We can’t afford another Budget that fails to move the needle on the cost-of-living crisis. So what should we do?

Summary of the event

On Tuesday 15 September, Clive Lewis, MP, Bell Ribeiro-Addy, MP and Lord John Hendy KC jointly sponsored an important event in Parliament to launch the new 99% Organisation report: Ending Treasury-Induced Decline. The event was open to MPs and Peers from all parties as well as invited guests.

The event was opened by the sponsors who explained the need for change. Clive Lewis showed that the last 40 years has seen an economy which increasingly fails to meet the needs of the UK population. Lord Hendy spoke about the increasingly poor treatment of working people, and Bell Ribeiro-Addy highlighted how marginalised groups have suffered even more than the median citizen – even their life expectancy is shorter.

The sponsors were joined by an expert panel whose experience covers economics, finance and business.

• Esther Giles is an economist by education. She then trained as a public finance professional and worked as finance director in many parts of the NHS, most recently in the South Region as Finance Director for Specialised Services. Esther is now a Director and Treasurer of The Socialist Health Association, and Treasurer and Trustee for War on Want.
• Vince Gomez is a former bond trader and a member of the Bank of England’s citizen forum. Vince had a very successful career in the city—and when the Global Financial Crisis struck, he realised that it was not only economists who had failed to predict it: hardly anyone in the City fully understood what had just happened either. Since then, Vince has been assiduously studying, speaking and writing about the myths we all believed about money and the bond markets.
• Ann Pettifor is Director of PRIME (Policy Research in Macro-Economics) and was one of the few economists who predicted the global financial crisis. Ann is perhaps best known for her work on The Green New Deal. She wrote the book, The Case for the Green New Deal in 2019. Ann’s new book is just out: The Global Casino.
• Mark E Thomas is the Founder of the 99% Organisation; His background is mathematics and business strategy. His book 99%: Mass Impoverishment and How We Can End It was one of the FT’s Best Books of 2019, and he is also the lead author of the new report (the co-authors were the panel members, plus Dominic Minghella and Liwia Klipa).

After Mark gave a summary of the new report, Ann explained that we should look at the last 40 years as being a radical and failed experiment – the risk of continuing without change has become unacceptable. Vince explained that almost everything we read about the bond markets is wrong: the bond markets follow the lead set by central banks; not the other way around. It is folly to think that government policy should be driven by anticipated bond market reactions. And Esther pointed out the enormous value of financial control, but that no business would even contemplate allowing its financial control department to set the corporate strategy. And yet the Treasury performs that role for the UK.

There then followed around 40 minutes of Q&A from the Parliamentarians and others to the expert panel. Unfortunately, recording of events in the Committee rooms is not permitted, so we cannot summarise all the discussion.

Summary of the report by Mark E Thomas

The Prime Minister has talked about the failures of the last 40 years and his desire to change direction. The key point of our report is that, if we are to succeed in delivering on the Prime Minister’s goals, we will need to change the way we manage the economy. And that means rewiring our key economic institutions.

Paradoxically, as well as delivering economic failure, the last 40 years have entrenched the orthodoxy which drove that failure. The more it has failed, the stronger it has become. Challenging orthodoxy is never easy, but the alternative – business as usual and continued failure to deliver – quite apart from not helping the British people in the short term, may hand power to the far-right at the next election.

Many commentators, the press and the voices of some supposed experts and holders of high office in the existing system will defend the status quo, but unfortunately, we can all see – in our dilapidated high streets, or as we pass the tents of the homeless, or as we think of our children’s reduced prospects – that their orthodoxy offers no answers beyond waiting and hoping.

We need to change our system of economic management, and that may sound scary. But failure and its consequences are scarier still.

It is time for evidence – economic evidence, and also the evidence of our own eyes – to win over orthodoxy.

I’m going to look at 3 questions:

1. what is the risk of not rewiring? (with an important clarification of the Liz Truss debacle)
2. which institutions must we rewire, and how?
3. what practical steps can we take now?

So let’s start by thinking about what will happen if we don’t rewire.

