Philippa Lamb: Hello and welcome to the ICAEW Insights podcast, with news and analysis from the world of accountancy, business and finance. I’m Philippa Lamb, and in this episode, we’re discussing – what else – our new Prime Minister and the macroeconomic challenges she faces. Will broad promises made on the campaign trail now become detailed policies? If so, which ones and what would they look like? And what else might the PM have in mind for her first 100 days? We have three ICAEW experts with us to shed light on those crucial questions. Economist Director, Suren Thiru, Iain Wright, Managing Director Of Reputation And Influence, and Business Tax Manager, Richard Jones. Now, it felt like a long wait, but as we record this on Tuesday, September 6, the new PM is about to arrive at Number 10 at an exceptionally difficult moment, with severe economic challenges across the board. Recession and a prolonged period of economic stagnation and high inflation are the challenges for Liz Truss, with the energy crisis and widespread industrial action already in the mix, and a very tough winter ahead. Suren, Iain and Richard, thanks for joining us. Suren, just how challenging is the economic situation the PM has inherited?
Suren Thiru: Certainly, the new PM is inheriting an economy that is deteriorating rapidly. For example, the latest results from ICAEW’s Business Confidence Monitors shows that the UK economy is at a perilous turning point for business confidence, now in negative territory on the back of untested inflation pressures and chronic supply-side constraints, which is stifling economic activity, and is also driving a significant cost-of-living crisis. Against this backdrop many expect – including Bank of England – that the UK will be in a technical recession, which is two successive quarters of falling outputs, by the start of next year.
PL: I was listening to Ken Clarke, the former Chancellor, on the radio this morning saying he was expecting a recession as bad as 1990. Is that your analysis?
ST: The red light’s really flashing on the recessionary risks, because what we’re likely to see is consumer spending, which is the key driver UK economic output, reducing quite significantly over the next few months, as households struggle with a rising energy costs and broad inflationary pressures as well. We’re also likely to see business activity really struggle, because businesses are facing a perfect storm of falling customer demand, while they will see their cost base increase quite significantly. And that means we see businesses struggle to continue to operate on existing models.
PL: Iain, we’ve heard what Suren feels about the economic situation, what’s your own analysis?
Iain Wright: Well, Philippa, I agree with everything that Suren said. I think he’s articulated it absolutely correctly. I’ll just mention two things in terms of speaking to people and demonstrating how things are connected and have repercussions elsewhere in the economy. Suren was talking about small businesses. I was speaking to a chartered accountant the other day who runs a small business, employing a couple of staff. His energy bill at the moment is £6,000 a year, and he estimates that it will go up to £35,000 a year, which essentially wipes out most of his profits. It’s not worth his while opening the front door for business. So, he’s thinking, ‘Shall I just shut up shop and make people redundant?’ Those are decisions that members, that people in business are having to make at the moment. And then there’s a slightly more macro example. I’m from the north-east of England, we’ve got some really great manufacturing businesses there. And we’ve got a great chemicals cluster. And there’s one business in particular that produces as its final product fertiliser, that’s used a variety of different things, particularly food production to increase yield, and it goes into some degree of other manufacturing elements. They can’t afford the energy bill. And if they stop production, if they reduce shifts, well, what will farmers do? Will they just not produce the food that they need? Will they substitute a product from overseas? And we’ve talked about the value of sterling, that will be more expensive, making our food even more expensive. These have knock-on effects all the way through the economy that will be felt by businesses and by households.
PL: As Suren says, this is a raft of problems for business. How destabilising do you feel that economic environment is going to be for UK business?
IW: I think it’s very destabilising. Business wants certainty as much as possible. I liken this to a prize fighter in the ring, who has been punched continuously for a long period of time, but has now had a really killer blow when it comes to the pandemic, and is just starting to get back on their feet. And then there’ll be another killer blow when it comes to inflation. Absolutely disorientating for businesses. And there are a number of factors in that, as Suren said. The cost of doing business, price rises, really is providing that degree of volatility for businesses, you can’t factor in stability at all. Secondly, and I don’t think this is talked about as much as perhaps it should be, the value of our currency has devalued quite alarmingly, to the point that we’re recording this on Tuesday, and yesterday it was said that the value of sterling is at its lowest level against the dollar since 1985.
