Winner of the New Statesman SPERI Prize in Political Economy 2016

Tuesday 31 January 2017

Why the reassuring stories about Donald Trump are quickly falling apart

When May visited Trump, the UK media were full of comparisons with Thatcher and Reagan. The US free press paid little attention to the visit, because they were fully preoccupied by the enormity of what was happening to their country. They were not seeing the first few tentative steps of another Republican president, they were seeing the confident strides of the equivalent in the UK not of Nigel Farage, but the leader of the BNP or the EDL. If you think this is going over the top, read on.

There were three kinds of story about Trump that encouraged people to think things wouldn’t be so bad. The first, which we now know is untrue, is that he would surround himself with more experienced and wiser counsel. Instead probably the most powerful man in Trump’s White House is Steve Bannon. He is executive chairman of Breitbart News, essentially a far right, or what is called in the US alt-right, news and opinion outlet that promotes white supremacist, anti-Muslim, anti-Semitic ideas. One of Trump’s latest actions is to oust the director of intelligence and the chairman of the Joint Chiefs of Staff from always attending the Principals Committee of the National Security Council and replacing them with Bannon. John McCain said the appointment of Mr. Bannon is a radical departure from any National Security Council in history.

The second story was that everything said on the campaign trail was to win the presidency, and that once that was achieved more ‘serious’ (aka traditional Republican) measures would be introduced. (US financial markets might have bought into that idea, and are now beginning to realise their error.) Once again the first few days, and particularly this travel ban, have proved that wrong. Trump is enacting the headline measures that were both highly controversial and also effective on the campaign trail, and doing that fast. This is smart politics. His strength was never in the Republican party or in the business community, but in those who watch propaganda networks like Fox News and who helped him into the White House.

The final story, which continues on both the left and right, is that Trump and his team are inexperienced buffoons who will quickly make fools of themselves, and will be brought to heel by the checks and balances of the US constitutional system. Its too early to tell, but the signs so far do not look good. Take the holocaust statement. According to this story, leaving out any mention of Jews or anti-Semitism from the Holocaust Day statement was perhaps an oversight that would get corrected later. But it was not, but instead intentional and purposeful.

A far more plausible explanation of what is going on is that it is part of a strategy, not only to firm up Trump’s base but also to test those checks and balances. Telling border agency staff to ignore court orders is not confusion but deliberate, to see how far they can go. Initial reports that the top state department officials had resigned were perhaps deliberate misinformation: they were all fired by the White House, with no replacements in sight. What this looks like is a concentration of power at the very centre. The lack of consultation about the immigration order was not inexperienced oversight but the shape of things to come.

The trouble with checks and balances are that they are designed to work on the margin, stopping small acts of overreach by different parts of a normal government. Whether they can cope with a determined and fast moving small team in the White House we have yet to see. These checks and balances are often slow. For example Trump has become president with his business affairs hardly altered. The travel ban excluded the four countries in the area in which Trump has business interests. “This isn’t the way the presidency has worked since Congress passed the Ethics in Government Act in 1978,” said the director of the U.S. Office of Government Ethics, but what is anyone going to do about it?

Given all this, for Prime Minister May to celebrate a “new era of American renewal” after meeting Trump represents either craven grovelling or a complete misreading of what is going on, or both. As Simon Schama tweets:

“Nothing is being renewed in USA except hatred. Nothing is being renewed in USA except ignorance and the dissolving of distinction between lies and truth. Nothing is being renewed in USA but much is being destroyed: equity under law, the climate, civil decency, public education, public health.”

If you think that quote, and this post more generally, are overreactions of the type often found in the worst kind of left-wing hyperbole, here is Charles Koch, scourge of the American Left: “We have a tremendous danger because we can go the authoritarian route ….”.

All this is going to have huge consequences for the people of the US and the world. But I make no apology for ending on a more parochial point, because it is critical and happening right now. Brexit is like a train with no way of stopping before its destination, full of people who think they are going to paradise, but their paradise has just been taken over by someone who is turning it into hell. Does our leader say we must get off the train before it starts, fit it with more brakes or even that we must pause before we leave? No, she says she sees and hears nothing, and even the normally rebellious guard says we must follow the will of the people. As Trump goes about putting his campaign pledges into action within days of taking office, Boris Johnson in the Commons yesterday actually said that it was clear that “Trump’s bark is considerably worse than his bite”. Keynes may not have said “When the facts change I change my mind. What do you do, sir?”, but it is the right question to ask right now..

