Experts and Elites

It’s like 2016 all over again. Lots of forecasts of how much poorer we will be under different Brexit scenarios, which if the last time this happened is anything to go by will be ignored or dismissed by around half the UK population. Perhaps I should call for a total and complete shutdown of pronouncements by experts until our country's representatives can figure out what the hell is going on.

More seriously, what has led to this apparent distrust in the words of experts? I want to focus on experts in particular, rather than the more general concept of elites, and even more specifically experts from academic institutions or places directly tied to them. Will Davies has a nice account of the many reasons why distrust in politicians in the UK has increased, but a lot of what he has to say does not really apply to academia.

I have to admit to being completely partial in believing that once society starts ignoring what the evidence says it is on a road to ruin, and academics in the sciences (including the social sciences) have as their raison d'etre trying to understand evidence. And to be fair, much of society understands that. As an IPSOS MORI survey consistently shows for the UK, academics (‘professors’) regularly come close to the top of groups that people trust most.

Furthermore, if anything public trust in professors or scientists has been growing rather than falling over time. The same is also true of social trust in the UK, contrary to many popular accounts.

These results suggest that there has not been any recent decline in how much academics are trusted. But if you replace ‘professors’ by ‘economists’, levels of trust decline sharply. [1] And for good reason. I would have fairly low levels of trust in probably what most economists I see in the mainstream media say, and this is because I most frequently see economists in the media who are not academics. They are typically doing one of two things. The first is making up stories (sometimes plausible stories, but still based on zero evidence) about market movements. The second is describing macro forecasts: a necessary but highly unreliable activity.

Many journalists do not understand the difference between these kind of forecasts (‘unconditional’) and the kind of analysis presented on the economic effects of Brexit (‘conditional’). The analogy I tend to use is between a doctor telling you that you are more likely to die of a heart attack if you eat too much fat (‘conditional’), and a doctor trying to predict your exact time of getting a heart attack (‘unconditional’). This failure to understand the difference between the two activities is the first major reason why academics who say Brexit will reduce living standards are not trusted as much as they should be. It is predominantly a failure of the media rather than economists themselves.

I sometimes wonder, however, if certain journalists and politicians deliberately choose not to understand the difference between the two because it suits them to remain ignorant. This brings me to the second reason that academic economists may be ignored or dismissed over Brexit, and that is because certain elites have an interest in doing so. Here is Stewart Wood reacting to Jacob Rees-Mogg’s comments on Mark Carney after the Bank released some of its Brexit analysis.

The Bank’s analysis is of course not beyond criticism. [2] But the attacks of the Brexiter elite are quite deliberately not economic in character but political: Rees Mogg claimed Carney is a second rate politician (a second rate foreign politician!) and his forecast is designed to produce a political outcome (‘Project Hysteria’). The idea is to suggest that these projections should not be taken as a warning by experts but instead as a political act. Once again, I’m not suggesting we should never think about what an experts own interests might be, but if you carry this line of thought to the Rees Mogg extreme you undermine all expertise that is not ideologically based, which is exactly what Rees Mogg wants to do.

This I think is the second reason why the view of the overwhelming majority academic economists that Brexit will be harmful is going to be ignored by many. Since Mrs Thatcher and the 364 economists, the neoliberal right has had an interest in discrediting economic expertise, and replacing academic economists with City economists in positions of influence. (Despite what most journalists will tell you, the 364 were correct that tightening fiscal policy delayed the recovery.) Right wing think tanks like the IEA are particularly useful in this respect, partly because the media often makes no distinction between independent academics and think tank employees. Just look at how the media began to treat climate change as controversial.

But isn’t there a paradox here? Why would members of the public, who have little trust in politicians compared to academics, believe politicians and their backers when they attack academics? In the case of Brexit, and I think other issues like austerity, these elites have two advantages. The first is access. Through a dominance of the printed media, a right wing elite can get a message across despite it being misleading or simply untrue. Remember how Labour’s fiscal profligacy caused record deficits? Half the country believe this to be a fact despite it being an obvious lie. What will most journalists tell you about Brexit and forecasts? My guess is that forecasters got the immediate impact of Brexit very wrong, rather than the reality that what they expected to happen immediately happened more gradually. Why will journalists get these things wrong? Because they read repeated messages about failed forecasts in the right wing press, but very little about how GDP is currently around 2.5% lower as a result of Brexit, and real wages are lower still.

