Winner of the New Statesman SPERI Prize in Political Economy 2016

Tuesday 26 February 2019

We need a political party that is tough on the causes of Brexit

I fully share the anguish of so many people over the madness of Brexit. All the evidence points to not leaving the EU, and the reasons given for leaving are generally vague or false. The vote on which this crasy policy is based was deeply flawed. As an economist I can clearly see the damage Brexit is doing and will do. While I could see the rationale for Labour’s triangulation strategy over Brexit before and immediately after the 2017 election, during 2018 as public opinion began to move it stopped making sense in electoral terms, and of course their policy often appeared unicorn-lite or, more realistically, close to a policy of Brexit in name only which only gives away control. The new party that will surely follow the formation of the Independent Group, if it continues to promote a People’s Vote, should be quite attractive to people like me.

But I’m in the more uncommon position of having been in the similar place twice before in the last decade. The reason is very simple. I have been all my life a macroeconomist, and for the last twenty odd years an academic. That gave me a perspective on 2010 austerity and the 2015 election which was largely absent from the popular debate. As a result, I can see that Brexit was not an isolated event, the result of one bad decision by Cameron, but part of a pattern suggesting deep problems with how UK politics works.

Understandably, most people are against austerity because of the impact it has had on those in need who depend on the NHS, local authority care and the welfare state. They are also now seeing its impact on schools, on our justice system and much more. But that still leaves open the idea that somehow austerity was necessary for the good of the economy as a whole. As Conservative politicians never tire of saying, they came into office in 2010 with the country on the edge of a crisis created by the previous Labour government. As an academic macroeconomist I know that is completely false.

Pretty well every first year undergraduate textbook tells students why in a recession you need an expansionary monetary and/or fiscal policy and you should ignore the deficit. When interest rates run out of road, as they had in the UK by 2009, then fiscal expansion was vital. One of my own specialist fields is fiscal policy, so I also know that state of the art models also suggest exactly the same thing as the textbooks. The insights of Keynes that have been accepted by most academics ever since remain valid today. It is this received wisdom that the UK followed in 2009 before the Coalition government came into power.

Just as many feel that Brexit makes no sense, I felt that austerity which started in 2010 went against all our knowledge and evidence. The one doubt I had was that an irrational financial market might suddenly stop buying UK government debt, but this was dispelled when I realised the Bank of England’s unconventional monetary policy of buying government debt to keep interest rates low (Quantitative Easing) would quickly kill any panic. That analysis begins my book based on the blog I started as a result of austerity.

Just as both main political parties now support some sort of Brexit, so both at the time supported austerity, with the argument being over how much, how quickly. Neither the Coalition nor the opposition argued for the right policy, which is to delay fiscal consolidation until the recovery was underway and the Bank started raising interest rates. Experts on trade or the EU Brexit negotiations are infrequently heard in the media, but they were almost never seen over austerity.

My point in making these parallels is that evidence based policy making on major issues didn’t end with Brexit, but six years earlier with austerity. In both cases these are policies that create great harm to all, and acute harm to many. I calculate austerity cost the average household £10,000, and NEF using similar methods get an even larger figure. No government since the war, including those of Thatcher, has embarked on prolonged austerity during an economic recovery, and so it is no surprise we had the weakest recovery for centuries.

Brexit is therefore not the exception in a period of otherwise normal government. If you ask why Brexit happened, it was not that David Cameron made one mistake in an otherwise capable period as Prime Minister. There is evidence that austerity encouraged the growth of UKIP and by implication the Brexit vote. I remember often hearing people in areas that are described as ‘left behind’ dismissing the economic impact of Brexit by saying things could not possibly get worse than they are now. But austerity was not the main cause of why Brexit happened.

To see what was we need to look at the second period where I felt similar to how I feel today about Brexit, and that was the run up to the 2015 general election. Political commentators had decided from polling that the economy was the Conservative’s strong point, indeed perhaps their only strong point going into that election. To a macroeconomist that made no sense. Not only had we had the worst recovery for centuries but real wages had suffered their worst fall since records began. The government extolled record employment growth, but given the slow recovery they were in reality just celebrating the flatlining of UK productivity that was a key factor behind falling real wages.

Economists like David Blanchflower, John Van Reenen and myself set out just how bad UK economic performance had been over the previous 5 years, but once again expertise was ignored. As far as the media were concerned reducing the deficit had become the most important priority for the economy, and that was how they judged politicians. You will not find that in any textbook either, but the media had either sold or been sold a narrative and they didn’t want to know any different.

That narrative said that the Coalition had brought down the deficit that the previous government had allowed to grow out of control. Of course in reality the worst recession since the Great Depression of the 1930s caused by a Global Financial Crisis had pushed up the deficit, but the media had pushed, or accepted, the idea that the Coalition was clearing up the mess that a profligate Labour government had left. I had written a paper on fiscal policy under the Labour government and there was no way they were profligate, but because Labour didn’t challenge the accusation the media accepted something as true that was obviously false.

