Are buoyant stock markets a sign of financial trouble ahead?

I have written before about how well many stock market indices have performed, notwithstanding the pandemic. That good performance has continued, with the US S&P 500 reaching record levels last week. This is puzzling, and might be a sign of a crisis in the making.

What is clear is that few, if any, of the world’s economies are going to shake the crisis off quickly. A rapid partial recovery from the depths of the lockdown is more than plausible, but it is hard to see things getting all the way back to normal. Consumer demand, the main driver of modern economies, looks to be dented for the long term, as many of the public, older people in particular, remain cautious, even if most lockdown restrictions are completely lifted – which they won’t be. You can take a horse to water, but you cannot make it drink. And, of course, a lot businesses are going to fail because of the lockdown, meaning that a lot of people will be put out of work. Meanwhile many businesses and public agencies will suffer a significant loss in productivity as safety measures continue to be in operation. While that might benefit jobs, it implies reduced living standards too, which will also make it hard for businesses to bounce back. The prospect of a vaccine being universally available is distant. The whole world cannot eliminate the virus like New Zealand has done, at the expense of cutting itself off from the rest of the world.

So if the economy is unable to bounce back to where it was in December 2019, why are stocks doing so well, after they fell so far earlier in the year? The obvious answer is that investors have taken leave of their senses, falling for optimistic stories peddled outside the mainstream media. Well I have seen such craziness take hold, back in the late 1990s with the tech boom, but this does not look like it. There must be a more rational explanation. I can think of two, and neither are good news.

The first is that not all companies’ share prices are doing well, and the rise in well-publicised indices is based on large companies who are expected to do well out of the crisis. Companies like Amazon, Microsoft or Alphabet (i.e. Google). When businesses fail, others benefit. The crisis will provide stronger companies with opportunities. The stock market indices are not a representative cross-section of businesses in the economy, but a collection of the bigger ones. But for this to justify such a high level of price gain, it means that investors think these businesses will be able to take advantage of their market dominance to raise prices. In other words, the wreckage left behind by the crisis will lead to widespread price-gouging, which will benefit the companies represented in the indices. This would be bad news because it means that yet another dent in productivity that will reduce living standards of everybody except the lucky. I don’t think this is very likely, but it is plausible that this is what many investors think will happen. There would be parallels with the tech boom of the 1990s if so.

The second possible explanation for high stock prices is an idea I have read in quite a few commentaries. It is that investors “have nowhere else to go” except to put money into shares. In other words, there is a savings glut, and the alternatives to shares look a worse prospect. There is plenty of reason to think that there is a savings glut. Many people are saving more as a result of the crisis, because there are fewer opportunities to spend, while incomes are being propped up by government support schemes. Meanwhile businesses, with a few exceptions like pharmaceutical companies, are cutting investment due to uncertainty. More saving plus reduced investment means a glut. And many people have suggested the world economy has been stuck in a chronic savings glut for the last couple of decades anyway.

The main alternative investment to shares, if you are are looking for a home for trillions rather than mere billions of dollars, is bonds. But interest rates on public debt have been cut to minimal, even negative, levels as part of the monetary response to the crisis. This means almost no prospect of a positive return either from interest payments or capital gains (which would require interest rates to fall even further). Some private companies have bonds offering higher yields (i.e. ratio of interest to price), but that is because of a higher risk of default. These do not look an attractive prospect in the current environment.

Which leaves either keeping the money uninvested in bank accounts, or investing in shares. A lot of people are keeping their money in cash, but this suffers a similar problem to bonds: low interest and no capital gain. Which leaves shares, whose price then rises because demand exceeds supply. That does not necessarily mean that shares offer a better return in the long run. Most investment decisions are not made by people for their own money, but by middle men such as investment managers. They need a good story rather than a sober assessment to justify their decisions. One advantage of shares is that it is very easy to spin a story, and picking crisis winners, as well talking up a rebound, might be just such stories.

But the savings glut explanation is bad news. It is not a stable situation because it implies that demand is being sucked out of the economy. This is one of the standard principles of Economics that is taught in undergraduates’ first year (the so-called Economics 101). It is what caused economic depressions before the economist Maynard Keynes showed that governments could offset this with deficit spending. Governments are indulging in deficit spending to an extent that is unprecedented in peacetime, but the rise in stock markets seems to be showing that they are not doing enough, or rather that their interventions are being parked in savings rather than spent.

How might this play out? The financial system is under a high level of stress. Levels of private and public debt are very high in most of the major economies. Private debt is the most likely breaking point, both in terms of bond default and bank bad debts. This vulnerability plays out in different ways in different countries, but the USA, the EU and China all look vulnerable this time in their different ways. Britain has its own vulnerabilities too, with a high current account deficit, a badly managed epidemic and full departure from the EU about to impact later in the year. This could then lead to a more widespread financial calamity.

The Great Financial Crisis of 2008-2009 was preceded by over a year of unreality, when the nature of the crisis was exposed, but markets were in a sort of stunned disbelief. It was like a supersaturated solution waiting for speck of dust to start a mass crystallisation: the Lehman Brothers collapse was the speck of dust. I was scared enough in 2007 to move my pension fund into index-linked government stock – so I’m not using hindsight here. The situation now is different, but I think the same sort of unreality is present. This will be a very different crisis if it comes.

I don’t think that most countries will suffer a 1930s style depression. Governments will have to intervene big, but they can and look ready to do so, though this will be more complicated in the EU. My prediction is that this will not just take the form of measures to stimulate demand, but interventions to keep businesses going.A lot of wealth will be destroyed. It will be a great moment to be a socialist.

Have I finally succumbed to cabin-fever? I have noticed more than one columnist I respect going a bit off the rails (look at Matthew Parris in The Times this weekend). I will have to leave that to you to judge!

The post-growth economy has arrived. It’s time people accepted that

The idea that economic growth should be the top political priority, after keeping people safe, became established in the 1950s, and has become so imbedded in political thinking that it is now taken for granted. But it’s a bit like Wil E Coyote running over a cliff; we may not realise it yet, but the ground has disappeared from under this notion. We need to focus on different priorities, in rich countries anyway.

