Merlin Weekly Macro: Is Labour heading in the wrong direction?

It was Ronald Reagan who memorably said, ‘the nine most dangerous words in the English language are: “I’m from the government and I’m here to help”’. Today in the UK it can be amended, updated and made more emphatic: ‘I’m from the government and I’m here to tell you what to do and how to do it.’

‘Retaking control’: just not how it was sold in 2019

Keir Starmer’s pledge on the electioneering stump was that his government would ‘tread more lightly on your lives’. It is obvious that was a straightforward deceit. This week at the Labour conference where the government front bench was still electioneering rather than understanding it is now already nearly a quarter of a year since it came to power, Starmer was explicit. He hijacked Boris’s 2019 ‘Retaking Control’ mantra (which in the context of Brexit was all about the restoration of UK sovereignty from Brussels); Starmer’s redefined version of ‘Retaking Control’ means extensive state intervention in all aspects of UK life, society and the economy. As an example and without any awareness of the idiomatic irony, he made it clear that we all have a duty to behave responsibly to protect ‘our’ National Health Service (achieved through sugar and fizzy drinks taxes, banning smoking, the proposals being ‘socialised’ to curtail pub opening hours and banning pint glasses etc); one fondly imagined that the National Health Service exists to serve us rather than the other way around. That the NHS is broken (‘but not beaten’) seems to be our fault, nothing to do with government or failings of NHS management. A second example of brazenly trampling with size 11 hobnails rather than ‘treading lightly on our lives’, is the removal of the right to object to new housing planning developments, including on what is supposed to be protected Greenbelt, and trying to vote down National Strategic Infrastructure Projects including intrusive solar and onshore wind industrial developments.

Closer to home impinging directly on the investment world, he made it clear that in his view free markets have been ‘a failure’. Capital markets and the corporate environment must work in favour of social benefit and can only do this with direct government intervention, otherwise, as he claims, how can one ‘retake control’? When he talks about his government working with business, it is in the context of increased scrutiny, regulation and the imposition of additional frictional costs, particularly in the areas of employment and the environment.

Even before the 2024 election, the UK was already a long way from the Thatcherite concepts of free markets and light-touch regulation, the freedom of the individual and minimal state intrusion beyond what is required for what are clearly defined services to be funded from the public purse (i.e. by the taxpayer: e.g. law & order, defence, the basic state pension, a minimum safety-net for the genuinely needy etc). Starmer’s government envisages a return to socialist principles, last seen by the Wilson and Callaghan governments of the 1960s and 70s, explicitly defining the superiority of the State and the subservience of the individual to the benefit of the common good; favouring the public sector over the private, without actively restoring Clause 4 (Labour’s former commitment to universal public ownership, rescinded by Tony Blair in 1995), nevertheless key industries and services will be re-nationalised including rail, buses and elements of the utilities sector.

A new Chancellor being pulled in different directions

Hopefully, the fog will lift on the new administration’s fiscal policy on the publication of the Chancellor’s Budget on October 30ᵗʰ. It is obvious from the media and policy think-tank websites that many ideas are under consideration about how best to raise income not only for day-to-day public expenditure, but also to lay the foundations for the significant regenerative capital expenditure required for new schools and hospitals, courts and prisons, road and rail projects; also the major new expenditure needed for the wholesale conversion of electricity generation, the upgrading of the national grid and investing in new carrying capacity to meet the projected surge in demand over the next two decades.

A good perspective of the political pressure Reeves is under from different directions can be gained from columns in The New Statesman, the house paper of the political Left: to resist a return to ‘austerity’ and public spending cuts; to ignore the financial constraints of fiscal prudence as laid down by the Office of Budget Responsibility and to take no notice of the need to reduce both nominal debt and the debt/GDP ratio by the fifth year of the fiscal plan; and finally to raise significant sums (depending on the commentator and his/her agenda and their individual vision of the future, estimated anywhere between £20bn and £50bn) in taxes to be sourced from those ‘broad shouldered’ people with assets and/or high earnings who can ‘afford to pay their fair share’. This ignores that currently, already labouring under the yoke of the highest tax burden since the Second World War forecast by the Office for National Statistics (ONS) to be 37.7% of GDP in 2027/8, the Institute for Financial Studies estimates that the reliance on top earners continues to grow. The top 1 per cent pay 29 per cent of all income tax now, up from 25 per cent in 2010 and 21 per cent at the turn of the century (a bigger picture shows that in 2022/3 the top 10 percent of income earners paid 60 percent of all income tax, while the bottom 50 percent of income earners paid only 9.5 percent.)

There is already a live example of the consequences of ill-considered tax policy resulting in unintended consequences: documents leaked this week from the Treasury to the press about the abolition of the Non-Domiciled tax regime introduced by Jeremy Hunt in March (effective from April 2025) both endorsed and reinforced by Labour, indicate predictably that the people directly affected have voted with their feet. Many have already relocated abroad. The estimated £1.2 billion income the Treasury hoped to raise has quickly vanished to virtually zero. In contrast, Georgia Meloni the Italian Prime Minister, has been welcoming mobile ‘Non-Doms’ with open arms: not because she wants to squeeze them for tax until the pips squeak, but because they bring the direct benefits of their capital for investment and their spending power to stimulate consumption. Labour’s is a cynical calculation: the majority of the better off will not become economic migrants fleeing her new high tax regime; instead they will stay put and stump up.