To the media the fact that the Conservatives were thought to be strong on the economy only confirmed their narrative. In reality the causality was the other way. There is a growing literature identifying the power the media has to influence elections and shape popular narratives. The 2015 election was a precursor for Brexit in three important ways. First, and most obviously, the media helped elect a Conservative government that was committed to an EU referendum. Second it showed that politicians could tell huge lies and get away with it. Finally it showed the power the media had to influence a popular vote.

Brexit would not have been possible without the UK media. A large part of the press pushed anti-EU propaganda, and the broadcast media balanced the view of the overwhelming majority of experts against the lies of a few. Viewers desperately wanted information, and the broadcast media gave them politicians rather than experts and balance rather than facts. Fear of immigration was important in deciding how many people voted, and it was the right wing press that had since the beginning of the century pushed countless negative stories about immigrants. Although austerity may have played a role, it was the media that played the major part in giving us Bexit.

Although the Independent Group (IG) may have a more attractive policy on Brexit, and they will talk the talk on a broken politics, the group is made up of politicians who either believe their government did the right thing over austerity, or who in opposition urged accepting Osborne’s policy. Deficit obsession is damaging to the economy, but it also shuts the gate to so much else that needs to be done. It means the IG will be unable to undertake the far reaching and radical industrial policy that is needed to tackle the huge regional inequalities within the UK, and help those left behind that voted for Brexit. It means no Green New Deal. Although so far policy light, they have pledged to keep our current ‘free media’, which will mean they would do nothing to mend much of our dysfunctional press that acts as a propaganda vehicle for their owners, or a broadcast media that balances truth with lies and is largely expert free.

Brexit was not an aberration in an otherwise well functioning UK democracy, any more than Trump was in the US. They are symptoms of a deeper malaise. I cannot put it better than Anthony Barnett when he says if all you want to do is stop Brexit and Trump and go back to what you regard as normal, you miss that what was normal led to Brexit and Trump. Unless we have politicians in power who understand the need for radical change, the snake oil sellers who sold us Brexit and US voters Trump will happily carry on plying their wares.

Friday 22 February 2019

The new party: lessons the Labour leadership and its supporters failed to learn

I know it is a cliché but too many supporters of the Labour leadership, and perhaps the leadership itself, seem to have forgotten it. Labour is a broad church. It has to be a broad church if it is to be successful. It has to be a broad church when led from the right because otherwise the leadership drifts too easily into the centre or worse. Labour needs its left to stay honest to its principles. If Labour is led from the left it needs to be a broad church to win elections and avoid policies based on ideology rather than evidence. 

In other times Labour led from the left would need to be a broad church because otherwise the Conservatives would go for the centre ground and deprive Labour of the votes to win. Labour today does not face that problem, because the Conservative party is more right wing than at any time since WWII. Labour also had the great advantage that the only centre party around, the Liberal Democrats, are still struggling to shake off the damage their period in power did to their appeal. So the position Labour had was extremely favourable to a left led Labour party, and it has to be favourable because the media will always be hostile to it.

It is also essential that Labour win the next election on a radical economic and societal programme of the type the leadership have put forward. If we continue with a deficit obsessed politics we will see standards of living in the UK continue to fall behind other countries, and we will not see the radical industrial policy that is required to revitalise some of the poorest regions in Western Europe. Nor will we see a genuine Green New Deal that will help us mitigate climate change if Labour do not form the next government. And without an outright Labour victory we will continue with a right wing press and a cowed BBC that has already given us Brexit and will continue to have a pernicious influence on the UK.

The one threat to the advantageous position Labour had is the formation of a new centre party made up in most part of defections by Labour MPs. But even that would not be fatal to a Labour election victory if this new party appealed more to disgruntled Tory than Labour voters. So the task the Labour leadership had was to ensure that the appeal of any new party to Labour voters was minimised.

With its Brexit policy the leadership, and more particularly the cabal around Corbyn himself, failed to do this job. What defines the new Independent group is their position on Brexit. I am fed up with supporters of the Labour leadership telling me that Remainers cannot be a strong political force because the LibDem vote is so low, when the same people take every opportunity to remind the LibDems of their record in government. The LibDems are still toxic for that reason, but a new anti-Brexit party is not, which is a big problem for Labour when the majority of the population now favour Remain to Leave.

As I have written before, Labour’s stance on Brexit is a gift to the new party. It gives them a large pool of Remainers, many of whom were Labour voters in 2017, to fish in for support. This is but one of the many reasons why looking at the SDP for lessons is misleading. As Brexit is going to be a defining issue over the next four years, the new party could become a home for those who see Remaining or rejoining as their most important political priority. That is why the new party is a serious threat to Labour.

For Corbyn to pledge that members will make party policy, and then ignore the view of the overwhelming majority on the most critical issue of the day, just reeks of hypocrisy. From the day the referendum was lost the signals he has sent have been clear. Owen Smith was sacked for suggesting a People’s Vote, yet nothing happens to those who vote against extending the Article 50 deadline. The final paragraph of a letter to the PM drafted by Starmer mentioning a People’s Vote gets left off ‘by mistake’. If Corbyn did not want to send out the message that he does not want a People’s Vote then he and his team are extraordinarily inept, and I do not think they are. *** The triangulation strategy, which was smart before the election of 2017, has now become an existential threat to Labour winning the next election. 

