Winner of the New Statesman SPERI Prize in Political Economy 2016

Wednesday, 30 May 2018

Nominal wages are not real wages, and why it matters in the UK



This post is just an extension of a recent tweet from Chris Dillow. I think it is worth writing more about it because it reflects on an issue that is widely misunderstood, by some on both the left and the right. Here is the share of employees compensation and corporate profits in total income since 1948. Note that everything below is about the UK experience: the US is different.

I have gone back to 1948 to show that the wage share can change, and has fallen from the 1950s until the end of the century, from 60% to 50%. But that has not been accompanied by a rise in the profit share, which has stayed pretty close to 20%. The missing pieces, that are the counterpart to the fall in the labour share over this period, are income going to indirect taxes, self employment and unincorporated businesses.

The key point I want to make is that neither the wage share or the profits share has changed over the last 15 years. This busts two myths that you will often see.

Myth 1 Immigration has kept real wages low.

There was a large increase in non-EU immigration at the end of the 1990s: if anything the wage share increased at the same time. The second large increase in immigration, this time from the EU, was from 2004, and there was no noticeable impact on the labour share. Immigration may have been depressing nominal wages, but those lower nominal wages were allowing lower output prices, leaving real wages unchanged. This is consistent with the econometric evidence that immigration has no significant impact on real wages.

This evidence is often dismissed in two ways. The first is that it does not correspond to workers 'lived experience'. But that experience reflects either the impact of immigration on their own nominal wage, or falls in real wages which reflect the lack of productivity growth and sterling’s depreciation. It is just possible that immigration might have discouraged firms from investing in higher productivity techniques, but it is rather more likely that immigration has allowed firms to produce in the UK who would otherwise have produced abroad. For other reasons why intuition on immigration may be misleading see here.

The second way that some people argue that there ‘must be’ a link between real wages and immigration is to invoke simple supply and demand. That is just fallacious: immigration shifts the labour supply curve but it also shifts the demand curve. A slightly more sophisticated argument is that the demand curve does not fully shift to compensate for greater supply immediately after an increase in immigration because it takes time to invest, but if that was the case we would see a temporary fall in real wages and a rise in the profit share following periods of immigration, and we do not.

Myth 2: Real wages have fallen because labour is now weak compared to employers.

Since the Global Finance Crisis (GFC) and subsequent recession, nominal wage growth may be slow because the labour market is weak, but the data shows that employers are not taking advantage of this to increase the profit share. Low wages are being passed on into lower prices.

There are two main reasons why real wages are currently low: almost non-existent productivity growth since the crisis and the depreciation in sterling which has raised the cost of imports and therefore consumer prices.

Note that I am not at all saying that the labour market is not as weak as it appears. In many areas conditions of employment seem to have deteriorated since the GFC. What I am saying is that real wages depend on prices as well as nominal wages, and in the UK at least there seems to be sufficient pressure on firms to pass on low wages into low prices, leaving the relationship between real wages and productivity unchanged.

It is also important to point out that the wage share is different from median wages. As the study by Pessoa and Van Reenen I examine here shows, median wages from 1972 to 2010  declined relative to the average compensation because of rising non-wage benefits and rising inequality. A good part of this rising inequality reflects incomes of the top few percent.  

It is often difficult to convince those on the left that weakening labour power over wages can be a good thing, if lower nominal wages are passed on to lower prices. It can be a good thing because it allows the central bank to raise demand and therefore output by more than they otherwise could while keeping inflation stable. It reduces the sustainable unemployment rate: the NAIRU. Furthermore lower wages are more likely to be fully passed on into lower prices if the goods market is highly competitive, and that is more likely to happen if the economy is open to overseas trade.


Saturday, 26 May 2018

Delegation as a reaction to the politicisation of advice


In my last post I used the example of Brexit to show that politicians, even when their ideas are seen as seriously harmful by most experts, will still find policy entrepreneurs to give them enough information to sound knowledgeable when they appear on the media. But this may be an extreme example of a more general phenomenon, which I would describe as the breakdown of the way expertise is utilised by government: a breakdown of what I call the Knowledge Transmission Mechanism.

It is nothing new, of course. The first example I ever had experience of was as an economist at the Treasury when Mrs. Thatcher became Prime Minister. As far as her new Treasury team were concerned, most Treasury civil servants were not ‘one of us’, and they had little time for their advice. When Treasury economists predicted a recession in 1980, they were ignored. (There was a recession.) As the young Treasury economist I was then, the contrast with the ever curious Denis Healey was quite shocking.

Even back then, Conservative ministers tended to seek advice from City economists rather than academic economists, which may be one reason why the record of Conservative Chancellors in running the economy from Thatcher onward is so much worse than the 13 years of Labour government. Part of the role of right wing think tanks is to hide that fact, which they do very successfully. It is why the 364 academic economists in 1981 who attacked Conservative macro policy are generally thought to have been wrong, when in reality they were broadly right. This was perhaps the beginning of the Conservative party’s disdain of experts who interfered with their ideological projects.

