Britain is not an emerging market yet

PHOTO

CAMBRIDGE – Following British Prime Minister Liz Truss’s “mini-budget” – a mishmash of policies ranging from Reaganomics-style tax cuts for corporations and the wealthy to an old-style socialist cap on energy prices – commentators have reacted with increasingly florid hyperbole. Many now wonder whether the United Kingdom is coming to resemble less an advanced economy than a wayward emerging market.

True, financial markets have sent the pound spinning to its lowest level ever (against the dollar), with no bottom in sight. The pound’s reserve-currency status, the last remaining vestige of Britain’s once-vaunted position at the center of the international monetary system, is being called into question. While talk of an outright UK default is overblown, it is not unreasonable to anticipate a painful reckoning just short of that outcome.

And it is worth remembering that the UK repeatedly took bailouts from the International Monetary Fund from the 1950s through the 1970s (making it the IMF’s most loyal customer). It would be naive to think that this could not happen again, especially if global long-term interest rates continue to return to their (very) long-run trend. No wonder the IMF is already pushing back against the UK’s half-baked economic package, just as it does for potential emerging-market claimants on its resources.

But the sky is not falling – at least not yet. Notably, as of the end of September, the UK government’s ten-year borrowing rate is roughly half a percentage point above US Treasury rates. It is thus still well below that of emerging markets like Indonesia, Mexico, and Brazil, whose government borrowing rates exceed those of the United States by three, five, and eight percentage points, respectively. That said, interest rates can rise very quickly, especially if markets lose confidence.

The Truss government’s two most problematic policies are the tax cuts for the wealthy and the energy subsidies. While they were celebrated by the conservative press, the tax cuts, especially, are a head scratcher. True, low private investment has perhaps been the single biggest factor hampering UK growth since the 2008 financial crisis, and cutting marginal tax rates should spur investment, in principle. But that is only if businesses expect the low marginal rates to remain in place. If you think that a Labour government could come to power and reverse the tax cuts (and much more) within the next three years, there is no point in starting construction on a new plant that will take three years to complete. And, of course, the more incoherent the policy package, the more likely it is to be reversed, regardless of who is in power.

The energy subsidies are an even worse idea. Aside from adding an estimated £100 billion ($108 billion) to the UK’s already high debt load, they also will distort the incentives to reduce fossil-fuel consumption at a time when it is in high demand. And though the measure has been billed as “temporary,” energy subsidies are notoriously difficult to remove once in place – as many developing countries and emerging markets know all too well.

While other European countries are also resorting to desperate measures to deal with the huge price spikes consumers have been facing since Russia’s invasion of Ukraine, the Truss plan resembles an emerging-market scheme in both its scope and scale. Many emerging markets, particularly fuel exporters, seek to cap the energy prices their consumers face, often at huge fiscal expense.

There are also some parallels between the Truss tax package and the effort by US President Joe Biden’s administration to implement a raft of progressive economic policies that fall well outside the scope of what Biden campaigned on. But at least the Biden policies were clearly articulated by other Democratic presidential contenders in 2020, notably Bernie Sanders and Elizabeth Warren. Moreover, it is not impossible to imagine a 2024 Democratic presidential candidate winning on such a platform, particularly if Donald Trump is the Republican nominee.

Truss’s policies, on the other hand, have had no such recent airing. She won the premiership after a brief campaign among the Conservative Party’s 180,000-odd dues-paying members. No one else had a say, and there was no good reason to believe that voters would embrace her program.

Moreover, even if one argues that the mini-budget is meant to be political theater, it has not been a very effective performance. Voters tend to become most attuned to the economy and government largesse in the year before an election, and there are well-documented “political budget cycles”: during election years, governments push highly visible spending projects and cut back on less-visible longer-term investments. But the next UK election might not be until January 2025. By that time, it should be clear that the tax cuts will not pay for themselves by boosting economic growth, and any initial positive reactions from voters will have dissipated. While Truss could call for an early election to get a broader mandate for her policies, that would be extraordinarily risky.

To be sure, radical policies, particularly from conservative politicians, are often berated by the press before proving to be far more successful than anticipated. British Prime Minister Margaret Thatcher and US President Ronald Reagan are two leading examples of this tendency, and Truss has made no secret of her admiration for the Iron Lady. But Thatcher and Reagan at least had a coherent policy framework that they clearly communicated; the same cannot be said for the Truss government so far.

Truss and her chancellor, Kwasi Kwarteng, are right to argue that the UK’s biggest economic problem over the past couple of decades has been anemic productivity growth, and that the solution must lie in supply-side reforms. Moreover, there is still time for them to come up with better plans, and to explain them better to the public. The Bank of England is key here also. Until then, the pound is going to be a punching bag, and things are likely to get much worse before they get better.

Kenneth Rogoff, a former chief economist of the International Monetary Fund, is Professor of Economics and Public Policy at Harvard University.