The Labour leadership have also failed to kill the issue of antisemitism within Labour. Much of this is because the media is hopelessly biased on the issue, and remain almost silent on the at least as important problem of Islamophobia in the Tory party. However given that this was always going to be the case, the leadership have not done enough to shake the charge of institutional antisemitism. Not adopting the IHRA definition in full was a huge tactical mistake. The party has done a lot to improve how it works, but disciplinary procedures seem to remain mired in controversy and delay, and there is more that the leadership could do. 

Which brings me inevitably to the attitude of too many supporters of the leadership. Because, for obvious reasons, Labour are so vulnerable on the issue of antisemitism, you do not attack those making accusations. It makes it appear you have something to hide. Unfortunately 30% of the membership cannot see that antisemitism is a real issue for the party and think it is entirely a media scam, which means they fail to tread carefully. At its worst this can amount to institutional antisemitism.

Being a broad church means you have different opinions within that church, and those differences are respected. Yet too many leadership supporters regard criticism as treachery, and find it too easy to tell critics they should not be in the party. Indeed some are right now encouraging good Labour MPs to leave. They seem obsessed by criticising the previous Labour government, using Blairite as the ultimate form of abuse, and trying to purify the party in their own image.

Just as the leadership were always going to be vulnerable to charges of antisemitism, they were also going to be charged with being a hangover from the early 80s Labour left. Yet rather than do all they can to distance themselves with this political failure, they seem to regard it with a kind of romantic attitude. How else can you explain letting Derek Hatton back into the party. It sometimes seems as if the party’s distaste for spin means they do not think about how the party appears to those outside it’s band of loyalists at all.

Who knows what will happen in UK politics now. The new group could gradually fade away as voters get tired of Brexit or if there is a quick election, or it could completely change the shape of UK politics. The most likely single outcome, once you factor in media bias as you have to, is that they stop Labour forming the next government. If you think this post sounds unusually angry that is why. 

It is crucial that winners as well as losers learn the lessons of past conflicts, and the Labour leadership and its supporters did not learn the lessons of the vote of no confidence. Corbyn is not a natural manager of a large team, and that makes it all the more important that Labour policies keep the majority of MPs and members on board. The current Brexit strategy fails to do that. The smartest move that Corbyn could make right now would be to give Keir Starmer back the driving seat on Brexit, but I fear Corbyn is just too keen on Brexit happening to do that. As a result, Labour have given the new party the opportunity to eat into Labour's support. It is almost certainly Corbyn's biggest mistake since he became Labour leader.

*** Postscript (23/02/19) I have had a lot of responses saying that he is just following conference policy. It is the perception of voters that matter here, but on that particular issue see this letter from the party members who helped draft that policy.   

Tuesday 19 February 2019

How to pay for the Green New Deal

The Green New Deal has recently been promoted by a group of Democrats including the inspirational Alexandria Ocasio-Cortez. I first came across it in a report in 2008 by the Green New Deal group, most of whom are pictured above a decade later (HT Andrew Simms). The view that we face a potentially existential climate change crisis, which politicians seem currently reluctant to sufficiently tackle, and which therefore requires a government led programme on the scale in each country of Roosevelt’s New Deal, is something I share.

Why a New Deal? What is wrong with treating climate change as we would any other kind of pollution, with a mixture of regulations, taxes and subsidies? I think the answer is put rather well at the end of an article in the Economist (HT Laurie Macfarlane) which seemingly complains about the Green New Deal’s departure from what it calls ‘economic orthodoxy’. They write

“In fact, the criticism of the economic approach to climate change implicit in the Green New Deal is not that it is flawed or politically unrealistic, but that it is a category error, like trying to defeat Hitler with a fascism tax.”

I would put it in the following way. Tackling climate change is resisted by powerful political forces that have in the past prevented the appropriate taxes, subsidies and regulations being applied. Which is a major reason why the world has failed to do enough to mitigate climate change despite decades of warnings from scientists. You need something like a Green New Deal to push aside those vested interests, and get the right taxes, subsidies and regulations into place. Just as proponents of a Green New Deal are savvy about the need to overcome the resistance of, for example, the oil and gas industry, they also realise that the Green New Deal needs to be politically popular. So the New Deal package has to include current benefits for the many, perhaps at the expense of the few.

What the most effective measures are to mitigate climate change, and perhaps other global environmental disasters, is a fascinating topic. We can learn a lot from the successes so far. Solar energy is now at least as cheap as coal, oil and gas, but this was not always so. It required substantial subsidies or state help for initial development, despite protests that solar energy would always be too expensive. Once a technology is widely used it tends to get cheaper to produce because innovations continue when a mass market emerges, and that is what happened with solar energy. It is impossible to pick winners in advance, so we need to try a number of things some of which will fail. Partly because of those failures a great deal of the required research and development must come from the public sector. No stone must be left unturned when the future of humanity is at stake.

