Winner of the New Statesman SPERI Prize in Political Economy 2016

Tuesday 29 August 2023

Attitudes towards redistribution


This book by Charlotte Cavaillé is forthcoming, so this post is based on this excellent podcast, which is well worth an hour or so of your time (and/or buy the book when it’s out).

Although inequality can be measured in many ways, here I want to focus on one particular measure: the share of income going to those at the top of the income distribution (1% or 0.1%). In the UK this started rising from the early 1980s to the mid-2000s, but it hasn’t risen significantly since then. (It rose from about 6% to around 15% for the 1%, and about 2% to around 6% for the 0.1%. Figures from this IFS paper, discussed here.) Yet when people are asked whether (see figure 2) “government should redistribute income from the better-off to those who are less well off”, the percentage saying yes (about 50%) is much the same today as it was in the early 80s. Admittedly this question doesn’t specify who the ‘better off’ are (more on this latter), but nevertheless the combination of growing inequality at the top with unchanged views on redistribution is interesting.

Here I found Cavaillé’s framework for thinking about attitudes to inequality very helpful. The first point is that if views about redistribution from the top 1% were governed by self-interest alone, the proportion wanting more redistribution should be 99%. However Cavaillé argues that attitudes to redistribution are governed only partly by self-interest but also by views about fairness. We are a social creature after all, rather than just individualists out for ourselves. Furthermore she argues that when it comes to redistribution, views about fairness are divided into two: “redistribution from” and “redistribution to”.

This might seem counter intuitive when thinking about a survey question that combines both aspects. But if you think about it, redistribution does involve two acts: taking away (redistribution from) and giving (redistribution to). Cavaillé convincingly argues that the way most people think about fairness when thinking about taking away is rather different to fairness when giving to others. In general terms, different attitudes about ‘redistribution from’ tend to go along economic left/right lines, but attitudes about ‘redistribution to’ are more correlated with socially liberal or conservative mindsets.

To be more concrete, experimental evidence from behavioural economics suggests the dominant idea concerning ‘redistribution from’ is proportionality: have those earning higher incomes earned (in a moral sense) those better rewards? Proportionality is used by people far more often than notions of equality. Whether incomes under capitalism are deserved or not will be correlated with where people are on an economic left/right spectrum, but they are also influenced by elite discourse about the extent to which rewards are justified.

In contrast, notions of fairness concerning ‘redistribution to’ involve social solidarity and free riding. Again in behavioural economics experiments ideas of reciprocity (help others until they start to free ride) dominate concepts of need. Cavaillé suggests that social liberals tend to be more optimistic about those who are in receipt of redistribution and welfare, while social conservatives obsess more about free riding, and are unconvinced that the state can prevent this.

Cavaillé uses these ideas to explain changes in attitudes in a number of countries, including why support in the UK for redistribution has fallen or at best stayed constant while incomes at the top have risen so dramatically. First she points out that following Thatcher’s election victory in 1979, the debate about whether incomes produced by the UK’s capitalist system were fair or not, a debate that had been prevalent in the 1960s and 70s, largely disappeared. Instead dominant narratives became about wealth creation and incentives, both of which were generally and selectively used to refer to those earning high incomes. This was continued under Blair, who was famously relaxed about high incomes.

This meant that attitudes to redistribution shifted from thinking about ‘redistribution from’ to thinking about ‘redistribution to’, particularly under the Blair/Brown government where social support for the poorest increased substantially. This was a gift to the political right, and particularly to the right wing press, which produced endless stories about scroungers sponging off the welfare state. This helped to make attitudes towards redistribution more unfavourable in the first decade of this century. To put it another way, the left wing social conservative, whose views on redistribution would always be conflicted, thought more about ‘redistribution to’ and free riding, even though inequality at the top was rising.

Still, doesn’t self interest count for something? How much it counts for depends a lot on information. Better off social liberals may often be in favour of redistribution until the moment they realise how much their taxes will need to increase! I would argue that systematic information and debate about top incomes is very thin on the ground, and in particular is unlikely to reach the less well informed who are often left wing social conservatives. (There is a strong positive correlation between the amount of education people have received and social liberalism.) In particular, very few people realise how much they have become personally poorer as a result of the growing incomes of the 1% (assuming, as seems reasonable as a first approximation, that this is a zero-sum game). To put it simply, if today the 1% get nearly an extra 10% of national income compared to the post-war period, then the 99% have on average 10% less income.

