Winner of the New Statesman SPERI Prize in Political Economy 2016

Tuesday, 9 August 2022

Labour shares, decoupling, real wages and inequality


There is still a lot of confusion around about why UK real wage growth has been so low since the Global Financial Crisis and 2010 austerity. Many want to point to what economists call the functional distribution of income, which is the split between wages and profits. This was one of the issues I talked about this in a recent post, but perhaps a more direct approach is required.

The first point to note is that none of the decline in real wages over the last decade or so is about a shift from wages to profits. Here is the labour share of income from the 1970s until 2021.

The labour share has fallen since the 1970s, but all of that fall occurred before the recent period. Furthermore, the share of corporate income in GDP has remained fairly flat during this century. There has been no sustained shift from wages to profits over the last ten to fifteen years according to the data. There are a lot of problems with UK corporations, but decreasing labour’s share of national income isn’t one of them.

As my earlier post makes clear, the main reason why real average labour compensation has grown so slowly over the last ten or fifteen years is that output growth and productivity growth have been so low. It’s not about the distribution of the cake, but the size of the overall cake. It is no coincidence that ever since Conservatives started talking about a ‘strong economy’, the UK economy has been anything but strong. (It is no coincidence because Conservative politicians calling things a success to distract from failure started with Cameron/Osborne and the economy.)

What about this year? In the first quarter of 2022 the picture is very similar to the above. Of course real wages in April were lower than in January, but that is because inflation has been pushed up by higher commodity prices. The only company profits to benefit from that are those of commodity producers, and in particular oil and gas producers. That is why high windfall profits taxes on those companies make perfect sense.

I think some of the confusion on this issue comes from the US, where the story is different. While real labour compensation in the US tracked productivity growth pretty closely in the 1980s and 1990s, this stopped happening at the beginning of this century, with labour compensation growing less rapidly than productivity. This in turn has produced a substantial fall in the US labour share, and a rise in the share of profits. But this has not been happening in the UK, and the picture overseas varies greatly from country to country. Note also that a falling labour share does not automatically imply a higher profit share, but may instead reflect increases in indirect taxation, lower subsidies or higher other income.

Another source of confusion is generated by comparison of productivity and real median wages. I first talked about the decoupling between these two measures in this post back in 2014, based on a study by Pessoa and Van Reenen. That study has recently been updated and extended by Teichgräber and Van Reenen (HT @centrist_phone), which gives me a good excuse to talk about its conclusions once again.

In terms of real median wages and productivity there has been uncoupling in the UK. As there is no decoupling between productivity and average real labour compensation, then why are things different for real median wages? As with the earlier study, Teichgräber and Van Reenen find two major causes. The first and most important is the difference between mean (average) and median due to growing inequality at the top, and the second reflects growth in employers’ non-wage compensation (basically pensions).

Here I want to focus on the inequality cause, which is in large part down to the increasing income share of the 1%. Earnings at the very top have risen more rapidly than the rest (see below), which gets into the mean or average compensation measure but is not part of the median measure. A lot, but by far from all (see also below), of these high and rapidly growing earnings are in the financial sector. If you think that was a thing of the past (pre the Global Financial Crisis), think again, with earnings in the financial sector growing over the last year more rapidly than most. This in turn should make us sceptical about seeing the Global Financial Crisis rather than 2010 austerity being the key turning in the UK economy's fortunes, but that issue is for another time.

The key point I wanted to make in my post 8 years ago was that the growing inequality of the 1% has a big impact on everyone else. Concern about inequality at the top need not be, as much of the media likes to suggest, about envy, but instead can be about there being less income for everyone else. The growing income share of the 1% has not paid for itself in terms of more rapid growth, so their extra income comes from the 99% i.e. other workers.

There is a lot more of interest in the Teichgräber and Van Reenen paper, particularly about the self-employed, but I want to stick to the theme of inequality at the top by moving to a recent IFS paper on top incomes. Here is a chart from the paper.

It shows total income for the 1% and 0.1% over the last hundred years. Their share fell almost continuously from WWI to around 1980 , and it then went back up over the 1980s and 1990s. Over the last decade and a half it has been erratic with no clear trend.

This is total pre-tax income, not just wage income, but income from employment accounts for most of the income of the top 1%. As Chart 3 from the paper shows, around ¾ of the income of the 1% comes from employment: it is only for the top 0.1% that falls to just over half. As the paper points out, only a tiny proportion of the 1% are CEOs. To quote (references to studies omitted)

“Instead, many of the top earners are working in highly profitable industries. 29% of wage earners within the top 1%, and 44% of those in the top 0.1%, work in financial services, compared with just 5% across the top half of the income distribution….This speaks to the increasingly well-documented international trend that increases in income inequality that have taken place since the 1980s have been primarily driven by increases in wage differences between firms rather than within them. That is, the top of the income distribution seems increasingly populated not by the most senior individuals from a wide range of firms, but by the employees of a narrower group of high-paying companies concentrated in, for example, the finance industry.”

