Unpicking the legacy of neoliberalism

 

Neoliberalism as an overarching ideology for UK government died with the Brexit referendum in 2016, just as it did in the US with Trump’s election that year. Its last hurrah in the UK was austerity, although whether squeezing the state by reducing the quality of public provision rather than the amount the state does counts as neoliberal is a good topic for discussion. But Johnson’s right wing populist government in the UK did not mean that the neoliberalism of the previous thirty odd years was completely swept away. Much remained, which is why Prime Minister Burnham can legitimately claim to want to end forty years of neoliberalism.

Robert Shrimsley asks where is a modern day Thatcher to fight what Burnham hopes to do? Most politicians on the right nowadays seem keener on fighting culture wars and immigrants, in a kind of horrific beauty contest to see who can be nastier to asylum seekers, Muslims or other minorities. Indeed you can argue, as I have done in the past, that right wing populism is the inevitable legacy of neoliberalism in practice.

However there is another reason why there is no current equivalent of Thatcher, and that is because defending neoliberalism today is too hard an ask. So many of the claims made under the banner of neoliberalism thirty years ago are questionable at best and in some cases clearly untrue.

I have argued elsewhere that neoliberalism in practice, or neoliberalism in government, is essentially about acting in the interests of business and those that run them. I prefer this definition to anything involving markets because I think it is more accurate in describing what neoliberal governments do. Of course neoliberal politicians and neoliberal advocates more generally extol the virtues of free markets when arguing against regulations, for example, but not when it comes to breaking up monopolies or large firms. As Ronald Coase pointed out, the firm is in many ways an alternative to the transaction costs that would be incurred by numerous markets.

It is more widely recognised that definitions of neoliberalism based around a smaller, less active state are also inadequate. Neoliberal governments actively used legislation to diminish the power of trade unions, for example, because this was in the interests of business.

The central claim of neoliberalism is that if governments supported the interests of business in general [1] then society as well as business would benefit. Businesses dislike regulations and taxes imposed on them, so the claim is that if these regulations and taxes were reduced then businesses will grow faster leading to a general increase in prosperity. It is that corporations or privately owned businesses are better at providing goods and services than the government, so where possible the government should privatise or out source such activities to the private sector. Those who run firms need strong incentives, so taxes on high incomes should be reduced.

With the advent of Thatcher and Reagan these neoliberal claims were difficult to evaluate empirically, and support tended to focus on the inadequacies of the governments they were replacing. That is no longer the case. We can directly compare the experience before and after the 1980s, and see whether the neoliberal arguments hold up.

For example we can compare rates of economic growth, or growth in living standards, before and after the early 1980s, as Michael Jacobs does here. For the UK the simple comparison suggests neoliberalism reduced growth rates, although as Michael says we cannot know what would have happened if neoliberalism had never happened. I have noted in the past that this simple comparison is likely to be unfair to neoliberalism because the pre-neoliberal years benefited from a recovery from the devastation of WWII.

What about comparisons between more or less neoliberal economies over a common time period? If you asked what the greatest economic success story of recent times has been, I think it would have to be China. A lot of that is due to China’s integration into globalisation, and its adoption of a market economy, but the Chinese economy can hardly be described as neoliberal. The Chinese state maintains far more economic control than it ever did in the pre-1980s UK, for example, but this has not appeared to inhibit its continuing growth and development. Today China is also at the forefront of innovation. [2]

A clear empirical refutation of neoliberal claims that regulations inhibit growth and should therefore be reduced is the Global Financial Crisis of 2008/9. Deregulation of the financial sectors in the US and most of Europe brought economic disaster. It is a testament to the continuing power and influence of neoliberal ideology that even today politicians on the right and centre call for a reduction in red tape as a means to promote growth, with hardly anyone noting that is what was said about the financial sector before the GFC. Nevertheless it is hard to deny that stronger financial market regulation could have either avoided the crisis or greatly reduced its impact, and that the neoliberal ideology of deregulation was at least in part responsible for letting that crisis happen.

Of course one failure of deregulation, however large, does not imply that all regulations are always beneficial. But neoliberal governments did not argue that regulations should be judged on their merits, but rather that regulations were almost always bad for growth and bad for society. The Global Financial Crisis shows that argument to be wrong. Other examples of where deregulation has had harmful effects are not hard to find.

While regulations are often essential in particular industries and markets (as economists without a political axe to grind have always understood, of course [3]), we are becoming increasingly aware that if left to itself the private sector can sacrifice the future for the present. While thoughtful neoliberals have never denied the existence of market externalities, in practice neoliberal politicians tend to downplay their existence. Climate Change has been described as the greatest market failure ever seen. Government action, particularly through promoting in various ways innovations in green energy (see [2]), has been essential to reducing carbon emissions, although we still do not know if it has been too little too late. [4] Those promoting neoliberalism have often impeded rather than helped this endeavour to save human civilisation as we know it.

The idea that private sector ownership will always produce better outcomes than social (government) control has been dealt a severe blow in the UK by developments in the water industry. It is not my area of expertise, and it may be that the true story is not as simple as it appears, but in this particular case the combination of private ownership of a natural monopoly plus external regulation has produced a crisis today on various levels. It is another example of why any serious attempt to resell neoliberalism faces a tough task.

Finally, a key part of the neoliberal revolution in both the UK and US was a substantial reduction in taxes on top incomes and also on profits. The idea was that the more business leaders and firms are given financial incentives, the more wealth they will create for society as a whole (‘trickle down economics’). Few would dispute that incentives are important, but whether they remain important to those already on very high incomes is questionable.

