Is Australia a neoliberal success story?

I have just started a six week tour of Australia. Right now I am in Perth pictured), our first stop. Australia is a country I know quite well. I have visited it in every decade since the 1980s. In the late 1990s and early 2000s my visits were frequent as I was working for an Australian-owned company. But my last visit was in 2006. I am interested to see some new places (Perth is one; Tasmania will be another), and also to understand how the country has developed.

I have just finished reading a special report by the Economist on the country. It paints it as a neoliberal beacon; it doesn’t use that word of course - neoliberals never use it themselves. That is an interesting thought to challenge while I’m out here. The country is a remarkable economic success story, with continuous growth since 1991: a better record than any other developed country. It has weathered two financial crises (the 1997 Asia crisis, and the 2008-09 crash), and several twists of the commodity cycle, impressive for a country for whom mining is so important. Doubtless raw materials and hitching the country’s fortunes to China’s economic growth, play an important role – but other Southern Hemisphere countries do that without Australia’s success. Its economic policies have a clear neoliberal bent. Fiscal policies have been conservative; pensions and healthcare have been substantially privatised. The currency floats freely. Levels of immigration are high. It stands as a reproach to the conventional wisdom of the left, which hates the involvement of markets in public services as well as governments aiming for low levels of public debt. It also stands as a reproach to the conventional wisdom of the right, which holds that multiculturalism is doomed to failure, and that high levels of immigration undermine social cohesion.

These headlines cover a much more complex picture, of course. In fact the Economist’s report is maddeningly shallow. But Australia is an interesting case study. To me the it looks as if the critical element to its success, which helps explain the way it has beaten the conventional wisdom of left and right, is healthy incomes across a broad stretch of society. This allows people to take more responsibility for health and pension expenses. It also makes them less stressed about the economic impact of immigration. But why? That is one of the questions I want to gain insights into by talking to people who live here.

Maybe Australia shows that it is too early to write off neoliberalism. Interestingly it is making a comeback in South America, as Brazilians follow Argentinians (and others) in turning their backs on leftist economics. Indeed outside some developing economies (including China perhaps), there seems to be no example of a successful economy that has abandoned neoliberal tenets. Even Scandinavian economies have tilted in the neoliberal direction in the last decades. And yet things are clearly not right in most neoliberal economies, including Britain’s. A lot of this has to do with pressure on those with middle and lower incomes, and in the phenomenon of left-behind places: middling and smaller towns, and rural areas. It will be interesting to understand how Australia has met these challenges, if, indeed, it has.

You don’t run a national economy as if it was a business – understanding the productivity “crisis”

Economists, especially the macro sort, look down on ordinary members of the public when they suggest that a nation's finances operate in the same way as a household's. They have a grand name for it: "the fallacy of composition". And yet most of them suffer from very similar fallacious thinking. They imagine that running the production side of the economy is like running an individual business.

Economists are not good at looking beyond the aggregate statistics that describe an economy as a whole: total income (GDP or GNP), employment/unemployment, inflation, trade and current account deficits and so on. These numbers take on a  reality in their own right, rather than being statistical abstractions. This leads to a ludicrously simple mental model of what is happening behind them. It's a bit like understanding a car through the operation of the accelerator, brake, steering wheel and gear stick, without thinking about the engine. Economists imagine a national economy to be a bit like a single business, or perhaps an aggregation of similar ones, churning out all the things the people need. The more that gets produced, the more that gets consumed, and the happier we will all be, following the ideas of classical economics. Once you have reached full employment, the only way to increase production is to make the business more efficient by raising productivity. It is one of the central challenges to economic management in this classical view. And it is one Britain seems to be failing at. Commentators from right across the political spectrum (except the Greens, maybe) seize on poor productivity performance with their own favourite explanations.

But the economy is not analogous to a single business. To understand this we need to consider the different sorts of production activity that make up our economy. These divisions are largely my invention to convey the essential dynamics. Many actual activities are in two or three categories at once.

Let's start with the easy bit: what I will call commodities. These go beyond globally  traded things like oil and coffee to all goods and services that behave more or less as economists expect. Utilities might be an alternative name. These are most of the things sold at a supermarket, or basic cars, like a standard VW Golf, and the raw materials that make them. Services might include bank current accounts, household insurance and so on. Actual utilities a slightly more complicated, because they are distributed through networks that rarely compete with each other. All well and good, but what needs to be understood about these things is that from a consumer point of view there are diminishing returns. Your first fridge or car is really useful; your second one much less so. Not many people have three. That means demand is subject to saturation. Sales of white goods and cars rocketed in the 1950s and 1960s as people bought their first ones, but then slowed as most need came from replacements. This sea change for these and many other goods of the postwar light industrial revolution was surely one of the reasons for the economic wobbles in the 1970s, but one you will not hear mentioned by macroeconomists. A good definition of a developed economy is that it is one where most commodities have reached near saturation.