At this point we need to address the problem that survey questions talking about rich and poor, although they provide useful information about changing attitudes over time, may be too general to pick up views about the very well off: the top 1% and especially the top 0.1%. After all, even the right wing press carries stories about ‘fat cats’, even if they tend to be more about those in the public rather than private sectors. In this recent opinion poll, for example, 66% of voters say that the wealthy do not pay their fair share of tax, relative to just 6% who say they pay too much. Using the term ‘wealthy’ rather than ‘better-off’ may tap better into views about the top 1%, but note also that this is only a question about ‘redistribution from’, and avoids talking about where any extra tax might go.

Let me summarise by using this analysis to suggest what those (like myself) favouring greater redistribution from the top 1% need to do to convince others. The first thing is to focus on the very top of the income distribution, and be explicit about how much the rise in income going to the 1% has made everyone poorer. The more information people have, the more self interest will kick in. Along the same lines, stress that greater incomes for the 1% have been accompanied by lower, not higher, growth rates. Second, stress that CEO pay is not determined ‘by the market’ (which might make some believe it reflects effort or contribution), but is instead set by other CEOs or well paid executives and board members. Finally, when asked about ‘redistribution to’ (as will inevitably happen), focus on areas of public spending where there is less perceived scope for free riding, like the NHS. Some of this is intuitive, and probably bread and butter for those who campaign on this issue, but I found it useful to see how these lessons follow straightforwardly from Cavaillé’s framework.

Tuesday 22 August 2023

Wage inflation, unemployment and what you wish to believe


Two weeks ago I described how the UK’s inflation problem has now become about labour market strength and private sector wage inflation. Earnings data released last week has confirmed that view, in part because of the latest data but also because of revisions to the previous two months. Here is both year on year wage inflation, and the annualised three month rate.

Year on year wage inflation is at around 8%, and more recent increases have been above that. If that continues it is consistent with 6-7% inflation, which is well above the government’s target of 2%. So private sector wage inflation has to come down. Maybe wage inflation will follow price inflation down, or perhaps further efforts to reduce aggregate demand and therefore the demand for labour are needed. That question is not the subject of this post. Instead I discuss why some on the left find this diagnosis for our current (not past) inflation problem difficult.

A year or so ago, when inflation in the UK was primarily due to higher energy and then food prices, mainstream economists could legitimately be divided on what the policy response should be. On the one hand, decreasing aggregate demand in the UK was not going to have any effect on the drivers of inflation. On the other hand, it could be argued that policy should become restrictive to prevent higher inflation becoming embodied in expectations, because if that happened then inflation would remain too high after the energy and price shocks had gone away. To use some jargon, opinions will differ on what the policy response to supply shocks should be. Until the beginning of 2022 central banks went with the first argument, and did not raise interest rates. When nominal wage inflation started rising, and it became clear the labour market was tight, interest rates started to rise. 

Now mainstream economists, at least in the UK, are on clearer ground. Excess demand in the labour market is pushing up wage inflation, and therefore aggregate demand needs to be reduced to bring private sector wage inflation down. There may also be excess demand in the goods market, pushing up profit margins, but the remedy would be the same. (Data on profits is less up to date than earnings, but as yet there is no clear evidence that the share of profits has risen in the UK.) Excess demand in either market needs to be eliminated, which requires policy to reduce aggregate demand, leading to fewer vacancies and almost certainly increased unemployment.

The understandable difficulty that many have with this diagnosis is that real wages have fallen substantially over the last two years, and nominal wage inflation is only just catching up with price inflation, so how can wages be the problem? I have addressed this many times, but let me try again in a slightly different way.

Inflation over the last two years has been about winners and losers. The winners have been energy and food producers, who have seen prices rise substantially without (in the case of energy at least) any increase in costs. To the extent that the government can (and is willing), profits from energy producers can be taxed and the proceeds returned to consumers through subsidies. But the reality is that much of these higher profits on energy and food production are received overseas, and there is nothing the UK government can do about them. As this is essentially a zero sum game, those who have benefited have to be matched by those who have lost. The only issue becomes how those losses are distributed between UK consumers, the profits of other UK firms, the government and its employees.

Workers in this situation could try and raise nominal wage inflation to moderate this loss in real wages, and that is one interpretation of what has been happening. Yet if those in the private sector are successful in this, who are the losers? They can only be firms, through lower profits. Why should firms reduce their profit margins when wages are rising across the board? In a weak goods market they might be prepared to do so, but there are no signs of that in the UK. So firms are likely to match higher wage inflation with higher price inflation. That is the major reason why the price of UK services has been increasing steadily over the last two years (now at 7.4%).

