The evolution of the UK Conservative party since 1979

 

This is in part a follow-up to my post two weeks ago, which argued that parties of the centre-right that adopt unpopular right wing economic policies are attracted to high profile socially conservative policies like cutting immigration or Brexit. Unfortunately that strategy over time legitimises political parties that are more socially conservative and authoritarian, so the centre-right can end up fighting on two fronts, or itself become more socially conservative and authoritarian.

I received some interesting comments on that post. One was that some of Thatcher’s and Reagan’s economic policies were quite popular, so how did that fit into my assumption that Conservative economic policies were unpopular? Others wanted to explore the role of the main centre-left party in this dynamic process. This post tries to answer both questions by widening the time frame, but restricting my attention to (mainly) the UK.

I increasingly see the core of neoliberalism in practice as being about economic power, rather than some abstract idea about the benefits of markets and the dangers of government interference in them. Before Thatcher, both the main political parties in the UK operated within a social democratic framework where the state held considerable economic power through the ownership of key industries, and workers had considerable power through the growing influence of trade unions. Economic issues were often discussed and resolved in a tripartite framework involving the state, trade unions and business.

Neoliberalism was about changing this radically, with trade unions losing almost all their power at a national level and significant power in the workplace, and the state largely deferring to business and corporate interests on key economic issues. Nationalised industries could be turned into profitable private sector businesses, and state functions could be out-sourced to the private sector. Increasingly the state was seen as enacting the interests of corporations and businesses. As these interests were whatever CEOs and shareholders told the government they wanted, it also meant that top tax rates were cut to supposedly improve firm performance, and the Conservative government put cutting taxes ahead of improving the provision of public services..

None of this happened overnight with the election of the 1979 Thatcher government, and some of the changes to a more neoliberal regime were (at least initially) popular. In the 1970s the public increasingly saw an association between trade union influence, a high level of strikes and high inflation, and so curtailing trade union power under Thatcher was popular among many. Selling off state assets, including council houses, often at discounted prices was also popular among many, although it was popularity with a clear shelf life as the government ran out of assets to sell and instead felt the consequences of a reduction in revenue. Tax cuts were initially popular, particularly when they were funded by North Sea Oil rather than spending cuts.

For all these reasons it is not surprising that gradually moving the economic compass from the left to the right might be popular at first. This of course was reflected within the centre-left party, with New Labour replacing more traditional Labour because the latter was associated with the less popular pre-Thatcher economic regime, and trade unions in particular. Many have serious misgivings about the extent to which New Labour accepted key aspects of neoliberalism, and of course popularity was influenced by a right leaning media landscape, but it seems clear to me that Labour were playing follower here, with Thatcher and the Conservatives taking the lead. (The response of the Democrats to Reagan’s success was similar in some ways.)

Yet one area where neoliberalism was not popular was in allowing public services to deteriorate in order to cut taxes. (This is often called ‘shrinking the state’, but privatisation aside in practice shrinking the state doesn’t so much mean the state does less things but rather doing the same things badly.) The substantial additional money the Blair/Brown government put into the NHS in particular was sufficiently popular (despite the higher taxes that came with it) that the Conservative party felt compelled to pledge that they would match Labour’s spending until the Global Financial Crisis gave them an excuse to do otherwise.

There can be no doubt that Conservative MPs, party members, the right wing press and party donors wanted more tax cuts and therefore to reduce public spending. On the ‘size of the state’, therefore, the Conservatives in opposition wanted to be well to the right of where public opinion was. I want to focus on this aspect of being economically right wing for the moment, and suggest later why other aspects also fit this pattern.

Cuts in public spending dominated the Conservative led Coalition government from 2010. It was justified by scare stories involving higher government debt after the Global Financial Crisis, stories that the media and enough of the public completely fell for. This deception was critical to the Conservative 2015 election victory, but the deception had an expiry date. Boris Johnson understood this, and he conducted a partial and selective reversal of these cuts when he became Prime Minister. This combination, of social conservatism but moving away from very right wing economic policies, seemed for a moment quite powerful.

However even under Johnson the associated tax increases proved too much for Tory MPs. Although partygate sealed his fate, it is far from clear whether Johnson would have wanted or been able to continue to undo the impact of Osborne’s austerity. We have now returned to a Conservative party intent on cutting taxes whatever the consequences for public services. On economic issues Conservative MPs are now well to the right of their members and voters, let alone the public as a whole

If we think about the one issue of the size of the state and the level of taxes, it is not surprising that Thatcher started as popular but over time the Conservative party became more and more out of touch. Lower taxes and a smaller state were not achieved overnight, but gradually over decades. Lowing taxes from 1970 levels (particularly if they were paid for by North Sea Oil) might have started off as popular, but as taxes and the quality of public spending were reduced further and further by Conservative led administrations that policy became more extreme and more unpopular.

To what extent has the Labour party allowed or facilitated tax cutting and shrinking the state? In government New Labour reversed it, but this didn’t stop the Conservative press writing endlessly about government waste and the Conservative opposition calling for cuts once they had the excuse to do so. Subsequently as the opposition, Labour found criticising the Coalition government’s actions increasingly futile as the media bought into austerity, so largely gave up. Conceding the argument may have helped lose the 2015 election, but it seems a stretch to suggest that had any influence on what Conservative politicians wanted to do. Perhaps pressure from Corbyn (after 2017) had something to do with Johnson’s limited and partial reversal of austerity, but I suspect it had more to do with needing to sell Brexit. I still think Labour has played a minor part at most in the Conservative party’s journey to the political right.

