Truss’ reverse-Thatcher moment

Dr Oliver Hartwich
4 October, 2022

The British Prime Minister received an unflattering open letter. Its signatories were 364 economists, all united in condemning her economic management.

“We believe that a large number of economists in British universities, whatever their politics, think the Government’s present economic policies to be wrong and for that, for the sake of the country – and the profession – it is time we all spoke up,” the letter stated.

The Prime Minister ignored it. And rightly so. Because as history showed, Margaret Thatcher eventually restored fiscal and monetary discipline with the enormous tax increases in her 1981 budget.

Fast forward 41 years, and there is another Tory Prime Minister – a self-confessed Thatcherite even – and another radical (mini-)budget. Maybe it is just a matter of time until Liz Truss receives a similar open letter from concerned economists. She has already received a highly critical message from the International Monetary Fund.

But this is where the parallels end. Because, in many ways, Truss’ ‘Growth Plan 2022’ is the opposite of Thatcher’s 1981 approach.

Contrary to what many may associate with Thatcher today, she did not start off as an extreme tax cutter.

Thatcher took over Britain when the budget deficit was high, inflation was rising, and interest rates were doing the same. To counter all this, Thatcher and her Chancellor Geoffrey Howe took the drastic step of increasing taxes by £4 billion. That equalled about 2 percent of GDP back then.

With this fiscal tightening, Thatcher and Howe went against the prevailing Keynesian consensus of the time. Those Keynesian economists predicted that tighter fiscal policy would deflate demand, deepen the recession and threaten political stability.

As it turned out, Thatcher’s 1981 budget achieved the reverse. Her fiscal consolidation path, painful as it was, worked.

Many years later, the London-based Institute of Economic Affairs published a collection of essays under the title Were 364 Economists All Wrong? The conclusion of the contributors was mostly ‘Yes’.

The 1981 episode is instructive for us today because the circumstances facing the government of new British Prime Minister Liz Truss are similar.

Today, as then, British public finances are in disarray, inflation and interest rates are on the rise and the economy is stuttering. But instead of increasing taxes by 2 percent of GDP, Truss plans to cut taxes by the same amount.

What is dressed up by Truss as a Thatcherite supply-side reform is instead an uber-Keynesian stimulus.

Ambrose Evans-Pritchard, the World Economy Editor of The Daily Telegraph, was scathing in his assessment.

“There is an elemental difference between borrowing to spend on infrastructure with a high growth multiplier – or to coax capitalists to invest – and naked borrowing to flatter an unsustainable standard of living,” he wrote. The Budget was a “festival of stimulus” with which the “Chancellor has over-egged the pudding.”

From a newspaper traditionally close to the British Conservative party, the criticism could hardly be harsher. It got harsher still in Evans-Pritchard’s next column, which concluded “the Government seems embarked on a course of sheer madness.”

However, Evans-Pritchard is right – in more than one way.

Like many other economies around the world, the UK’s economy is facing massive supply constraints from disrupted supply chains and war-induced energy shortages. Stimulating the economy in this climate will necessarily push inflation higher when it already stands at just under 10 percent.

This will force the Bank of England to counteract to protect the pound. Where Thatcher wanted to tackle inflation to pave the path towards lower interest rates, Truss will make further interest rate increases more likely.

The Bank of England has already sprung into emergency action with its intervention to bail out the pensions sector. It bought £65 billion of gilts to prevent Britain’s financial system collapse. Unfortunately, this new round of quantitative easing also adds fuel to the inflationary fire.

Meanwhile, sterling plummeted towards parity with the US dollar once markets realised just how big Britain’s fiscal calamities are going to be after the Truss plan.

As a free-market-minded economist, it is hard not to feel at least a little sorry for Truss and her Chancellor Kwasi Kwarteng. The Tories have just had 16 years of milquetoast and largely conviction-less leaders. And Britain since Tony Blair has had a quarter century of economically unprincipled Prime Ministers.

Truss and Kwarteng are the first occupants of Nos. 10 and 11 Downing Street in a long time who want to shake their country and their party out of this state. They declared their ambition to lift growth, remove supply constraints and liberalise the British economy.

You may not agree with these goals. But even if you did, you would be dismayed by the sheer clumsiness of the execution. It is a clumsiness bordering on recklessness.

If Truss and Kwarteng really wanted to emulate a Thatcherite supply-side reform, they should have studied her historical example more closely. Before all else, Thatcher was a budget hawk. She started with a substantial budget deficit in 1979, which she then gradually reduced.

Yes, Thatcher was a tax-cutter, too. But there is a world of difference between cutting the top rate of income tax from 83 percent to 60 percent as Thatcher did in 1979 and abolishing the current 45 percent top rate as Truss wants to do.

Apart from that, Thatcher’s income tax cut was offset by an increase in value added tax to prevent the policy from adding inflationary pressures.

Finally, Thatcher – at least in her early years as PM – listened to her economic advisors and was keen not to spook financial markets. However, she was not afraid to take on 364 Keynesian economists.

In trying to become a 21st-century Margaret Thatcher, Truss has introduced Thatcherite policies in reverse.  She may have sealed the fate of her premiership before it has even begun.

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