Revolutions in Economic Policy

The Commission on Economic Justice hosted by the Institute for Public Policy Research (IPPR) has just published a substantial and comprehensive report on the UK economy called ‘Time for Change’. I hope to write about aspects of that report later, but its basic premise is that we need a revolution in economic policy making, akin to the revolutions enacted by the post-war Attlee government and Mrs. Thatcher. The thinking behind the idea of economic policy revolutions is outlined by Alfie Stirling and Laurie Laybourne-Langton in a paper in The Political Quarterly.

The authors adapt the ideas of Thomas Kuhn’s The Structure of Scientific Revolutions to economic policy. I do not want to get hung up on the legitimacy or details of this. The basic idea that some periods involve profound changes in economic policy is not really contentious. Also the idea that the ‘failing paradigm’ will first try to adapt itself before being replaced by the revolutionary idea is straightforward. You only need to look at the state of current politics in the UK and US to take seriously the idea that what could be called the neoliberal era - the set of policies and world view associated with Thatcher and Reagan - is coming to an end.

There is a lot in the paper that I agree with, at least until the conclusions. [1] But I think my main critical comment would be that the paper focuses too much on macroeconomics, and as a result goes a little astray. It is if, having borrowed Kuhn’s idea and applied it to economic policy, the authors feel obliged to keep going back to an actual academic discipline, macroeconomic theory, rather than staying with economic policy as a whole. Let me set out first how I see the macroeconomic transformation that took place around the time of Thatcher and Reagan.

A key mistake that many people make is to say that conventional Keynesian macroeconomic theory was unable to explain stagflation, and that policymakers adopted monetarism or new classical ideas as a result. The basis for understanding stagflation and reducing inflation was known since at least Friedman’s famous address in 1968 giving his account of the expectations augmented Phillips curve. This Phillips curve was not used to guide monetary or fiscal policy before the end of the 1970s because most policy makers and some economists were reluctant to raise unemployment as a way of reducing inflation. [2]

In the UK this use of demand management to control inflation (or its counterpart, which was to abandon attempts at direct control like incomes policies) coincided with the election of Thatcher, but in the US it was initiated by Paul Volcker under Jimmy Carter. In both the UK and US it was associated with attempts to control monetary aggregates, but this lasted only a few years. You could argue that abandoning incomes policies was neoliberal, but to me it looks like the inevitable result of double digit inflation.

There was a revolution in macroeconomic theory, but I have argued elsewhere that it does not fit into the Kuhnian framework. The New Classical Counter Revolution (NCCR) did not come up with an alternative analysis of inflation: instead their concerns were more methodological. It is true that that many who promoted the NCCR also favoured neoliberalism, and you could relate reductionism to individualism (and hence neoliberalism), but I think the appeal of the NCCR owed much more to a collection of good ideas that the then mainstream resisted, like rational expectations.

Inflation targeting by central banks involves an attempt to manage the economy in much the same way as Keynesian fiscal activism had done before. The central bank is a part of the state. Central bank independence didn’t come to the UK until 1997, and existed in the US well before Reagan. What I call the Consensus Assignment (monetary to demand management, fiscal to debt control) was dealt a fatal blow by the GFC, but the popularity of this assignment owes little to neoliberalism. Attempts to link inflation targeting to neoliberalism, which are frequent, are in my view a mistake.

Trying to fit macroeconomics into an account of the rise of neoliberalism is therefore problematic, and more importantly it detracts from the real economic policy revolution that neoliberalism represented, which was a change in the attitude of policymakers to state intervention of almost any kind. Out went government partnership with industry (described as ‘picking winners’), together with a regional and industrial policy serious enough to counteract the effects of globalisation and technical change. There was a corresponding shift from the collective (including attacking trade unions) to the individual, together with the idea that ‘wealth creators’ (aka high earners) had to be incentivised by cutting ‘punitive’ taxation. Public money became ‘taxpayers money’ and so on.

All this was a successful neoliberal revolution, where by success I mean it took hold for decades. It, together with subsequent overreach, has caused serious problems and is therefore ripe for review. But ironically the attempt at a truly neoliberal macro policy - hands-off monetary targeting with no demand management - failed within a few years of being tried.

[1] I should say why I think the conclusions do not follow from the rest of the paper. There are some simple mistakes, such as “the failure of these same models to predict accurately the effects of the UK vote to leave the EU threatens to renew the crisis of confidence in economic theory.” But there is also an implicit very misleading equation pair: neoliberal policy=mainstream economics, revolution=heterodoxy.

First, the two previous revolutions in macro theory came from within the mainstream, not from outside. Second, neither austerity or Brexit have anything to do with mainstream economics. More generally, mainstream economics is as much a critique of neoliberalism as a support. As a result, a revolution in economic policy making could quite easily originate from within mainstream economics (see here, for example).