Other aspects of neoliberalism that might at first have been popular were always inherently at risk of losing that popularity. Privatised utilities could easily become natural monopolies that ripped off customers in favour of shareholders. Regulators were meant to prevent this, but if the government is not careful or is indifferent regulators can be captured, and we get the kind of situation we are now in with the water industry. There is currently widespread support, with caveats noted here, for renationalising many industries privatised under Thatcher.

Just as the Conservative party wanted to move further on cutting taxes and ‘shrinking the state’ than Thatcher, they also wanted to go further in outsourcing public sector provision. In particular, they increasingly saw the NHS as becoming a purchaser of health services from the private sector companies. While this might have gone under the radar for most people using the NHS, introducing the profit element with little evidence of compensating efficiency gains would mean the deteriorating services we are now seeing.

All this leaves one remaining puzzle. How did MPs from the UK’s most successful political party find themselves so divorced from public opinion on these critical economic issues? While in the past it has been claimed that the UK is a naturally Conservative country, such claims now cannot be true with Conservative politicians so far away from public opinion on economic issues. The answer isn’t just attachment to an ideology. In addition there is another dynamic that has been a theme of my posts for some time, which is how a party representing neoliberalism can easily become captured by monied interests to become a party representing the very wealthy.

The key moment in this transformation in the UK was of course Brexit. Although it is just about possible to rationalise Brexit in neoliberal terms, if we think about power, Brexit was far from neoliberal. The overwhelming majority of businesses and corporations selling to and from the UK suffered serious damage at the hands of newspaper owners and a few very wealthy individuals. This kind of capture of a neoliberal party by monied interests is not really surprising, because once a politician sees themselves as representing the interests of corporations and businesses generally rather than society, it is a small step to start representing the interests of particular and potentially unrepresentative corporations and businesses (and their ‘think tanks’), especially if those businesses happen to be newspapers or party donors or future employers. Corruption inevitably follows.

Which is why the Conservative party is stuck. If politicians in practice represent a selection of the very wealthy rather than the public then of course they prefer tax cuts to improving public services. It is why they believe the only hope of staying in power is to lead on socially conservative issues. As so often over the last few decades, many Conservatives will look to the US and the Republicans for how to get themselves out of this hole. All they will need, some (but not all) will suggest, is a leader with the charisma of Johnson (at first) or even, as Tim Bale suggests, Farage to sell what has truly become the nasty party. This is just one more reason why Trump’s fate in this year’s election for President will matter for the UK.

2024 will be the year UK fiscal policy became a sad joke

 

The media is full of stories about tax cuts in the Budget, stories encouraged by the Chancellor. Let's put aside the fact that the country really needs better public services rather than tax cuts. Let's also put aside that the economy will be far better off with additional public investment than tax cuts, but Jeremy Hunt is planning to reduce public investment over the next five years. Focus instead on the reality that any tax cuts the Chancellor makes will be a joke on the electorate where only he will be laughing.

To see why, it's useful to start with a similar joke it has been playing for a decade involving fuel duty. The government pretends that it will, in future years, uprate fuel duty in line with inflation plus a bit more. This increases OBR forecasts for future tax revenue, giving the Chancellor what the media calls extra ‘headroom’ to cut taxes. Then when each budget comes along the Chancellor announces they are freezing fuel duty, but just for this year.

Now any forecaster, seeing the government play this trick year after year for the past decade, would expect them to carry on doing it. But, to quote the OBR: “Parliament has stipulated that our forecasts be based on the Government’s stated policies and that we must not consider alternatives.” So the OBR is stuck making unrealistic forecasts.

It’s obvious why this trick is an easy win for the Chancellor. He gets to do the ‘protecting the motorist’ spiel in every budget by presenting the duty freeze as a ‘tax cut’, but gets to make any tax cuts look more affordable in the longer term than they actually are by pretending he will, despite his actions over the last decade, increase fuel duty in the future. The problem is that, when it comes to government policy, the OBR have to take the numbers the government gives them rather than do a forecast of their own based on the government's past behaviour.

Unfortunately Jeremy Hunt has found a new way to exploit this flaw in the way our budgets are done as we head towards the election, and its magnitude and importance is much greater. The Chancellor desperately wants to cut taxes, but does not want to break his fiscal rules in doing so. These fiscal rules, for whatever their flaws, are designed to stop Chancellors doing pre-election tax cuts (or spending increases) that they then reverse after the election because they were never going to be sustainable.

Hunt can get round this constraint because the OBR is forced to use the Chancellor’s numbers for future public spending in its forecast. All Hunt needs to do to ‘afford’ to cut taxes is give the OBR unrealistically low numbers for public spending after the election, and the OBR forecast will show he has room for tax cuts while still meeting his fiscal rules. Which is exactly what he did in 2023 [see link in postscript below].

It’s a joke he can keep on telling. With each new fiscal event (Budget or Autumn Statement), if the OBR’s forecast shows he doesn’t have enough room for another tax cut, he can just reduce the assumptions for future public spending until it does. Of course this makes a mockery of the UK’s budget process, the independence of the OBR and the government’s fiscal rules, but for this Conservative Chancellor and his predecessors politics and being in power wins out over all that. If you believed these Chancellor’s claims about being fiscally responsible then I’m afraid the joke is on you.

You might have thought that making unrealistic assumptions about future public spending should cause the Chancellor some political grief. They don’t, because the numbers for spending in four or five years time are just aggregates, and are not split down by department. The government can avoid difficult headlines by saying they will ‘protect’ spending on things like health, whatever these totals are. Fiscal experts, like the IFS, will do their best to calculate the implications for individual departments, but by then the headlines have been written.

