Post Segments
Post-War Labour Governments and Currency Devaluation
The 1945-51 Attlee government was forced to devalue Sterling by 30% against the $ in its final two years – a humiliation in the era of fixed exchange rates. The next Labour government (1964-1970) was similarly forced into a devaluation – of 15% – just before the era of fixed exchange rates ended. PM Harold Wilson notoriously told the public he was not devaluing “the pound in your pocket”, only the foreign exchange rate! The Wilson/Callaghan government (1974-1979) went cap in hand to the IMF in 1976 after a 30% fall in the Pound, with its final strike-ridden months known as “the winter of discontent”. Sterling also fell 30% during the Global Financial Crisis (GFC) in the last two years of the Blair/Brown administration (1997-2010). Labour claim that this was due to the USA’s sub- prime mortgage crisis and not its economic policies, but why then did the Pound fall so much against the $?
Over the whole period from 1945-2024 the £/$ rate has fallen about 70%. Virtually all that depreciation – after netting out the large cyclical swings – took place during Labour’s periods in office. A common factor in all those periods was a significant rise in the role of the state in the economy, including large increases in public spending, intensified regulation, higher tax rates and increased public debt.
Given a poor policy record and enormous unpopularity the 2024 Tory election campaign relied heavily on reminding voters of Labour’s reputation for economic and financial incompetence and warning of a repeat. The Labour Party has a schizophrenic attitude to such accusations – simultaneously denying their accuracy but being acutely aware of their potency. The Labour campaign therefore focused on neutralising these fears by repeatedly emphasising a commitment to restoring economic growth, political stability and sound public finances. A prolonged and effective campaign to reassure the business community was carried out. Shadow Chancellor Rachel Reeves consciously promoted a self-image as the “Iron Chancellor”.
Ironically, Lis Truss’s mantra that only higher economic growth would enable the UK to sustainably tackle its myriad social and political challenges – among them a “broken” NHS and social care system, increasing worklessness and a soaring welfare budget – became central to the Labour campaign. This approach successfully ensured a thumping electoral majority while calming the business sector and financial markets. However, apart from overhauling the planning laws and unleashing a major housebuilding programme, Labour’s economic growth plan was extremely vague and lacking in detail. This, it turns out, was an early warning sign that the reality would turn out far differently from the rhetoric.
An Assessment of Labour’s Initial Economic Policy Actions and Proposals
Far from introducing a credible and comprehensive “growth plan” the new government has announced a slew of economic policy decisions and proposals that will have a negative impact on economic growth and/or will weaken the public finances. It is not clear to what degree the extraordinary contrast between campaign rhetoric and reality is due to mendacity or to a misunderstanding of how market economies and businesses work.
There are a few encouraging signs. Trade Secretary Reynolds has praised accession to the giant Asian trading bloc CTPPP and vowed to continue free trade negotiations with India, the Gulf Cooperation Council and others. Deputy PM Rayner has approved increased flights from the City of London Airport despite strong local Labour council opposition. Early steps have been taken to institute the promised housebuilding programme, although Rayner has chosen to impose housing targets on local councils rather than use a market-led approach that builds houses where the demand is strongest (most notably in London). It is also unclear how the government intends to overcome the intense legal and bureaucratic obstacles that have prevented all recent governments from building sufficient houses.
However, the overall policy picture is disturbingly negative, as set out below:
- The single biggest policy mistake has been the decision to award large pay rises, well above the inflation rate, to a series of public sector workers who have been on strike, without requiring any reforms to working practises or the introduction of new technologies. The rationale for this largesse was to save money by eliminating future strikes, but instead there has been a wave of new public sector wage demands. After largely stagnating since the GFC UK public sector productivity then declined by a shocking 6.4% after 2019. A major rise in working from home by civil servants is probably a key contributor to this yet measures to curtail WFH have been stopped. The outgoing government planned to partially reverse the big Covid period rise in civil service numbers – cutting the bureaucracy by 90 000 – but this plan has also been dropped. A significant rise in the UK’s currently low potential economic growth rate cannot happen without a major turnaround in public sector efficiency. Deputy PM Rayner’s proposals to radically extend workers’ rights, and make it easier to strike, will erode one of the UK’s key competitive advantages – its flexible labour market – and thus deter private sector investment and further inhibit productivity growth.