Instead these tax reductions seem to have had a significant incentive effect on firms and CEO behaviour in a more negative direction. When taxes had been very high, there was not much point in CEOs devoting much effort into raising their salary. When taxes fell, that was no longer the case, and since the 1980s we have seen a significant rise in CEO pre-tax salaries relative to the average wage (from around x20 in the 1970s to x130 today.) This is a result of the combination of incentives and the bargaining power of CEOs, rather than any increase in CEO productivity. In the US a reduction in top taxes may also have led to a marked rise in the share of dividends in national income.

The net effect has been to reverse the post-war trend of a declining income share for the top 1% or 0.1%. The growth figures cited above suggest that this increasing share has come at the expense of the rest of the population. The most marked impact of this increased inequality has been the involvement of some wealthy individuals in right wing politics, most notably in the US. This is one of the direct links between neoliberalism and the rise of a right wing populist plutocracy. One of the strongest arguments against neoliberalism is that it opened the door to Trump and populist plutocracy. 

None of this implies that neoliberalism has no redeeming features, or that regulation and public ownership are always optimal. What it means is that the focus is on the form of interventions that the government can make, rather than whether any intervention is necessary. It is about the type of industrial policy, rather than whether there should be an industrial policy at all. It is about the best way the public can regain control over natural monopolies, which may or may not include ownership. These will be the important debates of Burnham’s premiership.

Of course losing the intellectual argument doesn’t mean that neoliberal ideas will disappear from public debate. The right’s dominance of the media, and the fact that a minority have done extremely well out of neoliberalism, will ensure that these tropes never go away. But it does mean that the interesting debates will be elsewhere, involving how best to unpick neoliberalism’s legacy.

[1] Not the interests of some firms against the interests of other firms, which is what often happens in a right wing populist plutocracy.

[2] To take one example, China is now at the frontier in terms of solar energy production. A recent paper examines how this was achieved as a result of competing innovation subsidies between Chinese cities.

[3] I talk about why economics is essential to any intellectual critique of neoliberalism here

[4] As Mariana Mazzucato has pointed out for the US, rather than the state ‘getting in the way’ of innovation it has often been the driver of innovation.

Long term fiscal projections are a good antidote to politicians talking about tax cuts

 

Every July the OBR publishes fiscal projections looking fifty years ahead. Each year the headline is the same. The public finances are on an unsustainable path, and if nothing is done government debt will be at some record level in half a century’s time. It’s a signal for general hand wringing.

The first point to make is that this has nothing to do with current government policy. This Telegraph headline is predictably silly, unless they believe Burnham will be Prime Minister for a very long time. The UK’s fiscal rules ensure that current policy is sustainable. Instead the report is about longer term trends in government spending and tax receipts. As the report says repeatedly, it is not a forecast because the government will act to ensure that debt remains sustainable.

It is also wrong to say that it’s just not possible to forecast fifty years ahead so the numbers are meaningless. This is not a normal macroeconomic forecast. For reasons that I will discuss below, the assumptions made about long term GDP growth are not central to the analysis, even though the report spends a considerable amount of time on them.

Instead the interest lies in what the critical long term fiscal pressures are, and what they might imply for future governments. Most of these pressures are on the spending side, as a simplified version of the reports Table 3.1 below shows

OBR’s Central Fiscal 50 year Projection: source

% of GDP	FY 2030/1	FY 2075/6
Health	8.4	13.5
Adult Social Care	1.2	1.8
Education	4.3	3.4
State Pension	5.0	8.6
Other welfare benefits	6.2	6.4
Public sector pensions	1.2	0.9
Defence	2.7	3.5
Other	10.9	10.6
Total	39.8	48.6

The share of total government receipts (mainly taxes) in GDP stays constant between the two periods at 42.7% of GDP. (There are offsetting small changes in the GDP shares of particular taxes.) So inevitably the increase in spending means the deficit steadily increases in an unsustainable way. This is only as interesting as the reasons why certain items of public spending are rising as a share of GDP.

The most obvious story is the state pension, where the triple lock ensures that the state pension rises faster than GDP over time. If governments are unable to end the triple lock, they will have to cut other areas of spending substantially or raise taxes substantially. As far as I know no leading politician has addressed this, and few in the media ever question them on this.

More interesting is health and social care. That the share of total GDP going to health and care spending has risen substantially in the past and is likely to continue to do so is something I have emphasised whenever I get the chance, starting from when Osborne’s lied that he was ‘protecting’ health spending by keeping that share constant. (A lie once again accepted by most of our wonderful media.) But the report’s analysis of why this trend continues in the future is interesting.

If you think this is all about an ageing population, you are only a bit right. The population is certainly ageing in the report’s projections, and the UK population starts to fall beyond 2055 because of a low birth rate, but the OBR think that only accounts for around a fifth of the rising GDP share of spending on health. Far more important is low productivity in health services (compared to the economy as a whole) and the fact that as people get richer they want to spend a rising share of their income on health.

The size of neither of these two more important factors is set in stone. Trends in expenditure shares are likely to level off at some point. AI may improve at least some aspects of health service productivity, although face to face care is always going to be central. Where I am more optimistic is that additional spending on prevention may reduce the need for ultimately much more expensive spending on treatment, but the problem there is getting governments to devote resources to prevention.

It is also interesting what items of public spending are not causing problems. Welfare spending other than the state pension, for example, far from being ‘out of control’ remains pretty constant as a share of GDP. Nor do pensions in the public sector create a problem. A falling population generated by lower births leads to a marked fall in spending on education, offset by higher defence spending. (Who knows what defence spending will need to be in twenty, let alone fifty, years time.)

The report is very good in presenting various scenarios alongside the central projection. However I have one important quibble. They present two alternative projections for productivity, one better and one worse than their central projection. However in these exercises they hold public spending constant in real terms, so higher productivity and growth substantially reduces the extent of increasing deficits (because higher growth automatically raises tax receipts).

