“It’s the economy, stupid.” That was the constant refrain of strategist James Carville when talking to staffers on the Clinton campaign back in 1992. Thirty years on, it remains decent advice to political aides. As Liz Truss is discovering, if voters believe the economy is heading in the wrong direction, the incumbents usually get the blame. The banking crisis of 2007 to 2009 was the major factor behind Gordon Brown’s defeat in 2010. But he’s far from the only example. A study by political scientists of the impact of that crisis on elections in 30 European countries suggests that whether a government is of the left or the right does not matter. Whoever you are, sitting in the hot seat during an economic crisis burns.
But how fair is this? Are governments really the ones in control anyway? That depends on what you mean by control. In a country like Britain, being an economic policymaker is more akin to sailing a boat than driving a car. A government can tack and trim with a greater or lesser degree of skill, but in the final analysis it cannot change the direction of the wind. Sometimes politicians get lucky and other times they do not. Sometimes they don’t just mess up the setting of their sails but needlessly put a hole in the hull.
Despite the importance of the economy in voters’ minds, the general trend over the last few decades has been for governments to give up economic power rather than take on more. Ever since May 1997 the Bank of England, the UK’s central bank, has been operationally independent. Control over interest rates – the key tool for managing the fluctuations of the economic cycle in the short run – was handed over by the chancellor to the nine technocratic members of the Bank’s Monetary Policy Committee.
Like so many of the early actions of the New Labour government, granting independence to the Bank of England was very much in keeping with the economic orthodoxy of the time, and having an independent inflation-targeting central bank has become the norm globally. The theory behind this apparently anti-democratic setup is essentially that politicians cannot be trusted to run the economy well. They will, so the argument runs, be tempted to lower interest rates before an election in order to curry favour with voters, and may combine this with cutting taxes or increasing spending. When difficult decisions have to be taken, such as raising borrowing costs in order to lower inflation, they will duck them or delay. By contrast, technocrats not subject to political pressure should be able to take decisions that may cause some immediate pain but help smooth the path in the long run. What’s more, the very fact that firms, investors and wage bargainers believe a central bank is prepared to hike interest rates in order to bring inflation down can be enough to decrease it without the need for higher interest rates.
Even the Bank of England’s freedom to set interest rates is limited, though. Britain is a relatively small, open economy. It may be the fifth or sixth largest in the world – depending on how you measure it – but it is still a mere fraction of total global GDP. If other central banks – such as the US Federal Reserve or the European Central Bank – are raising rates, then the Bank often has little choice but to follow. Failure to do so would make the pound less attractive to international investors, causing its value to fall and the price of imported goods such as energy and food to rise. There is a vein of commentary in the US that bemoans the dollar being the linchpin of the international financial system. That fact tends to keep its value high and has almost certainly cost the country manufacturing jobs over the last few decades. But the one thing worse than having the world’s primary reserve currency is not having it – and being a monetary follower rather than a leader.
Even if most governments no longer control their own monetary policy, having outsourced that to technocrats, they still generally have their hands firmly in control of fiscal policy – government spending and taxation. Even here, though, they face real constraints. The room for fiscal manoeuvre is not limitless. If a central bank reckons that a government has increased spending, or cut taxes too much, and that this will result in higher inflation, then it will move to offset the impact and raise interest rates. Just ask Liz Truss and Kwasi Kwarteng.
And then there are the voters. They might, in principle, like the idea of faster growth but they have a habit of opposing the practical steps that would make it possible – for example, liberalising immigration, building more houses and breaking the ground on big infrastructure projects.
Britain’s new prime minister and her team recognise that the country has a growth problem. In the decade before the financial crisis, the country experienced the second fastest growth among the G7 group of leading economies. In the decade afterwards, it had the second slowest growth in that group. But getting growth back up to something like 2.5% a year will not be straightforward. It certainly will not come about simply through cutting taxes.
The real lesson of economic history is that governments tend to overestimate how much they can change a country’s economy in the short run, but underestimate their potential impact over the longer term. Any budget, even two or three of them, can only achieve so much. But a parliament or two of gradual changes in skills policy, in infrastructure investment, in planning reform and in incentives around research and development – that can shunt the economy down a parallel and improving path. Unfortunately for those in power, this will often only show up in the data a decade or so later. That is grounds for optimism about the future – but is probably cold comfort for politicians looking to the next election.
• Duncan Weldon is the author of Two Hundred Years of Muddling Through: The Surprising Story of Britain’s Economy from Boom to Bust and Back Again (Little, Brown).
Further reading
Global Economic History: A Very Short Introduction by Robert C Allen (Oxford, £8.99)
States and Markets by Susan Strange (Continuum, £21.99)
Mission Economy: A Moonshot Guide to Changing Capitalism by Mariana Mazzucato (Penguin, £10.99)
