Lord Willetts is President of the Resolution Foundation. He is a former Minister for Universities and Science, and his book a University Education is published by Oxford University Press. He worked as an official in the Treasury.
After a brief flirtation with Reaganomics, the Conservative Party has now returned to the stern rigours of Thatcherite economics. This is firmly rooted in the realities of managing the family finances with a dose of Methodism as well.
I did once ask Mrs Thatcher why she had moved from Methodism to Anglicanism, and she said that Methodism was rather boring. We could do with some rather sober boring economics for a time, but there is still a lot to be done to get there. The next step is the financial statement due next Monday.
The fiscal scene facing the new Prime Minister now is very different from the one he himself set out in his March Budget. The Prime Minister and the Chancellor have got good grounds for their new Government not being held responsible for the mess that followed. Then there was £30 million of headroom in the public finances – which Liz Truss promptly spent. It was a vivid example of the Treasury’s dilemma that markets like seeing some fiscal headroom but ministerial colleagues always try to spend it.
The March budget suggested a borrowing requirement of £32 billion in 2026-27 – well within the fiscal rules. Our assessment at the Resolution Foundation is that the position is now a lot worse. Economic growth is not quite what was expected, and that will add over £20 billion to borrowing by 2026-27. Kwasi Kwarteng’s tax cuts have add another £45 billion.
Then the increase in interest rates, partly a global trend but exacerbated by a loss of confidence in British fiscal discipline, adds another £30 billion. Jeremy Hunt has started regaining the lost ground. His reversal of many of the tax cuts brings in about £30 billion, but that is only enough to offset the increase in the cost of borrowing.
Put all that together and we estimate borrowing will be about £95 billiom in 2026-27. That would probably break both of the Government’s fiscal rules. Borrowing would not just be funding capital spend but also some current spend. And national debt would still be rising. That is why Hunt is going through a cuts exercise now. He probably needs to cut about £30 billion from borrowing in 2026-27 to comply with his fiscal rules.
This cuts exercise is happening at the same time as the new Government is being formed. That is both an opportunity and a risk. The opportunity is quite simple – new ministers can be told that if they want to be appointed they have to agree to public spending cuts in their department. This is what Number 10 and the Treasury dream of. From time to time they have tried a kind of department-specific appointment letter where the new minister has to sign up to some tough options before leaving Number 10 with their prized new post. This unusual timing of a new Government coinciding with a cuts exercise is an opportunity for such an approach.
However, there are risks too. The Treasury is never quite sure if it would rather negotiate with an ingenu at their moment of greatest vulnerability or a wily old veteran with much greater grasp of what can or cannot be done. Many decades ago, I worked as an official in the Treasury General Expenditure Policy division – the only part of the Treasury to have survived unchanged over the decades. It is so hard-line that it regards the rest of the Treasury as dangerously soft on expenditure control.
I was there early in the Thatcher Government, and Keith Joseph was Secretary of State for Trade and Industry. He did not believe in most of what his Department did. Whatever cuts we asked for he conceded. If only, we thought, other spending ministers were like him. So we pocketed the cuts.
All was fine for about six months, until it became clear that just about every steel plant in the country was going to close as all Government support was removed. It was right to phase out the subsidies, but this was all too sudden and disruptive and was going to disrupt the supply chains of British manufacturing. The Government did an expensive about-turn and helped keep some of the steel plants going.
We had not considered any of this because the negotiations on the DTI budget had been so easy the Government had never had to assess the consequences of what it was deciding. It is important for the quality of decision taking that spending ministers do a bit of role-playing and make the case for their programmes and explain what cuts might mean. So the new Government does need serious collective discussion of its fiscal plans to ensure they are deliverable and hence credible.