I think this is misleading, and goes against their default assumption about public spending. It also makes little economic sense. Public services are not inferior goods. So as people get richer, other things being equal, they want more public spending. As they note in Chart 5.5, if they assume more realistically that public spending will rise in line with better GDP growth then the fiscal benefits of higher productivity are much smaller. This quibble is important because there is a danger that politicians will think that better growth will solve longer term fiscal problems, when it will not. It is also why I say above that the assumptions made about long term growth are not critical to the main message of the report.

Although some of the assumptions about the triple lock and health spending may be too pessimistic, I doubt if all these pressures on public spending will disappear. Indeed some pressures may be neglected in the OBR’s analysis. The most obvious to me as I write from a part of the country that has seen no rain and very high temperatures for over a month is the need for climate change adaptation. In addition, as the Prime Minister has made clear, there is the need to provide some kind of state insurance for the costs of social care for the elderly. (This is good on what other countries do.) We have also not acted on the lessons from the pandemic, many of which require spending more money.

This leads to what for me is the main message of the report, which is that taxes are almost certain to continue rising over the longer term. It is a message that pretty well all politicians do not want to hear, and instead pretend the opposite with talk of tax cuts. As usual it is the Conservative party that is the main source of this problem, always talking about cutting taxes but refusing to consider reducing the scope of the state in areas which might dent its popularity (like the triple lock). Yes, you can cut tax by stripping the quality of public services to the bone, but Osborne did that and public services have yet to recover.

But ultimately we get the politicians our media tolerates. Journalists have become very zealous at asking Labour politicians how they will pay for any additional spending, but rather less adept at doing the same for promises of lower taxes. This report provides ideal ammunition for any journalist prepared to do this. But as I have noted many times, journalists have little incentive to bother politicians with facts or expert analysis.

The relationship between capital, plutocracy and populism

 

In a recent post, where I discussed the Conservative party’s newfound opposition to net zero, I noted that one attraction that switch had is that it would likely attract generous donations from the fossil fuel industry. One legitimate question is whether I could have stopped my post right there. Was it really a surprise that a party of the right should be supporting the interests of a significant section of business?

I could put the question more generally. The US right now is often described as an oligarchy, where particular business interests have a pretty direct influence on the government and the policies it promotes. I prefer to use the term plutocracy rather than oligarchy, because the former makes clear that we are discussing an oligarchy based on wealth. In what way is this very different from neoliberalism in practice, which I have described as an ideology that puts the interests of corporations above those of the general population?

When I began to explore the rise of populism and plutocracy in the UK and US many years ago (see Chapter 9 here, for example), I drew a big distinction between policies that favoured all (or almost all) capital and policies that favoured one part of capital at the expense of others. Pretty well all businesses benefited from the decline in trade union power under neoliberalism, for example. However if we take the case of energy, for every oil company wanting to slow or even stop the introduction of renewables, there are producers of clean energy that would lose out. Furthermore, business as a whole would prefer the more stable and probably cheaper energy that a green transition would bring. In extremis, pursuing the interests of fossil fuel companies could bring about the widespread destruction of aggregate capital, not because of competition with other capital but because of climate change.

Alternatively, take Brexit. It is true that certain business leaders helped campaign for Brexit, sometimes because it was in their financial interest. But there is little doubt that the majority of businesses in the UK opposed Brexit, even if they were a little tentative in voicing their opposition very loudly. While with net zero you could argue that oil companies have more financial clout than companies producing clean energy, this was not the case with Brexit. As I noted in this post, right wing populism (and the fascism that it has developed into in the US) is typically very bad for the economy as a whole, and pretty bad for aggregate profitability as well.

For this reason I don’t think it is very informative to say we are where we are today because we have been following the interests of aggregate capital or the capitalist class. That does not imply, of course, that particular parts of that class, that we might call a plutocracy, are not a very important part of the rise of right wing populism. However even here you can tell two very different stories about the linkage between right wing populists and plutocracy.

The first puts plutocracy in the driving seat. It notes, for example, that neoliberalism led to growing wealth at the very top, reversing a post war trend of falling top income and wealth shares created by social democracy. Perhaps the majority of the new billionaire class are not overtly politically active, but a minority will be, and their politics are much more likely to be right than left wing. By decreasing the safeguards that had previously existed, neoliberalism allows politically motivated billionaires to directly influence politics and policy, inevitably shifting it to the right.

However it is also possible to tell a very different story. Take the US for example. There you could argue that the shift from class based politics towards culture wars came from politicians on the right, who found pursuing neoliberal objectives increasingly unpopular. This gave power to the section of the electorate who were very socially conservative and/or racist, a minority who were able to dominate the Republican party through in particular the primary system. Donald Trump emerged because he appealed to that minority of the electorate. Trump is inherently corrupt, which to some extent forces billionaires to become politically involved to curry favour and protect their business interests.

I think both stories are correct, and there isn’t a fundamental contradiction between them. What both stories have in common is seeing the neoliberalism of Thatcher or Reagan as a kind of transitional state, which paved the way for both the emergence of populism as a dominant force in right wing politics and enabled the emergence of a politically powerful plutocracy that would support that populism. Another way of putting this is that it was liberal social democracy that limited the ability of wealth to influence politics and also limited the influence of right wing populism on the political right, and when neoliberalism swept social democracy to one side it allowed both to emerge.

One area where rich individuals undoubtedly play a causal role is through media ownership. To go back to the issue of climate change and net zero, then the short answer to why the UK Tory party has abandoned net zero is simply Rupert Murdoch. As one climate scientist said, “It’s hard to think of another person who has single-handedly done more to muddy the public’s understanding of climate change.” Since the end of 2024 there has been an explosion in the number of editorials in the UK right wing press criticising net zero and the minister who was in charge of that policy, Ed Miliband. That explosion began before the Tories abandoned net zero in March 2025.