And of course, a lower-value pound means that everything costs more, especially for an economic model like ours, which imports an awful lot of goods, raw materials, and then exports things as well. And then the third element I’d mention is we’ve had political uncertainty. Yes, it’s been the summer, but there’s been a deteriorating economic situation, and in many respects, the government has had a political vacuum during the Conservative Party leadership. And although now we’ve got some degree of certainty, with a new Prime Minister about to kiss hands with the Queen [this recording took place on 6 September], there is still an element about well, what will Liz Truss’s priorities be? Things like tax, public spending, incentives for investment skills, how will that all work? So, businesses, I think Suren called it a perfect storm, in the terms of those three elements, it’s really volatile for businesses at the moment.
PL: The big story that everyone’s been hearing about for weeks now is the energy bill crisis. It sounds from what we can tell at this early stage in the week that Liz Truss may have something to say about that by Thursday. But Suren, what about business expecting huge bills as soon as next month? How bad do you think that pain is going to be? And what would you like to see from government?
ST: The pain is likely to be significant. We’ve had examples from some of our Member Insights that firms’ energy bills are greater than the rent they pay. And that’s making, for some businesses, their model unviable. So, what we would like to see is some targets of financial support for business, particularly smaller businesses who are really struggling with a cash-flow crunch, which has been first driven by COVID but made worse by what we’re seeing at the moment. This could, for example, look like COVID-style payments to businesses, direct financial support, but also looking at other ways of supporting businesses such as business rates relief, which will help ease the financial headache a lot of businesses are facing at the moment.
PL: Presumably you would need to see those remedies rapidly, because the cash-flow crisis SMEs face is immediate, isn’t it?
ST: Absolutely. What we’re seeing is businesses have already started making decisions on whether to go on. We may see, if we don’t get that sort of financial support, businesses start throwing the towel in, because their business models don’t work. So, in these types of crisis, cash is king. We need to look at how we can support business cash flow over this difficult winter period, because that means what we do is to help support viable businesses, which helps drive wider current economic growth, but also helps support businesses keep a lid on prices as well.
PL: Richard, Suren says economic growth is the issue here. Weak economic growth gives the government less wriggle room on fiscal policy. Liz Truss had a reasonable amount to say about tax in the run-up to today’s event. She’s already pledged to reverse the recent rise in national insurance. She said she’s going to do that straight away. She’s also said she’s going to scrap plans for increasing corporation tax next year. What do you think the implications of those decisions will be?
Richard Jones: We’ve got two things we’re looking at here. There’s the CTE and the national insurance. You’ve got two main potential drivers for this. One of them is how do we fuel further economic growth in the midst of a recession? And the other one, which you’ve touched on, is how do you help families, individuals, with the cost-of-living crisis?
The first one, if you look at the corporation tax freeze at the moment, the UK has the third lowest CT rate in the G20. So that obviously sends a message out to international business that we’re a friendly place in which to do business. If we were to put that up to 25%, that would put us right in the middle of the pack. We would lose that competitive advantage. So, I can see that there’s a definite advantage there to not going ahead with the rise. A few things we need to consider, though. Firstly, any tax cuts, or in this case not putting taxes up, is going to cost money. The government’s own figures suggested that it would raise £17bn a year to go from 19% to 25%. So obviously that extra money would need to be found from somewhere, or borrowing will have to increase.
The other thing to think about is the overall headline rate is one thing, but that’s not necessarily the amount that businesses pay. There are different reliefs, incentives available in different countries, and so the actual effective rate can be very different. So, there is a question mark there over if the CT rate doesn’t go up, could the Prime Minister or the Chancellor decide to take back some of the reliefs that are available in order to reduce the costs? That’s a possibility. For example, the super deduction, which is currently available to companies, that’s going to end on 1 April 2023, and the government’s own figures suggest that that would cost, in 21/22 and 22/23 – which are the two years that it applies to – £12bn a year. So that’s actually a big chunk of the £17bn that’s estimated to be raised by increasing the rate. So it could be that we just don’t have any further incentives of that kind. But of course, that doesn’t really help in terms of incentivising further growth.