What is economic growth? It is the expansion of the money economy through the ever increasing consumption of volumes of paid-for goods and services. It focuses mainly on Gross Domestic Product (GDP), a measure of aggregate income, adjusted for inflation. This (and the related Gross National Product: GNP, more used in the earlier days) only started to be measured consistently in the 1950s. Prior to that economic policy focused more on things like unemployment and the balance of payments, with growth only being an implicit goal. Focus on growth led first to the widespread use of Keynesian demand management within a system of managed exchange rates and capital controls in the 1950s and 60s, and then on the management of interest rates within a world of free capital movements and floating exchange rates, since the 1980s. It is the one element of continuity between these two very different worlds.

Why is there a focus on growth? I think there are two main groups of advocates. The first are public policy expansionists who wanted to secure growing amounts of tax revenues upon which to build the state system, as well as to reduce the need for welfare safety nets. It is probably fair to say that these dominated the earlier growth period.

The second are the rentiers. By rentiers I mean those seeking “economic rent”, or making money without making anything (such as renting out land). The more money there is sloshing around the more opportunities there are for rentiers. These include people with investments, workers and owners in monopolies that overcharge, many senior managers, and so on. These are much more than the top 1% of the wealthiest, and include people with a substantial stake in property (such as owning their own home) or other assets. In other words not just profiteers, but those who want and expect the value of their house to keep going up. The rentiers have been in the driving seat since the 1980s, since post-Keynesian (or Neo-Keynesian) economic policy became general. There is a bit of a paradox here: rentiers make growth harder to achieve, and in fact are one of the causes of slower growth, but they adore the policies designed to promote growth.

The first critics of growth were environmentalists. An early example was E.F. Schumacher in his book “Small is Beautiful”, which made a deep impression on the my parents in the 1970s. Environmentalists pointed out that growth implied the consumption of ever increasing amounts of natural resources, and damage to the environment, and that this was not sustainable. This was not entirely true, as economic activity became more efficient, reducing its impact on the environment. Many of Schumacher’s predictions turned out to be nonsense, and yet when I look back from now to the 1970s I am struct by how much we have destroyed; and then there is the rapidly emerging climate crisis.

A second group of critics might be called “lifestylers”. These people have rejected the need to work ever harder to consume ever larger amounts of stuff. At first these could be dismissed as eccentric hippies – but people who retire early come into this category, and that became a widespread life objective from early on. Since then the expression “work-life balance” has become popular among younger people. The interesting thing about lifestylers is that they don’t usually object to economic growth in principle (they may be rentiers after all), but their economic choices make achieving economic growth harder. They vote against economic growth with their feet.

The third important group of critics are conservatives: those that object to the changes that growth brings, such as the closure of old-fashioned businesses, outsourcing abroad or the growing use of immigrants. While some supporters of Brexit claimed to do so to improve Britain’s growth prospects, the Remainers cut little ice with their arguments that Brexit would slow growth down. Most Brexiteers simply thought that it was a price worth paying to send the immigrants home.

All three groups have been steadily gaining ground, and then into the mix has come the Coronavirus crisis. It is quite sobering to see how much economic activity people regard as “non-essential”, and how rapidly people are happy to reduce consumption when health and wellbeing are at stake. As we climb out of lockdown, we happily pile restriction upon restriction onto businesses to make them safer. There will be an inevitable cost to this, making it an impossibility to get back to the level of GPD prevailing before the crisis. Now even people who favour growth in theory will be unable to accept the price in practice. Furthermore, after the sobering experience of life being turned upside down in weeks, it is likely that people will save more and consume less to improve their financial resilience.

But abandoning growth as an objective means a profound change to the way our political class makes public policy choices. It is not surprising that so many of them are emulating Wil. E Coyote. What are the new priorities?

I put jobs first because that must be the focus of the recovery from the Coronavirus crisis, and it is urgent. It used to be argued that jobs had to follow growth. This isn’t nonsense: job creation schemes not based on sound economic principles will fail the end. But the link between jobs, and especially the sort of jobs that give people security and self-respect, and growth has become a lot weaker. Government interventions need to focus on jobs first, while still considering sustainability. The idea of a government-sponsored job-guarantee scheme is certainly worth a closer look. There are many potential pitfalls in such an idea, but for my money it is more promising than the much-touted idea of Universal Basic Income. It is important to make the point that an economy without growth is not an economy without jobs.

Second in my list is sustainability. This has both environmental and economic senses. Economic sustainability will need to be rethought, especially if people start to consume less and save more. This will mean that much higher levels of government debt will be sustainable. Environmental sustainability should be the main guide public investment. There is a lot of work to do to make our economy environmentally sustainable, but we should not delude ourselves that this will necessarily increase GDP.

Third is inequality. There is a lot of poverty in our society, and if the cake isn’t getting bigger then poverty will only be tackled by making somebody else poorer. This is a notoriously difficult problem, but some countries manage it much better than others. A job guarantee scheme could play an important role. Another important point is to tackle rentiers, through taxes and promoting competition.

And finally in my list (I could go on) is government effectiveness. In a low growth economy, the ability of governments to tax is limited, and a lot of resources will be consumed in addressing inequality. It follows that governments should use their resources more effectively. The public sector is rife with its own class of rentiers, from consultants offering to implement “world-beating” systems that don’t work, to defence contractors using national security to cover up waste, to excessive union power stopping managers from managing. We need to develop a culture of effective, delegated public sector management, accountable to a reworked political system.

Low growth has arrived, however much policymakers may dislike the notion. It is imperative that the political elites of rich countries reorient themselves to the new reality.

Universal Basic Income – why it doesn’t deserve the hype

To judge from my Facebook news feed and Twitter updates, the idea of Universal Basic Income (UBI) is gaining traction on the political left and centre-left. The extraordinary measures being undertaken by governments to prop up economies hit by Coronavirus and associated lockdowns somehow make it look less outlandish. In Britain the idea is getting closer and closer to being official policy for both Labour and the Liberal Democrats; it is already there for the Greens. I have always been a sceptic, and I still am.

The attraction is easy to see, and the crisis has highlighted its virtues. It is one answer to the massive information gap that lies between governments and the citizens they serve. This makes it impossible to target aid accurately to those in need. Government schemes like the furlough scheme leave many gaps, are subject to administration delays or injustices, and doubtless pay lots of money to those who don’t really need it, including fraudsters. On the other hand, attempts to target better involve humiliating procedures to verify need, which are often administered by officials that seem to take pleasure in the exercise of petty power for its own sake – and who are not empowered with discretion to use common sense nor accountable for the human results of their work.