The use of partisan think tanks and experts by the political right is now well established in both the US and UK. In contrast the last Labour government was much more open in its use of at least economic advice, but its biggest mistake was in ignoring expert advice on Iraq. There may be some on the left that would like to replicate the way the political right works for Labour under its new leadership, by suggesting for example that conventional economists are inherently hostile to its policies.

But this is not how the Knowledge Transmission Mechanism (KTM) is supposed to work. Good ideas and good evidence do not have to come with a left, right or centre political label attached. When I have advised political parties or governments or economic institutions I have not given them advice which is only appropriate if the recipient wears a particular political colour. A good understanding of how the economy works does not require a particular political allegiance.

I wonder how much the trend towards the delegation of decisions to independent bodies, and suggestions to do more of that, is a reaction to this growing politicisation of expert advice. I was listening to an interesting Resolution Foundation podcast based on a new book from Paul Tucker, which was all about the conditions for successful delegation. One of the participants, Kate Barker, gave an example where she thought proposals for delegation went too far: the LSE’s Growth Commission.

I turned quickly to the Growth Commission’s 2017 report to see what Kate had in mind. I suspect it could be this.
“The ultimate objective is a long term industrial strategy that is isolated from political cycles. An independent body should strive to overcome fragmentation across different levels of government.”

Now there may be a case for delegating the implementation of an industrial body to an independent body, just as the implementation of monetary policy is delegated to the Bank in the UK. Just as Chancellors may alter the timing of interest rate changes for political ends, ministers may also skew the distribution of industrial policy to favour some constituencies over others. To a considerable extent this is what the Growth Commission proposes. But I suspect saying that you want industrial policy “isolated from political cycles” portrays an underlying deep discontent with how the Knowledge Transmission Mechanism has broken down.

This is not a post about the merits or otherwise of delegation (on which Paul Tucker has sensible things to say), but an attempt to describe one reason why experts or civil servants may be increasingly inclined to suggest delegation. Put simply, if politicians base policy on an ideology that requires shutting expertise out, independent bodies that let expertise back in become increasingly attractive.



Thursday, 24 May 2018

Brexiter nonsense and policy entrepreneurs


Brexiters typically sound convincing if you know little about what they are talking about. Ian Dunt takes a typical example from Rees-Mogg (still favourite to be next Conservative leader). Rees-Mogg asserts, with absolute certainty, that a House of Lords committee have missed a crucial aspect of trade law related to WTO rules. Trade experts spend some time scratching their heads wondering what on earth he is talking about. They finally work out where the idea comes from, and why it has next to zero applicability to Brexit. (See also Jim Cornelius here.)

As Dunt points out, nonsense of this kind is effective. Because broadcasters often fail to match Brexiters with trade experts, they get away with their nonsense. By the time the nonsense is revealed as such, and enough people know why it is nonsense. the discussion has moved on and new nonsense appears. The fantasy that is Brexit remains intact at the level of public discourse.

Politicians like Rees-Mogg are not able to generate this nonsense themselves. How could they when they seem to spend most of their lives going from one broadcast studio to the next. Because this nonsense normally has some tenuous connection to reality, it has to come from someone with some knowledge of international trade and trade agreements. Welcome to the policy entrepreneur.

The term policy entrepreneur comes I believe from Paul Krugman’s first book from 1995, Peddling Prosperity, which unfortunately remains as relevant as ever. The book begins with the Laffer curve and the economists - including Laffer - who promoted the idea that cutting taxes would raise revenue. It is a typical piece of nonsense. It takes the reality that if taxes were 100% lots of people would stop working, and mutates this into the idea that taxes are already so high that cutting them would encourage more growth such that tax revenue will rise. It is typical political bullshit: giving an imagined respectable gloss on something that too many Republicans just wish were true.

But in the latter part of Peddling Prosperity things got personal, as Krugman describes how different policy entrepreneurs took some of Krugman’s own research and used it in a way Krugman would not to lobby President Clinton for trade protection. Economic theory suggests that if a profitable opportunity arises and there are no barriers to entry people will exploit that opportunity. I think the policy entrepreneur is a good example of that happening. Some politicians want to pursue a policy but want some kind of rationalisation for it, and the policy entrepreneur steps up with some nonsense erroneously derived from economics or some other discipline to provide that veneer of respectability.

Policy entrepreneurs can be academics: in the UK the most obvious example many would point to is Patrick Minford. But they can just be good lobbyists, who put themselves in the right place at the right time. In the case of Brexit, the policy entrepreneurs from whom the Brexiters get most of their information are in the Legatum Institute. BuzzFeed has a very good profile of their until recently director of economic policy, Shanker Singham. It is worth quoting from it.
“BuzzFeed News spoke to multiple economists, policy wonks, Conservative advisers, politicians, and journalists who said they’re baffled that he’s become so prominent in the Brexit debate. They say his standing in the trade world has been overblown. They don’t dispute that he knows the subject, but most hadn’t heard of him before he emerged at Legatum. They find it exasperating that he’s been portrayed in the UK as a vastly experienced trade negotiator, as if he were one of the decision-makers in the room when the world’s biggest trade agreements were hammered out. He wasn’t that close to the action, they say.”

