Is two-party politics really dead in the UK?

 

Rob Ford, previewing the upcoming election on 1st May in the Guardian, emphasises how the Liberal Democrats, Greens and Reform are likely to make big gains. Going further, in a recent article in Prospect, Peter Kellner suggests the domination of Labour and Conservatives, even in general elections where the First Past The Post (FPTP) voting system gives them a huge advantage, is over for good. I started out being more sceptical, but as I’m an amateur on these matters, I thought it was worth discussing in more depth.

The key evidence in favour of the view that multiparty politics in the UK [1] is here to stay is the trend in vote shares since shortly after WWII. Here is a more complete version of the numbers that Kellner gives in his article.

Since 1951, the UK vote share of Labour and the Conservatives combined has fallen from nearly 90% to below 60% in 2024. However the last observation is important. Kellner argues, convincingly in my view, that 2017 and 2019 are outliers because Brexit polarised politics, and so 2024 represents a return to a falling trend for the two main party’s vote share. But is this really a trend or a series of step changes due to clearly defined political developments?

Until 2010, the fall in the Lab+Con share was largely about a rising share for the Liberals/SDP-Liberal Alliance/Liberal Democrats, and here there is a clear step change around the 1970s. From 1945 to 1970 the Liberal vote share oscillated just below 10%, but from 1974 to 2010 it averaged around 20%. The rise in nationalist parties in Scotland and Wales plus the rise in UKIP in the 2000s (to achieve a 3% vote share in 2010) has a more modest influence over this period. In 2015 the LibDem vote collapsed, but the UKIP vote, and to a lesser extent the Green party vote, rose to almost compensate. Even if we discount 2017 and 2019 as Kellner suggests, 2024 looks like another step change, with the combined vote share of Reform, LibDems and the Greens being 33%.

The argument I want to present is that these two step changes occurred when the two major parties moved away from being close to where the average voter is. To understand more recent movements, we need to look at policy space in two rather than one dimension.

In the diagram above, the centre is where the average voter is, which may change over time as voter opinion changes. From 1945 to 1970, both parties were close to the centre of electoral opinion, with Labour being a little more left wing and socially liberal, the Conservatives more right wing and socially conservative. [2] Most of the political action was about economics, and voting was largely class based. FPTP ensured that there was little scope for other parties to gain a substantial vote share.

The 1970s brought inflation and industrial unrest, and I would suggest as a result public opinion moved away from both the union movement and a Labour party using incomes policies to reduce inflation. In terms of the diagram above, Labour shifted left because its policies didn’t shift with public opinion. This produced a step increase in the Liberal vote in 1974. The Conservatives in the 1970s (particularly after Thatcher became leader) moved right in economic terms, a move that in 1979 went well beyond public opinion and so they moved to the right in the diagram above. The gap between Labour and the Tories in economic terms was greatest in 1983, when the Labour vote share collapsed and the SDP-Liberal Alliance won almost as big a vote share as Labour. After 1983 Labour gradually moved back towards the economic centre ground, and won power again in 1997.

At this point the Conservatives were now much further away from the centre ground than Labour on economic issues, and as a result they began to campaign much more on social issues, and immigration in particular. Voting became less class based, and more age based (because older voters tend to be more socially conservative). This may have allowed the Conservatives to make inroads into traditionally Labour working class areas, but initially at least economic interests meant that their socially conservative rhetoric was not matched by actions. This led to the emergence of a populist right wing party, UKIP, that started to gain a significant vote share.

Skip to 2024, and Labour moved to adopt some moderately socially conservative policy positions, and also implicitly a more right wing policy in terms of public service provision. The Conservatives, in an attempt to counter the threat from Farage, adopted even tougher socially conservative policies (principally Brexit) and became increasingly populist in nature. This had two effects. The first, relatively minor, was to give the Green party its highest national vote share at 6.4%. The second, and perhaps more important, was to give the socially liberal LibDems their highest seat total since WWII.

For power, under FPTP, seats count for everything and vote share nothing. If the Conservatives stay as they are, which is a populist party advocating pretty extreme socially conservative views from a populist perspective, this leaves socially liberal but economically right wing voters very reluctant to vote for them. The Liberal Democrats in 2024 succeeded in capturing many of these votes, and as a result they obtained their highest seat total since WWII with a much lower vote share than most of the 1974-2010 period.

Seen in this way, the 2024 General Election was not the latest point on some inevitable trend to multi-party politics, but the result of shifts in the policy stance of the two main parties. Essentially the Conservatives first moved to neoliberalism, and then to right wing populism, and now Labour has moved in that direction leaving a large part of policy space empty for other parties to fill. As a consequence, whether this situation persists or becomes more marked will depend on whether the two main parties stay where they currently are, or whether they move back to where they once were.