The key point is that UK real wages didn’t fall over the last two years because the profits of most UK firms rose. They fell because the profits of mainly overseas energy and food producers increased. Trying to shift this real wage cut onto the profits of other UK firms will not work, and instead just generates inflation. It is also why nominal wage inflation, not real wage inflation, is the crucial variable here. We could debate whether it would be a good idea to see real wages recover at the cost of falling profits, but it hasn’t happened so far and is unlikely to happen in the future unless excess demand is replaced by excess supply.

Those on the left who find it uncomfortable to hear that nominal wages are growing too rapidly need to remember that since at least WWII sustained real wage growth, or the absence of growth, in the UK has not come from lower profits, but instead comes mainly from productivity growth, with occasional contributions from commodity price movements and shifts in the exchange rate. The reason UK real wages have hardly increased over the last 15 odd years is because productivity growth has been very weak, energy and food prices have risen and sterling has seen two large depreciations. [1] The interests of workers are served by policies that help real wage growth, and not by seeing nominal wage growth well beyond what is consistent with low and stable inflation.

If high inflation is caused by excess demand then policy needs to decrease aggregate demand, which will reduce the demand for goods produced by most firms leading in turn to a reduced demand for labour. That almost certainly means unemployment rises. If you worry that the costs of additional unemployment is too high, then something like a Job Guarantee scheme makes a lot of sense, although the potential costs of such a scheme also need to be recognised. Such a scheme does not change the logic, however, that inflation that is caused by excess demand needs to be corrected by decreasing aggregate demand.

Is there an alternative to using weaker aggregate demand to bring down inflation? If wage inflation is too high, it is because firms are having to grant large nominal wage increases in order to get and keep workers. To avoid the symptom (high inflation) you need to remove its cause (a tight labour market), which means either increasing the supply of workers or reducing the demand for workers by firms. Because the former is not easy to do quickly (e.g. because of controls on immigration) then the latter requires a reduction in aggregate demand.

In the 60s and 70s, before oil price hikes made a bad situation worse, UK politicians and some economists were unwilling to see unemployment rise enough to stop inflation rising. Instead they tried to use price and wage controls to keep both inflation and unemployment low. This failed, and UK inflation rose from around 2% in the early 60s to 8% in the early 70s, before oil prices rose fourfold. The reason is obvious given the logic in the previous paragraph. If demand is sufficiently strong (and therefore unemployment sufficiently low) that firms want to grant nominal wages increases that are inconsistent with low inflation to attract more workers, then controls on prices and wages have to persist to stop inflation rising. But permanent aggregate controls stop productive firms attracting workers from unproductive firms, which damages long run real wage growth. Inevitably governments come under pressure to relax aggregate wage and price controls, and therefore all controls do is postpone the rise in inflation.

Judging by comments on past posts, the reaction of some on the left to all this is to deny the economics, by claiming for example that the Phillips curve doesn’t exist. This also happened a lot in the UK of the 60s and 70s. The Phillips curve may be hard to estimate (because of the importance of expectations), and may not be stable for long periods, but the core idea that unemployment and wage inflation are, other things being equal, likely to be inversely related at any point in time is sound, as has been shown time and time again since Phillip’s first regressions.

Evidence should always trump political preferences in economics. Occasionally I’m called a ‘left-leaning’ economist, but this is partly because on major issues since I started this blog economic evidence has pointed in a leftward direction e.g. austerity and Brexit were terrible ideas. Neither of those examples has anything to do with political values beyond the trivial [2]. Facts, at least since I have been writing this blog, tend to have a left wing bias.

Inevitably, things are very different for many outside economics (and a few academic economists as well). The discussions I find hardest following my posts are those with people whose politics do determine, intentionally or not, their economic views. Those exchanges are hard because however much economics I try and throw in, it’s never going to be decisive because it will not change their political views. In addition, if I’m arguing with them, their natural presumption may be that disagreement must arise because my politics is different from theirs, or worse still that the economic arguments I’m putting forward are made in bad faith because of hidden political motives.

To those who do this the best reply was given by Bertrand Russell in 1959:

“When you are studying any matter … ask yourself only what are the facts, and what is the truth that the facts bear out. Never let yourself be diverted either by what you wish to believe, or by what you think would have beneficent social effects if it were believed.”

[1] Brexit is responsible for one of those depreciations, and it has also lowered UK productivity growth.

[2[ By trivial, I mean that reducing most people’s real incomes by large amounts for no obvious gain is a bad idea.