The paper includes a lot of interesting detail, and at the end there is a very good discussion of possible ways to increase top tax rates. However I want to return to the theme of low real wage growth since the Global Financial Crisis and 2010 austerity. As the chart above shows, the income share of the top 1% has not been steadily increasing over this recent period. This implies that increasing top incomes do not account for much of the poor growth in median real wages over this recent period. The Teichgräber and Van Reenen paper confirms this (see Figure 3). Figure 5 shows that most of the decoupling for median wages occurred in the 1980s and the first half of the 1990s.

Thus not only has there been no decoupling between productivity and labour compensation in the UK, but the decoupling caused by higher income inequality at the top mostly occurred at the end of the last century, and does not therefore account for the slow growth in median earnings in the last decade and a half. So even for median real wages, the last dismal decade and a half is mainly the result of poor growth in output, rather than any shift to profits or growing inequality at the top. It has been a dismal period in itself, but also in comparison with most other G7 countries (for the US, see here).

This allows a nice characterisation of three political periods in terms of the overall economic cake and how it was distributed. Thatcherism, from 1979 until the mid-90s, was a period of growing inequality at the top as well as widespread unemployment, but because overall growth was reasonably good (compared to other G7 countries) real wages still increased. So under Thatcher we had a growing cake shared more unequally. Under the Labour government inequality at the top grew much less rapidly and unemployment fell, and until the Global Financial Crisis the economy continued to grow well. So under Blair/Brown we had a growing cake, as well as a major improvement in the NHS in particular. The big change under Conservative-led governments since 2010 has been poor growth in GDP and productivity, and a decline in public services. Since 2010 the cake failed to rise.

This is one reason why it makes sense for Labour to focus on the poor growth record since 2010. It also shifts the argument away from alleged (not actual) Labour fiscal profligacy onto what really matters for voters today, which is their stagnant or falling real incomes. When the cake fails to rise, it makes little sense to talk about how what is left is divided between wages and profits, but instead to talk about getting a better recipe. Even if Labour’s recipe for growth is not totally convincing, particularly when the Brexit ingredient is still in there, voters will think they have little to lose by changing the cook. But as this post also makes clear, if Labour gets into government it has to decide whether it wants to improve the post-tax incomes of the 99% by belatedly doing something about the shift in incomes away from most workers towards the 1% at the top.

Thursday, 4 August 2022

Why does the Bank of England appear to be ignoring its mandate?


The MPC has raised rates by 0.5%, and forecast both very high inflation and a recession. To many people this will come as no surprise. When inflation is high and expected to go higher, central banks raise interest rates to reduce inflation. It’s what they do. A recession is just an unfortunate consequence of that.

However the Bank of England has a mandate set by the Chancellor. Significantly, that mandate is set out in the eighth paragraph of their summary about today’s decision. It is worth quoting what it says in full:

“The MPC’s remit is clear that the inflation target applies at all times, reflecting the primacy of price stability in the UK monetary policy framework. The framework recognises that there will be occasions when inflation will depart from the target as a result of shocks and disturbances. The economy has continued to be subject to a succession of very large shocks, which will inevitably lead to volatility in output. Monetary policy will ensure that, as the adjustment to these shocks occurs, CPI inflation will return to the 2% target sustainably in the medium term.”

It is an odd paragraph, because its first sentence is (rightly) contradicted by what follows. Every economist knows it would be impossible to hit 2% inflation every quarter or year, and foolish to try, especially when energy prices are rising so fast and unpredictably. For that reason, the key mandate is given by the last sentence, and you could add that the Bank should try and make this return to medium term stability as painless (in terms of excess inflation and lost output) as possible.

The table below gives the path of inflation in the two forecasts published today that the Bank traditionally presents: one based on market predictions of future Bank decisions (yet more increases), and the other assuming interest rates remain unchanged at their new level.














Market rates














Flat rates














Now if the Bank were setting rates so “inflation will return to the 2% target sustainably in the medium term” (see above) then that clearly does not happen in either of these forecasts. In 2025 inflation is well below 2% and falling. I’m used to seeing Bank forecasts after they increase rates where at least one of these forecasts shows inflation nicely settling to close to 2% by the end of the forecast period. Not this time.

While most people will understandably focus on the very high figures over the next year, a comparison of the two rows will tell you something Bank economists always stress, which is that it takes time for changes in interest rates to influence inflation. So raising rates now will have little impact on inflation over the next year, which as the Bank shows is substantially a direct consequence of higher energy prices. What raising rates by 0.5% today does is to prolong the recession the Bank is forecasting, and this is why we see a collapse in inflation in 2024 and 2025 in these forecasts. Unemployment is expected by the Bank to be around 6% in three years time, and rising.

