Economics & Finance – Page 9

What TalkTalk can teach us about the modern economy

I don’t often read George Monbiot. He is far too polemical for my taste. But for some reason I read an article of his last week in the Guardian, and I found myself mainly agreeing.

The article was an attack on the idea that Donald Trump’s victory will bring prosperity back to the rustbelt. Its conclusion was that war is becoming more likely. That was not what drew me to the article, though. It was the way he invoked society’s failure to deal with complexity as one of the real cause of its economic and political malaise. And here he is onto something very important. He links to an article by blogger Paul Arbair as his source, which he rates as “the most interesting essay I have read this year”. Well, see for yourself by all means, but I found that the article uses a lot of words to say not very much that is new. Attentive followers of this blog may remember that I have raised this issue myself, through the book by Cesar Hidalgo, “Why Information Grows”.

The thesis runs that the human mind can only handle a certain amount of complexity, and that we find arbitrary ways of trying to make our lives fit within that limit. The result is that we are continually hitting sub-optimal solutions, and we find the world running away from us. In Mr Arbair’s and Mr Monbiot’s view this human capacity to manage complexity is one of the main limiting factors to our current society’s development. I agree.

Let’s now try to make this less abstract. Over the last few weeks I have been trying to get a new landline installed for my 90-year old aunt, who lives on her own and has never succeeded in grappling with mobile technology. How she lost her phone line in the first place is another revealing story, but the issue for now is how to get a new connection. This has involved dealing with a major phone company, TalkTalk – though I am sceptical that their competitors manage these things any better. This initially involved an hour-long phone call, which I could only start by working out how to break the system so that I could talk to a human being – albeit that the human being only spoke with an accent that I could understand 75% of the time over my mobile connection (my aunt herself, when her consent was needed at one point, could understand almost nothing at all). Whether intermediated by a human or not, it meant navigating a set of pre-mapped options, without access to any real context. For example we were told that she could not have access to her old phone number – but I had no idea what the problem with this was. On the date installation was due I called again (even though the line offered to check progress required you produce a current TalkTalk number to proceed – before a number had been allocated!) and was then told that the whole order had been lost. I started the process again, though, having thrown my toys out of the pram, I was talking to somebody more senior with a stronger command of English. I was given a distant future date for connection, which was blamed on BT Openreach, whose lines carry the calls. This date is later today; we will see what happens.

This story will be familiar to anybody who negotiates the modern world. At every turn you are made to conform to a simplified structure that makes as few concessions as possible to context. Navigation requires a degree of cunning on the customers’ part or they end up in a dead end. It often takes the customer a lot of their time – though suppliers limit any time spent by their operatives. And disappointment is usually blamed on somebody else. Companies that use a more contextualised, intelligent approach can’t compete in the market, apparently – or else they only can do so if part of an exclusive service aimed at the wealthy. There is a limit to the complexity that a company like TalkTalk can handle, and you must pay that price if you want to use their services. Many people, like my aunt, could not hope to navigate this system without somebody to do it for them. The many failures that this approach leaves are simply shrugged off.

Now let’s reflect that so many politicians and economists tell us that one our society’s biggest problems is a lack of productivity growth. But more productivity means more experiences like ordering a new phone line with TalkTalk. To most people it is simply replacing one imperfect world with another that is not necessarily better. Is it really any wonder that progress is so slow?

In my view, this kind of problem – information processing and our capacity to deal with it – lies behind many of our society’s problems, including the rise of inequality between people and regions. It hollows out jobs while leaving many human problems unsolved. And yet amongst the intellectuals who analyse society’s problems it seems largely unrecognised. We lack a clear language with which to communicate and analyse it. One important question, for example, is how much artificial intelligence can help, or whether it can help at all.

What is the way forward? We need to recognise that limits to handling complexity affect how efficient political and economic organisations can be designed. You have to be able to manage complexity somehow. One favoured method, used by the likes of TalkTalk, is to create a system of simple scope but far reaching extent – able to deal with a small number of needs for large numbers, millions, of people. This thinking is grounded in the way modern societies have embraced the world since scientific discovery took hold in the 18th Century. You tackle a large scope by breaking it into pieces and then examining each piece in depth. This gets you a long way – but how do you fit the pieces back together again?

The other to tackle complexity way is to broaden the scope but reduce the reach – deal with smaller numbers of people, but handle a much broader array of issues. This is a commonly used technique in business and politics. The 1990s craze of “business process reengineering” was based on the idea – I built a large part of my professional career applying it to financial services. But it has fallen from favour. It would be interesting to understand why – I think it is because there are strong incentives for business leaders to increase the size of their organisations, because their own wealth and prestige grows with it. This delivers a natural bias towards large organisations of narrow scope – even though these are not necessarily the most efficient. Our legal, political and regulatory systems have in inbuilt bias towards such large organisations too. When the BSE crisis hit the British meat industry in the 2000s, for example, the men from the ministry simply assumed that small abattoirs had to be closed down, and so produced regulations that made it virtually impossible for them to operate.

Which is not to say that the world does not need big businesses, and big government too – but we need to rebalance these to make small government and small businesses more viable – because these will deal with more complex problems more efficiently.

But what on earth will it take to make people realise that?

Britain’s economic outlook is dismal. We need a new direction.

Yesterday the British Chancellor of the Exchequer, Philip Hammond, gave his Autumn Statement. It was his first big set-piece in that role, and the time the government has attempted to set out its financial plans since the country voted to leave the European Union. Amid the noise and kerfuffle that such events generate, it is easy to miss the big picture: Britain’s politicians have no answer to a dismal outlook.

What drives my pessimism? The most important piece of public life that I am involved with is schools. Looking back over the last decade there is much to be proud of in this patch of inner London. The professionalism and dedication of school leaders and staff have grown. The imagination they have used to reach out to disadvantaged children is wonderful to see, and the results impressive. Where once teachers vehemently defended their little classroom empires against any outside scrutiny, and blamed poor results on social conditions, I now see a new generation of professionals, willing to accept advice and scrutiny, and enthused by a team mission to ensure that all pupils achieve potential. Political credit needs to be spread widely. The New Labour government started the process by putting pressure on London schools to break out of the tyranny of low expectations. The Conservatives sharpened the focus on teaching quality. The Liberal Democrats’ Pupil Premium policy led to a step-change in the treatment of disadvantaged pupils, and will be their most enduring achievement in coalition. But the clouds are gathering.

Education funding is being squeezed. London schools are funded generously by comparison with many parts of the country, and so the pressure is being applied there sharply. Teaching Assistants, who do not have professional qualifications, are feeling the squeeze the most – just that section of society that is finding it hardest to make ends meet. And services, slowly but surely, are under threat. Children’s Centres, which provided pre-school support, we the first to be hit. Now nurseries are under threat. A system that was tackling the gap between the haves and have-nots is slowly being dismantled. And this picture is being repeated across public services generally. Health and social care services are gradually failing to cope with the steady rise in older patients. Neighbourhood police teams have been cut drastically, choking the process of community links and intelligence gathering. And so on. All this is slowly creating a society divided by education and the lottery of property ownership.