Tuesday 15 August 2023

Economics and neoliberalism


In an idle moment I was reading through the Stanford Encyclopedia of Philosophy, as one does, I came across this paragraph from Kevin Vallier’s entry on neoliberalism:

“One is on better ground arguing that neoliberalism is a twentieth century revival of classical liberal ideas in response to certain unique twentieth century challenges. Neoliberalism arose in the late 1940s as a response to three twentieth century ideologies that advocated large states: communism (as the most prominent form of socialism), fascism, and social democracy. Neoliberals sought to confine state power to a range of functions much more limited than that undertaken by extensive states of these three varieties. Hayek’s work on informational systems was a response to communist central planning. Friedman’s monetarism was a response to Keynesian macroeconomic policy. And Buchanan’s public-choice research program was a response to the economics of general equilibrium and market failure economics.”

I’m too untutored to comment on the first sentence, but I found the rest interesting because I have always argued that one of the best ways to critique neoliberalism is by using academic economics. [1] Here I wrote:

“Indeed, it is difficult for me to see how any effective critique of neoliberalism could not be based at least in part on economics”

I think many on the left would find this idea strange, because they often see neoliberalism as being in part derived from what they often call ‘neoclassical economics’. This is where the paragraph from Vallier comes in. The authors he quotes were involved in two simultaneous projects. One was to argue within economics itself, and the other was to use economic ideas in their more political writing. They were very successful at both, but there are important limits to that success within economics. If you look at current academic economics, Friedman largely failed in his attempt to discredit Keynesian macroeconomic policy (see below). [2]. While public choice theory has been very successful in taking economic methods into political science, it has not stopped economists talking a great deal about market failure and how the state can intervene in the market to deal with that failure.

As a result, academic economics is very different from the economics neoliberal proponents like to talk about. I have sometimes joked that neoliberal interpretations of economics are what you might get from attending a first year course on economics and missing half the lectures. Yet because economic ideas are very powerful, a selective use of that theory can be pretty persuasive, and the individuals like Hayek or Friedman were very good at doing just that. But because they were selective in order to persuade, their ideas become very vulnerable to a more general use of economic theory and evidence.

The most obvious example concerns the market itself. While economists will stress the efficiency advantages of exchange through markets, they are also experts on how and why markets fail to produce an efficient outcome, and how the state can best intervene to deal with those failures. A classic example is externalities like pollution. And while efficiency [3] is good to have, that does not mean that the resulting allocation is optimal from a social perspective, and much of public economics and plenty of macro is about looking at social welfare.

Discussions of neoliberalism as an ideology or set of political ideas generally focus on the primacy of markets as a central idea. But it may be a mistake to take what neoliberals say about markets as true of actual markets. One of the most egregious examples of this is justifying CEO pay as being ‘determined by the market’, when in reality CEO pay is generally fixed by a committee of board members and external CEOs. What is the difference between this and having wages fixed by a commission set up by government? Yet few would describe public sector wages set by public sector review bodies as determined by the market.

Colin Crouch in a very interesting book defined neoliberalism as “a political strategy that seeks to make as much of our lives as possible conform to the economist’s ideal of a free market” Yet economist’s ideal of a free market (an efficient market discussed above) requires ‘perfect competition’, which means that there are very many producers, none of whom has the power to set prices. Yet neoliberals (unlike ordoliberals) seem very relaxed about monopoly power when it comes to firms. [4] In contrast neoliberals are happy to attack monopoly power when it comes to workers and unions, but this is a classic example of a selective use of ideas from economics. Crouch recognises this by talking about market-neoliberals and corporate-neoliberals, but I think this exposes rather than resolves the problem. 

Perhaps neoliberals like to stress markets because a key part of any market are the corporations or companies that produce goods, and they want to support the interests of these corporations or companies relative to the interests of both workers and the state. I have argued that a better way to describe neoliberalism in practice (policies pursued in the US and UK by Reagan and Thatcher and subsequent governments) is that neoliberalism uses concepts from economics to promote the interests of capital (corporations and companies). 

Take privatisation for example. While in some cases privatisation did introduce competition (and therefore the idea of a competitive market), others did not. The water industry, for example, remains very close to the economist’s definition of a natural monopoly where competition is impossible. There is no market where different firms compete to sell consumers water, but just a single provider that sends out bills every quarter, which is exactly what happened when water companies were publicly owned.