But of course someone with more experience or more knowledge could not take Singham’s place, because they would not be the true believer that Brexiters require. When you have faith as the Brexiters have, you do not seek real knowledge, but just enough facts to sound good and thereby promote the cause.

Policy entrepreneurs, whether they are seeing a profit opportunity or really are true believers, are a symptom that what I call the knowledge transmission mechanism has broken down. As Krugman’s book indicates, Brexit is not the first time that policy entrepreneurs have helped politicians enact destructive policies. Here I argue that that the knowledge transmission also broke down when it came to austerity. (Paper here.) It is possible for policymakers to use intermediaries like civil servants to find the best research and use it - it has happened in the past - but today it seems like the exception rather than the rule.


Tuesday, 22 May 2018

A rotten corporate culture


Reports by select committees of MPs after some scandal should be treated with care. There is nothing MPs like more than to take the moral high ground and heap blame on others in front of TV cameras, whether their victims deserve it or not. But in the case of the collapse of Carillion, their condemnation of the senior management, the board and the auditor seem fully justified. When the Institute of Directors say that “effective governance was lacking at Carillion” you know things were very wrong.

Think of the company as a ship. The captain has steered the ship too close to the rocks, and seeing the impending disaster has flown off in the ship’s helicopter and with all the cash he could find. After the boat hit the rocks no lives were lost, but many of the passengers had a terrifying ordeal in the water and many lost possessions, and the crew lost their jobs. Now if this had happened to a real ship you would expect the captain to be in jail stripped of any ill gotten gains. But because this ship is a corporation its captains are free and keep all their salary and bonuses. The Board and auditors which should have done something to correct the ship’s disastrous course also suffer no loss.

To say this reflects everything that is wrong with neoliberalism is I think too imprecise. [1] I also think focusing on the fact that Carillion was a company built around public sector contracts misses the point. (I discussed this aspect in an earlier post.) To say, as the MPs do, that the collapse of Carillion is the result of recklessness, hubris and greed tells us nothing, because many people are bound to be those things if the system provides no incentives for better behaviour. The problem is that the senior managers, the auditors and the Board are not in prison and have not even suffered any financial loss.

In theory the incentive for better behaviour is that everyone except the auditors have lost their job and are unlikely to get another. But executive salaries are now so high that this penalty, if it is applied, is just not strong enough. The former chief executive, who resigned in 2017, earned £1.5m in 2016. (A third of that was in the form of a bonus that could have been clawed back until the remuneration committee made that more difficult in 2016.) Few people would think that never being able to captain a ship again was a sufficient disincentive for the imaginary captain who steered his boat too close to the rocks.

The idea from Econ 101 that CEOs are paid their marginal product is now laughable. Their pay is so high in part because it is set by cosy remuneration committees, but mainly because CEOs have considerable bargaining power over the firm that employs them. This power is intrinsic, so greater oversight by shareholders will do little to change this situation. I wrote some time back that perhaps economists should think about the benefits of a maximum wage, or a return to punitive taxation on CEO type salaries and bonuses. [2] That idea normally provokes shock and horror, but have economists come up with a better idea to offset this market failure at the centre of modern corporations?

As far as auditors are concerned, there is much talk of breaking up the big four. The idea is that in a more competitive auditor environment there would be more opportunity for firms to establish a reputation, and for those that failed to do so to go out of business. I suspect the issues go deeper than that. It would be interesting to know if existing auditors after a high profile failure like Carillion lost market share. It may be that shareholders have insufficient power to ensure the selection of auditors useful for them. If that is the case, there may be a case for giving regulators greater power to act on shareholders behalf.

Ultimately corporate failures are a reflection of how companies are governed. I tend to agree with Will Hutton that the model where the shareholder and more particularly the share price are king is deeply flawed. The term financialisation is a bit like neoliberalism in that it is used by different people to mean different things, but I think it does describe how corporate culture has changed in the UK and US (at least) over the last few decades. We must never forget that the largest disaster in recent times reflecting a rotten corporate culture was the Global Financial Crisis.

Will writes
“My contention is that limited-liability companies, having certain formal privileges and status, should not be the private playthings of transient owners interested only in their own immediate self-enrichment, without any concern for how their profits are made. They should be organisational structures that allow humanity to innovate and then produce to meet the great challenges of any era: in this context profits are made by delivering a noble, moral business purpose, integral to the wider legitimacy of the enterprise.”

The big challenge is to work out the most efficient way of achieving that goal.

[1] What I think is fair to say is that a neoliberal culture is why attempts to address these problems have been ignored for so long. Ed Miliband talked about predatory corporate practices, and the overwhelming reaction was that this made him ‘anti-business’ and ‘too left wing’.

[2] The idea currently being embraced by politicians is to publish firm pay ratios: the ratio of the CEO’s pay to the average employee in that firm. You could cap that as a policy, although it is not obvious to me why CEO’s in firms (in sectors like finance) that have highly paid employees should be allowed to expropriate more from the firm than those with lowly paid employees. However as this is not my area, I am happy to see analysis on the optimal way of removing this distortion within corporations.