Which all sounds rather expensive, and in particular will require large amounts of public money. An interesting and important issue is how this should be paid for. In the scheme proposed by among others Thomas Piketty, higher taxes on multinationals, millionaires and carbon emissions generate funds to tackle poverty, migration, and climate change. Others have suggested that this spending is better funded by borrowing or creating money. To examine who is right, I want to talk about some of the work of John Broome, an Oxford philosopher and economist.

John Broome was a key advisor to the Stern review on climate change. He argued, and Stern agreed, that we should not discount the welfare of future generations as much as market interest rates appear to do. The reason is ethical: the current generation had no justification for valuing the welfare of the unborn less than their own welfare. This helped Stern to recommend much more current action on climate change than other US based analysis. As Broome emphasised, the key argument here was ethical not economic.

In terms of the funding debate, ethical arguments are also critical. The polluter pays principle suggests that the current generation should pay to mitigate the impact of the pollution they cause. So we should all be paying more for energy, for example, so that the carbon used to produce that energy is priced to reflect its impact on climate change. The idea that the polluter should pay makes economic and ethical sense. It embodies an idea of fairness that most people would accept.

Unfortunately this does not work well enough in practice because those with an interest in selling more carbon and their political allies make people doubt that climate change is real. In addition the connections between the prices people pay and the emissions that cause climate change are often not transparent. So how do you deal with societies that for these reasons fail to pay enough to mitigate climate change?

The argument that Broome put forward (following work by Duncan Foley) is that measures to tackle climate change can be funded by issuing debt. This breaks the polluter pays principle, but it can still lead everyone to be better off (what economists call a Pareto improvement). If government debt rather than taxes are increased to pay for, for example, investment in greener infrastructure the current generation gets away with not having to pay. If future generations have to pay back the debt used to pay for these measures, that cost falls on them, but it is more than matched by the benefits to them because of the climate change avoided as a result. In other words if you cannot make the polluter pay, it is still better to take action to stop climate change even if future generations have to pay the cost of that action.

The case for using government debt to fund the Green New Deal has been strengthened by recent observations by Olivier Blanchard. He noted that interest rates on government debt have over the last half century been below the growth rate of GDP. What this means is that a one-off increase in debt may not require higher tax rates in the future, because that debt as a share of GDP will gradually shrink.

If both these reasons for using debt finance to partially pay for the Green New Deal fail to convince, just think of it this way. No one in a 100 years time who suffers the catastrophic and (for them) irreversible impact of climate change is going to console themselves that at least they did not increase the national debt. Humanity will not come to an end if we double debt to GDP ratios, but it could come to an end if we fail to combat climate change.

All this means that the question of how a measure is financed should never prevent that measure being implemented if it has a reasonable chance of reducing climate change. The whole point of the Green New Deal is that measures should be judged on how effective they will be at achieving their goal, and not on whether they can be afforded. Funding through taxes should be the first option because the polluter should pay, but if this is not politically possible then government debt should increase.

What are the chances of either of the two main political parties implementing a Green New Deal in the UK? It is hard to see a Tory government doing so because of its aversion to debt finance, its neoliberal reluctance to have government lead the way, and because the party contains many climate change deniers. The Labour party is much better placed, and has already set out plans to create its own Green New Deal. Crucially their fiscal credibility rule makes the distinction between current spending that does need to be covered by taxes in the medium term and investment spending that does not, because future generations benefit from that investment. The Green New Deal is all about investing now to improve the welfare of future generations.

Friday 15 February 2019

The Tory party lost its way from 2010, not 2016

“I have had it up to here with the Conservative party.” So writes a one time editor of the Spectator, Matthew d'Ancona. It is a good read: for example
“A chilling populism is now creeping into the language of mainstream Toryism: the language of treachery, snarling tribalism and impatience with anything that smacks of prudence, compromise or caution.”

He is talking about Brexit of course, and he is entirely right. What he misses, in my view, was that this problem did not begin with the EU referendum, but six years earlier, with the Tory ‘modernisers’, Cameron and Osborne.

I think d’Ancona gets to the heart of the problem when he writes
“By tradition, the strongest claim the Tories have had to office is a belief that ideology should be subordinated to reality. Even Margaret Thatcher – the most explicitly ideological of Conservative prime ministers – was ousted to stop the poll tax and to salvage Britain’s relations with Europe.”

Thatcher began neoliberal hegemony in the UK and a lot of the policies she introduced were popular, at least at the time. Her revolution was introduced with some caution, and when her caution ran out she was deposed. That caution, at the level of senior ministers or the party, had gone by 2010. The clearest indication of that is austerity.

Sound public finances, which d’Ancona says he supports, should never apply in the middle of a recession. We have known that since Keynes. As a result, in every post WWII economic downturn the government has focused on recovery and not the rising deficit. The single exception before 2010 was under Margaret Thatcher in her infamous budget of 1981. But that austerity was very different from 2010 for three reasons, in ascending order of importance.
  1. The deficit was not targeted for its own sake, but in a failing attempt to hit a money supply target.

  2. The deficit was mainly reduced by raising taxes rather than by cutting spending, which is more demand friendly. 2010 austerity preferred spending cuts to tax rises.

