Category Archives: Economics & Finance

Reflections on economics, investment and the financial world

British economy: neither Tories nor Labour have the answers

The political parties are playing a blame game on the British economy.  Yesterday another report by the Institute for Fiscal Studies (IFS) was the unedifying battleground. This debate is interesting but unresolvable. And what matters is what the parties might do now if they were in charge. And on that neither Labour nor the Conservatives are convincing.

The controversy starts with the financial crash which began in 2007, and let to wider economic collapse in 2008 and 2009. The crash was a huge surprise to most politicians, and their electors. Before this steady growth of about 2% a year seemed to be a force of nature. There were squabbles about how best the proceeds of growth should be used. The downturn was very sharp, statistically the worst recession since 1945; comparisons with the 1930s are made. But in human terms things were not so bad as , for example, the early 1980s; we are a wealthier country with more fat to draw on – and unemployment did not rise as fast as earlier downturns.

But two things stand out. Firstly, thanks to steady inflation and frozen levels of pay, real incomes have been squeezed since the crash. Previously those in work tended to do better, but there would be more unemployed. Secondly the recovery was very slow – and not the rapid bounce back typical of previous recessions. There is a very powerful graphic in the IFS report which shows how average household incomes changed, adjusted for cost of living, which illustrates both points:

IFS household income

This shows that household incomes were level at first and then dropped steadily for the 22-30 age group until a year ago and then rose. For the 31-59s the squeeze levelled off at the end of 2011 with a gradual rise since. The over 60s have not done so badly, depending on how you measure their cost of living. Individually many people may be better off (things have get better as we advance through the age brackets), but overall the country has not recovered its economic standard of living.

The Labour narrative runs something like this. The economy was hit by a global financial crisis while they were in power, but a rapid fiscal response limited the damage. Measures included a temporary cut to VAT, as well as maintaining benefit levels, and, of course, a big bailout of troubled banks. In 2010 the Coalition took power and cut back these fiscal measures prematurely and increased taxes, causing standards of living to plunge, with only an anaemic recover since. Labour spokesmen claim, and their more partisan supporters fervently believe, that the government’s austerity has been a disastrous policy mistake, especially for the worse off. There is also a claim that the rich have escaped the pain and inequality risen.

The coalition counter-narrative is that the crisis in the first place was Labour’s fault, through profligate public expenditure and lax regulation of the banks. And the fiscal measures after the crash came at a staggering public cost, with a deficit of over 10% in 2010. This was unsustainable, and the current government’s austerity policies have saved the country from huge levels of debt and a huge future tax burden. If the recovery was anaemic, that was because of deeper weaknesses in the British, European and world economies. Now these weaknesses have been largely overcome, we are doing very nicely thank you. And a previous IFS study has shown that inequality has actually fallen, with the richest 10% paying a greatly increased fiscal burden – though admittedly things have been tough for the young and poor.

What to make of these competing narratives? I think the coalition argument is closer to the truth, even if they play up Labour’s mismanagement a bit more than is fair – not so much because there wasn’t severe mismanagement, but because that insight comes mainly from hindsight. But I’m biased and many learned people think that Labour’s narrative is in fact fairer. There is no decisive way of resolving the conflict, which requires the building of counterfactuals with economic models that are deeply flawed. But that’s the past and the important question is what is the best thing to do now.

And the answer to that question must start with this fact: the British economy is displaying a striking level of weakness. Three signs of this are worth drawing attention to. First is the lack of economic productivity growth. The IFS makes much of this. Employment levels are quite healthy, but this has not led to the levels of production that it should – which means there is no money to pay people more.  Economists have been stressing about this for some years now, but they have not provided a clear analysis of what this is all about. Personally I think a lot of it comes about from the diminution of the finance and oil sectors. The former’s high level of productivity was in fact a mirage; the latter is trying to make the best of ageing oilfields. I also think there is a wider issue in all developed economies, as we transition to a world where improved wellbeing does not depend on higher levels of consumption – which used to be the motor of economic growth.

The second sign of weakness is more concrete. Our trade balance, which was strongly negative before the crisis, is not getting much better, in spite of a weaker pound sterling. This is strikingly different from the previous recovery from a recession, in 1992 – when a trade deficit was converted to a surplus quite quickly, and was the first part of a period of continuous growth that lasted until 2008. Martin Wolf, the FT  economics commentator, has said that in the Euro zone an adverse trade balance was a surer sign of trouble than a fiscal deficit. He seems more relaxed in a UK context, but I think it is highly significant. The country is living beyond is means, and has not solved the problems that led to the 2008 crash.

The third sign is closely related – the other side of the same coin. The vaunted recovery is mainly led by increased consumer demand rather than increased investment. The public (as well as the government) is trying to borrow its way out of the crisis. A strong level of investment would lead us to be more relaxed about a trade deficit – but this is not the case. Investment is recovering, but not by enough. And levels of debt remain stubbornly high.

A lot of the problem is actually beyond the control of any government. It is down to the freely made choices of individuals and businesses, and changes in technology, not just here, but in the countries we trade with.  But we do need our politicians to be on the case.

The Conservatives are unwilling to acknowledge the current level of economic weakness. They keep talking about their long-term plan for the economy, but this mainly boils down to further austerity, mainly cuts to expenditure, to bring government finances onto a more stable footing. They hope that private sector investment will pick up, and focus on things that will improve efficiency and wellbeing, rather than the merry-go-round of property prices. But further austerity will cause public investment in infrastructure to suffer, as well as education. Further, the party wants to “renegotiate” the country’s relationship with the European Union and put membership to a national referendum. The country’s international standing has already been a victim of this policy. Since so much of the country’s fate depends on the wider world, this is sheer folly.

Labour gloat about the current weakness of the economy, but have few answers. I have not heard a Labour spokesman willing to talk about increasing the economy’s productivity. They have ideas to tackle some of the symptoms, like raising the minimum wage to deal with low pay, but have no answers for the disease. And the party lacks a unity of purpose. Its left wants an end to austerity and attack on private business bosses; others talk of devolving power from the centre but have little understanding of what this really means. They do not look like a coherent government in waiting.

Meanwhile there are plenty of things we should be talking about. Encouraging weaker local economies to develop without permanent subsidy from the centre; choosing the right public infrastructure investments; developing a more complete and rounded education of our children and young people; working internationally through the EU and other institutions to tackle multinationals and tax evaders. But these do not reduce to bite-size policies and 140-character debates. So we will keep banging away at the unwinnable blame game.

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Greece: can you have reform without austerity?

The standoff between the Greek government and most other EU governments continues. The other governments are happy to extend loan facilities, but only if Greece stands by the conditions it had previously agreed. For the Greeks that is anathema, because it means holding to austerity. Many observers here in Britain seem to sympathise with the Greek side. And they offer a middle way: reform without austerity.

