Truss? Brexit? Covid? Who is really to blame for the Tories’ ‘fiscal hole’?
The Pandemic
Covid-19 ripped a £400bn hole in the government’s finances. The money was used largely to support the economy and it succeeded in allowing industries and workers to bounce back once restrictions were lifted.
Most western countries did something similar, pushing the world’s public and private debt mountain to $226tn. The average government debt was 99% of GDP, which is where the UK sits in the league table of indebted nations.
This debt is now becoming more expensive to finance and in the budget forecasts will be heading towards £100bn a year – more than double the near £50bn annual cost of running the defence department.
War in Ukraine
Energy makes up only 7% of the goods and services included in the inflation basket. But because energy prices have been increasing by about 60% over a 12-month period, they have directly contributed about 4 percentage points to the UK’s 10.1% inflation rate. Households and businesses have paid double the usual amount for their gas and electricity, dampening business investment and consumer spending.
It was expected to be temporary last year when energy prices first started to rise, but the Ukraine war meant the situation lasted much longer and fed into transport and food costs. To prevent energy bills spiralling higher, the government is committed to spending about £60bn by next April and many billions more after that, though how much is not yet known. This transitory bill is added to the UK’s debts, but its temporary nature means the funds are not considered to be part of the ongoing spending deficit.
Brexit
The Office for Budget Responsibility, which will take centre stage at the budget this week when it provides independent economic forecasts to guide Treasury policies, has said Brexit represents a 4% permanent hit to the economy. Last month research from Ireland’s Economic and Social Research Institute (ESRI) found trade from the UK to the EU had fallen 16% on the levels anticipated had Brexit not happened. Meanwhile trade from the EU to the UK was even lower, down by 20% on the same measure.
Research published in the summer by economists at the LSE estimated that labour productivity – a key measure of output per hour of work – would be down by 1.3% by 2030. It blamed a decline in the openness of the British economy after Brexit, equivalent to losing a quarter of the efficiency gains of the past decade.
About 500,000 foreign-born workers that were expected in 2019 to be part of the UK workforce in 2022 now live elsewhere, denying businesses many of the skilled employees upon which they had come to rely.
Trussonomics
The infamous budget hurriedly constructed by Kwasi Kwarteng and Liz Truss is expected to feature in Hunt’s list of things to blame. Two aspects of the budget have remained – the reversal of a 1.25% increase in national insurance and a cut in stamp duty on house purchases.
The cost of these two measures is estimated to be about £20bn. Another £10bn loss can be attributed to the higher interest rates triggered by a financial panic that followed the Truss budget.
The bill will eventually be much higher, according to many economists, after the most recent GDP figures showed a collapse in business investment in the third quarter, during which the Truss team was in charge for half the time. A loss of confidence among businesses cannot all be blamed on the sharp change of course brought about by Truss and Kwarteng, but the longterm damage to the UK’s industrial base could be worse as a result of their actions.
The Bank of England
Many in the Tory party have accused the central bank of failing in its task of keeping inflation low. They say steeper interest rate rises earlier in the year would have dampened the demand for goods and services, limiting price rises.
However, the government’s lastminute policy decisions dating back to when the furlough scheme should end have kept the bank guessing and forced the monetary policy committee to be cautious about rate rises that could trigger a recession.
The Ukraine war and the Truss budget forced its hand and now the central bank stands accused of precipitating a long recession through excessive rate rises.
The Cameron/Osborne years
The austerity of the coalition government and post-2015 Conservative administrations allowed many public services to fall into a state of disrepair. The NHS was ill-prepared for the pandemic and it has become clear that the absence of slack in the health system has caused huge knock-on effects for the economy.
Analysis by the Health Foundation found that by the second quarter of 2022, 200,000 older workers (age 50 to 69) had left employment due to illhealth since the start of the pandemic. In all, about 600,000 UK workers that would otherwise have been looking for work have quit the labour market, restricting the supply of skilled people and hampering economic growth.