Media barons like Murdoch are a good example of the distinction between plutocratic power and class power. While they are likely to promote policies and politicians who support capital in general [1], they can just as easily support policies and politicians that benefit one part of capital but harm other parts, and perhaps also work against the majority of businesses. For example in the UK the strongest and perhaps most influential supporters of Brexit were the right wing press, but Brexit has been bad for UK companies and UK profitability as a whole.

Murdoch’s relationship with Trump is also instructive. Trump at various points has not been Murdoch’s choice to lead the Republican party, and some sources report him as describing Trump as “a [expletive] idiot”, although he had denied this. Trump’s emergence as the leading Republican candidate in the 2016 election, together with his anti-immigration stance, was largely driven by the Republican base rather than media propaganda. (See here, for example.) Only after his victory in those primaries became clear did Murdoch form a close alliance with Trump.

This also has some relevance to a different debate, about whether right wing populism is an ideology or just a means of obtaining or retaining power. Right wing populism, despite going under many different party banners in different countries, seems to share a large number of common characteristics, such as rhetoric pitching ‘the people’ against ruling elites, stigmatising minorities, particularly immigrants, and hostility to democratic pluralism (alternative centres of power). This might indicate a common ideology.

However, while some billionaires who support right wing populism seem to share at least parts of this ideology (Elon Musk, for example), this is not the case for others. Jeff Bezos, for example, appears to hold rather different political views, and clashed with Trump during his first term, but chose to form an alliance during Trump’s second term in office. This suggests a more instrumental rather than ideological support for right wing populism.

I think it is perfectly possible to treat right wing populism as an ideology, just as it is possible to see its close relation fascism as an ideology. Both emphasise the importance of an authoritarian leader who embodies the will of the people, and have a nativist definition of ‘the people’ and therefore an intolerance of outsiders. That ideology is likely to appeal to people, including very wealthy people, who hold very socially conservative, racist and/or authoritarian views. Equally, however, it is quite possible for political or business actors to use that appeal in an instrumental way to obtain power and influence. Indeed, two features of populist governments may make at least the appearance of support a necessity for many businesses: the vanity of the political leader and endemic corruption.

Is capital better off under right wing populism than neoliberalism? I think the answer has to be a clear no, if macroeconomic aggregates mean anything. Partly because of the policies right wing populists pursue (e.g. curbs on movements of goods and labour), and partly because it is a much more inefficient method of government (relying too much on the wisdom of a leader, and ignoring expertise). But some parts of capital, through influence or corruption, may do better. In particular, if some feel that the alternative to right wing populism is stringent regulation of their business they may decide that they are better off supporting right wing populists that will allow them to be part of a plutocracy that shares some of the populist’s power.

[1] An important distinction implicit in this argument is between neoliberalism as an ideology of government and particular neoliberal policies. In my view Brexit makes it impossible to argue that the UK government remained neoliberal, because Brexit was harmful to much of UK business and corporations. However many neoliberal policies will still be pursued by a right wing populist government that is supported by a plutocracy.

The political barriers to radical tax reform

 

Want more public services, help with the cost of living, a simplified tax system and a reduction in the public sector deficit? It sounds like a Reform manifesto, but what I’m referring to is a detailed, radical and costed programme published by Prosperity 2030, a research institute at University College London. It got some publicity when its publication was accompanied by an Open Letter signed by, among others. Jim O’Neill, who is advising our new PM.

One of the core aspects of the programme is an extension of Universal Services, involving free local bus travel for all coupled with additional bus services, an end to the BBC TV licence, universal free school meals and much more, designed in part to replace the need for benefits with direct provision. On the tax side Income Tax, employee National Insurance, Capital Gains Tax, Dividend Tax, and Inheritance Tax are rolled into one, with a single schedule applied to all income (including benefit income and gifts), whatever its source. (I like the idea of calling this combined tax ‘national contributions’: see here.) Tax allowances are abolished. This raises around £75 billion a year. Rates run from 22% at the base to 46% at the top, with continuous progression between them and no cliff edges.

A Local Property Tax replaces Council Tax and Stamp Duty, taxing the property rather than the transaction or the occupant's 1991 banding, and contributes an additional £18 billion a year net. Tripled Air Passenger Duty raises around £8 billion in the first year. Overall the tax changes raise around £101 billion a year in new revenue, which fund £65 billion for the new universal services and £14 billion of capital investment in housing, hospices, and care, leaving around £38 billion (1.4% of GDP) spare to reduce borrowing.

Inevitably this involves raising taxes on certain groups by a considerable amount. The details can be found in the reports distributional analysis (see here), which takes account of the benefits of additional universal services as well as all the tax changes The main group to lose out are pensioners, except those in the lowest income quintile. Those in the richest quintile lose nearly £5,000 on average a year. One reason for this is that pensioners don’t pay National Insurance Contributions, so merging this with income taxes hits them. And of course they get no benefit from free bus travel because they already have it (although they will benefit from additional bus services).

Working adults with no children show net gains up to and including the middle quintile, although poorer households benefit the most. However the richest quintile again loses heavily, by on average £4,000 a year, in part because the top limit on national insurance contributions is in effect abolished. This profile is similar for couples with children, but those with children benefit more because of the extension of universal services. Of course all of this is based on quite complex modelling, including assumptions about how many would use free bus services, and how realistic that modelling is I cannot comment on. The distributional results are summarised below.