So it looks as if the Bank, by raising rates by 0.5%, is helping the economy stagnate into a prolonged recession with collapsing inflation well below the target and with rising unemployment. In fact it’s worse. Both forecasts above assume that energy prices stay high. The general expectation, and the assumption in futures markets, is that energy prices will fall back considerably over this period. The Bank provides an alternative forecast based on market expectations of interest rates where energy prices follow expectations in future markets. The level of inflation expected in 3 years time is then not 0.8% as above, but 0.3%!

So has the Bank departed from their mandate? That is a very serious charge, so I have been trying to work out what the MPC might say if I put that question to them. The first and obvious point is that MPC members are not bound by the Bank’s forecast. However if MPC members think that the Bank is too pessimistic on the length of the recession and medium term inflation they should really speak out, given how awful the Bank’s forecast is. A second obvious point is that the Bank could cut interest rates over the next year or so, which could avoid the collapse of inflation below target expected in 2025. But do they really believe that kind of very fine tuning works, and shouldn't they be open about what they expect to do? 

I want to go back to that rather odd paragraph that I quoted at the beginning. Why was that first sentence included, given that it was then immediately contradicted? The political explanation for why the MPC might raise rates today, even though they expect that decision to have very negative consequences later, is that with inflation expected to hit double figures they felt they had to raise rates. Hence the first sentence in that paragraph. But I really hope that is not the reason, because one of the justifications of having an independent central bank is that it is not subject to these kinds of short term pressures, although on this occasion our expected next Prime Minister has not been helpful in that regard.

When policymakers make an expected recession deeper and more prolonged through their actions, they need to provide very good justifications for doing so. Current high inflation is not a justification, as there is little the Bank can do about that. Their own forecast suggests that they are either raising rates excessively today, or they expect to reverse course fairly soon. Someone should really ask which of these is the case, or whether there is something else that I have missed.

Postscript 05/08/22

I missed one additional explanation for this inflation overshoot, which is that the Bank assumes current fiscal policy. Perhaps the MPC are assuming that the government will introduce a large additional degree of fiscal support for those on lower incomes, which isn't in their forecast, and this will stop the excessive inflation and output collapse they are showing. But the tax cuts promised by Truss, which go to the better off or corporations, provide much less stimulus. Excessive monetary tightening based on a guess of fiscal loosening is a dangerous game to play. 

Tuesday, 2 August 2022

Brexit supporters constantly deny that that problems caused by Brexit have anything to do with Brexit. Does this remind you of anything?


I hope this will not come as a shock to US readers, but one of the constants of UK culture is to laugh at the ability of so many in the US to believe nonsense. The number of Americans who believe the Moon landings were faked is a widely quoted example. More recently we have the QAnon conspiracy theory, where 17% of Americans believe “a group of Satan-worshiping elites who run a child sex ring are trying to control our politics and media”. We laugh because it’s assumed that the British are far too level headed to fall for such nonsense.

This illusion is often sustained by the lack of impact most conspiracy theories have on UK politics. The British don’t have an MP who is mad enough to promote conspiracy theories, as Republican Representative Marjorie Taylor Greene has done for QAnon ideas. Further evidence might be the acceptance from the Conservative party leadership, unlike Republican leadership, that man-made climate change is a real threat that requires policy action, although this is a difference in what is said more than what is done.

To see this is an illusion I suggest starting with this post from Chris Grey. It’s about the delays many UK tourists are experiencing trying to go to France. The evidence that Brexit is largely to blame for this is overwhelming, yet Chris notes “the speed with which patently nonsensical arguments about it have been spread, and the sheer bone-headed, brazen obtuseness with which they are clung to despite every effort to correct them.” [1]

This is not an isolated example. Just as the problems caused by Brexit are many, so the list of false claims promoted to make people believe that these problems have nothing to do with Brexit are numerous. These false claims often originate in Brexit supporting newspapers but they are invariably repeated by government ministers.

Most if not all of these problems caused by Brexit were foreseen and discussed by opponents of Brexit during the 2016 referendum, but at that time were rubbished by the Brexit side under the collective heading of ‘Project Fear’. In most cases what was then claimed as fear is now fact, and the general line taken by those on the Brexit side is that these facts are either not facts at all, or that these facts have some other cause that has nothing to do with Brexit. The most common generic claim is that Brexit problems are really just acts of revenge by EU governments who are spiteful that we left.