Everyone who knows anything about UK budgets knows what is going on. Chris Giles was being very charitable recently when he said that the next budget will show us whether the Chancellor thinks he can win the election. The idea is that if he thinks he could win, it will be him who has to raise taxes after the election so he will be restrained in playing the tax cut trick now. If he thinks the election is lost, then he will have no problem playing this trick because it will be Labour that has to raise taxes after the election. Chris is being charitable because in reality Hunt will play this trick as far as he can whatever he thinks his chances are of winning the election, because as I said earlier for recent Conservative Chancellors power and short term politics trumps everything else.

In an earlier post I talked about how to mend this flaw in the UK budgetary process by giving the OBR more discretion. But that is not going to happen before the election for obvious reasons. As a result, fiscal policy in the UK will become a sad joke (or for those who already think it always is a joke, an even sadder one.). It’s a joke that those in the know will understand, but most voters will not. It will be yet another example of where the media is unable or unwilling to tell people the truth (because the truth might be 'controversial'), and instead actively misleads the public.

We can see something similar happening with the charade about the government trafficking some of those seeking asylum in the UK to Rwanda. The Rwanda scheme is a cruel joke. Cruel if anyone is eventually forced on to a plane to Rwanda. But a joke because the numbers planned are tiny compared to the total numbers claiming asylum in the UK, and for this reason alone the scheme will not act as a deterrent. If you think that I’m exaggerating the absurdity and pointlessness of the Rwanda scheme, read this by Ian Dunt.

As a result, journalists should be laughing in Conservative ministers’ faces when they talk about the importance of the Rwanda scheme, and repeatedly ask them why they are spending so much of their time and our money on this nonsense. Unfortunately most of the time this doesn’t happen. The result is that voters get seriously misled. About half of voters believe that more people seek asylum after crossing the Channel (‘illegals’) each year than migrants who receive visas (‘legals’), when the opposite is true by a mile. Because most viewers will not find this out from the newspapers they read, broadcasters need to make telling people part of their duty to inform and explain. Most of the time they just don’t.

So when the budget comes around, journalists will go through the same routines as they do for every budget, examining the fiscal projection numbers in great detail, even though those numbers are based on assumptions that are pure fiction. They will talk about the Chancellor meeting his fiscal rule, even though with any sensible assumptions about future public spending he wouldn’t. Political journalists will obsess over whether Labour will reverse Hunt’s tax cuts, even though Hunt will have to reverse his own cuts. In other words journalists, by treating these numbers as they would any normal budget, will be making sure the trick the Chancellor is playing will work.

This in turn tightly constrains what the Labour opposition can do. When it looks like a normal budget to voters, and is treated as a normal budget by the media, Labour calling it what it is - a sham - will probably be seen as far too high an electoral risk. Yet if they don’t say why the Chancellor’s tax cuts are built on sand, and will have to be reversed, they not only further legitimise the process, but they make life more difficult for themselves in government. If the media was more honest, so could the Labour opposition.

The best we can hope for is that anyone who gets a chance makes it clear that any tax cuts this year will be reversed after the election whoever wins. In addition, any government that wants to improve the dreadful state of our public services will need not only to reverse this year’s tax cuts but in addition to raise taxes further. But if this happens it will be the exception rather than the rule in both Budget and election commentary. Instead most participants will continue to pretend not only can you get better public services without additional tax revenue. They will pretend that any tax cuts made this year, or promised for the future, will be permanent rather than the temporary election gimmick that they actually are. 

Postscript (24/01/24) Here is the head of the OBR describing the public spending numbers he has to work with. 

Why the centre-right has helped cause the drift to the far right in Western democracies

The far right now holds power in Hungary, Italy and Argentina. Trump, undoubtedly a far right figure, has a good chance of not only becoming the Republican’s presidential candidate but also beating Joe Biden. Nigel Farage was welcomed at this year’s Conservative party conference. Tim Bale notes similar trends in other European countries. The tide is not uniform, as defeat in Poland shows, but it does seem as if the far right is both gaining ground and becoming more respectable in many Western democracies.

A key question is how much this drift has been caused by or facilitated by the actions of centre-right political parties. This could involve the actions of centre-right parties encouraging support for parties further to the right, or it could involve the dominant centre-right party itself moving further right. In this post I want to draw on some of my earlier discussions to answer why this might be happening.

A prior question is what we mean by moving further right, or far right political parties. It is, as ever, helpful to distinguish between economic policies on the one hand, and social policies on the other. What most seem to focus on when worrying about the far right is the latter, and particularly a trend towards more authoritarian policies that reduce democratic freedoms and which scapegoat and harm minorities like immigrants or welfare claimants. The argument I will put forward in this post is that, for some countries like the UK at least, it is the right wing nature of economic policies pursued by centre-right parties that lead them to adopt or encourage more right wing or authoritarian social policies, which in turn encourages the far right both outside and within these parties..

The first point to make, which I explored in this post, is that it is quite possible for centrist parties to attempt to ostracise rather than encourage or adopt policies from parties less near the centre. Famously Edward Heath fired Enoch Powell after his ‘rivers of blood’ speech. On the left Starmer has excluded many left wing candidates, including the previous leader Jeremy Corbyn, from standing as MPs. In a predominantly two party system, excluding rather than embracing policies further from the centre makes perfect sense in a simple model where the two main parties try to capture the support of the median voter, and where there is little risk of many more right or left wing supporters voting elsewhere or not voting.

