Economics Daily: Harsh truths for Britain

Tax and the economy dominated a feisty first television debate between UK Prime Minister Rishi Sunak and Labour leader Keir Starmer last night. Sunak relied on a historically dependable Tory attack line by warning that Labour would hike taxes, claiming they would rise by £2,000 for each family under the opposition. Starmer meanwhile repeated claims that the Conservatives "crashed the economy," pointing to their record of running public services over 14 years in power. Each leader's assertion underscores a harsh truth: a massive debt hangover is in store for whoever wins the July 4 election, making a higher tax burden unavoidable. Snap surveys after the debate showed a dead heat, rather than the knockout blow Sunak needed to turn around a 20-point deficit in opinion polls. The economy is at the front of voters' minds, with a YouGov survey suggesting that people put the cost of living as their No. 1 issue, followed by health, the economy in general and immigration. When Sunak rolled the dice on an early election, he hoped that growth would show enough green shoots to turn his dire prospects around. The data are showing improvement. Inflation slowed to just above the Bank of England's 2% target in April, the economy exited recession with the fastest growth in over two years in the first quarter of 2024, and real wages are growing at the strongest pace since the end of lockdown. But the polls haven't budged, putting Labour on course for a large majority. Sunak may wonder why he's not getting credit for steadying the ship after Liz Truss's chaotic premiership triggered market turmoil. One possible explanation is that voters are still feeling the squeeze. While inflation may have slowed, UK households have still suffered one of the largest increases in price levels compared with global peers. Another explanation is that the Truss episode — a key theme for Starmer on Tuesday — did lasting damage to the Conservatives. There is historical precedent there. The economy was performing strongly before the 1997 election — but the 1992 Black Wednesday debacle, when sterling crashed out of the European Exchange Rate Mechanism, still weighed on the minds of voters. John Major's Conservative government lost in a landslide victory for Labour that heralded 13 years in power. Newspaper headlines declared that Sunak came out fighting on Tuesday night — but for him, the UK economy's healing may be too little, too late.  Need-to-Know Research Economists and investors have debated for some time which historical parallel might work best for the current period, with 1970s stagflation, late 1960s inflation, and 1990s tech-driven productivity all having adherents. Deutsche Bank AG macro strategist Henry Allen now says consider the 1950s. If Friday's jobs report shows unemployment stayed under 4% in May, that will mark the longest such run since the 'fifties. That decade also saw heightened geopolitical tensions, strong performance for risk assets and "an initial burst of inflation that mostly subsided." "If these similarities do hold, there could be a lot of scope for optimism," Allen wrote in a note Tuesday. "Low unemployment has often been a spur to productivity growth," and, "with strong productivity growth, that could also help to dampen inflationary pressures." While there are caveats, "given the growth of AI in our own time, this suggests there could well be some upside risk to economic growth over the years ahead," Allen wrote.