This information gap has two main causes. The first is privacy, whereby we deliberately limit the information we make available to the authorities, or anybody else. The is one of the core aspects of what we understand by freedom, and all psychological benefits that come with empowerment and autonomy. But there is also the sheer scale and complexity of the information problem. Even in countries unworried by the idea of privacy, like China, face colossal problems trying to understand individual people’s needs, and often resort to arbitrary rules.

UBI is income that everybody is entitled to, on the minimum possible qualifications (such as nationality; there would likely be some form of age-based entitlement too). This would eliminate the need to provide targeted help in most cases, its advocates argue. In particular it would not depend on whether the citizen is working, and could replace unemployment benefit, or, in the UK, Universal Credit. There is no need for the state to gather data on income and work status in order to check entitlement.

Some support for this idea has recently come from Finland, where a randomised trial was carried out between UBI and unemployment pay. It was found that UBI did not reduce the incentive to look for work, while significantly improving the wellbeing of those receiving it. One worry about UBI, especially if it is substantial enough to replace entitlements to benefits, is that a significant number of people would give up the search for work, because they would not need it. But advocates point out that the incentive to work is improved because people keep all the extra earnings (subject to taxes), rather than having benefits withdrawn. The Finnish study provides some interesting evidence here.

But if the incentives argument falls away, there remains the question of how the state manages to pay for it. There is a dilemma here. The higher the rate of UBI, the more it can replace other benefits, and so deliver the advantages advocates want to see. In the UK Universal Credit is an obvious target, and so is the basic state pension. And yet as soon as it reaches this sort of level, the state outlays required to cover it become massive. Of course there are savings. Since the state pension is already a more or less universal entitlement, there may not be much extra outlay. Tax free allowances on pay could be withdrawn. But the gap remains massive.

Some on the left wave all this away, based on the insights offered by Modern Monetary Theory (MMT), which basically suggests that budget deficits can be funded by borrowing or printing money, and so traditional ideas of balancing budgets are old hat. Now I’m not as rude about MMT as most conventional economists seem to be, but it does seem to have encouraged the sort of magical thinking I last remember being widespread at the time of the tech boom in the late 1990s (“losses are the new profits”). The problem is that UBI would potentially unleash a wave of extra consumer demand across the economy, which could lead it to overheat and break down, through inflation or a debt crisis (because of the need to borrow foreign currency to buy imports sucked in by the excess demands). That is unless demand could be dampened down in some way, i.e. taxes raised. This is not a question of just taxing wealth, and top pay either. This may be a good idea anyway, but it is not likely to have a big enough impact on demand to head off trouble. Some combination of increases in basic income tax, national insurance and VAT will be needed too. This needs to be discussed more openly by the idea’s advocates.

But my reservation goes deeper. To me UBI seems to be trying to shortcut the sort of interventions that our society needs. It is an attempt to give people money in the hope that their problems will go away. That may work for a lot of people, but we will still be left with a vast residue of people with more complex needs, which a basic UBI does not begin to solve. I prefer solutions based on a highly devolved interventions by empowered professionals, able to tailor solutions across the whole range of public services from health, to housing, to law enforcement. The way to bridge the information gap is through people intelligently examining individual needs and crafting complex solutions. This will entail a judicious mixture of conditional and unconditional benefits. Our public services have been going in the opposite direction for two decades or more, as successive governments have sought to take the humanity out of public services and replace it with targets that turn out to be meaningless. By focusing so much on UBI, we are distracting attention away from the real crisis in public services.

The craze over UBI illustrates one of the biggest failings in a our politics. The search for simple, if radical, ideas instead of trying to understand the humanity of our society, and going about the messy and painful business of adjusting to this reality.

Tim Harford and “degrowth”: missing the broader point

In his weekly column last Friday, Tim Harford criticised the concept of “degrowth” now being promoted by some environmentalists. But I think he’s missing the main point.

Degrowth, as presented by Mr Harford, is the idea that the stopping of economic growth must be part of the policy toolkit towards creating a sustainable economy. As such he thinks it is misguided.

His reasoning is sound. The current Coronavirus epidemic has halted and reversed economic growth, and that has indeed has been mostly beneficial to the environment, by reducing carbon emissions for example. But the environmental effects are not proportionate. Even this scale of disruption is not enough to deal with the climate crisis, for example. Much deeper changes are required. Much better to focus on these instead, rather than being diverted into arguments over growth. He further argues that the idea is too blunt an instrument to deal with the environmental crisis, and that policies need to be much better targeted to be persuasive.

I agree on both counts. But Mr Harford quotes one supporter, Ricardo Mastini, as defining degrowth as “the abolition of growth as a social objective.” Put like that, I don’t think it can happen soon enough. Economists and policymakers are far to focused on growth, and its companion, productivity. They need to abandon this if they are going to help with the transition that the global economy surely needs. For conventional economists, the idea that growth will reduce to zero or even reverse is very scary. Our entire financial infrastructure seems to built on an assumption that we will keep growing. There is also an assumption that in order to find the resources to deal with environmental and social ills, the best way is to divert the proceeds of growth. And as growth has slowed in the developed world, these economists are getting increasingly anxious. They moan loudly about low productivity growth and try to find culprits. Instead they should be trying to think through the implications of slow, zero or negative growth, and the best way of promoting public policy in that environment. If that means big changes to the financial system and policy framework, then we have no time to lose in working out what those changes should be.

The first thing that economists need to appreciate is that the main reason that growth is slowing is through the freely made choices of people based on a rational appreciation of their needs. It is not some kind of disease that needs to be cured. That would apply whether or not an environmental crisis was engulfing us. Productivity gains apply to a shrinking proportion of the economy; consumption of goods is long past rational saturation. Productivity improvements in one part of the economy are balanced by losses elsewhere as people pursue less intensive lifestyles (think organic farming), or demand more expensive healthcare treatments. That is the way things are. Get used to it.

Meanwhile, chasing after productivity can be positively damaging. Direct environmental damage is easy to see, for example as modern agriculture decimates biodiversity. But it is also more subtle: the systematic hunting down of resilience in the name of improving efficiency is one of the reasons that the Covid-19 epidemic has been so destructive.