During the referendum campaign the use of the label ‘project fear’ was extremely successful as a way of dismissing expertise about what would happen after Brexit. But when these expert predictions largely turn out to be correct, continuing denial becomes something even more alarming. As Chris points out, it didn’t need to be this way. It would be quite possible to admit the existence of trade-offs. Brexiters could say ‘yes, Brexit has caused problems, but it also has advantages that outweigh those problems’. So why have most Brexiters decided not to talk about trade-offs, but instead pretend all of Brexit’s problems have nothing to do with Brexit (what I will call Brexit harm denial)?

One argument could be that project fear requires subsequent denial, given the number of Brexiters who denied these problems would occur during the referendum. This argument is unconvincing, because one of the surprising aspects of Brexit has been how little the mainstream media have used previous statements by Brexiters as evidence against what they say now. Being proved seriously wrong in the past seems to be no barrier to the broadcast media allowing the same people to pontificate about subsequent events. Right wing newspapers think nothing of publishing mutually contradictory headlines within weeks, let alone years.

A better explanation for Brexit harm denial is that using the trade-off argument will not cut much ice, once it becomes clear that the benefits of ‘taking back control’ are either close to an empty set, or instead involve doing things that are generally unpopular. In a period where many people are finding it difficult to pay their bills, abstract notions like sovereignty cut less ice.

However I suspect even this explanation does not get to the heart of why Brexiters continue to deny the reality of Brexit harm. Instead we need to recognise Brexit as primarily a populist project, and ask why populists tend to routinely lie. Populism aims to ascribe general feelings of discontent and powerlessness to one or a small number of causes (immigration, the EU, globalisation, liberal social norms etc), and in addition to assert that these causes persist because they benefit a ruling elite. Populists like to draw a dividing line between their supporters (who are true nationalists) and the rest of the population, who are alien in some way (e.g 'woke').

Generally that association between feelings of discontent and the claimed causes is either greatly exaggerated or incredible, and so the only way of convincing people otherwise is by lying. As long as there is a large enough proportion of the population that takes little interest in politics and understands it poorly, lying can be successful. We are programmed to overrate personal confidence, so the populist never shows any doubt, or weakness, or fallibility. Lying becomes bullshitting in the Frankfurt sense. The more confident the populist appears, the more they appear on the side of those to whom they are trying to appeal to.

Brexit appealed to those who felt left behind by advancing social liberalism (see the appendix here), and the locus of that discontent was immigration. EU immigration was blamed for reduced access to public services and low real wages, claims that were greatly exaggerated or incredible and so required the techniques of propaganda or populist bullshitters to successfully persuade enough people of their validity. As real wages continue to stagnate and access to public services has got worse since Brexit, the only hope Brexiters have is to continue in the same manner by denying reality and ascribing any Brexit problem to something other than Brexit. Brexit populists need to appear to be still on the side of their supporters.

Which prompts the question: what difference is there between the way Brexit is currently defended and conspiracy theories? Both deny reality, or ascribe events to incredible causes. Both stress the need to believe in their cause, and dismiss experts as involved in a self-interested conspiracy to dispel their belief. Every problem caused by Brexit is claimed to be part of a conspiracy by the EU to hurt the UK or by ‘Remoaners’ to smear Brexit. Both Brexit and many conspiracy theories have at their heart some emotional feeling, like lack of control or fear of the other (where other can include vaccines). Both are surprisingly resistant to evidence. (Surprising to anyone who understands how science works). In this light it is no coincidence that those who support Brexit are more likely to believe conspiracy theories, and that populists often attempt to appeal to common conspiracy beliefs. (For a more academic take on links between populism and conspiracy belief, see here for example.)

Once we see Brexit as akin to something like QAnon, then any smugness the UK might feel about conspiracy theories in other countries evaporates. [2] Brexit as a reality-denying faith has captured the UK’s party of government. [3] Unfortunately, unlike some conspiracy theories like those about moon landings, Brexit has done great harm, and its proponents seem intent to increase that harm by breaking the treaty they recently signed.

Does seeing Brexit harm denial as similar to a conspiracy theory change anything? [4] Let’s start with those who supply the misinformation. They are not going to give up anytime soon, and their influence on public debate should not be underestimated. For that reason alone it remains important to combat the lies with the truth, because that is one way of preventing more becoming true believers.

