The Prime Minister’s Inbox: The United Kingdom and the Challenges Ahead

Following the resignation of Liz Truss and selection of Prime Minister Rishi Sunak, panelists discuss the economic and political challenges facing the United Kingdom (UK), including calls for a general election, the soaring costs of living, and broader relations with Europe. 

TREVELYAN: Thank you very much. Good morning, everyone. Thank you all for joining us for what I hope will be a fascinating discussion about “The Prime Minister’s Inbox: The United Kingdom and the Challenges Ahead.” And challenges indeed there are.

I’m delighted to introduce our two distinguished panelists today. We have with us Sebastian Mallaby, the Paul A. Volcker senior fellow for international economics at the Council on Foreign Relations; and also Matthias Matthijs, senior fellow for Europe at the CFR and associate professor of international political economy at Johns Hopkins University.

So, without further ado, I would like to ask our panelists—we have half an hour with them and then I’ll turn it over to you, the audience, for questions. But I’d like to ask both of them to briefly, if they could, outline the challenges. Of course, Rishi Sunak is the 57^th prime minister of Britain, but he is the third prime minister in four months. He’s come to the job at a time when his predecessor, Liz Truss, lasted about forty-five days after her radical economic plan to borrow more money and to cut taxes on the highest earners was greeted with an enormous raspberry by the financial markets. It now costs much more for Britain to borrow and the value of the pound has fallen somewhat.

So, Sebastian, economics is your area. If you could just outline this challenging landscape for Rishi Sunak before we get to the detail of it, please.

MALLABY: Sure. Well, you did that a little bit yourself, Laura. The good news is that the markets have actually greeted both the appointment of the prime minister, Rishi Sunak, but also before that the new chancellor of the exchequer, or finance minister, Jeremy Hunt, and between the two of them they’ve kind of replaced what used to be known as the “moron premium” where, you know, Britain was paying a premium to borrow money because the people in charge were perceived as being M’s—the “moron premium” now having been displaced by the “dullness dividend,” where you have the steady hands—particularly Jeremy Hunt—who won’t do anything non-grownup, as it were. And therefore, in fact, the pound has gone back to kind of where it was at the beginning of the month and the borrowing costs not all the way back, but a good part of the way back.

TREVELYAN: Very good.

And so, Matthias, it was so interesting to see that after Liz Truss resigned European leaders greeted her resignation with a plea for stability—Britain, this beacon of stability, and now it’s being compared to Italy. Could you just give us your overview of the challenges facing Rishi Sunak, particularly when it comes to relations with Europe? He, of course, was a Brexiteer, but now he must make Brexit work.

MATTHIJS: You summarize it very well, Laura. Rishi Sunak is actually the fifth Tory prime minister since 2016, but probably the first and only committed Brexiteer, right? Boris Johnson could be in the Brexit basket if you want, but let’s not forget he wrote two columns the night before he decided that he was going to be a Leaver rather than a Remainer. And I think many of us know, or as far as I understand, this was more about Boris Johnson’s political career. Rishi Sunak’s very different. He’s a committed Brexiteer. He believed in it from the beginning. He’s ideologically committed to it.

And so the two things that I think he’ll be facing very soon are the two bills that are now making their way to the Houses of Parliament.

The first one is the Retained EU Law bill, and that’s this commitment which he made last summer, as well, that basically the U.K. would get rid of any leftover EU legislation from its time as members by the end of 2023. And there’s a sunset clause in this legislation that that that’s the big discussion item. But that, of course, means a tremendous amount of work for mandarins and bureaucrats in Whitehall, and it—I mean, most experts agree here that this is completely unworkable. So how he’s going to thread that needle—because this is a very important bill for the Spartan Brexiteers, if you want, the European Research Group in the Tory party.

Second bill that’s making its way through the Lords right now is the Northern Ireland Protocol bill, right, where basically the U.K. has decided to unilaterally be able to overrule some of the legislation there that was agreed with the European Union. And that’s, of course, even more pressing right now, since we know that Northern Ireland will have to have new elections now that, after six months from the previous elections, it’s clear that they can’t form a new—a new government.

So these things are in his inbox right now. There’s a bit of pressure because the hope always was to sort the Northern Ireland Protocol issue by the 25^th anniversary next spring of the Good Friday Agreement, and it looks very hard to do. That said, there is hope in Paris, in Berlin, and in Brussels that Rishi Sunak, given the budgetary pressures he has and given that he is a former chancellor, won’t, you know, start an all-out trade war with the EU.

TREVELYAN: Indeed. Well, we will see.

Sebastian, the new prime minister has been very honest about the scale of the economic challenge that faces him and he’s said that he won’t go to the U.N. climate conference that’s upcoming because he needs to concentrate on the domestic situation. But how would you describe, as an economics expert, exactly the situation that the British economy is in right now, where the government’s made a commitment to try and help people with their high energy bills and roll back these tax cuts?

MALLABY: Yeah. He’s caught between on the one hand the fact that inflation in the U.K. is running very high, kind of like it is in the U.S. but a touch worse, and that’s giving rise to this talk of a cost-of-living crisis. And so to fight that inflation you need to kind of rein in demand. There’s too much money chasing too few goods. And so the Bank of England is going to be raising interest rates and the government can’t afford to run a big government budget deficit because, you know, that’s exactly what Liz Truss tried to do and that blew up. So inflation forces some austerity, but at the same time austerity is miserable and, you know, you want to protect the poorest segments of society from the effects of that. And so you’ve got to kind of both cushion the economy but do the opposite and fight inflation, and it’s how you balance those two objectives which is particularly tricky.

