Understanding free trade

A past member of the UK’s monetary policy committee once told me that they got much more intelligent questions from committees of the House of Lords compared to committees of the House of Commons. This should not be too surprising, as there are some people with considerable knowledge and experience in the Lords.

Below is an excerpt from the conclusions of a recent Lords EU Committee Report (HT Frances Coppola)

“The notion that a country can have complete regulatory sovereignty while engaging in comprehensive free trade with partners is based on a misunderstanding of the nature of free trade. Modern FTAs involve extensive regulatory harmonisation in order to eliminate non-tariff barriers, and surveillance and dispute resolution arrangements to monitor and enforce implementation. The liberalisation of trade thus requires states to agree to limit the exercise of their sovereignty. The four frameworks considered in this report all require different trade-offs between market access and the exercise of sovereignty. As a general rule, the deeper the trade relationship, the greater the loss of sovereignty.”

There you have, in one calm and measured paragraph, the contradiction at the heart of the argument put forward by Liam Fox and others that leaving the EU will allow the UK to become a ‘champion of free trade’. You cannot be a champion of free trade, and have sovereignty in the form of taking back control.

It is not a contradiction, of course, if you are happy to accept the regulatory standards of the US, China or India. That appears to be the position of Leave leaders like MP Jacob Rees Mogg. Ellie Mae O’Hagan spells out what this may mean in practice. Lead in toys - bring them in so we can sign a trade agreement with China. And you can be sure that this will be the nature of the discussion every time a trade deal is signed. In each case we will be told that we have to accept this drop in regulatory standards, because British export jobs are on the line.

This is the point of Dani Rodrik’s famous impossible trilemma: you cannot have all three of the nation state, democratic politics and deep economic integration (aka free trade). His trilemma replaces sovereignty, by which in meant in this context the nation state being able to do what it likes, by democracy. In the past I have always found this problematic. Surely a democracy can decide to give away a bit of its sovereignty in return for the benefits of international cooperation (in the form of trade deals, or indeed any other kind of international cooperation). After all, every adult in a relationship knows that this relationship means certain restrictions on doing just what they would like.

At first sight, it would seem as if the Brexit vote shows Rodrik is right. Democracy voted to take back control, which means reducing trade integration. But I think it is becoming increasingly clear that this is the wrong interpretation. Voters were told they could take back control and be no worse off, and polls make it clear that message was believed by many Leave voters. As it becomes clear that people will be worse off, as depreciation induced inflation cuts real wages, opinion is changing. Polls already suggest that if the vote was held again, we would get a different result. Polls also suggest more voters want to prioritise favourable trade deals in negotiations, not curb immigration. Over the next year or two this will only intensify, as prices rise, as companies make plans to leave the UK, as the problems caused by declining immigration emerge, and as the UK’s weak negotiating position becomes clearer.

Leavers know this, hence the attempts to remove any kind of democratic oversight from the Brexit process. At present MPs appear transfixed by the light of the Brexit vote, even though most know Brexit is an act of self harm. But it was utterly predictable from the day that Corbyn was re-elected that we would see a revival of the Liberal Democrats. As they chalk up election victories, it might just be possible that we could yet see some democratic oversight of the Brexit process. [1]

To see a model of what could and should happen, look to Switzerland, where referendums are part of political life. In February 2014 Switzerland voted to restrict immigration from the EU, even though this jeopardised their trade relations with the EU. Since then the EU has insisted that its bilateral trade deals with Switzerland depend on free movement. As a result the Swiss parliament has backed down, and just passed measures which greatly diverge from the referendum proposal, even though in Switzerland referendums are (unlike the UK) meant to be constitutionally binding.

So we see in Switzerland, and perhaps we will see in the UK, that parliamentary democracy can be compatible with trade integration. Rodrik is right that deep trade integration (the pressures from which will continue, as Richard Baldwin outlines) puts pressure on the ability of nation states to decide on their own laws, but a democratically negotiated compromise is possible. (After all, national languages are a barrier to trade.) Perhaps the examples of the UK and Switzerland suggest two things: first that these negotiated compromises should be out in the open rather than done behind closed doors, and secondly that what is very difficult to mix are trade integration with national referendums.

[1] The conventional logic is that MPs would go along with Brexit because the Remain vote is concentrated in too few constituencies. But outside Scotland the Leave vote is now split three ways (Conservative, Labour and UKIP). Labour may mock the LibDems as Brexit deniers, but as the LibDems get the votes not only of people who deeply care about being part of Europe (see the surge in Remain identity noted here) but also of those that voted Leave but are now getting concerned, they will be the ones with the last laugh.