This leaves society with two huge problems. The first is changing lifestyles to the environment to recover, rather than degrade further. The second is to reduce inequality and the piling up idle financial resources while too many others pile up debt. This is what economists need to be thinking about, rather longing for steady economic growth.

To me “degrowth” is about changing the conventional policy mindset. And that is an urgent task. More people need to be talking about it, not fewer.

Suddenly then gradually is how the economic downturn will be

On Friday (1 May) I was astounded to hear that the US stock market index S&P 500 had its best month since 1987, after its dramatic fall in the earlier months of the year. I was aghast when I further thought I heard that it had recovered practically all its lost ground in 2020. That reinforced an impression that many people are in denial about just how bad things are, especially in America.

Some notes of caution before readers rush to sell their American shares, or short the index. The S&P 500 was in fact still 13% below its starting point at the end of April, and fell nearly another 3% on that Friday. I probably misheard a comment about the tech-heavy NASDAQ, which was just 2% down. The movements of share prices arise from dark forces, whose nature only becomes apparent long after the event, if ever. Newspaper headlines attributing movements to some coincidental event (on Friday it was trade relations with China) are just speculation. There may well be a much more rational explanation for the stock index level other than delusion. Though it still looks like a long-term “sell”.

The impression of delusion was heightened by statements, from the President among others, that the USA is past the peak of the virus outbreak, and many states are relaxing their lockdowns. In Britain the Prime Minister, Boris Johnson, has been saying the same thing about being over the worst, though still very reticent about relaxing the lockdown. Economically at least, however, the world’s troubles have only just begun. The troubles are in several layers.

The first issue is that the virus has proved itself to be both very infectious and deadly, and it is still very far from beaten. The relaxation of restrictions in the USA is most likely to result in a surge of infections that will overwhelm the hospitals in the states where it happens. This is a complex business, and some US states may not in fact be very vulnerable, because their populations are very dispersed and populations relatively static. But that does not apply to many of the states relaxing restrictions, such as Georgia. In Europe each country is wrestling with how to relax the lockdown, without reigniting the crisis. Only a small number of states (and not in Europe) seem to be able to relax lockdown significantly, and that only by drastically limiting travel in and out. It will be impossible to get back to normal until a freely available vaccine or cure is found and distributed en masse. That’s a long way off.

The second issue is that this crisis is a global one; no country will be able to bounce back and lead the recovery. In the Great Financial Crisis, a relatively small number of countries took the initial brunt (the USA and Britain mostly); others (in particular other European countries) suffered in the aftershock, but while the initial impacts had stabilised. Across the globe countries were able to launch a massive stimulus to use up the spare capacity created by the crisis, with particular credit to both the USA and China. This will not happen this time; both of these countries have had suffered severe shocks to the supply sides of their economies, which limits their ability to carry out effective stimulus. States across the world are intervening massively to limit the economic damage of the pandemic, but this is strictly damage-limitation. Reversing much of the damage already done is another matter.

And this leads to a third problem, which is the biggest of all. The world is coming to the end of one of its 40-year growth cycles, and the crisis is about to cause a deep unravelling of the growth model that drove it. They old tricks don’t work any more, just like Keynesian stimulus did not work in the 1970s.

The current growth cycle began to take off in the 1980s. It was driven by three main things. The first was continued productivity growth by developed world businesses, partly through the application of new technology, and partly by a ruthless cutting away of “slack” regardless of whether this represented waste or sensible resilience. One feature was the extensive use of outsourcing, and the stretching of supply chains. The main problem with this steady transformation of business was that the rewards were skewed towards the owners of capital and the top managers and their advisers, and not most of their workers. The second growth driver was steadily increased consumer spending, driven by steadily increasing private sector borrowing, in turn linked to increasing property valuations. This allowed the mass of consumers not benefiting so much from the productivity gains to nevertheless keep growing their consumption. The problem with this is that it is not sustainable in the long term – but as the saying goes, tomorrow never comes. The third factor was the entry of the less developed Asian economies as a source of cheap labour. Japan was the first, followed by Korea and Taiwan, and then China and India. It is important to note that this development was not exploitative for the most part. Those Asian economies benefited hugely, which allows those taking a world view to say this 40 year cycle has been by far the most beneficial to humanity (if you gloss over environmental impact). What was happening is explainable using the ancient economic principle of comparative advantage, and benefited both sides. What people did not appreciate at the time, and for the most part still don’t, is that these gains are time-limited. As the developing nations catch up, their labour increases in price, and so the developed world ceases to benefit. And so it has been as China in particular closes the gap.

The whole system is now unravelling at speed. Just how much developed world industry has been relying on reduced resilience to get next year’s increase in profits is only now becoming clear. As an illustration this Economist article on the US meat industry shows how scary it can get. And, of course, reliance on cheap foreign labour to keep prices down looks like a bad bet too, as hospitals scramble to find masks and gowns to protect their workers. But the most worrying development in terms of its potential impact is that the shock will puncture the ever growing cycle of consumption, debt and property values.

What this amounts to is a prolonged and almighty economic slump. Demand management through government stimulus will only help so far because the crisis is killing productivity and supply. What will emerge from this is hard to say. Many hope that it will be a kinder, more sustainable and more equal economic system. But there are other possibilities of course. I have written before that there will be a huge impetus to get back to familiar world of before, and this will undo many of the short-term hopes raised by the crisis. But over the longer term something better is possible.

“Gradually and then suddenly,” is the famous Ernest Hemingway quote about bankruptcy. With this crisis it will be the opposite.

Will the Euro survive the Coronavirus crisis?

So far in this astonishing episode, the world’s financial systems have held up well. Remarkably, lessons have been learned from the Great Financial Crisis, both in the behaviour of policymakers, and in the resilience of banks. But many claim that the Euro is especially vulnerable. Are they right?

The crisis so far has not been good for the egos of the Europocrats. The response has been led almost totally by the governments of its member states. It turns out that the EU really is just a free trade area after all. When something more important than trade comes along it has nothing important to do. And when its leaders at last got together to sort out a financial response, the outcome was pathetic, and spoiled by the sort of bickering shows that there is little solidarity amongst the member states.