  3. The austerity experiment was short lived and quickly reversed.
I do not want to minimise the damage done by the 1980/2 recession. My point is just that Thatcher and her ministers saw that monetarism was not working and they ditched it. Not soon enough but it was reversed. To use d’Ancona’s words, ideology was subordinated to reality.

The contrast with the austerity that began in 2010 is clear. As I never tire of saying, almost every first year economic undergraduate around the world is taught that in a recession you stimulate demand. Nowhere do the textbooks talk about worrying about the resulting deficit at the same time, because that implies austerity rather than stimulus. Unlike Thatcher, in 2010 there was no runaway inflation. The debt funding crisis that Coalition politicians were so fond of telling us about was a figment of a few City economists’ imaginations.

By 2012 it was obvious that austerity was a huge mistake. The recovery was nowhere in sight, and a key reason for this were large cuts public sector investment. It is no good complaining about the Eurozone crisis when you are cutting spending while interest rates have fallen by as much as the MPC dare. That is a schoolboy error. An imminent funding crisis implies rising interest rates on UK government debt, but by 2012 those rates were falling. The majority of academic economists who predicted that austerity would damage the recovery had been proved right. But did Cameron and Osborne change their policy, as Thatcher had done, and switch to fiscal stimulus? Of course we know they did not. Reality did not get a look in.

In economic terms austerity was the most damaging aspect of reality denial by the 2010 Tory based government. I calculated that austerity cost the average household £10,000, but the true figure may be much more if we allow for the damage austerity did to the supply side of the economy. It is certain that cuts to social care and the NHS cost lives: it is just a question of how many thousands of lives we are talking about. Austerity represented political deceit at its worst. Voters accepted nonsense pushed by the government about its credit card, and this allowed Tories to achieve an ideological goal of a smaller state which was otherwise unpopular.

If that was not bad enough, austerity also helped sow the seeds of Brexit. When people in communities that had been left behind voted for Brexit they said things couldn’t get any worse, and they said that in part because of austerity. But this was not the only grand deceit of this Tory led administration. They established a target for immigration that they had no intention of meeting because they knew the damage meeting that target would do. But their rhetoric that immigrants were responsible for the ills caused by austerity was a major reason that Cameron lost his referendum. A Prime Minister who had falsely told the nation why it was essential to reduce immigration had no answer to those who pointed out it could not be completely controlled because of Freedom of Movement.

Cameron did not just make a mistake in allowing a referendum in the first place. Through his ruinous policy of austerity and his demonisation of immigrants he ensured that referendum would be lost. d’Ancona is right that Europe brings out the worst in the Tory party. It shows how Tories can elevate ideology and party above the interests of the country. But that did not start in 2016, but with the destruction it has sown since 2010.

Tuesday 12 February 2019

The economic cost of the Brexit decision that Leaver voters do not get to see

Those promoting Brexit are fond of saying that it’s not about economics. Gary Younge in the Guardian tells us that there is nothing wrong with poorer people voting to be worse off, and of course he is right if that is what they knowingly do. But polling evidence suggests that only a small proportion of Leavers think the economy will be worse because of Brexit. Here are the results from three consecutive ORB polls (via here) where the respondents are only Leave voters.

As a result of leaving the EU, the UK’s economy will be
Date of poll
May 2018
Nov 2018
Jan 2019

In May of last year, only 16% of Leave voters thought the economy would be worse off after Brexit, and incredibly 42% thought it would be better. As the table shows this view has only begun to shift in the last few months, and as John Curtice points out this has coincided for the first time with more Leavers than Remainers changing their minds about Brexit.

This tells us two important things. First, the Project Fear mantra worked. The Leave campaign, with the essential help of the Brexit press, managed to convince people that all this talk that the economy would be worse off after Brexit was false. Second, when the small percentage who think Brexit will damage the economy increases, support for Leave falls. Correlation does not prove causation, but this evidence suggests we should be sceptical about claims that Brexit is all about values and not about the economy.

So why are some Leave voters only now realising that Brexit will have a negative impact on the economy, and three quarters still think otherwise? After all, everyone was made worse off as inflation increased following the collapse in sterling immediately after the vote. According to one study, by the third quarter of 2017 the average consumer was worse off by £400 as a direct result of paying higher prices for imported goods following that depreciation.

The problem of course is that those price rises didn’t have a ‘made by Brexit’ tag attached to them. If you read the Financial Times of course you understood the connection, but if you read a Brexit newspaper and watched the 10 o’clock news those connections will not have been made, or if they were they would be muddled by Brexiters claiming the depreciation would be great for exports. It wasn’t great for exports, for straightforward reasons. I suspect some Leavers are only now changing their mind about Project Fear because they are seeing on the news iconic UK companies either cancelling investment projects or threatening to leave because of Brexit.

The problem is that there is no mirror image of the UK economy that didn’t vote for Brexit that voters can easily look at and see how much they are currently worse off. People cannot easily see that they are already paying a price for Brexit because firms and markets are anticipating what will happen after we leave. But it is possible to do the next best thing, and try to create a synthetic UK economy that didn’t vote for Brexit by looking at how other similar economies are doing. We know the UK has moved from around the top to around the bottom of the international growth league, but what does that actually mean for individual households?