What are the consequences of this when we think about productivity? First, commodities are generally where advances in productivity have been the steadiest - production is relatively easy to automate and processes easy to redesign because there is little individuality in them. But as demand reaches saturation it means that workforces become smaller rather than more goods being produced. And that means that the weight of commodities in the total economy shrinks. First was agriculture, which used to account for the bulk of the economy, but now for about 1% or so. Next came manufacturing. And so on. How much of the total UK economy is in utilities? There's no hard and fast definition, but it could be down to 20%.

Now let's think about something else. Let's call them "bads". Direct bads are activities that are directly harmful; indirect bads are other activities we enter into to stop bad things from happening. Crime would be an example of the first, and police forces and security guards of the second. Into this category we might put armed forces and defence industries, a lot of the legal profession, regulators and compliance people, many consultants, and so on. We have little practical control over these activities, and they do not add directly to our wellbeing. An economy composed largely of security guards and armed criminals may have a decent GDP but it isn't a good place to live. More is not better. The fewer bads overall, the better the economy will function for the population as a whole.

Productivity is clearly relevant for indirect bads. If you can treat the same danger with fewer warplanes or policemen then clearly that's a good thing. But is this being measured in the economic statistics? And note that more productivity means the sector becomes smaller, like commodities but more so.

Next comes human services. The essence of these is human interaction. Economists' favourite example is the hairdresser. The economy would be more productive if we all shaved our hair off, but somehow that misses the whole point. There are plenty of other examples: most of education, health care and social work, for example. One fascinating study (by BBC Horizon) showed that longer and more sympathetic consultations with doctors produced more effective treatments (the treatment in question was a placebo, which proved more effective than conventional drug interventions, but that's an issue for another day). Productivity is a rather ambiguous concept for human services:if there is less waiting around and bureaucracy then that helps. But if you try to improve productivity by reducing the contact time with each client, you are likely to destroy the benefits of the service. This is not understood at all by economists. Trying to improve productivity in this way is how many public services are being undermined at the moment, with detrimental effects on society as a whole. But as a modern economy develops, human services, alongside hobbies and leisure, weigh higher, partly because we choose to consume more of them, and partly because there are few productivity savings to reduce the workforce. So the overall productivity of an economy (or at least the rate of productivity growth) will decline.

And then we have status goods and services. The primary purpose of these is to prove your status in society. The important point is for you own or use them when other people don't. Think of luxury goods like smart sports cars or designer handbags. The interesting thing about these is that there is an anti-productivity factor. The more labour involved in producing the product, the higher status it confers. Improving productivity is a delicate matter. And, of course, status is a zero-sum game. Rising volumes of status goods simply lead to an arms race of expensive products that does nothing to advance human wellbeing overall.

I could go on. There are rents, public goods and finance and so on, each of which produce a different twist to the productivity puzzle, but none of which follow the classical pattern of commodities. There are two key points to make. First, improvements in productivity in a modern economy do not lead to expanded production, but to a redeployment of the workforce. That redeployment usually goes to sectors with lower productivity (status goods or human services), which means that the benefits of the original productivity gain are limited. But human wellbeing could well advance faster than overall growth, if people have more time for life-enhancing human services, for example. This isn't a problem, it is a sign of a mature, successful economy. The second issue is that most economic activity is now in areas where productivity is practically unmeasurable because the outputs are intangible (bads, human services and status goods for example).

Look a bit deeper into Britain's productivity statistics and both of these become important. The poor productivity growth is now attributed to a "tail" of small businesses, just as you would expect if productivity savings are being deployed into status goods and human services. Meanwhile the two sectors where virtually all measured productivity growth has happened in the last two decades are finance and business services. These are both sectors plagued by bads, the undermining of human services and rents. It is hard to argue that this growth has advanced human wellbeing. All of which leads to an alternative explanation of Britain's low productivity. The British economy is simply further along the development path than others. In particular, unlike the Germany and France, we have run down export-focused commodity production, and that distorts any comparison.

There's a further insight from this way of looking at things. Advancing human wellbeing in a developed economy does not come from producing ever more commodities. It derives from producing fewer bads, containing status goods, and expanding human services. Depending on how pricing works, that is unlikely to lead to measured growth in GDP. But that is not a bad thing: if it simply arises from the freely made choices of empowered citizens.

Of course productivity is an important issue for individual businesses and public agencies - at the level where managers should know whether value is being created or destroyed. But macro-economists should take their own advice on the fallacy of composition: don't try running a national economy as if it was a business.