- The PM and Chancellor claim to have “discovered” a £22bn shortfall in the public finances left by the previous government. This is nonsense on two grounds. Firstly, almost £10bn (and counting) of this shortfall is caused by the above-mentioned rises in public sector wages. Most of the rest is accounted for by unspecified cuts in spending planned by the previous government. This was well known before the election and as Rachel Reeves herself has admitted the work of the Office of Budget Responsibility (OBR) ensure that the public finances are transparent. Credibility is crucial in economic policy making, and Labour’s story of a hidden shortfall is fooling nobody in financial markets or in business.
- The Chancellor has made a small £3bn cut in state spending to help meet the shortfall but has made the classic error of cutting infrastructure spending, which promotes future growth rather than current spending which does not. Part of this cut is the cancellation of the Restoring Our Railways Scheme, set up by Boris Johnson as part of the levelling up agenda and which aimed to restore up to 50 railway lines closed in neglected areas of the country during the “Beeching cuts” of the 1960’s. The first of these projects is in my local area, the Northumberland Line from Ashington to Newcastle. Fortunately, the line is nearly finished, and will greatly improve connectivity, job prospects and lifestyle choices in historically deprived communities. No government with a serious growth agenda would cancel such high economic and social return projects.
- However, the main route to filling the shortfall is to be higher taxes, as Starmer/Reeves have repeatedly warned since the election, though curiously not during it. Given manifesto commitments not to raise VAT, income tax rates or national insurance this means higher taxes on assets and on savings. Since the tax burden was already at record highs – a consistent complaint of the Labour Party for many months – it is a perverse “growth plan” to be vigorously pursuing still higher taxes, especially those that are most likely to deter private sector investment, entrepreneurship, and innovation. The gloomy tone of all economic policy statements is also counterproductive. Recent surveys of legal firms, estate agents, and businesses already show a marked fall in investor and business confidence and a rise in mobile highly skilled professionals, entrepreneurs, and wealthy investors planning to leave the country. The combination of very high taxes and poor-quality public services is not an attractive one, and it is this group and not state bureaucrats who are the engineers of economic growth. Having clearly decided before the election that taxes on assets and savings – such as capital gains and inheritance tax – were to be raised it has also been naïve in the extreme for these intentions to have been aggressively signalled. The intended victims of these measures are already busy rearranging their affairs, so that the actual money raised will turn out much lower than Budget.
- This will also be the case for the revenue-raising measures that were included in the Labour manifesto. These are ideological in nature and make little or no fiscal sense. VAT is to be imposed on private school fees, intended to raise £2bn but likely to raise little if any net revenue as the resulting school closures will mean displaced pupils move into the state sector and thus become a cost to the taxpayer. The tax regime for non-domestic taxpayers is to be tightened up next year, but according to Oxford Economics research this may end up costing £1bn in revenue due to an expected large exodus of current non-dom taxpayers. Even the controversial withdrawal of winter fuel allowance from pensioners who do not claim pension credits may raise much less than the claimed £2-3bn, as low-income pensioners who are eligible for credits, but don’t currently claim are now likely to become claimants.