The Chancellor offered us no hope of relief. The government budget deficit is still 4% of GDP, a level not usually thought of as sustainable. A large current account deficit shows that the country as a whole is consuming more than it is producing, as it has been for the last two decades. To be clear, neither of these deficits is a cause to panic. In current global economic conditions they look quite sustainable for a good while yet. But they show that there are limits to what the state can fund. In conventional analysis what is needed is a bit of economic growth, and more productivity from British workers. But, for all sorts of reasons, that productivity growth has dried up globally. Mr Hammond boasted that growth in Britain compared favourably with other developed world economies. That is not good news, because it demonstrates that the country’s problems are deep-seated and unlikely to be solved by a bit tweaking here and there. We are all in the same swamp.

What we need to understand is that these problems follow from profound changes in the world around us. Developed world populations are aging – by which I mean that the proportion of older people is rising and leaving the productive workforce. Technological change is wiping out working class jobs, pushing economic rewards towards a minority of professionals and the owners of capital. Globalisation was making things worse in some ways for developed economies, but provided solutions in others – but in any case it is slowing down as the Chinese economy in particular matures.

And to this rather gloomy picture we are adding wonton acts of self-harm. Climate change is helping to destabilise the world, creating waves of refugees. In Britain, Brexit will make things worse. It is not that economic integration of the type offered by the European Union was helping particularly, but the act of leaving the union is creating a colossal distraction for both government and businesses. It has also given populism, a turning inwards and the rise of charlatan political leaders bent on self-aggrandisement, a big lift, Donald Trump’s American isolationism promises to do more harm than good both inside and outside the USA.

Politicians left and right are responding mainly by trying to turn the clock back to imagined happier times. The right imagine a world of self-sufficient, ethnically homogenous nation-states undistracted by the pressures of global integration and technological change. The left fondly recalls a time of institutional Keynesianism and an ever-expanding state. Neither confronts the challenges of technological change and the need to heal fracturing communities.

So what about hope? We have some things to play with. The current younger generation is the best-educated and most cosmopolitan ever in the developed world. By and large they are not fooled by the lure of the past – one reason why they are so disengaged by current politicians. That their expectations of an easy, inevitable and prosperous life are being dashed means that at least they will be open to positive change. Technological change has its plus points too, by enabling cooperation and personalisation. The advance of renewable and energy-efficient technologies offers plenty of hope too.

But we do need to start thinking of different ways of organising political and economic activity. Ways that offer less power to corporate monopolies, and better able to tax and recycle their profits (perhaps the most persuasive reason for staying with the European Union is its ability to confront the multinationals). We also need to place less faith in highly centralised systems that struggle to deal with complex problems, while concentrating political and commercial power. We need better schools, better public healthcare, and stronger, local public services to support struggling communities – and controlled by those communities rather than the whims of politicians in a far-off capital.

As blogger David Boyle wrote recently, we are in a dark tunnel, but we need to press towards the light at the end of it, not try to turn back.

Making America small again. Trump’s victory marks the decline of the USA

“Make America Great Again.” That was the slogan of Donald Trump’s insurgent campaign to take the US presidency. It resonated with many Americans. They felt that the US had been subject to serial humiliations in its international dealings, and that Mr Trump’s more robust and confrontational leadership would help to reverse it.

But politics is full of paradox. To exercise power is to diminish it. Power accumulates to those who understand restraint. In Britain English and Welsh voters took to heart the slogan of “Take Back Control” and voted for Brexit. The country is now basking in the thrill of exercising direct power in its relations with its fellow European neighbours. And yet the result will be a medium-sized power adrift in a friendless world, seeking to trade freely when everybody else is becoming more protectionist It will be more rather than less subject to the whims of foreign powers. Britons may prefer it that way, but they will come to understand that the keys to “taking back control” actually lie in Westminster and their local council chambers, rather than in Brussels.

So it is in America. Mr Trump’s supporters will revel in the assertion their country’s direct power. And yet he will exercise this assertiveness in order to carry out a retreat. The result can only be diminishment, relegating the US to the middle part of a medium-sized continent.

Let’s look at some specifics. Consider the Trans Pacific Partnership (TPP): the multinational trade deal put together by President Obama. This was a central element of his Asian diplomatic strategy, designed to collect a number of Asian countries into America’s orbit in trading terms, conspicuously excluding China. Mr Trump (along with many Democrats) denounces this as a bad deal and will scrap it. That leaves a vacuum into which China is ready to pounce. It plans its own version of a free trade area, involving most of the same countries. Mr Trump has also questioned the value of America’s military alliances in the region. The clear message to countries there is that they must acquiesce with China’s increasingly imperial ambitions. The Philippines’ President Duterte looks a little less eccentric in his pivot to China. The USA is suddenly a much less important country.

Mr Trump’s promised assertiveness in trade relations with China makes little sense either. It comes at an important moment in the evolution of China as a nation. It has built its economy on international integration, especially with the US, and developed a large trade surplus in the process. But there is nothing particularly beneficial in a trade surplus – it implies that a country’s citizens are consuming less than they could – an act of self-denial. A trade surplus has political advantages – it makes you less beholden to foreign creditors – but China is already powerful enough for this not to matter much. So it is in the process of carrying out an economic pivot to develop its consumer economy, and away from integration with developed economies – though the scope for integration with less developed economies remains. An economic model where it exports less to America and integrates more with other Asian countries, and even African ones, suits it just fine strategically. Mr Trump means to hurry it along, but it will disrupt the US economy more than the Chinese one.

In Europe the issue is not so much trade. The proposed trade deal between the US and the European Union, TTIP, looks dead in the water without any help from Mr Trump. The main issue for Europeans is military and diplomatic support for the European countries against Russia in particular. Mr Trump has said that the current balance involves America in a disproportionate level of commitment. He has a point. If America steps back from its military commitments, and caves in to pressure from Vladimir Putin to create and extend a Russian sphere of influence, then it will put European countries in a very tough position. It is not very clear where this will lead – but one thing is very clear: America will be less important to Europe. This is not necessarily a bad thing for Europe, but it will be very uncomfortable.

And then there is economics. We are still guessing what will emerge from Mr Trump’s presidency – but there could well be a short-term lift for America. Some form of fiscal stimulus is in the offing. Mr Trump and his advisers hope to lure in US corporate profits that are stacked offshore for tax reasons, and to use the proceeds to fund infrastructure investment. Unlike many of his Republican colleagues, Mr Trump will be reluctant to cut state handouts, like pensions or healthcare – though health insurance is under threat. This could give a short term lift to the US economy . And, as this week’s Economist points out, much of this gain will be at the cost of other world economies.