Sunday 29 January 2017

Why voting for Article 50 may ruin an MP's career

The last time I did something like this was to urge Labour party members to vote for Smith rather than Corbyn, knowing full well that Corbyn was almost certain to win. Being proved right on that occasion is no consolation, because I would rather have been wrong. This is even more futile, but now as then I feel a decision is about to be made that is both disastrous and irreversible.[1] I also want to say something about the longer term interests of MPs that I have not seen said elsewhere.

There are so many principled reasons for MPs to vote against triggering Article 50. Let me summarise what I see as the main ones here, but this is far from comprehensive.
  1. The vote was close, and is advisory. Unlike the Scottish referendum, it excluded 16 and 17 year olds, who by the time we actually leave will be able to vote. Demographic trends suggest that at some time in the near future the referendum would go the other way. Migrants from the UK were excluded, even though they are directly affected by the vote and legislation is on the table to give them votes for life in a UK election.

  2. The vote was also won on the basis of clear lies of a kind that have never been used in a UK election before. There is strong evidence that these lies helped swing votes. I would add that the broadcast media facilitated the propaganda coming from most of the tabloid press, in particular by treating knowledge as opinion.

  3. The referendum was only about leaving the EU, and not about how we leave the EU. In particular, it was not about leaving the Single Market. We have no way of knowing which way a referendum on the Single Market would go. May’s logic that the referendum was ‘really’ about immigration and that therefore we have to leave the Single Market is conjecture. Polls on immigration that do not also note the costs of reducing immigration are worthless, like polls that ask about cutting taxes.

  4. A proper response to the referendum would be to note that many ways exist to leave the EU, including staying in the Single Market, and allow parliament to decide what the UK’s negotiating position should be. The statesman like response to such a narrow vote would be to seak the softest of Brexits. The fact that May does not wish that to happen is an affront to parliamentary democracy. That alone is reason enough to vote against.

  5. [Added 30/1/17] What triggering Article 50 actually means is still unclear. Is it reversible? Do we have to wait until we leave before we can negotiate new trade agreements with the EU? As Rick says, you would not exchange contracts on a house with these kind of fundamental uncertainties unresolved. Why has everything to be so rushed?   
But alas, being realistic, this is not the basis on which many MPs will vote. Instead they will think about their political careers, and the backlash they will encounter if they vote No to Article 50. But conventional wisdom on this is at best incomplete and quite probably wrong for many MPs.

The assumption in much of the media, encouraged of course by the tabloids, is that MPs in constituencies that voted Leave will face a backlash from angry Leave voters if they personally vote No to triggering Article 50. However it is far from clear that the number of Leave voters who would change their vote on this basis is greater than the number of Remain voters who will do the opposite. My reason for thinking this is partly the local and national election results since the Brexit votes, where we have seen huge swings to the LibDems in both Remain and Leave constituencies. It is also because, unlike Leave voters, many remain voters are personally affected by the referendum result. They may have family living in the EU, or have close colleagues who are from the EU. They may work in firms that could well decide or be forced to downsize if we leave the Single Market.

If May is defeated on Article 50, she will almost certainly call an immediate election. How will the fortunes of a MP that voted for Yes to triggering Article 50 compare to any that vote No? Labour MPs that vote No will lose some Leave voters, but these are likely to split between Conservatives and UKIP. They may do this even if they vote Yes because they will have read in their papers that Labour is stalling Brexit. Conservative voters that vote No are unlikely to lose many votes to UKIP. Those from either the Conservatives or Labour that vote Yes are likely to lose many Remain voters to the LibDems. How these opposing forces pan out is very difficult to judge, and is likely to vary a great deal across constituencies, and without additional information it is far from obvious why MPs should only worry about Leave voters.

Labour MPs may feel that they are bound to lose badly in a quick election because Corbyn is so unpopular. I think that is right, but for every reason why that might get better by 2020 I can think of reasons why it will get worse.