The second is that the elite often plays on a simple understanding of how things work, and dismisses anything more complex, when it suits them. Immigrants ‘obviously’ increase competition for scarce public resources, because people typically fail to allow for immigrants adding to public services either directly or through their taxes. The government should ‘obviously’ tighten its belt when consumers are having to do the same, and so on. In the case of the economic effects of Brexit, it is obvious that we will save money by not paying in to the EU, whereas everything else is uncertain and who believes forecasts etc.

As the earlier reference to Mrs Thatcher suggests, there is a common pattern to these attacks by elites on experts: they come from the neoliberal right. If you want to call the Blair/Brown years neoliberal as well, you have to make a distinction between right and left. The Blair/Brown period was a high point for the influence of academics in general and academic economists in particular on government. As I note here, Iraq was the exception not the rule, for clear reasons. Attacks by elites on experts tend to come from the political right and not the left, and the neoliberal right in particular because they have an ideology to sell.

[1] See this YouGov poll. Thanks to John Appleby for finding this for me. 

[2] For example, including a ‘worst case’ No Deal scenario designed for stress testing banks in a graph alongside more standard projections of the impact of the Withdrawal agreement is just asking for misinterpretation of the former.

How BBC balance and bad think tanks discourage evidence based policy

The Knowledge Transmission Mechanism (KTM) is how knowledge produced by academics and other researchers is translated into public policy. Evidence based policy is the result of this mechanism working. The media is, in theory, an important conduit for the KTM: media publicises research, policy maker sees/hears/reads media and gets their civil servants to investigate research. Or media communicates policy consensus on issue, and politician is questioned by the media on why they are not following this consensus.

The rigid application of political balance in the broadcast media is in danger of negating the KTM, and therefore evidence based policy. The moment an issue (call it issue X) is deemed ‘political’ by the media, balance dictates that any view expressed on issue X is an opinion rather than knowledge. As a result, when the media want to talk to non-politicians (‘experts’) about issue X, the imperative of balance remains.

Now suppose that in the knowledge world there is in fact a consensus on issue X. That would be a problem for balance broadcasting, because it would be difficult to get an expert to argue against the consensus. The BBC overcame this problem valiantly during Brexit, using Patrick Minford (who is not known as a trade economist) time and again to balance the IMF, the OECD, more than 90% of academic opinion etc. But another way of solving this problem is to use certain think tanks.

There are two types of think tank. The good kind can be a vital part of the KTM. There is often a genuine need for think tanks to help translate academic research into policy. Sometimes these think tanks will be very like universities (like the IFS for example). Other times they will be think tanks that have a broad left or right orientation. These think tanks are an important part of the KTM, because they can establish what the academic consensus is, translate academic ideas into practical policy, and match policy problems to evidence based solutions. The IPPR is an obvious example of this type of think tank. They are part of evidence based policy making.

The bad kind are rather different. These produce ‘research’ that conforms to a particular line or ideology, rather than conforming to evidence or existing academic knowledge. Sometimes these think tanks can even become policy entrepreneurs, selling policies to politicians. This is often called policy based evidence making. It would be nice to be able to distinguish between good and bad think tanks in an easy way. The good type seeks to foster the KTM, and ensure policy is evidence based, and the bad type seek to negate the KTM by producing evidence or policies that fit preconceived ideas or the policymaker’s ideology.

I would argue that transparency about funding sources provides a strong indicator of which type a think tank is. Why is this? One obvious reason why you would not want, say, company Y listed as a funder is if you subsequently produced a report that was directly in the interests of Y. A clear example is the IEA’s arguments against plain packaging of cigarettes, and its funding from tobacco companies. To be clear I am not suggesting that the IEA (who have been in the news recently) is insincere about the arguments it makes, but if funding was transparent it would be very easy to suggest their arguments on plain packaging were contrived by just pointing out its funding sources. So that is an obvious reason to keep funding secret. In contrast, an IFS type think tank has no reason to hide its funders, because it is not in the business of producing policies that meet the specific wishes of these funders. [1]

It has been suggested to me that IEA type think tanks need to keep their funding secret because some personal donations would get individuals into trouble with their employers if they became public. It would be interesting to know from some IFS type think tanks how much funding they lose for this reason. Perhaps the answer is not much, and that in any case the principle of transparency is more important than a few extra donations.