If the Conservatives continue to focus on competing with Farage, then the LibDems have a good chance of keeping their high seat total, but their scope for further growth is modest as they were last year second in only 27 seats. [4] Otherwise the main beneficiary of this Reform/Tory battle is Labour. If Labour stay where they currently are, the Green party is second to Labour in 39 seats and therefore has scope to increase both its vote and seat total. [3] If Farage can be persuaded into an electoral pact or (less likely) the Conservatives collapse, we could get the neat result that the UK becomes a four party system, with each party representing one of the quadrants in the diagram above.

However it is equally possible that 2024 represents a low point for the two main parties. Labour could, if only for purely electoral reasons, shift back towards a moderately socially liberal position while at the same time increasing taxes further to fund better public services, as they did in the early 2000s. The Conservatives, under a new leader, could focus more on winning back the Liberal Democrat rather than Reform vote. In those circumstances Labour could use the prospect of a return of a Tory government to squeeze the Green vote, with the Conservatives using the same tactics to squeeze both the LibDems and Reform.

Both scenarios are possible. In particular, with less tactical voting in Council elections and more protest voting, the pressure on the two main political parties to change their policy positions and tactics before the next General Election will be intense. What is clear, if this analysis is right, is that any continuing decline or resurgence in the fortunes of the two main parties lies largely in their own hands.

[1] Multi-party politics has of course been with us for some time in Scotland, Wales and Northern Ireland, so this is really a question about England.

[2] In this diagram the centre is the average of voter opinion, which in terms of policy positions may shift over time. For example, since WWII voters have been becoming much more socially liberal. Undoubtedly opinion did shift left in 1945, which was why Labour’s radical policy agenda was able to win that election, and Conservative policy did then shift left to reflect that.

[3] Competition from existing or new left wing parties would of course hinder this.

[4] The main danger for the LibDems is if Labour become very unpopular among economically right wing voters, and the Conservatives successfully argue that the LibDems would support a minority Labour government. 

The new silent majority

The term silent majority, in both the UK and US, was once used for voters who were socially conservative and also, it was assumed by the politicians who used the term, moderately conservative in their economic views. While the ‘majority’ part was dubious, the ‘silent’ bit had some validity. In the UK members of parliament have long been far more socially liberal than the public that voted for them. For example MPs voted to abolish the death penalty for murder in 1965 and completely in 1988, while opinion polls still suggest a majority of voters would reintroduce it for various crimes. In addition an older generation that tended to be more socially conservative were not strongly represented in the broadcast media.

It still appears true that MPs in the UK are much more socially liberal than voters, but this cannot be said for the political party platforms of the two main political parties. The reason is familiar. The political right in the UK, following the US, started weaponising social conservatism in a big way to gain votes when neoliberalism started to become increasingly unpopular among voters. For reasons I discussed here, in the UK this ironically created the space for an insurgent party to challenge the Conservatives for not being socially conservative enough. After its heavy defeat in 2019, Labour in opposition adopted far more socially conservative policies. As I noted here, its success in the 2024 General Election has encouraged it to maintain that stance in government.

While the three main political parties in terms of current opinion polls have socially conservative policy platforms, they are also on the right in terms of taxation and public services. While not surprising for the Conservative party, this positioning for both Reform and Labour is more interesting. Undoubtedly Nigel Farage’s own economic views are pretty right wing, but in other countries right wing populist parties have found it advantageous to adopt a more left wing rhetoric on some economic issues. This is because many socially conservatives have left wing views in terms of disrespect for the economic system and economic elites, and a more favourable view of redistribution and the provision of public services. Farage is conflicted because his main aim is to replace the Conservative party, but in general elections Reform is the challenger party in many largely working class Labour seats yet his policies don’t fully reflect that.

On some specific issues, like workers rights and protections for renters, Labour can claim to be significantly more left wing than the Conservatives. However on public services they have failed to raise taxes sufficiently to lift the share of public spending in GDP beyond the level at the end of the previous Conservative government. While that share is high in historical terms, this just reflects the growing demands of health across OECD countries, as well as in the last few years higher interest rates on debt. It seems hard to see this government significantly improving on the current dire provision of public services, so in this crucial respect Labour are right rather than left wing.

If we use the term silent majority to represent those voters without a strong voice in terms of political representation and public debate, then in the UK and perhaps also the US the new silent majority are those voters who are either socially liberal, or centre to left wing in terms of public service provision (or both). This new silent majority is probably actually a majority of voters. It extends way beyond what is typically referred to as the left in the UK.

This rather strange state of affairs is encouraged by the voting systems in the US and UK. Social liberals tend to be younger, and younger voters tend to be concentrated in cities, which means that the majority of parliamentary seats will be socially conservative even if socially conservatives only make up half of the voting population. Brexit was a good example of that. The US senate and electoral college is also biased towards rural and red state voters.

The term silent majority seems particularly apposite when it comes to public debate in the UK. The print media has always been heavily skewed to the right, but the broadcast media has tried to be impartial. Impartiality in practice has focused on being even handed between the two main political parties. When the two main parties promote socially conservative policies and argue against tax increases to improve public service provision, that can mean that a social liberal and economic centre or left point of view struggles to get much airtime. The BBC's obession with Nigel Farage also does not help. To take just one example, voices reflecting the majority view that immigration into many types of job should be encouraged are rarely represented in the media.