 

 

Economics for the Many – voices from the echo chamber

I promised you I would read and review Economics for the Many, a collection of essays edited by John McDonnell, Labour's Shadow Chancellor. The purpose of the book is to show that Labour is not trying to reheat failed ideas from the past - but it is brimming with new ideas fit for the 21st Century. It doesn't really succeed in that aim, but it does contain some interesting pointers.

My first idea was to review each article in about 200-300 words and produce a series of posts. That was how I started. But I quickly realised that this wasn't going to work. Most of the 16 essays are pretty poor, and readers would have been subject to long tracts of rather sarky criticism. And not much of a thread would have emerged. As I waded through essay after essay, I was gaining more idea about Labour's mythology, but little clarity on what they might do. Even when I could wholeheartedly agree with an essay, such as one supporting political devolution, something seemed missing. It was all too abstract; there should be a passion in ideas. And then, in Chapter 9, the book burst into life, with Democratic Ownership in the New Economy. I could even forgive the cringe-making comments about Jeremy Corbyn and Mr McDonnell, and claims of a  public uprising in the 2017 general election. It had passion, and pointed to practical examples of its ideas working. The central idea was local, grassroots-led action to develop local businesses based on local networks, using cooperatives, anchor institutions (like hospitals) and so on. The following essay, A New Urban Economic System: The UK and the US followed the same ideas and was less gushing but more convincing, again pointing to examples, including Preston in Lancashire. Both had a common thread: based on a think tank called the Democracy Collaborative that gets involved in real world projects, and which co-authored both articles. The book got a bit better after this, but the only essay to match this highlight was the last one: Rentier Capitalism and the Precariat: The Case for A commons Fund by Guy Standing.

This article had much the best overall narrative - developing the idea that capitalism had gone wrong, hoarding monopoly profits and creating a whole class ("the precariat") of insecure jobs. This made a nice change from banging on about austerity (a Tory word, somebody has pointed out to me, suggesting frugality and discipline). It reads like a Marxist tract, but a good one, and much of it could in fact have been written by The Economist. Even if it was fact free and exaggerated it created a strong narrative based on things that are clearly actually happening. Mr  Standing recognises that Labour is not doing a good job of appealing to the precariat, which is either politically apathetic, or taken in by socially conservative populists. Then he develops the case for building a "Commons Fund", which would pay a dividend, which would then develop into a universal basic income (UBI). This is the best constructed case I have read for this idea. It is interesting that it is the only place in the book where UBI, such a darling idea on the left, gets traction, and it is a very mild version of it. No hint here of it replacing welfare benefits.

Two other themes are worth mentioning. First is "financialisation", which was the topic of two essays (by Costas Lapavitsas and Johnna Montgomerie). This awkward abstract noun is taking its place in the left's lexicon. It covers a disparate variety of things, of which the most important is the expansion private debt. This is all part of the neoliberal villainy. The argument is that a lot of growth in the UK is built on private debt, and an influx of financial investment from abroad (typically in London property). This latter has created a high exchange rate which has helped hollow out productive business. There is clearly something in this. Where the essays break down is trying to work out what to do about it. If the process is to be reversed, and levels of private debt cut, then this will conversely be a drag on the economy. Unless it is simply replaced by public debt - but neither essay makes the case for that. The first essay gets the closest by advocating the creation of public sector institutions to take over lending. There may be something in this, but public sector banks have led to some of the biggest wastes of public resources around the world: the operating models are critical, and the essay says nothing about this. It just falls in with a general prejudice through the book that nationalised institutions are good.

Another theme is the development of online platforms, from Google and Amazon to Uber. This is clearly a worrying development,and it is very well described by Nick Srnicek, including the political difficulties of doing anything about it. A badly-written and excessively abstract article by Francesca Bria, who works for the city of Barcelona, takes this forward with the advocacy of more active management of data networks by city governments. This is something policymakers should talk more about. Some networks, such as Uber or Airbnb, could be replaced by locally managed cooperatives that retain profits locally without being less efficient - this dovetails with the Democracy Collaborative's ideas. Others are global issues, but here initiatives like the EU's GDPR can have an important impact.

