Winner of the New Statesman SPERI Prize in Political Economy 2016

Monday, 14 September 2020

Whether its COVID or Brexit, this government is continuing to fail terribly at everything it does. Will Conservative MPs do anything about it?

Testing failure

So for many visits to grandparents are off. No one should dispute that the government needed to do something after a sharp increase in the number of positive tests. However there is also no doubt that one of the factors pushing them to act was the partial collapse of the test and trace infrastructure. Stories of people being told their nearest test was tens or even hundreds of miles away, or that no tests were available, abound, and now we have leaks of hundreds of tests being thrown away because they cannot be processed and cases returning to care homes.

The specific reason for this failure remains unclear. Keir Starmer tried repeatedly at PMQs to get some explanation from the Prime Minister, but the best Johnson could manage is that demand was high. Which of course was completely unforeseeable with schools going back and other forms of increased mixing encouraged by this government. Matt Hancock at one point blamed people who were not meant to get a test being tested, which is the first time he has ever suggested that some people should get tested and others shouldn’t. At least the director of NHS test and trace had the decency to apologise.

As an aside, the inability of the Prime Minister to either answer straight forward questions or handle any kind of detail at PMQs is a sign of his own personal incompetence. His initial response to criticisms of how his government is performing is to suggest that somehow the leader of the opposition is unpatriotic to even question such things, and he comes close to suggesting that to be an opposition is itself unpatriotic, which of course is the typical stance of a autocratic populist. In other words PMQs are a clear demonstration of the kind of administration Johnson runs and his severe inadequacies. No wonder Cummings makes sure he avoids scrutiny on a scale far in excess of any  previous Prime Minister 

The underlying reason for the failure of the UK’s testing system, just at the point it is most needed, stems from this government’s decision to outsource the whole operation to private companies (but still calling it NHS test and trace in their usual duplicitous way.) Starmer has been right to highlight testing failures, but so far has failed to link it explicitly to the privatised system which many voters will not be aware of. This privatised system is also a big reason why the source of the failure is unclear: when you farm things out to private companies who then delegate to other companies, getting to the truth quickly is hard. The money would have been much better spent increasing the budget of local authority public health teams, and backing that up with government oversight that could get additional resources to hotspots quickly.

Looking at France, Spain and some other European countries, it may be tempting to conclude that nothing could have stopped a rebound in cases. If you are tempted to think that way, consider New York, where there is no sign of any rebound. As Miguel HernĂ¡n suggests here, New York has so far avoided a rebound by having more tests, more tracers, and being more cautious in opening up social consumption like eating out. Sunak may come to regret his £10 off meals idea. But Spain and France, as with last time, were a warning to the UK. And just as last March, the UK government took no notice and made things worse, 

It is just so typical of this government that at the moment they are having to restrict individual freedom partly because of the failures with their own testing system, they announce a grandiose scheme to test everyone everyday, or something like that. At a cost of £100 billion, which is the same order of magnitude as the annual NHS budget. From the people who gave us a testing system that cannot get enough tests today, do we think that this £100 billion will be spent wisely? Even if it works, will it be value for money, will it detract from getting the current testing regime right, and will it be quickly superseded by a vaccine. Johnson’s record on these things (Garden Bridge anyone?) is not good, but like all autocrats he loves grand projects, and there is nothing we can do to stop him wasting yet more public money.

Breaking the law

The decision to break the Withdrawal Agreement (WA), an international treaty, is quite shocking but it shouldn’t come as a surprise. As I noted at the time, Johnson only got the ERG to agree to his deal because his partners in crime told them it could all be changed later. Either the ERG was being duped, or they were being told the truth, and with Cummings and Gove running the show it was always likely they were being told the truth. Of course it makes a nonsense of everything Johnson said during the election about his deal, but this is the Vote Leave team that lied through their teeth to get the result they wanted in 2016, so why not do it again in a General Election? If his track record counted for anything, the media would ignore every word he says. (Oh, and ministers are almost certainly breaking the ministerial code,but don’t expect that to worry them.)

What we don’t know is whether this is a piece of theatre to detract from pandemic failings and taunt Starmer at PMQs with being a Remainer, or their idea of a negotiation tactic, or the start of a futile and costly trade war. I think we can discount the first possibility. Although this government is in continuous campaign mode, this explanation seems unlikely because, as Chris Grey observes, this move has been in the planning for months, and as I suggest above was thought up before the last election.