Things might have been different if the Liberal Democrats had managed to get more seats than the Conservatives in the 2024 General Election, and had as a result formed the official opposition. That they failed to do so was not due to the Liberal Democrats so much as Labour, whose vote declined during the campaign. If their vote had been a little stronger, even more Conservative seats would have fallen to Labour. In this respect the argument from some on the left that tactical voting was no longer necessary in 2024 was both unhelpful and ultimately harmful to the left.

Ignoring the new silent majority worked for Labour in opposition because the principle aim of most voters was to get rid of the terrible Conservative government, and they knew that could only be achieved in most constituencies by voting Labour. Where it could be achieved by voting LibDem or Green, voters did that too. Labour achieved a huge majority with only a third of the popular vote not through any brilliant strategy, but because voters’ primary aim was to be rid of a Conservative government, and socially conservative voters could vote Reform rather than Conservative.

To the extent that votes in local elections reflect national issues, the situation will be very different over the next four years. Those in the new silent majority who want to use local elections to send a message to the government will vote Lib Dem or Green, or not vote at all, and a few may even vote Reform. As disappointment in Labour’s performance on improving public services grows, this silent majority revolt will only increase.

Is the government’s strategy to take these ‘mid-term’ losses in its stride, and assume that the silent majority comes back to Labour in the next general election? There are at least three problems with this idea. First, I have seen many times that once people start down a road they can find it difficult to turn back. Many will continue to vote in protest against Labour even though a Conservative (or Conservative/Reform) government would be much worse.

Second, among feasible results the ideal for social liberals will not be a Labour majority government, but instead a minority Labour government which is dependent on the Liberal Democrats to get legislation passed. This is because the Liberal Democrats have a platform that is generally more socially liberal than Labour. Many in the new silent majority may justify not voting Labour through a desire to achieve this result.

Third, building on the previous two, without the active support from the new silent majority a Conservative/Reform electoral pact could sink Labour. Whether this happens seems to depend on the views of one man, Nigel Farage. Any strategy where success depends on which way the UK’s pre-eminent populist moves in four years time is not a good strategy.

For these reasons, for Labour to continue to ignore the new silent majority seems at best very risky, and at worst foolhardy. Unfortunately it is also easy to see why they are making this mistake. Generals tend to fight the last war, and when the last war resulted in a huge victory in terms of parliamentary seats, fighting the last war is all the more tempting. Pursuing socially conservative policies and keeping the state small also reflects the ideology of some of those on the now dominant Labour right. In addition I suggest here that Labour ministers are hugely overestimating the extent to which their better, less ideological management of the public sector can bring about improvements in services that the public will notice. Finally, when there is so much media discussion of why populism is on the rise, it is easy to focus on these voters at the expense of everyone else.

Understandable mistakes, but clear mistakes nevertheless. The number of poor decisions Labour have made since they came to power, and the speed with which it lost its honeymoon period, testify to their ability to make political errors. Most recently their initial attempts to cast Trump in a positive light (remember ‘project chainsaw’) continue to show a basic lack of political understanding. It may take some very poor performances in local elections before Labour recognises the danger of ignoring the new silent majority.

Why populists can do so much harm

 

Trump’s ‘Liberation Day’ naturally reminded me of Johnson’s ‘Independence Day’. There are of course many differences between the two. Tariffs are a tax on imports, while Brexit erected bureaucratic barriers to trade with the UK’s largest trading partner. A more important difference is that tariff barriers can go down as quickly as they went up, while Brexit was a much more drawn out and permanent affair that couldn’t be reversed quickly. But essentially both are bad because they stop mutually advantageous trades taking place.

Another difference between Brexit and Trump’s Liberation Day tariffs is that the latter only impact US imports directly. US exports are only hit if other countries respond with their own tariffs against the US. If other countries do not respond by raising tariffs on US exports, then the impact of the US tariffs can be offset by an appreciation in the dollar. This is one of the many reasons that raising tariffs across the board to improve your trade balance makes little sense.

If other countries retaliate with tit for tat tariff increases, then we wouldn’t expect an appreciation in the dollar. That situation is more like Brexit, and just as Sterling depreciated following Brexit a US led tariff war might lead to a depreciation in the dollar, because the hit to the US economy is bigger than the hit to the Rest of the World. Of course we cannot really infer anything from exchange rate movements immediately after Trump’s announcement, because higher tariffs had been anticipated for some time before that. (In contrast, Brexit went from a possibility to a certainty the moment the referendum result was announced, so we know Brexit depreciated Sterling against the Euro.)

As Mark Carney notes here, it took time for the impact of Brexit to influence GDP, and the impact of Trump’s tariffs on the real economy is also unlikely to be instantaneous. As a result, monetary policy has time to react, and the bond market seems to be expecting the US Federal Reserve to ‘look through’ the direct inflationary impact of higher tariffs and instead cut interest rates faster to support economic activity. If a US recession happens this year, it will not be just because of tariffs, but rather a result of the uncertainty created by giving so much power to just one individual who has little contact with reality.