Entryism and Corbyn supporters

Owen Jones writes “Corbyn’s opponents .. are, by turns, bewildered, infuriated, aghast, miserable about the rise of Corbynism. But they should take ownership of it, because it is their creation.” I have argued the same in the past, but I would go further. If this crisis within Labour does prove as destructive as I fear it will be, it will be a result of the behaviour of many of Corbyn’s opponents. It is their actions and words which make compromise between the membership and the PLP so elusive.

As I argued in my post on the future of the Labour party (the gist is in the title: Mutually Assured Destruction) those who tried to undermine Corbyn’s leadership from the start in a very public way (I called them the anti-Corbynistas) became in the eyes of most Corbyn supporters their opposition. As a result, they see the vote of no confidence as just an extension of this anti-Corbynista activity, and therefore believe they must defend their original choice at all costs.

While this characterisation of all of the PLP is wide of the mark, the way the anti-Corbynistas characterise Corbyn supporters is far more bizarre. Their model is Trotsky style entryism. This was very real in the UK in the 1970s and 1980s, and my one and only experience of standing for election when I was a student involved defeating them. They were always small in number. [1] Their modus operandi was taking over other organisations through a mixture of subterfuge, strategy and persistence, targeting in particular groups where more traditional support had become moribund.

What has actually happened over the last few year to the Labour party in the UK is very different. Labour’s increased membership is similar to the support for Sanders in the US and the rise of the ‘new left’ in other European countries. Of course those who were previously in far left fringe groups will be getting involved, but in this case they are a tiny minority in an organisation that has become rejuvenated as a result of Corbyn (as his opponent in the forthcoming elections, Owen Smith, has acknowledged). If you really want to know who these new Labour party members are, read this post from the Very Public Sociologist, or this article by Ellie Mae O'Hagan or this from Helen Lewis. These accounts chime with my own experience. Militant entryists they are not. Of course this wave of new support contains a fringe of entryists as well as a fringe of intolerant twitter trolls, but to characterise the whole by this fringe is to wilfully misunderstand it.

As Ellie Mae O'Hagan describes, Corbyn supporters are also a group with few representatives in the media (and I’m talking Guardian not Mail), which allows too many in the Westminster-centric media to dismiss them as Socialist Worker fodder. Of course for those journalists in the right wing press who are not sympathetic to Labour, entryism is an attractive story to tell. For those on the right of the party who know this membership will never support their side, the myth of entryism provides a convenient excuse to pursue measures to exclude them. But if you are neither of those and want to influence this new membership, the last thing you do is go on about entryism. Which is the trap Tom Watson fell into earlier this week. [2]

Just as the anti-Corbynistas are happy to falsely characterise Labour party members who support Corbyn as either entryists or being under their sway, so they also claim that Corbyn and McDonnell never intended to try and work with the PLP. Instead it was always an entryist plot. I am called naive when I have suggested otherwise in the past. What I have actually said is that cooperation with the PLP was the only path that offered the new leadership any chance of success, which is what my MAD post is all about. But of course the anti-Corbynista claim about the leaderships real motives is unprovable: the leadership trying to work with the PLP (as it did) can be put down to pretence, and when the leadership failed it could be put down to deliberate intention rather than lack of ability.

The group whose motives are really suspect are the anti-Corbynistas. With Corbyn’s election in 2015 they saw their ability to influence the party slipping away, and have subsequently done everything they can to ensure it disappeared out of sight. They have publicly undermined the leadership, giving Corbyn supporters a clear excuse to ignore the polls. They have attempted to exclude Corbyn from this new election, allowing Corbyn’s supporters to say that by voting for Corbyn they are standing up for democracy. They have called Corbyn supporters entryists when most are clearly not. If they really wanted to win hearts and minds they have been utterly useless, and as a byproduct have probably destroyed hopes of any kind of compromise. (I have lost count of the number of times I have been told by Corbyn supporters that Owen Smith is bound to come under the sway of the anti-Corbynistas.) It is not clear to me yet whether this behaviour is just incompetence, or whether it is they who really have an undeclared objective, which is to split the left.

[1] Colin Talbot argues that because these organisations had high churn, there are a lot of ‘ex-Trots’ out there. “It is this mass of vaguely ‘socialist’ middle-aged ex-Trots – and there are an awful lot more of them than they or anyone else probably realized until recently – that might explain a lot of the ‘Corbyn’ phenomena. Disillusioned with Blair (mainly over one single issue – Iraq), despondent of Labour ever winning again anyway, they have turned to Corbyn as the political equivalent of going out and buying a Harley.”

But maybe these ‘ex-Trots’ are ‘ex’ because they went off the concept of entryism - like the author himself. Being disillusioned by Iraq and despondent at Labour losing in 2015 are virtues. The implication that by supporting Corbyn they somehow have not grown out of their youthful behaviour is nothing more than an opinion.

