Truss Takes a Bold Economic Gamble. Will It Sink Her Government?
LONDON — Prime Minister Liz Truss of Britain campaigned as a tax cutter and champion of supply-side economics, and she won the race to replace Boris Johnson. Now she has delivered that free-market agenda, and it may sink her government.
Four days after Ms. Truss’s tax cuts and deregulatory plans stunned financial markets and threw the British pound into a tailspin, the prime minister’s political future looks increasingly precarious as well.
Her Conservative Party is gripped by anxiety, with a new poll showing that the opposition Labour Party has taken a 17 percentage point lead over the Tories. It’ a treacherous place for a prime minister in only her third week on the job.
Labour is seizing the moment to present itself as the party of fiscal responsibility. With some experts predicting the pound could tumble to parity with the dollar, economists and political analysts said the uncertainty over Britain’s economic path would continue to hang over the markets and Ms. Truss’s government.
“It’s entirely possible she could be replaced before the next election,” said Tim Bale, a professor of politics at Queen Mary University of London, who is an expert on the Conservative Party. “It would be very, very difficult to conduct a full-blown leadership contest again, but I wouldn’t rule anything out.”
That Ms. Truss should find herself in this predicament so soon after taking office attests to both the radical nature and awkward timing of her proposals. Cutting taxes at a time of near-double-digit inflation, when central banks in London and elsewhere are raising interest rates, was always going to mark Britain as an economic outlier.
But the government compounded the shock last Friday when the chancellor of the Exchequer, Kwasi Kwarteng, unexpectedly announced that the government would also abolish the top income tax rate of 45 percent applied to those earning more than 150,000 pounds, or about $164,000, a year.
And Mr. Kwarteng did not submit the package to the scrutiny a government budget normally receives, deepening fears that the tax cuts, without corresponding spending cuts, will blow a hole in Britain’s public finances.
On Tuesday, the pound stabilized briefly against the dollar, as did 10-year rates on British government bonds, though both began to gyrate later in the day after a senior official at the Bank of England signaled an aggressive rise in interest rates.
Already, the specter of higher interest rates was causing the housing market to seize up. Two major British mortgage lenders announced that they would stop offering new loans because of the market volatility. Higher rates will hurt hundreds of thousands of homeowners who need to refinance fixed-term mortgages — property owners, analysts noted, who are the bedrock of the Conservative Party.
Rising Inflation in Britain
- Inflation Slows Slightly: Consumer prices are still rising at about the fastest pace in 40 years, despite a small drop to 9.9 percent in August.
- Interest Rates: On Sept. 22, the Bank of England raised its key rate by another half a percentage point, to 2.25 percent, as it tries to keep high inflation from becoming embedded in the nation’s economy.
- Energy Bills to Soar: Gas and electric charges for most British households are set to rise 80 percent this fall, further squeezing consumers and stoking inflation.
- Investor Worries: The financial markets have been grumbling with unease about Britain’s economic outlook. The government plan to freeze energy bills and cut taxes is not easing concerns.
“It’s not like the U.S., where people are on 30-year mortgages,” said Jonathan Portes, a professor of economics and public policy at King’s College London.
An estimated 63 percent of mortgage holders have either floating rate mortgages or loans that will expire in the next two years. And the steep decline of the pound means that interest rates will have to rise even further than they would have merely to curb inflation.
Ms. Truss, he said, could have taken a more cautious approach: rolling out the supply-side measures first, like plans to untangle Britain’s cumbersome residential planning rules and build more housing, which are hurdles to economic growth. Then, when inflationary pressures had eased, the government could have cut taxes.
But that was never in the cards, Professor Portes said, because Ms. Truss and Mr. Kwarteng are free-market evangelists who ardently believe that cutting taxes will reignite growth, and because they have little more than two years to turn around the economy before they face voters in a general election.
“This is ‘shock and awe,’” he said. “Truss, Kwarteng, and the people around them think they had to act quickly. The longer they wait, the more the resistance will build up.”
During the campaign, Ms. Truss modeled herself on another female prime minister, Margaret Thatcher, who also announced a series of free-market measures after taking office and endured a turbulent couple of years. Unlike Ms. Truss, though, Thatcher worried about curbing inflation and shoring up public finances; she even raised some taxes during a recession in 1981 before reducing them in later years.