Another good indicator of a bad think tank is their relationship to academia. I have told the story about how the IEA under Philip Booth tried to cultivate the idea that the 364 academics who famously objected to the Thatcher government's 1981 budget were embarrassingly wrong, when in fact they were proved right. The IEA’s media and political connections are sufficiently strong that even good BBC economics journalists were taken in by their line. To the extent that it emboldened Osborne to ignore the majority of academic economists over austerity it was a dangerous myth to cultivate.

In the case of global warming the BBC has been forced (I don’t think that is an inappropriate word, as it often breaches the guidance) to treat man made climate change as a fact rather than an opinion that always has to be balanced. That is not going to happen for some time over any economic issue, however strong the academic consensus (like Brexit). This is partly because the pressure from academia is much less, and partly there is still a prejudice against social science (as if evidence based policy making cannot occur for economic or social policy!). But the BBC does need to explain their attitude to the use of think tanks. Why do they use think tanks that do not declare their funding sources, and when they do why is this information not passed on to its audience?

[1] To understand why arguments like the IFS gets money from the government or the EU and therefore it is biased do not work, see here.

Brexit and neoliberalism

In a recent post I talked about the “neoliberal fantasists who voted Leave”. Here is Ryan Bourne from the influential Institute of Economic Affairs. He notes that “the mood music from the post-referendum Conservative party — with former Remain backers in No 10 and the Home Office overcompensating with a caricatured view of what voters want — is not a good sign for the short-term”. But he still believes that Brexit can be transformed into some kind of neoliberal wet dream, with a bonfire of regulations and a unilateral abolition of UK tariffs on trade.

The economics of this was always fantasy, as John Van Reenen and colleagues painstakingly demonstrate here, but it also seems politically naive. After all the Leave campaign was a success largely because it promised to control immigration as a result of leaving the EU, controls which are distinctly anti-neoliberal. Controlling immigration is not a caricature of what the majority of Leave voters wanted, but instead what most were voting for. It does seem naive to believe that a government after Brexit would try and quietly forget about this, particularly when led by someone who had spent the previous 6 years trying and failing to control immigration. It also seems naive to imagine that this turn against neoliberalism would not go beyond immigration.

And yet, the ‘southern strategy’ was highly successful for the Republican party in the US. This combined an economic policy that favoured finance and corporates, increased inequality and free markets with an identity politics that appealed to race, religion and cultural identity. (I could perhaps add geographical identity here as well: see this article by David Wong.) Perhaps the UK party of the right could follow a similar course, using immigration as a substitute (and for some a proxy) for race, whilst pursuing an otherwise neoliberal agenda?

Is this what the Conservative party tried to do under Cameron and Osborne? Actually I think that is the wrong question, for reasons I will come to shortly. In terms of what the Coalition government actually did, Jonathan Portes summarises it thus:

“The promise to cut net migration to the “tens of thousands” was generally regarded by immigration policy experts as unachievable, or achievable only at an economic cost no sensible government was willing to pay. In practice, the latter course was never tested: resistance from within government from the Department of Business, supported to a greater or lesser extent by the Treasury, meant that even non-EU migration was only reduced very substantially for non-HE students; for most other routes it has stabilised. Non-EU net migration is currently about 150,000 a year, slightly higher than EU net migration

This does not mean the policy changes had no impact: the increase in the regulatory burden on business and the education sector has been substantial, and has certainly resulted in some reduction in skilled and student migration. The most damaging single decision was probably the closing of the Post-Study Work Route. However, overall, any economic damage was considerably mitigated.”

Of course that resistance from the Department of Business came from a Liberal Democrat, Vince Cable, and not a Conservative. Which leaves open the possibility that the economic damage from attempts to hit the immigration target might have been greater if just the Conservatives had been in power. So it is not clear that the Conservative focus on immigration was just so they could win elections with zero cost to their more neoliberal objectives. It still remains the case that, just as Trump exposed the flaw in the Republican’s southern strategy, so Brexit was the critical flaw in Cameron’s emphasis on the problem of immigration and his failure to meet his own targets.

I said it was the wrong question, because I think in this case it was not a political party that was calling the shots but a section of the print media: the right wing tabloids. As Andy Beckett writes in this comprehensive history of this part of the UK media:

“[Brexit] was an outcome for which the tabloids had campaigned doggedly for decades, but never more intensely – or with less factual scrupulousness – than this spring and summer, when the front pages of the Sun, Mail and Express bellowed for Brexit, talking up Britain’s prospects afterwards, in deafening unison, day after day. Two days before the referendum, the Sun gave over its first 10 pages to pro-Brexit coverage.”