[2] He said “There are Trots that have come back to the party, and they certainly don’t have the best interests of the Labour party at heart. They see the Labour party as a vehicle for revolutionary socialism, and they’re not remotely interested in winning elections, and that’s a problem. But I don’t think the vast majority of people that have joined the Labour party and have been mobilised by the people that are in Momentum are all Trots and Bolsheviks.” My italics, suggesting his analysis is similar to mine. But then he went on about “old hands twisting young arms”, which is really not a good way to persuade those with young arms!

Fiscal rule redux

Although this discussion is about the UK, the macroeconomic issues involved apply equally elsewhere.

Most of the media discussion of Labour’s new fiscal rule presented before the budget focused on the commitment to balance the current budget. The media did this because ‘the hook’’ was the similarity between this aspect of the rule and the rules proposed by Brown or Balls. As I noted at the time, no one in the media seemed to want to compare this goal to the Chancellor’s overall surplus objective, which remains rather extraordinary.

In some ways this element is the least interesting part of the rule. Two other key parts are that current balance is a rolling five year target, and the knockout if interest rates hit their zero lower bound (ZLB). Both are more difficult to explain quickly in a mediamacro world where the deficit is considered all important, although at least with the rolling 5 year target a quick response is that the coalition government adopted exactly that form of target. If they had adopted the less flexible target of current balance by 2015, the economy would have been even more screwed by austerity than it actually was.

The really new feature of the rule is the knock out. (This was described as a ‘loophole’ by one political reporter: mediamacro again.) The rule is deliberately suspended to allow for fiscal stimulus when interest rates hit their ZLB. How much stimulus? Whatever it takes to get interest rates to rise above the ZLB. In Portes and Wren-Lewis we suggest the Bank of England are the obvious people to advise on this (the size of stimulus, not its form in terms of spending increases or tax cuts). The focus of fiscal policy switches from deficit control to stabilising demand, but only because monetary policy can no longer do that job effectively.

If such a rule had been in operation during the Great Recession, we would have seen a continuation of the fiscal stimulus we saw in 2009 into later years. That would have meant, for sure, that government debt would have risen by more than it did, but it would also have meant, for sure, that output would have recovered more quickly. What would have happened to the debt to GDP ratio we cannot know for sure, but the important point is that this does not matter.

It is this last point which is the most difficult to convince people about in the mediamacro world. In this (imaginary) world, we have to worry about the deficit because if we do not there might be a financial panic, with interest rates on government debt rising and perhaps even an inability to sell that debt. The best response to this concern is it would not matter even if it happened, because the Bank of England would buy the debt and keep interest rates on that debt down. Of course the market panic scenario will not happen anyway, because there is zero chance that the government will default, but trying to convince people that the financial markets will behave rationally after the global crisis is hard.

Many non-economists think creating money to cover the deficit sounds outlandish, until you point out it is already happening with QE. The potential size of the QE programme is unlimited. The whole point of QE is to keep long term interest rates, like the interest rate on government debt, low. QE happens when short interest rates are at their ZLB. That it why, when rates are at the ZLB, fiscal policy can focus on stimulating the economy. [1]

There are some who think that any kind of fiscal rule represents appeasement of the austerity position. As I discussed in my post on MMT, I do not think that is very good economics, particularly for a party (like Labour) that is committed to maintaining an independent central bank that uses monetary policy to stabilise demand. In that regime, when you are not at the ZLB, deficit bias is a potential problem. I think intergenerational fairness is important, and we shouldn’t ignore it just because the argument is misused to support austerity. I am reminded of this every time I look at Norway, and recall how Mrs. Thatcher effectively used oil revenues to cut taxes rather than build up a sovereign wealth fund. There is a certain irony that George Osborne’s current policy of going for surplus, while totally wrong for today, would have been the right policy in the late 80s and 1990s.

Ellie Mae O'Hagan recalls how many on the left (in my recollection all shades of the left) argued that when austerity started to bite there would be a popular revolt against the policy. That did not happen, in part because of mediamacro, but also because there was not a clear alternative to unite behind. Labour tried to have it both ways, expressing worries about what austerity was doing but also agreeing that the deficit was a current concern. In Labour’s new fiscal rule we have a policy that sets out clearly how we should deal with any new crisis, and also how we should have dealt with the last one. It is a policy the left should unite behind, because overcoming mediamacro’s obsession with deficits will not be easy.

[1] You can only do this if the government controls the currency its debt is issued in. When that does not happen, as many developing countries have found to their cost, you do have to worry about the bond markets. That was exactly the problem that led to the Eurozone crisis, until the ECB came up with OMT.

A more elaborate argument for countries that do borrow in their own currencies is that a market panic over government debt would be accompanied by a run on the currency. Paul Krugman tackles this, but following discussions with the FTs Martin Sandbu I do plan to discuss this issue further at some point.