Three columns in the FT make the case. I have provided links, but beware – the FT operates a paywall with a very limited number of free goes. First was the weighty (intellectually) Martin Wolf. He condemns the EU programme for focusing too much on austerity and not enough on reform. Austerity sucks demand out of the economy, causing mass hardship; reform would make Greece’s economy more efficient. Next came the intellectually much lighter Tony Blair: Two false paths for Europe – and a new third way. This puts the idea into more overt political terms, though conjuring up memories of his own British “third way” that was politically successful for a while, but whose reputation is now somewhat tarnished. As an aside this is interesting because it shows that Mr Blair accepts uncritically the basic left wing economic narrative – looser fiscal and monetary policy will lead to growth. On Monday was regular FT columnist Wolfgang Munchau: Athens must stand firm on failed policies. This is positively vitriolic about the EU conventional wisdom on austerity, which he regards as economically illiterate and a complete failure. This article contributes to the picture by exploring Greece’s options in the event of breakdown, including the intriguing one of the country printing its own money.

So what to think? Austerity refers to the reduction of public spending and the increase of taxation. It is considered economically counterproductive because it sucks demand out of the economy, which in turn knocks tax receipts – which makes things worse by creating a downward spiral. In Greece’s case the object of vitriol is the target that the government should run a primary budget surplus of 3% , to pay for debt interest, which comes to about 3%, after the recent restructurings (and a remarkably low figure for debt of 175% of GDP). Surely even prudent governments should be allowed a deficit in a recession? So what about reform? It is here that each of these commentators is awkwardly silent. Just what on earth do they mean?

Economic reforms to promote efficiency usually mean changes to product and labour market regulation to make them more open to free market forces. These are undoubtedly required in Greece.  But they promote short-term insecurity to jobs and businesses. They are not politically popular, and I doubt very much that there that the Greek public distinguishes between these reforms and austerity. They all part of the same hateful phenomenon.

And the problem goes deeper. Regulation tends to create public service jobs., which deregulation threatens. Besides it is the scale of the public sector, both in terms of jobs and transfer payments, that is a large part of the problem. In several ways this undermines a dynamic private sector. They tie up resources; they undermine labour markets, and so on. For too many people the way to wealth involves politicking rather than delivering things that people actually need and want. And so reform often means cuts – which is back to austerity.

In fact to find ways of stimulating demand without blocking reform is quite hard. There is the economists’ old favourite: investment. But efficient public investment requires an efficient state to direct it. Otherwise the money simply lines the pockets of well-connected people. Surely Greece is vulnerable to this? More bank lending? Another can of worms. Frankly I will not be convinced that reform without austerity is a possibility until somebody can spell out a programme which delivers it. The Greek government is proposing a reversal of both austerity and reform. Once again British (and American) economists are guilty of using macroeconomic analysis to skate over practical problems that turn out to be the very heart of the issue.

There may be some hope a middle way though. Perhaps some fudge around economic cycles can be used to cut the target for primary surplus. And there must be some opportunity to reshape the austerity/reform programme to put more weight on collecting tax from wealthiest – which the new Greek government seems much better placed to do that the last.  Alas I am too far away from it all to have any feel for how likely such a deal might be. All I will say is that British commentators are generous with the taxpayers’ money of other nations, but their credibility would rise if they suggested that British taxpayers should join in. All the talk of respecting Greek democracy would then be put into a clearer perspective.

Meanwhile it seems quite likely that there will be some kind of Greek default. Following Mr Munchau it looks quite likely that the Greek government would issue some form of electronic currency of its own, in the from of IOUs, to keep things going. This may well be against the letter of the rules for the Euro area, but it could buy enough time for a compromise to be reached. And perhaps the development of a safety mechanism for the Euro currency area. The Eurozone needs to find some sort of middle way between the inflexibility of a gold standard, and the creation of a federal state without democratic consent. Might what amounts to local currencies be part of this?

Meanwhile, as the saying goes, if something looks too good to be true, it probably is. That is surely the case for reform without austerity. Sorry Mr Blair.

 

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Economics in the age of information. Why are so many conventional economists wrong?

It feels an unequal battle. On the one side are ranged distinguished Nobel laureates, such Paul Krugman and Joseph Stiglitz, formidable intellects such as the FT’s Martin Wolf, together with any number of media economics correspondents, bristling with PhDs. On the other there’s me with a trifling 2:1 BSc (Econ) awarded in 2008 by UCL. But I’m hanging on in there. Clever as these people are, I think that they are working in the wrong paradigm. The world has changed but their basic views as to how the economy works hasn’t.

In my defence I can usually quote some formidable intellects, though, pronouncing very similar views to mine, such as Adair Turner or The Economists’ Buttonwood column. In this post I sketch a narrative that explains how this divergence of views came about, and why so much intellectual firepower might be ranged on the losing side of the argument.

My narrative pictures the developed world economy moving through a series of ages,  each of which required its own style of economic management and analysis. This is a giant oversimplification, of course. But then the science of economics is a giant oversimplification, and not physics applied to the human sphere.

I start my narrative in what I will call “the age of heavy industry”. This is not the beginning of the story, of course, just a good place to start. This is the century leading up to 1945. In this period economic development is led heavy industry and the construction of public facilities. These include infrastructure such as railways, ships, roads, and houses; intermediate facilities such as coal mines and steel works; and, we should not forget, armaments.  Other things were important, of course: agricultural development released workers from the countryside; the textile industry provided an important consumer goods sector. But world leaders saw their nations’ status in terms of the big, dirty, heavy things. Railways and steel works; dreadnoughts and artillery pieces. “Guns will make us powerful; butter will make us fat,” Hermann Goering said, capturing the spirit of the age. Such concepts as GDP were hardly developed; by modern standards rates of economic growth were unexciting. The view that inflation rates should be small and positive was alien, as the world swung between bouts of positive and negative changes to prices. Classical economics dominated conventional wisdom. “Working class” was synonymous with “poverty”, something which cut through political discourse, and many simply assumed was an inevitability.

After 1945, and starting in America,  this morphed into the age of light industry. Suddenly the domestic consumer became the leading driver of the economy. Technologies developed in wartime – such as plastics, motor vehicles, antibiotics – transformed the lives of ordinary people, and their production and distribution created stable blue and white collar jobs in a virtuous circle of job creation and consumption. Growth was led by increased consumption of ordinary things like cars and fridges; alongside this grew a service economy to support the growing wealth of ordinary people. The Soviet Union, stuck in the mentality of the age of heavy industry, was caught out completely, and in the end collapsed from a complete loss of faith in itself. All those steelworks, nuclear missiles and coal mines did not lead to economic power. Economically the management of GDP started to dominate everything, and an orthodoxy of demand management, whether through fiscal or monetary policy, became taken for granted. Arguments between different schools of economics were vitriolic, and yet they agreed on much. That inflation should be low but positive, for example, or that productivity growth would generate a steady, long term increase of national income, or again that distribution of income and the workings of finance were of secondary importance in economic management. And this is the world still inhabited by the those Nobel laureates, modified only slightly by recent events.  The problem with the modern economy, they say, is a lack of demand. It needs to be stoked up with fiscal or monetary policy; once this has been achieved rising productivity will get us back onto the road of steadily increasing income and the repayment of debt.