The other thing to think about is loss-making businesses. They don’t pay corporation tax until they start making profits. Those companies won’t see a benefit, and they’re the ones that are in most need of the cash. So it could be that something like providing grants or upfront incentives might be something that could help them alongside that freeze in the CT rate.
PL: And national insurance?
RJ: Yeah, I think the thing that often people forget about this is that the rise impacted both employees’ and employers’ NIC. So this won’t just be a saving for individuals, it will be a saving for businesses as well. So again, that’s another good reason to go ahead with it, if Liz is looking to reduce the costs for employers, but the same question comes back around affordability. That rise was expected to raise about £39bn over the next three years.
PL: That’s a big number, isn’t it?
RJ: Exactly. And that was earmarked specifically for health and social care.
PL: Which is something she said she’s going to prioritise.
RJ: Exactly. But where will the money for that come from? So that is one of the big question marks around that particular policy decision.
PL: We’ve heard a bit from Liz Truss on that, as a lever to address the cost-of-living crisis. What do you think we might see there?
RJ: There are a couple of things to think about there. Firstly, businesses are under no obligation to reduce their prices. So even though they’re charging less VAT, they might still charge the same amount. And particularly if they’re struggling businesses, they might find that that will help their cash flow, help their profitability. They’re under no obligation to pass that saving on. The other thing, of course, to bear in mind is that not all goods are subject to the standard rate. Some are zero-rated, some are reduced rated and some are exempt. And particularly essentials, your typical supermarket shop, that’s going to be predominantly made up of zero-rated supplies. And so reducing the standard rate isn’t going to have any impact on the VAT charged on those items at all.
I think those particular two points make that particular policy probably relatively ineffective. Some potential alternatives to that on the indirect tax side of things. Well, rather than affecting the main rate, perhaps there could be a reduction in the rate charged on domestic energy. At the moment, that’s reduced-rated, so that could be moved down to zero-rated, for example. And it’s been estimated that that would save households around £169 a year. Not a huge amount, but at least it would be something to go towards helping with the cost of living.
PL: But again, that’s another one where it’s an untargeted relief, isn’t it?
RJ: That’s true. Some of the other things – looking at potentially reducing fuel duty, again, that’s something that the previous Chancellor had done in the last budget. So, there’s precedent there. But if the government still has the target of net zero by 2050, those kinds of measures really do move against that headwind of “let’s encourage individuals and businesses to be more green in their activity”, that sends a very different message I’d say.
PL: Iain, we’ve covered a lot of ground already. I’m thinking about operational challenges of the new Treasury routine we’re going to need to deal with. Can you shed some insight on that for us?
IW: I think you have to recognise that the Prime Minister has no easy options. For things that are possibly seen as necessary, there will be unwanted consequences. If you think about the cost-of-living crisis, the cost of doing business and her political philosophy in terms of maybe giving more money to businesses, to individuals, to do with what they like through tax cuts, that has consequences. Having massive spend in the economy, based upon a really significant injection of public spending to deal with unprecedentedly high energy bills has a consequence. These are all inflationary. And of course, if you inject more inflation into the economy, the Bank of England will raise interest rates faster and further than would otherwise be the case, putting us at risk of an even deeper recession.
She’s actually trying to do some contradictory things. So tax cuts, but actually massively increasing government spend as well. And there’s another factor, Philippa, that you need to take into account, or the Prime Minister and the Treasury need to take into account, which is, you’ve got to look like you’ve got a credible plan for the markets, because the markets will be lending us the money. We will be borrowing quite significant sums of money. And if you look like you haven’t got a plan, if you look like spending is out of control, then that will be more expensive debt. We already, at the moment, are paying £100bn in debt interest every year. If the markets don’t have faith in you, that will increase. You’re seeing signs of that already. Gilts, the way that government borrows, is increasing in terms of its price. And for every percentage point, you’re talking about several billion pounds of public spending, it’s public spending that can’t go on things like the NHS, can’t go on things like defence, can’t go on things like levelling up. So, these are the factors, often paradoxical, contradictory factors, the Treasury will have to put into play.