That should please Mr Trump’s supporters. But the problems will start quickly. The stimulus is badly timed. In many aspects the US economy is running at close to potential output. All the stimulus might do is suck in imports and push up prices. But there may well be a lot of hidden potential in the US economy – more workers could be drawn into the workforce, and other workers could be made to work more productively. But if Mr Trump is serious about rolling back free trade and driving out foreign workers, then he will cut the capacity of the US economy when it needs to be increased. A financial crisis is in the offing.

The truth about the American economy is that, far from being taken for a ride and funding lavish lifestyles of foreigners, American consumption is being supported from abroad. This is what a trade deficit means. A transition to a more self-sufficient economy, as wished for by Mr Trump’s supporters, will entail economic shrinkage. Americans may rail at the loss of jobs in many industries, but they exchanged these for cheaper products, made abroad or with automated technologies, or both. Reversing that means reducing living standards.

Except that most Americans could still end up better off. If the country can share out income more evenly, with lower profits and higher wages, and more of those wages paid to middle and lower level employees and less to the top layer, then this shrinkage need not be painful to the majority. But what chance is there of a Republican administration, run by senior businessmen, achieving that? To Mr Trump exploitation is simply good business practice, and profits are reward for enterprise. There is no sign of a mindset that wants a different distribution of the fruits of economic success.

America and the world is in for a rough ride. But strategically it has been clear for a long time that American power, relative to the rest of the world, is in decline. That is not such a bad thing – it results from a fairer distribution of the world’s wealth. After the diminishment of Europe, it is now America’s turn. Mr Trump’s victory marks a big step along that journey. But it should surprise no follower of politics that he is claiming to do the opposite.

Fiscal activism makes a comeback. But it won’t help savers

Even the Prime Minister Theresa May is saying it. Low interest rates are not lifting the economy in the right way. So time for government spending and tax cuts to take over? Or, as economists call it, active fiscal policy. She joins a chorus of academic economists and newspaper commentators.

The story goes back to the 1930s when the Depression was rampant. This hit government tax revenues and the conventional wisdom was that government spending had to be cut to balance the budget. Enter the great economist Maynard Keynes.

Keynes pointed out that the problem with the economy was a shortage of demand – not enough people buying things to pay for the people in jobs. Or to put it another way, there was excess saving. If people are saving, they are spending less than they earn. That means that there isn’t enough spending across the economy to pay everybody’s wages, so the economy sinks. Or it will sink if the savings are not spent on investment, which is another type of spending. Stuffing cash into mattresses is not investment. Neither is putting the money into a bank account unless the bank lends it to somebody who in their turn pays somebody to do something. In a depression people are unwilling to invest, and so saving tends to be higher than investment. And so the economy enters a doom-loop. Before the 1930s economies were marked by severe boom and bust cycles.

Keynes pointed to a way through. If government increased its spending or cut taxes, they would put money in people’s pockets, which would be spent, neutralise the excess saving and bring the economy back to life again. Slowly governments followed his advice, most famously US President Franklin Roosevelt with his New Deal. The most spectacular success came in Hitler’s Germany, which spent freely on infrastructure (think of the autobahns) and armaments. Keynes pointed out that it did not matter what the spending was on provided it was spent at home, or at any rate it didn’t matter at first. As the economy approaches capacity wasteful government spending is a problem, but not before then. The rapid expansion of the US economy as it was placed onto a war footing in the 1940s proved Keynes right beyond doubt. Thus was born fiscal policy as an instrument of economic management, and economics as a discipline entered a golden age. The swings from boom to bust were notably reduced in the 1950s and 1960s.

Then it came off the rails. In the 1970s things changed. The first shock was the breakdown of the Bretton Woods system of managed exchange rates – it could not handle the excess of US spending on the Vietnam war. This destabilised the international financial system. Then came the oil shock in 1973, as OPEC ramped up oil prices massively. The governments that tried to spend their way out of the subsequent recession merely created inflation and not jobs. The governments that applied stricter fiscal policy, West Germany and Japan in particular, suffered much lower inflation. Enter another economist: Milton Freidman.

Freidman suggested that Keynes had it all wrong. The issue was not managing government spending and taxes, it was managing the money supply. The Depression was severe because the banking system collapsed, and people couldn’t borrow money. A lot of what Freidman said turned out to be nonsense, but what evolved was the neo-Keynesian consensus. This relegated fiscal policy to a relatively minor role. In the conventional wisdom of the time (often referred to nowadays as “neoliberalism”), government spending could easily get out of hand, destroy inventives and make economies less efficient. Instead the main responsibility for managing the business cycle came to something referred to as “monetary policy”, run by central banks.

Monetary policy is a bit of misnomer, a hangover from Freidman’s emphasis on money supply. To this day people often explain monetary policy as if people paid for things in banknotes, which are printed at will by the central bank. In fact money has moved almost entirely to accounting systems of debtors and creditors, with banknotes relegated to a very minor role. The economic implications of a bank account are utterly different from those of a pile of banknotes. The idea of money supply is nearly meaningless. Instead of that, as regular commenter to my blog Peter Martin put it in a post to Lib Dem Voice, what we have is interest rate policy. Money supply in the economic models taught to students has become a completely theoretical concept that cannot actually be measured . If demand is falling in an economy, this is corrected by reducing interest rates, which should encourage people to spend more. If things look like getting out of hand, then interest rates are raised.

Through the 1990s and early 2000s this system seemed to be working, but it came under increasing criticism. Central banks used inflation targets to judge whether the level of demand was too high or too low. But this measure excluded asset prices, which were directly influenced by interest rates. Asset bubbles were allowed to develop. Then they popped in 2007 to 2009, in the financial crash and the big recession that ensued, which interest rate policy proved unable to correct.

Fiscal policy made a return. But it was tentative. As soon as the worst of the recession was over, governments cut back (widely referred to as “austerity”). Critics argued that this was stalling any recovery. Then the victims of low interest rates, those saving for pensions in particular, started to get agitated. This is most evident in Germany – but Mrs May was voicing concerns amongst her constituents in the UK.

So can fiscal policy help lift economic growth, in place of low interest rates? There is a strong case for this, but caution is warranted. Most economic commentators hedge their bets by recommending that extra spending is on infrastructure projects, that will yield economic returns in their own right.

This hints at the first of three reasons for caution. What if the reasons for slow growth are structural and not to do with low aggregate demand? Are we making the same mistake as the mid 1970s, when economists saw high unemployment and low growth and assumed that this meant lots of spare capacity? In fact economies then had suffered a major dislocation from the oil shock, and were slow to adapt because of excessively unionised and corporatist economic management. That was then, but there are plenty of suggestions as to what the capacity restraints might be now, starting with demographics. Investing in infrastructure should help overcome these constraints, killing two birds with one stone.

