This implausible growth strategy won’t meet the challenges facing Britain
Here’s the unvarnished truth: lockdown costs in combination with today’s energy crisis have rendered Britain a whole lot poorer than it was. Yet the voters and large parts of the political class don’t yet recognise this dispiriting predicament, and are therefore still entirely unprepared for the hard yards needed to bring inflated expectations into line with the real world mediocrity to which the nation’s circumstances have been reduced. However, let’s not exaggerate; notwithstanding the fact that nothing seems to work anymore in this once scepter’d isle, the UK is not about to lose its advanced economy status. But it will eventually have to accept that many of the things we take for granted – from burgeoning entitlement and benefit spending through to low cost mortgages, rising real wages, inexpensive food and cheap foreign holidays – will no longer be affordable or available in the way they once were. A rude and politically destabilising awakening is in prospect. Liz Truss’s new government continues to delude itself with the idea that the circle can be squared by turbocharging growth. Yet even if its “plan for growth” could do such a thing, it is already clear that key elements of the plan are essentially undeliverable. In the short two weeks since the plan was published, there have already been two screeching about-turns. With the Government paralysed by unruly backbenchers, others will surely follow. As things stand, the public finances are all too visibly set on an unsustainable path – not off the scale unsustainable, but as Office for Budget Responsibility (OBR) forecasts presented privately to the Chancellor on Friday no doubt revealed, alarmingly off kilter none the less. Without further action, there is no foreseeable path back to balanced budgets and falling public indebtedness. As a proportion of GDP, the national debt would be set inescapably on a rising trajectory. The Chancellor can either accept that judgment – and the similar assessment from the International Monetary Fund that awaits him in Washington next week – shrug his shoulders and hope that the bond vigilantes won’t come for him in quite the same way as they did last week. Or he can attempt to do something further about it in the time left before his scheduled “medium term fiscal plan” on Nov 23. Virtually all available options are fraught with political difficulty, for they either involve a climbdown from low tax objectives, or the kind of cuts in public spending that key elements of the party deem unacceptable. To be absolutely clear, the situation is not quite as dire as sometimes portrayed. High inflation may be a curse in most respects, but it is generally quite good for the public finances. Fiscal drag alone will markedly boost receipts from income tax and VAT. Analysis by the Institute for Fiscal Studies (IFS) finds that the four-year freeze on income tax thresholds will push hundreds of thousands into higher rate tax brackets over the next few years, costing workers twice as much in additional tax as the Government is giving back by cutting the headline rate. Low tax agendas are never quite what they seem. Even so, fiscal drag on its own will not be enough to fill the emerging black hole in the public finances. What the Government gains in tax receipts from higher inflation it more than loses on the other side of the ledger in increased public sector pay and debt servicing costs. According to the IFS, the Government’s offer of around 5pc for public sector pay awards means departments will have to find an additional £5bn a year of cuts to stay within current spending plans – equivalent to axing 200,000 jobs. Given that even 5pc nominal would amount to a real terms pay cut of 5pc, you wouldn’t bet on the Government holding the line. Ministers will have to eat deep into public services, and or benefits, if they are credibly to plug the hole through spending cuts alone. This would be a huge ask even for a government that could be sure of its own party’s backing. So here are a couple of ideas on the revenue side the Government might want, in desperation, to turn to. One would be to cancel or reduce the interest the Government pays on Bank of England reserves. With the advent of quantitative easing, these reserves have risen massively to approaching £1 trillion. As interest rates rise, the Bank has to pay a higher amount to commercial banks for holding these central bank reserves, seen by some as an unjustified, or at least an unnecessary, transfer from taxpayers to already well-heeled bankers. Cancel this transfer, and the Government would save itself £57bn over the next three years, according to calculations by the New Economics Foundation. Simples. Except that nothing is ever cost-free in the world of finance. Any such action would seem like a default, and would probably – even if tiered in a way that would safeguard at least partial payment of interest on reserves – have one of two deeply undesirable consequences. One would be that the money would shift to alternative central banks overseas, undermining Britain’s position as a safe home for capital. This would be perversely at odds with the Government’s objective of revitalising London as a financial centre. Much the same capital flight would occur if holding Bank of England reserves was made mandatory. Capital would flee at the prospect of imprisonment. Alternatively, the money might be applied to an inflationary boom, ending in an almighty bust, as bankers, denied a rate of return, sought to apply the reserves to high-risk credit instead. So if abolishing interest on reserves is a non-starter, how about the following suggestion from Charlie Bean, a former deputy governor of the Bank of England. The present cap on unit retail energy prices could be transformed from a ceiling into a floor when wholesale prices fall below it, as inevitably they will at some point. The effect would be to turn what is currently a subsidy into a source of revenue, acting much like a backdoor carbon tax. Over time, the Government would both recover all the money it has spent on its energy bills support scheme and derive an ongoing source of environmentally friendly tax revenue. Boris Johnson would have leapt at the idea. I’m not so sure about Truss, who would gladly abolish all net-zero targets in an orgy of “drill, baby, drill” zealotry if she thought it politically acceptable. As is apparent, there are no good choices to be made. Is it enough for the Chancellor merely to give vague commitments on spending as and when the necessity arises? Would that satisfy markets? The evidence of last week’s flash crash in gilt prices is that it would not. What’s required, I fear, is something far more concrete that fully reflects Britain’s diminished circumstances. Merely parroting a faintly implausible growth strategy won’t hack it.