And the principle means the tabloids used to obtain this result was the “endless xenophobic nudges of its immigration coverage.” Of course these newspapers will say they were just expressing their readers fears, but when they are reduced to making up stories to encourage this fear any claim to innocence becomes very hollow. Fueling anti-immigration feeling was their version of a southern strategy, and Brexit saw its culmination.

Having achieved this objective, will the tabloids start ignoring the immigration issue, enabling the greater immigration and zero tariffs that Mr. Bourne desires? Or will the influence of these tabloids, perhaps now greater than it has ever been, start to fade away? To the extent that these seem silly questions reveals the political naivety of the neoliberal Leavers. It is highly unlikely that Theresa May will become squeamish about damaging business through immigration controls to enable her to meet her immigration target. The best hope of those who do not want to go down this path is that, as Jonathan Portes expects, the Brexit vote itself starts to reduce the immigration numbers.

Brexit will also put other pressures on May which are likely to move her away from neoliberal policies, as the assurances given to Nissan indicate. As Bourne writes in a recent blog: “if this is a commitment to permanent or semi-permanent support to almost ‘make up for’ changed trade arrangements then it is hugely misguided.” Misguided it may be, but that is the direction the politics will push a Prime Minister determined to be seen as making a success of Brexit. Just as Republican’s have agonised over how to deal with Donald Trump, so it will become clear to UK neoliberals the damage to their cause that Brexit will generate.

The politicisation of truth

I showed some poll results yesterday suggesting that on Brexit the public trusted academics more than anyone except friends and family. Academic economists overwhelming think Brexit will be bad for the UK economy, and therefore bad for the average person’s prosperity. Ryan Bourne of the Institute of Economic Affairs (right wing think tank, second lowest level of funding openness) says the British people should not trust the academic consensus because of “the credibility of the individuals involved”.

He then gives some examples of where economists have have been wrong. I have dealt with many of these before, but Mr. Bourne goes further in a way that totally destroys his case. Here is the relevant paragraph.

“In fact, one would suspect George Osborne himself would be equally sceptical of consensuses given his own experience. For a recent Centre for Macroeconomics survey found that there was an overwhelming macroeconomic consensus, a full 81% surveyed, who thought his fiscal policy in the last parliament was bad for growth. The IMF, who the Chancellor now lauds as being a credible voice on Brexit, of course urged the Chancellor to soften his fiscal consolidation in 2013, with its economist Olivier Blanchard suggesting the Chancellor was ‘playing with fire’ if he did not ease up on deficit reduction, precisely at the time when the economy began to recover, despite the Chancellor not altering his discretionary fiscal plans.”

The impression you would get from that paragraph is that macroeconomic consensus about austerity was wrong. Here is my favourite chart, of UK GDP per head (logged).

Now explain to me how this data shows that 2010 austerity was good for the UK economy! Annual growth in every year from 2010 has been below the pre-crisis trend of two and a quarter per cent. Growth was highest in 2014, but that was still only 2%. UK recoveries in the past have involved above trend growth to return to a long run trend, but not this time.

I know you can try and explain this awful performance by other factors beside austerity, but that is not what Mr. Bourne tries to do. He just tries to pretend that it is obvious the consensus was wrong. He knows that in a world of politicised truth this kind of thing is possible.

Now you might think that the terrible performance of UK growth since the crisis is so obvious in the data it could not possibly be portrayed otherwise. In which case let’s go back to 1981, and the famous letter from 364 economists. It was an awfully confused letter, but at its heart was a criticism of the deflationary 1981 budget, and whether or not that budget was good for the economy is what the letter should be judged on. According to Mr. Bourne, the 1981 budget was “just about the time the economy began growing robustly.” So let’s look at the numbers from that period from the chart above

Growth in 1981 as a whole was -1%. Growth in 1982 as a whole was at trend at 2.2%. That is hardly a “robust recovery”. The quarterly growth numbers are erratic, but they show that a robust recovery (growth consistently above trend) only began at the end of 1982. I guess that accounts for the word ‘just’ in Mr. Bourne’s description quoted above!

So the deflationary budget of 1981 did appear to hold back the economy, delaying a recovery for another year or more. As Steve Nickell makes clear you needed growth above trend to stop the rise in unemployment. [1] Here is what happened to unemployment around 1981.

Unemployment stopped rising during 1984, three years after the 1981 budget.

