A few weeks ago, Liz Truss resigned from the position of Prime Minister of the United Kingdom – a mere 45 days after being elected – cementing her as the shortest-serving prime minister of the UK. Despite her short reign, she has left in her wake various economic issues for her successor, Rishi Sunak, to deal with.
One of Truss’ first policies was a plan for massive tax cuts. This economic policy was unveiled by Liz Truss and her chancellor, Kwasi Kwarteng, without following the usual protocols. It involved huge tax cuts for Britain’s richest and a rollback of previously proposed corporate tax rate hikes. The tax-cutting package was equivalent to 45 billion pounds and was funded by further public borrowing. This policy has resulted in a significant drop in the value of the pound as well as a surge in borrowing costs. The pound fell to its lowest-ever value against the dollar of $1.03. The resulting market reaction was so severe that there was a large sell-off of government bonds, which are usually considered safe investments. Consequently, the Bank of England had to step in and buy 65 billion pounds of government debt to prevent the collapse of certain pension funds. Even before this programme, the UK had considerable public debt. The UK’s Office of Budget Responsibility had previously stated that without tax hikes, public debt would rise from 96% of the British economy currently to 320% in 50 years. Thus, in an already precarious situation, Liz Truss’ infamous economic policy has only made things worse.
Liz Truss’ policy and its disastrous effects on the British economy even drew the ire of the International Monetary Fund (IMF), with the IMF urging the UK to trust its central bankers, reconsider its measures, and ‘not prolong the pain’. This sort of rebuke from the IMF is unprecedented, given that it is usually reserved for developing nations.
The impact of this policy also extends to the ordinary people of the UK. Inflation is on the rise globally; however, this is especially true in the UK where consumer price inflation has reached double digits. The Office for National Statistics declared that consumer prices were 10.1% higher than in the same period last year – an almost 40-year high. More than half of the adults in the UK have responded to a survey saying that it has been difficult for them to pay basic household costs over the past six months. While Britain’s economic woes and high inflation existed before the introduction of this policy, the situation was exacerbated by Liz Truss’ measures.
This leaves one question unanswered – what exactly made this policy so ruinous? It is partly a function of timing. Having a tax cut is not an inherently bad idea. However, doing so while inflation is high and the central bank is raising rates is antithetical to fundamental economic principles and is inviting disaster. Moreover, cutting taxes in a manner that benefits the rich and disproportionately negatively affects the poor and middle class is quite unwise. In addition, this drastic turn in economic policy was taken suddenly, with markets not being given enough warning. These measures have been withdrawn, leading to markets cooling off to some extent. However, the damage caused by this policy to the UK economy is irreversible.
The current economic situation in the UK is unfortunate and it will not be easy for the next Prime Minister, Rishi Sunak, to steer the UK’s economy back to stability and growth. Nonetheless, this entire debacle has produced important lessons for other countries. These lessons include introducing new economic policies only after sufficient consideration and consultation with the Central Bank and other experts and not contradicting basic economic theories in policies.