The second reason for caution is that economies have internationalised. A lot of the benefit of fiscal stimulus can leak abroad, especially if other countries have a deficiency of demand too. Fiscal stimulus might simply drag in imports from countries eager for export-led growth. Globally coordinated fiscal policy works much better. This was achieved in 2009, but consensus has broken down since. The risk of stimulating other people’s economies can be reduced if the stimulus programme is carefully designed. But it can be quite hard to tell where best to direct spending or tax cuts.

And the third reason for caution is the difficulty in understanding when to turn the tap off and tighten policy. Politicians are prone to fiddling the figures to put the evil day off. British Chancellor Gordon Brown was notorious for this in the mid-2000s, contributing, in my view anyway, to the severity of the financial crash in 2007-09. Anti-austerity has become a political totem on the left – and yet there must come a point in any business cycle when austerity is required. This is also a problem with using infrastructure investment as the prime instrument of fiscal policy – it is not so easy to manage according to the business cycle. Lead times can be long and if an investment project is worth doing, it is probably worth doing at all points in the cycle.

And a final point. looser fiscal policy is unlikely to help savers with raising interest rates. Interest rate policy and fiscal policy should not be working against each other. To raise interest rates we need to see a healthier British and world economy. That looks some way off.

Does the fall in the pound presage a financial meltdown?

The British pound is now at its lowest effective (i.e. trade-weighted) level ever, according the Bank of England’s 168 year index. There was a sharp initial fall after the referendum to leave the EU, and then a further fall over the last week after the prime minister’s conference speeches pointed toward a quicker and harder exit than expected. Is this just a routine fluctuation that can be shrugged off, as bigger falls have been in the past, or does it portend something nasty? It is, of course, too early to tell.

The pound’s fall has been seized on by supporters of Remain as the sole piece of substantive evidence to support their prediction that exit would make Britain worse off. Leavers are predictably unimpressed. Of course both sides seek to gather every scrap of evidence to justify the stand they took in the campaign, and this argument leaves us none the wiser. This blogger is not beyond such things, of course, but I do try to set a higher standard.

The first question posed by the depreciation is what was the pound doing so high before the referendum anyway. The country has a large current account deficit. In other words, as a nation we are spending more foreign currency in imports than we are getting in exports and investment income (or persuading foreigners to accept more sterling than they want to spend on British imports – it boils down to the same thing). In theory this suggests that the currency’s real exchange rate is too high. This has been a persistent and to me perplexing phenomenon since the late 1990s. Demand for sterling has remained high, notwithstanding the deficit. Investment by foreigners in property and business assets (or Britons selling off overseas assets and repatriating the proceeds) has kept the pound afloat for 20 years – though at a much higher level before the financial crisis of 2007-09.

This is, literally, a confidence trick. Investors have had sufficient confidence in the British economy to think that their assets will grow in value in terms of their home currency, rather than ours. It is hard to pin down why for sure. Britain is an easy place for foreigners to do business – we don’t have a xenophobic attitude to foreign investment, sometimes seen in countries as close as France. That encourages footloose capital in our direction. We have seen many takeovers of great British businesses (notably this year the chip designer ARM). Buoyant high-end property values have no doubt encouraged investors too, though it is hard to quantify.

Britain’s membership of the EU is doubtless part of the charm of Britain, for business investors at least. They can set up operations here with ready access to European markets, free of tariff and non-tariff barriers. Leaving the EU, and its single market, must surely dent the country’s attraction. But we don’t know by how much. It won’t change the ease with which foreigners can buy assets here. By itself it should not affect high-end property either.

There is, therefore, a clear case to keep calm. As sterling takes a fall, it makes British assets cheaper. This should be a compensation enough for British exit to the EU, though you might be wise to stay clear of some businesses, like motor manufacturing. A lower exchange rate should help rebalance the economy, reducing the current account deficit, and the country’s dependence on foreign investment flows. This is all self-correcting. And if you are a true Brexiteer you will be confident that a more efficient, better balanced economy will eventually emerge from any transitional wobbles. That may be right – I always thought that the hair-shirt case for Brexit, as I called it, was intellectually their most persuasive argument (referencing a post I made in March which stands the test of time). Could EU membership have caused that current account gap, or allowed it to persist, leaving us with an unbalanced economy?

There is a problem, though. Capital markets are not rational. Nobody really understands how they work, and they are at least as influenced by a complex game of second-guessing short-term movements as they are by cool, calm assessment of long-term prospects. They are prone to bubbles: excessive periods of confidence followed by excessive pessimism.

You can see this by the way market observers talk about movements in prices being persistent trends, rather than asking what the right price is. This is at its most striking in the property market, where price movements are talked as “performance” rather than finding an appropriate level. A long view investor might say that the pound has simply found a new and more appropriate level. A short view investor might suggest that the pound has been performing badly, so that further falls are to be expected. In the former case you have would expect the fall to be limited, in the latter the fall becomes a self-reinforcing trend. And the difference comes down to a not entirely rational quality: confidence.

Confidence is not a nice, mathematically well-behaved quantity. It is prone to behaving in a very non-linear way. It can disappear suddenly. Confidence in Greek government bonds used to be nearly as rock-solid as German ones. And then it disappeared. Could confidence in the pound, and then other British financial investments, like government and corporate bonds, disappear just as quickly? Could the 20 year bubble burst? It doesn’t have to be rational. If it does the wider consequences would be severe. Inflation could take off as the monetary floodgates are opened (by the government funding itself directly through the Bank of England); bank lending could simultaneously dry up causing a recession. Back to the 1970s in other words when, amongst other things, a massive rise in oil prices caused a rapid rebalancing. Is Brexit a similar shock? (even accepting, as with high oil prices in the 1970s, we end up in a better place).

It is hard to believe that things will turn out like this. There are some signs of vulnerability: property prices are high; the budget deficit remains high by historic standards, and so is the level of the national debt. There is little scope to restore financial markets by cutting interest rates. Gilt yields have been rising recently – suggesting that confidence in government finances is starting to fade. And yet the overall statistics do not suggest alarm – foreign exchange reserves, for example, look plentiful. But ultimately if the country has a current account deficit, and if foreign investors don’t want to finance it, there will be defaults or inflation or both.

As the FT’s Martin Wolf points out, a financial meltdown is not likely, but the risk of it has risen in the last week. The capital markets have given Britain an easy ride through its recent troubles, but that could change quickly. The government needs to be very careful about how it handles Brexit. Sovereignty in an interconnected world is always incomplete.

The housing crisis is an opportunity for the left.