On this basic point, the deflationary 1981 budget looks like it was bad for the economy, and the 364 appear to have been right. But that is not the received wisdom. As I noted yesterday (footnote 1) BBC journalists will happily state that the 364 were wrong as a simple fact. They do this because it has become a politicised fact: repeated as fact endlessly by those on the right. The Institute of Economic Affairs has done all it could to establish this as a politicised fact, including publishing a book in 2006 where all but one of the contributors agreed that the 364 were wrong.

This is what I mean by the politicisation of truth, and I can only thank Mr. Bourne for providing such a clear illustration of the process at work. And Mr. Bourne’s has the nerve to suggest that he has more credibility than the overwhelming majority of economists. Economists are certainly not infallible, but at least we as a collective do not attempt to distort what the data says.

 [1] Unemployment has declined rapidly since 2013 because UK productivity growth has been so bad, perhaps in turn because of a record and quite unexpected decline in real wages, something that did not happen in the 1980s.

Speak for yourself, or why anti-Keynesian views survive

“The evidence for the Keynesian worldview is very mixed. Most economists come down in favor or against it because of their prior ideological beliefs. Krugman is a Keynesian because he wants bigger government. I’m an anti-Keynesian because I want smaller government.”

Statements like this tell us rather a lot about those who make them. As statements about why people hold macroeconomic views they are wide of the mark. Of course there is confirmation bias, and ideological bias, but as the term ‘bias’ suggests, it does not mean that evidence has no impact on the views of the majority of academics.

The big/small government idea makes no theoretical sense. Why would wanting a larger state make someone a Keynesian? Many Keynesians, and most New Keynesians, nowadays acknowledge that monetary policy should be used to manage demand when it can. They also know that any fiscal stimulus only works, or at least works best, if it involves temporary increases in government spending. So being a Keynesian is not a very effective way of getting a larger state.

It is also obviously false empirically. In the UK and US a large majority of economists appear to hold Keynesian views. I think it rather unlikely that a similar majority want a large state, and I can think of some notable Keynesians who clearly do not. Central bank models are typically Keynesian. Does that mean central banks want a larger state? No, it means the evidence suggests Keynesian economics works.

Russ Roberts says more recently:

“The evidence is a mess leaving each of us free to cherry-pick what sustains our worldview be it ideological or philosophical or just consistent with our flavor of economics.”

Ryan Bourne of the Institute of Economic Affairs goes further:

“when the facts change, the Keynesians don’t change their minds.”

To illustrate their belief that Keynesians ignore awkward facts both the authors above use the example of US growth following the 2013 sequester. (In my experience anti-Keynesians tend to shy away from data series, and especially econometrics, and prefer evidence of the ‘they said this, and it didn’t happen’ kind - particularly if ‘they’ happens to be Paul Krugman.) The problem is that this episode actually illustrates the opposite: that anti-Keynesians are so keen to grasp anything that appears to conflict with Keynesian ideas that they fail to do simple analysis and ignore others that do.

In this post I just looked at the data and did some simple arithmetic to show that this episode was quite consistent with Keynesian fiscal policy analysis. I’m sure others have done the same. But such analysis just gets ignored: they have a superficially good story, and that is all that matters. (Read this post to see how Scott Sumner in response to my work dug himself an even deeper hole.)

Why do we have to go over, yet again, that the clear majority of studies show that Obama’s stimulus worked. Why do we have to keep going over why UK growth in 2013 does not prove austerity works? Why do these people never mention the meta studies that confirm basic Keynesian analysis of fiscal policy? Because they want to believe that the “evidence is a mess” so they can carry on holding their anti-Keynesian views.

Parts of the political right have always had a deep ideological problem with Keynesian analysis. As Colander and Landreth describe, the first US Keynesian textbook was banned. New Classical economists, for all the many positive contributions they brought to macro (in the view of most mainstream Keynesians), also tried to overthrow Keynesian analysis and they failed. 

When anti-Keynesians tell you that support or otherwise for Keynesian macroeconomics depends on belief about the size of the state, they are telling something about where their own views come from. When they tell you everyone ignores evidence that conflicts with their views, they are telling you how they treat evidence. And the fact that some on the right take this position tells you why anti-Keynesian views continue to survive despite overwhelming evidence in favour of Keynesian theory.

No basis in economics

That was the claim about George Osborne’s plan to outlaw government deficits in normal times made in the letter signed by 79 economists. It is a strong claim. To see why it is a tenable claim, it is important not just to think about the short term situation and the usual controversies that go with it.