But true believers in conspiracy theories are generally unpersuaded by evidence, which is one reason why so many accept Brexit harm denial. (As footnote [2] points out, over a third think Brexit has had a positive impact on the UK). Ridicule is counter-productive, and calling true believers stupid even more so. The starting point with combating conspiracy theories is empathy with the underlying concerns that motivate the false belief. If I’m right that a key underlying concern motivating support for Brexit was a reaction to liberal social change and in particular immigration, then this is very hard for social liberals to do, particularly in the face of policies like trafficking refugees to Rwanda. [5]

The end point is that it will be both hard and will take a long time to significantly reduce the proportion of the population that accept Brexit harm denial. Because of our FPTP voting system that proportion will have an oversized influence on at least the next election. This realisation may be one reason why a recent poll showed 51% believing Starmer was right to commit Labour not to rejoin the Single Market or Customs Union, and only 24% disagreeing. That should never mean Labour joining in Brexit harm denial, but when a combination of the government, much of the media and over a third of the population accept what is akin to a conspiracy theory, those of us who like evidence led policy have to be realistic about our current predicament and recognise the importance of getting back a government that deals with reality rather than its own fantasy.

[1] The main cause of these delays are the requirement that tourists entering the EU from third countries, which the UK is after Brexit, to have their passports stamped. Before Brexit tourists could just wave their EU passport at an official. Multiply that small extra time taken by the number of tourists crossing the Channel between England and France in summer at a few specific points and you get long delays. Chris outlines the spurious stories that Conservative newspapers and ministers (including the two candidates to succeed Johnson as Prime Minister) have promoted in an effort to suggest that these delays have nothing to do with Brexit.

[2] Like most other conspiracy theories, Brexit has a minority appeal, albeit a sizable and currently very powerful minority. In July this year, 48% thought that Brexit had had a negative impact on the country, while 37% thought it had had a positive impact. (Less think the government is handling Brexit well, but this comparison shows that many ascribe Brexit problems to poor implementation rather than reflecting badly on their concept of Brexit.)

[3] If you suspect, following their leadership contest, that Brexit is not the only example where Conservatives are living in an imaginary world divorced from reality you may well be right.

[4] Looking retrospectively, it helps explain the strength of the second referendum movement. Arguing that this movement was very unlikely to succeed, or that its leaders had mixed motives, is really beside the point. Perhaps an analogy would help. Suppose Johnson had declared that Covid was a myth and refused to do anything about the pandemic. Would it have made sense to argue that he had the power and there was nothing people could do about it. Of course not. Suppose he had put that policy to a referendum and won it, would that make any difference. Of course not.

[5] This helps explain why Cameron was the worst possible person to defend EU membership. Not only did he find it difficult to empathise with low real wages or reduced access to public services because he had run the country for six years, not only had he participated in the lies that this was due to excessive immigration, but he had also made a point of ‘modernising’ the Tory image by championing issues like gay marriage.

Tuesday, 26 July 2022

Sunak vs Truss: a battle between two failed economic policies


While the dividing lines between the two candidates on economic policy appear fairly clear, the division is more fundamental than the timing of tax cuts. It is the politics of one big lie, that we saw under Cameron and Osborne, against the politics of perpetual lying, that we saw with Brexit and Johnson. Both candidates share the same aim, which is to minimise the quality of public services and maximise tax cuts while still winning elections. They differ only on what the best political means of achieving that goal is.

The big lie under Cameron and Osborne was that reducing the deficit was an important, in fact the most important, goal of the government's macroeconomic policy, and that reducing the deficit meant cutting public spending across the board. It was a big lie because even at the best of times reducing the deficit is not a primary objective of policy, and in a recession when interest rates were stuck at their lower bound reducing the deficit is the macroeconomic equivalent of serious criminality.

To give some credit to Sunak, he recognised the need in the middle of the pandemic to support the economy, just as Labour had done after the Global Financial Crisis (GFC), support which Osborne attacked from opposition. But while Labour's 2009 fiscal stimulus was an intelligent response to the GFC recession, Sunak seemed to make no attempt to understand the pandemic in formulating his macroeconomic response. Instead all his decisions subsequent to introducing furlough both made the pandemic worse (eat out to help out, encouraging a delay in effective action to deal with the second wave etc) and failed to grasp the importance of controlling infections for the health of the economy. It is therefore Sunak as well as Johnson that we have to thank for the severity of the UK death toll from the pandemic and also the depth of the consequent UK recession. As they both found out but continue to deny, before vaccines were made available lockdowns delayed meant more deaths and longer lockdowns later.

The UK recovery from the pandemic recession was swift and more complete than the recovery was from the GFC recession, as it was in most countries. This reflected a combination of rapid vaccine development, the very different nature of the two recessions and the absence of austerity during the initial recovery period. It had very little to do with Sunak's one stimulus measure, a big investment incentive for firms, which has turned into a costly flop. But with the UK currently experiencing the combination of a relatively weak recovery and high inflation, it is clear that Sunak and Johnson's failures during the pandemic, coupled with the costs of Brexit, are depressing UK incomes just as Osborne's austerity did.