What a privatised water industry introduces that a nationalised water industry does not have is profit maximisation designed to provide dividends to shareholders. So neoliberals will extol the virtues of profit maximisation as ensuring efficient production. It sounds like using economics to justify privatisation, but again it’s selective. In a monopoly a profit maximising firm will set prices too high, and for the same reason may invest too little. That is why privatisation is typically coupled with an industry regulator, but regulatory agencies can easily be captured, so the net effect on efficiency of privatisation is unclear. So privatisation of natural monopolies is not about creating markets, or using economics in an impartial way, but instead selectively applying particular economic ideas to create new private capital.

Another aspect of neoliberalism in practice, reducing taxes on the wealthy, is even more interesting in this respect. Again, this has nothing to do with markets, but involves the selective use of bits of economics to pursue political ends. The standard justification for reducing taxes is that it increases incentives to supply labour, but that applies to the worker on the shop floor as much as the CEO. Both are ‘wealth creators’. To use economic jargon, all taxes are distortionary (reduce efficiency), not just those on high incomes.

This example is particularly interesting because, as Vallier notes, what is called ‘trickle down economics’ is not part of the neoliberalism of Hayek or Friedman. Nor is it obviously in the interests of corporations or companies as entities, because lower top rate taxes do not help increase profits. Indeed one theory about why CEO pay is so high is that it is the result of low top rate taxes (see here), and high CEO pay represents a (small) deduction from profits.

The distinction between capital (in the form of companies or corporations) and the wealthy (CEOs or shareholders) may seem pedantic, but I would argue it becomes central to the development of neoliberalism. Although some on the left like to call the governments of Johnson or Trump neoliberal, they are not like the neoliberalism of Thatcher or Reagan. Thatcher helped create the EU’s single market because this benefited UK capital involved in international trade, but Johnson by promoting Brexit did the opposite, because he was backed by very wealthy individuals (especially newspaper owners) who had their own individual interest in leaving the EU. Free trade and free movement of labour benefits capital, but Trump attacked both.

Ironically I think you can use arguments often associated with Buchanan to explain this apparent paradox. Buchanan wanted to suggest that the state would not be able to successfully correct market failures because of the incentives individual politicians faced would lead them to depart from the public interest. But in principle the same can happen to politicians who start off wanting to promote the interests of capital, but find the incentives they face (through donations from wealthy individuals or pressure from newspaper owners) lead them to promote policies that act against the interests of capital. It is why some neoliberals could pretend to themselves that Brexit was a good idea by imagining that labour or environmental regulations were more onerous to firms in general than the red tape associated with trade under Brexit. It was nonsense, but the incentives they faced pushed them in that direction.

Even if I have convinced you that academic economics can be a very effective tool for critiquing ideologies such as neoliberalism [5], this has an obvious downside, which is that academic economics can in turn be influenced by, and in some cases distorted by, ideologies. How do those outside academic economics know to what extent this continues in academic economics today? What stops ideology permanently influencing academic economics is evidence. Economics in academia, more now than perhaps ever before, is an evidence based discipline. So it is appropriate that in assessing the influence of ideology on mainstream academic economics we look at the evidence.

As I have already mentioned, Friedman’s arguments against Keynesian fine tuning never had widespread academic support, and have very little now. Across the globe central banks move interest rates month by month in an attempt to regulate the business cycle. [6] As I have also noted, many academics study market failure. Another example was austerity, which was opposed by the majority of academics, a majority that came close to a consensus as the evidence came in. On the left, many economists in the 60s and 70s argued maintaining very low unemployment was essential, and prices and incomes policies should be used to contain inflation. Once again, evidence was not on their side, and that approach lost favour among economists.

A response I often get when I make these arguments is why do we hear so much from economists that support right wing policies. The answer to that is straightforward: just look at who controls the means of information. Few people would argue that medicine was ideologically biased because we heard so many medics in the media arguing against lockdowns. Equally the media chooses among academic economists based on the ideas they want to see promoted, and not on whether they represent the academic consensus, as Brexit clearly showed.

[1] That critique is unlikely to be complete, as economic theory has its limitations, such as its focus on individual behaviour.

[2] The New Classical Counter Revolution was a more successful attack on Keynesian policy, for reasons I discussed here. It too proved temporary.

[3] An efficient outcome is pareto optimal, which means no individual’s position can be improved without harming someone else. Pareto optimal allocations can also be very unfair.

[4] I note here Will Davies’s account of how ideas about the virtues of competition, and the need to break up monopolies, changed within the University of Chicago from the 1930s until the 1980s.

[5] Needless to say it can also do the same for left wing ideologies.

[6] This is fine tuning aggregate demand. The fact that central banks use interest rates while the Keynesians of post-WWII period used fiscal policy is, in my view, of secondary importance here.