Sunday, 20 May 2018

How the media and politicians dumb down economics


I’m all for economists improving their communications skills, and there are some good initiatives currently around. But all that is as nothing when politicians and the media keep promoting bad economics.

One of the most obvious is the focus on jobs rather than output. There are some circumstances were this makes sense. The most obvious is a recession, where unemployment is high and the focus of policy should be getting unemployment down. Another is when thinking about the geographical distribution of employment. But at times when unemployment is low, the focus on jobs rather than output can be very misleading for one simple reason. We can easily create jobs by having technological regress.

What has happened in the UK since a year after austerity was imposed is that productivity, measured in terms of output per hour worked or output per worker, has hardly increased. Productivity normally rises in a recovery, and it began to until the middle of 2011, but we have seen almost no growth since then. That is terrible news, because it means that there has been no increase in average living standards: add in the Brexit depreciation and real wages have fallen substantially.

Yet politicians and newspapers continue to talk up employment growth as if it was a huge achievement. Here is the Mail from a few days ago.


So many times I have heard government ministers counter criticisms over output growth performance by talking up employment growth, and I do not remember a single occasion where they have been pulled up with the obvious retort ‘so you are happy with stagnant productivity and falling real wages then’. [1] Because strong employment growth coupled with weak output growth means something is very wrong with productivity, and we cannot have sustained growth in real wages and living standards without productivity growth.

You might expect politicians to try and get away with nonsense economics if they can, and you would certainly expect right wing papers to turn reality upside down in an effort to protect their precious Brexit. That is why it is so important that political journalists working for the broadcast media know some basic economics, and are prepared to use it to call out the distortion of some politicians. Until they do, basic misunderstandings about simple economic relationships will persist.


[1] A BBC journalist did try once, and got into trouble as a result, as I relate here.

Wednesday, 16 May 2018

Delusions of National Power


As soon as the EU decided, quite rightly, to support Ireland in rejecting any deal that resulted in placing infrastructure at the Irish border, the idea of a Free Trade Agreement between the EU and the UK was dead. It became inevitable that the UK would stay in the Customs Union (CU) and the Single Market (SM). The two possible alternatives, which is that the UK would go ahead and impose a hard border and forsake any deal with the EU, or that a border would be created in the Irish Sea, would not be approved by a majority in parliament. If the UK had a strong bargaining position, it could perhaps persuade the EU to compromise over how much of the Single Market it needed to be part of (the Jersey option), but according to Sam Lowe who gave that option its name the “EU will not contemplate the backstop applying to the whole UK”. The UK gave up any bargaining strength it had when it triggered Article 50.

Yet neither leader of our two main political parties allow themselves to see this inevitable implication of the Irish border. Delusion is at its most extreme in the case of Theresa May, who still thinks it is possible to conclude a deal with the EU that would keep the Brexiters in her party on board by appeasing them at every step. So we have the ludicrous situation where the UK cabinet is at loggerheads over which of two impossible plans they will put forward so they can be rejected by the EU. This isn't rearranging deck chairs on the titantic. It is having a full blown row over how the deck chairs should be arranged as the ship sinks. 

This charade could be put out of its misery by parliament telling May that the UK has to stay in the CU and the EEA. The former might happen, but the Labour leadership, along perhaps with some of its MPs (and not just the few Brexiters), still think that they can negotiate a bespoke version of the Single Market that either avoids rules on state aid or avoids free movement. There is no reason why the EU need contemplate this, given that they know MPs will not approve No Deal. The left or Lexiters can talk all they want about uniting to guarantee that the EU cannot obstruct a future socialist government, but the lesson of Greece is that if the EU has power it will use it.

It is easy to imagine where these delusions of power come from. After all, despite what Brexiters say, the UK did have considerable influence in the EU when it was a member. Ironically both the Single Market and EU expansion owed a lot to UK pressure. The more interesting question I think is why these delusions continue when the reality of the UK’s powerlessness becomes obvious. Political leaders have had a painful year to learn that in these negotiations the EU calls the shots.

I can think of two answers. The first is ideological blindness. This is obvious in the case of the Brexiters, but I think you can also see it elsewhere in various ways. But I also think there are specific dynamics created by the referendum. Leave votes were in part predicated on an illusion of power: the UK would not be worse off because the EU would be desperate to accede to our demands. Once a politician agrees to go with the 'will of the people', they find it very hard to go back to the 52% and say your beliefs were delusions. And no politician wants to say in public that the UK has to do what the EU says. It is very hard for an elected politician to confront English nationalism, a nationalism largely exploited and distorted in my view by a deeply corrupt press.

The UK is therefore in a trap of its own making. It is obvious what has to happen in the end: the UK stays in the CU and SM either inside or outside the EU. But the leadership and perhaps a majority of MPs in the two main parties either cannot see that yet, or can see it but dare not take the steps to get us there. If Brexit is to survive despite always being a fantasy project it has to end with a whimper, but it could take many wasted years and much economic harm to get to that point. There is one way out that will spare politicians’ blushes and revitalise the economy, and that is to hold a referendum on the final deal where the economic costs of the deal are clearly spelt out.