Before I do that, I have a confession. I had until recently assumed that the surplus target would be inserted into the kind of rule he set up when he became Chancellor, which allowed considerable flexibility in how quickly that target was achieved. However while writing this post I realised I may be wrong: he could be planning to replace that kind of flexible rule with legislation that simply outlaws deficits in normal times. That is important, because it would mean one of two things. The first is that the government would attempt to hit some target for a small surplus (say 0.5% of GDP) each and every year. That means that in response to quite normal shocks and forecast errors that hit the public finances, taxes or government spending would be pushed up or down to compensate. [1] The second is that the government would have to aim for surpluses somewhere around 2% of GDP, to provide a sufficient buffer to absorb those shocks and forecasting errors.

The most basic of macroeconomic theories when it comes to thinking about fiscal policy is due to Robert Barro, who is hardly an active supporter of Keynesian stimulus spending. It is called tax smoothing, but it can easily be applied to government spending as well. (It forms the basis of much of what economists call the dynamic optimal taxation literature.) This says it is taxes and spending that matter, not debt or deficits, and it is best to plan such that the path of taxes and spending is smooth. Another way of putting the theory is that the deficit should be a shock absorber, and planned reductions in debt should be slow. (This was the theory behind the recent IMF paper I discussed here.)

So how does the plan to outlaw deficits look in the light of this literature. If the plan involves targeting a small deficit each and every year, that is the complete opposite of tax smoothing. Taxes and spending would become volatile so the deficit could be smooth. That is crazy, because it is taxes and spending that impact on people and not the deficit.

If the plan involves going for a larger surplus on average, that would allow smoother taxes and spending in the short term. However average surpluses of 2% would imply an incredibly rapid reduction in government debt. Coupled with 4% nominal GDP growth they would cut the ratio of debt to GDP from the current 80% to Gordon Brown’s 40% target within a decade. Within two decades government debt will have largely disappeared, which allows taxes to fall or spending to rise. [2] But that will also violate tax smoothing, this time at a frequency involving generations rather than years. You could put this in terms of intergenerational equity: the current young, who suffered most from the Great Recession, will bear the full burden of reducing debt. Future generations will get the benefits of existing public capital while contributing nothing towards it. 

So both versions of outlawing deficits in normal times violate the tax smoothing idea. But it gets worse. If real interest rates and wages vary over time, it is best to invest when borrowing and labour are cheap: that is not just basic economics but common sense. Both borrowing and labour are currently cheap. Yet to meet the surplus target, the government plans to keep public investment on infrastructure lower than at any time over the last twelve years.

So even if you put all the short term Keynesian concerns to one side (which of course I would not), outlawing deficits makes no economic sense. Yet Philip Booth of the IEA takes exception to this claim. But the only theory he can come up with to support the plan is the idea that sometimes it is better for the government to tie its own hands. He says “the 79 seem unaware of these basic ideas”. Of course the 79 are aware of the pros and cons of commitment (for a full discussion applied to fiscal rules see Portes and Wren-Lewis), but what you should never do is commit to rules that make no sense. Following daft rules will always be daft. Outlawing deficits is a daft rule.

[1] The rule then is virtually identical to a policy of always running a balanced budget. Students learn the problems with that rule in their first year studying economics.

[2] The only way you could make sense of this policy is if the surpluses continued even when debt had disappeared, and the government built up a large sovereign wealth fund. Although I have explored this possibility in an academic paper with colleagues, the current government has never mentioned this goal, so I think we can discount it here.  

The wrong kind of political economy

Thanks to Google I get to see when someone writes about me, so I read an article by Ryan Bourne in CityAM. It basically says that while Keynesians keep saying that their models have been vindicated by the economic effects of austerity (but economists always disagree with each other blah blah), they have lost the political debate. In the case of the UK, even Labour is no longer Keynesian. While Labour are planning hardly any additional austerity, but the Conservatives are planning a lot, according to Mr. Bourne Labour are not justifying this less contractionary stance in Keynesian terms.

For the sake of argument, let us assume that Mr. Bourne is correct about Labour. We also need to ignore the SNP of course. Suppose Mr. Bourne is right that Keynesians have lost the political argument. This line is not new, with more authoritative newspapers having said similar things in the past. What should seem very strange is that Mr. Bourne and others do not appear to view this as a cause for concern.

