The new UK government on Friday announced surprising tax cuts costing around 1.8% of GDP, with no explanation as to how they should pay for them, other than a hand gesture to ‘growth’.
Unlike President Ronald Reagan’s debt-funded tax cuts, investors responded by dumping the pound and selling Treasury or Treasury bonds. 10-year benchmark gilts are the most sold since at least 1989, when new Prime Minister Liz Truss’ hero Margaret Thatcher was Prime Minister.
There are three very major problems with the new approach. The first is the starting point. Unlike in the early 1980s, British business is not choked by red tape, ransom held by powerful unions (with the exception of some critical industries) or crippled by high corporate taxes. Almost all poorly run public companies have been privatized and those that remain in government hands have improved a lot. Major supply-side reforms have already been implemented.
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Of course there are reforms worth pursuing, and the government announced some on Friday: easing rules for building new infrastructure, lifting special restrictions on onshore wind farms, lifting the banker bonus rules Britain tried to block. when they were still in the European Union. But they won’t allow for growth like Mrs Thatcher has broken unions, privatization program and lifting of many worker demarcations – including the City of London’s ‘Big Bang’ – did.
The biggest supply-side changes needed in the UK are reforming building approval rules that delay or prevent the expansion of homes and businesses, and securing or improving key free trade agreements, notably through the bureaucracy that will impact Brexit on the UK market. introduced trade with Europe. Both stay off the table.
The second is Britain’s shaky position as a global borrower. At the beginning of Thatcherism and Reaganomics, both the UK and the US had small current account surpluses and the UK had debt of only about 40% of GDP. There was ample room to borrow from abroad by turning it into a deficit as foreigners helped finance a run-up of domestic loans, consumption and investment.Read:Wall Street drops; S&P 500 relinquishes summer gains By Reuters
At the start of what is being called “Trussonomics”, Britain has a record current account deficit and debt of more than 100% of GDP, both to deteriorate from the extra loans for the tax cuts and for a huge package of energy subsidies. .
The third problem is politics. Mrs Thatcher had a strong mandate to enact unpopular policies, allowing her to make major cuts in government spending to partially fund tax cuts, while Mrs Truss has none. After a decade of austerity following the financial crisis, exacerbated by the pandemic, many of the country’s public services are already crumbling, making major austerity even more difficult.
Ms. Truss also faces a two-year election that was widely expected to lose, at least before the tax cuts.
Politics will get even tougher if the country goes through difficult times instead of the promised growth. The Bank of England thinks Britain may already be in recession, thanks in part to two royal holidays. The surge in demand from the unfunded tax cuts means the BOE will need to raise rates even faster to contain the country’s double-digit inflation rate, perhaps deepening and prolonging the recession. Both Thatcherism and Reaganomics started nasty recessions as interest rates rose, but both leaders managed to stamp them out and wait for better times. Mrs. Truss doesn’t have the luxury of time.Read:Californians have been charging electric cars the wrong way, study says
To solve all these problems, the government should have taken care of preparing the markets, explaining its position and predicting a confident future for the country’s finances. Instead, it has only promised that its independent forecasting body will show the effects of all additional loans by the end of the year.
Investors got the impression that the government either didn’t care or wasn’t aware of the impact of its retro-80s policies on its finances. That was reflected in what appears to be a larger risk premium for Britain, with the pound falling 2.8% against the dollar even as two-year yields rose 0.37 percentage point, a huge move that would normally attract money. to flow in.
If the markets lose confidence, it will become even more difficult for an already risky fiscal policy to succeed.
Write to James Mackintosh at [email protected]
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