“A Britain that works for everyone.” This is what Britain’s Conservatives say they want to achieve under the new prime minister, Theresa May. Partly, of course, this talk is meant as an attempt to divert attention from the difficult choices implied by Brexit. But there is an issue that is slowly coming to dominate the life-chances of “everyone”, and could be even more important than Brexit: housing. Or to give this a bit more precision: the high cost of buying or renting residential property. In order to fulfil their slogan, the Tories will have to make progress on this. Will they?

What brought this home to me last week was a report that people born in the 1990s (the so-called millennials) are worse off than those born in the 1980s at the same time in their lives. This is startling for a society that has, generally speaking, benefited from economic growth over the last 30 years, and where educational standards are rising. And the reason is easy to see: compared to people born even ten years earlier, many fewer millennials can afford to buy their own homes. They are unable to benefit from a general rise in property prices that has proceeded apace over that 30 years. Meanwhile rental costs have gone up too, which only makes the gap wider. This phenomenon does not just apply to Britain’s overheated southeast – it afflicts most major urban centres, to say nothing of popular university cities like Oxford and Cambridge.

Why is this such a big issue? The millennials themselves are not particularly important electorally, especially as so many of them show little interest in the political process. But their troubles worry their parents. And the trend is evident from before the millennial generation. More importantly, the generations following the millennials will be equally deprived. The numbers of property have-nots are growing, and property wealth is being concentrated into a smaller number of hands. High rents is a cause of hardship for ever increasing numbers of people – and a cause of rising homelessness, with all the other problems that brings in its wake.

Politicians are increasingly aware of this. Conservative leaders are talking the talk. Mrs May has appointed a new cabinet level minister of housing, Sajid Javid, who talks of a moral crisis. All leading politicians talk grandly of building many more houses. But there are two political problems, which are linked. The first is that the crisis arises from a profound failure of market incentives. And the second is that any policy that actually works is going to hurt a lot of politically influential people. This combination presents a test for Mrs May that she is unlikely to pass. It is one of the few decent opening in British politics for the left.

First consider market forces. Read The Economist and you might think that the housing problem is quite simple at heart. It is a failure of supply to meet the increased demand for housing from a rising population and changes to lifestyle that mean more people want to live alone. And there is a ready culprit for this: restrictive planning laws and NIMBYs who resist new housing developments, which between them surround our cities with over-protected green belts. This glib explanation contains some truth, but it misses two awkward points: much land where development is permitted is not being developed because owners would rather wait – “land banking”; and loose monetary policy has pushed up the cost of housing regardless of supply and demand.

Consider the first point. Property developers profit massively from increasing property prices. Indeed, it is central to their business model. They like to build cheap houses to maximise their profits from land trading, fighting furiously any regulations that might make homes more thermally efficient, for example. It is not in their interests to increase supply to levels where the value of property starts to come down. For all their moaning, they are quite happy with the situation as it is – though they would love to get their hands on green belt land with permission to build, and bank that too. A similar logic applies to rental values, since so many new properties are bought to let. The economic incentives do not point to the private sector solving this problem by themselves. In fact many private sector actors are likely to oppose any policy that actually bites, since that means cutting rental and sale values.

The effects of monetary policy are less understood: by this I mean the way governments and their central bankers have had no real qualms about rising levels of debt used to finance private house purchases. This has been happening since monetary policy was let off the leash by the collapse of the Bretton Woods system of fixed exchange rates in 1970. The extra monetary demand for housing set off by this increased availability of finance has not been matched by an increased supply of housing. Indeed it is about this time housebuilding slowed down. Easy money has simply led to the inflation of land prices.

To illustrate this, look at this graph of the ratio of house prices to earnings from Wikipedia (By D Wells – Own work):

We should expect to see house prices rising in line with earnings, given its relatively limited supply. We can see that the ratio of prices is tied closely to monetary conditions. Monetary conditions were loose in the late 1980s (the Lawson boom), but had to be tightened as inflation started to get out of hand. That caused a crash that is seared into the memory of older Tory politicians – the years of negative equity. Then things eased, with the mid to late 1990s and early 2000s being years of easy money. The financial crash of 2008 tightened things up, but now conditions are loose again.

Of course easy money and land-banking are self-reinforcing. If property prices dip, property developers can be confident that monetary conditions will ease and come to their rescue.

If I am right about these two problems lying behind Britain’s housing crisis, the solution is quite easy to see. First there needs to be a massive public-sector house building programme, including a large proportion of good-quality social housing, available at rents well below the current market level. This is best done by local and regional authorities, and financed by allowing them to borrow much more. This would put downward pressure on rents, which is perhaps the most urgent aspect of the housing crisis. It would also make it much easier to tackle homelessness.

The second thing that needs to be done is to tighten monetary policy. This may be by using some form of quantitative control on housing debt, but it may also mean raising interest rates. The main idea would be to encourage banks to finance local authority housebuilding, rather than private mortgages. This will require political courage, as it means, for a time at least, property prices falling without making property more affordable (since it will be harder to get finance) – as happened briefly after the crash of 2008/09.

The good news is that the first of these two groups of policy is fast becoming consensus on the left – sweeping in Labour, the Greens and the Liberal Democrats. And yet it will be very hard for the Conservatives to stomach. They associate social housing with left-wing voters. It may also upset NIMBYs where the estates are to be built, to say nothing of hordes of people who have invested in property to let – all natural Tories. Tory politicians talk freely of raising large sums of money to push house construction forward. But I have not heard any talk of giving a serious boost to social or public sector housing, or giving local authorities more freedom. It sounds horribly like subsidies for the private sector that will end up by inflating prices and developers’ wallets further.

On the second issue – reducing the volume of private housing finance – I see little sign from anywhere in the political spectrum of this being taken up. This is unsurprising. It would mark a profound change in economic management, which is heavily based on monetary policy. And change would cause outrage in Middle England, attached to its property values. And yet the current way speaks danger. It is increasingly dependent on ever increasing property prices, as these lose touch with incomes. It is a bubble that will surely burst at some point. Even so, I am sure that the left is closer to this policy change than the right. One implication is that more of the load of economic management will be taken by fiscal rather than monetary policy. The left is much more comfortable with that, though I suspect few have taken on that it means supporting austerity at the top of the economic cycle.

Mrs May talks much of making life better for the hard-pressed in our society. Lower rents are surely by far the best way to achieve that. Does she and her party have the stomach for it? If not, the left will have its chance.

Globalisation has undermined economic autonomy by more than most people realise

“We are all in this together.” Thus spoke George Osborne, Britain’s Chancellor of the Exchequer in 2010, to justify the austerity policies of the Conservative and Liberal Democrat coalition. He meant that the burden of austerity should be shared right across society. Whether or not his government delivered on that promise, it is true in another sense. The world increasingly works as a single economy, and individual nations are losing their power to manage their own microclimates.