TREVELYAN: But as a former chancellor, is Rishi Sunak well-placed to try and do it, do you think, Sebastian?

MALLABY: Yeah. I mean, I think he’s pretty well-placed. I think Jeremy Hunt, although not a former chancellor before this round, knows what he’s doing as well. I think the two of them, you know, have completely done a U-turn in terms of the way in which technocrati experts are regarded. Famously, you know, Kwasi Kwarteng, when he came in as Liz Truss’ chancellor of the exchequer, the first thing he did was get rid of the top civil servant in the treasury, Tom Scholar. And now, you know, you have their kind of top civil servants being re-enthroned as the real arbiters of what you can do budgetwise. So I think Rishi Sunak, you know, knows what he’s doing. He’s going to empower the people on the staff who know what they’re doing. But you can’t escape the basic logic of an economy that is, you know, facing very tough times.

And you know, some of what is happening here is the backwash from Brexit, which is pulling down, you know, both trade opportunities and just general dynamism in Britain; constraining immigration, which is another source of growth. And so, to some extent, just as Rishi Sunak on the Northern Ireland Protocol or on the sunsetting of EU regulations, those two laws that—or those two bills that Matthias was talking about, that is in a way the Brexit legacy catching up with a pro-Brexit prime minister, Rishi Sunak, so in the same way the problems in the economy are the Brexit legacy catching up with a Brexit supporter, Rishi Sunak.

TREVELYAN: Interesting.

Matthias, is there some hope in Europe that there could be a slightly less confrontational relationship with Britain’s new prime minister? Because since Brexit things have just been so fraught, haven’t they?

MATTHIJS: Yeah. I mean, there’s always hope, right? Every new prime minister gets a bit of a honeymoon period even though, like, I think we know Rishi Sunak’s honeymoon will be—will be mercilessly short. There’s—I mean, I think often—and that’s true for Americans and Brits—they often forget that, you know, the rest of the world speak English and reads the newspapers, right? So in the EU they are very well aware that, as much as Rishi Sunak is pushing this government of all the talents, that he doesn’t have the full support of this parliamentary party, right? There’s only about thirty-nine, forty MPs that have to basically balk at something or refuse to support something and it doesn’t go through.

And what is problematic—and here that’s also problematic with Rishi Sunak—he’s more willing to admit that there was a tradeoff when it came to Brexit, right? The only other real Brexiteer—Lord Frost, David Frost—occasionally does admit, you know, Brexit was about so much more than, you know, trade or economic opportunities. It was about sovereignty and taking our—you know, the fate of our country in our own hands sort of thing and other trade deals in the rest of the world. But that—as long as the Northern Ireland Protocol bill goes through Parliament and Sunak has to commit to this, that’s a nonstarter for Brussels, for EU officials, who want to see this—you know, this bill implemented, right? Sorry, not this bill implemented, but this protocol implemented the way it was agreed, you know, at the end of 2020. And there remains, you know, real worry, right, that Sunak, just like his predecessors, will be beholden to these kind of Spartan Brexiteers.

TREVELYAN: The interesting thing about Northern Ireland—and I covered the Good Friday Agreement twenty-five years ago, and I remember the euphoria that night when it was signed at Stormont—Sebastian, Northern Ireland’s economy is actually doing the best, I read, out of any bit of—(laughs)—Britain currently. Is there—because, of course, it’s part of the single market still; it hasn’t made it more difficult to trade with the rest of Europe. How does Britain’s new prime minister square this circle of Northern Ireland’s relatively good economic performance and what that means?

MALLABY: Yeah. I’m not sure. I haven’t looked at the growth numbers specifically in Ireland, but I do know there’s a Northern Irish budget problem, right, you know, because their power-sharing Executive has fallen apart or couldn’t even be formed. They haven’t got a budget. They, therefore, need to be covered by a Westminster budget. There’s some uncertainty around the mechanics of that. So I think you’re right that in a sort of structural way there’s still—you know, they have access to EU markets for the moment and that’s an advantage. I don’t know, but I doubt that they are escaping the general economic downturn which, after all, affects both the EU and Britain—I mean, high energy prices, high inflation, as a consequence higher interest rates. Whether you’re talking about the Bank of England or the European Central Bank, they’re both tightening. And so I think it’s a pretty grim outlook economically all over Europe.

TREVELYAN: And, Sebastian, how does Rishi Sunak embrace what he’s called the opportunity and the promise of Brexit? What does that mean specifically? And will he get any of these trade agreements done, particularly the one with the U.S. which hasn’t happened thus far?

MALLABY: Well, I don’t think there’s much prospect of a trade agreement with the U.S. I mean, the U.S. is not in the mode politically where it’s going to be doing a lot of trade deals. And if it were to change its mind and do a trade deal, I don’t think it would prioritize a middle-sized country like the—you know, like Britain. I mean, a deal with the EU would be far more attractive to the U.S. So don’t hold your breath on that one.

I think there are other things that could be done to sort of do smarter regulation in Britain. You know, the whole series of constraints on what you can build has become totally ridiculous, both on the residential side—you know, there was this famous story where one mulberry tree attracted such a following in East London that a plan to build 291 flats in a derelict hospital—convert the hospital to useful dwelling—was blocked because of this tree. I mean, this is just—you know, I’m all for some environmental safeguards, but this is just taking it too far. You know, NIMBYism—not in my backyard—has given way to BANANA—build absolutely nothing anywhere near anything. And you know, you need—there’s been no nuclear power plants built, no reservoirs for the water system, very little, you know, fresh transport or roads. Everything’s kind of griding to a halt because the permitting system is so complex. So I think, you know, a deregulatory-minded prime minister, if willing to kind of break through the logjam and step on some toes, you know, that’s where there is some upside.

