Long ReadSep 20 2022

The economic challenges facing Liz Truss’s government

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The economic challenges facing Liz Truss’s government
(Photo by Dan Kitwood/Getty Images)

Liz Truss took office after the biggest economic convulsion the world has ever seen, during a shooting war in Ukraine, with inflation in double digits and an economy heading for recession — an economy, moreover, that has persistently underperformed relative to its peers.

Many in her shoes would run a mile. To succeed, she will need nerves of steel, a healthy dose of good luck, the support of her party and, above all, good advice.

Good advice starts with clarity. How did we get here?

In 2007, the UK economy seemed to have found the formula for success. That was reflected in asset prices: you could get $2.10 for one pound. Now it is $1.15. 

But sterling was overvalued back then, because of the banks. Banks were in fashion. That is where the money was, where the smart people worked. That is where innovation was happening.

The UK led the major economies in the share of banking in the whole economy, encouraged by ‘light-touch’ regulation, an extremely favourable inflation and interest rate environment and excessively loose fiscal policy, with the government running a deficit during a boom. 

It could not last, and it did not.

The great financial crisis of 2008-09 corrected that overvaluation. Banking equities collapsed and so did the value of sterling. Neither have recovered since.

After the GFC, the UK ‘recovery’ was practically non-existent, thanks to our disjointed and unambitious policy choices. The mix of tight fiscal policy and loose monetary policy, including unconventional monetary loosening, was not in itself flawed.

But the Troubled Asset Relief Program in the US worked much better than the UK’s austerity combined with the Bank of England’s ‘work-to-rule’ version of unconventional monetary policy (quiet-quitting quantitative easing).

GDP collapsed during the GFC, and productivity growth – already unremarkable – all but disappeared afterwards. 

Short-term remedies

Low rates can haul an economy out of recession, but they undermine productivity growth in the long term, by suppressing the gales of creative destruction and encouraging the zombification of the economy.

Monetary meds are addictive and damaging to your health in the long term. They should be applied in scale when they are essential, and then removed as soon as feasible afterwards.

The same applies to fiscal meds: take them when you must and then stop. After anaemic growth post-GFC, the budget of 2013 applied another dose and unlocked a short boom, thanks to a cynical juicing of house prices through the Help-to-Buy scheme.

All the drivers of UK growth are absent except for macroeconomic policy, which is poison for productivity growth in the long term.

That budget reeked of short-term political rather than long-term economic imperatives. It probably won the 2015 election for the Conservatives, but it committed the UK to an even lower long-run growth path.

In the long term, the drugs of demand management via macro policy do not work, they just make you worse.

Then the 2015 election brought us the Brexit referendum, the result of which caused sterling to tank again and business investment – already weak compared with the UK’s peers – to flatline, or worse, ever since.

There followed a series of short-lived, weak governments until 2019. The election of Boris Johnson promised a shift to a new, more decisive economic policy backed by a strong political mandate. But Covid-19 saw to that, and caused a spike in global goods prices too, just to twist the knife. 

 

The task of government is to cultivate innovation, in part by celebrating and prioritising thought, reflection and ideas over repetitive ‘hard work’. 

 

 

Then Russia invaded Ukraine. Amid the suffering caused by that brutal and pointless act, one of the lesser consequences was higher energy prices everywhere, but especially in Europe, including the UK, which saw sterling tumble against the dollar again. 

In coming months, Truss will need to deal with the cost of living crisis and the widening gap between private and public sector pay. But it is the long term I am concerned about. 

The UK economy is approaching recession with GDP probably still 2.5 per cent below its pre-Covid level. And all the drivers of UK growth are absent except for macroeconomic policy, which is poison for productivity growth in the long term. 

Truss might feel it would have been better if we had not started from here: but here we are.

How do we find a better path?

It is not about the size of government. Economies with small governments and large governments (expressed as the tax take as a share of GDP) can both grow rapidly, and many in both camps reliably outperform the UK. 

It is not about bringing monetary policy back under the control of the Treasury. There has been no meaningful gap between what the Treasury or an independent BoE would have done with monetary policy for a decade at least. 

It is about innovation. How can the UK economy create a culture of innovation? There is no magic bullet. But we could start by learning from others.

The French, for example, are a lot more productive than the British per hour worked. They work fewer hours than we do, but they produce more. How? 

Truss should focus on the positive: think more; talk more; innovate more. Create a culture that supports those things.

They have a larger stock of both fixed and intangible capital per employee than we do. The parts of people’s jobs that involve ‘doing’ have, to a larger extent than in the UK, been replaced by machines or by innovative processes.

But you can not just magic investment like that up out of nowhere. Capital accumulation follows a culture of innovation, it does not create it.

The task of government is to cultivate innovation, in part by celebrating and prioritising thought, reflection and ideas over repetitive ‘hard work’ or graft. 

When my own business is slow, I often feel that the answer is hard graft. The answer is really that we should think and talk more. That is the most productive part of working.

The other parts are important and need to be done, but if you neglect the creative part you are accepting that you will never grow once your company has reached maturity.

Truss should focus on the positive: think more; talk more; innovate more. Create a culture that supports those things.

Celebrate ingenuity rather than bemoaning a lack of graft. Focus on the creative route out of our current malaise. There are people around who want to help.

Erik Britton is chief executive and managing director at Fathom Consulting

Before working in consultancy, he managed a team of economists in the Bank of England’s monetary analysis division.