Sunak, like Osborne, likes to frame his job as Chancellor (and perhaps Prime Minister) as being responsible with the deficit, rather than improving the welfare of UK citizens. Osborne began the decline in the NHS, and Sunak has allowed that decline to reach critical levels, such that poor health is now producing a poorer economy. Even within the self imposed deficit straightjacket, he had the opportunity to use the higher deficits of the pandemic period as an excuse the put major resources into both the NHS and public investment, but instead he was too quick to set deficit targets so increases in both were far too modest. He also accepted a fiscal rule that imposed an arbitrary limit on public investment.

Under Sunak, like Osborne, arbitrary deficit targets limit public spending, and any better than expected news on the deficit is normally earmarked for tax cuts. Sunak, like Osborne, fails to see the essential role that public services play in producing a healthy and efficient economy. Instead the public sector is seen as a burden, and the private sector as always more efficient, an ideology that evidence provided by outsourcing failures like test and trace fails to dent. [1]

In this context the willingness of Truss to relax the deficit constraint might seem welcome. But she wants to relax the constraint to produce not better public services, but tax cuts today that are greater than Sunak's future tax cut plans. That their ultimate goal, tax cuts, is the same shows that the difference between the candidates involves strategy rather than objectives. The strategy Truss is adopting is taken from the Republican party, and is called 'starve the beast'. (See George Eaton on Sunak’s Thatcherism compared to the Reaganism of Truss.) Like Reagan's tax cuts, her policy is to raise borrowing to sufficiently high levels such that at some point a deficit crisis will be declared, the answer to which is of course spending cuts. This may not even be the initial plan, but with the ideology of her party and the dominant media narrative it is an inevitable outcome. So while Sunak aims to keep to deficit targets and cut taxes in good times, Truss plans to cut taxes now so spending is cut in a future manufactured deficit crisis.

Starving the beast involves not just one big lie, but a whole series of untruths. Voters are being told that tax cuts will not raise demand and therefore inflationary pressure, and will also pay for themselves. When both fail to happen after the next election voters will be told that the high interest rates that tax cuts have made inevitable and a larger deficit has nothing to do with tax cuts, but is all the fault of a bloated public sector. The Conservatives' favourite economist, Patrick Minford, will do overtime in TV studios to give this nonsense economics some spurious credibility, just as he did with Brexit.

A steady stream of lies about economics is what Brexit, and Johnson’s period of government, was all about. In that sense Truss promotes the Johnson continuity strategy, just as Truss in many ways represents the Johnson continuity candidate: often radical changes in political beliefs to satisfy personal ambition, a self-discribed “disruptor-in-chief”, with an ability to claim personal triumphs that is inversely proportional to actual achievement. Cutting taxes and spending more in the short term is what Johnson wanted to do but was prevented from doing so by his Chancellor and the Treasury.

Tax cuts now is a strategy that works in winning over Conservative party members, because they represent the small minority of voters who want tax cuts and lower public spending. These members are also the ultimate Brexit faithful, believing the lies constantly fed to them by the Brexit press. But both the ideas advocated by Truss and the policies proposed by Sunak are the opposite of what the UK economy needs right now. The twelve years of Conservative rule have put theUK economy in as bad a state as it has been since WWII, and all they are doing is advocating more of the same.

The Cameron/Osborne period, the years of the one big lie, turned what had been a vibrant economy into a depressed economy. Large percentages of economic output and incomes were lost, as austerity first delayed a recovery from the GFC for three years and then ensured that recovery was tepid. Lack of investment caused by weak demand and uncertainty meant productivity growth, which had been in relatively good health in the decades before 2010, became one of the weakest in the OECD. Johnson’s answer to that was to promote the continuous lies of Brexit, which ensured yet more percentage points in output and incomes would be lost. Yet the damage he and his Chancellor did was not limited to that. Criminal mishandling of Covid and inadequate funding for the NHS and social care meant poor health started producing macroeconomic harm, and their brand of crony capitalism encouraged rent seeking rather than innovation.

The macroeconomic priority of any new Prime Minister has to be two-fold: to deal with the current crisis and to deal with the problem of slow growth in productivity, output and incomes. The current crisis is about the distribution of income: those most hit by higher energy and food prices are those that can least afford it. Part of the solution is to transfer more income from those who have gained from the crisis, the energy producing firms, to those that need it most. It’s the solution that Sunak was reluctantly forced to introduce, after insisting for months that a windfall tax was a bad idea. Sunak’s scheme was temporary, involving a 25% tax with far too generous exemptions for investment. To fund further help for the poorest this winter, it could be made permanent, at a rate above 25% and with no exemptions for investment in fossil fuel extraction.