And when you have stagflation—which is what we’ve got now in Britain, both stagnant economy and inflation—the only things you can do to boost growth are to do with smarter regulation, allowing more immigration, and that’s about it, right? And so I think they need to pull both of those levers, immigration and better regulation.

TREVELYAN: We’ll talk about that, immigration, in just a second.

But, Matthias, when it comes to the war in Ukraine, what do you think the elevation of Rishi Sunak to the prime ministership, what is—how is that going to affect the dynamic in Europe? As it seems that there are splits over the continuing costs of the war in Ukraine.

MATTHIJS: Yeah. It’s a good question. I mean, this was always the main worry, I think, among political elites in Western capitals, including Washington, D.C., is that as much as there is stanch commitment to Ukraine and Ukraine’s right, and to push back Russia out of their country, there was always a worry that the public support was much more flimsy, right, was much less strong. You see this in the United States, both on the Republican and the Democratic side. But this is also the case in Western Europe.

And so I think the fear is that Rishi Sunak’s treasury view on foreign policy is a much more austere view of what Britain can do in the rest of the world, right? It basically means that, you know, more sanctions would be an extra hit to the British economy. It also means that more aid, military and humanitarian, also costs more money. And at a time where the latest reports are talking about fifty billion pounds in savings either through tax cuts or spending cuts, usually defense and foreign aid are easier to do because it doesn’t affect the day-to-day population, right, in the United Kingdom.

That said, he did keep Ben Wallace, the very highly respected defense secretary who’s stanchly committed to the Ukraine war effort. But what he notably did not commit to is the rise in defense spending in the U.K. towards the 3 percent mark of GDP. Because I think, honestly, there is just no budgetary room for maneuver there. So if you’re Zelensky you’ve got to start worrying, right? This is not going in the right direction.

And interestingly enough, I think when it comes to Ukraine unlike when it comes to Brexit and the things that still need to be sorted out, Sunak is probably closer to the views in Paris of Emmanuel Macron and of Olaf Scholz in Berlin that, you know, without stating it openly—you usually catch them off guard—but, you know, they are starting to talk about, OK, how does this end? At some point, when do we sit down? And what will this peace look like, right? And I think that is something that a Prime Minister Sunak will now have to start thinking about as well.

TREVELYAN: And, Sebastian, how does Britain’s prime minister afford the continuing cost of the war in Ukraine? Boris Johnson and Liz Truss were fervent in their support of Kyiv. Britain has supplied numerous missiles. But what is the cost? And how does he continue with it?

MALLABY: Well, you know, obviously he has to make tough choices. There are lots of ways you can raise tax or cut your spending. None of them are delightful. And it’s just going to be a question of whether Sunak, out of some combination of moral commitment to Ukraine perhaps or just maybe political self-interest, he may view staunch support for Ukraine as a device to keep his party united. And I think that’s the sort of sliver of hope maybe in Matthias’s somewhat downbeat analysis, you know, in terms of Ukrainian interests, at least. I mean, the thing that might make Sunak stick to supporting Ukraine is a sense that all of his party supports it. And that’s one thing he can hang onto.

And you know, if he wanted to do that, he would just need to cut a bit more spending on the domestic front and raise a bit more revenue. There are things he could do. I believe, for example, that a windfall energy tax makes eminent sense. You know, Shell just reported record earnings. These are earnings that it didn’t expect to make but it—you know, the Ukraine war pushed up energy prices, and so Shell, you know, is able to increase its dividend to its shareholders by 15 percent. Why did the shareholders really deserve that? I mean, they didn’t do anything. And nor did they even buy the shares in the expectation of getting a higher dividend, because they didn’t predict the war.

I mean, it feels like you’re not hurting investment incentives if you say to Shell, you got this by mistake because of the Ukraine war. We actually need the money for the Ukraine war. So we’re going to tax you and use the money to sustain our support for Zelensky. It seems totally reasonable to me.

TREVELYAN: Interesting point. And, Matthias, when it comes to President Macron in particular, who always has a grand vision for Europe, how do you think he might use the youth, the appeal of Britain’s new prime minister, the first prime minister of Indian descent, perhaps someone who’s a bit less encumbered with some of the ideology of Brexit, in a way—how could he use that to enhance his vision of the different tiers of Europe, do you think?

MATTHIJS: Yeah, it’s an excellent question. Let me just briefly come back to what Sebastian said earlier. And it reminded me of Robert Shrimsley in the Financial Times who said that—

TREVELYAN: An excellent writer.

MATTHIJS: Hmm? Excellent, yeah. He said: Rishi Sunak is offering Johnsonian but without Johnson and without money, right? And so there’s a lot less appeal to that in many ways, because that’s really what kept the party together, and the different factions, and so on.

So when it comes to Macron, I mean, it is interesting, right? I mean, they’re very close in age, in that sort of early to mid-’40s. And honestly, I mean, the biggest problem on the domestic side, on the immigration side, for Rishi Sunak is, you know, the illegal travels of migrants from France to the U.K. So it’s not that hard to come up with some sort of deal there that then allows the border patrol in France and the Coast Guard to kind of basically bring back many of those, you know, boats that may be very perilous journeys across the English Channel.