Monday, 14 May 2018

How the broadcast media created mediamacro


If you do not watch Carlos Maza’s short commentaries on the US media you should. Here is his latest, on why comparisons between the investigations into Nixon and Trump fall short. The reason, quite simply, is Fox News. With Nixon most Republican voters were getting their information straight from one of the established networks. As a result, Republican politicians were coming under Republican voter pressure to impeach Nixon when the extent of the cover-up became clear. Today, Republican voters get aggressive attacks on the investigations into Trump and his associates, attacks which are completely divorced from reality. And Republican politicians, reflecting the views of their base, repeat the attack lines from Fox News.

In the UK we have our equivalent of Fox News, but because our aggressively partisan media is the press there is a chance for the broadcast media to modify its impact. That it did not do so over Brexit because it failed to call out the lies of the Leave campaign is why the vote went the way it did. But Brexit was not the first time this happened. As some of the essays in a new book show, austerity was also an occasion where the broadcast media reinforced rather than countered the lies of the right wing press.


Laura Basu and Mike Berry show how virtual hysteria about the UK budget deficit was strongest in the right wing press, but as Mike Berry writes:
“Whilst BBC coverage lacked the strident editorialising seen in the press, it still operated within a framework which stressed the necessity of pre-emptive austerity to placate the financial markets.”

Historians will find this extraordinary. It is standard textbook macroeconomics that tells you not to try and counteract the deficits that arise when taxes fall and spending rises as output growth declines in a business cycle: that is why they are called automatic stabilisers. Keynes taught us and modern theory confirms you particularly do not do this when interest rates are stuck at their effective lower bound. It was natural to expect record deficits because it was a record recession and because conventional monetary policy was impotent.

So why did the BBC and other broadcasters largely ignore this point of view, and instead promoted what I call mediamacro? This is the subject of my own contribution, and here is a very brief and partial summary
  1. Journalists typically had no direct contacts with academic macroeconomists, with just one or two exceptions. The economists you tend to hear in the broadcast media are City economists, who for various reasons over-exaggerated the deficit problem.

  2. The IFS do appear regularly in the broadcast media. But the IFS do not do macroeconomics, and there is no equivalent of the IFS for macroeconomics. Initially the IMF supported fiscal stimulus, but they became spooked by the Eurozone crisis.

  3. The main way that academic expertise about the macroeconomy was filtered through to journalists was via the Bank of England. It should have been they who warned of the danger of austerity at the interest rate lower bound. However, in a then very hierarchical set-up, its governor Mervyn King was a strong supporter of austerity.

  4. The message of probably a majority of academic economists, which was to focus on the recovery and stop worrying about the deficit in the short term, ran counter to journalist’s intuition, particularly after a financial crisis where financial panic had just brought down the economy.

There is a more conventional radical political economy point of view, which is set out in another essay by Aeron Davis. That is that the media, including the broadcast media, has a default position that supports an essentially neoliberal, financialised order. That position was disrupted by the financial crisis, but once that crisis had stabilised the media took the opportunity to return to where it was comfortable.

I do not think these two accounts are incompatible, as long as you do not see this political economy view as some kind of neoliberal conspiracy. Davis certainly does not see it that way. He describes, for example, why journalists often depend on City expertise: not because someone tells them that is what they have to do, but because they need readily available expertise that they themselves often lack. Try asking most academic economists to explain the latest retail sales data with virtually no notice. The fact that the expertise they receive is often presented as fact when the reason for market moves are generally unknowable is similar to the media’s attitude to macro forecasts.

We can make the same point about the role of central banks. There was no inevitability that they supported austerity, as the US experience under Ben Bernanke showed. Bernanke’s view made little difference in a highly polarised Congress, but I have often wondered whether a Bank of England warning of the dangers of austerity might have made a difference to the media’s coverage of austerity in the UK.

I was reminded of all this by the recent TUC march. After austerity we had the 2015 election, which I argued mediamacro won for the Conservatives. They did so by tending to affirm rather than critique the idea that the economy was ‘strong’, despite the fact that the data said quite clearly that it was in fact very weak. Once again we had a huge gulf between what workers and academic economists were saying and the message journalists were getting from City economists, and how journalists generally went with the latter. The BBC really needs to hold an inquiry into how they handle economics, similar to their inquiry into statistics, but I doubt it will happen under this government.



Saturday, 12 May 2018

Remain fundamentalism


An argument I have often heard is why are people talking about getting a softer Brexit (by staying in the Customs Union (CU) or Single Market (SM) for example) when what we should be doing is staying in the EU. There is a more extreme version of this which says that attempts to get a soft Brexit are dangerous, because they make the prospect of remaining in the EU less likely. I will call this more extreme position Remain fundamentalism.

