final lesson: the macrofinancial framework the UK operates within needs some serious examination. Government debt is no longer simply a useful long-term safe asset for institutional investors. The rise of market-based finance whereby capital market players use government bonds as collateral to hedge their market positions has clearly increased financial market fragility and volatility. We need less complexity in our financial system, not more, as the global financial crisis made clear. A progressive government should seek to simplify the financial system and de-financialise government debt instruments; it could start by reintroducing defined benefit pension schemes.
The next 18 months – assuming the Conservatives survive that long – will be painful. It will be tempting for Labour to double down on the cause of this being the “fiscal irresponsibility” of the Tories and demonstrate its sound-money credentials by refraining from major spending commitments. Instead, it needs to redefine fiscal responsibility not as about keeping the deficit down but as investing strategically – but on a large scale – in the nation’s productive capacity and resilience, in order to support sustainable growth and a green transition.
Josh Ryan-Collins is associate professor of economics and finance at the UCL Institute for Innovation and Public Purpose