Yanis Varoufakis, the former Greek finance minister, called this out on BBC Radio 4. The most important part of the EU’s infrastructure, the Euro, has turned into an instrument of oppression. The rich northern states, notably Germany and the Netherlands, were vetoing any serious aid to the most afflicted states, such as Italy and Spain, while not allowing them to help themselves. He said that German leaders should level with their public: the Euro was really good for their economy, but to keep it going they needed to be more generous to other members. The Italians, in particular, are throughly disillusioned and could provoke an existential crisis for the zone.

There is plenty of truth in what Mr Varoufakis is saying, but nobody should bet on the dissolution of the Euro just yet. Critics of the system miss two things. Firstly, as this week’s Buttonwood column in The Economist has pointed out, the European Central Bank (ECB) has learned a lot from the previous crisis and has now become the EU’s most effective institution, and not bogged down by the bickering that undermines the more overtly political arms. It has, amongst other things, rushed to buy up debt from Italy and Spain, thus greatly assisting a strong fiscal response to the crisis. This has the effect of mutualising their debt by stealth. The ECB has learnt the art of doing just enough to keep the Euro going, while being unable to fix its deeper flaws.

The second point is more subtle. It is wrong to suggest, as Mr Varoufakis does, the Euro is in effect a plot by Germany to rob Italy. It is better understood as a conspiracy between German workers and Italian savers. The Germans get plentiful and secure jobs, because their currency is held down, allowing its industry to run a surplus. Italian savers get more buying power for their money in a currency that is stronger than their own would be, with less risk of inflation. The victims are Italian workers, whose firms struggle to make progress with such a strong currency, and German savers, who lose buying power. It is arguments between these victims that drive the acrimonious politics of the Eurozone. Politicians like to blame an outsider, so German ones like to blame lazy Italian workers for low returns by their savers, and Italian ones like to blame the Germans for screwing their businesses.

So the Euro’s losers drive the day to day politics, but as soon as it looks as if they might succeed in their goal of causing the collapse of the Euro, the winners, German workers and Italian savers, hoist it out of trouble with a twitch upon a thread. The clearest example of this is Marine Le Pen’s tilt at the French presidency. Her bid featured resentment at the Euro, and it got her into the final round against Emmanuel Macron, but it rapidly collapsed when, in one of the debates, she floated the idea that France might leave the Euro. French savers, many of them older voters sympathetic to Ms Le Pen’s anger at liberal elites, suddenly realised that there could be a cost to their protest and deserted her. Something like this effect will happen in Italian politics if anti-Euro politicians get too much traction there.

So the Euro is safe but the politics is grim. What is needed are two things: more enlightened self-interest from northern leaders, and more willingness to embrace economic reforms by southern ones. The big trading surpluses by northern countries mean that they could easily be more generous to their southern neighbours by buying their goods and services or through direct aid (though lending them money simply builds trouble for later). Each of the southern economies has economic inefficiencies that their leaders should do more to tackle. In Italy it is excessive petty regulations to protect economic vested interests. In Spain it is lack of labour market flexibility. In Greece it is a failure to collect enough tax, especially from the better off. Until they tackle these they will always be supplicants and politically vulnerable.

For all that, the Euro has some very challenging times ahead (as do the US dollar and the Chinese Yuan, for differing reasons). Italy could easily be faced with a banking crisis, at a time when the attempts to mutualise banking risk across the Eurozone are incomplete. The acrimony will continue.

And this will set the EU on a trajectory that makes it more and more resemble the Holy Roman Empire. This was a tangle of German states, led by an Emperor with little practical authority. It was much despised by Enlightenment thinkers, and finally brought to an end by Napoleon. But it was the foundation of the strong commerce and devolved administration that makes Germany (and Austria) such successful states today. This is something Anglo-Saxon observers almost never understand.

Covid-19 will not make the world a better place

In these strange times I have been thinking a lot about the meaning and consequences of it all. I’m not alone. With so little else to do in lock-down many others are thinking about the effects of Covid-19. Alas this effort is as unproductive as so much else that is going on right now.

For contrasting ideas compare these two pieces. In the New Statesman philosopher John Gray explains Why this crisis is a turning point in history. For him it marks the reverse of globalisation and the return of the nation-state as the dominant idea in political and economic organisation. On the other hand in The Times there is Matthew Parris who explains why We say everything will change but it won’t. For me Mr Parris is much more on the money, but then I have never liked Mr Gray, a very clever man who somehow always seems to miss the point.

The remarkable thing about almost all the predictions of change is that they are expressions of wish fulfilment. Environmentalists say that we will stop travelling by air and learn to value the environment we have so despoiled through largely pointless economic activity. Socialists say the crisis is a vindication of socialist organisation at the expense of markets and capitalism, and that we cannot return to “Neoliberal” ways. Nationalists say that it is all the fault of outsiders and countries will raise borders and expel foreigners. Critics of the European Union say the crisis proves its uselessness and will prove terminal for it. The Economist suggests that the crisis will be good for big companies and herald a period of consolidation and takeover (to be fair that newspaper does not openly advocate such consolidation as a good thing, but its bias in favour of bigness is very evident). Critics of Donald Trump say the crisis means his presidency will end this year. And so on. Perhaps with the crisis having so badly disrupted people’s expectations for how the year would progress, there is some kind subconscious compensation mechanism which leads them to conclude it will hasten what they were always advocating. There must be a silver lining to all those dark clouds.

A lot of these thoughts have merit, but we need to adjust the seasoning. One of the deepest instincts of humankind is conservatism and a desire to recreate better times in the past. When all this is over there will be an overwhelming wish to go back to how things were before, which will be seen as a sort of golden era. This may take a little while to emerge, as a lot of people have been genuinely scared by the idea they could be contaminated by their neighbours. But a lot of infrastructure is simply falling into disuse rather than being destroyed. The planes and airports are still there. Many airlines will go bust, but their assets will be bought up on the cheap by stronger airlines and new ones. Dirt cheap fights will be on offer and, alas for those of us who think it is mainly pointless and destructive , things will get back to something like what they were.

Still, a number questions are worth posing. The first is whether we will treat this affair as a nightmare to be put behind us and forgotten, or whether we will take real steps to make ourselves less vulnerable to future pandemics. Much of history points to the former conclusion, as Mr Parris points out. But one of the interesting things to emerge is how much better East Asian countries have proved to be at handling the pandemic. This applies as much to China’s Communist dictatorship as to Taiwan’s and South Korea’s vibrant democracies. The reason seems to be that they have had major scares before, such as SARS. So perhaps western societies will learn too. Also it may prove very hard to beat this virus. An effective vaccine, the silver bullet we seek, might prove elusive. That would mean that we would have to build longer-lasting systems to fight it, and in particular tighter surveillance of people’s health so that outbreaks can be detected and isolated quickly. This will not be dismantled so quickly.