In essence this programme funds a large increase in public spending, mainly involving new universal services, by raising a very large amount of tax. The latter is achieved by simplifying the tax system, which in itself should be recorded as a significant benefit, although simplification can also produce changes that are seen as unfair [1]. I can see the appeal of a system that involves just one tax on all forms of income with no tax allowances, but also the arguments against. This and other aspects of the project involve issues that we should debate more, but such debates rarely take place in part because those that determine what is debated and what is not would lose out from such a reform, and also because the government has stuck itself with a ‘no additional taxes on working people’ pledge.

While some of the ideas in this proposal are relatively novel (like abolishing tax allowances and merging inheritance tax with income tax), others have been discussed periodically (e.g. universal services), and some much more frequently The idea of combining income tax with employee national insurance contributions has previously received support from many economists (see here), as has the idea of reforming property taxes. But major reform of the tax system has been largely off the radar of politicians for decades.

The reasons why a right wing government would never enact a scheme like this are obvious, and not worth discussing. To say that the reason such reform is off the agenda of Labour governments is because these Labour governments are not left wing enough is too simplistic. The problem is also that reform of this kind helps those that are less inclined to vote for it, while those who would lose out from such a scheme are more likely to vote against it.

This is most obvious with pensioners. As I noted above, pensioners in most income brackets lose out in this scheme, because they pay more in tax and already receive some elements of universal services. The current Labour government very early on tried to do something that hit most pensioners except the poorest, but on a much more minor scale, and the government’s popularity never recovered. The state pension triple lock, although obviously unsustainable in the longer term, seems almost untouchable in political terms. This is simply because pensioners make up a large and growing share of the population, and they are more likely to vote than other age groups. In recent general elections, around 80% of those over 65 voted, compared to around 60% of those aged 35-44 for example.

Exactly the same issue arises if we look at voting by income. Richer voters have always been more likely to vote, but that gap has been growing in recent years. To quote from a recent study written by Ben Ansell and Jane Gingrich that was part of the IFS’s Deaton Review of inequality: “Moving from the poorest to the richest group (up four quintiles) is associated with a 20 percentage point higher probability of turning out in elections since 2010, as compared with a level of under 10% until 2000.” In addition home owners are more likely to vote, and many of them would be hit by higher property taxes. It is no longer safe to assume that wealthier voters are unlikely to vote Labour, particularly if they are university educated.

Add to this the suspicion that those who lose out from tax changes make more noise than those that gain, and it is not hard to understand why our tax system remains complex and is full of inefficiencies. The reaction of those who vote make it much harder for any Prime Minister or Chancellor to enact a major tax reform that helps those who are poorer and simplifies the tax system, whatever their own political inclinations. This suggests that radical tax reform of the kind proposed by Prosperity 2030 will regrettably not be a major part of the UK political debate any time soon.

[1] To take an example that is not in this proposal but which is frequently mentioned by economists, zero-rating of VAT for food costs a great deal, benefits the rich as well as the poor and leads to expensive disputes at the margin. It would be much more efficient for poorer households to receive the equivalent saving in higher benefits, with the additional advantage that these households could choose how to spend the money. However I suspect that, partly for this reason, public support for the fairness of zero-rating food and other essentials is much higher than for higher benefit payments. 

How Right Wing Populism came easily to the Conservative Party

 

All the evidence points to the alarming extent of man made climate change. This isn’t just evidence available to scientists, but the everyday experience of everyone witnessing or experiencing both hotter temperatures and a more extreme climate. Yet Reform in the UK and the Republicans in the US not only deny this reality but propose policies that will end attempts to mitigate climate change, and instead encourage more use of fossil fuels.

It is far from unusual for right wing populist parties to ignore evidence in formulating their policies. They often deride expertise (experts are part of the despised elite, and universities are full of lefties etc), and appeal instead to common sense (the reasoning of the people). In an interesting substack, Joseph Heath relates this to Kahneman’s idea of fast and slow thinking.

While I think there is some truth in this, the example of climate change suggests it is not the full story. It is not obvious what common sense about climate change is, and as I noted above most people can observe (directly or indirectly) the evidence of climate change, if not its man made origins. So climate change denial is hardly common sense.

An alternative to the idea that right wing populists appeal to fast (intuitive) thinking is that they instead appeal to wishful thinking. At the level of right wing populists themselves, it is very convenient for them to deny the implications of climate change because the fossil fuel industry will then become rather generous with donations. At the voter level wishful thinking kicks in when mitigating climate change appears to cost money or involve unwelcome change. [1]

From a UK point of view, an interesting development over the last decade or less has been the attitude of the Conservative party to climate change. There used to be a degree of cross party consensus between Labour and the Conservatives on this issue, even if in reality Conservatives were less keen. (Cameron famously talked in private about ‘Green Crap’.) More recently, however, the Conservatives have explicitly abandoned their commitment to net zero. They want to repeal the 2008 Climate Change Act, get rid of carbon taxes and advocate for more extraction of fossil fuels.

While this change in attitude and policy is very regrettable, it really shouldn’t come as a great surprise. I would argue that the Conservative party has for some time been highly susceptible to wishful thinking and inclined to ignore evidence. In particular on two occasions over the last twenty years they have followed their own wishful thinking rather than evidence with disastrous results for the country.

The first is austerity after the Global Financial Crisis. The wishful thinking involved here had two aspects. The first was the belief that the size of the state could be reduced without cutting the responsibilities of the state. The second was the belief that the biggest recession since WWII was a perfectly good time to embark on a massive programme of fiscal consolidation (aka austerity).

The first aspect of their wishful thinking has been so all-pervasive on the political right that it might seem odd to say that it represents a failure to look at evidence rather than just an opinion, but the evidence is pretty clear. Take the NHS for example. After 2010 spending on the NHS was held flat as a share of GDP. But just a brief look at historic trends and trends in other countries would show that spending on health has tended to rise over time since WWII, in part because of an aging population.