But what if the centre right party is committed, for ideological or other reasons, to economic policies that are quite far from the centre ground? To get elected, it needs to do two things. First, it needs to focus its campaigning away from these unpopular right wing economic policies. This is possible if the centre-right party has substantial support in the media, which it often does. Second, it needs to focus on more social issues, and try to attract socially conservative voters who may also have relatively left wing economic views. This inevitably moves it away from the centre on these social issues, unless it can successfully paint parties to the left as very liberal. I will call this the ‘culture war’ mechanism.

Focusing the policy debate on social issues, like immigration or nationalism, in itself allows political parties with more authoritarian policies the space to attract support. It also makes it more difficult for the centre right party to ostracise more extreme views. For example, if the centre right party is focusing on the dangers of immigration, it is difficult to suggest a party that believes immigration should be curtailed further is somehow beyond the pale.

This problem, of parties further to the right attracting the support of voters, members or even MPs, becomes even more acute if, while in office, the centre right party fails to implement policies that satisfy socially conservative voters. The example of the 2010 Coalition government in the UK’s immigration targets is an obvious example. As I argued here, there are strong economic reasons why a centre right party would not want to strongly curtail immigration, but if it campaigned on the basis that it will it leaves itself open to challenge from a party further to the right.

In large part, political parties that campaign to strongly and quickly reduce immigration are involved in deceit, unless they are explicit about the economic costs. I argue this here, but Nesrine Malik probably puts it better when she writes “apparently vexingly high [immigration] numbers are, to a large extent, the outcome of economic and political decisions that mean we invite immigrants to fill labour gaps that policymakers either did not anticipate, or ignored warnings about.” In the UK this also involves filling gaps that the centre right party deliberately created in the public sector by reducing the relative pay of medical, social care or teaching staff.

There is a second mechanism by which a centre right party that is committed to strongly right wing economic policies may encourage the far right. Part of having a strong right wing economic policy typically involves wanting a smaller state. In this post I looked at the strong evidence that austerity in the 2010s played an important role in increasing support for the far right. The key point I made is that this link is not just (or even mainly) because voters are reacting to being poorer, but because when cuts occur or real wages fall socially conservative voters tend to focus on ‘outsiders’ who they either feel are responsible for these bad times or who they feel do not deserve their meagre share of a shrinking pie. In this second political dynamic, the ‘austerity mechanism’, it is the right wing economic policies that directly encourage support for socially conservative policies.

With both the ‘culture war’ and ‘austerity’ mechanisms we have the adoption of right wing economic policies (e.g. neoliberalism) by the centre right leading to increasing support for far right political parties, and/or a further drift to the right (in the social/authoritarian dimension) within the centre right party itself. In both cases neoliberalism creates a drift to the far right and, because the centre right party itself moves, encourages the media to make these more far right views respectable.

To the extent that the far right (or the more right wing centre right) party is about encouraging internal divisions within society (us and them), it is likely to become populist, where its leaders represent ‘the will of the people’ (us) against the elite, their supporters and outsiders (them). This in turn can provide the platform for policy that severely curtails human rights (the rights of ‘them’ of course), and actions that bias democracy in favour of the right wing party. Such actions can range from requiring photo ID at polling booths to mounting insurrections when an election is lost.

The relative importance of these two mechanisms will obviously vary from country to country, and my focus on these two mechanisms obviously reflects the national experiences I know most about. It leads me to be able to say, in the UK and US at least, that the centre-right has played a large part in the way politics has drifted further to the right over the last decade or so. In other countries the role of the centre-right in facilitating more right wing figures taking power can be much more direct, as Tony Wood describes in Argentina here.

Both the dynamic processes I have highlighted have been pursued by centre-right parties for ideological or electoral gain, but whether those gains will be sustained or indeed reversed over time remains an open question. This is because the strategy either creates a big threat to the centre-right party from further right, or it shifts the party further right than many of its politicians wish. Both could make the centre-right party less likely to win elections in the longer term, because it opens up space for an opportunist centre-left party, particularly if that party is prepared to suppress its natural social liberalism.

Will this lead to a re-evaluation of strategy within centre-right parties? From what I know there is no sign of centre-right parties moving to the left (and therefore towards the centre) on economic or social issues as yet. I suggest here that the forces keeping them where they currently are or moving further right are too strong, and these forces in the UK include the influence of the media, the membership and those providing political donations. (Andrey Tomashevskiy finds that parties which receive a greater percentage of their income from private donors tend to adopt more extreme positions on socio-cultural issues.)

If this analysis is correct, then the global political landscape for some time to come will involve both opportunities and distinct dangers. The opportunity is that centre left parties who are prepared to appeal to the centre ground will find it easier to win elections, as centre-right voters are put off by the drift to the right of centre-right parties. The danger is that a far right party (or a previously centre-right party that has moved to the right) will come to power and curtail democratic freedoms.

Unfortunately, as I have noted before, there is no way the opportunity and danger offset each other. Even if centre-left governments became more common as a result, democracy inevitably leads to changes of power. As we are seeing in the United States, even quite obvious threats to democracy can be insufficient in dissuading enough of the electorate from voting a far right party or leader into office. If a far right party comes to power and starts distorting democracy to entrench its own position this may become very difficult to reverse.

Postscript 18/01/24

On evidence that centre-right parties adopting socially conservative, anti-immigration policies helps rather than hinders the far right, see here 

For discussion of the success of the far right in the Netherlands, which is consistent with the 'culture war' mechanism described above, see here. (HT Anand Menon)

If the next government isn’t diverting resources to investment then it will be giving up on our future

 

To prove you are not a robot, click on the cars in this picture.

You might be surprised that this blog has featured the causes and consequences of flooding over half a dozen times. However this is the first time I have been able to illustrate one of these posts with a picture taken five minutes walk from my home. In case you are wondering, there are unfortunately three cars in this picture, almost completely submerged by flood water.