The first priority in solving the underlying problem of slow UK growth should be to begin the process of restoring the NHS to the position it was when Labour left government. Part of that process is reversing the privatisation of health provision, which while it might have saved money initially either costs more in the longer term or reduces the quality of care, and sometimes both. This is going to cost a lot of money, which is why tax cuts either now or in the near future are such a stupid idea.

Another priority is public investment, including investment to help green the economy. Public investment can be a spur to productivity enhancing private investment, which will promote growth by expanding the supply side of the economy. We also need to reverse direction on Brexit, start cooperating with the EU and begin the lengthy process back into their Customs Union and Single market. Public investment and health come together with Covid, where the government should be embarking on a massive programme to have effective ventilation in every school, workplace and other areas outside the home where Covid can spread.

The problem for most people living in the UK is that both candidates for PM find it impossible to do these things, both because of their Thatcherite ideology and Brexit obsession, and because their own MPs believe the public sector is bloated, inefficient and needs to get out of the way. This is hardly surprising for a party that is increasingly controlled by very wealthy donors and press barons, and that is dependent on them to outspend and misrepresent their political rivals before elections.

Both candidates pledge policies that pander to prejudice or press misinformation, like pledging no more on-shore wind farms (Sunak) or ending the green fuel levy (Truss), when green energy offers the only secure way to avoid a future energy crisis (as well as saving the planet!). So expect no progress on reversing the damage the Conservatives have done to the UK economy over the last twelve years whichever of the two candidates becomes Prime Minister. Instead the only relevant question is how much more damage each can do until the next general election.

[1] The waste of money produced by inappropriate outsourcing and corruption under Johson’s leadership is immense, yet as Chancellor Sunak was in an excellent position to stop it happening, yet he didn’t. His solution to the current NHS crisis seems to be only the power of his leadership, the same leadership he failed to show when Chancellor.

Tuesday, 19 July 2022

The 1970s: myths of left and right about inflation and trade unions


With a global energy price hike generating high inflation in most countries, and central banks reacting by raising interest rates, comparisons with the 1970s are in fashion. The 1970s have for a long time been seen by the political right in the UK and US as the chaos before the calm, where the calm is the advent of neoliberalism. For much the same reasons, a common refrain on the left is that the 1970s were a lot better than what came later in many ways. A good example of the latter is a recent article by Adam Tooze in Foreign Policy. While taking the kind of holistic view he does there has its merits, it also frames the debate as an answer to the question ‘1970s: good or bad?’, while reality is more complex than that. In this post I just want to focus on just two issues: inflation and trade unions.

Tooze says that successfully controlling inflation (through independent central banks) was a victory for conservative politics. Historically inflation produces winners (borrowers) and losers (savers), and so controlling inflation was a victory for savers. In addition high inflation goes with unpredictable volatility. Inflation started at 5% in 1970, rose to over 25% in the mid-seventies, then fell to below 10% only to rise again in the early 1980s. So those who prefer stability, like most business owners, will also prefer low and stable inflation. But the constituency that enjoyed the high and variable inflation of the 1970s is both small and lacks political representation. 

The high and variable inflation of the 1970s was generally unpopular, and as a result no political party campaigned for it, just as no political groups today are arguing that the current increase in inflation should continue. I think it would be fairer to say that successfully controlling inflation is generally popular, rather than characterise it as a victory for conservative forces. There are many reasons why high and variable inflation is unpopular. While economists often focus on the costs of unwarranted relative price dispersion, what was far worse in the 1970s was heightened social disruption. Days lost in strikes reached a post-war peak in the 1970s and early 1980s. Strikes are costly because of lost pay and production, but also because of the social dislocation they can cause. 

The political right likes to slide from this observation to suggest that strikes are always the fault of workers, or even worse ‘trade union barons’. Their predictability on this makes their claim to be ‘the party of the working class’ risible.

Many on the left do the opposite. Strikes, after all, appear to be the archetypal battle between workers and capital. Unfortunately this overlooks one key point, which is that firms also set prices. As a result, when inflation is widespread strikes are not a battle between wages and profits for their share of any surplus, because employers can often recoup their share of the surplus by raising their prices. The reality is that strikes represent the breakdown of negotiations between two sides, where either workers, employers, both or none can be to blame. Such breakdowns tend to be bad for both the employers and employees involved, and often for many who use the products or services they create. High and volatile inflation goes together with a high number of days lost through strikes for obvious reasons. 

The unfortunate reality that is often missed on the left, but which is understood by most macroeconomists, is that a large increase in global energy prices have to lead at some point to a corresponding reduction in real wages (compared to what they otherwise would have been), for reasons I discussed here. Governments can and should act to cushion that effect for those on low incomes (and more widely if higher commodity prices don’t redistribute from consumers to those working to produce commodities but instead redistribute to the profits of commodity producing multinationals), but unless higher energy prices are known to be temporary there is no reason to permanently cushion that impact for all workers, and good reasons why they shouldn’t. 

