Why is the government making such a mess of Brexit?

A year and a half after the vote to leave, and the government has still not decided on what form of Brexit it wants. This is despite triggering Article 50, which means we will leave in about a year. If this isn't chaos in government, what is? But why is the UK government making such a mess of Brexit?

That is the question addressed by Tony Yates in a New Statesman article. He makes the case that all the problems we are seeing, and in particular the fact that the government have still not yet agreed what they want, come back to the referendum question. Because it did not specify how we would leave, it allowed quite conflicting visions of Brexit to unite. And it is not just a matter of working out which of those visions wins, because the losers may well decide they would rather stay than leave on those terms. Hence the inability, but also the reluctance, of May to spell out exactly what our Brexit plan is.

I think there is a lot of truth in that, but it is far from the full story. It might have been possible to have got all those advocating Leave to sign up to a single vision before the referendum. It might not have won, but it could have come close to winning. But that vision would have been based on fantasy: fantasy about the economic consequences of any particular path, and a fantasy about how the EU would respond.

Brexiters are not details people. They deal in visions, as Johnson’s recent speech showed. But worse still, they are so attached to their vision that they will not let details (like everyone being 8% poorer as a result) get in the way. A less kind way of saying this is that Brexiters are fantasists or ideologues.

Am I being unfair? Just look at what is now happening in relation to the Good Friday Agreement (GFA). The GFA is now in the way of the Brexit vision, so they are all saying the GFA has passed its usefulness. Anyone sane can see such a statement is completely mad and utterly irresponsible. However it also shows us something else. It was clear the moment the government signed up to the first stage agreement that the Irish border issue would to a considerable extent dictate the terms of any final agreement. It has taken the Brexiters this long before they realised this, and started attacking the GFA. They are not details people.

You might think that people who would allow their vision or ideology to become more important than details like a 8% GDP loss or peace in Northern Ireland shouldn’t be anywhere near the levers of power, and you would be right. One of the side effects of Brexit is that because May feels she has to have some sort of balance between Leavers and Remainers in her cabinet, we have an even more incompetent Conservative administration than usual. Yet more chaos.

Unfortunately, that incompetence is shared by May herself. The number of mistakes she has made is endless. The moment she was elected leader she should have realised that she had to exclude the fantasists from government as much as possible, but instead she gave them key government posts. She drew up red lines that were impossible to negotiate. She invoked Article 50, which instantly put the UK at a tactical disadvantage, without any agreed plan of how to undertake the negotiations. She made all these mistakes because she was afraid that the Brexiters would try and depose her and the press would turn on her the moment she started being realistic. But the point at which she was elected she had the most power (over both Brexiters and the press) she would ever have, and she didn’t use it. That is incompetence.

What this all means is everyone is right. Tony is right: the referendum was too vague and put the government in a difficult position. But no government knowingly cuts UK GDP by percentage points unless it is convinced there is some greater danger, and the EU is hardly a danger right now. So even if the referendum had been more precise it would have been a precise fantasy, either about the economic consequences or what the EU would allow. As a result, Brexit was always, and remains, an impossible project for any sane government. But even saying all this, the government has still managed to try doing the impossible in an extremely incompetent way.

These different reasons for chaos are all related, and all stem from the disastrous referendum vote. May is Prime Minister because of that vote. Fantasists are at the heart of government because of the vote. And if anyone is tempted, for other reasons, to get on a high horse to talk about press freedom right now, remember the main reason that disastrous vote went the way it did. Social conservatives and the left behind were sold snakeoil, and the main salesmen were the press barons of the right wing press. 

The OBR’s risk assessment lacks context

In its recent report on fiscal risks, the OBR talks a lot about all the shocks that could make the government debt to GDP ratio rise again. It then says the following:

“None of this should be taken as a recommendation to refrain from particular spending increases or tax cuts, or to avoid particular fiscal risks – that would lie beyond our remit. And there are those who believe fiscal policy is still too tight, given the pace of economic growth and the looseness of monetary policy. But ….”

Should I be grateful for the second sentence, being one of ‘those’ who think that way?

I think the reverse is true. The OBR has played the tune the government wanted, but it is the wrong tune, and this now mature and independent organisation is capable of much better than this. I will first deal with a particular issue to do with monetary policy, and then talk more generally about the concept of ‘fiscal risks’.