Tuesday 8 August 2023

What the United States might tell us about UK inflation


If you wanted to be optimistic about UK inflation and interest rates, then at first sight looking at the US might help. Here is inflation in both countries since the start of 2022.

US inflation peaked in June last year at 9.1%, and at first its fall from this peak was slow. By February 2023, eight months after the peak, it had fallen by only just over 3% to 6.0%. In the UK inflation peaked four months later than the US, at 11.1% in October 2022. Eight months later, in June 2023, it had also fallen gradually by around 3% to 7.9%. However in recent months US inflation has been falling quite rapidly, and in June it was only 3%. Might UK inflation also begin to fall rapidly? Are we following the US with a lag of around 4 months?

The way the central bank has behaved in both countries tells a similar story, with the UK lagging behind the US in raising rates.

Although inflation was pretty high at the beginning of 2022, central banks had kept interest rates low because they expected the increase in inflation to be temporary and they wanted to protect the recovery from the pandemic. But from mid-2022 the US Fed increased rates faster than the Bank of England, and that has helped ensure US inflation is now falling rapidly. (Quite how much it has helped is another question.)

UK inflation is indeed expected to fall quite quickly in the UK in the next few months. The Bank of England’s latest forecast is for inflation to be below 5% by the last quarter of this year. However if that suggests to you that interest rates will soon start to come down, you will be disappointed. Once again a look at the US is instructive. Despite inflation falling to 3%, the Fed raised interest rates at their last meeting. The Bank too has said that rates will stay high for some time. If the inflation outlook is improving, why are rates staying high?

The answer lies in the labour market, which in both countries still looks tight. In both countries wage inflation is still well above what would normally be regarded as consistent with a 2% inflation target. Here is a comparison of wage inflation in the UK and US. (For the UK I have shown a three month rate rather than the usual year on year rate to better pick up possible turning points, and I have used the Atlanta Fed Wage Growth tracker for the US. Official US data on wages shows a similar picture.)

In the US wage inflation reached a peak in the middle of last year, but falls since then have been modest. In the UK we cannot be sure that wage inflation has peaked. In both cases, but particularly in the UK, this rate of growth in earnings is well above what would be consistent with 2% inflation. (Something between 3% and 4% would be consistent with 2% inflation over time.)

As I noted in a recent post, you can tell two very different stories about what is currently happening. In the first story, wage inflation is high because price inflation has been high, and so once price inflation starts falling so will wage inflation. In this story, the inflation problem will be largely self-correcting, and what we are seeing now is the ‘second round’ effects of a very large but temporary inflation hike. [1] The second story acknowledges the temporary inflation hike, but says there is a second problem arising from the pandemic recovery that requires a policy reaction. This second problem is a tight labour market.

Until the beginning of last year, central banks believed in the first story. But since then in both countries the data has suggested a persistently tight labour market, and it is this that is the main reason why interest rates have increased. As ever with macroeconomic data, there is a lot of debate about how reliable any particular labour market indicator might be (see this for the US, for example), but the key question is how tight the market is, rather than is it tight at all.

Where the two countries differ greatly, however, is in the principle reason why the labour market is tight, and therefore why wage inflation is high. In the US it is a story of economic success, with a very strong recovery from the pandemic. (See the final chart in this post.) In part this is because fiscal policy supported the recovery, rather than (in most of Europe) just supporting the economy during the recession. In contrast the UK has had a terrible recovery from the pandemic, with GDP per capita still below pre-pandemic levels. The tight labour market in the UK is the result of a contraction in labour supply rather than an increase in labour demand, where causal factors include health problems createdby NHS underfunding and labour shortages as a result of Brexit in some sectors.

Over the next few months, therefore, interest rate decisions will focus on what is happening to wage inflation much more than what is happening to price inflation. As in the US, in the UK we may find that although price inflation starts coming down quickly, nominal interest rates will not start coming down and may even rise. As I emphasised here, what makes interest setting hard is trying to judge whether you have done enough when there are considerable lags before higher interest rates have their full impact on activity, and therefore the labour market and wage inflation. [2]

Perhaps the most important factor behind the Bank of England’s decision to raise interest rates last week was this chart, shown at the MPC press conference.