What will happen if we don’t rewire?

This chart shows that our economy has, for at least the last quarter of a century, been decreasingly able to bounce back from shocks. And unfortunately, shocks are becoming more rather than less frequent.

After the early 1990s recession –  which was quite serious – the economy regained its previous growth rate and by the time the dot.com bubble burst, we were close to the previous trajectory. The bursting of the dot.com bubble did not itself cause a recession, but it caused our growth rate to decline so that by the time of the Global Financial Crisis, we were already far below our previous trajectory.

And, thanks in large measure to the policy of austerity, we simply did not bounce back from the Global Financial Crisis, and we grew further and further away from our previous trajectory.

Then 2020 brought the twin shocks of Brexit implementation and the pandemic. Once the initial recovery had happened, our trajectory has been almost flat.

Our per capita GDP is around £37,000 – it should be over £60,000. Imagine how much difference that would make.

Nobody believes this is working. The latest forecasts from the International Monetary Fund  suggest we are on track for the 2020s to be the worst decade since the 1920s –  the worst for a century.

Looking at this longer-term picture shows a stark contrast between how well we used to be able to manage our economy in the post war period and how well we can manage it today.

What has changed? One important thing that has changed is that, over the more recent period, our economic institutions – the Treasury, the Bank of England, the Office for Budget Responsibility – have all become increasingly powerful, and all other departments – and our elected politicians – have become less powerful. Today, they all operate within constraints set by our institutions.

If we measure the performance of these economic institutions by the performance of our economy – and how else should we measure them? –  there is only one conclusion: they are failing institutions.

And when we look at their remits and beliefs, it’s not surprising. They are almost guaranteed to be harmful to the economy. Our system has failure baked-in.

Let me give you an example of how our institutions can destroy a progressive policy: suppose the government wants to engineer a green transition involving the large-scale thermal insulation of Britain’s leaky houses. They earmark a considerable sum to drive a boost for jobs and for the economy, a reduction in household bills and a reduction in the UK’s carbon emissions. A simple, powerful idea.

But here’s how, given our institutions and orthodoxy, such a plan can turn rapidly sour:

• First of all, HMT shapes the stimulus, arguing that it is not for government to act on the supply-side – that is to be left to the market;
• The stimulus does drive demand, initially up to the level of capacity – which means that businesses happily meet that demand – and then beyond existing capacity. CEOs will hire already-skilled people for demand they can see, but after 16 years of false dawns, will be reluctant to make a major investment in training and developing new capacity for the future. Instead, they raise prices while they wait to be convinced that the demand will be sustained;
• So, we need more labour to deliver the plan, but the Home Office does not allow immigration of ‘semi-skilled’ people, only those whose salary exceeds the threshold;
• Then inflation takes hold, and the BoE, with its strict inflation target of 2% regardless of circumstance, uses the only instrument at its disposal, and raises interest rates;
• At this point, the OBR pipes up, noting the combination of higher stimulus spending and higher interest rates and warns of ‘serious risks’ to the Chancellor’s ‘fiscal headroom’ and the nation’s debt sustainability;
• The media react hysterically, talking of the government ‘bankrupting the country’ and ‘economic Armageddon.’

From noble plan to economic and political disaster in six easy-to-picture steps – driven by our institutions.

I said I’d mention Liz Truss. This example sounds quite different, but in fact the Liz Truss debacle is also a story about our institutions. The usual version of the Truss story is highly distorted. It goes like this: Truss, with her unfunded tax cuts, borrowed too much, too quickly. That damaged the credibility of the UK as a borrower, so the bond markets took fright and moved against both bonds and sterling – and an inevitable crisis ensued. The bond markets, we are told, will only tolerate a certain pace and scale of borrowing.

That story can’t be true. If it were true, there would be evidence in the data. We would see that when borrowing rises, bond ratings decline and the cost of borrowing rises. We would see that a very rapid increase in debt causes an immediate crisis in the bond markets. We would see in other words that if British politicians borrow too quickly, they are punished by the markets.

Instead, this is what we see.

