The UK’s Ailing Economy: The Choice of Doctor Depends upon the Right Diagnosis and the Correct Prescription 

 It is unfortunate that, at a time when all attention needs to focus on measures to prop up the UK’s flagging economy, what we have instead is an increasingly fractious dispute between two contestants for the nation’s political leadership who appear to strongly disagree about both the underlying causes and the nature of the curative treatment. Members of the general public are right to be confused as the great and the good of the world of economics take sides in the polarised and intensifying debate, currently being played out in formal televised public debates and in party hustings around the country. 

 The Bank of England has forecast inflation to rise to 13.3 per cent by October 2022 and also predicted a five quarter (15 months) recession from October onwards. Coupled with slowing economic growth and the cost-of-living crisis, this means that the UK is likely to enter a period of stagflation. But not everyone is as gloomy, as one of the contenders (Liz Truss) indicated that “bold action”, presumably by herself, might indeed avert a recession, which was “not inevitable” 

 Both candidates for the soon-to-be-vacated post of Prime Minister have some knowledge of economics and some job experience in the world of public finance. Liz (Mary Elizabeth) Truss and Rishi Sunak both read PPE (Philosophy, Politics and Economics) at Oxford University-at Merton College and Lincoln College, respectively. According to a university undergraduate prospectus, “PPE brings together some of the most important approaches to understanding the human world around us, developing skills useful for a whole range of future careers and activities”. Both candidates also have experience of the Treasury, Truss as Chief Secretary (2017-2019) and Sunak as both Chief Secretary (2017-2019) and Chancellor of the Exchequer (2019-2022). 

 The Prime Ministerial battle has settled on the economy as the main battleground, appropriately during a cost-of-living crisis, characterised by rising food commodity, fuel and energy (electricity, gas) prices. Rising inflation has also triggered a series of demands for wage rises, as wages fail to keep up with price rises, leading to a number of strikes and many more threatened, while some economists in the know fear a wage-price spiral that perpetuates inflation as a consequence of meeting inflationary rises in wages. 

There are many reasons for the rising costs of daily living. Persistent global supply chain disruptions have created shortages, such as those caused by China’s Zero Covid lockdown strategy, and the impact of the Russia-Ukraine conflict on trade in food, gas and oil. It so happens that around 50 per cent of Britain’s food supplies have to be imported. Household energy bills will become unaffordable for many as the energy price cap (the maximum limit on default, or standard variable, tariffs) is raised by Ofgem, the UK’s independent energy regulator, from £1,971 in April 2022 to £3,359 in October 2022, ostensibly to best help providers cope with high and volatile wholesale prices in a competitive energy market.

The Bank of England has targeted inflation in line with its responsibilities, raising the bank’s base rate  by 50 basis points (at 0.01 per cent each) from 1.25 per cent to 1.75 per cent in August 2022, with the nine-member Monetary Policy Committee voting for a sixth successive increase in interest rates to their highest level since January 2009. The idea is that high interest rates will put a brake on spending and reduce demand for goods and services, thereby pulling down costs and reducing inflation. On the other hand, higher interest rates will also add to the demands on household budgets, leading to higher tracker (variable rate) mortgage costs and higher repayments on bank loans, car loans, and credit cards, thereby lowering spending and slowing economic growth. Unfortunately, there seems little agreement on the level of inflation that is acceptable, as some economists question the somewhat arbitrary 2 per cent annual inflation target traditionally opted for by the Bank of England. It’s all about carefully balancing low interest rates, or “cheap money” and high interest rates, or “tight money”. 

Truss has blamed the increased tax burden for the slowing of the UK’s economic growth. Not surprisingly, her prescription is to slashing taxes drastically, to the tune of £30 billion. Truss’s package of tax cuts involves overturning her opponent’s Health and Social Care levy on National Insurance and increases in VAT and corporation tax, putting more money in the hands of individuals and companies. She also seems less keen on Net Zero Transition, as shown by her desire to impose a temporary moratorium on the green levy on energy bills that is meant to finance the transition to a greener economy. The rationale for Truss’s fiscal policy is that lowering taxes fuels economic growth as people have more money to either spend or invest, which in turn increases demand, fires up the economic engine, and reduces unemployment. The problem with tax cuts is that they also reduce government revenue and thereby spending on public services, such as the NHS, social care, infrastructure projects, and energy support packages, for which plausible alternative sources of income have to yet to be convincingly identified. This can lead to a situation of deficit spending, as government expenditure outstrips tax revenues. Truss also has alluded to plans to review the Bank of England’s mandate for setting interest rates, potentially undoing the independence it was granted under Gordon Brown, to increase the government’s influence on monetary policy measures to aid the economy. 

Sunak, on the other hand, has committed to a path of “fiscal prudence” and has prioritised inflation, as did Margaret Thatcher before him, justifying temporary increases in tax, until at least 2024, to ensure sustainable public finances- making him a “socialist chancellor” in the eyes of many Tory dignitaries. Sunak’s electoral message is that he can be relied upon to cut taxes “responsibly”, rather than pander to grassroots instincts that favour tax cuts, more in keeping with what are considered to be traditional Conservative values.

From past experience, the economy does not necessarily function like a machine which responds predictably and consistently to inputs, such as fiscal measures. The economic landscape has been further muddied by the consequences of the COVID-19 pandemic and of Brexit. Less attention has been devoted to the root causes of the economic downturn, by addressing supply chain issues and by enhancing energy security in the short-term. A more pressing priority is to support households that will struggle to pay their energy bills this coming winter. It couldn’t be a worse time to take over as Prime Minister, with little hope of a honeymoon period given that both contenders have been part of the government under which the tragedy has developed. Come September, we’ll most certainly have to hope for the best, given the limited choices on offer. 

Ashis Banerjee