But all this is thinking short term. MPs that are not ideologically opposed to the EU must surely know that Brexit is very likely to be a disaster. The impact of leaving the Single Market is going to be pretty bad, but as the OBR has made clear the impact of reduced immigration from the EU on the public finances is also going to be large. To tell yourself that this is all uncertain is to deliberately ignore the judgement of the best economists both at home and overseas and the major economic institutions. The outlook for the NHS and other public services is therefore dire.

The government’s position is full of contradictions. They are desperate to make trade deals with anyone, but are prepared to see a sharp fall in trade with the huge market that is our closest neighbour. They say that leaving the EU is to regain sovereignty, but every expert knows that the major gains from trade, particularly for the service orientated UK economy, come from reducing non-tariff barriers which inevitably compromise sovereignty (look at UK trade to the EU before and after we helped create the Single Market). Do we really want to take back control from Europe only to give it to Donald Trump?

The political implications of May’s strategy are more speculative, but initial signs are not good. May now finds herself unable to condemn the immigration policy of President Trump that overtly discriminates against Muslims including UK MPs, and which is the biggest gift to terrorists since Bush talked about a crusade. (At least when that happened Blair was quick to tell him to stop.) May has threatened to turn the UK into a tax haven if the EU do not meet our demands, once again without parliament having any say. All this makes her desire to help the left behind and the just managing into empty words that will become a sick joke. She sees reducing immigration as an absolute priority, which will further hurt business and feed growing UK xenophobia.

All this means that Conservative MPs who will vote with the government because they have ambitions for a ministerial career will find if they succeed that they will spend most of their time administering cuts. If it passes, the Article 50 vote will soon be regarded by Labour members as they now regard the vote over the Iraq war, meaning that those that vote Yes will find it very difficult to achieve a senior position in the Party. Another comparison with similar implications is Suez, another failed attempt to regain a lost imperial past.

All this should make MPs very reluctant to base their decision on perceived self interest, when that cuts so many ways. They should instead heed the words of a well known ex-MP.
“The first duty of a member of Parliament is to do what he thinks in his faithful and disinterested judgement is right and necessary for the honour and safety of Great Britain. His second duty is to his constituents, of whom he is the representative but not the delegate. Burke's famous declaration on this subject is well known. It is only in the third place that his duty to party organization or programme takes rank. All these three loyalties should be observed, but there in no doubt of the order in which they stand under any healthy manifestation of democracy.” Sir Winston Churchill on the Duties of a Member of Parliament. (Source)

MPs should ask where stands the honour of Great Britain when its leader feels that Brexit
prevents her joining leaders in Europe and Canada in condemning Trump's Muslim ban.

[1] At present there is no mechanism for parliament to stop the process of leaving the EU once they trigger A50, whatever Corbyn may imply. Once we leave, rejoining will almost certainly mean we would have to join the Euro, which is not a good idea..  

Friday 27 January 2017

The UK’s 1976 IMF crisis in the light of modern theory

During the arguments over austerity, its supporters would often point to 1976 as evidence that it was possible for a country with its own currency to have a debt funding crisis. At the time this was frustrating for me, because I had been a very junior economist in the Treasury at the time, and my dim recollection was of an exchange rate crisis rather than a debt funding crisis. But I could not trust my memory and did not have time to do much research myself.

So with the publication of a new book by Richard Roberts on this exact subject (many thanks to Diane Coyle, whose FT review of the book is here), I thought it was time to revisit that episode combining Robert's comprehensive account with our current understanding of macroeconomic theory. I think any macroeconomist would find what happened in 1976 puzzling until they realised that senior policymakers did not have two key pieces of modern knowledge: the centrality of the Phillips curve, and an understanding of how the foreign exchange market works.

In terms of where the economy was, there is one crucial difference between 1976 and 2010. In the previous year of 1975 CPI inflation had reached a postwar peak of 24.2%. Although that peak owed a lot to a disastrous agreement with the unions, it probably also had a lot to do with the ‘Barber boom’ which had led to output being 6.5% above the level at which inflation would be stable in 1973 (using the OBR’s measure of the output gap). Although this output gap had disappeared by 1975 and 1976, inflation was still 16.5%. Given the lack of any kind of credible inflation target a period of negative output gaps would almost certainly be required to reduce inflation to reasonable levels.