I would be very happy if Starmer and Reeves use Trump’s tariffs as an excuse to put up taxes, but what they are really an excuse for is to abandon Labour’s red lines on the EU, an excuse the UK government seems determined not to make. The harm US tariffs might do to the UK are only a fraction of the damage leaving the EU’s Single Market and Customs Union have already done and will continue to do. The best way for the rest of the world to deal with Trump’s tariffs is to encourage trade diversion from the US to elsewhere. Retaliatory tariffs are best kept to measures that will have an immediate negative political impact on Trump himself.

Yet another potential difference between Brexit and Liberation Day is that Brexit ended free movement of labour between the UK and the other EU countries. But Trump has that covered, not only by restricting immigration but also deporting immigrants on a largely random basis, sometimes to a prison camp in a third country. The real difference may be that what Trump is doing will actually reduce immigration into the US, and therefore do some sectors of the economy real harm, whereas for the UK Brexit largely ended up diverting the origin of immigrants from the EU to elsewhere.

While immigration is central to right wing populism, erecting trade barriers is not. We didn’t get Brexit because some politicians wanted to erect trade barriers with the EU, but instead because some feared the EU and others thought backing Brexit would help their careers. With Trump I don’t think he is erecting tariffs because they are some part of a grand economic strategy. Instead I think Trump just likes tariffs. In part this is because he sees them as a solution to a problem that is in his mind only (bilateral trade deficits). In part it is because he likes the idea of countries giving him things in deals to avoid tariffs.

Whatever the personal motivations, the United States and the Rest of the World have to live with a disastrous policy because of the whims of an elderly narcissist with no respect for facts. In the UK we got Brexit because another narcissist with little respect for truth wanted above all to become Prime Minister. The reason that successful populists can do so much harm when they gain power is not just because they are inherently evil characters, or lack empathy of any kind, or because they lie all the time, but also because populists dismantle the checks and balances that are inherent in a pluralist democracy.

As regular readers may remember, I tend to follow Jan-Werner Müller in seeing opposition to a pluralistic democracy as a defining characteristic of populism. For the populist leader, their views reflect the will of the people, and therefore if a party, cabinet, parliament, the civil service, the courts or parts of the media oppose their wishes then their wishes should hold sway rather than those of these other institutions. In short, the populist wants to be a king. Where once a king might have justified this unchallenged authority through god, now for the populist king absolute power comes not from divine right but from the imagined will of the people who elected him.

But whether you see this as a defining characteristic of populism or not, populists invariably do try to dismantle the checks and balances embodied in a pluralist democracy. Johnson illegally suspended parliament, and his supporters in the media condemned the judges who called out its illegality. Trump has usurped the power of Congress through his executive orders and the antics of Musk, and attacks judges when they call out this illegality.

Imagine a British Labour Prime Minister who decided it was a good idea to set tariffs of 20% or more to end the deficit on the UK’s balance of trade, against the advice of pretty well all the economists inside and outside the country. They would have to persuade a sceptical cabinet, and in particular a very reluctant Chancellor backed up by a Treasury happy to provide chapter and verse on why it was a terrible idea. Even if they succeeded in this, parliamentary approval might be one obstacle too far, with rebel MPs encouraged by a highly skeptical if not antagonistic media. [1]

The key difference between Trump’s first term and today is the extent to which he and his followers have eliminated most of the features of a pluralist democracy that might oppose his views. In his first term Trump had little time to pick his cabinet, and as a result they often tempered or eliminated some of his crazier ideas. This time he has picked yes men and women, which often meant selecting those with little or no experience or expertise. In his first term Trump had just been elected, so there were plenty in the Republican party that were prepared to stand up to him. Today all but a few fear the electoral consequences (in primaries) of doing so. The power of Congress has been usurped but the Republicans in Congress have so far rolled over. In his first term it took time to select a Supreme Court that would allow him to break the law, but now it is in place and he can. Trump has become king, not only in his own court but also in his own country. If these differences seem as obvious to you as they were always obvious to me, then let’s just follow Paul Krugman in noting that many in US business and financial elite missed this point completely.

We can take the checks and balances of a pluralist democracy for granted, and ignore how important they can be in avoiding some of the more damaging ideas of political leaders becoming a reality. [2] But often the way politics is presented by the media actually devalues pluralist democracy. Media discourse is too often about leaders and their wishes, and when these leaders defer to other political institutions or actors they are described as ‘weak’ and ‘failing to get things done’. Partly as a result, systems of government in the US and UK have moved to give more power to the executive and its leader. It is therefore perhaps not surprising that sections of the electorate see little difference between populist leaders like Trump, Badenoch or Farage and those of other political parties. In all these ways we have made our pluralist democracies more vulnerable to a populist takeover.

[1] Here Brexit is not a good analogy, because trade barriers were a by-product of leaving the EU, rather than its central objective.