It is a concern because Keynesian economics is taught to pretty well every student who ever studies economics anywhere in the world, and usually not as just one competing theory among many but as how the world works. Nor is it the case that academic macroeconomists are hopeless divided over the issue: a large majority on both sides of the Atlantic agree that fiscal austerity/stimulus reduces/enhances growth when monetary policy cannot offset its impact. Most major central banks use Keynesian theory as a basis for their monetary policy decisions. The reason for all this is that the evidence overwhelmingly backs Keynesian ideas, including that fiscal contraction tends to reduce output.

Given all this, if all three major UK political parties are ignoring Keynesian economics that would be a real worry. Now this might not worry Mr. Bourne if he was just one of these politicos for whom politics creates its own truth and that is all that matters. However he is in fact head of public policy at an outfit called the Institute of Economic Affairs. Perhaps, given the level of debate about fiscal policy in the media nowadays, that would be economic affairs of the more homely kind.

Silly questions or silly economics

On cue to confirm what I wrote yesterday, Ryan Bourne at the Institute of Economic Affairs complains about the BBC coupling the Telegraph business leaders story with the CFM economists survey. [1] Mr. Bourne’s main gripe is that the CFM question on austerity was silly. The question was “Do you agree that the austerity policies of the coalition government have had a positive effect on aggregate economic activity (employment and GDP) in the UK?”

Why was it silly? To quote: “the overwhelming majority of even supporters of austerity would disagree with the question, because in the short-term they would also believe that cutting spending and raising taxes would dampen growth. Indeed, the OBR and others factored this into their models. It is well known.” And later on: “these proponents of austerity were willing to make a trade-off: slightly slower growth today, in order to achieve other objectives.” [2] So they would be forced to disagree with the statement, even if they agreed with austerity. 

This tells us two things. First, it emphasises something I and others have occasionally said, which is how far austerity supporters have lost the intellectual debate. I remember not that long ago the arguments being about expansionary austerity, or how monetary policy could (would) offset any impact that fiscal policy might have on activity. Or it was about how we had to have austerity, because without it there would have been market panic. Apparently not - it was really all about current sacrifice for future gain.

Second, it illustrates the gulf between what most economists understand and mediamacro. In mediamacro, austerity was necessary because without it terrible things would happen (or at least there was a good chance of them happening). Not sometime in the future, but pretty soon. To quote the Prime Minister: “Britain was on the brink“. This of course is why some of the non-partisan media found the CFM survey interesting.

There is a huge amount in Mr. Bourne’s post that I could take issue with [3], but let me just focus on one point. He says: “Certain commentators are keen to claim that employment growth has only been strong because the productivity performance of the economy has been weak. This is an utterly bizarre claim.” He mentions this, of course, because the government is making great play over the number of jobs ‘they have created’.

To say that this is a bizarre claim is, frankly, bizarre? Let me explain why. No one disputes that our labour productivity performance over the last five years has been terrible. Here is a chart from the latest ONS release.

  

Note that a fall in productivity during a recession is not unusual. What is unusual is what has happened during the period of the coalition government. (See more on UK productivity from Ken Mayhew at the coalition economics site.)

Labour productivity is just output divided by employment (or hours worked). Why is stagnant productivity a problem? Because over the long term (across booms and recessions) the level of employment is essentially tied down by how many people want to work and how many hours they want to work, so productivity growth means output growth. Improving living standards depend on improving productivity. So if over the last four years we have lost productivity growth that we are not going to get back for some time, this will mean lower average UK prosperity.

Does this not also imply that had productivity growth been stronger over the last four years, output would have been higher and employment growth much the same? No, because coming out of a recession caused by a collapse in demand, most economists see output as being determined by aggregate demand: how much people want to spend, how much firms want to invest, and how internationally competitive UK firms are. That is exactly why austerity hurts output, a point which Mr. Bourne seems happy to concede. It therefore follows that if productivity growth had been stronger, output would have been much the same because aggregate demand would have been much the same, but employment growth would have been weaker. Over the last five years strong employment growth and weak productivity growth is much the same thing. Which is why celebrating strong employment growth is effectively celebrating poor productivity, which does seem silly.

[1] Mr. Bourne will have been pleased to note that, at least from what I saw, none of the evening news bulletins covered the CFM survey, while the business leaders’ letter retained its top spot. I’d love to know the reason for this change.