That is the exercise that John Springfield at the Centre for European Reform is regularly doing, and he calculates that GDP was 2.3% lower in September 2018 as a result of the Brexit vote. That roughly translates into the average household losing almost £2000 worth of resources (mainly lower private consumption, but also lost public spending and investment). This number is broadly consistent with estimates the Governor of the Bank of England gave in May, using a different method.

To get a handle on how much public resources we are currently losing as a result of Brexit, Springfield calculates that GDP loss would amount to taxes being lower by £17 billion a year. Given the way this government runs its fiscal policy, that means we could have had tens of thousands more police officers and nurses if Brexit had not happened. This isn’t a forecast, but an estimate of what Brexit has already cost us.

Why has Brexit slowed the economy by enough to lose the average household resources worth almost £2,000 before we have even left? The answer is down to anticipation and uncertainty over what Brexit will mean. The foreign exchange markets had to anticipate the impact Brexit would have on future UK trade, and that was a major reason why there was an immediate collapse in sterling after the vote. Uncertainty about which kind of Brexit the UK would choose has mainly affected investment. In the chart below the Bank of England show how business investment has flatlined since the referendum, when the evidence from previous recoveries suggest it should have shown strong growth.

In addition the number of foreign direct investment projects coming to the UK, which was on a rising trend until 2015, has been falling since the 2015 election when it became clear there would be a referendum.

Will investment bounce back once Brexit uncertainty has been resolved? Certainly not if we leave with no deal, because industry's worst fears will have been realised. Even if we leave on the terms of the current Withdrawal Agreement there are two reasons to think the investment bounce back will be small. First uncertainty does not disappear. Will the government manage to agree a new trade relationship before the transition period runs out, or will we go over another No Deal cliff edge? Second, the decline in investment involves some anticipation as well as uncertainty, with a lot of service sector investment diverted towards investment in the remaining EU economies. All the time investment in the UK remains depressed this eats away at our ability to produce, at our productivity and therefore future living standards. As austerity showed, prolonged periods where the economy is depressed will have permanent negative effects.

Imagine if someone came to every Leavers door demanding nearly £2,000 for their household’s current contribution to Brexit. The evidence suggests that Brexit would quite quickly become about the economics. One of the reasons Brexit can happen is that its economic costs are not immediately visible. It is experienced but not isolated as a Brexit effect. It can be estimated to a reasonable degree of accuracy by experts, but the Brexit press keeps going on about the pre-referendum Treasury forecast and the broadcast media prefers a quiet life to routinely quoting these expert assessments. Brexit is not about the economy only because Leave voters are being kept in the dark about the impact Brexit is already having.

Friday 8 February 2019

The Media and the Public

If you take note of the growing evidence that the partisan media can influence public opinion rather than simply reflect it, then this new book by Mike Berry (full title ‘The Media, The Public and the Great Financial Crisis’) is a must read. At its heart is content analysis (what the media said) and audience studies of two key periods: the Global Financial Crisis (GFC) and Austerity.

There is a wealth of fascinating material here, which I couldn’t possibly summarise with any adequacy in a single post. Instead I want to focus on the two final chapters. The first helps explains why large sections of the public were so receptive to the 'Labour profligacy caused the crisis' myth. The second involves discussions with journalists.

I have written in the past (and also in my own book) about why the suggestion that Labour profligacy caused the deficit is simply untrue. The deficit was unremarkable in 2007, and exploded because of the GFC. I have focused on how this untruth was repeated endlessly by Coalition politicians and the right wing press, and how it was not challenged by the broadcast media or the Labour party.

What Chapter 6 of Mike’s book shows is why this idea of Labour profligacy caught on so easily. Between the early 2000s and 2010 the right wing press (in Mike’s sample the Telegraph, Mail and Sun) began to publish more and more stories about public sector waste. Now defenders of the press might argue that there was more waste because of a Labour government, but the number of stories in these papers increased over the period by 600%. A much more plausible explanation was that these papers were trying to undermine what the Labour government was doing, particularly as it was popular.

In this way readers of these papers were primed for the idea that Labour was being profligate. As a result, something that was clearly false could be sold as true. The idea that the media is ‘only reflecting the views of their readers’ is so obviously false in this case, because any journalist worth their salt could look up deficit figures, see that the recession caused the deficit to rise, and inform their readers. In reality these papers promoted the lies, and the non-partisan media did not bother to correct them.