PL: And as you say, when you’re talking about the markets, you’re talking about the international market. She needs to impress abroad, as well as at home, doesn’t she, to keep her finances stable?
IW: Absolutely. It’s really important that we are seen as essentially a safe haven, a mature economy that’s well run, that you have the rule of law. If that’s put into doubt, in any shape or form … there was no question that the UK Government will not default on debt. But in terms of if the markets, spending is out of control, tax cuts reduce the ability of the UK government to be able to pay back the interest needed. That makes the UK Government, the UK economy, much more of a risk and therefore much more expensive. And we, as taxpayers, will have to deal with that in the medium to long term.
PL: It’s a confidence issue, isn’t it? Suren, as we’ve said, we’ve not heard a lot about targeted measures so far. Obviously, they are cheaper in general for government to bring in. Everything we’re talking about is going to cost money. What’s your sense of where the money is going to come from?
ST: This is certainly true that policymakers have a really difficult balancing act between supporting the economy, houses, businesses, without making the situation worse by stoking inflation, as Iain mentioned. Not to mention the issue of the public finances, which has been hit hard by rising inflation. I guess one way to look at this, when you’re looking what the best policy measures are, is where can you target the most support without increasing demand, which may increase inflation? And that means looking at those parts of the economy where the current headwinds are hitting hardest.
So, for example, low-income households who have seen a big hit to their incomes – if you provide everyone with support, including high-income households, what you are likely to see is the market economy increase because you’re giving people support who don’t really need it. So that if you target more low-income households with direct financial support, for example Universal Credit, that is a good way of doing it. If you do something else, like some of those measures that have been mooted during the campaigns, for example the VAT cut, that is very generic and it’s across the whole economy. Some of the things that have gone up most in price, like food and fuel, food is mostly zero-rated and fuel for households is at 5%. So, it won’t really help if those things increase. We need a common-sense approach to what new measures are needed to support the wider economy, because the headwinds we’re facing at the moment are ones that can’t easily be tackled with domestic policy. So, the role of government is to try and cushion the impact on businesses and households.
PL: And obviously, the backbone of the Truss philosophy is to boost UK growth, isn’t it? But the question must surely be, can she boost it fast enough? Because UK business is facing significant difficulties right now, isn’t it? Is it your sense that this idea that growth will solve everything? Is that actually viable, will that work?
ST: It’s difficult because a lot of what you’re seeing at the moment for households and businesses, it’s a battle for survival. You’re seeing this huge cost, the cost shock on the business and on personal incomes. It’s difficult to see how businesses can go for growth at the moment. Cutting taxes in that environment probably won’t be as effective as during normal times. So, that has to be looked at quite closely. I think a lot of this has to do with to do with timings as well. But also with tax cuts, you want to be careful not to make the situation worse, because the big headwind at the moment is inflation. And if you are planning tax cuts, there is a risk that that can be inflationary, particularly if you cut something like VAT. So, you have to be quite careful what you’re actually targeting that you’re not making the situation worse and holding back some of the long-term growth prospects.
PL: Yeah, so on inflation, that brings us rather neatly to the Bank of England, doesn’t it? The PM does seem to rather have the bank in her side. She’s raised questions about its current role and arrangements and whether they’re fit for purpose. What’s your feeling about that?
ST: I think we are seeing a bit of a difference between campaigning and governing. And I think, Liz Truss in her campaign, the language on the Bank of England has softened over the last few weeks, more about the independence of the Bank of England. But it’s important to step back and understand what the central bank’s role is. And their role is to be a credible force against inflation. That independence is really important, because if the economy, households, businesses think that government can lean on that central bank or guide policy into a boom in the run up to elections, that undermines the credibility of fighting inflation, which can have wider impact to help people asking for pay increases, that sort of thing. So, it’s really important that central banks including the Bank of England have their independence.
Now, of course, it can be argued that the Bank of England maybe acted too late in raising interest rates to combat inflation. But one of the unfortunate issues around the current situation is that a lot of inflation headwinds are globally driven, which means that raising interest rates or using any of the levers that banking has is pretty ineffective at bringing inflation down. And that’s why you’re seeing inflation just rising. It’s not really having an impact on inflation, particularly now, but it may have over the longer term. So, if you had a different approach to setting interest rates, or a different approach for central banks, it’s difficult to see how we wouldn’t have a similar situation to what we’re seeing at the moment.