The solid white area represents the output of various models of year on year wage growth, and the white line is the actual data plus the Bank’s forecast for year on year wage inflation. The models (based on inflation expectations and various measures of labour market pressure) are suggesting wage inflation should have started falling this year, but the actual data hasn’t. The Bank’s/MPC’s reaction is to assume that wage inflation will continue to be above the models' predictions, and as a result to tighten policy. [3]

What is clear is that the UK is entering a new phase of this inflationary period (which the US has been in for several months), where the focus shifts from energy and food prices and large cuts in real incomes to the labour market and positive real wage growth. [4] In the UK average private sector wage inflation has almost caught up with price inflation. The key issue now becomes whether, as price inflation falls, wage inflation will also do so, allowing interest rates to stop increasing and start falling.

[1] You could call this a price-wage spiral, but I wouldn’t. ‘Spiral’ is one of those words often used in the 1970s that implies an explosive process, whereas today is a very different world. The idea behind the first story about current inflation is for periods where either price or wage inflation lead the other, but both naturally decrease over time.

[2] A lot of popular discussion about inflation on the left focuses on profits rather than wages. As I have argued before, there was a case for stronger windfall profits on energy producers, and there remains a very strong case for windfall profits on banks to offset the gains they are making on holding reserves. However, none of this can avoid the fact that wage inflation running at current levels in most of the private sector is inconsistent with achieving the inflation target, which is why interest rates have increased so much over the past year and a half.

[3] There are a whole host of reasons why wage inflation in the UK might be higher than most models would predict, including data errors or backward rather than forward looking inflation expectations.

[4] Food inflation is still high however, and this will particularly impact those with lower incomes, some of whom may experience further falls in their real incomes.

[5] Because US growth is much healthier than in the UK, as well as other reasons, real wages have been rising for a year in the US.

Tuesday 1 August 2023

The Farage-Coutts affair exemplifies the bankruptcy of UK media and politics


Failed politician [1] loses account at exclusive bank. It’s a story with very minor human interest, and of no importance whatsoever. Yet it has consumed the attention of the UK media for weeks now, involved the UK Prime Minister and other government politicians, and led to two very senior people at the bank concerned resigning. It is summer, but there are plenty of far more important stories the media could cover. So why does something so insignificant dominate much of the media, and what does it tells us about the state of politics in the UK today?

You cannot begin to understand why this story hit the headlines without understanding the nature of the current Conservative party, including its media arm that dominates the UK press. To put it bluntly, the main purpose of the Conservative party today is to preserve the interest of its very rich donors. It is not there, as some on the left continue to believe, to pursue neoliberal ideology or (equivalently?) to support the interests of large corporations. That notion died with Brexit, and Johnson’s ‘f**k business’.

It is not there because its MPs believe in rolling back social norms to sometime in the last century. A few MPs may actually want this, but most Tory MPs are more socially liberal than the average voter. The party’s social conservatism and anti-woke crusade is mainly a device to conceal how right wing its economic goals are, and attract votes so the party can maintain power. Power for power’s sake, the financial perks that it brings, and the maintenance of right wing economic policies that benefit some (not all) of the top 0.1%.

Maintaining power requires money, and those providing the money want to see a return on their investment. Sometimes that return might be very personal (a seat in the House of Lords for example), sometimes it may involve rent seeking for the businesses donors are involved in, and sometimes it may be to promote the political views of donors. Among this self-selecting group of the very rich a handful matter more than all the rest: the owners of most UK press titles with large circulations. The relationship between these newspaper owners (and the editors and journalists that work for them) and the party is two way: the newspapers print articles which most of the time slant the news in the party’s favour, but the party will also respond to causes and issues highlighted by these newspapers.

One more fact of UK media life is required to complete the picture. The mainstream broadcast media, which is in theory independent of any particular political party, sees the UK press as a major source of news stories. There are a number of reasons for this. First, the government controls the finances of the BBC, and has appointed some of its senior leadership. If the BBC fails to run a story the right wing press think is important, it runs the risk of censure by that press and incurring the displeasure (see above) of the government. In addition senior political journalists work in a market that includes not only print and broadcast media, but also in some cases politics itself. Partly for these reasons, Westminster political stories tend to dominate the broadcast media.

I have seen it written more than once over the past few weeks that Nigel Farage has an uncanny ability to capture news headlines. This is nonsense, and just reflects the media’s own inability to recognise itself. Farage gets the headlines not because he wins some kind of opinion poll for what really matters, but because those choosing what should be headline news find it useful to amplify what he has to say.

Farage, like Johnson, is a populist who is attuned to the concerns and worries of newspaper owners and the 0.1%, and so knows how to become the subject of their headlines. For them, a bank for the wealthy where you need to have savings of over £3 million is their kind of bank. For most of us, who are quite happy to use normal banks like NatWest, being refused a Coutts account and offered one instead at NatWest is beyond our experience and sounds trivially unimportant. Compared to most other news stories it is trivially unimportant. So in itself this is a story that editors and columnists in the right wing press are happy to write about with one snag, which is that no one will read it.