I want to argue against Remain fundamentalism by imagining a soft Brexit that involved the UK staying in a comprehensive Customs Union with the EU and staying in the EEA. (For an excellent discussion of what the EEA is and is not, see Ian Dunt here, here and here - in that order.) [1] That is what the current UK withdrawal bill specifies as amended by the Lords, so let me call this the Lords’ Brexit. Compare this to the only hardish Brexit deal that can be done (assuming, as I think is reasonable, that parliament would never pass No Deal), which is something close to what John Springford and Sam Lowe have called the Jersey option: staying in the CU and the SM for goods but not services, perhaps allowing some UK flexibility on freedom of movement.

We have no idea whether the EU would accept either option, because the UK government has been wasting its time (which given they are supposed to be running the country on our behalf is also our time) trying to choose between fantastical solutions to the Irish border problem that the EU will not accept. But for the sake of argument suppose that May ignores her Brexiters, and perhaps with parliament’s help chooses something like the Jersey option and that the EU agrees to it, or instead that May has to go with the Lords’ Brexit and the EU (and EFTA) agree to it.

The Remain fundamentalist argument is that because the Jersey option does more economic damage to the UK than the Lords option (because the EU has a comparative advantage in exporting services, and immigration from the EU is beneficial to the UK), it is more likely that parliament would grant a referendum on it and that people would reject that deal in favour of staying in the EU. I actually think the opposite is the case, We are much more likely to see parliament grant a referendum if we go for the Lords’ Brexit, and that people would reject the Lords’ Brexit in favour of staying in.

The case for a referendum on the final deal is much more clear cut if the deal is the Lords’ Brexit, because the Lords’ Brexit has virtually no advantages compared to EU membership and a clear disadvantage. In practice being in the EEA would mean accepting rules adopted by the EU with no say on those rules. In short, we gain nothing by having no say on the rules we have to obey. I cannot imagine any politician being able to get people to vote for the little bit of wriggle room and influence being in the EEA gives you compared to the having a real seat at the table.

In contrast, with the Jersey option things are much more complex. There will be perceived advantages of this option compared to staying in, such as greater control over immigration. You can be sure that the more Mrs. May can fudge the agreement such that she can pretend these advantages are there even when they are not, she will.

Now add in a powerful group of Brexiters. They would angry that they did not get the hard Brexit they want, but in the Jersey option they would still see hope in ambiguity. More importantly, with the Jersey option there would be plenty of meat for this group to work on, including immigration of course. But with the Lords’ Brexit it is hard to argue a strong case for why this is preferable to be in the EU, even if you are a Brexiter politician or newspaper.

I would be the first to admit that these arguments are not clear cut. But the Remain fundamentalist position only makes sense if you can be sure that a harder Brexit makes a referendum more likely. To me, at least, it is not obvious that it does. The more you can eliminate the economically damaging but superficially attractive aspects of Brexit, the more chance people have to see that the whole thing is a complete waste of time.


[1] There are a lot of differences between being part of the EEA and what is called BINO: the UK being in the Single Market and Customs Union and everything else to do with the EU except being absent from its political structures. I am assuming that there would be no problem being in the EEA and a CU, that agreements with the EU would also be made on agriculture and fisheries that would at least allow a soft Irish border, that the EU and EFTA would allow all this and so on.

Thursday, 10 May 2018

Fiscal policy remains in the stone age


Or maybe the middle ages, but certainly not anything more recent than the 1920s. Keynes advocated using fiscal expansion in what he called a liquidity trap in the 1930s. Nowadays we use a different terminology, and talk about the need for fiscal expansion when nominal interest rates are stuck at the Zero Lower Bound or Effective Lower Bound. (I slightly prefer the latter terminology because it is up to central banks to decide at what point reducing nominal interest rates further would be risky or counterproductive.) The logic is the same today as it was in the 1930s. When monetary policy loses its reliable and effective instrument to manage the economy, you need to bring in the next best reliable and effective instrument: fiscal policy.

The Eurozone as a whole is currently at the effective lower bound. Rates are just below zero and the ECB is creating money for large scale purchases of assets: a monetary policy instrument whose impact is much more uncertain than interest rate changes or fiscal policy changes (but certainly better than nothing). The reason monetary policy is at maximum stimulus setting is that Eurozone core inflation seems stuck at 1% or below. Time, clearly, for fiscal policy to start lending a hand with some fiscal stimulus.

Yet the goal of the new German Finance minister, from the supposedly left wing Social Democrats, is to achieve a budget surplus of 1%. To achieve that he is cutting public investment from 37.9 billion euros in the coming year to 33.5 billion euros by 2020. Yet German infrastructure, once world renowned, is falling apart. Its broadband connectivity could be greatly improved.

The macroeconomic case for a more expansionary German fiscal policy is overwhelming. Germany has a current account surplus of around 8% of GDP. There are some structural reasons why you might expect some current account surplus in Germany, but the IMF estimates that these structural factors account for less than half of the current surplus. It estimates that a third of the excess surplus is a result of an overly tight fiscal policy. As Guntram Wolff points out, the main counterpart to the surplus is saving by the corporate sector. Perhaps more public investment might encourage additional private investment.