But the world has changed. Since the 1990s the age of light industry has been supplanted by the age of information. To understand this, think about a few ideas. First is the idea of satiation. People only need a certain number of things, after which increased consumption becomes pointless. There are still plenty of poor people, of course, but they are in a minority. and it is increasingly hard to understand poverty in terms of a lack of volume of goods in circulation. Many observers define poverty in relative terms, not in terms of physical benchmarks like nutrition and shelter. Thus you might be poor because you lack a flat-screen TV. Not because you need it, but because you feel excluded without it. It is clear that this kind of poverty is not going to be solved by cranking up the volume of goods produced.

Secondly, consider that often what people buy when they spend money is actually rather intangible. They pay a lot of extra money for the right label or provenance. These goods aren’t really being bought for their direct utility, but for what owning them says about the purchaser and where they belong. Again, these things aren’t driven by quantities that are consumed and plays havoc with quantitative notions like productivity.

Thirdly consider how the nature of technology has changed. Information and communications technology, and the services delivered by the new devices,  lead the way.  These advances are not, by and large, driving us into an ever rising cycle of consumption of physical things or even services. We are consuming experiences and information. and these things do not follow the standard laws of economics developed by Marshall and Walras who laid the foundations of modern economic theory.

And fourthly look what is happening to the nature of work. Those steady blue and white collar jobs are disappearing. Once they were considered demeaning and soul-destroying. But we valued the social stability they brought. Instead we have a world of work that is increasingly polarised, and where stability, in all jobs, is becoming rarer.

A further point is worth mentioning. Globalisation, and the rise world trade, especially between the West and the Far East has obscured many of these changes. Driven by the law of comparative advantage, developed economies gained from cheap manufactured imports in the 1990s and 2000s.  But this economic principle is driven by differences in the makeup of the trading economies. But each of the Far eastern economies, starting with South Korea and Taiwan and moving on to China, progressed and became more like the developed world. Comparative advantage, and gains from trade, are falling away. That party is now over. And as for the effect of global financial integration on national economic management… suffice it to say that this has profoundly changed the way nation monetary and fiscal policy works.

All these things point to a world that doesn’t follow the old macroeconomic patterns. Fiscal and monetary policies don’t seem to working as they once did. Variables such as inflation and productivity misbehave. These then join forces which old-fashioned economists understand, or should. Demographic change is reducing the number of workers as demand for labour-intensive health services is rising.

This creates a world in which economic growth cannot be assumed. Distribution of income and wealth becomes of primary importance, as does managing finance, and especially levels of debt. The world is ill equipped with economic models for this new age, and many distinguished economists are contributing nothing, especially when pontificating rather than basing their views on deep and up to date analysis of the data.

We have cause to be worried by the new trends, as it appears that much government and private debt might never be repaid. If that is gloomy, we should also reflect that this is a problem of success. The ages of heavy and light industry have achieved their wider purposes and left us with societies of unbelievable wealth and comfort. But we need to understand that improving the human lot requires a new way of looking economics.

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Syriza’s victory. This is going to end badly for somebody

Last weekend the anti-establishment, far-left party Syriza won the general election in Greece, and did better than most people forecast. Under Greece’s unique electoral system, which gives the largest party a bonus of 50 seats, they almost won an overall majority. Guardian journalists jumped for joy. For them it showed that their hated austerity policies can be challenged and beaten. Elsewhere there are quite a few calming voices; things can be worked out, seemed to be attitude. Both views are naïve.

First, in fairness, a couple of positive things need to be said about Syriza. The Greeks have been badly let down by their political establishment, represented in two political parties: New Democracy and Pasok. And yet it is these establishment parties that have been entrusted with sorting the mess out so far. Syriza are coming to government with fresh eyes and should be in a better position to clean things up and distribute the burden more fairly. They should certainly be given the benefit of the doubt for now.

And one of their central positions, that Greece should be forgiven much of its debt, is perfectly coherent. We need more caveat emptor from buyers of sovereign debt. Repayment of debts is not a sacred duty that comes before basic human needs. A more liberal attitude to debt is one of the ways in which progress can be made in unfamiliar economic environment we find ourselves in. There are, of course, trying consequences to such liberality: it will become more difficult to borrow.

That I think is were the more moderate commentators start. But difficulties with Syriza’s position start come thick and fast after that. This is what Syriza’s leader Alexis Tsipras said immediately after his victory:

Greece is leaving behind catastrophic austerity, it is leaving behind the fear and the autocracy, it is leaving behind five years of humiliation and pain. Your mandate is undoubtedly cancelling the bailouts of austerity and destruction. The troika for Greece is the thing of the past.

This is rage against austerity: the need to cut back government expenditure and raise taxes in response to the economic crisis. And this is what those Guardian writers like. The left wing narrative, applied to countries as diverse as Britain, France and Greece, runs something like this. In the 1980s a malign conventional wisdom infected the governments of the western world: neoliberalism. This sought to reduce the scope of government and regulation, and in its place rely on free markets.  All this did was to enrich an elite at everybody else’s expense. And it ended in banking madness that led to economic collapse in 2008. And yet these neoliberals remain in charge! They have used the crisis as a reason to pursue austerity policies. But these policies are an evident failure: everywhere they have been applied growth has been stagnant. When will the world come to its senses, reverse austerity and let growth return?

Syriza’s victory will test this narrative to destruction. The first problem is the debt renegotiation. Sovereign debt is about 175% of Greek national income. This sounds unsustainable. Surely all Syriza is doing is asking for common sense to be applied so that everybody can move on? But all is not what it seems. The size of that debt is a bit of an accounting fiction. Debtors have already conceded a lot on both interest rates and repayment schedules; the debt is not anything like as burdensome as the headline figure suggests.

And there are powerful reasons for preserving that accounting fiction. First, outright debt forgiveness is unpopular right across northern Europe – and not just Germany. Conceding ground on it will nourish the far right from France to Finland. And of course, it will undermine mainstream governments in Europe’s periphery: Portugal, Ireland, Spain and even Italy. The original Greek deal, put together with the hated Troika (the European Commission, the European Central Bank and the IMF) was an elegant compromise designed to balance these destructive forces. The best the Greek government can hope for is a bit more of the same fudge. Allowing Greece to drop out of the Euro and the EU would be very destabilising for the rest of Europe; but it is hardly clear that conceding a lot of ground to “renegotiation” (a euphemism I have always hated) is any better.