What of the rest? Prem Sikka puts forwards ideas for improving the tax system. These aren't particularly new, and I don't actually think there is much low hanging fruit for extra tax revenues - but some of the perverse incentives of the system could be fixed. He advocates a version of unitary tax for multinationals, which I have favoured for a long time, but which the British political class has always shied a way from.  Ann Pettifor produced a disjointed essay with quite a lot of lazy rhetoric in it. Her main idea of a "Green Deal" might have a worthy objective but looks like an invitation to mismanagement. Barry Gardiner (Labour's trade spokesman) advocates a middle way on trade policy between protectionism and a free for all, which promotes human rights and helps "vulnerable" economies. Good luck with that. Rob Calvert Jump delivers a flat essay on models of business ownership that people who remember the nationalised industry disasters of the 1970s and the successes of privatisations in the 1980s will be more than a little surprised at. He offers no thoughts on why privately owned companies might be a good ownership model in many contexts. Christopher Proctor has an essay on rethinking economics, with a clear explanation and critique of classical economics (puzzlingly referred to as "neoclassical"), but then fails to develop any ideas about how it is to be replaced, beyond a collection of unexplained initiatives which he says need more work. Ozlem Onaran expands on one these: feminist economics. Actually I don't disagree with her idea that there should be more public spending on what she calls "social infrastructure", but a lot her logic was unpersuasive - one suspects a lack of challenge in the development of her ideas.

So what to make of it? Labour's critics will find their prejudices reinforced. There is no admission that Keynesian stimulus might not be appropriate in many contexts. Low productivity is always down to poor motivation, pay and social conditions, while process design and effective management don't get mentioned. The concept of creative destruction is alien. Most of the ideas are about the state doing things from the centre, rather than empowering individuals and communities. There is little thought on how effective management can be encouraged and the abuse of power curtailed. Facts are few and far between, and silly factoids make their appearance (the £93bn of "corporate welfare" for example in Guy Standing's). And all that rage against austerity and neoliberalism, when the politically uncommitted can see that there are some good aspects to both policies. The overwhelming impression is of ideas being developed in a leftist echo chamber without proper external challenge, for circualtion within that echo chamber. Still there is plenty of scope for liberals to share parts of the analysis and many of the solutions. Lib Dems passed something that looked very like Mr Standing's Commons Fund at its last conference.

For me though, the most important and exciting essays were the Democracy Collaborative's on building local networks to revive local and regional economies that have been hollowed out by modern economic policies. This involves a radical decentralisation of power and properly faces up to the challenge that modern economies face. If Labour's leadership really do pick these ideas up and run with them, I'll be impressed. There is clear scope for a coalition between socialists, greens and liberals here.

But I remain sceptical. Mr McDonnell's big idea at the last conference was the expropriation of shares in public companies to put in employee trusts to pay dividends to workers up to a point. This has little to do with any of the ideas in this book and looks like a gimmick. But we should welcome much of the new thinking nevertheless. These ideas need to be brought out of the left's echo chamber for the discipline of wider public debate.

Was austerity a horrible mistake? Three challenges to the left’s narrative

The Prime Minister Theresa May recently suggested that "austerity" was coming to an end. That word is one of the political left's most successful abstract nouns; that Mrs May is now using it shows just how successful it is. Alongside the word comes an austerity narrative that is nowadays largely unchallenged. This is that the programme of public expenditure cuts started by the coalition government in 2010 was economically unwarranted, and therefore "ideological", and that this foolish policy is responsible for the UK's weak economic performance in the years since.

Conservatives are unbothered by this austerity narrative. They peddle their own rival one: that the preceding Labour regime was profligate with other people's money and that the cuts were needed to stop public waste. They further, and tendentiously,  suggest that this profligacy is what led to the financial crash in 2007-2009. They feel no need to challenge the left's austerity narrative; they just ignore it. For Liberal Democrats, as part of the coalition, the austerity narrative is much more painful. They neither challenge the left's version, nor come up with one of their own. That war is over and the Lib Dems lost, but for the small number of people who care about what happened and why, should we meekly accept the left's version of events, and acknowledge that it was a horrible mistake?

The economic logic of the left's case is based on the idea of Keynesianism. In 2010 Britain was suffering a recession, with a collapse in output in 2008 to 2009 following the financial crash. A recession is a temporary dip in aggregate demand which can become a doom loop: lower demand cause job losses, which in turn reduces demand further. The quickest way to counter this is to stoke up government spending: this keeps demand going, stopping the job losses until confidence returns, the economy starts growing and the excess government spending is then cut back to restore balance (funnily enough left-wing economic commentators rarely talk about that second phase). This is what Labour did to a modest extent in 2009. But the coalition embarked on a massive programme of cuts in 2010, sucking demand out of the economy when demand was already weak. Instead of bouncing back from recession, as you would expect, the economy stayed at its low level with little or no growth for years, until weak growth eventually returned - the worst performance of any major economy.  America, the argument goes, was not as severe in its cuts, and bounced back much more quickly. Some commentators go as far as to project how much the economy would have grown at the average rate before the crash, to show a massive gap between now and where the economy could have been.

One of the reasons why this narrative is largely unchallenged is that the picture is actually very complicated, so that it is not particularly easy to pursue a considered argument. The winner is goes to the person that shouts the loudest in a dialogue of the deaf. I will sketch out three challenges, however, but I will inevitably oversimplify things to keep this post a manageable size.