This is the message of a very interesting article in last week’s Economist. The immediate point of the article is to criticise Germany for its persistent and large current account surplus. This is making it harder for its neighbours, especially in the Eurozone. It is sucking demand out of the European economy; meanwhile, through its strong advocacy of budget discipline, Germany is making it very hard for other European countries to make up the shortfall, especially in countries like Greece, who arguably need it the most. This is an old story, which has been pursued many times by commentators such as the FT’s Martin Wolf; some recent IMF research just underlines the matter.

But the article goes on to make a wider point. There seems to be a wider contagion problem in global demand. In weak economies, demand falls, and one way or another this reduces current account deficits and increases surpluses. Weak demand directly reduces imports; a weak currency or pressure on wages makes exports more competitive. Greece has turned a spectacular deficit in 2009 into a significant surplus. But this reduces demand in healthier economies, spreading the weakness. There arises a cycle of doom, unless surplus economies, like Germany, start borrowing to stoke up demand. But there is little political imperative to do so: there are political benefits to surplus, which tend to strengthen the hands of ruling elites and allow greater stability. Financially secure deficit countries, like the US and Britain, might also do a bit to stoke up demand – but ultimately their deficits limit their capacity to do so. Sustained fiscal stimulus, as practised by Japan for example, really requires a current account surplus.

But this is only the start of global interconnectedness. Both inflation and interest rates seem to be determined more by world markets than domestic policy – in the developed world at least. Hence a remarkable convergence between nations as far a apart as Japan, Britain and the USA. The penny does not seem to have dropped amongst many economic commentators, though.

What accounts for this degree of interconnectedness? It was not so evident in the 1970s, when there was much more divergence between the major economies: compare that decade for Britain, Germany, Japan and the US. The most important single driver was the collapse of the Bretton Woods system of global capital controls, and the liberation of currencies to float where markets took them. There is a paradox here: these freedoms should in principle make governments more independent. Alas there are no free lunches in economics.

Free capital movement frees up countries to run large current account surpluses and deficits. In a system of limited capital flows a surplus country had a problem of what to do with its foreign currency earnings. Meanwhile deficit countries can find it quite hard to find the money to pay for imports. The decades before the 1970s were dominated by balance of trade crises. Older Britons will remember the devaluation crisis in 1967 (which I still remember though I was but 9 years old – such was its impact). In 1956 the US abruptly ended Britain’s adventure in Suez as it threatened to cut support for the UK currency.

Now governments find it much easier to ride imbalances of trade, though eventually deficit countries run out of road (Argentina comes to mind); surplus countries find things much easier, except every so often their foreign financial holdings can take a hit.

But the freedom to run up surpluses and deficits has also given rise to a dependency on global capital markets to fund businesses, governments and private individuals (typically to fund house purchases). The financial crash of 2008-2009 was only the nastiest episode of many, where events in one country shook economies far away. The British government of the time could not believe that a tumble in US sub-prime real estate prices could totally derail their own economy. Labour politicians still put on an air of injured innocence – though Britain’s dependence on global capital flows was positively reckless.

There has been an important second development, apart from the freedom of global capital, though: the rise of global supply chains, and of China in particular. It is hard to underestimate the impact of global trade and global competition on the world economy. This has led to the biggest reduction in world poverty in human history – but the impact on traditional industrial areas of the developed world has not been so benign. One of the most important consequences has been to change the dynamics of price movements in both the labour and goods markets. A rise in the price of goods does not automatically lead to a rise in wages, as it used to. In the 1990s and 2000s economists attributed the remarkable stability of inflation in the developed world to sound monetary policy. But the globalisation of supply chains was a large factor – which may have allowed monetary policy to be looser than it should have been, contributing to the eventual crash.

All this leads to a key question in the current world economy. Does the generally disappointing level of demand in the developed world arise from the lack of coordination of economic policy, rather than deeper factors like demographics and changes to technology? The recent G20 meeting seemed to suggest as much, but no concerted action was agreed upon. I have always suggested that deeper factors where more significant – but Economist article poses troubling questions.

And then there is a question of economic strategy. A global economic government is clearly out of the question. We only have to look at the struggles of the Eurozone to see that. So is there a way of regaining control of our microclimates, without throwing away the gains from world trade? This applies, incidentally, not just to countries, but regions within countries. Clearly the answer is not the free movement of currencies, as some Anglo-Saxon commentators like to think. But we do need to think about how to manage the movement of capital better, both internationally and within our countries.

Should central banks raise their inflation targets?

About this time of year the world’s central bankers converge on Jackson Hole, Wyoming for a conference. This is an opportunity for many to think about what this important set of government officials should be doing. To judge by the coverage in the Economist, one of the main topics is whether the developed world’s leading central banks should raise their inflation targets, from, say, 2% to 4%. The Economist thinks they should. I am sceptical.

Monetary policy, and in particular the manipulation of interest rates, has a special place in the neo-Keynesian conventional wisdom that became mainstream in government circles from the 1990s through to about 2007, when things started to go badly wrong. The idea was that economies are best regulated at the macro level through interest rate policy, alongside “automatic stabilisers” in fiscal policy; this replaced an approach centred on fiscal policy alone that fell apart in the 1970s. Essentially central banks cut interest rates when the economy needs a lift, and raise them when it needs cooling down. The way this is managed is in relation to an inflation target, typically of 2%. If inflation dropped much below the target, it was time for a lift, if it rose above, it was time to remove the punchbowl from the party, as one central banker put it. Inflation is the main way policymakers are supposed to judge whether an economy is running above or below its natural capacity, around a target rate which is supposed to be neutral.

For a decade or so this all seemed to go very well, as the leading economies experienced steady growth and low but steady inflation. Japan was the exception, as it suffered from deflation and weak economic growth – and the country’s central bankers and political leaders were much criticised as a result. It was all too good to be true. After 2007 all the leading countries looked like Japan, and proved unable to use monetary policy to give their economies the lift they generally thought was needed. Central bankers had to deal with low inflation and near zero interest rates, meaning that they could not use interest rate policy to achieve stimulus – since they could not reduce rates below zero (a boundary that some have tried testing more recently, with mixed results). They resorted to buying bonds instead (which they called “Quantitative Easing”). Amongst other problems with this policy, it threatened to blur the line between central banking an ordinary government treasury management. There remains little sign of a serious breakout from the lacklustre post-crash economics.

Hence the idea of raising the inflation rate target. The theory behind this is that it would allow central bankers to put more oomph into their monetary easing , once they have found a way to raise inflation up to the target. The advantage of a higher rate of inflation is that it becomes much easier for central banks to implement a negative real interest rate, should that be warranted. If inflation rates are 4%, and interest rates zero, the thinking is, people and businesses will rush out to buy things rather than watch their monetary assets shrink. That then corrects the imbalance savings and investment that they think is dragging economies down.