The lack of understanding by senior policymakers of how the foreign exchange market worked was due to floating exchange rates being a novelty, Bretton Woods having broken down only 5 years earlier. We had a policy of ‘managed floating’, where policymakers thought the Bank of England could intervene in the FOREX markets to ‘smooth’ the trajectory of the exchange rate. My job at the time - forecasting the world economy - was a long way from where the action was, but my main recollection of the time comes from one of the periodic meetings of all the Treasury’s economists. It seemed as if the Treasury’s senior economists believed in the ‘cliff model’ of the exchange rate. The cliff theory suggests that if the rate moves significantly away from the target that the Bank was aiming at, it would collapse with no lower bound in sight. At the meeting I remember some more junior economists (but more senior than I) trying to explain ideas about fundamentals and Uncovered Interest Parity, but their seniors seemed unconvinced.

It is much easier to understand the 1976 crisis if you see it as a classic attempt to peg the currency when the markets wanted to depreciate it, and this is the main story Roberts tells.. The immediate need of the IMF money was to be able to repay a credit from the G10 central banks that had been used to support sterling. It is also true that sales of government debt had been weak, but Roberts describes this as stemming from a (correct) belief that rates on new debt were about to rise - a classic buyers strike. Although nominal interest rates at the time were at a record high, they were still at a similar level to inflation, implying real rates of around zero.

Here we get to the heart of the difference between 2010 and 1976. If there had been a strike of gilt buyers in 2010, the Bank of England would have simply increased its purchases of government debt through the QE programme, the whole aim of which was to keep long rates low. They could do this because inflation was low and showed no sign of rising. Contrast this with 1976, with inflation in double figures but real rates were near zero.

I think what would strike a macroeconomist even more about this period was the absence of the Phillips curve from the way policymakers thought. Take this extract from the famous Callaghan speech to the party conference that Peter Jay helped draft.
“We used to think that you could spend your way out of a recession and increase employment by cutting taxes and boosting government spending. I tell you with all candour that that option no longer exists, and so far as it ever did exist, it only worked on each occasion since the war by injecting a bigger dose of inflation into the economy, followed by a higher level of unemployment as the next step”

As a piece of text it only makes sense to modern ears if there is a missing sentence: that we failed to raise taxes and cut spending in a boom. Far from a denunciation of Keynesian countercyclical fiscal policy, it was an admission that politicians could not be trusted with operating such a policy, essentially because they imagined they could beat the Phillips curve using direct controls on prices and incomes. The fact that fiscal rather than (government controlled) interest rate policy was being used as the countercyclical instrument here was incidental.

Reading this book also confirmed to me how misleading the Friedman (1977) story of the Great Inflation was, at least applied to the UK. These were not policymakers trying the exploit a permanent inflation output trade-off, but policymakers trying to escape the discipline of any kind of Phillips curve. They were also policymakers who had not fully adjusted to a floating rate world, and the IMF crisis was superficially a failed attempt to manage the exchange rate. More fundamentally It was also a reaction by the markets to a government that was not doing enough to bring down an inflation rate that was way too high. The IMF loan was useful both as a means of paying back existing foreign currency loans, but also a means of getting fiscal policy and therefore demand to the level required to reduce inflation.

Although inflation fell steadily until 1979, another boom in 1978 together with rising oil prices reversed this, and through the winterof discontent helped elect Margaret Thatcher. Unfortunately the IMF crisis and the 1970s more generally is another example of the consequences of politicians, in this case particularly those on the left, not accepting basic lessons from economics.            

Monday 23 January 2017

Did centrism beget populism?

Warning: amateur political science below

Stewart Wood has a well argued piece in the New Statesman, saying that it was the move by left and right towards a common centrism that laid the foundations for populism. Although parts of his argument ring true, I find others less convincing..Labour certainly moved to the centre and beyond in terms of its economic policies. The Conservatives moved to the centre in terms of social policy. But on economic policy, the Conservatives moved strongly to the right with austerity. Senior Labour thinkers still seem to have a blind spot on austerity.

