A referendum on taxes

Suppose we had a referendum on taxes. A simple question: should taxes be reduced or not? Polling evidence suggests that the resounding answer would be yes. But polling evidence also suggests that most voters would also say yes to more money for schools and the NHS. They might also say yes to reducing the deficit. Referenda do not need to respect constraints, which in this case is a simple budget constraint.

You might say that polls are a bad guide to what might happen in a real referendum on lower taxes. Those in the No campaign would point out that you cannot have over the longer term both lower taxes and higher public spending. But those arguing yes would say that lower taxes could be 'paid for' through greater efficiency in public spending. They might even say that lower taxes pay for themselves because the incentives they provide would lead to more growth and therefore more tax receipts. Most economists would say that this was highly unlikely, but we know economists will be ignored.

There was a similar constraint in the EU referendum. Reject free movement of labour and you cannot be part of the single market, and if you are not in the single market growth will suffer. Some might say that the success of the Leave campaign lay in making the EU referendum into a referendum on immigration, but as I argued before the campaign started this was always likely to happen. While the equation relating free movement to EU membership was straightforward and uncontested, the constraint relating free movement to the single market and growth was contested.

The real failure of Cameron and Osborne was not to forsee this would happen when they agreed to a referendum in the first place. They should have known, because they had managed to shut out economic expertise in the 'debate' over austerity. Their mistake, and perhaps arrogance and conceit, was not to realise that their opponents would do the same to them over Brexit.

After Oxi, what next?

A lot of the commentary on Greece fails to see why the Greek No vote changes anything. This view tends to see the stance of the Eurozone group as simply expressing their own voters’ preferences which will not be changed by what happened yesterday. Here is an alternative reading.

It starts from a simple observation. The Troika will get far less of its money back (if any!) if Greece is forced out of the Eurozone. (I say forced out because Greece does not want to leave, so Greek exit is first and foremost an ECB decision: if you think otherwise read Karl Whelan and Matthew Klein and Paul De Grauwe. [1]) That is why creditors are generally weak in negotiations of this kind. Things are different in this case only because the creditors include the ECB, and Greece wants to stay in the Eurozone. The Troika has played this for all it is worth. They were relying (you could say gambling) on the Greek people, one way or another, deciding that they would agree to the Troika’s demands because they feared Greek exit more.

So far this strategy has failed. First they pushed Tsipras further than he could possibly go, hoping perhaps that Syriza would collapse in recriminations. Tsipras’s response was a unifying referendum. They then gambled that Greece would say no, and they lost that too. Tsipras continues to offer the Troika the chance to be more reasonable. He followed the referendum not with triumphalism but by removing his finance minister. This was both a signal - I really want a deal, even though it will in all probability inflict further (unnecessary) pain on Greece - and a lifeline, because the Troika can now say that an important obstacle to a deal has been removed. (An obstacle, because Varoufakis was too open - something politicians and much of the press hate - and too honest about the other side’s lack of economics.)

Now the Troika seem to face a simple choice. Agree a deal and get a little more heat from your political opponents at home for ‘giving in’, or force Greek exit with the risk that you will get a lot more heat when Greece defaults and people realise you have lost all their money. If they are really just interested in getting as much of their money back as possible, it would seem crazy to throw away their best card by forcing Greece out of the Eurozone.

Of course rationality may not prevail, or interests may be rather different. The IMF may continue to be an unhelpful nuisance. (If you think my criticism of their role was harsh, read this from Peter Doyle.) Some within the Troika will be happy to go for Greek exit because they think nationalist sentiment can overcome any kickback from the subsequent Greek default. Others may fear a deal may encourage anti-austerity sentiment in their own indebted countries.

Unfortunately there is a third possibility, which is probably the worst possible outcome. To prevent any loss of face, the Troika may continue to gamble, waiting for days or even weeks, and watch ECB pressure, together with reluctance by Tsipras to introduce a new currency, gradually bring chaos to the Greek economy. Only then will it negotiate, allowing any deal to be portrayed as the result of desperation by the Greek government. In which case, recent European politics will have reached a new all time low.    

[1] Postscript: Martin Sandbu provides a very clear account.

When National Interest and Party Advantage Conflict

I would not be the first to observe that there is a potential conflict between George Osborne’s role as Chancellor and his deep involvement in Conservative Party election strategy. The fact that this is often said does not mean it is real - it could just be a story told by those commentators who are themselves fixated by the battle between political parties. However there are two major areas where the Conservative part of the coalition government seem to be putting perceived election advantage ahead of prospects for the UK economy: immigration and Europe.

Jonathan Portes has clearly described the contradictions between an economic philosophy that stresses the importance of deregulation and a flexible labour market, and tight restrictions on the ability of firms to hire who they want if they happen not to be UK residents. In addition, making it difficult and risky for foreign students to study in the UK directly hits the exports of the education sector, which I have talked about before. Now perhaps immigration control is so deeply embedded in conservative philosophy that it trumps economic liberalism, or helping increase UK’s exports. Or alternatively, immigration is seen as a vote winner and so any damage that this will do to the UK economy can be set aside.

The Prime Minister has now finally made his commitment to hold a referendum on EU membership in four years time. This has been widely interpreted as a move to both appease the anti-EU wing of his party, and to stop the drift of voter support to the UK Independence Party. The opposition has claimed that this will create damaging uncertainty, and on this occasion they are almost certainly right. We do not need to just take the word of business leaders on this. A number of studies (e.g. here and here) have recently highlighted the role of uncertainty in influencing the macroeconomy. There can be little doubt that decisions by multinationals or export orientated domestic firms on where to locate or expand production are heavily influenced by whether countries are inside or outside trading blocs. Given the real risk that a majority in the UK referendum will vote to leave, investment decisions are likely be postponed at best, and diverted elsewhere at worst. Neither is what the economy needs right now. The economic benefits of promising a referendum on EU membership in five years time are hard to see. It is also hard to imagine why the Prime Minister had to make such a commitment, besides the political imperatives of Party unity and keeping votes.

So what is new, the cynic might say. Politicians have always been more concerned with winning elections than the economic health of the country. Well lets just suppose this is true, for the sake of argument. What is clearly true is that winning elections also depends on the state of the economy. To say the the UK economy is not looking too good right now would be an understatement. (Those who point to trends in employment in an attempt to suggest things are not so bad are really deluded. How can the fact that UK labour productivity is still well below levels before the recession, and has hardly increased at all in the last year or two, possibly be good news?)

Which brings me to the potentially conflicted Chancellor. Ministers are meant to represent their portfolio - and most of the time the complaint is that they do this too much, with too little regard to wider interests. Again the cynic might say that is natural enough, because their own personal political capital is bound up with the perceived success of that ministry. So a Chancellor who was totally focused on being a Chancellor, in a situation where the economy was doing badly, would be banging the table against anything that put a recovery at risk. Now perhaps George Osborne has been lobbying hard against immigration controls, and against the referendum commitment, although if he had I suspect we would know about it. A more plausible story is that he shares the Prime Minister’s view that on these two issues at least political advantage outweighs economic interests. But in making this judgement, he is acting as Conservative Party strategist and not as the UK Chancellor of the Exchequer.