In Britain, the year 1976 was marked by three big events – a summer heatwave, a change of prime minister and a sterling crisis. In 2022, we have had the first and will soon get the second. Few would be entirely surprised if the third arrived by the end of the year.
As has been the case this year, in the summer of 1976 people enjoyed the sunshine and seemed not to care much about high inflation. According to a 2004 report from the New Economics Foundation thinktank, the UK has never been happier than it was in the year when Denis Howell was made the drought minister, Concorde made its first commercial flight and the Sex Pistols released Anarchy in the UK.
However, as the year wore on, the economic problems intensified. James Callaghan, who had taken over as prime minister from Harold Wilson in April, was forced to go to the International Monetary Fund for financial support. An IMF team spent the autumn coming up with a package that involved painful spending cuts. The diaries of Tony Benn, the then energy minister, reveal how split the cabinet was between those who reluctantly supported austerity and those – such as Benn – who thought Britain should try to grow its way out of trouble.
The UK is now less than a month away from getting a new prime minister and for either Rishi Sunak or Liz Truss the challenge looks 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 figures do not really capture the fundamental weakness of the economy. A better guide to that are the trade figures, which are truly appalling. As Samuel Tombs, a UK economist at Pantheon Macroeconomics, pointed out, the trade deficit expressed as a percentage of GDP has been bigger in the first six months of 2022 than in any comparable period since quarterly records began in 1955. The position is only going to get worse in the second half of 2022 as the bill for imported gas rises sharply. Sterling looks vulnerable, Tombs says, and he is right.
There are plenty of things that might trigger a run on the pound. Inflation could overshoot the Bank of England’s 13% forecast, the recession could arrive sooner and be deeper than expected. Financial markets would react badly to any social unrest that followed October’s increase in the energy price cap. They are also worried about Truss’s hints that she will meddle with 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 one difference. If the polls are right, this time the radical – Truss – is going to win. She aims to revitalise the right in the way Margaret Thatcher did in the 1970s.
That will prove some task. Thatcher was leader of the opposition in 1976 at a time when postwar social democracy looked to be played out. Her argument that tough action was needed to curb inflation and union power found an echo. The country was ready for a period of austerity, even though in 1976 it had no idea just how tough the austerity would be.
Truss’s economic approach seems to owe much to Joseph Schumpeter, the economist who championed creative destruction as a way of constantly reinvigorating capitalism. To be sure, there is an argument – strongly made 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 keeping zombie companies in existence.
But neither emotionally nor intellectually does Britain seem to be ready for a government that allows – even encourages – firms to go bust in their droves. Truss is also swimming against the tide if she thinks this is a country that would prefer cuts in taxation rather than money off their energy bills. The massive package of support provided to sustain the economy through the coronavirus pandemic 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 big-state Britain. Between 1997 and 2010, when faith in free markets and globalisation was absolute, Britain had a left-of-centre government that struggled to find a way of adapting to the prevailing orthodoxy. Since 2010 it has had a series of rightwing administrations struggling to adapt to a world that – as far as the economy is concerned – has been leaning leftwards. In their different ways Theresa May and Boris Johnson understood this, which is why they talked about helping the “just about managing” and “levelling up”.
Despite the grim outlook for the economy, there is still a possibility that the Conservatives could win a fifth term. Inflation will start to fall rapidly in the second half of next year. Growth and living standards might be rising by 2024. Voters might not be convinced that Labour would be significantly different. The election might be fought on the basis of culture wars rather than the economy.
But even to get to the stage where it is competitive at the next election, the government has to avoid a full-strength economic crisis. The choice is simple. Provide massive and speedy assistance so people can heat their homes and have a relatively mild recession, or refuse to act and have a monster recession. It is not a question of whether the winter ahead is going to be grim but of just how grim. And, if Truss wins, whether the lady is for turning.