PL: So, it sounds as if your sense is that Liz Truss is going to be reluctant to actually change the status quo?
ST: Well, I think we may well see a review of the Bank of England’s remit, as is common practice in other countries. For example, the Bank of Canada’s remit on interest rates is reviewed every five years and you may see some of that here in the UK. But I don’t see that review giving any significant change to the remit of the Bank of England, not least its independence.
PL: Iain, there is more change to the UK financial authorities possibly on the horizon isn’t there? I think in August, the FT reported that Liz Truss wanted to launch a review into merging the Financial Conduct Authority, the Prudential Regulation Authority and the payment systems regulator. Now, I know none of these bodies directly regulate accountants, but what might that mean for the financial sector? And indeed, for investor confidence?
IW: The question I would pose is, what is this trying to solve? I can absolutely understand that ministers in a Liz Truss administration, the new Chancellor and the new Business Secretary might go, ‘Well, let’s have some sort of Brexit dividend by having some sort of regulatory divergence away from the EU’. Very clear blue water between what the European Union is doing and what the UK is doing. But I counter that in two different ways. One is a very human thing. The Prime Minister, the Chancellor of the Exchequer and the Business Secretary have only got so much bandwidth and they need to focus on this short-term crisis in terms of making sure that we can minimise the long-term damage to the UK economy arising from inflation that was not of domestic making, but we have to deal with. There are only so many hours in the day, and in her acceptance speech yesterday, Liz Truss said she’d focused on three things: tax cuts, cost-of-living crisis and the NHS. Those should be her priorities. And it’s a case of is anything else needed at this time to be able to do that? The other thing that I would mention, Philippa, is we talked about the international markets earlier on in this discussion. Is this going to spook some of the international markets going: ‘Why are we changing now? What are we doing?’ We have been traditionally, over the last 20 years or so, a great place for people to do business.
PL: Because of the regulatory framework, in part?
IW: We’ve got a flexible regulatory framework. The present framework was put in place as a result of structural weakness that were recognised that came to fruition in the 2008 financial crash, but it’s recognised as stable, providing goods, it’s a good place to do business in the UK. And we want this to be the best place anywhere in the world to start and to grow a business, and you need the capital to be able to do that, you need that regulatory strong governance framework to be able to do that. At a time when we want to see that international markets confidence, do you start reforming the regulatory system? So those are the questions that I would pose. Absolutely, let’s make sure that as much international capital can flow to London and the UK as much as possible, but do we need change when the top three people at the at the heart of government and economic policy need to be focusing on how we mitigate this potential damage?
PL: Suren, would you agree with that? This suggestion that we’re just going to undermine confidence internationally, and indeed at home, if there’s any suggestion that government ministers might be given the power to overrule regulatory decision?
ST: This is absolutely right. And I think, as Iain mentioned, the markets are key in looking at what Liz Truss and her new team are going to be focused on over the next few weeks. And clearly there was a general sense that markets want reassurance that new the government and the new Prime Minister are going to focus on the matter at hand, and that is dealing with this inflation, energy crisis, and not deal with some other stuff yet, other sort of not-urgent stuff at the moment.
PL: Iain what about productivity?
IW: I think this is a really important point, and it’s central to the long-term performance of the UK economy and ultimately, the rising of living standards all the way through our population. If we don’t deal with productivity, and stagnating productivity over about 15 years or so, we’re not going to see a rise in living standards. So, it’s absolutely right that the new Prime Minister and her new administration focuses on that short-term crisis. How do we deal with energy bills? How do we deal with the cost of living? How do we make sure that those are addressed for the benefit of households and for businesses. But let’s have an eye on the bigger longer-term prize as well. We are like other economies going through transition, post pandemic, trying to deal with a net-zero economy in terms of our particular circumstances. We are going through a post-Brexit economy, and we’re dealing with things like levelling up. We have to deal with those structural challenges about regional economic disparity, productivity challenges, skills imbalances. And ultimately, how do we make sure we have a modern UK economy, knowledge-based, embracing technology, having high skills that can produce fantastic growth and living standards for all of our population that can then fuel and fund public services to the highest possible way? That’s the big challenge that will take a decade or so. And I hope that the new administration, whilst dealing with that short-term crisis of which is we’ve not seen the like for 30 or 40 years, will also think about, how do we have that modern long-term economy by 2030?