And then there are those austerity policies on which the Troika have insisted. These are often portrayed as economic nonsense by the left, because of their effect on aggregate demand, which leads to a sort of doom loop. That is indeed a problem, but their fundamental aim is to put the Greek economy on a sustainable footing. Government expenditure and taxation were way out of line with each other; Greek industry was internationally uncompetitive. Unless these problems are tackled no solution is credible, which means that nobody will lend the Greek government money. Read the more thoughtful “Keynesian” critics and you will suggest that stimulus is focused on initiatives that do not undermine sustainability – infrastructure investment is a favourite. And that, as I have pointed out before, is not as easy as it appears.

Now the Syriza leaders are not stupid, even if some of those Guardian commentators are. Elements of their programme address the issue of sustainability: improving tax collection and targeting the wealthy elite more effectively. But many of their promises seem to go in the absolute opposite direction – reinstating government jobs and raising salaries; reversing changes to employment protection.

Now it is possible to sketch out a fudged way forward; changing the balance of Greece’s reforms, allowing a little more short-term slack, and a little more debt rescheduling.  But how is this “leaving behind catastrophic austerity”? It is impossible for Syriza to meet the expectations it has raised. The Vox Pops broadcast by the BBC over the last week or so suggest that the Greek voters themselves largely understand this – which is one reason to think that maybe such an outcome is what is in store. Mr Tsipras will simply follow the trail blazed by France’s Francois Hollande. In that event it will be the far left in other countries that will be left empty handed.

But a Greek exit from the Eurozone, and the EU, is the other likely outcome. If that happens Greece will indeed have banished the Troika and liberated itself from its debt burden. But the austerity that the Greek populace have suffered to date will look tame.

There is very little middle ground. This is not going to be an easy year. Behind that we can see a flaw in the leftist narrative. The economic policies of the 1990s and 2000s did not just benefit a wealthy elite in developed countries; benefits were spread right across society, including an expansion of government programmes. But these advances were built on sand. Lacklustre growth since 2008 is shaped by fundamental economic forces. It is the new normal. We had better get used to it.

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Inflation – deflation. More evidence that most economists have lost the plot

The economic crash of 2008 took most economists by surprise. As a result many thought tha the discipline was discredited and that it would, or should undergo a rethink. Alas though we underestimated the resilience of conventional thinking. For example, commentary about Britain’s recent low inflation figures, and about inflation in other countries, is straight out of a pre-2008 text book. That’s worrying because the world faces huge economic challenges – while professional economists are looking in the wrong direction.

This week Britain’s lowest annual inflation figures on record – though I’m not clear exactly which set of records this refers to. Overall prices were calculated to have risen by just 0.5% in 12 months of 2014. There was a lot of talk about whether this was good or bad news. On the bad news front the commentators suggested that these figures might presage deflation – negative inflation – which is a Bad Thing. Bad they explained because it undermines demand because people defer purchases, Bad because it makes debts more difficult to repay, or Bad because it makes raises the floor for real interest rates, so making money supply tighter than it should be. Japan since the 1990s is then quoted as the spectre. Some economists will point out that some deflation is not bad – if it is a sign of increased productivity making things cheaper, rather than a spiral of decreasing demand.

What’s wrong with all of that? It is based on a logical fallacy that is so commonplace that most macroeconomists don’t seem to realise they are making it. In order to understand a complex thing like  a modern economy they have developed a series of aggregated statistics, of which GDP and its cousin economic growth, is one, and inflation is another. Fair enough – but for them these aggregates take on the properties of single, uniform phenomena. They then go further by inventing theoretical concepts such as “capacity” and “the natural rate of unemployment” which are unmeasurable and unreal, and pretend that they are real physical things. They then create a world rather anecdotal stories around this fictional world of statistical measures to convince themselves and others that this world is real. This fictional world is populated by people and businesses that are all essentially the same.

But reality is meanwhile diverging ever further from the fictional world. Let’s go back to that commentary on inflation. Will people put off purchases if prices are falling? The prices in question are largely fuel and food; deferral seems unlikely. And remember when the prices of electronic goods and imported manufactures was falling in the 2000s? Where people putting off purchases? It all depends on the precise circumstances – getting underneath the detail. Debts becoming easier to pay off if there is inflation? This depends on two things. Firstly that inflation must apply to your household income, so that it rises faster than the principal of the debt. Second that interest rates are less than the rate at which your income is rising. Neither is true for most people, or even close to being true. Inflation is not making debts easier to repay; deflation should not make repaying debts more difficult. And as for the business about money supply, this opens up a whole new parallel world that economists inhabit – that of monetary policy.

To work out what is really happening in the economy, you need to get behind the aggregated figures and ask what is actually happening and why. Most macroeconomists are unwilling to do this. They play with their aggregated statistics and focus on a fairly short to medium term policy options known as “fiscal policy” and “monetary policy” as if these were the only things that really matter. They remind me of Russian Tsars sending directives to distant provinces . We’re too busy and important to bother with the details; Just do what you are told and  it will all work out on average. And the world goes somewhere else, perhaps disastrously as was the case in 2007/08.

We have another case study in this muddled thinking: Japan. Macroeconomists are quite excited about Japan at the moment, because the current government is adopting a highly aggressive economic policies, following decades of stagnation. This includes an aggressive monetary policy that is straight out of the pre-2008 textbook – increasing the money supply and raising inflation expectations. This is not going particularly well, but the macroeconomists have a ready culprit – the Japanese have wrecked things through bad fiscal policy, since they raised the rate of VAT. Actually the fundamental problem with Japanese economic policy was that while prices were rising, pay (other than a few temporary bonuses) was not. In other words inflation has not proved the uniform phenomenon that economists assume. And that simply highlights that the main issue with the Japanese economy is the functioning of its labour market, not the conduct of macroeconomic policy (see this perceptive article in the FT from Bill Emmott). That and some severe secular trends that afflict all developed economies (demographic change, the evolution of the global economy, excess debt, accumulation of stagnant wealth, and changes to technological progress).

To be fair, the Japanese government, under its Prime Minster Shinzo Abe, has always been aware of this wider and more complex picture, and has been attempting to tackle the many roadblocks to change. For that prominent economists, like Joseph Stiglitz, call them “stupid”.

The world economy, and our individual nations, face huge challenges. We need new thinking. The laissez-fair (or “neoliberal” in leftist parlance) approach adopted in the 1980s has run its course. But the aggregate demand-management polices that preceded them are not the answer (I will not call them “Keynesian” out respect for the highly intelligent and flexible mind that Maynard Keynes possessed). Politicians and central bankers are grappling a range of practical problems that most macroeconomic commentators brush aside. and yet these commentators dominate the airwaves and newspaper columns.

Some of the outlines of this new thinking are quite clear. More focus on redistribution and public investment. Moving away from an obsession with economic growth. Tackling excessive debt. But these leave huge questions. For example: how do you tackle excessive debt without economic growth? I wish economists would turn their attention to these vital questions rather than rehash yesterday’s textbooks.

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Are politicians as stupid as Joe Stiglitz says?