Flooding and the damage it causes illustrate three themes that run through this blog. The first is the harm caused by governments trying to hit arbitrary and unnecessary financial targets by cutting back on public investment. The 2010 Coalition government cut back spending on flood defences sharply, and we see the consequences of that almost every year when we get high levels of rainfall. The second is that most of the media invariably fails to hold politicians to account for these failures, either by choice or because the broadcast media prioritises getting reporters in front of flood waters over briefing them properly.

The third theme is the ability to ignore or forget expertise. In 2007 the Pitt review concluded that climate change would create more and more of the kind of events we saw last week (essentially because a warmer temperature means that clouds can hold more water), and while the Labour government acted on Pitt's recommendations by increasing flood prevention spending substantially, the review was ignored by subsequent governments and largely forgotten by the media. As we saw with austerity, Brexit and Covid, it is very easy for governments to do things that a majority (or even almost all) experts think is foolish, and yet much of the broadcast media thinks its job is to present Westminster gossip or political debates rather than inform its viewers about the knowledge we have. The BBC’s cut in funding for Newsnight is just the latest example of how it is ignoring its mission.

In this post I want to use flooding as an example of a fourth theme that I am bound to return to time and again over the next few years, and that is the scale of extra public investment, and incentives for private investment, that are now required. My last post talked about greening the economy to get cheaper and more sustainable energy. Flooding, and how to mitigate its effects, is an example of adaptation to the climate change we have already created and are bound to create in the future however quickly we green the economy.

Unfortunately climate change is just one of a growing list of problems that require more investment. The Covid pandemic demonstrated the need for additional capacity within the existing health system to rapidly scale up its ability to test and trace new viruses. Those countries, like South Korea, that had already invested in this capacity did far better at saving lives than most other countries. Yet, as John Burn-Murdoch showed here, the NHS has been deliberately starved of investment since 2010, as has spending on preventative care. As a result, we need massive investment in health just to catch up to where we should be, let alone help us deal with any future pandemic. [1] In addition, we need to make our public buildings (especially schools) more resistant to airborne disease transmission.

More than ever, we need the popular narrative on what governments should do to move from obsessing about government debt to obsessing about public investment. We owe it to future generations to mitigate the impact of climate change, prevent worsening climate change and deal better with future pandemics. Not doing so would saddle these generations with a burden far greater than paying a bit more interest on government debt.

However it is equally foolish to pretend that investment on this scale is costless in economic and political terms. With the major economies, like the UK, working at or near to a non-inflationary maximum, additional public and private investment requires a significant shift of resources from private consumption. As Martin Sandbu noted here, democracies are not well set up for such shifts outside periods of war. Instead politicians prefer incremental changes, where losers can be compensated if necessary. But as he also writes, “what choice do we have” if we want to avoid leaving far greater problems for future generations.

While higher public spending on day to day activities in such situations requires higher taxes, higher levels of investment paid for by borrowing will require interest rates to be higher than they otherwise would have been to free up resources for that investment. [2] We can already see the battle lines of the next election reflecting this, with the Conservatives saying that Labour’s “reckless” (meaning very necessary and beneficial) additional green investment will push up mortgage rates. This line to take may not gain much immediate traction because people remember the results of Liz Truss’s little adventure as PM, but it will remain an attack against any government that dares to invest.

If a future government does prioritise public investment over reducing its debt and keeping interest rates low, the biggest threat it will face is from simplistic (“populist”) political attacks which suggest that you can cut taxes while maintaining public services, invest without borrowing and attract the labour industry needs without immigration. It is therefore imperative that all parts of society begin to see the benefits from additional investment, particularly those areas that have been neglected in the past. This, in turn brings us an additional reason why public investment in the UK has to be much higher, and that is improving transport infrastructure outside London.

The United States under Biden not only shows what can be done, but the political fragility of any attempt to invest in the future. The Inflation Reduction Act has been stunningly successful at using public money to mobilise private investment to green the economy. Partly as a result, the US economy is much stronger than most other major economies, and inflation is coming down with the soft landing theory predicted was possible but which many economists thought improbable. Yet Biden is getting little credit for all this. Instead political commentators obsess about his age, and polls suggest a close race with would-be dictator Trump.

Flooding in the UK is inevitable, but the scale of damage it inflicts is not. Climate change is inevitable, but its extent and destruction it creates is not. At some point another pandemic is bound to happen, but how much illness and death it causes is a choice society makes. To have any hope of making the right choices requires cooperation within and between societies with governments taking the lead in investing today. It requires a relatively small current sacrifice for a far greater future gain. The ability to do that is part of our humanity, but unfortunately so is tribal division, falling for charisma and believing we can return to a romanticised past.

[1] We also, of course, need to spend more day to day on health, including paying NHS staff much better, but while investment spending should come from borrowing current spending should be paid for by raising taxes. For this reason I don’t think taxes on working people in the UK should be lower.

[2] There are two reasons why interest rates will raise. The first, and most likely, is that higher demand for labour (because investment increases) will lead the central bank to raise short term interest rates to head off inflationary pressure. This in itself will raise long term interest rates, including interest rates on government debt, by at most the increase in short term rates. The second, and less likely, is that long term interest rates on government borrowing will rise just because the government is borrowing more.     

The case for increasing government debt to green the economy is greater than for increasing debt during the pandemic

 

As the chart below shows, the story of UK government debt since 1900 (as a share of GDP) is a story of crises (source).