Putting down domestic legislation allowing the government to break the WA may be the government’s idea of putting pressure on the EU to get a better deal. In reality it will make the EU less likely to trust anything the UK says and determined to drive a hard bargain. Brexiters have never understood how you negotiate when you are the weaker partner. The damage to the UK from this negotiating tactic goes well beyond the EU negotiations, and includes what is left of our international reputation and a US trade deal.

The third and most worrying explanation is that Johnson has decided that no deal is his preferred option, and hoped this action would make the EU break off negotiations. The fact that they had every right to do so suggests he doesn’t fear no deal. The problem with blowing up the negotiations by revoking the WA is not just the short term disruption and the longer term hit to UK industry, although all that is bad enough. By breaking the WA the government is threatening to reopen the Irish border issue, and that could lead to a full blown trade war.

Everyone with any sense knows that there has to be customs checks between the UK and the EU. The Withdrawal Agreement puts those checks in the ports on the Irish Sea - between Northern Ireland and the rest of the UK. The only other place those checks can be is the border on the Irish mainland, and anyone who wants to retain peace in Northern Ireland wants to avoid that. (Gove, however, compared the Good Friday agreement that gave Northernn Ireland peace to appeasing the Nazi’s in the 30s, so he has no worries on this account.) But if the UK fails to impose the necessary checks on the Irish Sea, what is the EU going to do? They will not just give in and accept a border on the mainland.

The same applies to state aid. If the UK decided it was going to subsidize some part of UK industry to gain a competitive advantage over EU industries, the EU’s ultimate sanction is to impose tariffs on the goods or services that these subsidized UK companies produce. As Northern Ireland is in the same tariff zone as the EU, it cannot apply that sanction to any Northern Irish company, so any such company (whether based in Northern Ireland or not) has to be subject to EU state aid rules. If the government is saying they didn’t understand that at the time they signed the WA then they are not fit to govern, but in this case they are just lying as usual.

If the EU will not accept a border on the mainland, what will they do if the UK refuses to put one in the Irish Sea? The ultimate sanction the EU has is to restrict exports of UK goods into the EU in some way or other. Ending the WA in the absence of a deal can only mean the beginning of a trade war with the EU. The UK cannot win such a trade war, because the EU knows it will hurt the UK much more than it will hurt themselves. Perhaps that is the outcome Johnson relishes, so he can pretend to emulate his hero Churchill. But would the party that got rid of Thatcher over the poll tax really stand by as whole UK industries collapsed, and farmers dumped the produce they could not sell in Whitehall?

The Conservative Party

Johnson, Cummings and Gove are all very different from Trump, but their actions are similar to Trump’s. They are happy to override or destroy every element of our pluralist democracy, but are incompetent at government. Until now they have got away with it because they were popular with enough voters and very popular with their base. Most Conservative MPs will suffer most things to retain power, including a Prime Minister that likes suspending parliament. They chose Johnson knowing all his faults because he was the man who could save their seats and keep their power.

However the failures of government that occurred before recent events have had an impact on this government’s popularity among voters, and I suspect these latest events will continue to eat away at their support. Many Leavers will be annoyed that something they voted to get done is back in the headlines again, and voters can see the faults with the government test and trace system. If the government provokes a trade war, then we will see how far manufactured nationalistic bluster can carry voters through economic disaster.

Conservative MPs now have a choice. Do they go down with the sinking ship that is Cummings/Gove/Johnson as it destroys the fabric of UK democracy and becomes steadily more unpopular because of its failures, or do they call a halt to all this. Things are not going to get better, because these three are incurably incompetent as well as destroyers of democracy. The time to call a halt is now, by telling Johnson that Cummings has to be confined to campaigns and kept well clear of government, and the internal market bill that breaks international law must be withdrawn . If they don’t, the Conservative party becomes the party of law breaking that despises democracy. It will go down the rabbit hole that the Republicans have in their blind support of Trump.

There is some puzzlement about whether Johnson represents an end to neoliberalism as the dominant ideology of the party. I think that is the wrong way to think about what is happening. Neoliberalism contains a dynamic that tends to lead to autocratic plutocracy sustained by a culture war. Conservative MPs and the cabinet remain fundamentally neoliberal, as is evidenced with the UK’s test and trace system. If there is a change, it is from abandoning the attempt to squeeze the state to reduce taxes that austerity represented, to a belief that the state is a pot of gold that certain companies can plunder.