Let me start by looking at the country that now has populism in spades as a result of electing Donald Trump as President. To argue that the Republican party has been moving to the centre over the last 30 years is obvious nonsense. The traditional centre right virtue of fiscal rectitude went out of the door with Ronald Reagan, and was completely ignored under the second Bush. The Republicans only extol the virtue of cutting budget deficits when they are not in power. When they are in power, they want cuts in taxes for the rich, increases in military spending but cuts in other government programmes.

Margaret Thatcher was considered pretty right wing when she was in power. Many of her key achievement in terms of her own agenda, such as a diminished union movement and shrinking the state through privatisation, were not reversed by Blair and Brown. It is difficult to argue that the Cameron/Osborne duo made any attempt to undo the Thatcher legacy. Instead they tried to go beyond it, by shrinking the state to a size relative to GDP not seen since the end of WWII. They did it under the pretense that they were forced to because otherwise the markets would no longer buy government debt. This was a colossal deceit. There no evidence that markets were concerned about government debt, and strong evidence that they were not. [1] This deceit should have become clear when Osborne cut taxes at the same time as continuing to cut spending.

Let me use a diagram to illustrate what I mean. [2] (The vertical axis could also be labelled 'identity' as well as 'culture'.) No doubt we could discuss the detail of the size and direction of the arrows, but I think this is roughly right.

In the US, the Republicans had moved steadily in a downward, socially conservative right wing direction, whereas the broad church that are the Democrats have largely remained in the same place (unless you go as far back as the southern Democrats). One possible argument is that this move by Republican politicians helped create the Tea Party. Republicans have always pretended their policies would help ordinary people, whereas in reality they have helped a rich elite. This has laid the ground for a populist leader who was prepared to move economic policy in certain respects away from the right (in particular advocating protectionism). The growing loss of respect of Republicans for their party elite allowed voters to ignore the views of senior Republican leaders in selecting Trump as their candidate.

In the UK David Cameron moved the Conservatives to become much more liberal, by in particular supporting gay marriage. (When I argued in an earlier post that the Conservatives had moved to the right, I was surprised how many comments I got back telling me this was nonsense, and naming gay marriage as the main reason why.) In the UK this left a large gap in this political space, which UKIP - the first successful mass party in England since the SDP - filled. As Jonathan Wheatley showed, UKIP members are social conservatives, but are much more left wing than the Conservatives in terms of economics.

Labour moved to the right under Blair, while remaining socially liberal. I agree with Stewart Wood that this alone was important in preparing the way for populism. As well as the lack of a major industrial policy, they did nothing to curb a rampant financial sector or reverse the gains of the 1% that were a feature of the Thatcher period, a point emphasised by Jean Pisani-Ferry in respect of both the UK and US. I think New Labour’s position is better described as liberal rather than neoliberal: New Labour substantially increased the amount of resources (as a proportion of GDP) going to the NHS, and they also did a great deal to try and reduce child poverty. Labour moved further right (and more neoliberal) as they became more accommodating towards austerity. It was hardly a surprise that party members tried to pull the party back by electing Corbyn as leader.

As I argued here, Brexit was a perfect storm where the economically left behind united with social conservatives. With Labour no longer seen as representing the working class, this allowed the right wing media (with the support of the Conservatives) to help convince the left behind that their problems were a consequence of immigration. The Leave campaign was populist in the sense I describe here: advocating a superficially attractive policy to some that would leave everyone worse off. Much the same is true for Trump, who won the electoral college by convincing the left behind that he really could bring back their traditional jobs, something he will be unable to do in any kind of general way.

So the idea of growing centrism in the US makes no sense, yet it is they who have just voted for a populist President. In the UK it only makes any kind of sense if you think in one dimensional terms.

[1] This is essentially because the Bank of England was pledged to buy whatever it took in the way of government debt to keep interest rates low.

[2] I think the first time I began thinking in this two dimensional way was this post, but more recently I used it to analyse the forthcoming French election.  

Saturday 21 January 2017

Attacking economics is a diversionary tactic

Forgive the numbered note form. For some reason it seems appropriate to me in this case
  1. The financial crisis in the UK was the result of losses by banks on overseas assets, originating from the collapse in the US subprime market. It was not a result of excessive borrowing by UK consumers, firms or our government. As the Bank’s Ben Broadbent points out, “Thanks to the international exposure of its banks the UK has been, in some sense, a “net importer” of the financial crisis.” This overseas lending caused a crisis because banks were far too highly levered, and so could not absorb these losses and had to be bailed out by the government.