[2] They don’t always do so, of course. I learnt in 1980 that Margaret Thatcher was very keen on a poll tax. The Treasury was horrified by the idea, and it took almost a decade before she managed to implement it (first in Scotland, then England). But then it was her party that stopped it, just as it was the party that ended Johnson’s premiership.

Last week’s spending cuts were not the fault of the OBR or a medium term golden fiscal rule

 

In my last post I said that Rachel Reeves’s statement last week, and more generally the way fiscal policy has been done since 2010, had nothing to do with the OBR. Many have subsequently questioned this, noting that the OBR was set up in 2010 by George Osborne. When one of the UK’s best journalists suggests that the OBR’s “creation has had unintended consequences and reinforced a short termist, tail chasing psychology to UK economic policy making” you know that these misconceptions about the OBR are widely shared.

Why are they misconceptions? Because the OBR was created to do one key job, and that was the macroeconomic and fiscal forecasting that had previously been done by H.M.Treasury. The Treasury had, by act of parliament, produced a forecast twice a year, so the OBR did as well. The Treasury before 2010 also did a 50 year projection once a year, so the OBR does too. Essentially the Treasury farmed out its macroeconomic forecasting to this new, independent body.

One reason George Osborne liked to give for doing this is his belief that under the previous Labour government Chancellors had leant on Treasury forecasters to produce more favourable forecasts. That may well have happened occasionally (under both Labour and Conservative Chancellors), but it certainly wasn’t routine, for the very good reason that if Chancellors regularly did this Treasury forecasts would lose all credibility. As I showed here, under Gordon Brown Treasury forecasts were at first far too pessimistic about the public finances, and then too optimistic, but it was in 2009 that the Treasury produced forecasts showing massive deficits without policy changes.

So if the OBR had never been created, and the Treasury was still producing its macro forecast, it is almost certain that Osborne's austerity would still have happened, and Reeves would have done exactly what she did last week. Why can I be pretty certain of the latter? Because it was widely known that both growth and tax receipts had been disappointingly poor since the October forecast, and long term interest rates were also higher, so Treasury forecasts were bound to show the deteriorating outlook for tax receipts that I discussed here. If they hadn’t then journalists would have been rightly complaining that Treasury forecasts lacked credibility and that these forecasts should be farmed out to an independent body! [1]

So why is there this misconception about the OBR? [2] The answer is straightforward. The OBR was created at the same time and by the same person who solidified a change in the way UK fiscal policy was done. Before 2010 Chancellors would say that aggregate fiscal policy was about achieving a good macroeconomic performance as well as achieving fiscal rules. From 2010 aggregate fiscal policy became just about hitting fiscal rules. Also important was that Gordon Brown, because of the Treasury’s pessimism noted above, had reduced public debt substantially at the end of the 1990s, so meeting his fiscal rules did not become an issue until the second half of the 2000s.

Osborne thought that by focusing on the deficit he was just following the academic consensus, which said that monetary policy should control short term output and inflation and aggregate fiscal policy should target debt and deficits [3]. His great mistake was not to notice that, both before and certainly following the Global Financial Crisis, macroeconomists were shouting ‘but not when interest rates hit their lower bound’, which they had in 2009. Brown’s government had understood this, which is why fiscal policy was very expansionary in 2009, but it suited Osborne politically to pretend he hadn’t heard or disagreed.

While interest rates remained at their lower bound, fiscal policy should have been directed at achieving a stronger recovery, and debt or deficit targets should have been put to one side. That this didn’t happen is almost certainly partly responsible to some extent for the UK’s poor productivity performance that became evident in the 2010s, and which led to poor growth in real incomes. Since the 2010s productivity growth has declined even further (see here, for example), undoubtedly because of Brexit but also perhaps because of a very badly handled pandemic and continuing austerity.

However, for the last few years interest rates have been well away from their lower bound, so it makes macroeconomic sense to focus aggregate fiscal policy on achieving fiscal rules. Ensuring we have the maximum level of output consistent with stable inflation can be safely left in the hands of monetary policy. Does this mean that any dissatisfaction with what happened last week should be directed at the fiscal rules Reeves has adopted?

Again I think this is mostly wrong, but first let’s be clear what fiscal rules we are talking about. Reeves has two, a ‘falling debt to GDP’ rule and the golden rule, which says spending excluding net investment has to be matched by taxes. The first is economic nonsense, and very damaging nonsense at that, for reasons I outline here. But the rule which is currently binding is the golden rule, so in the remainder of this post I will focus on this.

In my view the golden rule makes a lot of sense. It allows the government to invest as much as it likes, but it says that future taxes should cover planned future current spending. Broadly this rule ensures that government debt stays roughly stable as a share of GDP in the longer term. If we allow future current spending to always be significantly in excess of expected future taxes, the debt to GDP ratio will rise exponentially. That is not sustainable in the long run. [4]

Reeves made two mistakes last week. The first was to think the OBR’s non-budget forecast had to show the fiscal rules being met. As I argued in my last post, a more grown-up fiscal policy would have simply noted the OBR’s forecast, and pledged to take action to meet the fiscal rules in her next Budget. This approach would have been consistent with Reeves’s sensible pledge to hold just one Budget a year, while what she did last week was not. The bond markets would not have collapsed as a result. Her second mistake was to cut spending rather than raise taxes, for reasons examined in detail here, and what is more cutting spending in a particularly cruel way.

