Dr Gerard Lyons is a senior fellow at Policy Exchange. He was Chief Economic Adviser to Boris Johnson during his second term as Mayor of London.
Whoever wins the leadership race will inherit a difficult economic backdrop. More help will need to be provided to those in need, to help pay fuel bills this autumn.
Inflation has yet to peak, and could remain elevated this winter. Then there is the continued fall-out from the war in Ukriane and sanctions. Power cuts this winter are a possibility.
To compound this difficult backdrop, economic growth both here and globally looks set to slow. In fact, financial markets now believe that global inflation pressures are peaking, and their focus is on the prospect of a worldwide slowdown and possible recession.
What can be done? The leadership race has focused on taxes. Perhaps that is understandable, as it is an area of policy difference between the two contenders.
However, in another respect it may seem odd. That is because both candidates are committed to lower taxes, eventually, as indeed is the party they intend to lead.
Perhaps more importantly, it is growth – not tax – that should be the main issue. Indeed, tax policy should be seen in the context of a pro-growth economic vision. Such a vision has been lacking for some time.
Since the Second World War there have been four boom-busts: under Reginald Maudling, Anthony Barber, Nigel Lawson, and Gordon Brown. Even when chancellors have gone for growth, it has not always been sustained.
Admittedly, under Lawson supply-side policies were put in place that helped the economy. But keeping domestic demand in check has usually been the problem.
Since the 2008 global financial crisis, though, the challenge has become one of weak growth. And it has been evident in other Western European countries too. Since then we have emerged as a low-growth, low-productivity, and low-wage economy. To make matters worse, it is possible to now say a high-tax one too.
As a result, the need for a pro-growth vision should be central to our overall national economic debate. The fact that is not should tell us something.
Perhaps the status quo consensus thinking of economists is not able to provide the solution. Indeed, it is in that context that the criticisms by a number of the leadership candidates about the economic establishment was telling. There is a need for change.
One remarkable feature is that the two per cent inflation target has been missed by a mile. Yet, anyone who utters a critical word about the Bank of England is shut down.
This is not new, it has been characteristic for some time. But the argument that the Bank has achieved its two per cent inflation target over the last quarter century – and so should be trusted – is not good enough. For the bulk of that time, global inflation was low as China and other emerging economies exported low inflation through intense competition.
At the very least, the Bank needs to be held to more scrutiny, and ideally there should be a re-examination of its processes and policy remit.
Likewise, the economic and fiscal projections of the Office for Budget Responsibility (OBR) have a high margin of error. That is not a criticism, it is often the way it is with forecasts. Their analysis is always worth reading. Yet, when it suits the existing orthodox narrative, the forecasts are treated as if fact.
Just take the current debate about tax and whether there is any fiscal space to ease policy. In March 2021 the OBR forecast that borrowing in 2021/22 would be £234 billion. Such poor figures were used in the argument by the Treasury to hike national insurance. In the event the deficit for the year was just under £142 billion. A huge difference.
Then there is the Treasury, the super-ministry that dominates Whitehall. It combines powers that are split between different ministries in other countries, in particular separate budgetary end economic departments that are combined here.
Criticism of the Treasury does, in some respects, go to the heart of the current debate about an orthodox way of thinking.
But it would be wrong to blame the mandarins. It is the political leaders that need to provide the vision.
Yet it is important to be mindful of the orthodox view that dominates, which is that the UK is a slow-growth economy. Thus, more of the budget deficit is structural, explained by underlying forces, as opposed to cyclical, linked to where we are in the economic cycle.
Believing more of the deficit is structural points to squeezing government spending and higher taxes. This tax aspect has been much in evidence in policy thinking in recent years – it is like being in a hole and digging deeper.
Such thinking is misplaced and needs to be turned on its head.
In the current context, the UK faces twin problems of rising inflation and weaker demand. It requires a tighter monetary policy to keep inflation in check. Tax cuts that are timely, targeted and affordable are not inflationary, and are necessary to address weaker demand and are affordable.
Next spring the planned increase in corporation tax plus the ending of the investment super-deduction and the lowering of the annual investment allowance will see a tax cliff edge for business and as a result we will fall to 31st of 38 in the OECD for business competitiveness.
We need to focus on improving competitiveness with supportive tax policies. For many small firms, a start could be made by simplifying the tax system as well. It also requires working alongside the City to ensure more finance finds its way to fund British-based business.
The question should be, how can we grow the economy at a stronger pace?
Indeed, that is why taxes have to be seen in the context of an overall growth agenda. If not, then policy-hands will always be tied for the reasons noted above.
But it also should highlight that control of public spending, too, should be central. Taxes should not be thought of as just funding public spending. Yet, often they are.
Clearly, we need first-class public services. But reform is overdue. This is rarely talked about, even in a leadership debate.
The leader of the opposition has implied that the UK’s position is worse than others. That is wrong. Germany is heading for a deep recession. The European Central Bank (ECB) is discovering that a one-size-fits-all monetary policy can’t work. Their interest rates are not high enough to keep inflation at bay in Germany. In contrast, higher rates threaten a sovereign debt crisis.
Hence last week the ECB introduced a new protective tool: the Transmission Protection Instrument. Known as the TPI, it is best to think of it as Totally Protect Italy, whose debt position is poor.
This is not the only reason why it is wrong to say Britain is in a worse position than others. The good news is our economy has the ability to rebound to shocks. The flexibility of our labour market is just one example of that, as too was our ability to develop and distribute a vaccine at speed during the pandemic.
Part of the challenge is our lack of ambition, and the reluctance to change unless forced too.
A three pronged pro-growth strategy is needed: sound money to keep inflation low; reducing debt to GDP gradually over time; and supply side polices focused on the four “I’s of investment, innovation, infrastructure, and the incentives of smart regulation and low taxes.