But Thatcher came in after an election victory over an exhausted Labour government, which gave her more time to weather the downturn and for her deregulatory measures to take effect. She also got a lift after Britain vanquished Argentina in the Falklands War in 1982, which uncorked a surge of patriotism.
“Thatcher was thinking in 1979 that I only need to give voters something they like by 1982,” said Charles Moore, a former editor of The Daily Telegraph who wrote a three-volume biography of the former prime minister. “Liz Truss hasn’t got this amount of time.”
The better analogy to Ms. Truss, he said, is Ronald Reagan, with his emphasis on tax cuts and other supply-side policies, as well as his relative lack of concern for their effect on public deficits. Like Thatcher, Reagan weathered a recession before the United States began growing again in 1983. And like her, he had a cushion before he had to face voters.
Ms. Truss, by contrast, has taken office after 12 years of Conservative-led governments, and three years into Mr. Johnson’s tenure. She will have to call an election by the beginning of 2025, at the latest. The Labour Party, which had been divided by Brexit and internal disputes, has been galvanized by the new government’s chaotic start, in particular Mr. Kwarteng’s plan to cut the top tax rate, which has allowed Labour to stake out a clear contrast on issues of economic equity.
Speaking at the party’s annual conference in Liverpool on Tuesday, the Labour leader, Keir Starmer, declared that the Conservatives “say they do not believe in redistribution. But they do — from the poor to the rich.”
Labour’s lead of 17 percentage points in a new poll by the market research firm, YouGov, is the largest advantage it has had over the Conservatives in two decades. The Tories won the support of just 28 percent of those surveyed, raising questions about its ability to hold on to its existing seats, according to Professor Bale.
That forbidding political landscape only adds to the challenge facing Ms. Truss. For the tax cuts to have one of their desired effects — which is to encourage businesses to invest more — economists said companies would need to have to some reassurance that the policy is not going to be reversed by a new government in two years.
“This is a very inexperienced government swinging for the fences in a situation where Labour is the strong favorite in the next election, if they don’t swing too far left,” said Kenneth S. Rogoff, a professor of economics at Harvard. “If one believes that the tax cuts are going to be reversed under Labour, and that there is a high chance of a Labour government, why would they influence long-term investment?”
Britain, Professor Rogoff said, was also rowing against much greater forces in the global economy. After years of low inflation and extremely low interest rates, the flood of public spending because of the coronavirus pandemic has brought back the scourge of inflation and a shift toward higher rates.
“The verdict will almost certainly be that governments borrowed too much and should have raised taxes on the wealthy more,” he said.
In the short term, Ms. Truss is likely to find herself increasingly at odds with the Bank of England. The bank was already expected to raise rates at its next meeting in November. On Tuesday, its chief economist, Huw Pill, said the government’s new fiscal policies would require a “significant monetary policy response.”
Adam S. Posen, an American economist who once served on the Bank of England’s monetary policy committee, said, “The government’s policies are not only outrageously irresponsible, but they don’t seem to understand that the bank has to respond to these policies by raising interest rates a lot.”
Mr. Posen, who is the president of the Peterson Institute of International Economics, likened Britain’s loss of credibility in the markets to that of Britain and other European countries in the 1970s and Latin American countries in the 1980s. The best course, he said, would be for the government to reverse its fiscal policy, though he said Ms. Truss and Mr. Kwarteng seemed “willfully committed to it.”
Certainly, they have given no indication that they plan to back down. On Tuesday, Mr. Kwarteng told bankers and asset managers that he was confident the government’s plan would work.
After the turmoil that led to Mr. Johnson’s ouster in July, and the protracted contest to replace him, few in the Conservative Party have the stomach to move against Ms. Truss now. But analysts note that the new prime minister has a shallow reservoir of support among lawmakers. Barely a third of them voted for her in the final ballot against her primary opponent, Rishi Sunak, and she won the subsequent vote among party members by a closer margin than expected.
Taking note of the new YouGov poll, Huw Merriman, a Conservative lawmaker, may have spoken for many of his colleagues when he said on Twitter, “Those of us who backed Rishi Sunak lost the contest, but this poll suggests that the victor is losing our voters with policies we warned against.”
“For the good of our country, and the livelihoods of everyone in our country,” he added, “I still hope to be proven wrong.”