But this is not another article about how Germany needs to expand to help the rest of the Eurozone. The problem, as Matthew Klein points out, is that the whole of the Eurozone is doing the same. In the area as a whole, the fiscal position is as tight as it was in the pre-crisis boom. Unemployment in the Eurozone is still too high. And the reason fiscal policy is too tight is that key Eurozone policymakers think that is the right thing to do. “The right deficit is zero” says the French finance minister. He goes on: “ Since France is not in an economic crisis, we need to have a balanced budget, so that we can afford a deficit in tougher times.” You hear the same in Germany: the economy is booming so we must have budget surpluses.

A booming economy is not one that is growing fast, but is one where the level of output and employment is above the level compatible with staying at target inflation. Measures of the output gap are only estimates of what that level is: underlying inflation is the ultimate guide. Core inflation is well below target right now, which is why interest rates are at their effective lower bound. This is why the actions and rhetoric of most European (and UK) finance ministers are simply wrong.

You would think that causing a second recession after the one following the GFC would have been a wake up call for European finance ministers to learn some macroeconomics. (Yes, I know that the ECB raising rates in 2011 did not help, but I expect most macro models will tell you the collective fiscal contraction did most of the harm.) Yet what little learning there has been is not to make huge mistakes but only large ones: we should balance the budget when there is no crisis.

This is not a dispute between left and right as it is now in the UK, but a problem with the policy consensus in Europe. What we are seeing I suspect is a potent combination of two forces: a German obsession with balancing the budget which has it roots in currently dominant ordoliberal/neoliberal ideology, and Keynes famous practical men: advisers who learnt what economics they have in an era of the great moderation where the worst economic problem we had was relatively benign deficit bias. Fighting the last war and all that.

Monday, 7 May 2018

Theresa May’s perpetual Brexit and Labour's forsaken base.


Two pieces of recent Brexit news are that a majority of the ‘war cabinet’ outvoted May on the choice between two unworkable, and therefore unacceptable to the EU, proposals to keep the Irish border infrastructure free, and Labour plans not to support a Lords amendment to keep the UK in the Single Market (SM). I want to consider each in turn.

The Brexiters, and their followers who just want to be PM and are signaling to party members, have put their collective foot down over the Irish border. This could imply that May will have to finally break with the Brexiters. But first she will try to do what she has done since negotiations began, which is to find a fudge that is good enough for the EU and which just keeps the Brexiters on board. I have no idea if such a fudge is possible, but suppose she manages to achieve one and prevents a revolt from the rebels in her party, so we leave in 2019 as planned.

If that happens, we are in danger of having perpetual Brexit. A final deal cannot be fudged, and the reality is that no deal is possible that will keep the Brexiters happy and be acceptable to the EU. The stumbling block is the Irish border: the EU will not negotiate an FTA that requires a hard border, and the Brexiters will not accept either the UK staying in the Customs Union (CU) and SM for goods, or a border in the Irish Sea. A crunch point could come at the end of 2020, but to avoid that May will plead for an extension which the EU may grant. And so it will go on: perpetual Brexit.

In a strange way, it is in May’s interest for this to happen. No one thought she would last for more than a few years after the 2017 fiasco, but Brexit keeps her in place. The majority of the parliamentary party dare not allow her to go because they will get a Brexiter in her place, given that it is members who ultimately decide. Furthermore, the closer we get to 2022 the less the party will want a bust up over how transition ends, so she fights another election.

If she wins the 2022 election would that finally give her the confidence to do a deal with the EU and ignore the protests from the Brexiters? Two factors suggest not. First, the new intake of Conservative MPs could mean that she would lose a vote of no confidence over Brexit. Second the right wing press, with the election out of the way, might not hesitate to call betrayal if she agrees any kind of deal with the EU. Both the press and Brexiters, knowing that BINO was not at all what they had in mind, would be looking to break off negotiations with the EU and go for No Deal. If she gets an outright majority a deal that puts a border in the Irish Sea becomes possible, but I doubt she will take it or the party will allow it.

The underlying logic is simple. For Brexiters, transition is only bearable because they see it as a stepping stone to a hard Brexit. The EU will not negotiate an FTA without a border in the Irish Sea and no hard border in Ireland. These are irreconcilable positions, a point which the media have just not taken on board. So if May does fudge her way to agreement on the withdrawal bill, it means perpetual Brexit negotiations. Transition, or Brexit in Name Only (BINO), may not sound too bad, but it means never ending uncertainty because business cannot rely on this arrangement lasting decades.

One way to stop fudge is to force the government to break with the Brexiters. One of the difficulties Tory rebels will always have is that it is difficult to vote against a final deal that is fudge, because just as with the original Leave vote fudge can mean almost anything the fudgers want it to mean to get votes. As the polls I discussed here show, it is only by talking about something concrete that voters say wait a minute that was not my Brexit. Which is why votes on Lords amendments to the UK’s withdrawal bill to stay in a CU and (tomorrow) the SM via the EEA can be so useful. Conservative rebels think that with Labour’s support they could win both votes in the Commons. But while Corbyn has been persuaded to back the rebels on a CU, he appears unwilling to do the same on the SM.