[2] Mr. Bourne gave three reasons why sacrifice now would lead to later gains: (a) lower borrowing costs, (b) preparing for the next recession, and (c) a smaller state increases productivity. As I have argued before, there is no evidence that at the beginning of 2010 interest rates on UK debt involved any noticeable default premium. I have discussed at length how we might be better prepared for the next recession, but strangely sacrificing large chunks of GDP today was not on my list. As for (c), look at the record on productivity.

[3] For example, the question Mr. Bourne would have rather seen is whether fiscal policy was the main cause of weak growth from 2010 to 2012, or whether external factors were more important? He does not say why this is a much better question. Of course the question Mr. Bourne would really like is why the economy did worse than the OBR expected, because the OBR were always expecting austerity to reduce growth. Personally I find questions like what impact did government policy have on the economy rather relevant, particularly coming up to an election.  

Will the MPC raise UK interest rates in 2014?

Chris Giles of the FT thinks they will. His reason is straightforward: economic growth will continue to outstrip productivity growth, implying unemployment will fall below the MPC’s 7% threshold, and the MPC will worry that inflation will start rising.

While I try an avoid making forecasts (see my first answer to the FT questionnaire here), I would agree that strong growth in 2014 is more than possible. The savings ratio could continue to fall, net trade could pick up and non-residential investment may begin to recover. It would be bad news if this was accompanied by continuing near zero productivity growth, but as we do not know why UK productivity growth has stalled, we cannot rule this out.

Yet if interest rates did rise as a result, it would be extraordinary. To see why, just compare the UK with the US. US GDP began growing strongly at the end of 2009. So the UK is a full three years behind. Yet the US still has interest rates at their zero lower bound, four years after their recovery began, and has only just begun to scale back increases in its quantitative easing programme. (The MPC stopped increasing their programme some time ago.) So if we followed the US, there would be no question of raising rates this year.

The UK has been unusual in the past because of inflation. While US inflation has been at or below target for the past year and a half, it has been above target in the UK for 4 years. Yet the UK inflation rate is now down to 2.1%, despite the recovery in output. So it increasingly looks like high UK inflation in the past was down to a number of temporary factors, which the MPC rightly ignored. This is consistent with other measures of UK inflation, which have been lower throughout.

Now of course if inflation really does look like taking off in 2014, the MPC will raise rates. But what would ‘taking off’ mean precisely. As the MPC focuses on inflation two or so years down the line, I think it would have to mean a sudden tightening in the labour market. Given that unemployment is currently around 7.4%, and averaged 5.25% between 2000 and 2008, and earnings growth is currently running at 0.9% in nominal terms (!), we seem to have a long way to go before anyone could argue the labour market is about to initiate a wage price spiral.

Think of it another way. UK GDP is currently between 15% and 20% below where it would have been if it had followed past trends and there had been no recession. Past trends involved average growth rates of at least 2%. With that historically unprecedented gap, if two years of GDP growth one or two per cent above that past average meant monetary policy had to be tightened, it would mean accepting that something catastrophic and irredeemable had happened to the UK economy. That is why a rate rise this year would be extraordinary.

Now you might say a small increase in UK short term interest rates would still mean that monetary policy was easy, but just a little less so, and so a modest rate rise would be no big deal. The Resolution Foundation would strongly disagree. In a recent report they looked at the impact that various different scenarios for interest rates would have on households. The following chart indicates the key point.

The left hand panel gives the proportion of households paying over 25% of their disposable income in debt repayments (light pink), and over 50% (dark pink). The key point is this. The 2011 proportions are not very different from the average over the previous two decades, despite interest rates being much lower. In other words, we have not seen a wave of defaults and repossessions following the recession because the MPC cut interest rates to the bone. If interest rates rise but real wages do not (because productivity growth continues to stall), then that wave may happen after all. (See the right hand panel.)

As a result, even a small increase in interest rates is likely to have a large impact on at least some parts of the UK economy. The Bank is well aware of this (pdf, HT Pieria), so members of the MPC should not take this action lightly. As I have argued before, given the risks and uncertainties associated with the economy’s current position, it makes much more sense to take risks with inflation than to risk stalling the recovery. But I also thought that in 2011, when GDP growth was flat, and a third of the MPC disagreed, so nothing is for sure.

We can at least be thankful that interest rate decisions are not made by the so called ‘Shadow MPC’, a group set up by the Institute of Economic Affairs. They have been voting since February 2013 to raise interest rates! How can you vote for higher rates before a recovery starts, when it is obvious that there is large scale involuntary unemployment and underemployment? Well back in the 1940s Michal Kalecki had a theory, but then he was a Polish immigrant!