Challenge 1: the size of the government debt was becoming unsustainable. The budget deficit in 2010 was in the region of 10% of GDP (with estimates at the time being even higher). This is truly scary, and promised a massive rise in the size of government debt: could the financial markets absorb it? And if they couldn't, there might be a financial crisis that would create an even deeper recession. The Greek crisis, which was emerging at the same time, was used an example. But Greece doesn't have its own currency any more. In Britain we can simply create the extra currency when push comes to shove: the government doesn't run out. This is what Japan has been doing for decades with little ill-effect. But Japan has a current account surplus, meaning that the Japanese spend less than they produce, and do not need foreign money to keep the system going. Britain had (and still has) a large current account deficit, which means the opposite: we are dependent on foreign money. So, the argument runs, if these foreigners lost confidence in the British economy because of an ongoing 10% budget deficit, with the free creation of money (and hence a higher risk of currency depreciation and inflation), then there would be a crunch. At best, the government, or private sector, would be forced to borrow in foreign currency, destabilising the economy. At worst imports would rapidly become unaffordable, leading to severe inflation. This is a very hard argument to get to the bottom of on either side. There was no stress in the market for government borrowing as things turned out. But was that because of austerity? Or  sign that austerity was unnecessary? There is a very good case that the government could easily have borrowed more for investment (in council housing, say), a more difficult case for simply open-ended funding of bureaucrats and benefits.

Challenge 2: the government actually moderated austerity to reflect economic conditions. The government's plans to cut spending announced in 2010 were never adhered to; what actually happened followed the trajectory proposed by the Labour Chancellor in 2010 to tackle the deficit and included in the party's election manifesto. Unemployment never got out of control, and overall employment recovered much more quickly than the overall income figures. A lot of the comments from left-wing writers on the scale of the recession and austerity does not follow the facts. Some even suggest that because austerity was slower than planned "it was a failure in its own terms". This really is disappearing up your own backside. The scale of the cuts to public services simply shows how far public spending had got out of step with tax revenues. The more serious left-wing counter to this is that though employment held up, its quality did not. Pay was squeezed, and a lot of the new employment was insecure. There was scope for more demand in the economy, they say.

Challenge 3: the economy before the crash was unsustainable. To me this is the lynch pin argument, and I'm disappointed that it is so rarely made. This runs in a narrow form and a broader form. The narrow form is that government spending was at unsustainable levels, both because it was running a deficit at the top of the economic cycle, and, more seriously, because so much spending was funded by bubble taxes like capital gains taxes and stamp duty, while more reliable taxes, like income tax, were actually cut. That left a massive gap when the bubble burst, which meant that spending cuts or tax rises were inevitable even taking the Keynesian argument into account. There was never going to be a good moment to make the adjustment.

But the broader argument is more important. There was something fundamentally unsound about the pre-crash economy. It depended too much on the financial sector, drawing in foreign money to invest in British property and other assets. This drove the pound up, strangling export industries and giving us that large current account deficit. Growth in the economy depended on two very dubious sectors: finance and "business services" - the supply to services to other businesses, often in the finance sector. A lot of the reported income turned out to be fictitious, generating huge losses in the banks which the government then had to bail out. This was the culmination of two or three decades of poor economic management, when instead of modernising the economy, Britain went on an orgy of financialisation - not only pumping up a socially useless finance sector and its hangers on, but persuading people to increase consumption by borrowing more. In this light, projecting growth rates from before the crash to after it, to show how far it should have grown, is nonsense. The sustainable growth rate has been near zero for some years. And this puts a severe limit on Keynesian policies: the economy simply couldn't bounce back to where it was before without creating another bubble. In fact with the finance sector flat on its back, such policies would most likely have done little to raise domestic incomes, but simply sucked in more imports and foreign money invested in British property. The rebalancing of the economy, advocated by politicians of the right, left and centre, is a much slower and more painful process. We simply do not have the skills that a rebalanced economy will need.

This is not to say that the coalition government did not make serious mistakes. The more subtle critique made by prominent economists is that the government should have borrowed to invest. In other words the austerity was necessary, but that it should have been balanced by building more infrastructure and (perhaps) developing schools and colleges (the universities did fine). The left-wing commentators who cite these economists (the likes of Joe Stiglitz for example) overlook this.

The problem is that the British economy is in a deep mess, and it will not be easy to break out of it. We cannot do so by trying to go back to the economies of the 2000s, still less the 1970s. We cannot even go back to how the 2000s might have been if we had been wiser (looking more like Germany for example). Trying to work out what this new economy looks like and how to get there is the big challenge facing all politicians. Meanwhile we should regard any arguments about the easy restoration of growth with suspicion.