The red line is the ratio of Debt:GDP – the thing which is supposed to drive the market reaction. It starts to rise sharply after the Global Financial Crisis, so we should expect to see the blue line (the interest rate demanded by the market for holding government bonds) rise with it. We do not see that: we see it fall. Even when the bond rating agencies started to reduce the UK’s rating from triple-A to lower  levels, we saw the yield continue to fall.

Even in 2020, when Debt:GDP was already at around 80% and the government suddenly found that it needed to find an additional £70 billion to fund the COVID furlough scheme – money it had previously insisted it did not have – and debt shot up to over 100%, bond rates still did not even reach 2%.

This is because the government made good use of its institutions – the UK became the first country in the world to use direct monetary financing to pay for the spending. In this case, the Treasury instructed the Bank of England (BoE) to create the money, and the Debt Management Office turned it into bonds which the BoE then purchased directly without troubling the bond markets at all.

But when Truss launched her Budget, without getting the institutions on board, we were in an inflationary environment. The BoE had already started to raise interest rates. And so when Truss’s inflationary Budget came out, with no institutional support, we finally saw a rapid rise in bond rates. After just a few days, this began to cause dangerous problems in the pensions industry until the Bank of England, having first fuelled the fire, finally stepped in. As soon as they did that, bond rates stabilised, and with the BoE now backing gilts and a reversal of the Budget provisions, the problems started to subside.

The data flatly contradict the conventional story of Truss’s failure. Failure to control the BoE and ensure its backing, not excessive borrowing, was the fatal flaw in Truss’s approach. As the former President of the Federal Reserve Bank of Minneapolis wrote, “Markets didn’t oust Truss; the Bank of England did.”

There is a vitally important lesson for the UK government in the Truss debacle, but it is about the coordination of the UK’s institutions, not about the pace and scale of borrowing. If you want to succeed, you have to make the institutions work for you, not against you.

Without rewiring, any significant progressive policies are doomed to fail, and we will continue on the path of the last 40 years – and that runs a very serious risk of handing the next election to the far-right. What is happening today in America could well happen here.

Change will come at the next election, if not before, so it had better be responsible, evidence-led change.

So, how should we rewire these institutions?

The first step is to get rid of the idea that we should constrain government spending by static fiscal rules, which cannot possibly adjust to meet our real-world challenges. That is a huge subject on its own, which we covered in our previous session – but if anyone wants more detail, we have a few copies of that working paper, too. In brief the argument is simple: that kind of fiscal rule has never worked, and will never work.

As you can see, in the period before we had fiscal rules (1945-97), the lines were moving in the right direction: debt to GDP was generally falling, and real per capita GDP rose from around £6,000 to around £26,000. More than a four-fold increase. Not bad. The first set of fiscal rules also saw acceptable performance up until the Global Financial Crisis. But they failed to cope with that.

And every subsequent set of fiscal rules – and we are now on the 10th set – has corresponded with very poor performance.

The rules have not prevented debt:GDP from rising significantly; they have corresponded with almost zero growth. They have failed on their own terms. And they have not been immutable. There is no evidence in our history to support this kind of fiscal rule.

And the OBR has not helped. Even on their own terms – reducing debt:GDP – they have also completely failed.

The evidence is clear: we need a different framework for thinking about government spending.

The government has repeatedly promised to deliver much-needed national renewal. A responsible government must deliver on that promise, and that means addressing economic and social responsibility, as well as financial responsibility.

• On Economic responsibility – we must ask: has the government taken the steps necessary to create robust, sustainable economic growth? For the last 40 years, the answer to that question has been ‘no’;
• On Social responsibility – we must ask: has the government provided the services and support a wealthy, civilised society should expect? Since 2010, the answer has been, ‘decreasingly’;
• and on Financial responsibility, we must ask: have we met the private sector’s need for risk-free savings? This is the only question on which, in general, the answer has been ‘yes’.

This more realistic understanding of what the word “responsibility” really means – self-evident though it may seem – is alien to our institutions, so we need to rewire them.

And the Prime Minister’s plan for a Number 10 North could be a perfect vehicle for doing so.