Our politicians are being stupid. Thus says the eminent US International Festival of Literature in Cologne, Germany - 13 Oct 2012economist Joseph Stiglitz in a recent article The Politics of Economic Stupidity. In spite of its title, however, the article spends most it words explaining the economics, and actually says very little about the politics, beyond saying it is stupid in pretty much all of the developed world. He is venturing similar views to fellow US academic and Nobel Laureate Paul Krugman (who is even more vocal about stupidity) and the FT’s Martin Wolf (whose comments are more closely argued and less polemical). All three are formidable intellects. Why are they saying this? And why are their views having such little impact on those responsible for economic policy?

The starting off point is the meagre rate of economic growth enjoyed by developed economies (mainly the USA, Japan, the Euro area and the UK) since the economic crash of 2007/08. The politicians cheer from the rooftops if growth occasionally reaches the rate of 3% per annum. But all economies are well below where they expected to be at this point by forecasters in 2007. Growth is meagre and living standards for the median citizen are hardly advancing at all. After a recession you should expect a rapid bounce-back, and then a resumption of steady growth of 2-3%, referred to as the “trend” rate, observed since the 1950s.

The proximate cause of this slow growth is, as these economists have it, a lack of demand. In other words our economies are producing enough goods and services, but not enough people are buying them. This shouldn’t happen. Economics is a circle: what we pay people to produce things is spent by them, creating demand. Demand and supply should balance out. But this can go wrong. If people save too much, and this isn’t balanced by investment, then there can be a downward spiral, in a process brought to popular consciousness by the economist Maynard Keynes in the 1930s. This is what seems to be happening across the various world economies now.

The traditional answer to this problem is for governments to stoke up demand artificially and thus stabilise things. In recent decades the consensus was that he best way of doing this is through monetary policy, usually low interest rates. This encourages people and businesses to spend more; once they spend more the system stops leaking, growth picks up and things settle back to a nice even flow. This should all be a nice self-adjusting process which does not lead to worse problems down the track. But, as Mr Stiglitz points out, this process does not seem to be working. I think he is right here, as I have blogged before, although most economists are in various states of denial about this state of affairs – so central has a particular idea of money and monetary policy become in conventional economics.

That leaves a second weapon in the conventional toolkit: fiscal policy. This means that the governments deliberately spend more than they raise through taxes, creating extra demand that then plugs the gap. This has been the incessant cry of “Keynesians” ever since 2008. But this isn’t as simple as it looks. It is not self-adjusting the way that monetary policy is supposed to be. The risk is that you build a pile of government debt that cannot be repaid, causing another economic disruption down the track that undoes all your good work. Or to put it another way, it often means prolonging unproductive and unsustainable activities that will drag the economy down in due course. It is meant to be a temporary corrective, not a long-term solution.

But, Mr Stiglitz and Mr Wolf say (I’m not so sure about Mr Krugman – he has become so polemical that I’ve stopped reading him), there is a way to square the circle. There is a magic bullet (they don’t actually say that). Public investment. If fiscal policy can be directed towards investment projects it will be sustainable. These projects will generate a return from which government debt can be repaid, either through direct revenues, or through higher taxes. And when government borrowing rates are as low they currently are, it doesn’t take much of a return to achieve this. And yet the developed world governments are reluctant to do this. This is what Mr Stiglitz is calling economic stupidity.

But alas life is not so easy. Public sector investment is an elephant trap. Investment projects that generate their own revenues and collateral don’t need the public sector to run them. Indeed it is almost always better to let them run in the private sector, where management and accountability is sharper. And by and large all the easy ones are being done already. It leaves some big projects that turn out to be very risky – like, for example, Britain’s HS2 fast railway. And because they are risky they are slow to get up and running, and not much use as tool for temporary fiscal policy.

But there is another set projects where the returns are indirect – they come from taxes in various guises. These include things like roads and bridges (given the difficulty of charging economic tolls), schools and hospitals, under Britain’s NHS. But the returns are difficult to judge and projects are selected not through a process of objective rating of financial return, but through political arm-twisting in a bid for short-term prestige. And the more urgent the need to create economic demand, the worse in quality these decisions are.

Examples about. After 2008 China embarked on a massive and urgent infrastructure programme. But although the country remains underdeveloped, much of this money was wasted; whole cities have been built and lie empty. The Chinese government is now grappling with a rising tide of bad debts from the state banks that backed these projects. Japan in the 1990s invested massively in infrastructure projects; the country is littered with “bridges to nowhere” and its economic problems are as intractable as ever. In Britain in the early 2000s the country invested in a whole host of Public Private Partnerships. Many of these are turning sour because it turns out the facilities (notably in the NHS) were not actually needed. Though the political opprobrium surrounds the PPP structure, and the way that there was no real risk sharing with the private sector, we mustn’t forget the problem at the heart of it all – public sector organisations are very bad at choosing investment projects. (Actually private sector organisations aren’t any better if the accountability is weak – but that’s another story). I could go on with other examples of government expenditure that were sensible in principle but badly designed in practice (Labour’s Building Schools for the Future, for example).

The upshot is that public investment is no magic bullet. It’s a good idea, and we should do more of it – but a top down blitz directed by the need to rebalance the economy in the short term is asking for trouble. Each project needs to be properly thought through and well managed. That means you can’t get them going in a hurry.

So what to do? I think we need to be more realistic about the direction our economy is going. Things are changing. The demographics are adverse. The excessive wealth of an elite is economically inefficient. Modern businesses require less physical investment. Technological innovation is more about improving the quality of life than ramping up consumption. Economist such as Mr Stiglitz and Mr Wolf are well aware of these pressures. I think their time would be better spent helping us to craft long term solutions rather than ranting on about “stupidity” that turns out to be not so stupid after all.

 

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Polly Toynbee is right – we need more honest debate on tax and spend

I don’t approve of Polly Toynbee. She’s so deep in the Guardian bunker that she rarely has anything useful to say. She writes polemic that will entertain the left, but not persuade anybody else . So I wasn’t expecting much from her article last week Economic dishonesty is the deadliest deficit of all. I was expecting her to repeat the Labour myth that the economic crisis was somebody else’s fault, and that austerity policies have strangled the British economy. But she was making a point of value. It was that the Conservatives and Labour have very different views of the future government finance – but they were both concealing their differences.  The Conservatives do not want to spell out the implications on services and benefits; Labour do not want to look irresponsible, or to be painted as the party of high taxes.

She wrote her article before the Autumn Statement delivered by the Tory Chancellor of the Exchequer, George Osborne. Ms Toynbee should be pleasantly surprised at how things turned out, though I doubt that she is. The British government’s future policies on taxation and public expenditure have taken centre stage, and important differences have emerged between the political parties.

