The Great British Economic Bet

So much for a ‘small budget’. Two weeks into his new job as Chancellor of the United Kingdom, Kwasi Quarting announced the biggest tax cuts in half a century. This will be a government that cuts taxes, cuts regulations, and subsidizes energy on a historic scale – funded by borrowing and the hope of future economic growth. Fiscal discipline will be second only to fueling the economy. With growth sluggish since the 2008 financial crisis and inflation near 40-year highs, Britain’s economic model needs reform. However, this opening attack in “Trussonomics” represents a huge political and economic gamble.

True, the growth plan was pro-business, offering lower taxes, improved investment relief, and less red tape. The Liz Truss government aims to build on Britain’s strengths in financial services and accelerate infrastructure development, and recognizes the importance of streamlining the tax system. Striving for higher growth is a good thing. But relying entirely on achieving such growth to fix the fiscal hole that the overall economic strategy will create carries enormous risks.

Some fiscal easing was necessary to tackle the cost-of-living crunch, but the chancellor’s bragging was excessive. The British economy is fragile. Debt as a percentage of economic output has reached its highest level since the early 1960s. The upward pressure on borrowing costs is worrying: The Bank of England this week signaled further rate hikes – partly in anticipation of higher borrowing – and will sell gold bonds, via its quantitative tightening programme. The newly announced £45 billion tax cuts, along with a package already unveiled to help consumers and businesses with rising energy costs, will put the debt-ridden country on an unsustainable trajectory.

Holding tight to financial assets in a crisis is not always wise, but boldness must be balanced with the need to maintain confidence in the UK’s economic credibility. The British pound was falling, heralding more imported inflation. It fell again, to a 37-year low against the dollar below $1.09, following Kwarteng’s statement. Gilt revenue also jumped. Plugging the record British current account deficit also depends on international financiers buying or lending British assets. Presenting such a radical plan without independent forecasts from the Office of Budget Responsibility is not reassuring.

This makes the actions outlined in the growth plan all the more important. Significantly increasing trend growth is one way to return public finances to solid ground, but the odds are stacked against achieving that. In the short term, tax cuts will only stimulate demand in an economy already constrained by supply. This will increase price pressures, which the Bank of England will again push down, leading to potential tensions with the government.

Measures that increase supply capacity in the economy will be more important. New investment areas can boost capital spending, but will take time to develop – and may displace activity from elsewhere. Accelerating infrastructure projects and supporting business investment is commendable, but it will also take time to raise potential growth. The plan contains little to boost skills and reverse the increase in economic inactivity since the start of the pandemic.

While the details are not yet finalized and policies may evolve, it is now up to the government to prove that it can realize its growth ambitions. The need to meet other spending commitments — including extended public services and defense — will only test the strategy further. Financial markets will continue to accumulate pressure. This financial statement put the British economy on a perilous path.

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