Warren Buffett’s adage that it takes 20 years to build a reputation and five minutes to ruin it is not always true when it comes to economics.
Sometimes a reputation for sound economic management can be earned in a few minutes, as Gordon Brown found to his delight when he made the Bank of England independent in 1997. UK borrowing costs fell by about 0.5 percentage points and stayed low. Things only went wrong slowly.
Liz Truss and Kwasi Kwarteng, however, have proved Buffett right this time. It did not need the benefit of hindsight to know that implementing the largest unfunded tax cuts in 50 years, undermining the Bank of England’s independence, sacking the respected head of the Treasury, scoffing at economic orthodoxies and sidelining the Office for Budget Responsibility would be risky.
As I write this in Washington, Britain’s economic credibility on the international stage has noticeably plummeted. I have been asked with fascination, horror and pity how the UK could have descended so fast.
According to allies of the chancellor, it is all terribly unfair. Britain has the second lowest public debt burden in the G7, they say (using a silly definition). But it is true that the UK’s public finances are generally stronger than those of Italy, Japan, the US and France where debt burdens tend to rise every year and financial markets do not seem to mind.
This is a very odd argument for rightwing libertarians to make. Instead of complaining and seeking a handout from financial markets, they should be taking responsibility for their plight. The problem is that it is very difficult to see a sound solution to the UK government’s desire to marry large tax cuts with debt falling as a share of national income in three to five years’ time.
You can look at the always reliable Institute for Fiscal Studies analysis or my own calculations and you get the same result. In March, the government could have borrowed roughly £30bn more and the debt burden would still have just been falling. Since then, the economic outlook has deteriorated, with interest rates and inflation rising sharply, increasing the cost of servicing government debt, welfare and pensions.
These effects more than wipe out that £30bn headroom. But on top of that Kwarteng and Truss added at least £43bn a year of unfunded tax cuts. Add in a bit of extra defence spending and it is very difficult not to get a persistent hole in the public finances of something around £60bn a year, or 2.5 per cent of national income.
What can ministers do to regain credibility? The OBR cannot believably say the economy will grow faster during an energy price shock, because it published simulations of a similar scenario in July without an economic boost. The government could order the BoE to target 5 per cent nominal gross domestic product growth a year, which would solve the public finances problem on paper. But that is akin to asking for almost 1.5 percentage points of extra inflation and would blow up the government bond market and crash sterling.
Ministers could promise spending cuts after the next election, but no one would believe them. They could uprate benefits by less than inflation, but would not get this through parliament. At a time when they had more credibility, they could disagree with the OBR’s forecast and plough on, but they have squandered it and that option is gone now. Markets would panic.
There are only two things that will save Truss and Kwarteng’s economic credibility. First, a huge dose of luck, which is not something to rely on. Second, reversing all the unfunded tax cuts in last month’s fiscal statement. This is the only option, now financial markets have lost trust in the prime minister and chancellor. For them, the political cost of a U-turn would be enormous. But for the country, there is only upside.