This idea is unlikely to get very far. The first reason, and probably the most important, is that allowing inflation to rise breaches what many see as a sacred bond of trust between a government and its people. This is something that liberal economists struggle to understand. To them money is just another tool to be used in the process of managing an economy; a means to an end. But many others have a different view – a theme explored by Lionel Shriver’s recent novel, the Mandibles. This sacred bond view is why linking currency to gold is so persistently popular. And it has particular strength in the US and Germany, in spite their very different histories. Using inflation as a state policy is abuse of power in this way of seeing things. At the very least it needs a democratic mandate.

This is no small political obstacle, though I personally incline the liberal economist view, and feel that gold used as money is an outright evil. But I am sceptical that inflation works in the way it used to in the world’s leading, developed and globalised economies. Raising the central bank target is one thing, but persuading the rate of inflation to follow in an economically constructive way is another (it doesn’t help if consumer prices race ahead at 4% while wages are stuck at zero).

What’s the problem? I think global markets for goods and capital have become so integrated that efforts to raise inflation are rapidly undermined. Furthermore wages and prices seem to be driven by different forces. Public expectations of inflation, the critical driver of inflation in the neo-Keynesian model, have lost their force. The idea that there is a universal rate of inflation reflecting the depreciation of money is an idea that is becoming distinctly unhelpful. Inflation, for example, does not make private debt more affordable if it does not feed through to pay (quite the opposite, in fact); and something similar happens to public debt, as tax revenues are more likely to be driven by pay than the prices of goods and services. This is a problem that does not seem to occur to many commentators on economics.

A further problem is how low interest rates or QE transmit themselves to raised prices anyway. The old idea of expectations being managed by the government and the central bank has signally failed in Japan, for example, when Shinzo Abe’s government tried to do just that. Companies did not want to raise pay unless they really had to, and would not raise prices of goods either. It is true that a loose monetary policy can cause the currency to fall and raise import prices – but this does not necessarily transmit to the rest of the economy. In Japan it took much bullying by the government of big businesses to have any effect, and their response was so grudging that no lasting change was made. Other governments and central banks may have even less power. Imagine how German firms would respond to the ECB saying they wanted a bit of extra inflation?

So what does a looser monetary policy achieve? First there seems to be a lot of idle cash. Money that hangs around unused does not stimulate anything. And then the prices of some assets may be raised, both at home and in wider capital markets, which the globally liberated world has made very easy, without the creation of new assets. In other words, asset price bubbles start to inflate.

In short the conventional neo-Keynesian theory should be given a decent burial for the leading developed economies. It is a bit different in less globally integrated countries, or in developing countries that are subject to rising in productivity where we can expect pay to be more buoyant.

Instead of chasing this particular phantom, economists and policymakers need to ask themselves more searching questions. Why is the rate of investment so sluggish, and unable to keep up with savings? Why is conventionally measured productivity stagnant? This is the real problem. And what if low investment and low growth are facts of life in a mature economic system, rather than ills to be cured? And meanwhile we economic chatterers might ponder the role that the constancy of money plays in the social contract, and how, perhaps, we take a bit too lightly sometimes.

The post-Brexit phoney war on the economy

Two months after Britain’s shock referendum result, and what has happened? Not a lot. Though you wouldn’t think it from reading the running commentary. So was Project Fear the hoax that the Leave campaigners always said? Probably not.

The few days after the result seemed to fulfil Project Fear more quickly than even Remain campaigners suggested. The pound fell sharply and many stock indices tumbled too. There was much talk of this or that investment being stopped, or this or that institution or business being under threat. Remain supporters have kept up the pace of alarmist talk ever since, to judge by my Facebook feed.

But Brexit campaigners have a point when they poke fun at this. When it comes to cold, hard economic statistics it is very hard to see much, or any, adverse impact. The stock markets have fully recovered. Retail sales, employment and prices all looked pretty healthy in July. The government still finds it laughably easy to raise money on the bond markets; the Bank of England’s currency reserves went up. Only that fall in the currency has persisted. And no doubt that reflects weaknesses in the economy before the vote – given the scale of the ongoing current account deficit. The various indicators that have taken a plunge represent sentiment rather than hard fact, and may have been contaminated by the sheer shock of it all, as might the gloomy reports from the Bank of England and the Institute for Fiscal Studies.

On only one thing can Brexiteers be disappointed. The remaining EU has sailed on just as smoothly as the UK, with the Euro strengthening significantly against the pound. This defies predictions of imminent panic and collapse gleefully made by (some) Brexit campaigners. No other country seems at all inclined to follow Britain’s lead to the exit. Even as the emerging kerfuffle on Italian banks is as good evidence as you might ask for about problems with EU rules and democratic mandates.

There is, of course, one possible explanation for this insouciance: denial. Maybe people think that exit is so hard, and will have such obviously dire consequences, that it will never happen. Speculation about the invocation of Clause 50 for formal exit pushes it further and further into the future. If so it shows remarkably little insight amongst the market makers. Any process by which the referendum result is reversed will be very messy, and entail a lot of collateral damage.

Personally I think people are putting too much faith in the markets’ ability to see trouble ahead. The signs that the 2008 crash was in the works were obvious more than a year beforehand, when the interbank markets froze. Strong enough, as I don’t tire to point out, for me to move my pension portfolio from shares into index-linked gilts and cash. The more perceptive would have seen the trouble coming a year before even that, when US property prices started to slide, threatening the foundations of the whole financial edifice. And yet the markets did not reflect the mounting danger at all.

And at the other end of the scale, when it comes to the multitude of small decisions taken by consumers and businesses that drive the short term statistics, there is also a sort of built-in inertia. Short term decisions quickly overwhelm intangible longer term worries. People don’t know what to do, so they carry on as normal.

There are two ways in which the Project Fear may yet turn out to be on the money. One is a slow decline that accumulates: slower growth turns to a shallow recession that persists. That would be perfectly consistent with current statistics. The other way would be like the 2008 crash: a delayed reaction leading to a sudden crash. Both of these follow my metaphor of the economy being holed below the waterline in my post in the week after the result. The ship is in mortal danger despite no damage visible above water.

Why might trouble happen? It comes back to the basic weakness of the British economy (which, it must be said, EU membership was doing little to help) – a substantial trade and current account deficit. Britons as a whole are spending more than they are earning, and have been for many years. That has been OK because plenty of foreigners have been prepared to lend us money, or to invest in British businesses or property. Also British multinationals may be selling off foreign assets and bringing the proceeds home. Brexit is putting that investment flow at risk.

What happens if the country can’t get enough currency to pay for imports? Demand for Sterling falls, and the currency sinks. That might attract investors (British assets look a bargain) or scare them (with the risk of further depreciation). Currency reserves, private and national, start to be drawn down. That will affect living standards. Then either the trade balance corrects (buy fewer imports and sell more exports), or things start getting nasty with a financial crisis as the stability of banks and the entire payments system comes into question – which is what happened in 2008, for different reasons. These changes tend not to happen smoothly.