In these circumstances, suggesting all workers should aim to get nominal wage rises that match the level of inflation is unrealistic, as most will not. Attempts to do so will just risk recreating what happened after the 1970s: very high interest rates and a recession. Equally now is not the time for firms to attempt to generate large increases in profits, because this too invites a reaction from central banks. But the first is not a cure for the second, except insofar as a recession hits profits as well as workers. [1] (As the postscript to this post points out, larger than average real wage cuts imposed by governments on public sector workers are a completely different issue.)

For some on the left, this refocuses the debate on technocratic and undemocratic independent central banks. After all, if it wasn’t for higher interest rates, we wouldn’t get a recession. Tooze writes: “Independent central banks were not truly above politics; they were the extension of conservative politics by technocratic and non democratic means.” But, for better or worse, independent central banks have a mandate to keep inflation near a target. If central banks were not independent, it is very likely that politicians of all stripes would set themselves similar inflation targets, and go about achieving those targets in similar (although probably more erratic) ways.

Some of the dislike on the left for independent central banks is because the cure to excess inflation often involves an increase in the number of people losing their jobs. But this has little to do with central banks per se, and represents a more general dislike of using demand management to control inflation, whether it’s through interest rates via an independent central bank or a government using fiscal or interest rate policy. The 1970s in the UK in particular represented a prolonged experiment in attempting to control inflation without imposing the costs of higher unemployment, and instead using a mixture of wage and price controls and deals between governments and trade unions. The result of this experiment was clear – it failed.

There is a more nuanced criticism of independent central banks with low inflation targets, which is that they replace the inflationary bias of the 1970s with a deflationary bias. This is the line Tooze takes, although I think it needs pinning down more precisely than he does in the article. We have no clear evidence of deflationary bias in the 1990s or early 2000s. In the UK, for example, underlying growth was steady at similar levels to the 1950s, 60s, 70s and 80s. There is no reason why, in normal times, controlling inflation should be deflationary, and no good evidence that it generally is.

However it may well be the case that central banks, given the history of the 1970s, overreact to similar external shocks to those that happened then. David Blanchflower has rightly argued that the Bank of England was too focused on raising rates following higher commodity prices in the second half of the 2000s to notice the impact the Global Financial Crisis was having. The ECB raised rates in 2011 when commodity prices started rising after crashing during the GFC, and the Bank of England nearly did the same. Some might argue that central banks are overreacting now because the dangers of a wage-price spiral are much less than in the 1970s.

However it’s far from clear to me that this shows some flaw in the idea of independent central banks. Politicians, like independent central banks, are just as prone to refight the last war. There are ways of dealing with this deflationary bias without returning to high and variable inflation, like raising the inflation target or changing the target in other ways. Independent central banks with inflation targets represented a positive response to the inflation of the 1970s, and there is no reason why these cannot be improved if it turns out that central banks are overreacting to inflation today. [2]

I noted earlier that one reason why the left wants to question the image of the 1970s pushed by the right is because the 1980s saw the beginning of the neoliberal hegemony. In particular, it saw the start of a decline in trade unionism in both the UK and US. In addition, and whether it was a factor behind decline is not obvious, these neoliberal governments substantially reduced trade union power.

But if it is the case that we are less likely to get a wage-price spiral leading to a severe recession today because unions are less powerful, isn’t that a good thing? There's an apparent dilemma here which many on the left are reluctant to face. The dilemma is that there is an inherent power imbalance between employee and employer in most workplaces and trade unions are important in redressing that imbalance. But is it possible to have strong unions without also generating wage price spirals following commodity price hikes?

International experience suggests the answer may be yes. While trade union density has declined in many countries in a similar fashion to the US and UK, in others it has not.

Will these countries suffer a worse wage price spiral, and therefore recession, than elsewhere because of greater union coverage? If not, then the link between widespread unionisation and the high inflation of the 1970s is less clear cut than many on the right (and some econmists) like to suggest. There is no dilemma if it is possible to have strong unions that also recognise when real wages have to fall following higher commodity prices.

[1] This is why central bankers who extol wage restraint without also pushing profit restraint should know better. In the current context both are inflationary, and the only cure central bankers have for either is the same: higher interest rates and a decline in economic activity. There may also be more medium term concerns about rising mark-ups that are possible because of monopoly or monopsony power in particular sectors, but there are plenty of medium term remedies available to governments to deal with those, like encouraging competition (in the UK’s case, reversing Brexit), better regulation and a stronger antitrust policy.

[2] There is a stronger case against separating monetary and fiscal policy, which is that it facilitates austerity. I make that case here, although as I argue here even that strong case ultimately fails.