I have talked a lot about Labour’s triangulation strategy. That strategy works best when all those who want something that is softer than Theresa May’s Brexit think Labour in reality wants what they want, whatever Labour might actually say. In a purely two party system with rational voters Labour can get away with disclosing that they really only want a slightly softer Brexit than May, because Remainers have nowhere else to go. But reality isn’t like that in two important respects: Remainers can vote for the LibDems or Greens (many thought the Greens would be hammered in the local elections - they gained seats), or they can not vote at all.

Until now, I think we have evidence that Labour has largely succeeded in being all things to all those wanting something softer than May, including those who want to Remain. But as crunch time comes closer this is going to be difficult to sustain. So what does whipping your Lords against voting for the EEA option disclose: that, as long as May is in charge, you are content to see the UK leave the Single market. [1] That might firm your support among some Labour leavers, but it pisses off all Remain supporters and those Leavers who want to stay in the SM.

I think this is a mistake, although I am happy to have experts tell me otherwise. I think it is a mistake because you will lose more votes from disillusioned Remainers than you will gain from reassured Leavers, even when you allow for where each are in parliamentary seats. I keep being told that this is the Tories Brexit, but the moment Labour enable it they become complicit. If car factories in the North East go because we leave the SM, they cannot claim this is not our fault because we abstained on a vote that could have prevented this. Voting to stay in the SM indicates economic competence, which always matters in elections and particularly matters for Labour. 

It also seems like a political mistake beyond votes and reputation. The theory seems to be that a vote to stay in the CU, which the Lords did pass with Labour’s help, will do all the required damage to May. But there are those who argue that such a vote can help her, by giving her an excuse to ignore the Brexiters and do a deal. The Brexiters will be furious, but what can they do at the end of the day, as May can defeat any vote of confidence because Conservative Remainers do not want a leadership election. Wth UKIP dead, they have nowhere to go. May, free of the Brexiters, might even achieve a final deal by 2020 (although crossing her own red lines to do so), and fight the subsequent election as the Prime Minister who got Brexit done.

Which is a long winded way of saying that a vote on the CU may not be enough. If Labour does kill a vote on the SM, they lose another chance to cause problems for May, and this time over an issue she really does not want to lose. Put simply by doing this Labour may be passing up a chance to do great, and possibly terminal, damage to May’s leadership. So the Lords decision looks bad in terms of votes, and bad in terms of politics.

Perhaps most importantly it is also bad in principle. Staying in the SM as well as the CU is the right thing to do if someone else is doing the negotiation. We need to stay in the SM for goods to avoid a hard border in Ireland, and therefore to get a deal with the EU. But the UK is really strong in exporting services, so leaving the Single Market for services is just another act of self harm. I have always been worried, since my time on Labour’s EAC, that the leadership underestimated the damage leaving the SM could do. And if truth be told the Leave vote was won on false pretenses, which means few voted Leave thinking they would be poorer. Which is why there is no mandate to leave the Single Market.

To those who say that Labour have to appease those who voted Leave in our traditional heartlands I would say this. Past Labour leaderships have for many years neglected their traditional heartlands, partly in efforts to appeal to the middle class and partly by embracing neoliberal ideas. They have subsequently tried to win back their traditional base through appeasement over immigration. It did not work then, and it will not work now with Brexit. You win Leavers back to Labour by focusing on the economic issues that matter to them, and not by votes in the House of Lords. 

Appeasement over Brexit is a mistake because Labour alienates its base, just as happened with austerity and immigration. It is time Labour stood up for its principles, which include better public services. Leaving the Single market will mean less money for public services [2], which is why 87% of Labour party members want to stay in the Single Market. Leaving the Single Market is a policy that should be opposed, not enabled.  

Postscript: The Lords amendment was passed by 247 votes to 218. 83 Labour and 17 Conservative peers defied their party and voted for the amendment. Only 3 Labour peers voted against the amendment. Jeremy Corbyn now has to decide whether he regards leaving the Single Market as more important than inflicting what could be a mortal blow to Theresa May. 

[1] We need to dispense with one red herring here. Abstaining does not mean neutrality. If the Lords amendment succeeds it puts the issue on the table, and Conservative rebels think they have the vote to support it with Labour’s support in the Commons. If it fails, it is less likely to be resurrected in the Commons. To say that the EEA option is not Labour's preferred option is irrelevant because they are not in charge and they have limited influence on the outcome. This vote is one point of influence, and they have gone for the worse option. 

[2] Whether they intended it or not, the writings of MMT seem to have convinced many people responding to me on twitter that lower UK GDP has no implications for the level of UK public services. Lower GDP, caused by lower labour productivity because Brexit diminishes UK trade, reduces the resources available to go to private and public consumption. The only way you can avoid less resources going to public consumption is to cut those going to the private sector. Nothing in that statement contradicts or can be changed by anything in MMT theory. If resources are underutilised they should be fully utilised, whether we are in or out of the EU. This is not about utilisation of resources.