Economics for the Many: Labour’s challenge to the orthodoxy part 1

In my last post I referred to a new book, Economics for the Many, a collection of essays edited by Labour's Shadow Chancellor John McDonnell. I am very interested in any new thinking coming from the left because I spy the possibility of a coalition between liberals and socialists - whether inside Labour or between Labour and another party or parties - since the right  seem to have run out of ideas and started allying themselves with toxic nostalgists. So I bought the book. My first idea was to read it all and produce a single review article. No doubt I would have come up with something along the lines of this rather dismissive review by the FT's Chris Giles. But the interest is likely to come from some of the details rather than the general thrust, so my plan is write a series of articles as I read it, a few chapters at a time. This is the first.

Introduction - John McDonnell

In my last post I was somewhat dismissive of Mr McDonnell as a Leninist more interested in candyfloss policies than promoting serious policy debate. Be that as it may, Mr McDonnell is keen to portray a picture of a ferment of new thinking on the left, which will produce a radical new orthodoxy, much as Margaret Thatcher ushered in 40 years ago. This collection of essays is part of the evidence, and his introduction sets out an overview..

As such it doesn't tell us very much. Some of the familiar left wing narrative pops up. Those two abstract nouns, neoliberalism and austerity, play star roles as the villains. The first as a process of alienation of economic management from human values, the second being ideologically motivated cuts that have left tragic consequences. These let to the “social murder” of Grenfell Tower, for example.

But is it candyfloss? Is it designed to give the impression of intellectual movement just to provide cover for a power grab? I have two concerns. Are they coherent? And in particular, do they point to a radical decentralisation of power, or in fact the a Chinese style centralisation, guided by a political commissariat? And secondly, are they actually workable? Do they form a credible basis for reforms in our economic management?

1.    Democratising Economics in a Post-truth World – Antonia Jennings

This isn’t a promising start. The basic thesis is sound enough. There is widespread ignorance about economics, and bafflement at the way it is talked about. I think it is a bit worse than Antonia Jennings, a member of the political think tank/charity ecosystem, suggests. Many of that minority who think they have a strong grasp of the subject actually don’t. This allows politicians to build up myths not based on sound economics. The austerity policies of the 2010 government is, of course, used as the primary example. The Brexit campaign of 2016 is used as another.

Her solutions, though, don’t measure up to the task. She suggests a number of nice ideas: improve education at schools and universities, bring more women into the profession, change the way economics is presented. But these feel hopelessly inadequate.

The first problem is that economics rests on a number of insights that are profoundly counter-intuitive. One is that an economy as a whole has to be managed quite differently from a household budget – the idea of living within your means works out in a very different way. Another is the idea of comparative advantage – which means that trade should benefit everybody. Alas these ideas are not only counter-intuitive, they have layers of understanding, which even trained economists argue over. Many, for example, have not got beyond the basic idea of "trade is good" to understand how a changing world might affect the benefits of trade. This will take much more than a bit extra schooling and more user-friendly language to fix, surely?

The second is the sheer political imperative to frame an easily digestible narrative. Austerity illustrates this. There is a perfectly economically literate case to be made for this policy – many economically literate politicians and civil servants, amongst others, supported it. The government did not attempt to make that case in public because the level of political debate did not permit it. The counter-narrative from the left that austerity was unnecessary and therefore an ideological attack on public servants and poor people is just as illiterate, and framed from the same political necessity. In fact there is a very challenging debate to be had on the subject with well-made arguments on both sides. What is rather depressing about the whole episode is that so few people are or were interested in having that argument out. It is too politically important for that.

Political polarisation is no doubt a strong factor here. It is much more effective to shout down and demonise your opponent than start a reasoned debate. Labour is part of the problem, or, more generously, a victim. What is the answer? I am tempted to say that it is greater political pluralism based on electoral reform – though that has brought its own problems elsewhere in the world.

So yes to reforming the economics discipline. But expectations on the political impact of this need to be moderated. The problem is more deep-seated.

In fact I suspect this chapter is more about maintaining that sense of outrage at neoliberalism and austerity, with the suggestion that both are founded on economic ignorance. A rather bitter piece of candyfloss.

2.    Labour’s Fiscal Credibility Rule in Context – Simon Wren-Lewis

Simon Wren-Lewis is an academic macroeconomist, who has advised the Labour leadership on its economic policies. He writes lucidly and is perhaps an example of what Ms Jennings is looking for in clearer economic discourse. His topic is the Fiscal Credibility Rule (FCR), an operating principle for tax and spending policy that was adopted by the Labour leadership before the 2017 general election to show that it could be trusted with the government finances.