- Another supposed revenue raising measure is an increase from 75% to 78% in the windfall tax on North Sea oil and gas producers. This windfall tax was introduced by the previous government but softened by the introduction of a 100% capital allowance to encourage investment in new oil/gas fields. The new government is not only withdrawing these allowances but has also banned the award of any new licences for oil/gas fields. I have been working as an economist for nearly 50 years and have never encountered a more counter-productive economic policy decision. The motivation is to reduce carbon emissions, but even the most optimistic projections of renewable energy output imply large scale usage of fossil fuels in the UK for decades to come. The dramatic reduction in North Sea oil and gas production resulting from these policies means that the UK will then have to import more oil and gas from less environmentally friendly sources, thus increasing global carbon emissions. Large numbers of highly skilled workers in the UK will be laid off. Import bills will increase. Tax revenues from both workers and companies in the industry, and all suppliers to that industry, will decline. Our already large fiscal and balance of payments deficits will be increased. The funding for the £8.3bn new state run Great British Energy is supposed to come from the additional money raised by the windfall tax, so how is this body then to be financed? More taxes? This is policy madness. But it gets worse. Energy Secretary Miliband has brought forward the targeted date for the complete decarbonisation of the National Grid from 2035 to 2030. This date is almost universally regarded as impossible to achieve, but the attempt to reach it will still involve enormous investment and higher energy bills. The previous 2035 target date was set by previous Energy Secretary Coutinho to allow sufficient time for British industry to set up supply lines to meet the equipment, materials, and skilled labour required. Bringing the date forward means most of this supply will instead be imported from China, raising security risks and further increasing our import bills. Oh, dear.
Outlook
The UK entered the second half of the year as the fastest growing economy in the G7, recording annualised growth of 2.6%, in line with my Dec 2023 BfB article “The UK Will Grow Faster than the EU and the US in 2024/25”. Two key risks to that forecast were raised – first that Labour might not govern with the promised pragmatism, and second that the Bank of England might overdo its monetary tightening. Unfortunately, both are coming about. It could be argued that Labour might still change direction. I did consider delaying this article until after the Oct 30th Budget, but I have concluded that the die is already cast. It is apparent that the power dynamic in this government lies strongly with the PM and his Deputy, who are demonstrably not pragmatic centrists, albeit on the left, but ideologues who misunderstand how market economies and businesses work. Indeed, the entire cabinet has virtually no private sector experience and it shows. Chancellor Reeves is an exception, but she has made the fatal mistake of failing to exert her authority right from the start. This dominance of ideology over pragmatism is clearly shown in Labour’s decision to reverse Tory education reforms. Those reforms – allowing schools to break free of local authority control, a more rigorous curriculum, the introduction of phonetics – have resulted in the marked rise of English schools in international league tables of educational standards. Welsh and Scottish schools, which did not institute these reforms, fell further back in these same tables. Why would a government seriously committed to raising long term economic growth risk reversing successful educational reforms?
The Bank of England eventually cut Bank Rate from 5.25% to 5% in July, after the annual inflation rate reached the target level of 2%. Since monetary policy operates with significant time lags the Bank should have cut rates months ago. UK broad money growth is still running at very low levels that are more consistent with recession and disinflation than renewed inflation. Monetary policy therefore remains excessively tight.
The economy should maintain some momentum for the second half of the year, but Labour’s counterproductive policies and an overly restrictive monetary policy will increasingly weigh on the economy during 2025. The opportunity to continue outperforming the G7 is being squandered. Five decades as an economic forecaster have made me wary of predicting economic disasters and crises. The great classic economist Adam Smith -if only Starmer and Rayner had ever studied him! – wisely warned pessimists that “there is a great deal of ruin in a nation” i.e it takes a lot to bring ruin to a country. However, the UK’s economic “Achilles Heel” is that is has run current account deficits in a 2-6% of GDP range in each of the last 25 years, and as a result accumulating net foreign investment liabilities of around $ 1 trillion (30% of GDP). The deficit has fallen sharply from its peak of 6% in 2016 to the current 2.5-3% level – despite Brexit! – but this still means the currency is vulnerable to a sustained loss of investor confidence. Is Labour destined to yet again end a period in office with a currency crisis? I fear so, in which case we will need all our Brexit freedoms to engineer a turnaround through a deregulatory drive, and radical market-led reforms of our public services, institutions and tax system.
Robert Lee September 11th 2024.
