Democracy on a knife edge in the United States

 

Asking if US democracy as we know it will survive either seems very depressing or rather melodramatic. However it is actually quite hard to be melodramatic about the consequences of Trump becoming President again. Trump failed last time to turn the United States into a dictatorship of the kind he so admired overseas not because he didn’t want to, but because he was prevented from doing so. He and his supporters have learnt their lessons and will be much more difficult to stop if they get another shot, while those forces that held Trump back in his first term have not been reinforced.

Much of the resistance to Trump during his first term came from the established bureaucracy of government. The solution proposed by Trump supporters is to fire large numbers of them from day one. To put it in their language, they would get rid of the ‘deep state’ that opposed Trump during his first term. With the Department of Justice in his hands, a judicial system, already much more political than in the UK, would lose all independence. He would target his political opponents as he tried to do last time, and the Republican party starting impeachment hearings against President Biden on no basis whatsoever show they would be happy to go along with this. What the Republican party would surely do is ensure the US electoral system became even more biased, making it even harder to elect a Democratic President or Congress again.

The rest of the world would quickly see the effects of a Trump second term. He is unlikely to back Ukraine in the same way that the US is currently doing, forcing Europe to provide much more military support. He plans a 10% blanket tariff on all goods imported to the US. Trump and his party is likely to do everything it can to slow down the transition to green energy, which given the country’s carbon footprint would be seriously bad news for the survival of human civilisation as we know it. More generally, when Trump’s decisions are largely divorced from the normal pros and cons of politics, it is difficult to know what additional harm he could do freed from any executive restraint.

Donald Trump is the clear frontrunner to be the Republican candidate for the 2024 election despite the fact that he is facing trial in two separate cases for trying to overthrow the results of the last election, which he clearly lost. One is for putting pressure, in a recorded phone call, on Georgia’s secretary of state to find 12,000 votes to swing the state in his favour during the election. The second is a more general charge of trying to overthrow that election result by various means, including his role in the 6th January attack on the Capitol.

It seems incredible that someone charged, and perhaps even by then convicted, of trying to overthrow a democratic and fair election could legally become President, but there seems to be nothing in the US Constitution that clearly prevents that. Where there is any doubt, the key point to note is that the final legal decision maker in the US, the Supreme Court, has a Republican majority and is almost certain to vote in Trump’s favour.

If he cannot be legally prevented from becoming the next POTUS, will voters prevent that happening? Republican voters will not, and increasingly the Republican party is now Donald Trump’s party. Although there are quite a few Republican politicians who are unhappy that this has happened, few have dared voice their opposition. The reason is fourfold. First, a majority of Republican voters are supportive of Trump, for reasons discussed below. Second, Republican candidates at most levels of government are chosen in primaries by Republican voters. Third, there is enough of the 0.1% who think Trump will be good for them to ensure Trump supporting candidates will always run for those seats and have the necessary financial backing. As a result, opposing Trump is close to electoral suicide for any Republican politician. Finally, these politicians increasingly worry about their or their families' personal safety. Never underestimate the power of occasional violence from the extreme right.

This is why Trump is likely to be the Republican candidate in 2024. Fortunately there are enough voters (mainly Democrats and Independents, but also a few Republicans) who still believe in democracy to outnumber those voting for Trump, but three things may nevertheless mean that Trump could still become President.

The first is that many voters will not see the election as Trump vs US democracy. Of course with one of the two candidates having tried to overturn the result of the 2020 poll it is not as if Trump’s contempt for democracy is hidden from them. Instead it is because elections are always fought on many issues, and all the signs are that the non-partisan media will treat 2024 as just another election.

Remember the 2016 election where the non-partisan media obsessed about whether Clinton had used her personal email account for official business. This is how ‘balance’ works in the US media: journalists feel they have to be equally critical of both sides, so implicitly the trivial (which email account did Clinton use) is equated with the serious (is Trump suitable to be President?). We see the same thing happening today. The media obsess about Biden’s age, to balance their critical coverage of Trump’s various appearances in court. But worrying that the President is too old is a different class of concern to worrying about whether US democracy will survive.