Our macroeconomic institutional architecture is based around what I have called the consensus view about macroeconomic policy. This consensus involves what economists call an assignment. The stabilisation of output and inflation is assigned to independent central banks operating monetary policy. Fiscal policy should be confined to managing the government’s deficit and debt, and to help it with that task there should be a combination of fiscal rules and independent fiscal institutions (aka fiscal councils, like the OBR).

In a consensus assignment world, the job of a fiscal council is to stop deficit bias: the tendency clearly observable in some countries before the global financial crisis for deficits to creep up over time. In particular, when all is going well and the deficit appears not to be an issue, it is their job to tell the government to 'fix the roof while the sun shines’.

As I and others have noted many times, this consensus assignment has an Achilles Heel, which is that nominal interest rates cannot go below a number close to zero, the so-called Zero Lower Bound (ZLB). In the absence of some mechanism to allow interest rates to become significantly negative, that ZLB problem means that sometimes fiscal policy makers have to help monetary policy in its stabilisation role. The simple consensus assignment breaks down.

Although most academic macroeconomists recognise that, our institutions find it hard to do so. Monetary policymakers in the UK and Eurozone find it very difficult to say that they have lost their main instrument, and that therefore they can no longer reliably do their job. It seems that our fiscal council, the OBR, has similar problems.

We are currently at the ZLB. The most immediate risk we therefore face is that we are hit by a negative shock and monetary policy is unable to respond effectively. Hence the quote from their document above. But as far as I can see that is it. In their section in the Executive Summary on the risk due to a recession I would have thought the ZLB problem was worth at least mentioning, but it does not appear. Indeed I’m not sure the term ZLB or liquidity trap appear anywhere in the document.

I’m sure the OBR would in defence say two things: assessments of fiscal risks generally look at risks to fiscal sustainability not macroeconomic stabilisation, and their remit precludes them from talking about alternative fiscal policy paths. This is all true. The Treasury wanted a report that would enable them to say we must continue with austerity because of all the risks identified by the OBR. The Treasury also wrote the OBR’s current remit. 

But the OBR is supposed to be independent. Just because the government tries to pretend that there is no Achilles Heel to the consensus assignment, that does not mean it has to go along with that act. In particular, it will (I hope) have noted that the main opposition - which came close to defeating the current government - has a fiscal rule that explicitly says that fiscal policy needs to switch from stabilising debt to stabilising the economy when interest rates are at their lower bound (like now). In this context, I think something beyond a single sentence alluding to the ZLB would have been appropriate.

Tony Yates said similar things yesterday. He also made another important point: a key role of government in many areas is to be a risk absorber. It assumes risks, because it is beneficial to take risks away from individuals or individual generations and spread them more widely, and often the state is the only institution that can do this. In addition, its deficit and debt should be a macroeconomic shock absorber. Given all that, why exactly should we be concerned if various shocks increase government debt? That is what is supposed to happen!

To put the term risk and attach it to some level of debt or deficit, giving us ‘fiscal risks’, is questionable. It is a bit like saying their is a risk that your central heating will come on if it gets cold: that is not a risk, but why it is there. The OBR would no doubt respond that the government has a mandate in terms of a deficit or debt target, and it has been asked to look at risks that this may not be met. But that should not stop an independent OBR from asking more fundamental questions.

Implicit in the idea of ‘fiscal risks’ is either a belief that there is an optimal level of debt which is below current levels, or a view that there is some level of debt so high that markets would start worrying about the government choosing to default. If we are worried about a debt burden on future generations, does it make sense to put all that burden on a current, already disadvantaged, younger working generation? Unless these key issues are addressed, all the risk assessment the report undertakes is meaningless, or worse still just provides support for the government’s misguided policy. It is time the OBR stopped being constrained by its remit, and started providing the public with a useful framework in which to think about ‘fiscal risks’.

Still not getting it after all these years

I met Nick Macpherson, the most senior civil servant at the UK Treasury from 2005-16, for the first time (I think) a few weeks ago. It was at a conference about, among other things, getting economic ideas across to the public. He is also on twitter, and I saw the following exchange between him and Tony Yates.

