Liz Truss’s inheritance: A UK economy on its knees

Liz Truss will face the most daunting economic outlook for an incoming British leader since her hero, Margaret Thatcher, in 1979.

New Conservative Party leader Liz Truss is facing economic headwinds from all directions. Picture: Getty Images.

Britain’s new prime minister, Liz Truss, will face the most daunting economic outlook for an incoming British leader since her political hero, Margaret Thatcher, became the UK’s first female prime minister in 1979.

Britain’s slowing economy is poised to enter recession, inflation is at its highest rate in decades and households are facing crippling energy bills from the war in Ukraine.

Productivity growth has dropped to half the rate it was in the early 2000s, real wages are falling, the pound is nearing record lows and an ageing population is placing a growing strain on public services, even as the government tries to rein in the public spending that soared during the Covid-19 pandemic.

Britain’s exit from the European Union has hampered trade with the country’s largest trading partner, and immigration restrictions have choked off access to inexpensive European labour. That has worsened a labour shortage of a scale not seen in the rest of Europe, driven by an unexpectedly high number of people leaving the workforce after the pandemic.

The energy crisis combined with a labour crunch is an inflationary double whammy.

“They have the worst of both worlds,” said Mark Flanagan, who until recently led the UK team at the International Monetary Fund.

The country is on track to record the lowest economic growth and the highest inflation in the Group of Seven rich countries next year, according to the Organisation for Economic Co-operation and Development. The economic policy forum predicts the UK economy will record zero growth in 2023 and that inflation will run at 7.4 per cent.

Without major government intervention, the combination of higher energy prices and weak wages will translate to a fall of roughly £3000 ($5000) a year in average disposable income for UK households by 2024 – the biggest single decline in living standards in a century, according to the Resolution Foundation, a British think tank.

Only sanctions-ravaged Russia will have a worse economic performance next year among all major economies, the IMF predicts. While a prolonged period of stagflation – the unusual condition when high inflation combines with stagnant consumer demand and relatively high unemployment – isn’t yet on the cards, “policymakers need to be aware that there is an enhanced risk”, said Mr. Flanagan.

The British government has said those risks are overblown. UK Chancellor of the Exchequer Nadhim Zahawi pointed to the country’s record high employment and said many households built up savings during the pandemic and that its financial sector was well capitalised. “I think the UK economy is pretty resilient,” he said.

Ms Truss hasn’t yet laid out what she will do to mitigate what the public and press call the “cost of living crisis”. The 47-year-old former foreign secretary is a libertarian who campaigned on tax cuts to revitalise the economy rather than on more government spending. The Conservative Party’s 172,000 members selected her to replace Boris Johnson as prime minister in part because she promoted a feel-good vision of a smaller, nimbler British state. However, she is expected in the coming days to announce large-scale state intervention to help households and businesses deal with higher gas prices. This could push up government debt dramatically.

She will face the continuation of what has been a long, hot summer of discontent. Wage growth has lagged behind rising prices, and recent months have seen numerous strikes, including the biggest rail walkout since 1989.

Threats of a coming recession have weakened the pound, which is flirting with its lowest level since the mid-1980s, making travel and imports more expensive. The UK is a net importer of food, energy and manufactured goods, leaving it vulnerable to global price swings.

Britons are struggling to get passports, driving tests or appointments with doctors as public services creak in the wake of the Covid-19 pandemic and funding shortfalls.

Things are expected to get worse during the winter months, when cold weather will drive up energy bills for homes and businesses. Starting in October, the average British household will pay £3549 a year to heat their homes – nearly triple the rate paid last year, according to figures by UK energy regulator Ofgem, which sets a cap on household energy prices. Ofgem periodically revises its energy price cap to reflect market prices. By next April, that could soar to £5300 a year, according to estimates by independent energy consulting firm Cornwall Insight.

Unlike Germany, which has large domestic storage facilities for natural gas, the UK shut down its last gas storage facility in 2017, giving it no cushion against shocks in the spot price. The government is now rushing to reopen the facility.

Britain hasn’t yet matched the policies of some European countries that have stepped in to shield customers from rising energy prices and are putting plans in place to reduce energy consumption this winter.

“I feel like I am standing on the cliff edge asking myself, ‘When are we going to fall off?’” said Andreas Antona, who owns Simpsons, an upmarket restaurant in Birmingham, England.

His 80-strong staff are asking for pay raises to cover their bills. “The business can’t really take it, as we can’t put up our prices,” said Mr. Antona, who also runs a pub in the area.

The government has pledged some help for households to help them absorb some of the energy price hike, but there isn’t a program for small businesses such as pubs and restaurants. Bankruptcies in the UK rose 80 per cent to 5629 from the April to June compared with the same period last year, according to government statistics, and economists warn of a wave of bankruptcies over the winter.

Val Burrows, who runs a laundry shop in East Grinstead, England, said she was recently notified her company’s energy bill would jump from £10,000 a year to £16,000 a year. She has hiked prices by 30 per cent, but that wasn’t enough to break even. “I will need to consider closing next year,” the 64-year-old said. “It is soul-destroying.”

Ms Truss, who has argued that a recession isn’t inevitable, is expected to detail an economic plan in the coming days. Politicians close to her back boosting energy supply by fracking or drilling more in the North Sea.

“I will work to deal with the supply issues and also make sure people are able to keep more money in their own pocket,” she said recently. That is expected to be coupled with a support package for poorer households and businesses. She has said she may review the Bank of England’s mandate and give the government more power to cut financial regulations.

“We do not have to resign our great country to managed decline,” she told supporters recently.

Many economists say her government will have to announce a larger bailout for individuals and businesses to help cover energy bills if it wants to avoid a deep recession and a wave of bankruptcies this winter.

Sheila Correll, an 80-year-old retiree living on a state pension, said she was reluctant to go food shopping given recent price increases. “It’s not just a few pence. It’s £1, £2, and prices keep jumping,” said Ms Correll. “I steer clear of shopping now because it’s so nerve-racking.”

She is worried about rising energy bills. Last winter, she said, she didn’t turn on her heaters a single day, opting to take brisk walks in the park and bundle up instead. In the coming year, energy costs could chew up half the monthly income of pensioners like her, according Cornwall Insight, the energy consulting firm.

The Wall Street Journal