And that’s something I think both can agree on. I mean, in the end, there needs to be a modus vivendi between France and Britain. I mean, I think it’s too early to tell. Macron’s vision of this kind of European political community, which basically is, you know, something between membership and non-membership, but at least it’s understood that this would include countries like Turkey, Ukraine, definitely, but also the U.K. So, Norway. Countries that aren’t members of the EU but have, you know, common foreign policy interests. That—I think this is something clearly—Truss showed up for the first meeting, which was already a big diplomatic coup for Paris. But I don’t see why someone like Sunak wouldn’t want to continue this, right? This kind of much more positive engagement on foreign policy with the EU, where there are clear common values, right, to uphold.

TREVELYAN: And, Sebastian, Matthias mentioned there this idea of maybe kind of deal with the French on immigration. You talked about the importance of Britain having more immigration, just because of the state of the workforce. How do you see the new prime minister charting a course her? Immigration having been such a fraught issue since Brexit?

MALLABY: Well, I mean, what they seem to want to do and what’s been going on even before Sunak came in is—open immigration from other EU states has been stopped. But a point system, where you bring in skilled people from other countries, is very much, you know, going ahead. And so people are immigrating to Britain from India and from other countries outside. You know, I think India and Nigeria may be the two top suppliers of immigrant workers into the U.K. at the moment. And you can dial that up. And somehow, the polling evidence I’ve seen suggests that U.K. public opinion, which had been rather anti-immigration before Brexit, and I think it was a big driver of the Brexit vote, seems to be more OK with the point system-based immigration policy that brings in people from India, Nigeria, and so forth.

TREVELYAN: Now, before we move to the Q&A, I have to ask you both this question that people ask me in the street all the time, as a Brit. Which is, you know, really what has happened to Britain since 2016? And how this reputation for political instability which we’ve acquired over the last few months, how that—has that caused reputational damage to this country that was synonymous with the oak tree, somewhere that would bend but not break, and has come perilously close to seeming unstable?

So, Matthias, I have to ask you, how is Britain viewed these days in European capitals? And what does Rishi Sunak have to do to stabilize the reputation?

MATTHIJS: Yeah. I mean, this is the inevitable consequence of a very narrow Brexit vote, right? I mean, we don’t have to revisit this, but let’s not forget 60 percent of London didn’t vote for this. You know, the Scots didn’t vote, the Northern Irish didn’t vote for this. It was a very English nationalist vote, in the end. And then the path dependence of different decisions that were made. The hardest of Brexit that was decided on because it was the only internally logical solution. But I think also what worries many people in European capitals is that because of Boris Johnson’s 2019 victory, this really was a kind of cleansing of the Tory party, right? I mean, many kind of centrist Tories basically left the party then, because they didn’t want to sign the pledge—the Brexit pledge that everybody had to, in 2019. So I think the Conservative Party lost a lot of—lost a lot of talent.

Also, I mean, what Sebastian mentioned, the fact that investment hasn’t recovered since 2016, the trade, I mean, this is also—I mean, international investors think twice about this as well, right? I mean, the appeal of the U.K. was a relatively low-tax country, somewhere in between the U.S. and Europe, that had direct access to the European market. That spoke English, that had common law, that had rule of law, and things like this. So that, I think, is something that will take years to recover, right? I mean, it was never going to be as bad as people predicted, but it definitely matters. I mean, there’s a reason why the U.K. is the only G-7 country that hasn’t fully recovered from the pandemic, for example. I mean, other European countries have. And I think this is something that, you know, is going to stay with us for a while, unfortunately.

Laura, you’re on mute. You’re on mute.

TREVELYAN: Thank you for that.

And, Sebastian, Boris Johnson, the prime minister before the last one, famously said “hasta la vista” when he left. He hopes to be back. He almost ran again but didn’t quite because he didn’t feel he had enough support. The fact that he’s waiting in the wings. He’s talking about coming to Washington on a tour to support Ukraine and shore up support for Ukraine. Is there a political instability that affects the economics and complicates the job of the new prime minister?

MALLABY: I mean, it’s sort of nightmarish, isn’t it? You’ve got this person in the wings who, you know, in the statement he issued when he decided not to run for prime minister this time says, well, I might do it later. And if I’d run this time, maybe I would have run. Anyway, I can probably win in the future. I mean, he couldn’t have made it worse for Rishi Sunak, the way he phrased all that. And then to show up in Washington afterwards compounds the issue.

And so I think we have to hope that people will gradually figure out that, you know, Boris Johnson is a talented man, whose talents lie in being a TV personality, a Telegraph columnist, and an amusing speaker for after dinner purposes, not for PMQs, Prime Minister’s Questions. And so, you know, and that bit by bit people in Britain come to accept—

TREVELYAN: Oops. Sorry. We just—we just lost Sebastian there. This is one of the perils of Zoom. But we are just coming to the end of our chat. And I would like now to thank both Sebastian and Matthias for that, what they had to say there. And I’d like to open it up to the participants that we have here for this corporate program virtual meeting, The Prime Minister’s Inbox: The United Kingdom and the Challenges Ahead. Just a reminder that this roundtable is on the record. So if you have any questions please come forward. And if I could just ask you to say who you are, and if you’re directing your question towards one of our speakers, do do that as well.

So may we have the first question, please? And I hope that Sebastian is able to rejoin us. (Laughs.)

OPERATOR: We will take our first question from Jim Winship from Diplomatic Connections.

What is the future of the commonwealth? Will there be an effort to keep members of the commonwealth, even if they cease to recognize Charles III and his successors as their head of state? Is there any possibility that the commonwealth could play a role as a trade zone that might pick up some of the slack created by the U.K.’s exit from the EU?

TREVELYAN: Well, that is an excellent question, as a number of commonwealth countries have announced that they’re going to be holding referenda on whether or not to keep the king as head of state, since the death of the queen.

