The Walls are Closing In–the Economic Roots of the Conservative Party’s Political Crisis and the Implications for the Future of the British Economy
Despite the obvious economic roots of the UK’s political crisis, the press has covered the quick collapse of Liz Truss’ Prime Ministership and the even quicker succession of her rival Rishi Sunak largely as a battle of personalities. Liz Truss versus Boris versus Rishi, with Keir Starmer as a kind of Greek chorus. Absent is any look at WHY things came to this. WHY did the markets for UK Treasury bonds and for the pound have such an immediately negative reaction to the Truss mini-budget? And why did so many Tories embrace a self evidently mad growth strategy? What were the underlying causes of Tory desperation? And why did the Tories, despite being warned, walk away from more sensible options? And what will the triumph of some combination of Rishi Sunak and Jeremy Hunt mean for the ability of British public policy to foster innovation and productivity growth?
To understand the answers to these questions, we need to begin by understanding that the conflict in the Tory Party is actually a serious one over policy, disguised by personalities. And that conflict is at its core become so destructive because it is a conflict about how to respond to the long term structural crisis of Tory ideological hegemony– a crisis that is most evident in Britain’s productivity and growth crisis, but which is sort of oozing out everywhere in British society– from the trucking backups at the ports to the wait times for ambulances. The Tories are trapped in an economic trap of their own making, and rather than look outside their ideological box, they turned on each other.
Because at its heart what Britain has been experiencing is the inevitable crisis of three policies that have characterized Britain not just since the financial crisis, but in some ways since the advent of Thatcherism. Austerity shaped by low taxes as fiscal policy, financialization as industrial strategy, and finally the failed pursuit of deregulation through trade policy, i.e. Brexit, which has instead pointed in the direction of isolation.
Britain’s underlying economic challenge, disguised by debates over fiscal policy, is that as a result of productivity growth slowing dramatically since the 2008 financial crisis, according to the OECD, substantially as a result of decreased public and private capital investment, Britain is increasingly internationally uncompetitive and economically stagnant, with the United Kingdom being according to the Financial Times the only G7 economy with its GDP remaining below pre-COVID levels. How did this happen?
Essentially, Britain did three things following 2008 that were increasingly ruinous. First was austerity– pursued with greater vigor than in any other country in northern Europe, and combined with relatively tight monetary policy. That gutted public investment and caused a decline in education and health care provision. So it is not an accident that post-2008 Britain’s productivity numbers look like Italy’s. By contrast, the U.S., which had less austerity post 2008 and expansionary monetary policy, had much higher productivity growth.
Second was Brexit. Brexit both created an initial post crisis wave of uncertainty and instability, drove EU-oriented activity out of Britain, and over time impacted trade volume and production efficiency due to the impact of trade slowdowns on manufacturing supply chains. The result was both downward pressure on overall GDP and downward pressure on productivity from supply chain related problems. Keeping in mind that Britain’s economy is 27% imports (compared to 10.6% for the United States), the consequences of severing free trade with a market of over 400 million and replacing it with a free trade agreement with Australia’s 30 million were as economists say, non-trivial. So British exports peaked at 213 billion pounds (measured in 2022 pounds) in the fourth quarter of 2019, ironically the very moment Boris Johnson started trying to “get Brexit done.” British exports are now down to 180 billion pounds in the second quarter of 2022, driven substantially by a 25% fall in exports to the EU from 2019 to 2021. Brexit’s effect on productivity is harder to measure but an LSE team has estimated based on survey data that pre-COVID uncertainty related to Brexit was driving down private sector investment across the UK economy. https://blogs.lse.ac.uk/brexit/2019/09/11/the-impact-of-brexit-on-uk-firms-reduced-investments-and-decreased-productivity/
And finally there are the consequences of Britain’s real long term industrial strategy since the 1980’s– financialization. Financialization has required two public policy constants– low rates of taxation of capital, and a high and stable value of the pound. The issue of taxes is hard to really get accurate data on because so much capital managed in the City of London is domiciled in tax havens, many of which are part of the United Kingdom in some manner. But even within the U.K. proper, capital gains rates for shares are substantially lower than for residential property (20% vs. 28%). Britain’s low taxes on wealth amid a focus on wealth management as its key economic activity has meant an increasingly impoverished public sector– both in terms of social services and public investment. And of course financialization has meant prioritizing the infrastructure needs of London over the rest of the country.
As a result of these core Tory policies British gdp growth, productivity growth and international trade have both fallen significantly since the financial crisis, with the result being increasingly severe pressure on Britain’s fiscal and monetary posture and stagnant or falling living standards for Britain’s people. Ironically, COVID provided a kind of holiday from these pressures because globally almost all governments went into debt and all central banks printed money to keep economies from collapsing during lockdowns. In the extraordinary environment created by COVID, the British government could ignore the way in which Tory policies were causing the walls to close in economically. But now, as Liz Truss just found out, the bond markets and the currency markets are singing a different tune.
And for the Tories, ideology and internal party politics have closed off most obvious options. The Tories seem committed to worsening trade relations with the EU in order to satisfy the Unionists in Northern Ireland. Broad increases in taxes on capital are another taboo subject for Tories (note the tax proposals that cost Sunak his first race for Prime Minister were not even on capital– they were on business profits and on households to pay for social insurance). And the key functions of the state themselves are underfunded to the breaking point– particularly the schools and the NHS, and as a political matter, let alone as a matter of social justice, they cannot be cut further.
This is the environment that produced the substantive three way policy split in the Tory Party, a split that one might best understand as an argument about how to get out of trash compactor as the walls inexorably close in.