It started with some rather excitable coverage on the BBC Radio Today programme, which pointed out that Tory party plans for future spending would take it back to being the lowest proportion of national income since the 1930s. The bare statistics were factual (inasmuch as future projections can be described as factual) – but a comparison with the 1930s is farcical. National income is incomparably bigger than then – so a similar ratio of spending to income will not produce destitution that is in any way comparable. For similar reasons, the economic crash of 2008-09 is no way comparable to that of the 1930s, in spite of some of the ratios to national income being similar. Mr Osborne rather publicly objected to the coverage, drawing attention to the whole issue. Up to that point Ms Toynbee’s forecast seemed to be coming true.

In turns out that though Labour and the Conservatives are aiming at the same date to eliminate the structural deficit in British spending (i.e. cyclically adjusted spending less taxes), beyond that the difference between Labour’s spending plans and the Conservatives’ is as high as £27bn per annum. Differences on this scale are significant.

The next act in this drama was an attack by Mr Osborne on his Liberal Democrat coalition partners that they had lost the plot on economic policy because their plans were closer to Labour’s than the Conservatives. Danny Alexander, the Lib Dem Treasury minister, made a robust response about the impossibility of Conservative spending plans. Ms Toynbee, in typical Guardian bunker style, had painted the Lib Dems as indistinguishable from the Tories, so she would have been less than pleased about this – but not too upset since she no doubt thinks that the Lib Dems are a political irrelevance these days.

It is to be hoped that these spats are the beginning of a serious political debate. Up until now we have experienced manufactured political rows over the immigration, the European Union and the NHS. Admittedly the Tory preparedness to take big risks with Britain’s membership of the EU is a serious political issue – but the row is more about tactics and competence than strategy. On the other issues the politicians have very little of practical value to say. But the gap between left and right on state spending (I refuse to call it “economic policy” as most commentators do) foreshadows very different visions for how the British state should work.

The right has an economically liberal view of the state, with both state services and benefits being pared back, leaving more space for private enterprise and consumer choice. The left does not seem to have such a clear vision – much of its energy is being devoted to keeping public services and benefits as they are and avoiding serious questions about the future. That is a pity, because shifts in both demographics and the distribution of economic power point to a larger role for the state.

The problem with the debate, though, is that none of the political parties is being clear about what they want to do. It is good that we are talking about broad numbers on the size of the state – but this needs to be brought down to specifics. The Conservatives need to be clearer about what they plan to cut, and how they want to reshape benefits. Labour and the Liberal Democrats need to do this too – because their plans also involve big cuts. But they also need to talk about taxes. The Tories are quite right that the only tax raising idea that they will talk about, the Mansion Tax, is small beer.

Britain, along with most of the developed world, needs to rethink tax, state benefits and public services. I do not believe that they can be shrunk in the way the right suggests. But neither are they sustainable in their current form, as the left seems to think. That, not immigration, exactly who delivers health services, or even membership of the EU, is one of the critical issues of our time.

The more politicians debate these issues, the better. But if they obfuscate, then Polly Toynbee’s angry rhetoric will for once be justified.

 

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Labour should be taking credit for the coalition’s economic policy, not whingeing about it

“Too far, too fast.” Remember that criticism of the British coalition government’s economic policies? It was repeated incessantly by Labour politicians in the first years of the government. And, it appears, the government was listening. The actual trajectory of progress on the country’s massive fiscal deficit is close to what Labour were recommending. And economic growth has returned. So what are Labour saying now? They are vilifying the government for going not going far enough and doing it too slowly!

It is, in fact, quite hard to understand Labour’s political strategy on the economy right now. The party lacks credibility, according to opinion polls. It is natural for them to try and change the subject, to more comfortable topics like public services, but foolish to think that they can avoid talking about it. Following yesterday’s Autumn Statement by George Osborne, the Chancellor of the Exchequer, the biggest noise from the party was about the coalition’s broken promises. And indeed, back in 2010 the coalition’s plan was to eliminate the structural deficit by 2015; instead, it seems to be generally agreed, they will only be half way there. Progress is, in fact, more or less what was envisaged by Labour’s alternative plan. This sounds like criticising the government for following Labour policy.

It’s not a first. Labour were equally scathing about the government’s record on immigration, after its pledge to reduce net immigration to under 100,000 was spectacularly missed. And yet Labour was not advocating any policies that would have made this promise more achievable. Indeed it is not at all clear whether Labour would have done much different.

And there is a ready explanation for why both the government’s promises were not met. World events. Economic growth in the rest of the world, and especially elsewhere in Europe, has been below expectations. You can get only so far by rowing against the tide – and if you do on the economy, net migration goes against you. Of course neither promise should have been made (if indeed the deficit reduction plan can even be called a promise). They were dependent on matters outside the government’s control. This is obvious, and it is to grossly underestimate public intelligence to suggest that the anybody thought that the numbers were written in stone. What matters to the public is what the government should have been doing differently. And here there is no clear message coming from Labour benches.

What we get instead is a flood of expressions of discontent. Pay has not kept up with inflation (“the cost of living crisis”); the rich have been let off; we don’t like the public service and benefit cuts.  It’s all like the children’s complaint “it’s not fair!”. And the weary response of the public to this complaining is surely that of the child’s parent. It’s a difficult world. Could you manage any better?

What is the purpose of Labour’s relentless negativity? It is a poor way to attract votes to itself. Perhaps they just want to reduce turnout, or encourage Conservative voters to support Ukip? Perhaps they plan to flourish Labour’s vision of hope a bit closer to next year’s election? But the last time Labour won from opposition, in 1997, the message of optimism was clearly apparent by this stage. Labour seems to have an ambition to win a majority in Parliament with the smallest ever number of votes, by splitting opposition votes and persuading people to stay at home. What sort of a vision is that?

But I don’t Labour’s negative and confusing rhetoric is part of a cunning plan. It is a reflection of confusion that goes deep into Labour thinking, especially about the economy. The party has not admitted that it made major mistakes in handling the economy in the years up to 2007, at which point the economy collapsed. They mumble something about being a bit to easy on bankers. They also say that they should have been tougher on immigration, though exactly how, and whether this would have helped the British economy, is very unclear. Instead, in private, they complain that the criticism of their record is unfair, and that the public is wrong to blame them. It was the world banking crisis that did for them; and the government was not as profligate as it is made out.

There is an element of truth to these complaints. Few criticised the government’s record at the time, after all. But the party has to confront some difficult facts. First is that the party was clearly guilty of hubris before 2007. There most memorable slogan was “no more boom and bust”, which they shouted out at the height of a boom, and just before one of the most spectacular busts in British economic history. Shrugging it off and saying it was somebody else’s fault does not pass muster. And second is that the level of government services and benefits that prevailed at 2007 was unsustainable. It may have looked OK according to the size of the economy at the time (though that is debatable), but a lot of that economy was built on air.

What Labour needed to say back on 2010 and 2011, after having chosen their new leader, Ed Miliband, was that Labour had messed things up badly. They were honest mistakes, made from the best of intentions, and following the best advice, perhaps. But they were mistakes and the party must learn from them. But instead Mr Miliband fudged the issue, preferring not to provoke a big argument in his own ranks. At the time he wished to ride a wave of anger at austerity, and it was necessary to leave unchallenged the fiction that public service cuts were unnecessary.

