In Great Britain, 1976 was marked by three major events: a summer heat wave, a change of prime minister and a crisis in the pound sterling. In 2022 we had the first and we will soon have the second. Few would be entirely surprised if the third arrived by the end of the year.
As was the case this year, in the summer of 1976, people were enjoying the sunshine and didn’t seem to care much about high inflation. According to a 2004 report by the New Economics Foundation think tank, the UK has never been happier than it was the year Denis Howell was appointed drought minister, Concorde carried out its first commercial flight and the Sex Pistols launched Anarchy in the UK.
However, as the year progressed, the economic problems intensified. James Callaghan, who succeeded Harold Wilson as prime minister in April, was forced to turn to the International Monetary Fund for financial support. An IMF team spent the fall crafting a package that involved painful spending cuts. Diaries of then-Energy Minister Tony Benn reveal how the cabinet was split between those who reluctantly supported austerity and those – like Benn – who thought Britain should try to get out of trouble .
The UK is now less than a month away from having a new prime minister and for Rishi Sunak or Liz Truss the challenge seems as daunting as it did for Callaghan. The economy contracted by 0.1% in the second quarter of 2022, which was actually slightly better than expected, but the growth numbers don’t quite capture the fundamental weakness in the economy. A better guide for this are the trade numbers, which are truly abysmal. As Samuel Tombs, a British economist at Pantheon Macroeconomics, has pointed out, the trade deficit as a percentage of GDP has been larger in the first six months of 2022 than in any comparable period since quarterly records began in 1955. The position only gets worse. worsen in the second half of 2022 when the bill for imported gas increases sharply. Sterling looks vulnerable, Tombs says, and he’s right.
There are many things that could trigger a run on the pound. Inflation could exceed the Bank of England’s forecast of 13%, the recession could arrive earlier and be deeper than expected. Financial markets would react badly to any social unrest following the increase in the energy price cap in October. They are also worried about hints from Truss that she will meddle in the independence of the Bank of England.
In some ways, the struggle between Truss and Sunak mirrors that between Callaghan and Benn in 1976: one more cautious and the other more radical. With a difference. If the polls are accurate, this time the radical – Truss – will win. It aims to revitalize the right in the manner of Margaret Thatcher in the 1970s.
This will prove a certain task. Thatcher was Leader of the Opposition in 1976 at a time when post-war social democracy seemed to be playing out. His argument that strong action was needed to curb inflation and the power of unions found resonance. The country was ready for a period of austerity, although in 1976 it had no idea how harsh austerity would be.
Truss’s economic approach seems to owe much to Joseph Schumpeter, the economist who championed creative destruction as a means of constantly reinvigorating capitalism. To be sure, there is an argument – strongly advanced by Edward Chancellor in his new book The Price of Time – that a prolonged period of ultra-low interest rates has misallocated capital and stifled productivity growth by maintaining zombie companies alive.
But neither emotionally nor intellectually does Britain seem ready for a government that allows – or even encourages – businesses to go bankrupt en masse. Truss is also swimming against the tide if she thinks this is a country that would rather cut taxes than money on its energy bills. The huge support package provided to support the economy during the coronavirus pandemic has set a precedent.
Sunak seems more in tune with the public mood, but he too is an instinctive small-state conservative trying to come to terms with the fact that this is now Britain. Between 1997 and 2010, when faith in free markets and globalization was absolute, Britain had a centre-left government that struggled to find a way to accommodate the prevailing orthodoxy. Since 2010, it has seen a series of right-wing administrations struggling to adjust to a world that, as far as the economy is concerned, leans to the left. In their different ways, Theresa May and Boris Johnson have figured this out, which is why they talked about helping the ‘just manage’ and ‘leveling up’.
Despite the bleak economic outlook, there is still a chance the Conservatives will win a fifth term. Inflation will begin to fall rapidly in the second half of next year. Growth and living standards could rise by 2024. Voters might not be convinced that Labor would be significantly different. The election could be decided on the basis of culture wars rather than economics.
But even to get to the stage where it will be competitive in the next election, the government must avoid a full-scale economic crisis. The choice is simple. Deliver massive, rapid relief so people can heat their homes and experience a relatively mild recession, or refuse to act and experience a monstrous recession. The question is not whether the coming winter will be dark, but how dark. And, if Truss wins, if the queen is to spin.