On the crucial issue of the economy Biden should be way ahead. From the perspective of Europe (or virtually anywhere outside the US) the US has made a far better recovery from the pandemic then nearly every other major economy, and it looks like inflation has returned to target without the need for a major recession. Unemployment remains very low. But this is not how it is seen in the US, where sentiment about the economy is very depressed. There is a great deal of speculation about why this is, and whether it represents a media failure or something real (high interest rates, a short term confusion between the price level and inflation, or the onset of another Covid wave), but the upshot is that the economy is not as yet the strong card it should be for Biden.

The second reason why Trump could beat Biden is because the Electoral College, rather than the popular vote, decides who wins, and the Electoral College is heavily biased towards Republicans.

The third, and perhaps most alarming, is that Trump and the Republican party will dispute the result of any General Election result that Trump loses. Trump, once again, has learnt from his failure to overturn the 2020 election result, and has been trying to ensure that his people are in positions of power to at least sow confusion about the validity of any general election result in key states, something he failed to pressure Republican officials to do last time. The danger is that Trump, backed by the Republican party, can put a sufficiently strong case that he actually won to the Supreme Court, who will given its composition rule in the Republican’s favour.

That someone with such disregard of democracy should once again have another shot at gaining the White House seems incredible, so it is worth exploring why that can happen. There are two different but plausible stories you can tell. In the first, a majority of Republican voters have such great faith in Donald Trump that they are happy to overturn democracy to see him elected. To put the point in another way, they are happy with democracy as long as it only involves true Americans. The second story is that a majority of Republican voters are so misinformed by the media they consume that they actually believe Trump really won in 2020, and that it is Democrats rather than Trump who is a threat to democracy.

Reality probably combines both stories. There is little doubt that many Republicans want to believe the stories they are fed by the right wing media, and as a result allow themselves to live in a fantasy world where, for example, Trump was cheated in 2020 by voter fraud or whatever. On the other hand if the right wing media that provides this fantasy world did not exist, at least some of those Republican voters might be forced to confront reality. The evidence is also clear that exposure to right wing media does increase the Republican vote.

Whatever the causes and extent of the “The Paranoid Style in American Politics”, a crucial question is how such a minority can potentially overthrow US democracy. How is it so easy for a would-be dictator to capture one of the two main political parties in the United States, and therefore get close to power? There are of course many answers to that question, but perhaps two of the most important are the lack of control over the influence of money in politics (including through the media), and the widespread use of closed direct primaries in a two party system since the beginning of the last century. [1] If Trump loses, US democracy is safer but far from completely safe. There are plenty of Trump successors around. More importantly the voters to whom Trump appealed, together with a right wing media that feeds them and a voting system that gives them power, are not going to change.

[1] Recent UK history provides a similar illustration of the perils of party membership power within political parties on the right. Liz Truss became Prime Minister not because she was elected in a general election, but because she was chosen by just 80,000 Conservative party members. She was elected on a platform of tax cuts, when that was the last thing the country needed. Her attempt to implement those tax cuts quickly unraveled, and her period of being Prime Minister lasted only 49 days.

The next time someone says the government cannot borrow to invest, just mention RAAC

 

Kids not being able to go to their normal school because those schools are crumbling away is as good an example as any of the impact of 13 years of austerity government. It began with Gove scrapping Labour’s Building Schools for the Future programme (a decision he subsequently said was one of the worst he made) when the Conservatives came to power in 2010, and it may well end with thousands of children being forced to relocate to temporary accommodation because Sunak when Chancellor failed to respond to warnings from his own Education department.

It is also an example of the impact bad fiscal rules can have. As I have argued many times, whether to undertake public investment (which can vary from large infrastructure projects to replacing crumbling concrete) should depend on the merits of the investment, and not on some arbitrary aggregate limits. Yet governments have at various times imposed fiscal rules that either included public investment (a target for the total deficit, or a falling debt to GDP target) or in some cases imposed a limit on total public investment itself. [1]

The case of crumbling schools caused by RAAC concrete also clearly shows why arbitrary aggregate limits on public investment make no sense. When the roof of a primary school in Kent collapsed in 2018, ignoring the problem became, in the words of the National Audit Office, a “critical risk to life”, which meant many schools with Raac concrete in them needed replacing fast. That means spending a lot of money quickly. As we now know, and as the Treasury were told, not doing so would mean some school buildings would become unsafe to use. Unlike current spending on day to day services, the need for public investment can vary substantially over time, and sometimes that investment just has to take place.