Perhaps talk of ‘protecting’ NHS services was just propaganda, and austerity represented a deliberate attempt to squeeze spending based on a belief that this would force improvements in efficiency. More generally, right wing papers were often full of examples of alleged inefficiencies in state spending. But if this was the belief, then rising waiting lists that emerged pretty soon after austerity began should have led to a rethink. It did not.

The second aspect involved, as best as I can tell, a faith that monetary policy would be able to counteract the impact on aggregate demand of any fiscal consolidation. When interest rates hit their lower bound in 2009 that belief should have been discarded, but it wasn’t because justifying austerity on the basis of scaremongering about the budget deficit was just too attractive politically. Austerity went against what all the economics textbooks said and the majority of economists advised, a majority that became overwhelming within a few years.

The second example of wishful thinking that was disastrous for the UK was Brexit. Here the advice of economics textbooks and academics was even more overwhelming, but those pushing Brexit wished it away as ‘Project Fear’. Now you could argue that I’m being a little unfair here, because the parliamentary Conservative party was split on the issue. I would respond that it is a mistake to see the Conservative party just in terms of the views of its MPs. The party in the media (the right wing press) and at key moments the membership are also very powerful, and both were fully behind Brexit. Of course since the left the EU it has become fatal for a Tory MP to question Brexit, despite all the accumulating evidence of the harm that leaving the EU has done to the UK.

There are many other examples, of course. It would also be silly to argue that wishful thinking didn’t occur on the political centre or left, but it is difficult to think of similar examples where that wishful thinking had such a devastating result for the UK economy. You can blame the Brown/Blair government for deregulating financial services before the Global Financial Crisis, but it is harder to suggest that they did this in the face of the majority of expert opinion advising the contrary. (Expert opinion isn’t always right!)

Why the Conservative party should be so susceptible to wishful thinking is too big a question to answer here, and one I’m not sure I’m qualified to answer. Again, however, it is important to note that the party is more than just its MPs. Those MPs and their leader are at some point chosen by party members and are heavily influenced by a right wing press, a media that has never been known for its objectivity in looking at evidence.

Will Dunn notes the similarities between Trump and Kemi Badenoch here. That piece was written before Badenoch said she would purge Conservative candidates who supported a net zero policy, much like one of her predecessors purged candidates who didn’t support Brexit. It seems that denying bits of reality you don’t like is no longer just a fault, but has become an essential qualification for being involved with the Conservative party.

Among too many of those who comment on politics in the UK, right wing populism is seen as Farage, Reform and those parties and politicians to the right of both. This is a huge mistake. Right wing populism has for some time been integral to the UK’s mainstream right wing party. If support for Reform continues to decline, and the Conservatives overtake it in the polls, the threat of right wing populism in the UK will simply have changed the banner under which it marches. In this sense the UK is very like the US, where right wing populism is now the politics of the right.

[1] A third possibility relates to collective action. Perhaps social conservatives are more inclined to be free-riders, hoping someone, or some other country, will sort the problem out.

The UK’s falling debt to GDP fiscal rule is a rule to suppress public investment

 

Let me start by apologising to any regular readers of this blog. None of the arguments in this post are particularly new. But with a new PM and possibly a new Chancellor, and with Andy Burnham committed to high public investment including many more council houses, it seems appropriate to make this argument once again in as clear a way as I can.

The UK has for some time had two fiscal rules. One targets some measure of the future deficit as a ratio of GDP and the other requires debt to GDP to be falling. The second rule is about the change in debt, but the first rule is about the deficit which is the change in debt. So why do we need two rules which essentially target the same thing? [1]

Here are the variables relevant to the two current fiscal rules since 2000.

The red line, the ‘golden rule’ that targets the current balance, shows the impact of the two recent recessions quite clearly. As I have long argued, fiscal rules should be abandoned during recessions and the subsequent recovery. The blue line, which is the change in the government’s net financial liabilities as a ratio of GDP, is the falling debt to GDP rule. It is much more erratic, which automatically makes it a bad target for any fiscal rule, but it essentially follows the path of the current balance. The main difference is that, for a given deficit, when GDP is falling then debt to GDP will rise sharply, and equally when GDP is growing strongly debt to GDP will tend to fall.

So why two rules? Why not choose the more stable of the two, the golden rule for the current balance? The technical answer, which many of you will have already noted, is that the current balance excludes public investment. Without the second rule, then in theory public investment could be very high leaving debt to GDP rising even if the current balance was zero.

As I have argued many times, the golden rule makes good sense in principle. As long as we measure the current balance some years ahead to strip out erratic elements or the impact of the business cycle, and as long as we have an opt out from the rule in major recessions when interest rates are likely to hit their lower bound, then it makes sense to aim to have a fiscal policy that neither adds to nor subtracts from aggregate demand. A current balance target is a shorthand way of doing that. [2]

Why exclude public investment from the deficit rule? There are many reasons, but one of the more compelling is that politicians will often try to meet any total deficit rule by cutting public investment rather than current spending, because the political cost is less immediately visible. 2010 austerity was a clear example of that, and we are still suffering its effects. Better to target the current balance, which forces politicians to make choices that don’t damage the economy in the longer term. A second, and at least as important, reason is that individual public investment decisions should be based on whether the projects themselves are worthwhile, and not on some aggregate financial number. When a business sees a good investment opportunity it borrows to invest, so why shouldn’t the government do the same?

But that compelling logic means that it makes no sense to have a second fiscal rule, the only purpose of which is to constrain aggregate public investment. The logic that removes public investment from the deficit rule is just overridden by having this second fiscal rule! At best the falling debt to GDP rule just duplicates the golden rule, and at worst it constrains public investment and adds an erratic element to fiscal policy as well.