  2. This is why UK macroeconomists failed to pick up the impending crisis. They did routinely monitor personal, corporate and government borrowing, but not the amount of bank leverage. Macroeconomists generally acknowledge that they were at fault in ignoring the crucial role that financial sector leverage can play in influencing the macroeconomy. There has been a huge increase in the amount of research on these finance-macro linkages since the crisis.

  3. But supposing economists had ensured that they knew about the increase in bank leverage and had collectively warned of the dangers of excessive risk taking that this represented. Would it have made any difference? There are good reasons for thinking it would not.

  4. The main evidence for this is what has happened after the crisis. Admati and Hellweg have written persuasively that we need a huge increase in bank capital requirements to bring the ‘too big to fail’ problem to an end and avoid a future banking crisis, and the work of David Miles in the UK has a similar message. I have not come across an academic economist who seriously dissents from this analysis, but it has no impact on policy at all. The power of the banking lobby is just too strong.

  5. So the response of economists to the financial crisis has been as it should be. The error in neglecting bank leverage is being addressed. Economists have come up with clear proposals about how to avoid the crisis happening again. And these proposals have been pretty well ignored.

  6. In terms of conventional monetary and fiscal policy, academic economists got the response to the crisis right, and policymakers got it very wrong. Central banks, full of economists, relaxed monetary policy to its full extent. They created additional money, rightly ignoring those who said it would bring rapid inflation. Many economists, almost certainly a majority, supported fiscal stimulus for as long as interest rates were stuck at their lower bound, were ignored by policymakers in 2010, and have again been proved right.

  7. So given all this, why do some continue to attack economists? On the left there are heterodox economists who want nothing less than revolution, the overthrow of mainstream economics. It is the same revolution that their counterparts were saying was about to happen in the early 1970s when I learnt my first economics. They want people to believe that the bowdlerised version of economics used by neoliberals to support their ideology is in fact mainstream economics.

  8. The right on the other hand is uncomfortable when evidence based economics conflicts with their politics. Their response is to attack economists. This is not a new phenomenon, as I showed in connection with the famous letter from 364 economists. With austerity they cherry picked the minority of economists who supported it, and then implemented a policy that even some of them would have disagreed with. (Rogoff did not support the cuts in public investment in 2010/11 which did most of the damage to the UK economy.) The media did the rest of the job for them by hardly ever talking about the majority of economists who did not support austerity.

  9. The economic costs of Brexit is just the latest example. Critics have focused on the most uncertain and least important predictions about Brexit, made only by a few, to attack all Brexit analysis. The fact that this prediction involved an unconditional macro forecast, while the assessment made by a number of groups about the long term cost involves a conditional projection based largely on trade equations, seems to have completely escaped the critics. More important, the fact that the predicted depreciation in sterling happened, and is in the process of already causing a large drop in living standards, is completely ignored by these critics.

  10. Attacking economists over Brexit is designed to discredit those who point out awkward and uncomfortable truths. Continuing to attack economists over not predicting the financial crisis, but failing to ignore their successes, has the effect of distracting people from the group who actually caused this crisis, and the fact that very little has been done to prevent a similar crisis happening in the future.

Wednesday 18 January 2017

The Single Market was Mrs Thatcher’s great achievement for the UK

Parliament should be able to vote on whether leaving the EU means destroying this legacy.

The story of how Mrs Thatcher helped in the creation of the Single Market is told by Helene Von Bismarck here. She believed it would be of great benefit to the UK, and she was right. Here is a nice chart from this CBR report I discussed in my last post.

It shows the share of UK exports as a percentage of the GDP of the area exported to, for both the EU and the rest of the world. The rapid increase in the UK export share, doubling between 1990 and the beginning of the financial crisis, has to be largely down to the Single Market. [1]

But didn’t the CBR report say that the benefits of the Single Market had been exaggerated by the Treasury? Yes it did. Here is some of its reasoning. That growth in UK export share after the Single Market is not as impressive as it looks, because there is an underlying 6% 3.5% ** positive trend in the share relative to non-EU penetration, which you can detect before we joined the EU. That looks pretty on a picture, until you realise it is nonsense. A 6% 3.5% trend rise in an export share will imply that at some point not too far away UK exports to the EU will be as high as total EU GDP. UK exporters are just not that much better than exporters in other countries. There is no underlying trend rise in the UK’s export share.

