‘Very brave, Minister’, Sir Humphrey Appleby
Duncan Needham |
Commentators were drawing comparisons with the 1972 dash for growth even before Chancellor Kwasi Kwarteng stood up to deliver his ‘fiscal event’ on 23 September. In March 1972 his Conservative predecessor Anthony Barber injected an estimated 2 per cent of additional demand into the economy, primarily by raising income tax thresholds. The goal was 5 per cent GDP growth over each of the next two years. This time Mr Kwarteng will inject an estimated 1.5 per cent of demand, primarily by reversing the recent 1.25 per cent increase in National Insurance (in November 2022), scrapping the planned 6 percentage point increase in corporation tax, lowering the basic rate of income tax from 20 to 19 per cent (from April 2023), and abolishing the 45 per cent top rate for incomes above £150,000 (also from April 2023). The goal is 2.5 per cent trend GDP growth over the medium term.
History has not been kind to the Heath/Barber boom. Mr Heath sought to push the UK economy onto a higher growth plane. He achieved two years of unsustainably high growth, and lower unemployment, at the cost of a large current account deficit (even before the oil shock in late 1973), and significantly higher inflation which peaked at 26.9 per cent in August 1975. The 1972 dash for growth was predicated on revised productivity growth estimates that suggested the UK economy could grow at 3.5 per cent per annum, higher than the 3 per cent average observed during the 1960s. With the economy stagnating during the three-day week in early 1972 there appeared to be a large output gap which could be filled without significantly raising inflation. This turned out not to be the case. Ministers will be hoping that this time is different.
Harold Macmillan suggested that a Chancellor needed to keep four balls in the air: full employment, an expanding economy, stable prices and a strong pound. The Truss government, like the Heath government, is prioritising economic expansion, hoping that the energy price guarantee, deregulation and productivity growth will slice the top off inflation. Notwithstanding the difficulties of estimating the output gap (and the natural rate of unemployment), the UK was probably already at the point at which higher output would generate higher inflation when Mr Barber delivered his 1972 Budget. The most recent figures show a current jobless rate of 3.4 per cent – the lowest since 1974. This suggests that the UK economy may again be near full employment (although higher living costs may draw some, particularly older, workers back to the labour market they left during the pandemic). Mr Barber announced in his Budget that he would not let sterling, then still fixed against the dollar, stand in the way of his growth objective. Three months later, the pound was floated. The current government appears to be taking a similar approach to the currency. At the time of writing, sterling has fallen 5 per cent since Mr Kwarteng’s mini-budget, to its lowest ever level against the dollar. This will add to inflationary pressures.
So far, so similar. But there are three potentially significant differences. First, Mr Barber’s tax cuts were broad-based, with most of the labour force benefitting from his large (41.5 per cent for a single person) increase in the income tax allowances. Mr Kwarteng’s tax cuts are targeted at the highly paid, however, with the Resolution Foundation estimating that 65 per cent of the benefits will accrue to the top 20 per cent of earners, with 45 per cent going to the top 5 per cent. The wealthy have a lower marginal propensity to spend so the inflationary impact should be less than in 1972. For the same reason, so will be the boost to growth. Second, the Bank of England has regained its independence since 1972. Mr Barber’s loose fiscal policy was accompanied by even looser monetary policy as Prime Minister Heath repeatedly vetoed the higher interest rates that would have helped to cool down the overheating economy. The Bank can now raise interest rates without a Prime Ministerial veto, although the 50 basis point hike on 22 September now seems modest in light of Mr Kwarteng’s 23 September measures.
Finally, the UK National Debt stood at just over 50 per cent of GDP in 1972. It currently stands at just under 100 per cent – not especially high by historical standards. But Mr Kwarteng’s tax cuts will be financed by additional borrowing, at least until the anticipated growth delivers higher revenue. While the Coalition government of 2010-15 probably worried too much about the ratio of debt to GDP after the Global Financial Crisis, the current government may be worrying too little. Pre-twentieth century Chancellors sought to reduce the national debt burden so Britain would have the borrowing capacity to fight the next war (there were lots of wars). As James Macdonald points out, however, ‘in the age of nuclear deterrence, the ancient connection between war and public debt has been broken’ (for those possessing nuclear deterrents, at least). But modern-day Chancellors still need to retain borrowing capacity to pay for the next financial crisis, pandemic, or whatever else lies in store for us as climate change unfolds. It usually proved politically impossible to reduce the nominal amount of the National Debt. But growth and inflation significantly reduced the real burden. One hopes that growth, rather than inflation, will reduce the debt burden sufficient to provide future Chancellors with the headroom to deal with future emergencies. The market reaction to the mini-budget suggests that Ministers still have some persuading to do.Please note: Views expressed are those of the author.