Sebastian, are you back with us? Are you able to answer this question about the future of the commonwealth, and perhaps it’s role economically?

OPERATOR: Sebastian has not yet reconnected.

TREVELYAN: OK. Matthias, I’m guessing that the commonwealth may not be a question for you, but if you have some—

MATTHIJS: No, no, no. I’ve been studying the U.K. for twenty years. Happy to—

(Cross talk.)

MATTHIJS: —to some extent.

It’s a good question, right? The problem with trade deals all over the world—with India, with, you know, New Zealand, Australia, the U.S., is I’m not so sure that this is something that has a broad support framework in the U.K. overall, right? I mean, if you take the United States for example, what is the U.S. going to want out of a trade deal from the U.K.? We’re going to want access to financial services in the city of London. They’re going to want to pharmaceuticals to be able to play a role in the National Health Service. They’re going to want agricultural access, right? I mean, then chlorinated chickens and genetically modified organisms and things like this come into the discussion. This is not something that even pro-Tory tabloids are waiting for.

So I think there’s this kind of huge misunderstanding that somehow what you give up in the EU you can just replace in other commonwealth countries, right?

I mean, there was this excellent Financial Times video on the costs of Brexit. It was about a half an hour, which everybody should watch.

TREVELYAN: Yeah, I saw that. It’s got over two million views, and I would thoroughly recommend it if one hasn’t seen it.

MATTHIJS: Yeah. And what you see there are all these small business owners who had made their whole business model based on, like, exports to the single market, and how quick it was, because it was only two days shipping and things like this, and no paperwork. And they’re now saying this takes much longer. And so to replace that market with another market much further away is just very hard to do.

And then of course, politically, yeah, I think as the question already implies, right, I mean, King Charles III has much less appeal than his mother did, Elizabeth II, as this kind of symbol of stability, right? And so that, Laura, to your earlier question of Britain as this kind of temperate—you know, this kind of good temperament of a country, and this stable government. And part of this was the queen, right? It was this symbol of continuity. And it’s not clear that her son of the same caliber.

TREVELYAN: Well, the commonwealth countries certainly are holding referenda, a number of them, especially in the Caribbean. Let me just see, is Sebastian back with us?

MALLABY: I hope so. Can you hear me?

TREVELYAN: Excellent. Hello. Sebastian, I don’t know if you heard the question, but it was an excellent one. It was about the commonwealth, and what relations will be economically, and whether this could be—what the new prime minister—how he will handle this slightly tricky moment, really, after the death of the queen with commonwealth countries reconsidering their relationship with the British monarchy, and with Britain itself.

MALLABY: Well, I mean, I take Matthias’ point that, you know, King Charles is not quite as attractive a figure as his mother. And that’s probably going to have some impact on the commonwealth. I suppose against that, it’s good that Britain has its first, you know, person of color as a prime minister and that, you know, if you look back at the Conservative Party contest to take over from Boris Johnson, in fact, there were eight candidates. Four were white, four were not white. So I think there’s something to be celebrated there in the multiracial composition of a British leadership which, if you are a member of the commonwealth, might slightly increase the appeal of Britain.

TREVELYAN: Thank you very much, both of you, for answering that question, and to Jim for the question.

Could we take the next question, please?

OPERATOR: We’ll take our next question from Dov Zakheim.

Q: Thank you. It’s Dov Zakheim. You were close.

My question is about defense and the U.K. Sunak seems to have pushed back on really serious defense growth that Johnson pushed and that Truss pushed, and that Ben Wallace pushed. And, you know, Ben Wallace almost walked away from the job this week because of that. What is your sense of where Sunak really stands on defense spending in Britain? Because that’s one of the Britain’s probably strongest hands vis a vis Europe, given its defense spending levels. Thank you.

TREVELYAN: Yeah. Thanks for that question. And, Sebastian, you talked about this a little bit earlier, but perhaps you’d like to elaborate on Britain and defense spending.

MALLABY: Yeah. I’m sort of guessing a bit. But, I mean, if you look at, you know, who Sunak is, what his background is, right? He’s somebody who spent time at two different hedge funds, went to Stanford Business School, joined the government where he had portfolios that were notably in the Treasury, where he served in both the junior minister job and the senior one, and one other domestically oriented job, as far as I recall. He is really not a foreign policy or defense policy kind of person. And insofar as he’s an international person, he’s international finance not international defense.

And as somebody who myself spends a lot of time speaking to people in international finance but works at the Council on Foreign Relations, I’m very aware of the sort of tribal difference between people who think about defense and people who think about finance. And the finance types often just speak a different language and have a whole different set of priorities. So I think it’s a fair supposition. And you look at the way that, you know, Sunak has blown off the idea of going to the COP summit, which, you know, I think prime ministers ought to be able to do some multitasking. And just because you go to a COP summit doesn’t mean you’re not focused on figuring out your domestic budget priorities. But if you—I think—I think somebody more seasoned in international relations would not have made that call of just not going.

So I think, you know, you look at Sunak, not somebody who’s obviously going to be committed to the British tradition of military—sort of military prioritization. You look at James Cleverly, who’s the foreign minister and relatively, you know, new to that, and Ben Wallace remains the sort of standout individual who’s got some experience in what he’s doing as the defense minister, and some clout. Because both this time in the leadership contest and the previous time, before the contest really go underway Ben Wallace was spoken of as a natural successor. And both times, he decided not to run for his own reasons. But he has that standing in the party. And I think Sunak couldn’t afford to have him leave the Cabinet. He’s got enough trouble in terms of party unity.