As I say in The Independent, the rationale for going down the route of leaving the Single Market is completely wrongheaded. First, the Brexit vote was close - hardly a ringing endorsement for undoing Thatcher’s legacy. Second, all the evidence we have is that large numbers of Leave voters are not prepared to accept a reduction in their living standards as a price for reducing immigration, a reduction which is in the process of happening right now as a result of the collapse in Sterling. If you say we have no real evidence for this, show me your evidence that the referendum vote was a vote to leave the Single Market. If May really believes it when she says that the recent strength of the economy has convinced her that the costs of Brexit will not be that great, she is a fool. Third, the logic of saying that we cannot accept Single Market rules because we would have no say in what they are makes no sense because we will be worse off not accepting them. Once again, a majority of the country does not want to ‘take back control’ if it costs them money.

I say in The Independent that this is happening because May wants to finally show that she can bring down immigration, after 6 years trying and failing. It is also because she thinks she has to do this to keep her party together. But what Brexit means should not be up to the Prime Minister, particularly one who cannot be objective about immigration and who is a hostage to the Eurosceptic half of her party. The Single Market decision should be up to parliament. Leaving the Single Market was not on the referendum ballot paper, so it is not the ‘will of the people’. It does not follow automatically from the Leave decision, as many Leave campaigners correctly assured us before the vote.

Parliament should decide on whether we leave the Single Market as part of leaving the EU, not Theresa May. That is what living in a parliamentary democracy is all about. If the government denies MPs the chance to vote for leaving the EU but against leaving the Single Market, then that is effectively a coup against our democracy. MPs should block approval of invoking Article 50 until they get the opportunity to vote, in a way that is binding on the Prime Minister, to stay in the Single Market.

** I made a mistake in the original version of this post: corrected figures and clarifying text are in italics. For more details see this post

[1] The chart also casts doubt on the argument that being in the EU has held back UK exports to the rest of the world. This share was falling before we entered the EU, but has stabilised while we were a member.  

Tuesday 17 January 2017

Fake Economics and the media

If there is Fake News, is there such a thing as Fake Economics? I thought about this as a result of two studies that have received considerable publicity in the press and broadcast media over the last few weeks. Both, needless to say, involve Brexit. The first are two bits of analysis by ‘Change Britain’, saying Brexit would generate 400,000 new jobs and “boost the UK by £450 million a week”. The second is a more substantial piece of work by economists at the Centre for Business Research (CBR) in Cambridge, which was both very critical of the Treasury’s own analysis of the long term costs of Brexit and came up with much smaller estimates of its own for these costs.

Defining exactly what Fake News is can be difficult, although we can point to examples which undoubtedly are fake, in the sense of reporting things to be true when it is clear they are not. Fake News often constitutes made up facts that are designed for a political purpose. You could define Fake economics in a similar way: economic analysis or research that is obviously flawed but whose purpose is to support a particular policy. (Cue left wing heterodox economists to say the whole of mainstream economics is fake economics.) We can equally talk about evidence based policy and its fake version, policy based evidence.

The study by Change Britain seems to fit into that category. In looking at the impact on jobs of potential new export markets once Brexit has happened, it counts the jobs from any extra exports but ignores the jobs lost from extra imports. It adds the extra value of exports sold to the direct budgetary saving, which is a meaningless thing to do.

The CBR analysis is less obviously fake. However Ben Chu has gathered the views of some academics who are experts in trade theory, including Richard Baldwin (who has just written a definitive and widely praised book on the ‘new globalisation’) and AlanWinters, both hugely respected with immense experience, who pour some very cold water over the study.

My key point is that both of these studies were given considerable exposure in the media, and not just in the part devoted to pro-Brexit propaganda. Here is Larry Elliott in the Guardian on the CBR study. In all the cases I’ve seen the reporting has been uncritical, with no attempt to get the opinion of experts in the field. (The Guardian in their coverage of the ‘Change Britain’ report did note that the organisation was backed by pro-Leave campaigners, but it still published the claims without any criticisms of the analysis.)