A second question is how the world’s financial systems will cope with the surge in government spending required to confront the disease and to soften its economic effects. Each of three pillars of the world system is going to be put under immense strain: the US dollar as the world’s principal currency for reserves and international transactions; the Euro and the European financial system; and China’s opaque and highly manipulated system. Here in Britain our financial system looks a lot healthier than it did during the great financial crisis, but it cannot fail to be impacted if these other pillars start to falter.

And then there are things that people should be pondering but are not. The first are lessons about the most effective structure and governance of the state. Here in Britain we are seeing a lot of muddle, and many missed opportunities. A lot of these derive from excessive centralisation, which stops the government from making the most of many smaller organisations that could help unblock the bottlenecks in the supply of tests and personal protective equipment, for example. Instead people will probably conclude that the system was not centralised enough.

There is also a deeper philosophical question about our society. The lockdown shows how little of our economic activity we actually need to keep ourselves alive. Most economic activity is only of marginal worth when set against the big issues of life and death. Perhaps we should rethink our obsessions with economic growth and productivity, and instead try to build a society that is safer, more resilient, more sustainable and happier. But if that thought ever starts to get traction it will soon be crushed in our desire to put the nightmare behind us. I can’t yet see much of a silver lining to this cloud.

Guest post: YOUNG PEOPLE HAVE PLENTY OF THINGS TO WORRY ABOUT. THE LONG-TERM EFFECTS OF THE CORONAVIRUS SHOULDN’T BE ONE OF THEM

Sorry for the lack of activity. I haven’t succumbed to Covid-19. I have just been exceptionally busy, not least with a house-move. And not just that: my Treasurer duties have been quite intense, and still are: I’m in the middle of an audit. I will recount my tale when things settle down a bit. Meanwhile it is my pleasure to publish this piece from John Medway.

A recent article in the Daily Mail raised the question of whether it might be better to accept a high death toll among the elderly from the coronavirus than to impose a huge financial burden on the younger generations by allowing major short-term disruption of the economy. Stephen Glover wrote (25 March 2020 ): “We have to ask ourselves a rather shocking question. Is it right that, in order to save the lives of mostly elderly people … the future lives of millions should be devastated?”

I must declare an interest here – I am elderly. To be fair to Glover, he doesn’t come down in favour of letting the elderly die off. He accepts an imperative to “throw the kitchen sink at the problem”. In any case, I’m going to leave aside the moral issue of balancing human lives against economic well-being. My view is that his prediction of long-lasting economic devastation from the coronavirus is simply bad economics. I don’t accept that we necessarily face years of austerity because of a generous approach to the temporary economic victims of the coronavirus.

The coronavirus episode will have some significant short- and medium-term economic effects. One is that resources are going to waste because workers are being made idle. This means that for a time, the economy will be smaller than normal and that on average we will be poorer for a short while. If the episode is prolonged and government support for businesses inadequate, there could be some lasting damage to the economy through premature retirements from the workforce, loss of skills and delays in training. These are real, medium-term effects but should be manageable. They should not mean that “the future lives of millions” will be “devastated”.

Glover’s main concern is not with short-term effects on the real economy – its ability to produce the goods and services we need or desire. It is rather with the sudden and huge surge in government expenditure, the loss of government revenue and rapid growth of government debt. “Let’s be in no doubt”, he writes, “that our country faces years of austerity that will almost certainly make the past decade look like a minor irritant.”

That would be true if an unreconstructed George Osborne were to return as Chancellor but I hope this is most unlikely. Thatcherites liked to portray the state and the country as a household whose expenditure was limited by its level of income or by its ability to borrow. This gave some cover for their aim of reducing the size of the state and passing as much of the public sector as possible to markets – an aim no doubt with a strong appeal to the sort of people who donate five- six- and seven-figure sums to the Conservative Party.

But a government does not always need to finance its deficit by borrowing. If, like the UK, it does not belong to a currency union, it can also do it, in co-operation with its central bank, by “printing” money – also known as “quantitative easing” or QE. The limit on the prudent printing of money is set (if not by ideology) by the perceived needs of the economy. If, once the coronavirus is beaten, the economy is held back by the inability of many firms and households to repay or finance their debts, an injection of liquidity through QE could solve the problem. This could be done through a generous welfare system and by offering cheap credit to basically sound firms in temporary financial difficulty.

It is, of course, tempting to think that governments can go on indefinitely financing their deficits through printing money. Some countries have done this, with disastrous results. The volume and speed at which money circulates needs to match the productive capacity of the economy or inflation results. As the economy recovers and nears its short-term limit, there may be a need to reduce rather than increase the money in circulation. This can be done by increasing interest rates, increasing taxes, reducing public expenditure or any combination of these. The important point here is that when printing money is an option, taxes are needed, not to pay for government expenditure, but to help keep the supply of money in the economy in line with productive capacity. In normal times, the notion that taxes are needed to “pay for” public expenditure is a useful approximation to the truth. But these are not normal times.

To a person who thinks in terms of public expenditure invariably needing to be paid for through taxation or other revenue, a sudden and enormous surge in government spending is deeply alarming. Glover’s alarm is perhaps because his perception of the nature of money, spending, borrowing and taxation is fundamentally different from mine.

There are big things to worry about in the British economy. One is the age imbalance in the population and the problem of caring for a growing elderly population – ironically, a problem that might be alleviated by a cull of the elderly population by the coronavirus if it gets truly out of control. The age imbalance is a problem in the real economy – the resources devoted to the care of elderly people. The problem is exacerbated by unfunded public-sector pension commitments, to which printing money will not be the answer.

More serious is the climate emergency. It is an emergency because global warming seems likely to prove catastrophic unless action is taken urgently to reduce carbon emissions. Governments generally show no sense of urgency and some (such as the US government) are in actual denial of the problem. The medium-term economic and social effects of dealing effectively with the climate emergency are likely to be far-reaching – for good or ill, depending on the attitude and skill with which governments and societies approach the problem. The price of failure could be one or more future generations of people for whom life is nasty, brutish and short.