He starts with an elegant description of macroeconomic policy before the crash. He then moves into criticism of the 2010 coalition government’s austerity policy, which he says strangled economic growth. This story is central to Labour’s narrative, and you cannot expect a balanced discussion of this in a book like this, published on the party’s behalf. Mr Wren-Lewis, anyway, has taken sides, in an example of something that Ms Jennings might have commented on but didn’t: academic economists take sides in policy debates rather than trying to tease out the disputed issues and resolve them. I’m not sure how much this tendency is due to the politically charged nature of the discipline, and how much this goes on generally in academia. It is tempting to rise to the challenge, but this is the wrong place to do it. His is a perfectly respectable academic argument that I happen to disagree with. But it matters more in understanding the past than in working out what to do in the future.

The feature of the FCR that Mr Wren-Lewis thinks is most innovative is the idea that when interest rates are near zero, the government should use fiscal policy to help restore aggregate demand back to the point when interest rates start to rise again. The article then takes a rather puzzling turn. He talks about Modern Monetary Theory (MMT – SW-L shows a real weakness for TLAs). This is an idea that has growing currency on the left, which suggests that the regulation of demand should principally carried out by fiscal policy, and not the manipulation of interest rates by a central bank. If that is the case then the FCR is a bit of a miserable compromise. He leaves it unclear as what he really thinks.

Another interesting point is thrown in as an aside: Labour’s fiscal rule does not include borrowing for investment. This would be a radical departure for the British Treasury, who like to manage government borrowing as a whole, whether it is driven by investment or not. Many academic economists, such as Joe Stiglitz, a Nobel Laureate often quoted by writers on the left, think that this is critical. If you read their critique of the 2010 coalition government closely, you will see that they don’t particularly criticise the aspects of austerity that made Labour supporters most angry – benefit cuts and reductions to the government payroll – but focus on the slashing of investment. An interesting debate is glossed over here: if fiscal policy is to be the main instrument for managing the business cycle, what balance should be taken by capital spending, and what by revenue deficits? I can see arguments on both sides, but it isn’t talked about enough.

For what it is worth, I agree with the central premise of MMT (which Mr Wren-Lewis points out is old-fashioned Keynesianism) – which is that fiscal policy should take up a full role in managing the business cycle, relegating central banks to support. But that invites a whole series of difficult questions, of which the role of capital spending is just one. A more important one is how do you tell when the economy is overheating, and so fiscal policy should be tightened? Mr Wren-Lewis simply suggests inflation – but in the modern economy inflation is no longer a reliable signal: dangerous imbalances in the financial system can build up instead. And there is an even bigger question: MMT in its simplest form implies a massive concentration of political power at the centre. For Leninists that is a good thing; liberals worry that this simply leads to incompetence and corruption.

But Labour aren’t going there yet. The FCR is actually rather a modest proposal, and sensible enough as far as it goes. But there is a much bigger debate to be had about how to manage the macroeconomy.

 

So a rather disappointing start, but many of the more interesting chapters were always going to be later on.

 

 

 

Lib Dem economic policy takes a step leftwards

Last Monday the Liberal Democrats passed a policy paper on economic reforms, Good Jobs, Better Businesses, Stronger Communities. This covers economic policy outside fiscal and tax reform, and fits in with the party leadership's wish to address the challenges of what is often called the fourth industrial revolution. Does it measure up to the challenge?

Sometimes it is hard not to agree with fellow Lib Dem blogger David Boyle that liberals don't take economic policy seriously enough. There was little excitement about this motion, or another two which tackled taxation. I only attended two of the three debates myself and spoke in neither. But the party leader Vince Cable takes economics seriously (he was a professional economist after all), and the party does find itself well-provided with official policy, even if most of its members might struggle to know what it is. The party should be doing more to promote internal debate.

The Good Jobs motion, and the paper behind it, demonstrate one of the problems. They are very densely packed with ideas and policies. So much so that they are hard to read and harder to condense into something clear and ringing. There seem to be two problems here. First the scope was probably too large. You could easily produce a worthwhile motion on workplace rights, for example, rather than tucking it away in this much bigger motion. And then there is the desire to establish consensus. This boils down to including something for everybody: I'll let your hobbyhorse through if you'll do the same for mine. How much this dynamic came from the policy working group itself, and how much from outsiders I don't know. It must be admitted that there are some advantages to this approach. The Labour manifesto last year seems to have been produced by a similar process, and it collected together enough hobbyhorses to make it a good tool for roping in disparate groups of special interests. I remember one online commenter disparaging the Lib Dem manifesto because, unlike Labour's, it had no policy on puppy farms. It was an electoral success, notwithstanding major holes in, for example, university finance. Secondly, if your party actually does get into government, it helps to have a bank of small-ish policy ideas ready. This gives ministers something to do, and helps them set their own agenda, rather than being swept along by their departments and issues of the moment. So the policy paper should do valuable work, even if it failed to the party at large on fire.