Changing fiscal policy just once a year does something to tackle the charge of short-termism highlighted at the beginning of this post. But what about the ‘doom loop’ idea? This is that if growth falters, the deficit increases, leading the Chancellor to cut spending or raise taxes to meet her fiscal rule. But raising taxes or cutting spending reduces output, increasing the deficit, and we get into a downward spiral. If this is what following the golden rule implied, then you could indeed claim that it was helping to depress growth in the longer term.

If interest rates were at or close to their lower bound this would be a real concern, which is why fiscal rules should not apply in these circumstances. But when interest rates are well above their lower bound, as they are now, the doom loop will not operate because tightening fiscal policy will allow monetary policy to stimulate the economy. Crucially, however, monetary policy has to have time to do this, which means that the golden rule should apply to plans and forecasts five years ahead, rather than two or three years ahead. A little noticed mistake that Reeves made in her October budget was to change the golden rule to apply over a three year rather than a five year horizon, which precisely risks creating a doom loop (see the ‘fiscal rules’ section of my post-Budget post here). Needless to say I have seen no analysis in the media about this change, and why it might be harmful.

Why did Reeves make these two mistakes last week, and her mistake in altering the golden rule in October? Of course ministers remain responsible for what they do, but I suspect advice from the Treasury was far from helpful, and that Reeves and her fellow ministers are ill-equipped to depart from Treasury advice. In turn the Treasury may be making poor decisions in part because it has suffered from more than a decade of politicians pursuing poor macroeconomic policy.

I suspect the Treasury would have advised her, incorrectly, that it would be very risky to just note last week’s OBR forecast, with a lot of hand waving and frequent mentions of Truss. It may also have been the Treasury that preferred to listen to the great and the good (including in this case Lords) on fiscal rules without asking those who know rather more about them. This is speculation of course, and I’m happy to hear (in confidence) if I’ve got this wrong. What is clear to me, however, is that last week had nothing to do with the OBR and little to do with the 5 year golden rule, both of which remain valuable bits of the UK’s fiscal framework.

[1] Daniel Susskind argues in the FT that the OBR encourages the Chancellor to adopt policies that the OBR thinks will encourage growth, rather than policies that the Chancellor thinks will encourage growth. I doubt this very much. What the OBR does is look at the evidence in the literature, as it has done with the economic effects of Brexit for example. This is surely a better way to forecast than personal hunches or political wishes. I also doubt very much that the OBR's assessment of this evidence would have much influence on a Chancellor's political agenda.  

[2] Criticism of particular judgements the OBR makes is something completely different. Indeed one of the advantages of the OBR is that it is pretty transparent about the judgements it makes, which allows others to criticise them. 

[3] Of course individual tax measures can be designed to improve productivity. Osborne thought that cutting corporation tax would boost investment. It didn’t.

[4] In the long run we are all dead, so who cares? The simple answer is our children’s children, who will have to deal with a fiscal problem that is much more difficult to solve than it is today.

Why can’t we do fiscal policy in a grown up way?

 

I suspect to most people what Rachel Reeves announced yesterday went like this. The OBR published a forecast, something it has to do twice a year. Compared to its forecast that went with last year’s October budget, things have got worse, and if Reeves did nothing she would now breach her fiscal rules. As a result she chose to announce cuts to disability benefits which the government estimates will throw at least 250,000 people into poverty.

That is not the full story (see below) but there is enough truth in it to make most people think this is a very odd way to conduct fiscal policy. They would be right. The idea for the title of this post comes from remarks made by Charlie Bean (ex Bank of England, MPC and OBR) at a Resolution Foundation meeting. He notes that Reeves has, wisely according to many, committed to holding just one Budget each year. It follows, he suggests, that what he calls the ‘adult’ response to the OBR’s new forecast would be for Reeves to simply note it, and commit to changing tax and spending plans in the 2025 Budget later this year to ensure the fiscal rules are met.

By October all the spending plans will be settled, and the Chancellor will be considering if and how to change taxes. In a changing world potentially everything will be on the table. Even from a very self-interested political point of view, if she ended up making the same changes to disability benefits as she announced yesterday that announcement will be competing with all the other Budget news and so will have less of a political impact.

So why didn’t she take the adult approach yesterday of just noting the new forecast? The charitable explanation is to blame the Truss debacle, or rather the mistaken lessons that politicians and others have drawn from it. But if that is the case it really is rather silly and juvenile. News about the economy and public finances hits the bond market on a daily basis, and the OBR forecast is just one more item of news. If you have previously announced that you will only make major fiscal decisions once a year, there is no reason at all to think the bond market will react to the OBR forecast in a more significant way than any other piece of public finance news. Nor does cruelty earn you market credibility.