It is too late for that confession now. But it can be no wonder than the party’s credibility on the economy is so weak. As one columnist said in this morning’s FT, you can think that the coalition economic policy is disappointing, a mess even, and still think that Labour would be even worse.

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Slow growth is not bad. If that means debt default, so be it. The world must change

Inflation expecationsThe state of the world economy is worrying economists. GDP growth is lacklustre in the developed world, which in turn poses problems for the developing world. That’s bad enough, but the economist’s nightmare of deflation – prices dropping rather than rising – now beckons around the world. And yet the prescriptions of most economists are shaped by a way of looking at the economy that belongs to the past. A paradigm shift is needed. Debt is at the heart of it, not GDP growth.

For a clear, conventional analysis of the issue read this week’s Economist.  Here’s a brief summary. The developed world economies are suffering from deficient demand. In other words, the economies could easily churn out more goods and services, using existing capital and labour, but don’t because people aren’t asking for the stuff or can’t pay for it. Another way of putting this is that the amount of investment (people spending money on building capital rather than the immediate consumption of goods and services) is less than the amount of saving (the amount by which people’s income exceeds the goods and services they consume). This leads to low growth rates. Now inflation is falling and deflation threatens. Deflation is bad, at least when low demand is its cause, because it makes debts more difficult to repay, and this gunges up the financial system, which makes matters worse.

The conventional answer to this problem, which also goes under the name of “secular stagnation”, is to reduce the prevailing rate of interest. This will encourage people to invest more since the returns to investment, compared to simply sitting on piles of money, would then be higher. But deflation, or low inflation, makes this impossible, because it raises the floor – the lowest real (after inflation) interest rate it is possible to charge. Answer: you raise the level of inflation. The method of doing this is to increase the money supply, since inflation is a monetary phenomenon. All sorts of ingenious ways are then dreamt up of how to do this. But this is all the product of a conventional way of thinking based on aggregate economic statistics, rather than what is really happening in developed societies.

There a number of challenges to make:

  1. Stagnation, in and of itself, is not necessarily a bad thing in the developed world. Surely the current level of consumption of goods and services is sufficient, in aggregate, to secure perfectly decent wellbeing for everybody – and economic growth is not the most efficient way to securing improvement to that wellbeing. And as we judge the potentially catastrophic impact of man’s demands on the planet it is clear that a system based on ever increasing consumption cannot end well. We need to make better choices about what we consume, and distribute the consumption more evenly. But economists seem to worry about the speed of the train, rather than where it is going, or even whether it has arrived at where the passengers want it to go.
  2. Inflation in the modern, developed world does not work in the way the economic textbooks suggest. In particular the rate at which monetary wages rise has become detached from the rate of increase of consumer prices. Macro-economic policies, like monetary policy, aimed at increasing inflation may feed through to consumer prices without doing much for wages. This completely undermines the supposed benefits of a little bit of inflation.
  3. Things are no better in capital markets. Reducing interest rates seems to have little effect on levels of genuine, productive investment. Such investment is driven much more by zeitgeist than interest rates. Excess money either chases a relatively fixed pool of existing assets (land and buildings and shares), or it simply piles up in bank accounts. This makes conventional monetary policy very hard.

We can look beyond these challenges to recognise some issues that might be behind these challenges. Interestingly, these are, for the most part, not particularly controversial amongst modern economists – it is just that they seem unable to accept the implications:

  • Distribution of wealth and income matters more than aggregates. This is the complete opposite of  late-20th century conventional economic wisdom. The problem is that wealthy people have too much income to meat their needs, and that there are inadequate channels to invest the surplus productively (as opposed to bidding up property values, etc.). To try and balance out the deadening impact of this, the answer has been to get poorer people to consume more by piling up debt. That would be fine if those poorer people turned into rich people later in their lives – but that is not what is happening. This is unsustainable – and yet most conventional economic advice boils down to cranking this system around one more time.
  • Modern businesses require much less capital investment than previously. The modern business giants of Microsoft, Apple and Google never needed much debt and did not need much capital to get going. This is simply the way that technology has evolved. There remains demand for public infrastructure: railways, hospitals, power stations and so on, but the risks and returns, and their often monopolistic nature, makes this a difficult area for private businesses, as opposed to governments, to lead. This is one aspect of what economists refer to as “Baumol’s disease” – the paradox that the more productive the efficient areas of an economy become, the more the lower-productivity areas predominate in the economy as a whole.
  • Globalisation has changed economic dynamics profoundly. Amongst other things it has weakened the bargaining power of workers – one reason that prices and wages are becoming more detached from each other. Also,  less talked about and perhaps controversially, I believe that globalised finance means that developed world governments have less control over their currencies and monetary policies. This is one reason why it is more difficult to use monetary policy to manage inflation. It is also the reason that Europe’s currency union makes much more sense than conventional economists allow – but I digress.
  • Technology is changing the way the jobs market is working. Many middle-range jobs, in both manufacturing and services, are disappearing. This week Britain’s Lloyds Bank announced the loss of 9,000 such jobs in its branches and back office. This, and not the flow of immigrant labour, is the reason why the labour market has turned against so many.
  • And finally, I think that many consumers appreciate that additional consumption, and the income to support it, are not the answer to improved wellbeing. It is better to stop earning and pursue low-cost leisure activities. I notice this most in middle-aged middle-class types like me – who are retiring early. It is perfectly rational. And yet economists can’t seem to understand why reduced consumption and income might be a rational choice for an individual. There is a tendency to tell us to go out and spend more for the good of the economy. This is a perfectly liberal and rational downward pressure on national income – which surely should be encouraged for the sake of the planet.

Some of the consequences of these trends are straightforward. Redistribution of income and wealth are now at the heart of political and economic policy, rather something that can be ignored. A much greater proportion of economic investment must be government-led, which imposes a massive challenge for political management. Governments and central banks trying to tweak the inflation rate by a few percentage points is a fool’s errand. Also trying to revive the economy by getting the banks to lend more money to poorer people is unsustainable, even if the lending is collateralised on residential property. The appeal by many economists, such as the FT’s Martin Wolf, that developed country governments should borrow more to invest in infrastructure makes a lot of sense. Using monetary policy to help finance such investment makes sense too. Making sure this investment is directed sensibly is a bigger problem than most allow, though.

And the conventional economists are right to worry. A world of stagnant growth and low to negative inflation creates major problems. In particular many debts, in both private and public sector, will not be repayable. At some point there will be default, since the other options, inflation and growth, are off the table. Or to put it another way, much of the financial wealth that many people currently think is quite secure is anything but, in the longer term. This may a problem for many pension and insurance schemes, as well as wealthy individuals and corporations.

