By Elena Siniscalco
To say it’s been a dramatic week in financial markets would be an understatement. The reaction to the government’s so-called “mini-budget” has seen the value of sterling crash and has led to criticism from the IMF and the Federal Reserve and an unprecedented intervention from the Bank of England who have been forced to buy government bonds just as they had been planning to start selling them.
In many ways the markets probably overreacted to the mini-budget. But what matters now is how the government is going to restore confidence and get us out of this latest crisis and not make things even worse.
The options for the government are limited. The prime minister and chancellor could stick to their guns and ignore all the warnings and advice to the contrary. This would risk exacerbating the crisis.
They could do the exact opposite and reverse all the proposed tax cuts but of course that would be politically damaging if the government were to U-turn on their first major fiscal statement. Alternatively, they could go ahead with their proposed cuts but attempt to claw back some fiscal credibility by announcing massive cuts to public spending. This too would be politically disastrous, piling even more pressure on essential public services.
Instead, the government should do what they should have done in the first place. It should focus on the structural issues which are really hampering economic growth rather than tax cuts. Some of these were set out by the chancellor in his mini-budget but have been completely overshadowed by the announcements on taxation.
The biggest barrier to growth in the UK is the planning system. It stops us from building practically anything including homes, offices, labs, wind turbines, and nuclear power plants. Then there is childcare – it’s far too expensive in the UK and parents, particularly mothers, are prevented from working as many hours as they would like. Transport is also an issue, especially in the North and South West of England, and again this is hampering productivity. This is what the chancellor should be prioritising rather than tax cuts. Some of this will involve extra borrowing, but it is a more credible plan for growth than cutting taxes. The government should set out exactly how it will implement these policies, including how they will take on the rent-seekers in the economy who will attempt to thwart them.
The government also needs to demonstrate its commitment to stability. The aftermath of Brexit still looms large with fears of the government’s stance on Northern Ireland triggering a trade war with the EU. Liz Truss should make it clear that the UK will not breach its treaty obligations and signal that she would like a closer relationship with the EU.
Kwasi Kwarteng should stick to the reversal to the increase in national insurance contributions and not increase corporation tax. But he should also postpone the other tax cuts. He should make a statement setting out his plans to only cut these taxes when economic conditions improve as a result of the structural reforms. This would allow the chancellor to save face while also clawing back some credibility.
However, the government will need to go further to overcome its credibility crisis. It has maligned respected institutions such as the Bank of England and the Treasury. Truss unceremoniously sacked Tom Scholar, the permanent secretary, in an attempt to burnish her anti-orthodoxy credentials. But to win back some international respect, she should look to someone with an eye to the world stage. It would not be popular within the Conservative party, but a voice like Mark Carney’s could send a serious signal to international investors and start to steady the ship.
In an ideal world we could have more tax cuts. But for now the government has to face reality. It has tough choices to make but it needs to prove its integrity to the markets.
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