What did Sunak, or the Treasury, expect to happen when they revised down a RAAC based bid from their education department by a factor of 4? Were they crossing their fingers and hoping that the engineers were being over cautious, and that no more buildings would collapse? Or did they not even get as far as reading what the department had written, and instead just looked at numbers on a spreadsheet? Did no Treasury official raise their hand and say ‘but minister, what will happen when they start closing schools because they are unsafe’?

The term ‘Treasury brain’ is fashionable, but if the politicians in charge are determined to spend less public money then the Treasury can do little to stop them. Furthermore, these politicians are invariably short term in their political outlook, so they will always be tempted to cut investment rather than current spending. Investment by its nature has its benefits in the future, while current spending cuts will be noticed today. This is why it’s important to design fiscal rules that stop politicians doing this. If the Treasury can tell a minister that cuts to public investment will not do anything to help that minister meet their fiscal rules, they are less likely to make those cuts. [2]

The same is true for short term cuts that end up costing more in the longer term. Treasury brains are more than capable of seeing the foolishness of doing this, but if the remit from politicians is to get down borrowing over the next few years by whatever means possible, Treasury civil servants cannot keep options from politicians. Again fiscal rules need to be medium to long term, to avoid this kind of foolishness.

The whole current system, where dangerously crumbling concrete is kept in place because fixing it would require some borrowing, is predicated on a kind of deficit fetishism that treats reducing government borrowing as more important than almost anything else, including teaching children. Politicians are putting reduced borrowing ahead of essential investment. Asked why, they will mutter phrases like ‘fiscal responsibility’, and the media will find a City economist to talk about ‘bond market jitters’. Someone will mention the Truss fiscal event, as if borrowing to stop schools collapsing on children can be equated to cutting the top tax rate. (In reality the reaction to the fiscal event was all about interest rate uncertainty and pension funds taking risks rather than excessive government borrowing.)

Fiscal responsibility does have a real meaning. It makes sense to ensure taxation matches current spending in the long run so debt to GDP levels are sustainable. Fiscal rules are useful to prevent politicians cutting taxes or spending more to win elections and funding these giveaways by borrowing. But refusing to borrow to enable schools to remain open and safe is clearly not in any sense fiscal responsibility. For once household and firm analogies are appropriate. People borrow if necessary to fix serious problems with their homes, and firms would of course borrow to prevent their factories falling apart, so why not the government when it can borrow more easily and more cheaply than any household or firm?

However there is one area where aggregate conditions, rather than the individual merits of any investment, does matter. This is borrowing costs, which should influence when (not if) investment is done. The ideal time to start replacing RAAC concrete was when borrowing costs were almost zero, because short term interest rates were at their lower bound. Yet, as this graph from the IFS shows, this government cut capital spending on education compared to levels under Labour, just at the point when borrowing costs were at their lowest. Cutting investment when borrowing is cheap, and being forced to do the investment when borrowing costs are much higher, is a good example of this government’s economic incompetence.

This is one area where the way the Treasury does things may be lacking. Whether a project is worth doing is typically assessed using a constant 3.5% real discount rate, with some exceptions. There are good arguments for using a discount rate independent of market rates, although whether the rate should be as high as 3.5% is another matter. But deciding that public investment projects are worthwhile to do, and deciding when to do them, are two different choices. The latter will depend on many things, including the state of the economy and the cost of borrowing.

It is obviously cheaper for the government to undertake a worthwhile investment when the cost of borrowing is very low. Yet it is unclear how that basic point influences government spending decisions. Needless to say, a focus on reducing borrowing when the economy is depressed, and interest rates and borrowing costs are likely to be low, is completely the wrong thing to do. But even if that was not the case, it is not clear that Treasury practice encourages investing when it is cheap to borrow.

Closing schools because the government refused to replace crumbling concrete is also a perfect example of what this government has become in another sense. Before the 2020 spending review, Sunak as Chancellor was told by the education department that at least 300 schools needed replacing a year because of crumbling concrete, and they asked for funding to replace 200 a year in the first instance. Instead Sunk decided to halve the school rebuilding programme target from 100 to 50 schools per year. But when presenting the results of this spending review, he described it as producing a “once in a generation investment in infrastructure”. It’s not just that they lie all the time, but when Sunak like Johnson makes grandiose claims it is generally to disguise monumental failure.