In response, essentially three policy factions have emerged in the Tory party.
The first is the Establishment, which favors hawkish fiscal policy and the maintenance of core social and political institutions like the civil service and the NHS, but at the same time they view the City of London as the Goose that Laid the Golden Egg– and not to be messed with. If truth serum was administered to Establishment Tories, they would all oppose Brexit. Rishi Sunak, despite his public enthusiasm for Brexit, is the Establishment’s man. As were David Cameron and Teresa May. But the Establishment solution to the trash compactor problem is in truth austerity. And that is what we must assume is coming from Sunak and Hunt. More on that in a moment.
Then there are the libertarians– the ideological right wingers. They want to destroy the welfare state, and see cutting taxes both as an end in itself and as a means to the end of destroying the welfare state. Because this is Britain, there are both neo-feudal libertarians like Jacob Rees Mogg, who see libertarianism as a way to restore the ancient private power of landowners, and more modern type people like Liz Truss and Kwasi Kwarteng, who kind of believe the myth that without the state we would all be equal. The libertarians, in truth, are divided over Brexit– some see it as a way of getting rid of the yoke of the European welfare state, and others see the European Union as a free trade deal, and they are for free trade deals.
Because the libertarians want to destroy the state AND believe in the idea that tax cuts will pay for themselves, they are fine with borrowing to pay for tax cuts. Liz Truss and Kwasi Kwarteng showed how viable libertarianism was as a governing philosophy, but it still may be the majority view of the Tory membership, which is why the Tory leadership was so determined not to give them a vote in the selection of the next Prime Minister. Truss’ collapse leaves the libertarians in the place that certain Marxists were after the failure of the Soviet Union– arguing that in some way Truss and Kwarteng had actually misunderstood the gospel. But the truth is that the only way the libertarian program could work given the capital markets’ lack of faith that tax cuts for the rich will pay for themselves would be to dismantle the NHS, which no British politician would ever do directly.
Finally there are the Tory authoritarians. They want a strong state. They campaign around support for the state’s repressive capacity– attacking immigrants and woke people, defending the police, waging the culture war. Sending asylum seekers to Rwanda and prosecuting the people who pulled down the statutes of the Bristol slave traders is the kind of public policy this group likes. But underneath that is a fondness for the state more broadly– for the military, the police, the NHS, and for public investment. They are Brexiteers because to be pro-Brexit is to be anti-immigration and anti-foreigner. Ironically, two of the more prominent BAME politicians in Britain belong to this group– Kemi Badenoch and Suella Braverman. But they really dont have a coherent plan for changing the disastrous economic status quo because while they are for public investment they have no coherent strategy for what kind of public investment nor any appetite for public investment at the scale that would make a difference in the productivity numbers.
Boris Johnson played to all of these factions and drew support from all of them as well at times, But in truth he was boxed in by the moves he had already made– his championing of Brexit, the funding he took from the City and their foreign clients, his opportunistic racism that prevented the kind of immigration policies and Irish policies that would have made effective trade policy possible with either the EU or with major emerging markets– in the end he (and Rishi Sunak) had no support from their own party for the tax policies that were needed to support the minimal public investment policies necessary to give any reality to their Leveling Up agenda.
And so now where are we are. Britain still desperately needs both public and private investment to increase productivity and to make the transition to a net zero carbon economy by 2050 possible. And Britain’s public institutions– the NHS and the schools– need larger operating budgets or will face collapse this winter as their energy costs rise.
In this sense the issues facing the United Kingdom after Boris Johnson and Liz Truss boil down to issues about the investments and innovation that drive productivity, competitiveness and economic growth. Where will the funding for innovation come from? Not just the funding for scientific research, but the all important funding for rollout of new technologies in both the public and the private sector– the funding that was absent during the long years of Tory austerity, and that was effectively counteracted by falling private investment post-Brexit.
The answer appears to be, based on initial statements from Jeremy Hunt, the new Chancellor of the Exchequer, and from the Bank of England, is that the funding for innovation is simply not coming. Instead we are told that after COVID comes austerity. An austerity that means catastrophe for the United Kingdom– a complete breakdown of educational and health care systems that are already failing many communities, and a further slowdown in innovation and productivity growth.
Of course there is another path. That path though would mean smashing the Tory nostrums of the last forty years. It would mean taxing wealth to fund public services and public infrastructure, adopting Ireland policies and immigration policies that would facilitate trade with the EU and trade agreements with major emerging markets for British exports, and adopting genuine industrial policies designed to foster broad based prosperity throughout the United Kingdom, rather than the concentration in finance and the focus on metropolitan London that have defined British economic policy since the 1980’s.
There were hints of this type of approach in Rishi Sunak’s statements as Chancellor. But it is probably too much to expect from him now that he is the Tory Establishment’s chosen Prime Minister that he will break with the core principles that have animated his Party since the 1980’s. That means in the short run austerity, deep recession and social crisis. So the real question is not will the Tory party break with Tory orthodoxy (they almost certainly won’t), but what will the Labour government that is almost certainly coming do?
Because there is no way to manage Britain’s economy effectively within the parameters of the orthodoxies the Tories and their supporters among the wealthy have constructed. If Labour tries to govern within the Tory Party trash compactor, Labour will fail as successive Tory governments have failed.
The irony is that now that the capital markets have rejected Truss’ neo-liberal extremism, Labour faces the challenge of having to offer a different path. There will be those who urge Labour to take the well trodden path of trying to bring competence to a mistaken right wing ideology. In one sense those voices are right, Britain does need competent policy making. But in the Clement Atlee mold–in the service of a new, more inclusive, more innovative and more productive Britain.