The great virtue of markets is that they are coldly actuarial and politically indifferent. Win them over and you can get a lot done. Just ask Javier Milei, President of Argentina. Milei has defied his left-wing critics and the distrust engendered by a lengthy history of defaults to slash public spending, rebuild reserves and tackle inflation.
Fall out of favour and it is a different story. Bond markets are no longer buying Labour Chancellor Rachel Reeves’ proclamations that she is ‘going for growth’ with her plans for a tax-financed state expansion and debt-financed investment splurge which she laid out in her first Budget.
Markets fear her plans will add to inflation, further damage growth, and drive public borrowing even higher. This is why 10-year gilt rates, a key benchmark upon which borrowing costs across the economy are set, have risen from 4 per cent in mid-October ahead of the Budget, climbing to 4.9 per cent, virtually wiping out her limited headroom against self-imposed fiscal targets.
Although UK interest rates are climbing as part of a wider global trend, our outsized increase versus other economies indicates that it is growing riskier to lend to the UK than say, the US and Germany. Global creditors have the UK government pinned to the wall, demanding that the numbers underlying the government’s economic plans add up.
Starmer and Reeves should admit that state expansionism has reached its limit
Some say this is all terrible. Why should the government of the UK be at the mercy of faceless international creditors? But the turmoil serves as a reminder that political rhetoric is no substitute for economic reality. The last time a Westminster government embraced the harsh, but fair, discipline of markets was under Margaret Thatcher’s Conservatives. The result? From the sick man of Europe, the UK emerged as its most dynamic economy.
Until Reeves gets markets back onside, UK borrowing costs may keep rising. At least the Chancellor can say with a straight face that she is not solely responsible for the UK’s economic predicament, despite an unpropitious six months in the job. But now that Labour are in power, it falls on them to take the responsibility and opportunity handed to them by voters to stop and reverse the rot. A weak currency since 2008. An atrophying equity market. Anaemic economic growth. Repeated market panics. None of this is normal.
Anyone paying serious attention would see that the UK’s problems are decades – not years or months – in the making. Our 30-odd year experiment with neo-socialism under both Labour and Conservative governments has failed. When the Berlin Wall fell in 1989, the whole world agreed that free market economies in Western Europe, North America and parts of Asia had won the economic argument against the Soviet-backed central-planned economies. But in a sad irony of history, many western economies, including Britain, then shifted in the wrong direction towards an ever-bigger state and de facto central-planning through regulation.
Since 1990, UK public spending has risen from 35 per cent to 45 per cent of GDP while taxes have risen from 34 per cent to 41 per cent of GDP. Office for National Statistics data show that productivity in UK public services has flatlined since 1997. For each additional pound redistributed from the private sector, where it is earned, to the public sector where it is spent, productivity growth slows.
Many industries and businesses are private ‘in name only’ when how and what they can produce and sell is increasingly decided by the whimsical pen strokes of lawmakers. In their increasing efforts to protect consumers and workers from market failures and externalities, the fine-tuners in government and in Whitehall have created a bigger problem: an economy that no longer properly works.
Lengthy and needlessly complex planning processes, and ever-changing rules, inhibit productivity-enhancing investment and create parasitic compliance costs that squeeze profit margins and harm living standards.
Based on the then-Conservative government’s original plan, sales of petrol cars – one of the great liberators of mankind – were to be banned by 2040. But that date was brought forward to 2030 before being pushed back to 2035. Now Labour wishes to make it 2030 again.
How exactly can businesses risk their precious capital in this environment? The answer is that they cannot – which is why so many of them sit on piles of cash and yet seem to chronically underinvest in growing their productive capacities. Comparing the UK to the US – which has managed to retain at least some degree of healthy distrust for economic rule makers and regulators – shows a staggering difference in fortunes.
According to World Bank data, and adjusted for purchasing power, UK per capita GDP has slipped from 80 per cent of the US level in 1990 to 73 per cent in 2023. America started richer and is pulling ever further away. Even the sclerotic EU is starting to wake up. Mario Draghi, ex-European Central Bank President and ex-Prime Minister of Italy, concludes in his competitiveness strategy for Europe that ‘innovative companies that want to scale up in Europe are hindered at every stage by inconsistent and restrictive regulations.’
If Starmer and Reeves remain committed to growing the state, to balance the books they will need to raise taxes further. But if higher taxes tank the economy and widen the deficit further, it could backfire badly. A better option would be to admit that state expansionism has reached its limit, overregulation has failed, that the private sector cannot take higher taxes and that global financial markets will not tolerate more borrowing.
By making UK debt more expensive and constricting the government’s economic plans, the bond market is effectively saying today that enough is enough. The UK stands at a crossroads. One path leads to less growth, more inflation and the risk of repeated crises. The other path leads to more growth, less inflation and stability. If Labour fails to grasp the nettle, the opportunity is ripe for the Conservatives to put forward a genuine plan for embracing free-markets and shrinking the state down to size. Kemi, are you watching?
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