Liz Truss was right: without growth, Britain is doomed

A copy of "Ten Years To Save The West" by Liz Truss is seen in a branch of the Waterstones book store
If only Liz Truss's government and agenda had survived, we would be in a far better place - Leon Neal/Getty Images Europe

On Tuesday Liz Truss launched her new book Ten years to save the West. It is a call to arms to those of us in favour of free markets and a free society to engage with the leftward drift of our governing institutions on the key choices of the day.

Central to the debate is growth.

It is clear that for Britain to create jobs and raise living standards, the economy must grow at a reasonable pace. This is also necessary to provide essential public services like health and education; otherwise there will be insufficient tax revenues to pay for them. Accordingly, growth is now a key objective for Labour in its newly announced programmes.

British growth has been weak for a long time and looks set to continue this trend. Since 2000, UK GDP per capita has grown at less than 1pc per annum; in the 20 years from 1980, it grew at close to 3pc each year. This is a massive slowdown.

Why did it happen? First, higher growth was, in my view, the result of root-and-branch reforms to the economy brought in under Margaret Thatcher. Inflation was tamed, unions were brought under the law, the labour market was made much more flexible by cutting back interventionist regulations, major industries were restored to private ownership and destructively high marginal tax rates on business and entrepreneurs were sharply cut.

Yet this came to a halt, and in key ways was reversed, when Labour came to power in 1997.

It welcomed the EU’s building of a social market economy, a highly interventionist agenda for re-regulating business and the labour market apparently aiming to redistribute income without direct tax cost. In addition those marginal tax rates were raised again, with the top rate going up to 50pc. After the disruptive financial crisis recession, tax rose as a percentage of GDP.

This isn’t surprising. Around the world growth has been associated with low taxation and limited business regulation. Models in which these are the key factors driving growth because of entrepreneurial incentives account for important previous growth episodes, including the UK, the US, and China.

Now turn to Liz Truss’s experience when she tried to reinvigorate UK growth by a programme of tax cuts and deregulation.

She met a wall of resistance, across the board, from left-wing think tanks concerned at a lack of tax to pay for public services, through economic commentators arguing that it was impossible to sell to bond markets, to – I suspect – the vast bulk of the civil service for whom it threatened a cut in their budgets.

The irony in this opposition is that without growth these very problems of public service unaffordability will multiply. The forecasts from our Cardiff economy models find that the public sector debt ratio to GDP will rise inexorably in the absence of growth.

This is now beginning to be more widely understood. So despite the mockery to which Liz Truss is routinely subjected owing to her government’s rapid defenestration, her return to the policy charge is increasingly welcomed. Even Labour, her bitterest critic, now subscribes to a mantra of growth, albeit with a poor idea of how to create it.

It is clear to me that if only Liz Truss’s government and agenda had survived, we would be in a far better place. The burning question, then, is what killed it.

The answer is not that hard. Our own institutions did. It quickly became clear to me that the Truss programme was opposed by the Treasury, whose orthodoxy it flouted, by the Bank of England that found itself under attack for creating inflation and too slow a response to it, and by the OBR which found itself sidelined. The ensuing campaign of destruction is carefully set out in Truss’s book.

The mechanics revolved around the market yield on government bonds, off which mortgage rates are set by arbitrage.  Mortgages obviously have high political sensitivity, so as their rates rose, the Truss government became imperilled by its own backbenchers.

The government bond yields were rising anyway as US interest rates rose to combat inflation. However because the Bank was too slow to raise UK rates, domestic inflation expectations worsened, driving up expectations of future interest rate rises which then drove up long term bond yields via arbitrage with futures markets.

The rise in these long term yields and the implied fall in their prices then created the “LDI crisis” in which pension funds faced serious losses and collateral demands as regulators forced them to raise their bond holdings. Matters were further worsened by the Bank’s decision to sell off its bond holdings aggressively under “Quantitative Tightening”.

It was a perfect storm which cried out for calming Bank market tactics.

It should have raised short term interest rates, bought long term bonds to cool the fever in the long bond market and explained that its plan to bring down inflation would avoid the need for absurdly high interest rates down the line.

Had it done so, the storm would surely have passed. Instead, the Bank bought long bonds for a few days to calm the LDI crisis and then withdrew from the markets, leaving the government totally exposed to the political fallout from the rise in mortgage rates.

The resulting government collapse was of course very welcome to these institutions, and the general verdict from the government’s many opponents was that “UK institutions had come out on top”.

However, our democracy and our economy have suffered grievously from this apparent insubordination by officials who are supposed to serve it. We are counting the cost today. And we must welcome Liz Truss’s bravery in returning to this vital growth agenda in spite of the brickbats thrown at her.