Young people have plenty of things to worry about in the economy, society and environment that we oldies are bequeathing them. The long-term effect of the coronavirus should not be one of them.

The new economics: what does this mean for liberals?

My previous article on the changing world of political economy generated more interest than usual. It was, of course, a small dip into a large and complex topic. Given the interest shown, I feel the need to expand on it a bit.

The first thing to say is that what I am calling “the new economics” is based on standard economic principles, and the ideas aren’t new. The departure from political policy norms may be radical, but the departure from mainstream economic theory is not. This is partly how I have chosen to frame it. The heterodox idea of Modern Monetary Theory (MMT), popular in some parts of the left in the US and UK, is in fact not at all far from my new economics. But MMT advocates have, generally, chosen to frame their arguments as a radical challenge to conventional economics, and have a tendency to be very rude about mainstream economists. They have in turn drawn lots of rude comments from mainstream economists. A lot of this dispute, from both sides, is manufactured and I think that is a pity. Clearly some facts are in dispute, but it would be better to narrow these down and focus on the evidence rather than indulge in slanging.

Instead I take inspiration from people who are clearly on the mainstream spectrum. The main one is Adair Turner (whom I found going through some of my old papers was a Cambridge contemporary of mine: we were both members of the Conservative Association in 1976-1979). I haven’t read anything more than the Economist review of Dietrich Vollrath’s Fully Grown: Why a Stagnant Economy is a Sign of Success, but he is clearly another mainstream economist developing the same sorts of ideas. Mr Vollrath’s contribution is to bring rigorous numerical analysis to the table, where I have been plying with airy ideas.

Which brings me to my next point. A modern, developed economy will not show much in the way of GDP growth. We have become so conditioned to thinking that growth is a sign of economic health that this takes a lot of getting used to. But it is perfectly consistent with human wellbeing advancing. People may consume less stuff per head, but they can still have increasing levels of physical and mental wellbeing, and live in a nicer, friendlier and healthier environment. Mainstream economists have a tendency to suggest that people are being irrational if they consume less, work less, buy organic vegetables and have a healthier lifestyle, but the irrationality is theirs.

But a “stagnant” economy does bring a problem in its wake, and that problem is taxes and funding the public sector. GDP measures the size of the money economy, and the money economy is central to way governments operate. Indeed you can make a good case that money was invented so that the state could organise armies, build infrastructure and hoard surplus food. While the state could, and did, do this through forced labour and the appropriation of harvests and other goods, a system of taxation and wages is much more flexible. The rival idea that money was invented to facilitate trade is harder to sustain, though it used to feature a lot in economics text books. Of course the two functions of money, taxation and trade, fed off each other in a virtuous circle.

This all matters because there is no sign that the role of the state (in the broadest sense of collective public action) is about to diminish. The expansion of the state is one of the most important developments of the 20th Century, starting in large part with the creation of war economies, and then a dramatic expansion of the state role in education, healthcare and pensions and other welfare payments. To many on the right, this expansion of the state is seen as a hideous intrusion on human freedom that needs to be reversed. In fact it is a response to two important developments. The first is the tendency of capitalism to self-destruction, as noted by Karl Marx. If the capitalists succeed in creating too much profit, which is then hoarded, fewer people will benefit from the possibilities that the economy offers, and the system stagnates and collapses. If the state taxes those profits and hands them out to the less well off, this creates demand for capitalism’s products and the system is saved. (This is not the only way: capitalists being more generous with paying their workers has a similar effect, though it usually it takes organised labour to make this happen).

The second development causing the increased size of the state is the good old Baumol effect, which is the main driver of the new economics. The private sector is becoming so efficient that the relative cost of public goods is rising compared to what gets traded in private markets. Everything is more expensive in defence, law enforcement and healthcare. This issue is getting more acute. Public services are generally overstretched and many of their employees are underpaid. Stinginess on welfare benefits is creating knock-on problems elsewhere in society.

But this creates a political challenge. Public services need to be funded through taxes (it is possible to have a theological debate on this with MMT advocates, but let me duck that for now – without taxation public spending leads to inflation). People are generally willing to pay quite a bit of tax, but this comes at a political cost. Politicians have tried to sidestep this through economic growth. If the money economy is growing, then the state collects more money while keeping the tax rates the same. Those familiar with Baumol thinking will realise that this always was flawed thinking, as productivity in the public sector lags that in the private sector. But now we are in the stagnant phase of our economic evolution, the argument collapses completely.

That points to the raising of taxes, and all the political problems that come with that. But behind this there is a bit of a puzzle. For now state budget deficits look quite sustainable, as do higher levels of state borrowing. The fear is that deficit spending will create inflation, and high levels of public debt create financial instability – and that the risks are higher if the economy isn’t growing. But there is no sign that inflation is close to be awakened in developed economies, while monetary policy can be used to manage high levels of government debt, provided that you are borrowing in your own currency, and inflation is dormant. Meanwhile private sector demand for public debt remains very healthy. So just when do we need those higher taxes?

That is the central problem at the heart of the modern political economy. I don’t have an answer. But longer term there are three important things about a liberal approach to the new economics that I do hold on to:

  1. The government’s extra flexibility on fiscal deficits and debt should be exploited through investment programmes, creating assets that can be separately financed if necessary. These include social housing and renewable energy infrastructure. We need to be more careful with hospitals and transport infrastructure, but there are doubtless opportunities there too.
  2. The day when extra taxes will be needed to fund more public services will arrive. When it does the level of public accountability will need to improve substantially. This points to the need for a profound devolution of power, and especially the power to raise taxes, backed up greatly improved public governance.
  3. Meanwhile public services will need to be more efficient and effective (which is not the same as being more productive in my vocabulary). That means a profound switch to preventing and solving problems rather than service delivery and ticking boxes. That will require specialised services to work in a much more integrated way with much more delegated authority – and that means that services. mainly, need to be more localised. Which, of course, fits neatly with point 2.

I think this could be the basis for a grand bargain between liberals and either the left or, even, the right. The signs that either end of the political spectrum, or indeed liberals, are up for this are mixed. But there are some stirrings. On the other hand unscrupulous forces of the right or left could exploit the extra flexibility on public finances to line their friends’ pockets and consolidate political control while pretending to address the needs of “ordinary people”.