I found the chapter where prominent journalists were interviewed fascinating. Again I will focus on austerity. One of those interviewed was Kevin Maguire, political editor of the Mirror. He talks about how the real reasons for the deficit were presented in the Mirror, but
“You very rarely saw full appreciation of it on TV or heard it on radio and you felt you were running uphill with heavy boots whenever you made the argument”

So why did the broadcast media start obsessing with the need to reduce the deficit? What is clear from Mike’s interviews with Robert Peston and Evan Davis is that the broadcasters really believed a large deficit was a problem of the utmost importance that needed to be tackled. The book contains extracts from his interview with Evan which I abbreviate here.
Evan: “Simon Wren-Lewis comes with a very strong Keynesian view, which is I think incidentally perfectly sensible …. But that’s quite different from saying that we should just blithely come and just say don’t worry about the deficit”
Interviewer: “Do you think you fairly represented all of these opinions, because he thinks you focused far too much on …
Evan: “Yes, but … people who hold a strong and rigid position on an issue find it very difficult not to see that we’re biased against them on anything, and Simon Wren-Lewis is in that …

Mike then writes
“However as the analysis in Chap. 2 demonstrated during the sample period in 2009 when the deficit became a major political issue there were no sources - outside of Labour - who were given space to put the Keynesian view in comparison to a range of sources who put the case for a faster pace of fiscal consolidation.”

A journalist might say gotcha. So it wasn't the imagination of a 'rigid' Keynesian: the BBC really did promote austerity. You can see why I also treat BBC claims that they told everyone that more than 90% of economists thought Brexit would be harmful with a large pinch of salt.

If you want to understand political developments since the GFC you have to understand the media, and that means collecting and analysing hard data in the way that Mike and others media studies academics do. What Mike does so successfully in this book is show how stories in the press were reflected in people’s attitudes and how this can have a profound influence on the political climate and therefore what politicians do.

Tuesday 5 February 2019

There will never be a better time than immediately after Brexit to form a new political party

As the vote of no confidence by 80% of Labour MPs after the referendum result showed, Corbyn is at his most vulnerable over Brexit. The 2017 election result may have wiped memories of this painful period, but to say that it shows the vote of no confidence didn’t matter goes too far. Unfortunately Labour still lost in 2017, as their powerlessness over Brexit shows. How do we know that the perception that Labour MPs were deeply unhappy with their leader did not cost Labour in 2017 the crucial votes that prevented them forming a government?

Voters seem currently as divided on Brexit as they are by party, and most Labour voters and members want to stay part of the EU. There will therefore be no better time for centrist Labour MPs who are pro Remain to break away and form a new party. When Brexit happens there will be a lot of bitterly disappointed people around questioning where to go from here. That a few Labour MPs have been talking about the possibility of forming a new party is an open secret.

Unfortunately Corbyn has done virtually nothing for members and voters that closely identify with Remain. Hopes have been kept alive by Keir Starmer and occasionally John McDonnell, but neither attended Corbyn’s recent talks with the Prime Minister. The overriding impression given by the leadership and its supporters is that they do not want to antagonise Labour Leavers, and Remainers have nowhere else to go besides Labour. It is never a good idea to give the impression to those closest to you that you take them for granted.

If the objective of this new party is to remake UK politics it is almost certain to fail. But that is not what is important. The key issue is how much damage it can do to the two major parties. One of the lessons of the last two years is that the Conservative vote is pretty solid. Brexit is in a way their Falklands: an issue where they can ramp up the nationalism to maximum and their voters will forget the incompetence and damage to this country their government is inflicting on them. The minority of Conservatives who can see through this will be scared by stories (often false) of what a radical Corbyn government will do.

The new party therefore seems to be mostly a threat to Labour. This is true in part because our future trade relationship with Europe will play a major part in politics from now until the next election. (Those who think that Leaving the EU in March or whenever will stop politicians talking about Brexit will be very disappointed.) If the new party pledges to fight for staying in both the Customs Union and Single Market after we leave the EU, that will tempt Remain voters, because Labour only speak of a close relationship with the Single Market. There is a world of difference between being close and being in: ask any trading firm why. Staying in the Single Market requires Freedom of Movement, and this would allow the new party to attack Labour on immigration, where its recent actions have also made them vulnerable from the perspective of liberal Labour voters.

The problem a new party has is the MPs that are likely to be part of it will find it hard to major on radicalism. Will they really champion immigration, or instead fall back on anti-immigration rhetoric? If they match Labour’s economic radicalism with a kind of nostalgia for how things were before 2016, they will find to their cost that this nostalgia is not widely shared. All of these things mean that the party will fail to capture most Labour supporters. However when it comes to winning the next election Labour do not have supporters to spare. To lose some to a new party could mean another five years for this disastrous Conservative government,

What we can be sure of is that the media, pretty well all of the media, will big the new party up as much as they can. The reason they will do this is that a new party is a threat to Labour rather than the Conservatives. A consequence of the media blitz will inevitably be that some votes, mainly Labour votes, will follow. So whatever line the new party takes, if they are pro-Remain they are quite likely to be a threat to Labour come the next election. 

In economics we talk about ‘barriers to entry’ that prevent new firms entering a market. Some of these are intrinsic, like set up costs for a new firm. But existing firms in the market can also influence whether new firms enter or not. Corbyn’s Brexit strategy so far seems designed to create a ready market of customers who are dissatisfied with Labour’s policy on Brexit. In other words Corbyn is currently creating the conditions in which a new party could enter, and survive for long enough to cost Labour the next election. 