This case against the falling debt to GDP rule is overwhelming. I have been arguing against this rule for a very long time, and I challenge anyone to come up with a justification for it that I cannot debunk pretty quickly. It is true that a zero current balance rule will not guarantee falling debt to GDP, but if the government really wants to be absolutely sure that debt to GDP falls it can achieve that by targeting a small surplus for the current balance. (See the section headed “Why not focus solely on the current budget balance?” in Ben Zaranko’s discussion.)

I don’t think the reason we have the falling debt to GDP rule is technocratic. Nor do I think it is just because some want low public investment for political reasons. Instead I think it is part of what I call mediamacro. According to too many journalists in the media, government debt is bad, so a good fiscal rule has to ensure that this bad thing is getting smaller. If the rule doesn’t actually specify that directly, then from a mediamacro point of view that is a problem.

I became convinced of that when I was on John McDonnell’s Economic Advisory Council when he was Shadow Chancellor. I wrote a paper for the Council arguing for a form of golden rule and ditching the falling debt to GDP rule, and the only dissent on the Council (chaired by John) was from those against having any rule at all. But later I got a call from John’s team, saying that their political/media advice was that a form of a falling debt rule had to be included as well. (They did, however, try and reduce the eratic nature of that target.) I suspect every Chancellor before or since has been getting that advice, and as ever politics trumps economics.

If we combine the falling debt to GDP rule’s constraint on public investment under a Labour government with the Conservative predisposition to cut this investment anyway, and it becomes much easier to understand why UK public investment is unusually low. There may be occasions where the pressure on real resources is such that the additional domestic demand generated by additional public investment in the short term might lead to unacceptably high interest rates, but that is not always the case and the falling debt to GDP rule applies whatever. This constraint on public investment also means that Labour governments search for other less sensible means to increase public investment that avoid immediate public borrowing, such as PFI for example.

If public perception, which in reality means media perception, is really believed to be a binding constraint, then there is a way around the problem, a route that John McDonnell later took. Rachel Reeves has already redefined the measure of debt in the rule to include financial assets held by the government. The obvious next step would be to include physical assets as well, meaning that public investment would have no long term impact on the measure of debt [3] The disadvantage of taking that route is that it brings the falling debt to GDP rule even closer to the golden rule. but if that hastens the eventual demise of the falling debt to GDP rule so much the better. [4]

So my advice to a new Chancellor, if we have one, is to get the Treasury to write a paper setting out why the falling debt to GDP rule along side the golden rule simply acts as a barrier to public investment, and how under reasonable assumptions the golden rule achieves falling debt to GDP in the medium to long term. [5] At the same time commission an analysis of where the public sector capital stock has declined over the last twenty years, together with a sector by sector analysis of possible supply side constraints on increasing public investment today.  

The argument in this post is not that the government should never try to reduce debt if it can. I think there is a good reason why it might wish to, which is to make room for large increases in debt following a major recession. It can do this by, if necessary, setting a non-zero target for the current balance. Instead my argument here is that public investment should not be the means by which that debt is reduced, which is the inevitable consequence of having falling debt to GDP as our second fiscal rule.

[1] Why not target the level of debt? Targeting debt makes no sense, because debt is the shock absorber that allows governments to avoid erratic movements in spending and taxes following shocks to the economy. But debt (or money creation) has a downside, which is that it allows politicians to avoid tax increases or spending cuts not for the sake of the economy but for the sake of their popularity (‘deficit bias’). That is why it makes sense to target the difference between spending and taxes, which is the deficit.

[2] Why not just look at inflationary pressure directly, as MMT would argue? Well if the central bank is doing its job then it will always ensure inflationary pressure some years ahead is zero.The reason to have a balanced fiscal policy is to avoid our central bank having to raise interest rates just because politicians don’t like making unpopular decisions..

[3] Indeed, if the asset was worth more than than its initial cost, it would increase public wealth

[4] Subtracting physical assets from debt is a logical next step to the change made my Rachel Reeves to subtract public sector financial assets. It transforms debt into a measure of public sector wealth or net worth, that many including another Andy have suggested as a traget in the past. 

[5] While supportive of looking at public sector net worth, a standard line from the IFS among others is that looking at gross debt is still useful because public sector assets don’t necessarily yield a financial return. But this doesn’t matter, because in that case the government can just raise future taxes following the golden rule. Indeed that is the right outcome from an intergenerational point of view, because those who benefit from the investment pay for it.

I think this and similar arguments for retaining a rule involving gross rather than net debt owe something to the concept of ‘fiscal space’, which is the idea that there is some upper limit to what public debt can be, and crucially that we are always close to that limit. There is an upper limit to public debt, which is the level of debt where the government would rather default than raise taxes to service that debt. That level is an order of magnitude above current levels. Other attempts to suggest a much lower limit to the public debt tend to fall apart empirically.

Sowing the Seeds of UK Revival

 

As you have almost certainly read too many laments about having seven Prime Ministers in (just over) ten years, and too many ‘10 years after Brexit’ pieces too, I’m not going to do either here. Yes, the two things are connected of course, but as Chris Dillow says, seeing Brexit alone as the underlying problem ignores the fact that, after months of extensive debate, a majority of people voted for it. We need to fix the problems that led to the Brexit vote, as well as trying to undo the consequences of that vote.

You have also probably read plenty of pieces speculating about what Andy Burnham will do as Prime Minister, or what he should do. But here also it is important to see the political context. Burnham has at most three years before the next election, and so his overriding priority will undoubtedly be to do things that enhance his government’s popularity. In a political system that works that would be the same as enacting good policies, but we are still in the same system that allowed Brexit to happen. As a result, popular policies and good policies are very different things. (For example, a year ago a majority of people supported keeping the two child limit on welfare benefits.)