To be fair to Nick, I get many people saying the same thing: we are at full employment, so we should not be running deficits. Let’s not on this occasion discuss how we can be at full employment when nominal wage growth is so weak, or into the distinction between current and total deficits. The main point that Tony makes above is that you cannot discuss what an appropriate fiscal policy setting should be without thinking about monetary policy.

There was one reason, and one reason alone, that we had fiscal stimulus in 2009. It was because nominal interest rates had hit their lower bound. A recession in itself is not a sufficient condition for a fiscal stimulus if monetary policy can do all the work of getting us out of the recession. [1] But when interest rates are stuck at their lower bound, monetary policy has lost its ability to regulate the economy, which means we are either stuck in a recession or are vulnerable to any negative demand shock. Unconventional monetary policy, although better than nothing, is far, far less reliable than conventional monetary or fiscal policy.

It is therefore a prime duty of government to ensure that, if interest rates have hit their lower bound, fiscal policy is solely directed at allowing monetary policy to raise rates. This idea is not new. It was always implicit in New Keynesian theory and what I call the Consensus Assignment. Paul Krugman, Brad DeLong and others have been going on about it at least since the financial crisis. The idea should be part of any fiscal rule, as Jonathan Portes and I suggest here, and this is still part of Labour’s fiscal credibility rule.

In the UK, at this very moment, we are once again at the lower bound for interest rates. That means fiscal policy is currently too tight. Whether we are at full employment is neither here nor there. Interest rates are at their lower bound because the negative influences on aggregate demand are more than monetary policy can handle. One of those negative influences is fiscal consolidation. That fiscal consolidation should wait [2] until interest rates are safely clear of their lower bound.

This is not one particular theory of monetary and fiscal policy interaction. It is the consensus theory. That it is not understood by the public is understandable given mediamacro. But not being understood by senior civil servants (and I doubt Nick is alone here) when they are free to speak their minds is much more surprising.

[1] I’m using consensus theory here, and abstracting from uncertainty.

[2] It can wait because there is no problem in financing the deficit, and because we print our own currency there has never been any such problem.  

Minority rule: Migration, Brexit and Mandates

It is generally (not universally) agreed that the issue of migration played a large role in leading 52% of UK voters to want to leave the EU. However that does not mean there is a mandate to end Freedom of Movement (FoM) at the cost of losing access to the single market. I’m rather surprised by the number of people who think it does. There are lots of reasons why it does not, like voters being told they could end FoM and still stay in the single market, like that many people voted to end FoM because they wanted a better NHS, whereas the opposite will be true in practice. (Tony Yates discusses this general point here).

However the clearest reason why Brexit does not mean there is a mandate for ending FoM was made by Ian Dunt yesterday. Put simply, it is that a majority of a majority can be a minority. The fact that many people voted Brexit because they wanted more control over immigration does not imply that a majority of all voters did.

Suppose that everyone understood that there was an unbreakable link between freedom of movement (FoM) and membership of the single market. Suppose all the 48% who voted to Remain prefered to keep membership at the ‘cost’ of retaining FoM. Suppose 48% of those voting Leave felt the opposite. But 4% of those voting Leave wanted a Norway style arrangement, and wanted to leave for some other reason than FoM . In this case a majority want to keep FoM, and do not want further migration controls if that means being out of the single market.

Of course these numbers are made up, although polling evidence does suggest a majority of people prefer being in the single market to ending free movement. But the key point is that we do not know what the true numbers are. Yet the presumption seems to be being made in lots of quarters, from researchers to politicians, that the referendum result means that we cannot go for any arrangement involving FoM. This just does not follow.

Nor does the fact that the Leave campaign focused on immigration make any difference. Again imagine that the 4% who wanted to leave for reasons other than immigration were rock solid about voting Leave. For the undecideds, however, immigration was critical. In which case any decent campaign would focus on the undecideds. We could change the figures to make it even clearer: 30% of Leavers were rock solid because of sovereignty or financial issues, but 22% were undecided and also worried about immigration. Again a good campaign would focus on immigration, even though it was a minority concern. Election results, like prices, are determined at the margin.

There is therefore no mandate from the referendum result to sacrifice membership of the single market in order to end free movements. Which is one excellent reason why we need a second referendum on the final terms for Brexit before we leave.