So Sunak’s—you know, when Wallace makes a threat to resign, that’s a pretty powerful threat. Sunak has to listen. So what I’m sort of hoping is that you look at the constellation of people and essentially, you know, Wallace is going to be driving foreign policy and defense policy. And that’s probably good news in terms of the prospects for Britain’s continued serious engagement in the world.

TREVELYAN: And, Matthias, what do you think it means for EU leaders, the fact that Britain’s new prime minister perhaps has a slightly less hawkish stance on defense? What will that mean? How will that be interpreted in the European capitals, do you think?

MATTHIJS: Yeah, no, I think Sebastian summed it up quite nicely, right? I mean, you have Ben Wallace, who he can’t afford to lose, who has a strong support and backing in the party. That said, he does have a real budgetary problem on this hands. So you’re not going to see the kind of increases that Boris Johnson promised a few years at a time when there was—when there was money, right? So I don’t think the support for Ukraine will stop or even weaker in the short term, but the commitments won’t increase, right? And that’s probably what Ukraine needs right now.

When Sunak was running again, for the second time, to become leader, I think that was the worry amongst the foreign policy hands of the Tory party, right? That he was completely inexperienced in foreign policy, and that this was—this was not the moment, right, to give Putin, if you want, those chances. That said, I mean, like, you know, he seems to be—it’s not that his foreign policy instincts are out of the mainstream either, right? It just happens to be the case that he comes at this from a financial point of view. But it does seem that he is closer to European leaders on many foreign policy issues than maybe his predecessors were.

TREVELYAN: Thank you both for answering that question and thank you to Dov for the question. And I would urge all those that are sitting in on the meeting or are participants, thank you for being here. And please do ask some more questions. I don’t think that we have any in the queue right at this moment, so I’ll ask a few more of my own.

And, Sebastian, just tell us, how do you think Rishi Sunak’s background—his MBA from Stanford, the fact that he was the chancellor, his views on London as a financial center—how is he going to square the circle after Brexit and try to make London realize the opportunity of Brexit as a financial center, despite some of the inherent issues in having left the EU in doing that?

MALLABY: Well, I mean, I think one strength that Matthias mentioned in passing but really has not been undermined by Brexit is the common law system. And you know, the ability—you know, in a common law system, commercial lawyers can write contracts as they wish, and unless it’s proven that they are illegal they are OK. In the continental European system, you have to affirmatively be told they’re legal before they’re OK. So there’s a lot more innovation and sort of kind of business-friendly contract writing that can go on in London. In that sense, it’s like the U.S. And so for the Anglo-Saxon world, this is a system that is pro-business and it’s familiar. And I think that is an enduring strength of Britain as a financial center which I wouldn’t write off despite Brexit. And I think that the English language—the sheer fact that, you know, a very large number of people who are responsible for allocating capital in the world speak English, feel comfortable in London, understand how Britain works even when it’s not working terribly well, that can be an advantage for Britain in terms of being a financial center.

We have to remember that over the last pretty much hundred years there’s really been just two serious global financial centers, only two, and these are New York and London. There’s amazing sort of stability in that fact. And after Brexit was voted, all the big banks did, you know, careful exercises about how they could hedge against London being less attractive because of Brexit and it was very hard to find an alternative, and in fact there isn’t one. You can move bits of your operations into Dublin, but Dublin is small and you can’t fit too many people in the offices there; just aren’t enough—not enough real estate. You can go to France, but there’s problematic labor law in Paris. You can go to Frankfurt, but it’s quite hard to persuade your sort of senior staff that they want to live in Germany, and specifically in Frankfurt. So there are all these issues. And I know lots of people at banks who were in charge of running these exercises and they kind of tore their hair out because it was so hard to figure out an alternative to London.

So I think, you know, roughly kind of pro-business environment from a Conservative leader is sort of all you need to keep London relatively healthy as a financial center.

TREVELYAN: All right, good.

And we have a question, actually, in the chat from Meredith—thank you, Meredith—which says: Can you update us on how the Labour Party is approaching the new prime minister? What is Labour’s position on pursuing a trade agreement with the United States in the event the Biden administration would become more interested? And, Sebastian, I’ll just go back to you on that one. Perhaps you could answer it.

MALLABY: Well, I mean, Labour’s position has been that they’re calling for a general election. They think that, you know, for the Conservative Party to have a selection process, not even an election process, this time and install somebody who doesn’t have a popular mandate is unacceptable, and therefore, they’ve been saying, you know, we need to have another general election. The fact is the Conservatives will just ignore that. There’s nothing that forces them to listen to what Labour wants. So Labour can say that—and probably secretly they actually would be quite happy not to have a general election, in a sense, because the next year or two are going to be horrible because of the stagflation that we talked about earlier, and so allowing the Conservatives to, you know, manage the mess may be a smart move for Labour.

So I think for now they are just going to be a determined opposition. What their views are on a trade deal with the U.S. I’m not sure, but it’s irrelevant because I know what the U.S. view is, which is that the U.S. isn’t particularly interested. So, you know, that’s how I would leave it.

TREVELYAN: And, Matthias, how is all this viewed in Europe, you know, Britain scrabbling around, trying to get these new trade deals having decided to make it more difficult to trade with their nearest neighbor?