The less charitable answer as to why she didn’t take the adult response of deferring decisions until October is that the Chancellor found it politically convenient to suggest she had been forced to cut disability benefits in order to retain fiscal credibility. If that is the case, then it involves deliberate deception. To see why we need to briefly look at what changed between now and last October.

The OBR’s forecast yesterday incorporated assumptions about public spending across the board, and not just disability payments. Below is a chart of the path in yesterday’s OBR’s forecast of total public sector receipts (‘taxes’) and total public spending excluding net investment (i.e, current expenditure plus depreciation, labelled CE+D) as a share of GDP. Looking at GDP shares has a number of advantages, including abstracting from the main effect of changes in real growth as well as inflation.

The ‘golden’ fiscal rule, which says forecast taxes need to equal planned current spending, means that the two lines need to meet by the end of the forecast period. They do so mostly because of higher taxes, but also because of spending cuts. The share of current spending including depreciation in GDP for 2029/30 is 41.4%, compared to 42.1% in the last completed fiscal year of the previous Conservative government. That in my book is a spending cut, when as I argued in previous posts that increases in spending are desperately needed.

Here are the same chart from the OBR’s budget forecast.

It is the same pattern, but in October both lines ended up above, rather than below, 42% of GDP. What has happened over the last six months is that the forecast for taxes has fallen, so the government has reduced its spending plans to meet its fiscal rule. The government has chosen to respond to lower forecasts for taxes by reducing public spending, rather than increasing some tax rates, and that is a political choice. [1]

Some of the reasons people give for not liking what has happened I think miss the point. Getting the OBR to do the forecast rather than the government is neither here nor there, as any Treasury forecast will reflect similar developments in the public finances. (Been there, seen that.) That fiscal plans are reacting to a very uncertain forecast is unfortunate but how else besides a forecast can you compare spending plans to future taxes? You certainly don’t want to tie current spending to current taxes, but equally allowing future spending to drift apart from expected future taxes makes no economic sense either.

The main reason why it is wrong to react to lower tax forecasts by cutting payments to people with disabilities, and substantially increasing poverty as a result, is because of the political choice it reflects. The Chancellor is not having to make these cuts because otherwise she would not meet her fiscal rules. She is making these cuts because she has chosen to use this method rather than the many others available to her to meet those rules. In particular, she has chosen to increase hardship and poverty for some of the most vulnerable people in society rather than raise taxes on those who can easily afford it. To do this yesterday did not represent an adult and responsible fiscal policy.

[1] This underestimates the squeeze in departmental spending between October and now, because overall spending has been pushed up by higher interest rates on government debt.

Labour’s strategic error on tax

 

Two things have become clear to many people since Labour came to government. The first is that the party had done less preparation work for becoming the government than Blair/Brown did in 1997. Given what happened in 2019 its focus was understandably on winning the election. There were important exceptions of course, in the areas of worker’s rights and greening the economy for example. But as the Sue Gray episode, ending the pensioners winter fuel allowance and abolishing NHS England show, a lot more preparation for becoming a government could have been done.

The second is that Labour policy in government, like its policy in opposition, is governed by the need to win elections. In opposition that meant, correctly in my view, embracing policies and rhetoric that appealed to social conservatives rather than social liberals, despite most Labour party members being social liberals. Making Brexit work was the obvious example of that. Perhaps because the party hadn’t prepared as much as they should for government, it has meant continuing that socially conservative stance in government.

That is most obvious in the rhetoric Labour uses on issues like immigration, but it also extends to poverty reduction, foreign aid and welfare. The government has not abolished the two-child limit despite it being a major cause of poverty. Cuts to the welfare budget are also popular with a public who believe (incorrectly) that there is widespread fraud and abuse of the system.

Whether Labour are right that this positioning will help win them the next election as it did the last is unclear. In the last election most social liberals voted Labour or voted tactically because they desperately wanted the Conservatives out of office. Many of these voters will not vote Labour in local elections or byelections, because they don’t like some of the policies the Labour government are implementing. This virtually guarantees Labour will have a torrid time at the polls over the next four years. That doesn’t make a recovery before the next election impossible, particularly if the Conservative/Reform split continues, but it makes victory more uncertain. There is a real danger that being the moderate socially conservative party worked a treat when Labour were in opposition, but it may fail just as spectacularly when Labour are in government.

While that is debatable, Labour’s position on tax is in my view much more obviously damaging to its future prospects. Apparently according to some government sources suggesting Labour raise taxes is ‘unserious’, so what follows is why I think that suggestion is itself unserious, and reflects poor strategic political analysis. My argument is an elaboration of a recent letter to the Financial Times signed by a number of economists, including myself.

Labour ruled out raising most (by revenue) taxes when in opposition, because they feared doing otherwise would lose them the election. They have carried over that belief into government. Despite plenty of opportunities to say that the ‘world has changed’ and to row back on these pledges, Labour have so far kept to them. In addition, in the October budget Rachel Reeves was fairly conservative in raising taxes on unearned income, and she has also ruled out a wealth tax.