The rules of political economy have changed. Mainstream politicians and commentators haven’t noticed

Before the great financial crash of 2007-2008 there was a solid consensus as to the sorts of economic policies governments should pursue. In fact the underlying realities have been changing for some time. These new realities now dominate in developed economies, and yet the political mainstream hasn’t caught up. It is one of the reasons that populist politicians, not least Donald Trump, are doing relatively well when they defy the old rules.

What were those rules? First is that GDP growth is a critical indicator of economic wellbeing, and that increased productivity is the driver of this. Politicians should push through “supply-side” policies that improve productivity, which will allow income per head to grow, and with it individual incomes and wellbeing. With productivity apparently in the doldrums since the crash, especially here in Britain, there is much shaking of heads. Before the crash economists had thought something they referred to as “trend growth” of about 2% per annum was practically a law of nature. Many still think its disappearance is a failure of policy.

Second, governments must maintain a prudent fiscal policy that does not allow high levels of public debt to pile up. Public spending must be paid for through higher taxes. High levels of public debt can destabilise an economy, it was thought. This went alongside the idea that if public spending was not restrained it would be wasted, and cause low productivity.

Third: free trade is essential to a healthy economy. This follows from basic economics: the principle of comparative advantage. During the years of rapid globalisation of trade from the 1980s to the early 2000s, this idea received a terrific boost as new Asian economies entered the mix, with comparative advantage particularly evident in basic manufacturing. This generated huge gains in trade for both developed and developing economies.

And fourth, interest rate policy is the right way to manage the business cycle to ensure that recessions were smoothed out. This replaced the older post-war idea that fiscal policy was the right way to do this. Interest rate policy (or “monetary policy”) allowed the private sector to expand and contract as required, through an efficient market mechanism, rather than inefficient government direction.

What changed? First of all, the conventional wisdom on monetary policy, which evolved after the old system of fixed exchange rates and capital controls, known as Bretton Woods, collapsed in the early 1970s, led to an explosion of private debt. While policy makers liked to think that the policy was sustainable, there was a clear trend towards higher private debt and lower interest rates. This contributed to the great financial crash. Now interest levels can’t go lower, and people worry more about financial stability. This means that monetary policy is pretty much done for as means of regulating the cycle, with fiscal policy coming back into the picture, sometimes disguised as monetary policy with such ideas as “quantitative easing”.

Perhaps the most important change, though, was that productivity in manufactured and other tradable goods has advanced so far that they have ceased to have such an important role in the economy as a whole. This is known as the Baumol effect, and it is something I have been banging on about for ages. The modern economy is in fact dominated by things like health care, social care, and services, with status goods and land also playing a larger overall role. The old conventional wisdom around productivity doesn’t really work here.

On top of this environmental degradation, and especially climate change is posing a question that was always there. Is producing and consuming more and more stuff actually advancing human wellbeing? We all need to eat and wear clothes, but do we need to get through quite so much as we do? And yet an economic mindset in which consuming stuff is central to the way we measure wellbeing refuses to die.

A couple of other factors are worth mentioning. First is that the Asian economies are developing fast and converging with the western developed ones. This means that there are fewer gains from trade available, and that the globalisation boom is over; indeed many of those gains will actually reverse as the two worlds converge and comparative advantage diminishes. Second modern industry is not as hungry for capital investment as it used to be. This is partly to do with the Baumol effect, as the relative size of capital intensive industry shrinks, but also to do with the nature of modern technology, which uses more human capital. There are fewer opportunities in the private sector for savings to invest in, at any rate for things that aren’t outright speculative. The main cause of the great crash was an excess of private sector speculation as the relative scale of productive investment diminished.

So what does all this mean? First that it is OK to play fast and loose with fiscal policy. High levels of public debt are quite sustainable because the availability of private investment is diminished. Public debt is safer than private speculation. This is clearly evident in the USA and Japan. In Britain it is a little less clear because the country has a high current account deficit, meaning that is more vulnerable to international changes of mood – but surely there is much more scope than the government is currently using. Second, it is much less damaging than before to play fast and loose with trade policy. Once again Donald Trump is taking full advantage of this. His trade policy is mostly economic nonsense, but he can get away with it. Likewise Brexit is likely to be less dire for Britain than many predict – though the potential upside for “global Britain” is very slim. Trade just doesn’t matter so much, and the opportunities in Asia are disappearing.

All this is good news for populists. Mainstream policy needs to catch up. Policymakers need to drop their obsession with GDP and productivity, and start looking at wider quality of life instead. This includes the prevalence of poverty (I prefer not to focus on inequality, though that is clearly part of the picture), mental health problems and the environment. There needs to be a bigger drive on public investment, but not so much on roads, railways and airports, but on hospitals and healthcare therapies, social housing, and sustainable energy. There is scope for increased private investment here too, but the public element is vital.

There are other ideas, such as universal basic income, though I personally don’t favour this. But a rethink of state benefits is surely important. My instinct is for stronger set of social interventions to reduce poverty and its malign effects, rather than trying to make the problem go away by spraying money everywhere.

How does this work politically? It should be an opportunity for the left. And indeed Britain’s Labour manifesto in last election wasn’t quite as daft as it looked – in theory anyway. Bernie Sanders is making headway in the US in spite of defying conventional wisdom. But politics isn’t just about economics, and the left don’t really seem to grasp the demand for increasing personal autonomy. Besides so much of leftwing activism seems to be a rage against efficiency. Productivity may be an overrated issue, but the need for efficient and effective services remains as vital as ever.

Liberals, meanwhile, are badly compromised by their attachment to the old conventional wisdom. They have not yet found a new vision. Personally I think there is an opportunity for a grand bargain between the left and liberals, but there is no clear sign of this emerging. Meanwhile the political right has a clear opportunity. In the US they seem to be wasting it by failing to recognise that an efficient and effective state is critical to the future. They are failing to face up to the challenge on healthcare and the environment. In the UK the picture is different. The Conservatives are interested in courting more liberal-minded voters, and have not abandoned the idea of reducing carbon emissions, for example, or investing more in healthcare.

But at the moment the new rules of economics are providing more opportunities for the unscrupulous than they are to those genuinely want to make the world a better place. it is no wonder that the political centre is in such a mess.