Unless something unforeseen happens, we are destined for a year when all we can do is look forward to a change in government. An incoming Labour government may not have the same aversion to the public sector as this current lot, but they will still have fiscal rules. The government will still be working in a media environment where government borrowing is viewed with suspicion, and the distinction between how day to day spending and investment is funded is rarely made. Labour are committed to borrow to invest, but are saddled with Conservative fiscal plans that are unworkable and a falling debt to GDP rule that discourages investment. Rachel Reeves’ priority in government should be to raise taxes to match increases in day to day spending, and to scrap the falling debt to GDP rule so that we can start investing in the public sector after a decade and a half of complete neglect.

[1] That limit, of 3% of GDP, has now become redundant as the share of public investment is planned to fall to almost 2% in five years’ time. (Public investment reached 3% of GDP three times in recent financial years: 2008/9,2009/10 and 2020/21.

[2] It would be nice to say that good fiscal rules that excluded public investment would completely avoid austerity driven cuts to that investment, but unfortunately the experience of the Coalition government suggests that is not true. As I noted many times, the structure of the primary fiscal rule first introduced by George Osborne did exclude public investment, because it had a target for the current balance (the total deficit minus net investment). As a result, there was no need for the Coalition government to cut public investment, yet that is exactly what they did, particularly in 2011 and 2012. That decision alone cost the average household thousands of pounds in lost resources.

It was this cut in public investment that really hit the UK recovery from the Global Financial Crisis recession. Quite why the Coalition government decided to cut public investment so drastically when it did nothing to meet their fiscal objectives is unclear. Did the Treasury just ask departments to cut all spending, and naturally (see above) these departments initially chose investment over current spending? Or did the Chancellor not understand his own fiscal rule?

This is why I hesitate to claim better fiscal rules might have prevented this government cutting back on public investment. When politicians have an ideological belief that everything in the public sector is inefficient and wasteful, they may ignore even the most enlightened fiscal rule.

Equally when fiscal rules become things that are changed every couple of years, as they have been since 2015, then unfortunately it also tempting for politicians that know they are nearing fiscal limits to include public investment in any target, because it is easy to cut. 

It’s the economy, but is it good?

 

As Robert Saunders recently reminded us, “the economy” is a relatively recent concept. It emerged, I suspect, shortly after Keynes had effectively created a branch of economics called macroeconomics, and the government started collecting statistics on many aspects of the aggregate economy. As a macroeconomist I obviously think this was all an excellent thing. Saunders doesn’t disagree, but his concern is rather that this has made the economy something that is addressed in largely technocratic terms, divorced from both values and other concerns. To quote:

“First, it subordinated a moral and political judgment (what is "good economy?") to a blunter question: how do we make "the" economy bigger? … Second, it turned "the economy" into a "thing", to be weighed against other, different "things": such as "the environment" or "saving lives".”

I want to add a third concern. Most people are not macroeconomists, and don’t read macoeconomists or the Financial Times, so they have little conception about how the economy works, or indeed how to evaluate whether the economy is doing well or badly. What they do know is that the economy matters. It influences their lives, sometimes dramatically. The concern is that the combination of importance and ignorance allows politicians and the media to fool people.

The clearest example of this for me was the 2015 UK general election. Voters generally agreed that pretty well everything was worse in 2015 than in 2010, with one exception: “the economy”. Media pundits agreed that the economy was the Conservative party’s strong card. Yet real wages had been falling every year from 2010 until 2014, and had only begun to grow during 2015. As a result, Labour attempted to raise the ‘cost of living’ as an issue. What could explain this combination of real wage falls with the feeling a majority of voters had that the government was managing the economy well?

Part of the answer is that a crucial group of voters, pensioners, were cushioned from real wage falls. But the main answer has to be that many voters, encouraged by the media, had decided that ‘managing the economy’ was all about reducing the budget deficit. The major aim of the government was to bring down the deficit. Most media bought into the idea that the budget deficit was the major economic problem the UK faced, and as a result Labour gave up on their attempts to balance this against more conventional macroeconomic goals.

It was nonsense of course, for reasons I and others have elaborated on at length, but in political terms it worked, leading the Conservatives to win that 2015 election, leading to Brexit and further economic failure. How was it possible that faced with substantially lower real wages than five years earlier, voters and the non-partisan media nevertheless could be convinced that the budget deficit was more important than living standards?