It is true that Starmer’s Labour in government was far too focused on how policies played in the short term. But this was a mistake for two reasons. First, when his government came into power, it did have the chance to undertake major reforms that would have future benefits even if they were immediately unpopular. It did very little of that (and that little often came from ministers that No.10 briefed against), and instead lost popularity by enacting more minor policies that were very unpopular,  like ending the Winter Fuel Allowance. Second, Starmer’s government was inept at boosting its poll ratings. By affirming the right’s socially conservative agenda they increased the Reform vote and alienated their core support.

Given the failures of his predecessor, Burnham doesn’t have the luxury of championing major policies that are unpopular in the short term. For example, I argued strongly in this blog that taxes on working people needed to rise, and that the benefits of this in terms of better public services would within five years outweigh any short term unpopularity. But today that trade-off looks much less favourable.

The set of popular policies that are also good for the country is not empty, but once we take into account the ability of certain groups to make a lot of noise then that set is pretty small. However what Burnham can do is set in place three key processes which can begin to improve the UK’s political system. It may take a second term for the benefits of these measures to be felt, or even be enacted, but they need to be started now for this to happen. These are all things Burnham has supported in the past, so he has a strong motive to put them in place.

1. Changing FPTP

Many have noted that the First Past the Post system of electing a government is a recipe for chronic instability in a multi-party system. Of course FPTP was meant to stop a multi-party system coming about, but it failed to do that for one simple reason: the rise of right wing populism. Right wing populism just doesn’t split the political right, but it also fragments the centre and left. As the Conservatives go for ever more socially conservative policies to compete with Reform, more liberal but economically right wing voters choose the Liberal Democrats. As Labour attempts not to offend left leaning socially conservative voters, they are in danger of alienating their core socially liberal vote that can then move to the Green party.

I argue here that the rise of right wing populism is a consequence of a change in what the political elite considers acceptable, rather than a drift in voters’ attitudes. It will take decades rather than years to replace the political and social norms against racist and dehumanising rhetoric and policy, and that cannot happen with the Conservative party under its current leadership. That in turn means that there will always be a political party promoting far right social policies with a core vote of over 20%, and with the possibility of that vote going high enough to win a general election under FPTP. This is an intolerable outcome for two reasons. First, the majority of voters do not support far right social policies. Second, right wing populists in power tend to dismantle key parts of a pluralist democracy, and in extremis can end democracy itself.

Unless you support right wing populism, this is in my view an utterly compelling reason to get rid of FPTP. Having FPTP is like having a Brexit referendum every five years where you need only around 30% rather than 50% to choose major policies that will harm almost everyone in the country. The Starmer government was prepared to keep FPTP because they were happy to play high stakes poker to avoid making compromises with others. Hopefully Labour under Burnham will be a little more sensible. But another lesson of Brexit is what a disaster ending something without a clear idea of what replaces it can be. Burnham can start the process of ending FPTP by setting up some kind of Commission to establish the best replacement for it.

2. Restoring Leveson Two and Ofcom

The right wing press in this country increasingly owes its power not to the size of its direct readership, but the influence it has on the broadcast media and the political elite. Brexit would not have happened without the right wing press. In addition we now have the problem of billionaires doing to social media what wealthy newpaper owner so: distorting the information it provides to boost their own political agenda and to generate misinformation. This is an environment in which evidence based policy has little chance.

Two things need to happen for this influence to diminish. First, the right wing press needs to be held publicly accountable. The original Levenson inquiry did that very effectively, and that was precisely why that press lobbied so hard to prevent the planned follow-up happening. That Starmer decided to shelve Leveson Two inreturn for extremely small change was a clear indication of the mindset that would eventually bring him down. We can only hope that Burnham doesn’t allow his own preferences expressed before he became PM to be sacrificed to threats or bribery from press barons.

Putting the spotlight on the practices of the right wing press will provide political capital for more long term media reform, and in particular in dealing with misinformation generated by social media. Burnham needs to appoint a Secretary of State for Science, Innovation and Technology who has the will to take bold action and the ability to fight the attacks that will inevitably come their way.

3. Devolving power and money to the English regions

Essential for economic revival (alongside more EU integration) is growth in the UK’s major cities other than London. The UK has exceptionally high regional inequality in terms of productivity and therefore wages, which is partly a legacy of the UK’s early embrace of neoliberalism. I am convinced a lot of the reason cities outside London are so unproductive is because of poor transport infrastructure., Part of that is also a legacy of neoliberalism, but it also reflects that power and decisions are made in London. As Stephen Bush notes, power in England is unusually centralised, with in particular local government becoming less and less able to do stuff without centrally provided money and approval.

As Burnham’s speech yesterday made clear, greater devolution is at the centre of Burnham’s vision. But the idea that the cities outside London should be able to have the money and the power to make substantial investments to improve their transport infrastructure will horrify the Treasury. No.10 North may have the responsibility, but the Treasury will always control the purse strings. To achieve his ambition Burnham requires a Chancellor who has the experience and determination to overcome Treasury fears and ensure devolution happens.

None of the three areas above are among the major concerns of most voters, so Burnham should be able to start the process of reform off without worrying too much about the impact that will have on his chances of winning the next election. However the political right knows what a threat the first two at least will be, and also how to use rural areas to attack the third, so they will do all they can to prevent anything happening. Hopefully Burnham will understand that the right wing press and social media will also do everything they can to stop him winning the next election anyway, so attempting to minimise negative media coverage from these sources by appeasing the right is worse than pointless.