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The Conservatives lost the 2024 election, and Labour won, in large part because the country was clearly broken. GDP per head was less than in 2019, and public services were in a critical state. Labour pledged to fix both, and voters will hold them to that pledge. Indeed voters are already doing so, which is why Labour’s electoral honeymoon disappeared so quickly and Reform is doing so well in the polls.

With some justification Labour can argue that it is far too early for voters to judge them on their pledge to get the country working again, but what voters can see and Labour leaders seem in denial about is that the government is not doing nearly enough to get the process of renewal started. On growth, all the last Budget did was end the cuts to public investment the previous government had pencilled in, so public investment will not be an engine of growth. Neither will the planned closer relations with the EU be nearly enough to make a significant difference to growth. Making the planning process for new housing and infrastructure quicker is welcome, but it alone will not get productivity growing again.

On public services, the October budget implied a roughly constant share of spending relative to GDP over five years. As the share of health spending in GDP invariably needs to rise (as it has done in most countries over the last few decades), that means cutting other areas of public spending as a share of GDP over time. Barring miracles, that will not lead to significant improvements in the provision of public services by the time of the next election, and certainly not improvements that voters will notice.

Reform of public services is not an alternative to spending more as a means of renewal. Indeed, successful reform often requires spending more money, while reform done on the cheap can just cause dislocation and a deterioration in service provision.

The UK taxes its citizens far less than comparable countries.

Share of total taxes in GDP in 2022, OECD data

Virtually all our neighbours raise more in taxes than we do. (The only exception is Ireland.) The United States has lower tax, but that is largely because most US citizens pay for health by other means, so comparing our tax rate with the US is illegitimate. [1] Quite simply, if we want as good public services as France, Germany, Spain or Italy, we need to pay more in taxes. This the last Labour government came to understand, but this Labour government seems to have forgotten.

As much of the media is controlled by or made up of people who are relatively wealthy, the argument above is rarely made there. Instead we typically get fed two facts. The first is that taxes in the UK as a share of GDP are close to the OECD average. But the countries with lower taxes than the UK, like the US but also Turkey and Mexico for example, invariably supply much less in public services. The second is that UK taxes are at record high levels. But this is an inevitable consequence of health spending steadily rising as a share of GDP, as it has in most other countries.

I have set out the detailed analysis of why taxes have to rise to get the provision of public services close to the level enjoyed in our European neighbours and that we had at the end of the last Labour government here. It can be summed up with one simple statistic: planned total current public spending in 2029/30 (39.7% of GDP) is slightly below levels recorded in 2022/3 and 2023/4 (40.7% and 39.8% respectively, from OBR data bank). If the government doesn’t think this analysis is serious, perhaps they would like to provide some analysis of their own. I suspect however that the reason the government will not take the argument for higher taxes seriously is far simpler. It is that taxes increased in the last budget, and to increase them any further would be very unpopular, particularly given the cost of living crisis.

There are two fatal flaws in this argument. The first is that much of the tax increase in the last budget were simply reversing the unaffordable tax cuts announced in the last year of the previous government. The second is that crumbling public services are unpopular too, and this government was elected to do something about this. Most voters (unlike much of the media) put improving public services way above cutting taxes as an objective (source), which is why the Conservatives lost so badly.

Another argument used is that it is a mistake to raise taxes during a cost of living crisis. There are two reasons why this argument is wrong. First, there is considerable scope to increase taxes on the well off who are relatively unaffected by higher food and energy prices. There is in my view a strong case for much higher taxes on the very rich and wealthy. Second, for some time earnings have been rising significantly faster than prices, and the need for higher defence spending is a plausible and economically solid reason for breaking earlier tax pledges. Reeves followed Osborne in not raising fuel duty last year, and Stewart Wood calculates that the total cost of freezing fuel duty since 2010 is around £100 billion! As Osborne understood in 2010, higher taxes at the start of a government does not mean electoral disaster at the next election. As an election approaches, of course, it becomes politically harder to raise taxes.

Not raising taxes more in her first budget, and not raising them now, are the major strategic mistakes that Reeves has made. They are far more important than anything involving fiscal rules. [2] These mistakes in turn reflect the absence of any serious analysis of what will be required to allow a noticeable (to voters) improvement in public services before the next election. As a consequence, the best we can probably hope for is that despite this lack of improvement Labour leads the government after the next election, and like the previous Labour government restores the UK’s public services in its second term. Given the critical state of so much of public provision, that delay is both an electoral gamble and very bad for the country.

[1] Partly because of this, the US system for providing health is uniquely inefficient. The only other G7 country that raises slightly less tax than the UK is Canada, and it would be interesting to know why that is.

[2] Although the falling debt to GDP ratio rule is stupid, I suspect it is fears following the Truss debacle and worries about labour shortages that are holding back public investment. Current spending is constrained by the ‘golden rule’, but not wanting to raise taxes is not a good reason to break that rule, and I can see few good reasons to break it right now.