What about spending lots of money to create a tech giant, as Cummings seems to want? Does that represent an end to the idea that the state should not try to pick winners, which among neoliberals follows from a distrust of the abilities and motives of government. Not really, because it will be Cummings rather than any kind of government apparatus that is doing the picking, and it is the idea of an individual (Cummings) rather than a movement. It will be a bit like our privatised track and trace: a lot of money wasted in failure that will make certain individuals - including associates of Cummings - richer. Politics under a plutocracy always involves the mad ideas of those in charge: just look at Trump. The key question of the moment is whether Conservative MPs will allow this to happen.

Wednesday, 9 September 2020

In the UK Treasury cutting the deficit generally takes priority over the health of the economy

The UK Treasury bears some responsibility for the disaster of 2010 austerity, yet it has not accepted or understood the mistake it made. As a result it risks repeating the mistake, albeit in a milder form.

The problem is that fiscal prudence is basic to the way the Treasury operates, and with few exceptions other priorities, including the macroeconomic health of the nation, are not allowed to get in the way of that goal. Only the most determined Chancellor can change that. It is a longstanding problem. Back in the 1960s Harold Wilson tried to solve it by creating a separate ministry, but the Treasury maintained its power.

This was a key issue for the Kerslake review, of which I was a member. As we noted, the problem of prioritising the public finances over macroeconomic goals has got worse in recent decades, with outsourcing stabilisation policy to the Bank of England and fiscal forecasting to the OBR. This transfer of powers has weakened macroeconomics within the Treasury, because the idea was that macroeconomic stabilisation had been delegated to the Bank of England. The possibility that fiscal policy would need to be used for macro stabilisation when interest rates hit their lower bound was not on the raidar, and remains alien to Treasury thinking.

Of course politicians are ultimately in charge, but the Treasury can have a powerful influence on ministers' thinking. In 2009 the Labour government was, to its great credit, determined to combat the recession that followed the Global Financial Crisis (GFC) with fiscal stimulus, but the Treasury convinced Alistair Darling to publish forecasts that included substantial fiscal contraction during the recovery phase. If Labour had remained in power and the recovery had faltered as it did in reality (less likely because Labour's austerity was not front-loaded), it is unlikely that these austerity plans would have been enacted. However the key point is that it should not have been part of any fiscal plan for at least the first few years of the recovery. Its political impact was to give ammunition to deficit panic in the media.

In 2010 it was a briefing from the Treasury that helped convince the Liberal Democrats that the harsh austerity in the Cnservative programme was necessary, even though it wasn’t in the Liberal Democrat manifesto.

Despite all this, and many suggestions made to us, the Kerslake review did not recommend splitting off macroeconomic policy from the Treasury. Instead it recommended greatly enhancing its macroeconomic capability, as part of a general remit to look at major risks to the economy. The obvious risk at the moment, besides the resurgence in the pandemic itself, is that premature tax increases will stifle a full recovery from the pandemic (when the pandemic ends), and some of what should have been just a temporary fall in demand gets hard-baked into a permanent fall in the size of the economy. There is a strong case that this happened after the GFC as a result of austerity.

It is important to distinguish between two different questions, and mixing the two can lead to the kind of confusion I highlighted in my last post. The first question is whether taxes will have to rise at some point as a counterpart to politically essential higher levels of public spending. My guess is that it will to avoid interest rates going too high, but it’s a guess and I could be wrong.The second question is whether taxes need to rise anytime soon. The right answer to that question is no, because interest rates remain low as we are early in the recovery phase following the pandemic. Any increase in taxes before significant increases in interest rates will reduce the strength of the recovery.

In some respects the damage is already happening. Consumers that can will look forward when planning spending, such that expectations of future tax rises will have some impact on consumption today because of consumption smoothing. (An exception is expectations of a future VAT increase, which can stimulate consumption before the tax rise.) The Treasury and the Chancellor have let it be known that tax increases are coming since May (e.g. here, and more recently here), creating exactly those sort of unhelpful expectations.

In addition, the Chancellor is also showing little flexibility over the furlough scheme, in contrast to neighbouring countries. Once again the justification appears to be the financial cost (a larger deficit), which puts that above the cost of large increases in unemployment. As I have noted before, an obsession with re-opening the economy as fast as possible after the first COVID-19 peak is also counterproductive.

As Chris Giles has noted, there is an obvious motive for the Chancellor to raise taxes sooner rather than later, and that is the election in 2025. The Chancellor is among those who think taxes will need to rise eventually, and he would rather increase them sooner rather than a year before the election. As is often the case, the politics is not helping the economics. We have been here before of course. Osborne front loaded austerity for the same political reasons, which stopped the post-GFC recovery in its tracks.