The first change is a move towards long-term thinking with the creation of a Department for National Strategy. China and Singapore have created long-term plans for their countries, using a range of systems thinking and other techniques to assess the trade-offs involved. They have been remarkably successful in achieving their aims. And virtually every significant business has a strategy department for the same purpose. The UK government, however, does not have a department with the attitudes, instincts, and skills to produce such a plan. The result is a lack of joined-up thinking and a naïve reliance on ‘the magic of markets’ to solve every problem.

The need for more strategic thinking is clear. But, as Sun-Tzu said, “Strategy without tactics is the slowest route to victory. Tactics without strategy is the noise before defeat.”

If we don’t want to take the slowest route to victory,  there also needs to be a powerful Department capable of ensuring that the tactics are consistent with the strategy: i.e. that the national strategy is translated into operational plans, that these plans are resourced and coordinated and that they deliver. That would be an expanded role for the Cabinet Office, working with the other Departments of state. So our second proposal is an expanded Cabinet Office, sitting above the Treasury, charged with operational responsibilities.

The role of HM Treasury would be correspondingly reduced and refocused onto those areas where it can make a major positive contribution: revenue maximisation and ‘leakage’ prevention.

The inflation remit should go to a new body – the Inflation Control Office – which must have a full range of inflation control tools: not only interest rates (which place the burden of inflation reduction on those least able to bear it) but also taxes and price controls. Its remit would also recognise that, while inflation is undesirable, often the ‘cure’ has been worse than the disease.

The OBR, in contrast, would see its remit expand beyond debt to consider all three of the true aspects of responsibility. If it sees that the government is moving towards failure on any of our three dimensions, it should call it out. And, if the warning is found to be correct, the strategy should be modified. This is almost the opposite of what the OBR has been doing, so a change of leadership will be needed for it to deliver on this new remit.

Finally, we need proper regulation of our major industries. Currently everything from Energy and Water to the Press is regulated in ways which satisfy the shareholders of the companies involved but do not meet the needs of the British people. A new and powerful Office of Regulation should ensure that regulators are protected from capture by those they should be regulating.

By focussing the Treasury on its core area of expertise – financial control – there would be enormous potential gains to the Exchequer. And it would be possible to measure the success of the Treasury in achieving control over leakage from the public purse.  In the interests of time, I will not go through all this in detail today (but I will at our next session); the key point is that there are huge amounts of leakage which the Treasury has failed to address.

HMT could not realistically get all of the roughly £250 billion that is leaking out today, but it could certainly be expected to deliver many £10 billions – that alone would be a major contribution to national renewal.

What can we do today?

That rewiring sounds like a huge task – and it is. Rebuilding the capabilities for progressive government could not be done overnight.

But some things could be:

• The Bank of England’s remit could be tweaked so that when it knows that raising interest rates would do more harm than good, it declines to do so;
• The OBR could start tomorrow to work with a progressive definition of responsibility as we set out;
• And the Treasury could be instructed to use its powers to control interest rates – they should not be above the growth rate of the economy – and to cancel our so-called debt to the Bank of England immediately.

So there is an enormous upside from starting the process right now. First reject the nonsense of so-called immutable fiscal rules, then rewire, as we have set out today, and finally drive renewal (which we will present on 28 September).

This is clearly a time when politics can change fast. A moment when things could pivot, if we make them.

And, looking back at the data we started with, we have to ask, “how much more evidence do we want to see before we act?” And it is not just the statistical evidence, compelling though that is. It is the daily evidence of our own eyes: run-down high streets, homelessness, poverty, crumbling infrastructure, a struggling NHS and increasing damage to the environment. We can see it; voters can see it.

If we don’t fix it, we leave a very compelling case for the far-right that the traditional parties have had their chance. And after the next election things could get far worse.

It is time to stop listening to the voices defending a status quo that we can all see has failed and take control of the economy back into elected hands.

It is time to drive the change the Prime Minister has promised.

It is time to act.

Thank you. I am sure you all have lots of questions for the panel.

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