Merlin Weekly Macro: 24 hours to forget for the Tories

Another twenty-four hours the Tories would prefer to forget. Two (more) disastrous by-election losses, both on the same day. With not only big swings to Labour and Labour victories, confirmation of the polls that in double digit percentages of both votes in quite different constituencies, the significant leakage to Reform UK from the Conservatives has all the hallmarks of nemesis in a first-past-the-post electoral system barely nine months before the general election. If Labour is jubilant, like the Tories the LibDems will find no joy having in both by-elections trailed Reform UK.

Inflation; boats; debt; waiting lists; growth. Remember them? The Prime Minister’s five pledges made this time last year to be achieved by the end of 2023. Pouring on the misery for Rishi Sunk (sorry, sorry, Sunak, must get that right) the fifth and final data check confirmed one hit and four misses: not only did the economy not grow, with a 0.1% decline in the third quarter of 2023 followed by a 0.3% decline in the fourth, two consecutive quarters of shrinkage technically means a recession, the first since the roller-coaster ride of 2020 when the country was in lockdown. Whether it is or is not a recession largely misses the point: the UK economy has been treading water, going nowhere for a year. To be fair, inflation was halved on his watch; inflation is the least of the pledges directly within his control and is the responsibility of the Bank of England to manage, but when you’re a drowning man, any log floating past is a makeshift life raft to reach out for.

When is a recession not a recession?

For some, times are undoubtedly hard, a real struggle. But the odd thing is, to many people it does not feel much like a recession at all. January retail sales bounced back by 3.4%, nearly double the consensus estimate; holiday bookings are almost back to pre-pandemic levels; restaurants are busy; credit card transactions are edging ahead and so forth. There have certainly been difficult times as many consumers endure significant pressure on household budgets thanks to the cost-of-living crisis, and a sharp increase in mortgage rates for some, but wages are gradually catching up and now exceed the inflation rate. Compared with ‘normal’ recessions, there is no sign of significant unemployment pressure, indeed the labour market remains at what economists regard as ‘full’, where the official unemployment rate is below 4%. However, with 1.5m out of work and on benefits but a net 5.5m people of working age being economically inactive because they do not want a job, the unemployment rate needs to be viewed with a sense of scepticism and suspicion.

Hunt: one last shot

Politically, desperate times call for desperate measures and the Chancellor has been tossed the magician’s hat and told to pull out a rabbit. Chancellor Jeremy Hunt is warming up for the forthcoming budget, briefing that he is contemplating cuts in public spending to be able to fund pre-election tax cuts. It is so transparently unsubtle so close to the election it barely even passes as cynical. While we all welcome more disposable cash in our wallets and purses, is it good economics rather than desperate and opportunistic politics? And here the answer is almost certainly not.

The intent to get taxes down and grow the economy is entirely laudable, particularly when we have the highest tax burden since the War. But at approaching £2.7 trillion, we also have the highest level of government debt in history (where the cost of servicing the debt has more than doubled in four years) and an unbroken record of government deficits funded by borrowings stretching all the way back to the Millennium. Public services are demonstrably struggling if not in some cases crumbling; local authorities, some like Birmingham in big metropolitan areas, are regularly going bust.

Carts before horses

Simply cutting departmental budgets without any inclination for, or indication of, significant reform of how those departments operate to ensure the outputs are at least maintained or even enhanced is all the wrong way around. Far from being a successful strategy, it is far more likely to create a doom-loop of decline. Fundamental reform should be the precondition of smaller departmental budgets: doing things differently and better for less money should be the fiscal nirvana, even if that means challenging norms and making hard choices.

Take the biggest department of all, the NHS, ask yourself: starting with a clean sheet of paper, if you were inventing a new nationwide health system, would you create today’s National Health Service? Answer, almost certainly not; it would most likely be a very different model and would not take as its base assumption that every service should be free at the point of consumption. Of course, the reality is that here is where we are and there is no blank piece of paper; nevertheless, that should not preclude actively wanting to change a system that is demonstrably creaking, verging on broken. As the longest-serving Health Secretary Jeremy Hunt knows a thing or two about under-performing departments, in the case of the NHS, a voracious monster with an infinite capacity to devour incremental cash for no marginal gain.

Sound money

But back to sound economics: once you have redefined your newly reformed public sector cost base, then you can start making real choices about how best sustainably to grow the economy within which the tax strategy becomes an important means of determining not just net disposable income and consumption but incentives for investment to attract significant new capital and improve economic competitiveness. The real goal should be to create a multiplier effect for the economy so that every marginal pound invested generates more than a pound of output. Compounding wealth generation is something from which everyone can benefit both through employment, productivity and earnings. Not only does the tax burden fall, but debt/GDP falls too, rapidly, with the double ratio win of a simultaneously shrinking numerator and an expanding denominator. As time goes on, if the economy shows signs of running away and overheating, then temper its enthusiasm with higher interest rates working hand-in-hand with the central bank.

As it is, thanks to the time not so long ago that Rishi was in Hunt’s seat as Chancellor, health spending is protected, alongside overseas aid, schools and defence, all of which mean that the other spending departments have proportionately even bigger savings to find (or cuts to implement). But the principle of simply cutting expenditure with no aim other than to save money (in this case to fund tax cuts) is less a hard choice than an abrogation of responsibility.

We would like to think that Jeremy Hunt can come up with something more imaginative. Even if it did not win him the election, at least it would demonstrate responsible fiscal stewardship and earn him respect. But as the clock ticks down inexorably and time rapidly runs out, the opportunity for well thought-out strategic planning has passed. The expediency of needing to be re-elected in the face of a political gale points to the unsubtle, crude approach. Heigh ho.

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