By Professor Ignazio Cabras and Dr Emilio
Carnevali
In April 1985, just days after being elected general
secretary of the Soviet Communist Party, Mikhail Gorbachev visited a district
on the outskirts of Moscow. The road leading to the local hospital was still
hot and steaming with fresh tarmac laid just hours before his passage. Patients
in the hospital were impersonated by zealous security officers, perfectly
shaven and well-fed. They cheerfully praised food and medical staff but
struggled to describe exactly what illness they had. After that visit, the first
thing Gorbachev did was to improve access to reliable information: an extremely
difficult task even for the supreme leader of the then USSR.
During the 44 days Liz Truss was PM, Downing Street resembled
the hospital Gorbachev visited: a fictitious construction trying to cover up
the inconvenient truths coming from the outside world. Truss promoted the
construction of papier-mâché walls, surrounding herself with yes-men and
repeatedly denying evidence on the British economic situation provided by
publicly accessible data.
Useful lessons must be learned from the last government. To
do so, it is essential to understand exactly what happened. From different
readings of the facts, we can draw different indications of the economic policy
constraints with which future British governments will have to contend. Rishi
Sunak will face an "emergency" economic policy which will also deeply
affect the government emerging from the next general election.
Janan Ganesh wrote in the Financial Times that what
has been wiped out by the disastrous experience of the Truss government are the
"libertarian" utopia of the right-wing Tories as well as the
"progressive dream" of the British left. From now on, there will be
no alternative to austerity, recklessly dismissed as "abacus
economics" by Liz Truss. Abacus economics would be nothing more than the
rational realization that we, as a country, cannot live above our means. Still perhaps
we can interpret facts by avoiding simplistic ideological juxtapositions and
focusing on data so adamantly ignored during her infamous 44 days.
When Liz Truss became PM in September 2022, the unemployment
rate was at 3.5 percent - the lowest rate since 1974; and inflation at 10.1
percent - the highest level since 1982. Inflation was also believed to still be
far from the expected peak in early 2023. Last summer, reports from Bank of
America and Citigroup estimated inflation between 15 percent and 18 percent by
January 2023. Against this backdrop, the Truss government approved a £45
billion deficit tax cut plan, a substantial portion benefiting the wealthiest,
aside a two-year plan of generalized subsidies to household and business energy
consumption. The costs of the latter package were difficult to predict, but the
government estimated them to be around £60 billion for the first six months. This
move would have forced the Bank of England towards an even more aggressive
interest rate tightening to keep inflation in check and curb the pound depreciation. Once the markets incorporated these expectations
into asset valuations, the perfect financial storm was unleashed, tearing down
the paper-thin walls of Downing Street's fairy-tale court. At the end of
August, the interest rate on 10-year British government bonds was below 2
percent. By the end of September, it jumped above 4.5 percent. The collapse in
the value of these assets triggered margin calls on derivative contracts signed
by British pension funds that had government bonds as collateral, initiating a
perverse mechanism that jeopardized UK financial stability, with banks halting
the disbursement of new housing mortgages in the impossibility of making
reliable forecasts of future rate trends.
However, markets were not afraid about the UK failing to
honour the promised tax cuts. The solvency of a state that issues government
debt securities denominated in its own currency cannot so easily be questioned.
This was demonstrated by the decision of the Bank of England to buy long-dated securities
on September 28th. An exceptional intervention, yes. But not
unprecedented. In April 2020, as soon as the Covid 19 pandemic broke out, the
Bank of England unleashed the "Ways and Means Facility", a sort of
unlimited overdraft through granted to the government on monetary reserves backed
by no new government bonds. Even then, the government spent without worrying
about later bills, and rates on government bonds fell as markets expected an accommodating
monetary policy from the Bank of England.
At the height of the recent crisis, many observers raised
the alarm when yields on British five-year bonds exceeded those on Italian
bonds of equivalent maturity. Anyone monitoring the performance of credit
default swaps (the insurance cost against the risk of sovereign default) would
have noticed that those in the UK remained well below those in Italy, a country
that manages its public debt within entirely different institutional settings.
In short, the markets did not fear the British Treasury
running out of money but a disastrous economic policy that would have sent
inflation out of control and exacerbate the current account deficit situation (now
at 5.5 percent of GDP). A further weakened pound and soaring interest rates would
have meant public and private investment plummeting, with a devastating impact
on long-term growth prospects.
With Liz Truss gone we have freed ourselves from the
amateurish dogmatism of those who thought they could comfortably bend reality
to their ideology. We now must hope that
the dogmatism of balanced budgets “whatever it takes" does not replace intelligent
and shrewd economic policy informed by reliable data, effective analysis, and
well-balanced objectives.
As for the progressive dream gone with the Truss government,
Labour has no reason to despair. Rarely in recent history there was such an auspicious
alignment between economic reasoning in favour of higher taxation of wealthier
segments of taxpayers, and social justice pushing for a greater redistribution
of income and wealth. If Labour can focus on reasons rather than dreams, it may
have a truly historic opportunity at hand.