Saturday 2 February 2019

The Interest Rate Lower Bound Trap and the ideas that keep us there

Japan’s short term interest rate set by its central bank has been near zero since the mid-1990s. The UK’s equivalent short interest rate has been near zero since 2009, and the Eurozone’s since 2014. This in turn reflects core inflation being well below its target rate in Japan and the Eurozone over the same period. [1] This is not how it is meant to be. And because the short term interest rate in the US is above zero, it is not getting the attention from a US-centric macroeconomic community that it should.

We all know about interest rates hitting the lower bound after the GFC. But macroeconomic theory is quite clear. Governments can always, just always spend their way out of such a trap. The reasoning is simple. If the government cutting taxes and spending more on public services was not at some point inflationary, then why are we not having both? There must be a point at which demand exceeds supply by enough to make inflation meet its target.

I’ve often heard an objection that fiscal stimulus is not appropriate because these countries no longer have an output gap. But the output gap is difficult to measure. If these countries really did have a zero output gap, then why is inflation below target? Inflation, not the output gap, is the ultimate constraint on whether fiscal stimulus is needed. [2] If inflation is stuck below target and your measure of the output gap says that gap is zero, you should ignore the output gap measure and enact a fiscal stimulus.

So why has this not happened in Japan, or the UK, or the Eurozone? The answer has to be that for some reason governments in those countries have not done what they should have done, and therefore wasted a lot of resources that could have gone to their citizens. It takes quite a lot to convince governments not to spend when they should and to tax when they need not. So what is this force that stops these governments spending their way out of the interest rate lower bound trap?

There are three candidates I can think of.

The first is what I call the consensus assignment. The idea that monetary policy, and only monetary policy, can be used to stabilise the economy to hit the inflation target. It was the macroeconomic policy consensus until the GFC. It left governments unused to dealing with stabilisation themselves, because they had contracted out the problem to the central bank.

But this cannot explain it all. After all, all three countries/zones have used fiscal policy to expand the economy after the GFC, and Japan on many occasions. So something else must be inhibiting these countries from using fiscal policies by enough.

The second candidate is something that came with the consensus, and that is ‘deficit bias’. When interest rates controlled the level of inflation (and, contrary to MMT thinking, they were pretty effective at doing this job) many governments tended to allow government debt to gradually rise, for reasons that are hardly complicated. Rules were created and then institutions set up to prevent this happening. It may be that too many governments have internalised the idea that deficit bias is bad and therefore it is good to run down debt.

Of course that idea only makes sense when the consensus assignment is operating, and it does not apply when interest rates are stuck at their lower bound. When rates are stuck at around zero we need to reverse the assignment and use fiscal policy to stabilise the economy until rates are well clear of their floor. But perhaps some governments fail to see that and still think it is good for them to be reducing debt. 

To be honest I think this might apply to officials working for governments (including central bank governors), but not to politicians themselves. Officials who had learnt their economics when the consensus assignment was dominant and never read the footnotes (if they were there) about the interest rate lower bound. But that still matters, because officials play a big part in advising politicians. In particular, officials helped design a currency union which has no contingency for situations where monetary policy is ineffective.

The third and final reason is a phobia about government debt. Now there are good economic reasons why building up a large stock of government debt relative to GDP may have unfortunate side effects, but they all operate when the interest rate on government debt exceeds the growth rate (r > g for short). High government debt can crowd out private investment by raising interest rates, but inadequate demand is much more effective at suppressing investment and rates cannot be crowding out investment when they are at their floor! In short, the economic reasons for worrying about government debt fall aside at the lower bound. [3]

Now perhaps public officials and some others are influenced by the economic case against high debt to GDP and fail to see that it does not apply when interest rates are at their lower bound. But I think there are two more important reason for deficit phobia. The first comes from watching countries get into serious difficulties, and often resorting to the IMF, because they could no longer finance their debts. But this concern does not apply to a currency issuer whose debts are in their own currency, as Japan, the Eurozone and UK all are. However I suspect officials can be a little economical with the truth about this when it suits them (see the UK 2010 Coalition negotiations for example).

The second reason for debt phobia is ideological. Debt phobia is a means of keeping a lid on the size of the state. We see this in its most blatant form in the US from the Republican Party, but I think it is powerful everywhere. This is particularly the case under neoliberalism, where a key goal is reduce many activities of the state so taxes can be cut for the already well off.

The importance of this cannot be overemphasised. Two major economies and one economic block are wasting resources that could have gone to their citizens because of some all all of these factors. And perhaps even more importantly, they and other countries like the US are wide open to a negative demand shock creating a recession without effective [4] tools being ready to combat it.

[1] The UK is complicated by two large currency depreciations, but once you take out their effect everything here applies equally to the UK.

[2] With a Phillips curve, the only reason inflation can remain below its target besides deficient demand is if people and firms think the real target is below the official target. But if that is the problem, then policy makers should increase demand and inflation to show this is not true.

[3] Some may worry that high deficits will be difficult to wind down once we are off the lower bound. But a good fiscal stimulus is temporary, so this should not be a problem.

[4] Quantitative Easing is not a reliable tool.