When the history books of our era are written they will say that Britain had a huge financial crisis, then it left the EU. In those books Boris Johnson’s legacy as Prime Minister will be Brexit – and the politics and economics of Brexit are hard. Hard substantively, because they involve unravelling 40 years of integration. And harder still because politics, like life, is path dependent. A close referendum meant political trauma, but three years of it hardening into the main dividing line of our politics means that avenues that were once open in 2016 are well and truly closed – as Jeremy Corbyn has found out recently.
No new Prime Minister, however maverick, wants to be facing a choice between an immediate election or a constitutional crisis from ignoring Parliament – but that is the choice Boris Johnson faces, barring significant movement from both Brexiteers and Brussels. Gordon Brown only faced attempted terrorist attacks, floods, foot and mouth and a bank run in his first few months – happy days.
But our 77th Prime Minister isn’t entirely without luck. The defining features of this decade’s political economy have been the double squeeze – on public spending and household living standards. On both counts there will be good news awaiting him as he enters 10 Downing Street. The austerity squeeze is done and there is cash to spend, with the deficit now at historic lows. And our disastrous earnings recovery has at last picked up pace, with the fastest pay rises since 2008.
An end to austerity and a return of decent earnings growth would certainly makes a potential election easier. But making the most of this good news, and sustaining it, requires more than just luck. Here’s five lessons for the new Prime Minister as he confronts his Brexit storm with some economics tailwinds to help him through.
1. There is money to spend
The UK ran a deficit of 1.1 per cent last year – the lowest in 17 years. That means the new Chancellor has around £25 billion a year spare to end austerity for public services, or to cut taxes, if they still wish to see debt continuing to fall in the years ahead. While Boris Johnson may not have much to thank Philip Hammond for, he owes him significant gratitude for fending off the outgoing Prime Minister’s attempts to spend much of this headroom ahead of him taking office.
Reasonable people will disagree about how much fiscal loosening is sensible, and how much of that £25 billion headroom should be maintained. But the key shift is that, ten years on from the financial crisis, it is clearly now possible for austerity to be ended. Allowing all day-to-day departmental spending to grow in line with the economy in the years ahead would cost in the region of £10 billion, compared to current plans.
2. But you still need to prioritise
In practice the spending arithmetic will not be as straightforward as the above implies. That’s partly because the new government is already making promises that go far beyond this – not just ending austerity but starting to reverse it, by spending £5 billion more on schools and increasing police numbers. But it’s also because while the short term fiscal news may be relaxing, the structural pressures a Johnson government will face from an ageing population are anything but. The 2020s is the decade when those long-discussed demographic pressures will start to materialise – simply maintaining the existing welfare state will require an extra £19 billion by 2025.
And the old coping mechanisms won’t work. In the past we’ve partly managed the cost of the country’s long-term increase in welfare-state spending by shrinking the military. But there is no longer enough military to shrink, never mind the fact that many Conservatives actually want to see big increases in armed forces spending. So choices will have to be made unless the plan is simply to let borrowing rip – and remember the new Conservative government is already on course to be running a looser fiscal policy on the current budget, ignoring investment spending, than Labour currently proposes to do.
3. Don’t forget need
There’s what you came into politics for – and then there’s what just needs doing when you happen to get to the top. While schools and more police may well end up being the political priority, the scale of need for better resourcing of our local government and prisons is painfully clear. Oh, and child poverty is on the rise.
4. You can’t cut every tax under the sun and end austerity
The pressures above mean this is likely to be an era of a larger rather than smaller state. We should debate the exact per cent of GDP of tax and spend, but these debates are happening in Britain 2019, sandwiched between a fiscal consolidation excessively focused on spending cuts and the demographic pressures of the 2020s. So a new government will announce tax cuts, given they were a key feature of the Conservative leadership election, but they are much less likely to have such prominence in the years ahead.
Politically the tax cuts Boris Johnson trumped in his leadership campaign do not make sense for a Conservative Party anxious to avoid being labelled the party of the few. Candidate Johnson’s £10bn proposal to cut income tax by 20p between £50,000 and £80,000, while clawing back some of the cost via a 10p increase in national insurance between the same bands, were particularly regressive. A full 85 per cent of the gains would go to the top 10 per cent of households, with six in seven people not earning enough to benefit at all.
Politicians should also remember clever tax cuts can accidently create a huge number of losers – as the last Labour government’s 10p fiasco proved. Indeed the proposal above would create millions of losers because national insurance is calculated weekly, while income tax is only assessed annually. So if you have a one-off large pay packet (a bonus say) you could end up being hit by the higher national insurance, but not benefit from lower income tax. The general lesson here is that big tax changes are hard to reverse, easy to make mistakes with and expensive to fix.
5. Don’t take your tailwinds for granted
The new Chancellor’s fiscal headroom/Brexit war chest, and all of our recently returned wage growth, rely on avoiding an economic mess in the near future. The £25 billion headroom outlined above will need to be weighed up against the (generally conservative) £30 billion fiscal hit the Office for Budget Responsibility expects from a No Deal Brexit. Similarly on wages, even sustaining the current level of real earnings growth requires faster productivity growth than we are currently seeing. A messy Brexit will further suppress that, not least by holding back investment.
Crucially an economic slowdown is likely to have an even bigger impact on household incomes than it has on GDP if accompanied by yet another big devaluation in the pound, and higher prices in the shops. It’s this combination of weaker productivity growth and higher prices that have meant that the last two years were the worst for household finances on record, outside of recessions. In fact they were even worse than the 1990s recession.
Economic uncertainty isn’t just about Brexit either – with the IMF downgrading its forecasts this week. So appointing the right person to the near impossible job of being the new Bank of England governor would be a good idea, as would preparing for the next recession while aiming to avoid it.
So while the political strategy calculation of Brexit may revolve around whether the Conservative Party can win back the Brexit party’s vote, a more rounded political calculation would include the cost of undermining the PM’s economic tailwinds in the process. Because while the history books will all be about Brexit, actual voters don’t live in the history books. In the here and now they’d like better public services and a pay rise.