The problem is that the financial system is very complex, with all sorts of buffers and hidden dependencies, which makes it non-linear. Responses are not proportionate to the changes to the system. Past performance is a poor guide to future dangers. There might be a lot of short-term factors stabilising things, but that could be undermining resilience. The country could be building up vulnerability to the next financial crisis, just as the Labour government of the naughties created vulnerability to the banking crisis of 2008.

Or perhaps the Brexiteers are right. The financial system will adapt to the new realities calmly and the British economy is fundamentally stronger than the pessimists say. The economy will sail serenely on and gather strength to boot.

The thing is that it is just too early to tell. It could be many months, or even years, before any crisis caused by Brexit emerges. I will be watching for signs of trouble. But, to be honest, I haven’t seen them yet. It’s all a phoney war.

Was the coalition’s austerity policy a colossal mistake?

Politics is dominated by historical myths, about which the different political camps disagree. Examining these myths critically is one way that societies can find reconciliation. While “austerity”, the favoured shorthand for government cutbacks, is fast sinking as an issue in British politics, long since overtaken by Brexit, its mythology remains a defining issue. This mythology has right and left versions. I want to look at the mythology of the left.

Few in the Labour Party would disagree with Oxford Economist Simon Wren-Lewis in a recent article that austerity “will go down in history as probably the most costly macroeconomic policy mistake since the 1930s, causing a great deal of misery to many people’s lives.” We in the Lib Dems are implicated in this criticism, as part of the coalition government of 2010-2015 that implemented austerity. It is exhibit B in the Labour case that the Lib Dems should cease to exist as a political party, and that all “progressives” should simply join their party (exhibit A being the tuition fees fiasco). So what are we to make of it?

Mr Wren-Lewis sets out this narrative very clearly in his article. He is an open Labour supporter, so his comments come with a political slant – but he is a proper economist and the case he makes is a substantial one.

This narrative runs something like this: in 2008-2009 Britain followed the world into a severe recession, brought about by a global banking crisis. This inevitably created a government deficit, of which he says: “We experienced record deficits in 2010 simply because the recession was unusually severe.” The Labour government used fiscal stimulus to moderate the effects of the recession, but the Conservative-Liberal Democrat coalition that came to power in 2010 rejected this approach and focused obsessively (so the story goes) with reducing the deficit, using austerity policies – cutting government spending severely. He claims that this focus on austerity had no economic merit, and is best understood as a political exercise to reduce the size of government, with misery as its by-product.

Mr Wren-Lewis says that the government defended its policy with three arguments: that innovative monetary policy would provide the necessary stimulus; that improved business and consumer confidence would do the trick; and that financial markets would not finance the national debt unless action was taken. He demolishes each of these arguments, and I would not disagree with him, though there is an element of hindsight and the first two ideas came good in the end. As a result, he says, the British recovery was extremely slow, costing the average household £4,000 a year – coincidentally about the same as the Treasury’s estimate of the costs of Brexit.

But Mr Wren-Lewis is being disingenuous. There was a fourth argument for austerity. And that was that most of the deficit in in 2010 was “structural” – in other words had a deeper cause the recession. If I remember correctly, the Office of Budget Responsibility estimated that about 8% or so of the 11% deficit was structural. In other words a lot of the pre-crash tax revenues were gone for good, and would require more than short term demand management to bring them back.There is plenty of scope for disagreement amongst professional economists here – but it does suggest an alternative narrative, to which I personally subscribe.

This narrative posits that the British economy was not in a stable position when recession struck. It had already been pumped up by excess fiscal stimulus; there was too much private sector debt; and there was an unhealthy dependence on international finance and, to a lesser degree, North Sea oil. The evidence for this is not just the precipitate nature of the crash – bigger in Britain than in other developed nations – but the large current account deficit before, during and after the crash, and the high level of Sterling beforehand, and its abrupt fall. It is true that the public deficit did not look outsized by international standards before the crash, but, as my macroeconomics lecturer pointed out at the time, the overall economic context had classic signs unsustainable fiscal stimulus. The crash was more than an ordinary business-cycle downturn, it was Britain’s financial chickens coming home to roost.

So what does that mean? It means that fiscal stimulus as a response to the recession would have only a limited impact, and would not have restored the economy to its previous health, and in particular it would not have solved the government’s deficit problem. Before long the additional demand generated would have led to inflation (in fact unlikely outside economics textbooks) or (much more likely) a worsening current account deficit, i.e. stimulating other countries’ economies rather than ours. That put the British government in a bind. There was a case for stimulating demand through fiscal policy, and yet government expenditure had to be cut back towards something sustainable in the medium term. The government in fact plotted a middle way and, far from obsessively focusing on deficit reduction, moderated the cuts when the recovery proved slower than they expected. The trajectory of deficit reduction was close to that projected by the outgoing Labour government in 2010.

But many distinguished economists were and remain highly critical of the coalition’s austerity policies. Labour supporters can quote any number of famous names. But you need to read what these distinguished people actually said, rather than the mood music they fed into. In fact they hedged their bets. They focused criticism on the lack of public investment, and not across the board austerity. Investment, in theory anyway, is a magic bullet in this context. It generates future productivity growth, so helps to put the economy on a more sustainable future path, while at the same time providing short-term demand. This is a perfectly valid criticism of the coalition record, shared by many Lib Dems who were part of the government. But it does not suggest that the majority of austerity policies were wrong in principle. Taxes and spending were badly out of line and something had to be done to return them to balance. All I can say in the government’s defence is that public investment is much harder to do in practice than in theory – so often the money ends up in wasteful white elephant projects. But it would have relatively easy to allow the building of more council homes, for example.

Where I agree with Mr Wren-Lewis (though he does not explicitly say it) is that the macro-economic policy presented by Labour at the General Election in 2015, under Ed Balls and Ed Miliband, was much more sensible than the one presented for the Conservatives by George Osborne. Mr Osborne proposed a charge towards fiscal surplus that made little economic sense – and one year on it is being buried by his successor. The Labour strategy would have knocked some of the hard edges off austerity, while promoting a higher level of investment. The left is right to call to call it “austerity-lite”, but wrong to suggest that this was a bad thing.

So criticism of austerity is warranted, but this does not amount to what the left wants it to do: to prove that cuts to government spending and benefits were unnecessary, and still less that they can be reversed. Extra spending will require higher taxes. Economists may feel that austerity policies are self-defeating in many instances, such as in some of the Eurozone adjustment programmes. But there is also growing recognition of a deeper weakness in many advanced economies, including Britain’s, signified by the stagnation of productivity. That is limiting tax revenues and what governments can afford to do. That weakness should be the central topic of political debate.