The ratio of debt to GDP rose rapidly during WWI, stabilised thereafter and then started to fall in the second half of the 1930s, only to rise again during WWII. After WWII it fell slowly but steadily, returning to pre-WWI levels by the end of the century. It rose again during and after the Global Financial Crisis, finally rising a bit more during the pandemic.

As I explained here recently, government debt is a device that avoids sharp changes in taxes or government spending during bad times. It is therefore entirely right that during a crisis, like a world war or a financial crisis, government debt should increase substantially. To put it simply, the alternative of raising everyone’s taxes sharply would only compound the negative impact of the crisis.

For example if governments had raised taxes during the 2009 recession then the recession would have been even worse than it was. Consumers would still have increased savings and reduced borrowing during the crisis, so consumption would have fallen further than it did because taxes were higher. When governments did try to reduce their own spending and raise taxes after 2010, it caused considerable damage.

It was therefore natural for governments around the world to treat the Covid pandemic as just the kind of crisis where government debt needs to rise, to help pay for additional government spending during the pandemic. In Europe that additional spending was mainly paying large sections of the workforce to stay at home (furlough), while in the US it involved much higher unemployment benefits and other payments.

I will take the case for additional government spending during the pandemic as given. This is not yet another post from me about the wisdom of early but comprehensive lockdowns before vaccines became available. What I want to ask here is whether the reaction of most governments to keep taxes unchanged was correct? The reason that question should be asked is what happened to household savings during the pandemic. Here is the UK, and you will see a similar pattern in other countries.

In financial terms, the pandemic was not hard for most (not all) households. Instead most ended up saving much more than normal. The reason is straightforward, and goes back to something I have written a great deal about: social consumption. Most people substantially reduced their spending on activities like going out to the pub, restaurants, entertainment and travel. Sometimes this is because they were told to do so, but there are good reasons to believe this would have happened to a considerable extent anyway as people tried to avoid getting the virus from others. Social consumption amounts to about a third of total consumption, so it was inevitable that most households ended up saving a great deal during the pandemic.

There was therefore substantial scope on average for governments to pay for their additional spending during 2020 by temporarily raising taxes rather than increasing government debt. Most consumers would not have had to reduce their consumption further because they were paying higher taxes. Instead these taxes would have simply taken the place of large increases in personal savings during the pandemic.

If the pandemic was not like previous crises in that there was scope for the government to raise taxes temporarily in 2020, that does not necessarily imply that is what they should have done. For example higher taxes of whatever type will not perfectly match to reductions in social consumption, so there might be important distributional problems in raising taxes. Higher taxes might have discouraged some from working whose work was vital to keep the country going. Perhaps higher taxes would have reduced social solidarity at a time when it was most needed.

Whatever your view on this, I hope it suggests that higher government debt during a crisis is something that needs justification rather than something that should happen automatically. But strangely we do not seem to be having this conversation about the biggest global crisis facing the world today, which is climate change. So far at least the need to green the economy has not led governments to pay for that spending using deficit funding. I have talked on previous occasions about why climate change, and the need to green the economy to reduce carbon emissions, should be considered as a crisis which requires increases in government debt. Yet very recently we have seen the German courts prevent their government from increasing debt to pay for financing climate change expenditure.

The case for using deficit finance to pay for greening the economy is far stronger than paying for furlough during the pandemic. Although in theory carbon taxes fit the polluter pays model, the reality is that government spending and financial incentives have been much more effective at encouraging green energy production. As with most government investment, it is not clear why the current generation should pay for something that will mainly benefit future generations.

Why do some within Labour worry about the Conservatives weaponising their £28 billion a year pledge on green investment, and propose cutting back on those plans? Perhaps its because throughout most of the media, reducing government debt is either considered more important than preventing climate change, or the two are not connected in people’s minds. I want to propose a collective New Year resolution. If anyone claims that it is important for this or the next government to reduce their debt to GDP ratio, please someone ask why climate change isn’t the kind of crisis that should see government debt rise?

How a Labour government could be the tipping point for public discussion about immigration

 

Just over a year ago I wrote about the tipping point in public support for Brexit. The tipping point (in reality tipping points) is when trying to make Brexit work becomes an electoral liability for Labour, and they would gain votes in marginal seats if they instead talked about rejoining the EU’s customs union or single market. Despite what John Curtice has recently said, I agree with Chris Grey that the tipping point will not be before the next election, but it will only be hastened if Labour win that election.

This post asks the same question for public views on immigration. They are obviously linked, because attitudes to immigration will influence attitudes to the Single Market. At the moment both the Conservatives and Labour are saying they think net immigration numbers should come down substantially, and a majority of the public still think immigration levels should be reduced. However since around the Brexit referendum, public opinion on immigration has shifted substantially, as this chart from the Migration Observatory shows.

At first some speculated that this shift was because Brexit voters assumed that leaving the Single Market had solved their immigration numbers problem, but that idea must have been well and truly shattered by the recent figures for net immigration. To some extent more favourable views about immigration may reflect a backlash against populist rhetoric. However in the UK I think instead the major reason for this shift is a perception that immigration is no longer about more people looking for a fixed number of jobs, but instead a realisation that immigration is in large part about firms or organisations needing additional labour.

In an important sense Brexit has facilitated this change in perspective, both because of the end of free movement and because of well publicised job shortages in particular sectors. John Burn-Murdoch presents evidence along these lines in the FT (see also here), but you can also see this if people are asked about immigration to particular jobs.

For most of these occupations, more people wanted an increase than a decrease in immigration, even though they would say they wanted less immigration overall.