It is not difficult to understand why this happens. It is a combination of two problems: lack of journalistic resources and the concept of old news. It is the latter that means a report has to be reported on the day of publication, leaving little time to get critical reactions (particularly from academics). But these factors do mean that the non-partisan mainstream media is wide open to fake economics. (Columnists like Elliott should be able to do better, but he did support Brexit.)

This is how the public, and to be honest, journalists themselves get a distorted view of the economics of Brexit. The impression is given that, as usual, economists are divided over the issue, whereas in reality academics are pretty well united in their view that Brexit will reduce UK living standards. (And of course it already the depreciation leads to inflation and lower real wages.)

Journalist resources and culture are not going to change anytime soon. Which is why economists have to think seriously as a collective about how they can best counter fake economics. This has to involve doing something individual academics are not very good at: giving fast responses if journalists ask whether some new report is serious economics or fake economics. .

Sunday 15 January 2017

Blanchard joins calls for Structural Econometric Models to be brought in from the cold

Mainly for economists

Ever since I started blogging I have written posts on macroeconomic methodology. One objective was to try and convince fellow macroeconomists that Structural Econometric Models (SEMs), with their ad hoc blend of theory and data fitting, were not some old fashioned dinosaur, but a perfectly viable way to do macroeconomics and macroeconomic policy. I wrote this with the experience of having built and published papers with both SEMs and DSGE models.

Olivier Blanchard’s third post on DSGE models does exactly the same thing. The only slight confusion is that he calls them ‘policy models’, but when he writes

“Models in this class should fit the main characteristics of the data, including dynamics, and allow for policy analysis and counterfactuals.”

he can only mean SEMs. [1] I prefer SEMs to policy models because SEMs describe what is in the tin: structural because they utilise lots of theory, but econometric because they try and match the data.

In a tweet, Noah Smith says he is puzzled. “What else is the point of DSGEs??” besides advising policy he asks? This post tries to help him and others see how the two classes of model can work together.

The way I would estimate a SEM today (but not necessarily the only valid way) would be to start with an elaborate DSGE model. But rather than estimate this model using Bayesian methods, I would use it as a theoretical template with which to start econometric work, either on an equation by equation basis or as a set of sub-systems. Where lag structures or cross equation restrictions were clearly rejected by the data, I would change the model to more closely match the data. If some variables had strong power in explaining others but were not in the DSGE specification, but I could think of reasons for a causal relationship (i.e. why the DSGE specification was inadequate), I would include them in the model. That would become the SEM. [2]

If that sounds terribly ad hoc to you, that is right. SEMs are an eclectic mix of theory and data. But SEMs will still be useful to academics and policymakers who want to work with a model that is reasonably close to the data. What those I call DSGE purists have to admit is that because DSGE models do not match the data in many respects, they are misspecified and therefore any policy advice from them is invalid. The fact that you can be sure they satisfy the Lucas critique is not sufficient compensation for this misspecification.

By setting the relationship between a DSGE and a SEM in the way I have, it makes it clear why both types of model will continue to be used, and how SEMs can take their theoretical lead from DSGE models. SEMs are also useful for DSGE model development because their departures from DSGEs provide a whole list of potential puzzles for DSGE theorists to investigate. Maybe one day DSGE will get so good at matching the data that we no longer need SEMs, but we are a long way from that.

Will what Blanchard and I call for happen? It already does to a large extent at the Fed: as Blanchard says what is effectively their main model is a SEM. The Bank of England uses a DSGE model, and the MPC would get more useful advice from its staff if this was replaced by a SEM. The real problem is with academics, and in particular (as Blanchard again identified in an earlier post) journal editors. Of course most academics will go on using DSGE, and I have no problem with that. But the few who do instead decide to use a SEM should not be automatically shut out from the pages of the top journals. They would be at present, and I’m not confident - even with Blanchard’s intervention - that this is going to change anytime soon.

[1] What Ray Fair, longtime builder and user of his own SEM, calls Cowles Commission models.

[2] Something like this could have happened when the Bank of England built BEQM, a model I was consultant on. Instead the Bank chose a core/periphery structure which was interesting, but ultimately too complex even for the economists at the Bank.