Postscript (17/10/16) Here is some polling evidence supporting these arguments.  

The Media and Brexit redux

In this post I complained about how little attention the visual media gave to the fact that the overwhelming majority of economists thought that Brexit would involve significant long term costs. All I have now is more evidence to back up the argument in that post.

First, I was not alone in these thoughts. Here is Andrew Scott talking about his foreboding concerning the Brexit debate: “I just really wasn’t looking forward to the debate because I knew that it would stifle what are the really important issues, it would become partisan rather than insightful and that the economic voice and argument was vulnerable to being politically sidelined.” [1]

Second, the argument that there will be long term costs with Brexit has not, as yet, convinced most voters. In this poll, which is not unique, only 22% of voters thought they would be worse off as a result of Brexit. It seems unlikely that voters are unaware that David Cameron and George Osborne have claimed they will be worse off, but quite rightly they may be very distrustful of what politicians say. Virtually no voters will have examined the economic arguments on both sides and made up their own minds. Crucially, unless they read one of the broadsheets, they will have no idea that there is such an overwhelming consensus among economists. 

Third, we now have more evidence besides letters that there is indeed an overwhelming consensus among economists, thanks to the Observer. True, not quite as overwhelming as I had imagined, but 9/10 counts as a consensus for economists.

Fourth, there is polling evidence that the public do have a high level of trust in what academics say. Here is the relevant data (source):

So to sum up, most people do not think they will be worse off after Brexit, economists (including academics) overwhelmingly do think people will be worse off, and people have a high level of trust in what academics say. I can only think of one plausible explanation that is consistent with these three facts, and that is that people do not know what the overwhelming majority of academic economists think. [2]

In a vote that could well be close, you cannot argue that this failure to transmit information is unimportant.

One of the structural issues that help produce this problem is what you could describe as the politicisation of truth which comes from the overriding need to be unbiased. The visual media rely on either side to bring the relevant information to the table, because to do otherwise might seem biased. If a statement is made by one ‘side’ and disputed by the other it is contested, whether it is true or false. [3] 'Contested' is the word I heard a BBC reporter yesterday describe the £350 million a week claim, even though the UK Statistics Authority and one of their own fact check websites say it is false. So if one side does not headline that the overwhelming majority of economists think Brexit will involve significant long term costs, this fact - if it is reported at all - can get lost in the endless and tedious sequence of political claim and counterclaim.

This politicisation of truth did not begin with this referendum. The Leave campaign chose to headline a figure which they knew to be wrong. They did so because they also knew it would do them no harm. They knew it would do them no harm because no one in the media other than the broadsheets would have the nerve to describe it as a lie. They knew that from observing how the media has worked in the past. 

[1] Here is an example of how the media tries to fit this consensus among economists into their standard confrontational model. Now I have no objection to economists being challenged, but it is a shame that all this interview seemed to be about was Tony Yates trying to get across the concept of a counterfactual. Just one question along the lines of why do you think that on this issue economists are so united might have been interesting for viewers

But I do object strongly to the preamble. All the statements made were either wrong or beside the point. (1) that the 364 economists were wrong is the opinion of some but not others - it is not a fact. (2) the ‘establishment’ may well have thought we should stay in the ERM in 1992 but did the majority of economists think we would be worse off coming out? I certainly did not, and published a paper saying so. (3) it was the evidence from economists in the 5 tests analysis that convinced Brown to say no, not the other way around!

So rather than examining why there is such a consensus view among economists we get a rather poor interview about the value of counterfactual analysis, and certain opinions passed off as facts without any opportunity to challenge them. If anyone in the media asks me why academics appear reluctant to appear on TV, I shall show them this.

[2] Some people have a kneejerk reaction against complaints involving the media. In reading Andrew Scott’s piece an analogy occurred to me which I think might help here. Until the financial crisis, most macroeconomists (not all) tended to view the financial sector as a simple ‘transmission system’ rather than thinking about it as a system with its own incentives and dynamic. That was a huge mistake. Equally criticisms of the visual media which amount to ‘they are all biased’ are about as informative as saying the problem with the financial sector is that everyone in it is too greedy. More sensible critiques in both cases look at the way the sector works, and the incentives actors with each system face.

[3] Equally if something is stated often enough by one side and is not contested, it becomes a fact.