MATTHIJS: Well, on the Labour question, I mean, it is clear that Keir Starmer’s view of Brexit is to make it work better, right, is to basically improve on the trade deal—the very thin trade deal that Boris Johnson concluded around Christmas 2020. And so, I mean, for many, you know, small businesses, for services sector, there’s a lot of things that you could improve. Actually, even when it comes to the Northern Ireland Protocol, you know, signing up to the kind of SPS sytophanitary (sic; phytosanitary) and—you know, kind of regulations that the EU has would solve a great deal of trade that goes between Great Britain and Northern Ireland. It would simplify this whole thing, right?

So what they—what Labour hasn’t come up with—where they’re not going, that’s in the end to the big—the omerta, if you want, the promise of silence. It’s that—you know, and they’re not really talking about that it was a mistake, right, or that there are real costs to this, that there were massive tradeoffs to this. But they don’t really want to suggest, you know, some sort of single market arrangement or some sort of customs union arrangement, even though it probably would solve a lot of economic problems. But it would go against the idea of sovereignty. They also have an issue on immigration, right, where they’re moved away from the kind of harder line under Jeremy Corbyn.

But you know, here again—so it’s—there’s no good options, it seems to me, to Labour right now, and so I think Sebastian is absolutely right. I think they’re very happy that there won’t realistically be a general election any time soon because, you know, a Labour government that can’t spend and has to do different kinds of austerity and maybe more tax increases, this is not a greatly appealing prospect. That said, Labour does look more now than it did three years ago or five years ago like a government in waiting. And that—if you look at the polls, if you look at how they’re perceived by financial market participants, it’s clear that people have a certain kind of trust in Keir Starmer that they didn’t have in his predecessor, Jeremy Corbyn.

TREVELYAN: Yes, and although it may well be two years before there’s actually a general election in Britain, at least.

We do have a question. I’d like to hear the next questioner, please. Thanks so much.

OPERATOR: We’ll take our next question from Doug Rediker.

Q: Hey, Sebastian. Hey, Matthias, Laura.

Just a question for you on Macron’s political—European Political Community initiative—and the U.K. actually participated—whether you think that Sunak and any subsequent government might continue along the lines of trying to dip their toe into some broader definition of Europe and Macron’s vision or whether you think that’s just a Truss initiative under the moment and the U.K. is not going to pursue that even if it does go ahead under Macron’s guidance.

TREVELYAN: Sebastian, we’ll go to you first.

MALLABY: Well, I mean, Matthias sort of laid out the view that, you know, why would Rishi Sunak not show up at the next meeting of this sort of, you know, nonmember but associate whatever it’s called. That makes sense to me. I think we should remember about Sunak, although Matthias is quite right that, you know, he was a—more of a real Brexiteer than Boris Johnson, and in that sense it’s the first time arguably that we’ve got a committed Brexiteer as prime minister, it’s also true to say that there may well have been some political calculation in Rishi Sunak’s position on Brexit; you know, he wanted to—he could see that, you know, that was the tide of the party, and he wanted to rise in the party. And furthermore, we should remember that he voted in favor of the more pro-trade sort of closer-integrated option that Theresa May negotiated when she was prime minister, so he favored a softer Brexit than the one we’ve actually got now. So, therefore, I would expect that, you know, he would do the sensible thing, which is, you know, explore ways of making the relationship with Europe work better, you know, even in the context of, you know, Brexit has happened and we’re not going to revisit that.

TREVELYAN: Matthias, you said a little bit earlier about Macron and the European Political Community initiative. Do you have anything to add on it?

MATTHIJS: Yeah. I mean, it was—the Prague summit was seen as a success because, first of all, it happened, and it was a French initiative, and a lot of people showed up, and I think a lot of EU leaders and non-EU leaders—broadly speaking, European leaders—thought it incredibly helpful, especially from a bilateral point of view, right? So it may not be the best forum where you’re around 50, you know, heads of government and state around the table, where they all go around and give an opening statement, and then they all go around and give a response or something. But the bilaterals were incredibly useful. So, I mean, even from a kind of—a pure cost-benefit analysis point of view—and you know, Sunak is, you know, good at finance, right—this seems like a very efficient use of time because there are all these kind of bilateral issues that the U.K. may have with, you know, Baltic countries that are much easier solved in that sort of context.

Of course, I don’t see neither Truss nor any successor is going to go very enthusiastically in this, in the end, French view of a European Political Community, right? I mean, it would be one thing if Britain was co-leading it. And that will be interesting to see. I mean, there was talk about whether it could be in the U.K. next, it could be held in London and Sunak could be the host of it. I mean, that’s not going to happen tomorrow, but you know, you could see this happen down the line where then you could claim, well, you know, Britain is leading again in Europe and so on.

But, yeah, it’s unclear, right? We’re in the very beginning of this. For Balkan countries and for, like, Ukraine, this is a very halfway house. They really want full EU membership, so they don’t like it for that reason. But countries like Turkey and the U.K., who have no plans of joining the EU any time soon—at least not under the current leadership—this may well be a much more, you know, constructive exercise of engaging in kind of, you know, things, you know, common interests that can be solved together.

TREVELYAN: Thank you, Matthias and Sebastian. And thank you, Doug, for that question.

We have a written question now from Chris Wall, who says: There have been reports that the proposed budget would have 10 to 15 percent cuts across all areas, while others have argued that certain areas should be prioritized. What, in your view, would be the most palatable and politically feasible program for reducing expenditures in the next budget? Sebastian, over to you.

