Liz Truss Has Been a Victim of Forces Beyond Her Control — and That’s a Disaster for Britain

B y now, it is clear that British prime minister Liz Truss is, in the famous phrase, in office but not in power. She has sacked her close political ally and good friend Kwasi Kwarteng as chancellor of the exchequer after a record-breaking short period in office (only a chancellor who died after 30 days lasted for a shorter period) and replaced him with a “safe pair of hands,” Jeremy Hunt. Hunt has proceeded to rip up all of Kwarteng’s economic plans and provide an alternative vision that has calmed the markets but reduced Truss’s power more. Her Conservative Party is facing electoral oblivion, her personal unpopularity is unprecedented, and her days in 10 Downing Street may well be numbered — but who would want to replace her?

The perception is that free-market economics (or “market fundamentalism” if you listen to many of the critics) failed badly and crashed the British economy. As a result, not only has the Conservative Party seemingly lost its reputation for economic competence, but free-market policies are seen as the reason. This may well be a disaster for Britain, with one commentator saying, “The dream of a low tax, pro-business Britain is dead for a generation.” Anti-free market ideologues of Left and Right will be jumping on this perceived failure all over the world. Even a former free-market Conservative Party leader is saying, “Ideology is dead.”

Yet that reaction is overblown. Truss and Kwarteng made mistakes, certainly, but to a large extent they were victims of forces beyond their control. A closer examination reveals why.

First, to get it out of the way, Truss and Kwarteng mishandled their policy announcements. Badly. Kwarteng announced a supply-side strategy that focused heavily on tax cuts, with announcements on deregulation and spending to come. Yet at exactly the same time, he announced a massive new spending program aimed at alleviating the cost of energy-price increases to British households, and seemed to indicate an open-ended commitment. He and Truss wanted to focus on growth as the solution to Britain’s miseries yet at the same time gave no indication that they knew how to balance the books. This was the trigger for the economic chaos that was to follow.

What the markets saw was not a plan for growth, but a massive, unfunded fiscal stimulus at a time when inflation had reached double digits and the Bank of England had failed to raise interest rates as swiftly as it should have. Fears of a wage-price spiral gathered pace, and lack of confidence in the central bank helped cause a flight from sterling to the dollar, raising import costs and adding further inflationary pressure.

The lack of confidence in the government’s plans led to a swift rise in bond yields, which makes sense — if you are worried about a government’s ability to pay its debts, you’ll require a higher yield on those debts. Yet the panic was in many ways overblown. As Tyler Cowen pointed out at the time, “The UK government is borrowing more money at negative 2% real interest, and through tax cuts is allowing its wealthier private investors to reap higher expected returns. Politics aside, this is hardly the stuff from which economic disasters are made.”

Michael Strain was similarly bemused: “Markets and commentators have wildly overreacted. Much of what Truss has proposed is perfectly sensible.” As Strain noted, the tax cuts were the weakest part of the proposed strategy, yet they were the measures Truss and Kwarteng chose to lead with.

Unfortunately for the new government, the rise in bond yields coupled with a flight from Sterling triggered a crisis in U.K. pension funds. The U.K. has a lot of people still enrolled in legacy defined-benefit pensions, which in a world of low interest rates required some innovative hedging strategies. One of these strategies, known as Liability Derived Investment, relied on low bond yields and stable foreign exchange rates. With both these pillars removed, the pension funds faced margin calls that could have led to their collapse, probably requiring a massive bailout. The Bank of England stepped in as buyer of last resort to stabilize the bond market. This combination of circumstances is what people started calling the crash.

At this stage, one might ask how the financial regulators missed this after all the measures that were put in place following the financial crisis and the Eurozone crisis. In fact, they had looked at almost exactly the same situation in 2018 and concluded they had little to worry about. The Bank of England is independent of the government and there is a cross-party consensus that it should remain so. The central bank’s miss was not the government’s fault.

Well, what about that energy spending? As Andrew Lilico observes, it was thought to be a political necessity. Failing to do anything would have brought about just as much a crisis as the bailout. Indeed, ministers were boasting that the package was bigger than those of Britain’s European neighbors. Whole essays could and have been written about how the U.K. got into this energy-price mess, but it has been a long time coming. Kwarteng at least bears part of the responsibility for the problem from his time as business secretary, but some blame must also go to environmental activists who stopped the development of fracking and nuclear.

One hidden factor in all of this is the attitude of British business itself. Far from being fans of free-market supply-side reforms, British companies have grown hostile to deregulation. As a Financial Times columnist put it, “Nearly two years after Brexit-proper, the penny still doesn’t seem to have dropped that business overwhelmingly wants certainty, particularly when it comes to existing regulation that they’ve already invested in complying with.” They quite like that EU red tape, after all. The Truss supply-side agenda was supposed to be about creating more entrepreneurs, but as they don’t exist yet, their views aren’t considered.

This leaves Britain in a strange position — more spending is out of the question (which will be a potential problem for Labour when it takes over), but so are spending cuts. Tax raises are fine, as long as they are on the rich or businesses. Regulation is “just right.” Yet in reality the Bank of England has been exposed, inflation remains a problem, regulators are happy to expand their power, and Britain’s energy crisis is ongoing.

One of the virtues of market economies is that they provide information that policy-makers need to react to. What the British crisis has shown is that swift supply-side reform is unfeasible there at the moment. An incrementalist approach is much more likely to succeed. Yet time for that is limited. As the ever-insightful Allister Heath says, when Labour comes into power, it will probably bring “the hard Left, the full gamut of punitive taxation, including of wealth and housing, and even more spending, culminating rapidly in economic oblivion.”

And it will be cheered for doing so.