Is the left hand in touch with the right hand?  Joined-up thinking needed       

Clarity is needed to create a sound basis to attract both domestic and foreign inward investment. Currently, amid a mish-mash of competing, disjointed and contradictory policy pledges from different departments, it is difficult to make sense of any strategic coherence. Pointing to the publicly stated target of having the fastest growth in the G7, Reeves wants to talk up the growth prospects of the UK economy with a positive pitch to business; on the other hand (and presumably also fully endorsed by Reeves), Angela Rayner wearing her employment brief wants to impose a raft of enhanced rights for employees involving considerable costs to employers. Business Secretary Jonathan Reynolds is simultaneously proposing an automatic right for all employees to enjoy a four-day working week on the pretext of cramming five days’ work into one fewer, immediately creating planning nightmares for work rostering within companies and inefficiencies between companies doing business with each other.

Reeves talks of ‘wealth creation’ but has made no secret that taxes on assets and wealth will rise, whether through higher capital gains tax (CGT) rates or reform of the inheritance tax (IHT) regime or applying National Insurance to unearned income among a range of options being considered, thereby undermining both the scope and incentive for reinvestment. Frictional capital taxes cause capital stagnation on the basis that investors are not simply interested in the gross return on their investments, but the net return after taxes on any gains (bearing in mind that through Stamp Duty they will have already been taxed when making the investment in the first place). Rationally, capital follows the path of least resistance: place higher hurdle-rates in the way that erode returns for any given risk, investors will take that capital elsewhere where they can maximise returns rather than having frictional costs diminishing them. The suggestion that entrepreneurs’ relief and business relief could be abolished or significantly reduced immediately questions why risk-takers wanting to grow enduring businesses would bother; why tax early-stage risk capital egregiously if the objective is ostensibly to nurture a vibrant small business culture? A recent report suggests that such a reform to capital taxes on business ownership would largely pull the rug from under the Alternative Investment Market (AIM). If that were the result, such a reductive policy would not only be careless but an unforced own-goal.

As for clean energy policy, a topic we have analysed on many occasions in these columns, Ed Miliband’s is the path of the student eco-warrior rather than any mature, strategically considered plan to perform the transition to carbon-zero electricity generation for the world’s sixth biggest economy. Very few in authority are prepared to be up-front about how much the intended project is going to cost and how it will be paid for. The new publicly-owned Great British Energy company has been seeded with £8bn of public capital as a base from which to attract private development capital, not only to match but also hopefully with a multiplier effect. But far from lower energy bills for consumers, already new green levies are being planned. In August, the most recent auction for UK offshore wind licences was successful after its immediate predecessor last December produced none whatever, but only because the government had been forced to put another £1.5bn of public subsidy behind the system as a financial backstop to make the investment viable for bidders. That cost must be recovered from somewhere.

A brief history of decline

But let us step back from the weeds of the detail and look at the bigger picture of the UK economy. Since 1945, the period of post-War regeneration (Harold MacMillan’s ‘you’ve never had it so good’) gave way to post-imperial decline in heavy industry and large-scale manufacturing. The Thatcher era completed the transformation to a service-dominated economy. The twenty-year period encompassing the 1970s and 80s saw economic boom-bust (including an unforced economic “GO TO JAIL” card in 1976 when we were rescued by the International Monetary Fund), sky-high inflation with interest rates to match and high unemployment. The late Thatcher era, extending to 1997 and the end of the Major government saw fiscal responsibility restored, stable above-average growth resumed and unemployment falling, helped significantly by our being ejected from the straight-jacket of the European Exchange Rate Mechanism in 1992. Since 1997, regardless of who has been in power, enduring government deficits have been the norm, debt has been steadily accumulating exacerbated significantly by the fiscal measures adopted in the 2020 pandemic to keep us going while locked up; GDP growth has been on a near-three decade declining trend from over 3% to struggling to exceed 2%. In the post-global financial crisis era of easy money with all the economic inefficiencies it brought (the ‘zombie economy’) the tendency has been towards sub-2% growth, albeit predominantly with low inflation; unemployment has generally been low, notably in the last 10 years, but productivity has collapsed, public services are struggling and yet public spending as a percentage of GDP has risen from 37% of GDP at the turn of the century to over 45% today; government debt as a percentage of GDP, and the tax burden, are the highest since 1945.

Reeves’s benchmark for economic success is our GDP performance against our G7 competitors. Given that most of our European peers are in a considerably worse position that we are, arguably it is hardly an ambitious target. The danger is that even if we do perform well against them, it ignores the risk of continuing the long-term absolute decline. Essentially it becomes a race to the bottom, the last one there is the winner. We have used the term ‘reductive’ elsewhere: this is essentially a reductive strategy.

Rachel: please read, understand and implement

At the risk of banging on, unless and until significant public sector reform is pursued with vigour and a match-fit, highly competitive private sector is allowed to flourish with minimal frictional costs and minimal central interference (which in turn liberates growth, stimulates re-investment, increases the nominal tax take under its own steam providing the government with options, and rapidly brings down the debt/GDP ratio), it is difficult to be optimistic at the strategic level. All the evidence to date suggests that Labour is heading in the opposite direction. We would desperately like to be proved wrong.

In the Times this week, former Tory leader William Hague wrote a piece about the dysfunction in Number 10 and the need to get a grip. That is certainly true operationally. But we say that addressing the bigger picture, Labour needs to get a grip on reality. As Hague summed up, “Take it from a well-meaning Tory: you need to pull yourselves together before it’s too late”. Amen to that.

Investing in the UK: there are still winners!

If this assessment of the UK’s strategic economic outlook is gloomy, that is not to say UK companies are bad investments. The UK FTSE100 index is largely populated by big, high quality companies with significant international exposure. There are many good investment opportunities. Even lower down the market capitalisation scale where companies tend to me more UK oriented, there will be winners as well as losers. We remain fully focused on investing in active managers in whose funds we invest who have the skill to pick winners.

The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each.  With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions. Capital at risk.