The consequences of this are quite profound. Our society must break its addiction to debt. The banks and the financial sector must shrink. “Leverage” should be a rude word in finance. If low growth is the result, or if a new financial crisis is hastened, then so be it. Let us learn to manage the consequences better. Borrowing to support genuine productive investment (not excluding the building of new houses where they are needed) is to be encouraged, including government borrowing to finance public infrastructure. But other borrowing must be discouraged. Taxation should increased, especially on the wealthy. If that causes a loss of productivity, then so be it – this should be compensated by more efficient financial flows from rich to poor. Political reform must run in parallel to ensure that public investment is conducted efficiently, rather than just disappearing into the pockets of the well-connected.

This is a daunting programme. Stagnating national income and deflation are not inevitable consequences – since these policies do address some of the causes of deficient demand. But we must not think that these statistics are the lodestars of public policy. We need a much more nuanced appreciation of the wellbeing of our planet and the people that live on its surface, and put it at the heart of economics.

Such sound eco

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Why has the public bought the Tory narrative on the economy? Labour hubris

Opinion polls show that the Conservatives are the most trusted party on the economy. This gives them a big advantage over the Labour opposition, which they are trying to exploit by promising reckless tax cuts. The Tories say that the crisis was caused by the recklessness of the previous Labour government, which necessitated firm austerity policies, which in turn have led to a strong recovery. Labour supporters are sore about this, but their party leaders seem forced to meekly accept the Conservative economic narrative – and promise strict fiscal discipline. And yet economics writer Ha-Joon Chang writes in the Guardian that the Tory narrative is a fairy tale. Why aren’t the political class trying to challenge the narrative?

I am tempted to pick apart Mr Chang’s own narrative. He denies that the record of the previous Labour government was irresponsible, with the crisis in public finances simply inflicted by changes to the world economy. He further suggests that the coalition’s austerity policies to meet the crisis were misguided, and that the current recovery is not as good as it is made out to be. A lot of his claims are tendentious, and there is some sleight of hand with the numbers. But it is perfectly literate in an economic sense, and there is deal of truth in his claims, alongside the disingenuousness. This sort of argument tends to a turn-off for many of my readers. I would like to address the question he raises more directly: “Why did Britain’s political class buy the Tories’ economic fairytale?”

The first point is that we should remember the sense of shock that both the public and the political class felt as the scale of the economic crisis became plain in 2008 and 2009. This followed nearly 15 years of continuous growth in Britain. The political class felt that the economic problem had been cracked by Labour’s policymakers (though the first part of the growth period was under the Tory John Major). Gordon Brown, the Labour Chancellor in their part of the growth period, declared “no more boom and bust”. That caught the zeitgeist. Political thinktankers argued over how to distribute the proceeds of growth, which was assumed to be in the region of 2-3% for the foreseeable future. Mr Brown believed his claim; he was inclined to lecture political leaders from other countries (especially other European countries) on how wonderful his economic leadership was. And so when the economic performance proved to be so vulnerable, even if we accept that the shocks came from outside Britain, it was more than shocking. Our whole outlook on the British economy collapsed. And it must be pointed out that the scale of the economic crash in Britain was worse than in any other major developed economy. Labour’s claims were based on hubris. Any narrative that does not acknowledge this hubris (and Mr Chang’s does not, in this article at least) will not be politically credible. This trumps the fact that Tory claims about Labour’s recklessness are overdone or misplaced (e.g. because they criticise welfare policy rather than cutting income tax rates).

And that leads to a critical question. Why was the British economy so vulnerable? Was is really just a slightly bigger blip on a standard economic cycle, or were there elements to the pre-crash economy that were unsustainable? There are plenty of reasons to think it might be the latter. Inflation had been kept in check by cheap imports and a high pound, and yet there was a large trade deficit. The tax system had been tilted towards property transactions and capital gains, and away from ordinary income tax – which meant that the bust hit revenues very hard, and were difficult to revive in the recession that followed. The economy as a whole depended heavily on bubbly international finance and oil (whose price had just rocketed); amongst other things this gave a false perspective on productivity. Productivity based on fake profits in finance is not the same as the majority of workers steadily increasing their output. If you believe that there were substantial unsustainable elements to the economy, then you also believe that simple Keynesian stimulus would not be a path out of the crisis – this would be flogging a dead horse. That still leaves room for a respectable Keynesian critique of coalition government policy (especially if stimulus is concentrated on investments), but it also points to austerity policies being inevitable at some point.

And then there are the secular trends. There are the technology changes that, for now at least, seem to push economic rewards into minorities who either have the right skills or who own capital. That is a global trend. There are demographic changes; it is a boon that people are living longer – but that does imply structural changes to the way society works, and especially the tax and benefits system. And there is the growing up of the developing world economies, especially in China, which are no longer a source of ever cheaper imports. With such trends – and I could go on – is it any wonder that economic performance has been weak?

And so it should become clear why the Tory narrative is left to hold the field. An alternative narrative is very difficult to construct. To be credible such an alternative must contain challenging elements – that we can’t just bounce back to 2% growth by reversing cuts to public expenditure, as some on the left appear to believe. It has to acknowledge failings in the pre-crash British economy, and that strong well-distributed growth will be difficult to obtain in the future. Labour do not want to develop such a clear narrative, because they are reluctant to face up to their own hubris. In fact, as I have argued, Labour’s need to hold together its fragile coalition means that it does not want to develop a clear economic narrative at all.

And if Labour won’t produce the alternative narrative, who will? The Lib Dems are part of the coalition, and as such are happy to go along with most of the Tory version. They would emphasise that the austerity policies were not as austere as billed, and that borrowing for investment would be a good idea – but they do not challenge the main thrust. Ukip have decided to base their narrative on opposition to the EU and immigration – and as a result their economic policies have no coherence – they do not want to upset their own coalition of the angry. The Greens have decided to be the “Ukip of the left”, and blame all our troubles on failed neo-liberalism. They are against austerity policies, and yet want to rebalance the economy towards green growth, which surely implies a leaner public sector. This is a have-your-cake-and-eat-it stance, which will not stand up to close public scrutiny.

A credible alternative to the Tory narrative is hard to construct, and no political party wants to take the job on, because it would undermine their own wider political strategy. Mr Chang himself seems to acknowledge the problem in his rousing penultimate paragraph:

The country is in desperate need of a counter narrative that shifts the terms of debate. A government budget should be understood not just in terms of bookkeeping but also of demand management, national cohesion and productivity growth. Jobs and wages should not be seen simply as a matter of people being “worth” (or not) what they get, but of better utilising human potential and of providing decent and dignified livelihoods. Ways have to be found to generate economic growth based on rising productivity rather than the continuous blowing of asset bubbles.

Amen to that. But what chance do our humble politicians have of constructing such a wonderful narrative, when this poses so many unanswered questions? Might I suggest that Mr Chang spend more time suggesting “ways… to generate growth based on rising productivity” and not just joining the whinge-fest about our inadequate politicians?

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