MALLABY: Well, I think if you start from the principle that you’ve got to shrink the deficit but you don’t want to inflict undue hardship on the poor sections of society, the main point to start with is it’s better to raise taxes than it is to cut spending. The fact is, in the U.K. we already went through a round of austerity after the 2008 financial crisis, and you know, public expenditure was squeezed. And the results are that, you know, public services suffered. And the National Health Service already has a record-low waiting list. There’s, you know, threats of a strike by NHS workers because they’re so fed up. And it isn’t actually a good way of saving money to squeeze these public services further, such that doctors and nurses quit and then you have to rebuild the service at greater expense later on. And in the same way, public expenditure on infrastructure, if you don’t do it, you don’t do the maintenance, it ends up costing you more to fix it later. If you don’t, you know, spend money on something like, you know, climate retrofits of buildings—in other words, better insulation—you’re not going to be saving energy and that’ll cost you as well.

So there are a lot of types of cuts to expenditure which would be, you know, penny wise and pound foolish, as the Brits like to say, just false savings. And it’s way better, I think, to look at fixing the problem on the revenue side. Now, revenue side I mentioned already one idea, which is a windfall tax on energy companies, which I really don’t think damages incentives for future development of energy projects. I mean there may be some marginal impact, but there are no easy choices here. So that is a choice I would emphatically make.

I also think that in an ideal world you would have a higher property tax in the U.K. Relative to the U.S., U.K., you know, taxes on property owners are extraordinarily low, and that doesn’t make sense. There are a lot of people—it’s a good way of doing a wealth tax. And I think if you’re worried about some inequality and you don’t want to damage incentive too much by raising interest rates—I mean, sorry, raising income tax—then I think doing it on the wealth tax side would make sense.

TREVELYAN: Very interesting, this idea of the tax on the energy windfalls.

We have another question in the queue. Let’s hear the next question, please.

OPERATOR: We will take our next question from Jimmy Kolker.

Q: Thanks very much.

And talking about budget cuts, one of the areas in which the U.K. has fallen behind some of its comparable nations is on foreign aid and international development leadership. And Matthias talked about not meeting the 3 percent target on defense for budget constraints, but the foreign aid target has been shrinking from 0.7 to 0.5 and now maybe further. Do you think that the prime minister’s origins—with a(n) Indian background, his parents growing up in East Africa—will put that in a protected category of something in which he’d take a personal interest? Or is Britain’s foreign aid and former DFID shrinkage likely to continue?

TREVELYAN: Interesting question. Matthias, what do you think?

MATTHIJS: Yeah. This was definitely the number-one target under the previous Truss-Kwarteng government, when they were still in power and they were looking for savings after their, you know, non-funded tax cuts, that foreign aid was going to be, you know, reduced further. I mean, there is a constituency among the Tory party that feels very strongly about, you know, keeping it where it is and even increasing it.

Yeah, there are reasons to believe that Sunak sees this as important enough to keep. That said, you look at some of the statements they made—the eye-wateringly difficult decisions that Jeremy Hunt talked about; you know, the severe economic crisis that Sunak talked about. I mean, they are going to be looking for savings, right? I mean, Sebastian’s absolutely right. You can’t cut all departments by 10 to 15 percent if they’re already bare-bon. So, I mean, if you read some of the reports of the state of the NHS, of hospitals, of education, there’s not that much more there to cut.

So I think it’s fair to assume that it’s not going to be increasing back to 0.7 percent, but there’s probably some optimism warranted that it won’t be cut that much further. It’s also not the kind of thing where you can save a tremendous amount of money on either, right? I mean, yeah, you could just do it by some tax increases.

That said, I mean, why was Rishi Sunak so unpopular amongst the right wing of his own party? Because his instincts were to raise revenue, right? Martin Sandbu of the Financial Times—sorry to keep mentioning Financial Times; I’ve been reading a lot of it recently—but he calls it the Nike strategy, just pay it. If you have a shortfall in spending, just raise the extra tax of it. And he thinks that that would be much easier to do and much easier economically to do than it probably would be politically.

TREVELYAN: Thank you for that.

And, Sebastian, what are your thoughts about the foreign aid budget in Britain, and how Rishi Sunak will handle that, and whether he’ll prioritize it because of his origins?

MALLABY: You know, I don’t know how much his origins really are going to play into this. I mean, you know, yes, you know, there was an East African-Indian immigrant story, you know, two generations back, but we’re talking about a man who has, you know, been known to show up at political meetings in a helicopter; you know, whose family net worth is in excess of 700 million pounds; who went to Stanford Business School. I suspect, you know, his immediate environs may matter a little bit more to him than sort of where his grandparents came from. And if anything, you know, he has talked rather movingly about what it meant to his grandfather when he, Rishi, became a member of Parliament, and that this was sort of, you know, breaking—you know, this is the upwardly-mobile immigrant story. It’s that kind of part of the immigrant experience and the ethnic minority experience that seems to play with him, more than the sense that he’s got some sort of rootedness in East Africa or in India. So I don’t know how much that plays.

You know, a friend of mine who was involved in development aid in the U.K. government a few years ago used to joke that the question was how you—how you turn British people into Denmark—into Danish people. They seem to be happy in Scandinavia to maintain 0.7 percent of GDP commitments, kind of insisting that over different governments. There was a bit of an anomaly, I think, in the new Labour years where Britain became Danish, and now it’s kind of reverting to type. And I’m not sure that’s going to change.

TREVELYAN: Well, thank you so much, Sebastian, for that, and also to Matthias for your contributions. And thank you to everybody who has joined us for this session on “The Prime Minister’s Inbox: The United Kingdom and the Challenges Ahead”—numerous challenges, as we heard outlined there by our panelists. But thank you to everybody for participating and thank you to the Council on Foreign Relations for organizing. And I hope you all have a wonderful weekend. Thanks so much. Bye-bye.

MATTHIJS: Thank you.

MALLABY: Bye-bye.

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