In this respect immigration is a bit like taxes. If people are asked whether they would like lower taxes they generally say yes, but if they are asked whether they want lower taxes and lower spending on health, education and welfare they generally say no. Equally if they are just asked about immigration you are likely to get a different response than if they are asked about immigrants to staff the NHS, for example, particularly if they are aware of NHS staff shortages. Note that, just with taxes, these are not two equally valid questions. With our current immigration regime for sure (and in practice before that) a question that links immigrants to the jobs that immigrants will do makes much more sense. The gradual reduction in opposition to immigration since Brexit noted above may be because some people are making this connection without needing to be prompted.

If this analysis is correct, will this trend towards more favourable views on immigration continue? This may depend in part on the state of the UK labour market. With a probable Labour government committed to increasing growth, it seems likely that we will see a strong labour market for at least some of Labour's first term in office. This, together with the impact of demographic change (younger people are more liberal), suggests that the trend towards a more favourable view about immigration will continue. Working in the opposite direction is that, under a Labour government, the right wing press will go back to their pre-Brexit ways with stories about ‘waves’ of immigrants who live on benefits and steal jobs, and this in turn will influence the broadcast media.

The tipping point for Brexit is when a Labour government, whose politicians are not as constrained by ideology or their members/donors/newspaper owners, find it is no longer to their electoral advantage to pretend to be ‘making Brexit work’. This happens the moment Labour would gain more votes than they would lose in key marginals by, say, joining the EU’s customs union or single market. In principle this shouldn’t just depend on what voters tell pollsters about these options, but also indirect effects like benefits to growth.

Is there a similar tipping point for immigration? As with Brexit, that tipping point would be well beyond half of the population taking a favourable view of immigration. This is because our electoral FPTP system is biased towards social conservatives, so taking a pro-immigration stance could still harm Labour in marginal seats even if only a minority of voters want less immigration.

However I’m not sure Labour have the luxury of waiting for their pollsters to tell them the tipping point on immigration has been reached. In this respect immigration is not like Brexit. With Brexit Labour can move gradually in the direction of greater cooperation with the EU from day one, and judge the viability of key steps in reversing the Brexit process. With immigration Labour will find it much more difficult to talk about numbers being too high initially, and then switch to stressing the benefits of immigration later on. In other words, with Brexit the direction of travel is the same, whereas with immigration it is not.

Labour’s discourse on immigration today, in opposition, is almost too easy. With the Conservative government simultaneously presiding over record immigration, and its MPs demanding immigration be lower, Labour’s work is being done for it. Those voters that want lower immigration will think the Conservatives have failed them, while many others will be rightly appalled at Conservative rhetoric and actions on asylum.

The situation will become very different after Labour has been in power for a year or two. The Conservative opposition (including its press) will be saying immigration is too high, and now it will be a Labour government that will be seen as responsible for immigration numbers.

Any government, Labour or Conservative, faces a strong trade-off with immigration policy. Actually restricting the ability of immigrants to fill jobs in the UK hurts the economy, which is why successive governments (of both parties) have been very reluctant to do this. Instead governments tend to resort to different sorts of gimmicks or cruelty, where Sunak’s latest measures are a prime example of the latter. However neither gimmicks or selective cruelty will have much impact on immigration numbers, and so over years those who are concerned about immigration numbers will turn on the government. A government that talks the talk on reducing immigration but fails to bring numbers down is storing up trouble for itself.

With popular attitudes to immigration becoming more divided, an alternative approach which Labour could follow may be politically wiser. Instead of seeing immigration as a numbers problem, Labour could instead focus on the role immigration plays in helping the economy. It could actively oppose the Conservative narrative, rather than presenting a slightly milder version of it. By presenting the benefits of immigration in terms of additional output and better public services, it could strengthen the growing numbers who are in favour of immigration for specific professions. It might even make pollsters stop asking questions about immigration in abstract, and instead link immigration to the jobs immigrants do. [1]

Taking this approach would mean no targets for immigration numbers, or even aspirations to reduce numbers, as the media will treat these as targets. It can involve improving pay and training to reduce the need for immigration to particular sectors, but if that influences immigration numbers at all it will take many years to do so. Labour could also talk about the contribution overseas students make to universities, and how they save taxpayers money. It could talk about the UK taking its fair share of refugees, rather than trying to pretend it can just take a selected few.

Is such a shift in rhetoric the pipe dream it may seem today? The key electoral argument for such a shift in approach from Labour is that the alternative of doing what it and Conservative governments have done in the past does not work. Pretending to be concerned about immigration, but not doing anything significant to reduce numbers because of the impact this will have on the economy, has played a key role in bringing down three administrations. Immigration was the Conservatives main weapon against New Labour before the Global Financial Crisis, it was key in bringing about Brexit and the end of the Cameron administration, and it is currently doing Sunak’s government no favours either.

With the public shift in attitudes to immigration, the next Labour government may be the point where being honest with the public about immigration and the economy could pay electoral dividends. However to work effectively that change has to begin the moment Keir Starmer walks through the doors of No.10.

Have a great Christmas, and let's hope for a new start in 2024

[1] Such an approach will not convince those who oppose immigration on principle because of xenophobia or racism, but such voters will probably go to the Conservatives or another right wing party anyway.

Lessons (so far) from the inflation bubble of 2021-3

 

Inflation went up, but now it’s coming down again. Not just in the UK, but pretty well everywhere. What macroeconomic lessons can we learn from this, and what questions still remain? Were ‘team transitory’ right after all? Were central banks too slow to raise rates, and once they started rising did they rise too fast?

The preliminary point to make is that inflation is not the cost of living. A period where inflation goes up and then comes down again means prices end up a lot higher at the end of this period than they were at the start. Those whose incomes have not matched the inflation they have experienced will be worse off, perhaps substantially so. For some who were already finding it hard to make ends meet, that is a very serious problem, which has not gone away just because inflation has fallen.

