Alex Morton was a member of David Cameron’s Downing Street Policy Unit.
Theresa May is trapped by circumstances
Theresa May took office quickly and as a serious figure. This brought relief among the public, markets, and has given her a major polling boost. But the last few weeks have delivered constant reminders of the weakness in her position. Constant public squabbling within the Cabinet. A (frankly astonishing) public rebuke to the Prime Minister from the Governor of the Bank of England. Hardcore Remain Conservative MPs briefing to journalists that they will attempt to derail anything but the most negligible change in our EU status.
Many correctly argue that to succeed in terms of Brexit, the UK needs to be radical on domestic policy in terms of promoting growth and reforming the public sector to keep shrinking it. They are right. The problem is that May, unvalidated by a general election and with a majority of just ten now in the Commons (and none in the Lords), is too weak to be able to do what she needs to do. She is therefore trapped. To succeed she must be strong in negotiations overseas and reform at home. But her position is weak on both counts. Further, the two are linked – her small majority and noises by those such as Anna Soubry or Nicky Morgan embolden the EU to make polite but cold statements, while the fact no one knows what Brexit looks like causes political squabbling back home. Meanwhile, much of the London based media will be biased: each piece of bad news magnified, while good news is downplayed by arguing it will be reversed once ‘real Brexit’ hits.
Economic troubles lie ahead
I have noted before that every decade since the 1970s has seen a recession, and global growth now continues to struggle. Brexit will increase short-term uncertainty even if there are long-term gains. Abandoning George Osborne’s deficit reduction targets will make the market much more nervous. The UK is reliant on overseas buyers for a large share of gilts. There is simply not the trust left in the system if things go wrong. While May is quite right to argue against loose monetary policy, rising interest rates will increase debt servicing costs. If she is serious about protecting savers, this will cost tens of billions in the medium term as rates rise. This is partially offset by the Bank of England’s Asset Purchase Facility and the length of UK gilts, but by 2020 higher rates will begin to seriously hit the government’s deficit reduction push.
The worst possible situation for a politically weak May is to find herself in 2018 and 2019 with a slowing or even shrinking economy with a rising deficit again and higher borrowing costs, just as Brexit talks climax. It would cripple her negotiating hand overseas while making major cuts to spending further or hiking taxes inevitable since the market would be extremely nervous. It is likely that in such a situation she would be toppled, and the Party plunged into turmoil just ahead of the 2020 election.
Finances – boost incomes now to reform the state later
The UK’s deficit position is weak. We have cut the deficit by just £2.3 billion or so in the first six months of this year. Last year, it was £75 billion, still around 10 per cent of government expenditure. But while it hurts to say so for someone who is generally in favour of fiscal retrenchment, we need to take a step back to take a post-election leap forward. May is simply not going to be able to deliver the reform that we need from her current political situation.
Inflation is at one per cent but will rise further in the months ahead, potentially outstripping wages. To counteract this, Theresa May must boost incomes – by cutting to income tax, VAT and petrol duty. The ONS estimated that raising VAT by 2.5 per cent increased inflation by 0.8 per cent. Fuel costs are also now pushing up inflation so there is a legitimate argument for action there. Philip Hammond can make the most of the situation electorally by introducing a reduction immediately now and then another reduction at the start of April next year, maximising the boost to spending power ahead of an election in late May.
This should not be explicitly done as part of a Brexit budget. It should be done as part of the commitment to the just managing classes who deserve a break. It is worth remembering that paying for the state is the biggest burden on households across all classes.
This will not come cheap. For a package to deliver what is needed it is likely to be roughly £20 billion across two years, reversing much of the debt consolidation in these years. But it must be done to clear the path for a major reform and reduction in government spending from 2017 onward.
Buying Time now Means Serious Reform Post 2017
May probably has just enough credibility to get away with this proposal and pencil in further (unidentified) spending reductions from 2017/8 onward. But this strategy means that the next Government must be much more radical domestically. It is worth remembering that May delivered 24 per cent reductions in spending from 2010-15 at the Home Office. May and her team might praise the good government can do, but she and they were quite effective at delivering that good at a lower cost to the taxpayer.
Delivering this will mean she needs to relax her grip a little: the murmurs across Whitehall are that while May’s team are good at strategy, this is coming at a cost of impossible centralisation. But again, a strong elected mandate will give her and her team the self-confidence to do just that. The possibility of a post-election virtuous circle exists: a confident and strengthened May who requires loyalty and spending reductions by Ministers in return for the flexibility for Ministers to think creatively. The alternative is probably a weakening economic and fiscal position that leads to further political weakness and a potential bunker mentality arising within Number Ten over the next two years. The economic situation calls for an election next spring – and in the next column I will argue that the politics can be made yet more favourable still.