[2] Today, that view has been revived by members of the MMT school, who call using the Phillips curve to control inflation amoral.

The Left and Economic Policy

Why does the economic policy pursued or proposed by the left in Europe often seem so pathetic? The clearest example of this is France. France is subject to the same fiscal straightjacket as other Eurozone countries, but when a left wing government was elected in April 2012, they proposed staying within this straightjacket by raising taxes rather than cutting spending. Although sensible from a macroeconomic point of view, this encountered hostility from predictable quarters, as I noted here. But in January this year President François Hollande announced a change in direction, proposing tax cuts for business and public spending cuts. When your macroeconomic announcements are praised by Germany’s foreign minister as courageous, you should be very worried indeed. Any hopes that Hollande might lead a fight against austerity in Europe completely disappeared at that point.

You could argue that France was initially trying to oppose irresistible economic and political forces, and no doubt there is some truth in that. But what was striking was the manner in which Hollande announced his change in direction. He said “It is upon supply that we need to act. On supply! This is not contradictory with demand. Supply actually creates demand“. This is not anti-left so much as anti-economics. Kevin O’Rourke suggests this tells us that to all intents and purposes there is no left in many European countries. It would indeed be easy to tell similar stories about the centre left in other European countries, like Germany or the Netherlands. With, that is, the possible recent exception of the Vatican!

Unfortunately Europe here includes the UK. Labour’s shadow chancellor, Ed Balls, was correct in saying that the government’s austerity measures were too far, too fast, yet the party now seems to want to show they are as tough on the deficit as George Osborne. (Its opposition prior to that often appeared half hearted and apologetic.) Again you could argue that they have no choice given the forces lined up against them, and again I would agree that this is a powerful argument, but I cannot help feeling that this not the complete story.

I am not trying to suggest that if Labour had taken better positions, it would have necessarily made much difference. Take the issue of flooding, where Labour did try. The BBC failed to ‘call’ this issue, by for example reproducing the official data shown here, and instead fell back on ‘views on shape of the earth differ’ type reporting. Here the BBC failed in its mission to inform, and instead behaved in a quite cowardly manner. But at least in this case Labour tried.  

What strikes me about the economic pronouncements of the Labour Party is the number of tricks they miss. On too far, too fast, for example, an obvious line of attack would have been to note how Osborne did change his policy (proclaiming U turn! finally followed our advice etc). In addition they could say the recovery only took place once austerity was (temporarily) abandoned. Simplistic stuff I agree, but this is politics. To take a much more recent example, an easy line for Labour to take on the last budget and pensions was that Osborne’s policies would reduce incomes for prudent pensioners. Yet all Labour seems to be saying is that they will support the reforms, but want to wait to see the details. In other words, there is no opposition to the government’s claim that this was a budget for savers and pensioners.

With austerity and pensions there may be subtle factors that I have missed, but in their absence one conclusion you could draw is that the Labour Party in the UK is not getting good economic advice. I’m afraid I have no deeper knowledge on whether this is true or not. That has to be the conclusion in the case of Hollande’s apparent embrace of Says Law. Yet I doubt that the left does not want good economic advice. As I noted here, in the last Labour government the influence of mainstream economics had never been greater. Is this a paradox?

Perhaps not, if you think about resources and institutions. Seeking out good advice (and distinguishing it from bad advice) takes either money or time. An established government finds this much easier than an opposition or a new government. When labour came to power in 1997 they did immediately introduce well researched and judged innovations in monetary and fiscal policy, but they had had 18 years to work them out.

In addition, with the Eurozone there may be a factor to do with governance. I have just read a fascinating paper by Stephanie Mudge, which compares how economic advice was mediated into left wing thinking in the 1930s compared to today. To quote: “it stands to reason that an economics that works through inherently oppositional national-level partisan institutions would be especially fertile terrain for the articulation of alternatives; an economics that keeps its distance from partisan institutions and is more removed from national politics, but is closely tied to Europe’s overarching governing financial architecture, probably is not.” What is certainly true for both the Eurozone and the UK is that leaders of independent central banks often appear naturally disposed to fiscal retrenchment.

This gives us two problems that occur for the left and not the right. However the right has two problems of its own when it comes to getting good policy advice. The first comes from a key difference between the two: the right has an ideology (neoliberalism), the left no longer does. The second is that the resources for the right often come with strings that promote the self interest of a dominant elite. So although the right has more resources to get good economic advice, these strings and their dominant ideology too often gets in the way. But what this ideology and these resources are very good at is providing simple sound bites and a clear narrative.