What should now be well understood is that this period of high inflation was not just about high energy and food prices. There were additional supply problems that pushed up prices, but more importantly labour markets in most of the major economies were also tight. Almost without exception, unemployment in 2022 was lower than at any time this century in the United States, Germany, France and the UK.

This meant that any increase in energy and food prices was likely to lead to some increase in wage inflation. This in turn would make the inflationary shock caused by higher food and energy prices more persistent, because firms not producing energy or food would pass on much of any increase in labour costs. To avoid this turning into a permanent increase in inflation, central banks raised interest rates in the US, UK and Euro area.

Were central banks too slow in raising interest rates? It is important to understand that central banks cannot and should not try to always keep inflation at target. When the relative price of commodities increases, it would be deeply damaging to try and reduce all other prices so that aggregate inflation did not rise. So there was always going to be an inflationary bubble in 2021-3. The issue is whether central banks could have moderated it more than they did.

It is also important to remember that in 2021 the main concern was and should have been ensuring a full recovery from the pandemic. Few anticipated the size of the inflationary shock (i.e that Russia would invade Ukraine, or that there would be so many supply side bottlenecks), and the pandemic made it difficult to read the state of the labour market. My own view, and in contrast to many others including various Lordships, is that central banks were right to delay raising rates until 2022. Once they understood that the recovery from the pandemic had been strong and that as a result the labour market was tight, they acted by raising rates pretty fast.

The fact that inflation is now falling quite rapidly strongly suggests that central banks have done enough to stop this energy and food price shock leading to permanently higher inflation. What we don’t know yet is whether they did too much, because the lag between nominal interest rate increases and falls in economic activity can be quite long. [1] However we can still make one important point.

When inflation was near its peak some economists (let’s call them the inflation pessimists) argued that a significant period of depressed economic activity would be necessary to bring inflation back down to be close to the 2% target. Only when unemployment was significantly higher than it is today, they suggested, would wage inflation start to fall back towards levels that are consistent with a 2% target.

We now know that that argument is almost certainly wrong. Wage inflation has fallen in the US and elsewhere without any large increase in unemployment. Of course unemployment may still rise because of the delayed effect of higher interest rates, but it is a bit of a stretch in the US at least to suggest that falling wage inflation in the US is a response to expectations of above trend unemployment.

What is not often discussed is that current macroeconomic theory does not suggest a period of significantly higher unemployment is necessary to reduce wage inflation. In this sense the inflation pessimists could be accused of being old fashioned. The idea that ‘if it’s not hurting it isn’t working’ comes from a traditional Phillips curve, where price and wage setters only look at past inflation when forming expectations about future inflation. The key point about a central bank trying to hit an inflation target is that price and wage setters take the actions of that central bank into account when forming expectations.

If the central bank has credibility (an overused word simply meaning here that central banks will be successful in hitting their inflation target), then this anchors future expectations about inflation at the inflation target. Wage and price setters know that inflation will come down to 2% once inflation shocks disappear or excess demand is eliminated, and so form their expectations accordingly. In this situation, there is no need for a period of excess labour or goods supply to bring inflation down. To use another much overused macroeconomic cliche, soft landings are quite possible and should be what central banks aim for.

Of course central banks can still get things wrong. They may not do enough to eliminate excess demand, in which case inflation above target will persist. They also may do too much to deflate demand leading to a period of excess supply, which could lead to inflation undershooting it's target. This second possibility is still very real in the UK and Europe, although it is looking less likely in the US.

As De Grauwe and Yi show, getting inflation down in the 2020s has been much easier than in the 1970s. This is partly because the inflationary shock was more short lived (gas prices have fallen and post-pandemic supply disruption is over, although food prices remain high) so no permanent contraction in supply was required. However it is also because we now have independent central banks with inflation targets, and a recent history where inflation has been close to target (so these central banks have credibility).

If the inflation pessimists, who thought a period of excess supply and higher unemployment was necessary to get inflation down, have been proved wrong, have ‘team transitory’ been proved right? Well that depends on what ‘team transitory’ believed and said. For the sake of exposition, let me define team transitory as saying that inflation would have come back to target without the large increase in interest rates we have actually seen.

This question is difficult to judge, because we do not know what the path of inflation would have been if central banks had not raised interest rates so much. As someone who initially argued against the size and speed of interest rate increases, it would be nice to answer yes, I was right. A great deal will depend on what happens to economic activity and inflation over the next year or so. There seem to be two possibilities, and it is may be that the major economies end up illustrating both cases.

The first possibility is that the economy achieves a soft landing: inflation comes down close to target without any economic downturn relative to trend. If this happens, it suggests increases in interest rates were required, and in that sense team transitory was wrong. [2] The second possibility is if economic activity becomes depressed and inflation undershoots its 2% target. In that case central banks will have overdone their monetary tightening, and team transitory may well have been right.

All the indications are that for the US a soft landing is more likely than not. If this transpires then both the inflation pessimists and team transitory will have been wrong, and the Fed (the US central bank) will have done very well. For both the UK and Eurozone it’s too early to say whether we get a soft landing or not. But in the US at least, at the moment it looks like the experts in the central bank are rather better at managing inflation that many outside pundits. Not a popular conclusion I know, but also perhaps not a surprising one either.

[1] Part of the reason for this is that economic activity is influenced by real interest rates (nominal rates less expected inflation). Only now, with inflation falling, are real rates becoming positive.

[2] This assumes that higher interest rates reduce aggregate demand. As I argued here, the evidence is very strong that they do.