PL: Liz Truss has made mention of Levelling Up, hasn’t she, in the in the campaign and early stages? She’s reaffirmed the commitment to extending the rail link west-east, hasn’t she? You do wonder, though, don’t you? These projects, they are seriously expensive. Is there actually going to be the money in the budget, given everything that has to be done to address the other concerns you’ve discussed, to deliver rail links like that?
IW: That’s the balance that the new Prime Minister will need to decide. Politics is all about choices. It’s all about priorities. And my own personal view is that on a number of levels, the levelling up agenda is absolutely essential, from almost an ethical point of view. Regardless of where you are in the country, you have a good standard of living and you have good opportunities for a good career. I think there’s an economic reason. I don’t want London to fall to allow the north to rise, but there’s a real problem in an overheated London and south-east, with high housing prices, difficulties in skills that provides a real distortion in the economy. But this is not going to be cheap. The points that we’ve been making before about making sure that we’ve got confidence that public finances are on a sustainable long-term footing, you don’t change, arguably, a century of regional economic disparities with even a couple of £100m investment. These take billions, these take decades. But I think it’s right for the long-term economic and social performance and fabric of our economy that levelling up is a part of that.
PL: Yes, I appreciate Liz Truss has only just come into office, but she’s looking at a general election inside two years, isn’t she?
IW: So, we talked about the ethical imperative, we’ve talked about the economic imperative – actually there’s a really important, quite short-term political imperative. There are the red wall seats, traditionally long-serving, long-standing Labour-voting constituencies that went in 2019 Conservative for the first time. There’s about 35 to 40 of those. If they go, and revert back to anybody but Conservative, go to Labour, that’s her majority gone. If she wants to stay in office longer than say, two years, she needs to address the red-wall issue, and give people confidence that in that cost-of-living crisis, despite the hardship that people will feel, that actually life is getting better. That’s a real political challenge that she’s got.
PL: Suren, your thoughts on that?
ST: The key long-term structural challenges for the UK economy can’t be ignored, and in many ways has been exacerbated by the by the current situation, is on productivity point. I think one big issue the UK have had historically has been weak business investments. Now while the wider economy has largely recovered its lost output from the pandemic, UK business investment is something like 6% below pre-COVID levels, and it hasn’t really recovered yet. Yes, even before the current crisis. And business investment is really key to both boosting knowledge economy, boosting investments in green technology and the wider economy. And there needs to be real focus on looking at ways of boosting investment. Now, a couple of Chancellors back, Rishi Sunak did promise at the spring statements that this upcoming budget in the autumn, there will there be a key focus of business investment incentives to boost business investment. Now, of course, the landscape has changed quite significantly since then, and we’re seeing this big inflation and energy crisis. So, unfortunately, one of the victims of that may be the government run back on some of its previous commitments around supporting business investments. But that may be right now, while we’re dealing with crisis now, but it will have long-term impacts on our ability to boost investment and boost productivity more generally. And that’s really important, as Iain mentioned, in the Levelling-Up agenda, to the drive to create a high-skill, high-wage economy.
PL: Well, Liz Truss is clearly in for a busy time in her first 100 days and that key period ends in mid-December when we may or indeed may not feel in celebratory mood. Thanks very much Iain, Suren, Richard for being with us and sharing your thoughts on the road ahead. That’s it for this episode. Thanks for listening. You can catch the next Insights podcast in early October, when we will be sharing advice on the queries and concerns we hear most often from members with ICAEW consultant David Stevens. The next InFocus podcast, where we drill deeper into the economic challenges facing the UK, will air later this month. Join us for those two and in the meantime, please do rate, review and share this episode. And remember to subscribe to ICAEW Insights on your favourite podcast app.