I think the answer has to go back to the financial crisis, and then the subsequent Eurozone crisis. After the financial crisis most people blamed the banks, but a significant minority (including most Conservative supporters) blamed the government. From 2009 onwards UK voters, and perhaps more importantly journalists, watched regularly on the news a Eurozone crisis that was, in the way it was reported, all about government budget deficits of certain Eurozone countries. It became very easy for the Conservatives and their press to convince much of the media and a majority of voters that financial crises and budget deficits went together. (Remember Cameron and Clegg’s claims that the UK ‘was on the brink’ of disaster before they won the election.)

This was also nonsense. The Eurozone crisis was very much a Eurozone affair, and the problem lay not so much with periphery governments but with the European Central Bank and major Eurozone countries wanting to protect their own banks. But understanding that required the media to go beyond their usual sources (governments and market traders) and access people who were not trying to please voters or clients, and in particular to talk to academic economists. This the media repeatedly failed, and continues to fail, to do.

If this is the clearest example of misleading voters about the economy, it is far from the only one. More recently we have seen ‘the economy’ invoked by Johnson’s government (strongly encouraged by Sunak) in 2020/1 as a reason why we shouldn’t try to save lives using lockdowns before vaccines became readily available. Once again the media didn’t ask those making this claim obvious questions, like whether the economy would benefit from many more people getting sick if lockdowns were not imposed. The reality is that the economy/health trade-off only existed in the very short run, and in the longer run what was good for health was also good for the economy.

This is one of the examples Saunders quotes where “the economy” is thought of as a separate entity (to health), the environment being the other. They are actually quite similar. If there exists an economy/environment trade-off (at least in terms of fossil fuel usage), it is only over the very short term, because of the government investment needed to get green energy production into place. Once that is done green energy improves the economy because it is substantially cheaper (among other reasons). In the longer term the economy will only head downwards if we don’t get rid of fossil fuels.

This suggests to me that the problem is not so much that the economy is seen as a separate thing, but that it suits some political actors to pretend that it is independent of other things like health and the environment. Lockdowns only damage the economy if you imagine that a pandemic will have no impact on the economy, which is obviously nonsense. Getting to net zero is only costly if you ignore the benefits of cheaper and cleaner energy for the economy. Political actors can get away with this because most people don’t understand much about how the economy works, and the media does very little to inform them when doing so would upset some of those actors.

What about the contrast Saunders makes between the ‘good economy’, which is bound to involve moral judgements, and the more technocratic question of how we create a bigger economy? Again it’s not hard to see why certain political actors would resist talking about a ‘good economy’? One obvious aspect of a good economy is how resources are distributed, and those with everything to lose from such a discussion would rather it wasn’t discussed. A good economy would also involve good jobs with good working conditions, an economy where those who lost their jobs were financially secure and where the state made real efforts to help them find new jobs rather than making efforts not to give them money, an economy where firms were not able to pollute the natural environment for the sake of shareholder dividends, an economy that was family friendly (people could take time off to have and look after kids without taking a hit to their career prospects), an economy where public services were not crumbling, and so on. A good economy is likely to involve a lot more state resources and ‘interference’ than the political right would be happy with.

However I don’t think this is the only reason why the media often seems obsessed by more technocratic macroeconomic issues involving growth and the business cycle. Another is that monthly or quarterly data, or large daily movements in financial markets, provide journalists with news, and the number of journalists talking about news far outnumbers those able to tell generally more interesting stories about things that have been true for some time.

Don’t get me wrong. I think dealing with macroeconomic issues in a technocratic way can sometimes be extraordinarily useful. For example, both austerity and Brexit were bad for nearly everyone in the economy irrespective of any but the most trivial moral judgements. It is crucial to be able to make such judgements independently of any party political or ideological perspectives, because that is how you can convince those who are not politically partisan (and even some who are) what are good or bad ideas.

However I hope the last 13 odd years will be seen in the future as a relatively unusual period, where the government made so many obviously and seriously bad decisions in purely technocratic terms. If we move to a more benign period where the government avoids making such obvious technocratic errors, and where ministers are less resistent to state intervention, then the issue of what is a good economy might become more interesting and important than questions involving economic growth. Just don’t expect to see that change reflected much in what the media reports and talks about.

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.

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.

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.