Tuesday, 1 September 2020

Will taxes have to rise?

That is the question addressed in this debate between Jonathan Portes and Bill Mitchell. I found the discussion very frustrating, because it is really a debate about medium term inflation forecasts dressed up as something more fundamental. Both Mitchell and Portes agree that there is no need for taxes to rise to ‘pay for’ the fiscal costs of the pandemic. In an age of ultra-low real interest rates, shocks to the debt to GDP ratio like the Global Financial Crisis and the pandemic should be allowed to gradually wither away as growth outstrips interest rates on that debt. Trying to reduce debt by running deficits close to zero, or even surpluses, as Osborne tried to do, threatens to derail a full recovery.

I think it would be fair to say that the argument from Jonathan Portes is that we should increase the share of current public spending in GDP in various ways over the next few years, and without higher taxes, or substantially higher interest rates, that will at some point lead to a permanent rise in inflation above target. To prevent that, taxes should rise. Bill Mitchell would agree that public spending should rise, but he doesn’t think inflation will rise as a consequence. If inflation did rise, it is standard MMT (at least according to Stephanie Kelton) that fiscal policy should be the “primary tool for macroeconomic stabilisation”. Thus the debate between the two on whether taxes should rise is essentially a disagreement about medium term inflation forecasts.

This point is illustrated in the final statement from Bill Mitchell. He writes:

Should the government seek to command a far bigger share of productive resources—say, for a green transition—then, yes, perhaps tax rises would have a role in offsetting the extra spending and warding off inflation.”

Jonathan Portes might well respond that his argument is premised on just such a situation. In his opening statement he writes:

And as well as more on the NHS and social care, structural economic shifts—from the aftermath of Covid-19 to decarbonisation—will mean more is needed for education and training. We don’t need higher taxes to pay for the virus; but the virus has exposed, economically, socially and politically, that we need them to build a better future.”

This illustrates that there is no disagreement in principle here, but just a disagreement about what levels of public spending increase would tend to lead to above target inflation. Indeed as these quotes suggest, there may not even be a disagreement here, but just a distinction between what should happen to public spending (Portes) and what is likely under current or prospective governments (Mitchell).

I want to argue that the whole debate about whether taxes should rise to pay for additional public spending is unnecessary. We can afford to wait and see. If inflation does appear to be permanently rising above target, you can be sure that the central bank will raise interest rates to bring inflation back down. Exactly when central banks should act is a live issue right now in the US, where the Federal Reserve has decided it will allow inflation above target for some time to ‘make up’ for inflation being below target in the past. But important though this change is, it remains the case that no independent central bank worth its salt is going to allow inflation to permanently rise above the inflation target.

It is only when central banks start raising interest rates in earnest that governments need to think about raising taxes. By raising taxes they reduce the pressure on aggregate demand and inflation, and therefore moderate the extent to which interest rates need to rise. It would be foolish for governments to make the same mistake that central banks made before the pandemic hit, and try and anticipate what might happen to inflation based on outdated ideas about the NAIRU. [1].

What about deficits? Isn’t good fiscal policy all about trying to achieve sustainable deficits (deficits that stabilise the government debt to GDP ratio)? As Jonathan Portes and I have argued, those rules should not apply when interest rates are stuck at their lower bound. When interest rates are at their lower bound, fiscal policy should become the primary tool for macroeconomic stabilisation. When interest rates are at their lower bound, standard academic macro and MMT should be on the same page.

While academic macroeconomists now generally accept that fiscal consolidation is a bad idea when interest rates are at the lower bound, the UK Treasury appears to think otherwise. There is much talk of tax rises or spending cuts to 'pay for the (fiscal) costs of the pandemic'. No doubt this will be justified by OBR forecasts and talk of structural deficits, just as it was in 2010. But whether its spending cuts or tax rises, fiscal consolidation coming out of a recession where interest rates are at the lower bound risks turning what should be a temporary downturn into a permanent fall in output.

[1] The changes at the Fed are welcome, because they address an error that central banks have been making since the Global Financial Crisis (GFC). Before that crisis, they tried to guess where inflation would go in the future by looking at forecasts and indicators like unemployment, and they were pretty successful at that. But, as some of us argued at the time, after the GFC it was foolish to continue in the same way, because the crisis had fundamentally changed the way the economy worked and because the risks of getting it wrong were asymmetric.