To make this story into a headline people might actually read we need one final ingredient, the culture war. In the culture war, as portrayed by those that push it, those with socially conservative views are forever getting cancelled by the Establishment, which is of course totally made up of social liberal Remainers. [2] So Farage losing his account at Coutts was the latest instalment of this forever culture war, where the champion of social conservatism was losing his account because those running the bank didn’t like his political views. As many/most of the readers of the right wing press are socially conservative, this us/them victim/elite pitch is enough to get the headlines read.

Like nearly all culture war stories, the version of events pushed by the right wing press is mostly nonsense. The facts are set out clearly by Frances Coppola here. Farage’s account was closed because he no longer had a mortgage with them, and so the bank were no longer making money from him. They could have kept his account despite this, but they chose not to because of the reputational risk his activities posed. That assessment by the bank was correct ex ante and has been shown to be correct ex post in spades.

Yet despite the story told by Farage being at best a very selective version of the truth, the BBC has apologised for its original reporting, the source of that reporting - the Chief Executive of NatWest (that owns Coutts) - has resigned, as has Peter Flavel, the head of Coutts, under pressure from the Prime Minister and the Treasury. (The government owns about 40% of NatWest.)

What this reveals is that Farage is not a helpless victim because of his political activities, but instead is extremely powerful because of them. Others who have struggled to get any bank account at all have not only failed to get the headlines Farage has, but would never have obtained two high profile resignations and a BBC apology. Yet Farage not getting the elite account he wanted and instead being offered a normal account captures those headlines. What makes Farage powerful is the right wing press, and their political wing the Conservative Party.

Did the Prime Minister and government intervene in this case, and ministers rush to Farage’s side, because they are scared of Farage? In the past Farage has been a clear threat to the Conservatives, helping to remove two recent Prime Ministers, but today they effectively bat on the same side. Both UKIP, the party Farage previously led, and Reform, the party he created, have polled poorly in recent by-elections, because the government has stolen most of their cards. With the prospect of a Labour victory in next year’s general election the right wing press are not going to give these right wing insurgent parties any oxygen, so the Conservatives have little to fear from them. Instead this Conservative government is singing the same culture war tune as Farage, and so is only too happy to join in.

So for the next year we will see the government and their press turn up the culture war to max. It probably will not work anything like as well as it does in the US (if it works at all) because of important differences between the two countries, but the brutal truth is that this is all the government has. It cannot campaign on its record, which is as dismal as it gets. It can offer tax cuts (or promises to cut taxes), but with public services in a dire state most voters know any tax cuts will be quickly reversed and promises are worthless. Voters have moved left on economic issues since the financial crisis, but the Conservative party has not. The culture war is all they have.

As Emily Maitlis says, successful wealthy populists can turn a sense of entitlement into victimhood, and it is our mainstream media that generally fails to call this trick out, let alone expose how this trick is done. So while the UK continues to fall apart, our media obsesses about how a politician can no longer have an elite bank account. While many struggle just to eat, our media will be full of stories about how Low Traffic Neighbourhoods or 20 mph speed limits are an imposition on motorists. And as many parts of the world experience the dreadful consequence of global warming, our Prime Minister decides now is the time to grant hundreds of new licences to pump oil from the North Sea. [3]

In 2019 I wrote that “The UK is a failed state because the producers of information have made it fail.” At the time I was rightly criticised for using a term (‘failed state’) normally reserved for countries in a far worse situation, but events (and two PMs) since then certainly confirm that the UK as a state is failing. If you want one incident that exemplifies how and why this is happening, it is that a politician’s failure to keep his elite bank account should hog the headlines for so long.

[1] Failed in the sense that he has repeatedly run for parliament and lost every time. Failed in the sense that his main policy, Brexit, has been the disaster for the UK that many predicted. The only thing he is good at is hurting other people, including the voters who supported him. (To be fair, he can help one or two of the already very rich make even more money.)

[2] Those who push this culture war story are populists because they seek to divide society into us (social conservatives) and them (a socially liberal elite).

[3] Fatih Birol, the executive director of the International Energy Agency, said in 2021: “If [governments] are serious about the climate crisis, there can be no new investments in oil, gas and coal, from now – from this year.” For Sunak, I'm sure the fact that his family's business has strong ties to oil and gas is just a coincidence.