My main beef is that it pays homage to the idea that the country has a serious productivity problem, and that this is something politicians should worry about. But this is such a consensus view that I guess they had little choice. I don't particularly object to the polices that this gives rise to. Indeed many of its ideas would no doubt dent measured productivity in the short term (more regulation, tougher environmental focus, and so on), so it is probably politically wise to have some policies specifically focused on raising productivity. Labour does something similar.

So what, for me, are the key issues? The first is that too much money in the economy is being either retained by businesses, or distributed to shareholders, or paid to senior employees. Quite apart from the corrosive effect this has on people's sense of fairness, too much of this money is idle, causing a phenomenon called secular stagnation. One of the symptoms is low interest rates and too much private debt. This tendency started in the 1980s and  technological changes aren't making it any easier. In order to address this, broadly two sorts of reform are suggested. First there is attacking monopoly capitalism. This is David Boyle's big theme: he wants to rescue the old liberal concept of free trade as a liberator, after it has been hijacked by neoliberals to mean staying out big business's way. The second is to redress the balance of power between workers and bosses. I think this latter is probably more important - I am less convinced than David that modern monopoly capitalism is quite as harmful as it was in old economy days of oil, phones and steel - though I do think he is onto something over excessive protections for intellectual property. The Lib Dem paper embraces both approaches, though not intellectual property, which requires a policy paper all to itself. It opens the door to supporting unions. Having heard a very sensible presentation by a representative of the union Prospect at the party conference, I am changing my mind about the role of trade unions. One of my formative political beliefs (from the 1970s) was that unions were a baleful influence on the economy. But empowering unions sounds much more likely to redress the palpable power imbalabce than more shared ownership of businesses, a typical Lib Dem suggestion (though not advocated as radically as the left are starting to).

The second issue is that the economy needs to be pushed towards environmental sustainability. Not only does this mean unlocking renewable energy and leaving coal and oil buried in the ground, but it also means producing and consuming less stuff. The sustainable economy will be based on services, not manufacturing. This needs a change of mindset, and the policy paper does give it a big shove in the right direction.

A third issue is getting a more even geographical spread of economic success. It is a pity that economists are not giving this more thought. Certain economic processes seem to benefit from accelerating returns - returns that rise with concentration. The idea of accelerating returns sounds good, but it isn't, because it leads to success being concentrated, and increases inequality (unlike the alternative concept of diminishing returns, the more conventional assumption in economic modelling). This seems to be because of network effects among personal relationships, that work better in geographical proximity. This is not particularly well understood, but needs to be. I am convinced that government structure is part of the story. More devolved political power helps - but exactly how and why is less clear. The policy paper duly pushes for this, both in government and in the purchasing of public agencies. That is helpful. But whether more devolved government will help Boston, Margate or Merthyr Tydfil enough is doubtless open to scepticism. The centralised political culture runs deep in Britain.

And a fourth issue is human fulfilment. We have reached the point in our economic evolution when economists need to consider this explicitly, rather than simply trying to give people more money to spend. This fits in with worker empowerment, but there needs to be more. The paper's advocacy of lifelong education and individual learning accounts is helpful here. But I want to see the greater availability of counselling for people between jobs, or unsatisfied with their jobs, as a part of this. Simply giving people spending power is not enough, and can be dehumanising - one of the reasons that I am suspicious of universal basic income, a very fashionable idea on the left that the Lib Dems are sensibly steering clear of.

So, overall, this policy paper fits well enough with the economic agenda that I support. But standing back it leads me to a striking thought. There is a growing overlap between current liberal thinking and new socialist thinking (which isn't just a throwback to the 1970s as its opponents claim), and a step away from the neoliberal thinking that still dominates the centre-right. Perhaps there will be enough common ground for a future coalition, once Labour sees beyond its internal struggles and overcomes its more extreme tribalism. Alas that day is some way off. But a coalition with Conservatives once the Brexit hoo ha has settled looks even less wise than it was in 2010.

 

What can we learn from 1977? The need for fresh economic thinking

Economic thought follows a 40 year cycle. It starts with a period of doubt, as the conventional wisdom appears inadequate; this lasts ten to twenty years. A new way of looking at the economy then emerges and this leads to a period of confidence and optimism, lasting twenty to thirty years. And then optimism collapses into another period of doubt as the orthodoxies fail. Currently we are in a period of doubt, which started ten years ago. That was also the case 40 years ago. A chance discovery has just brought this home to me.

Last weekend I was staying at my father's house, and picked up his copy of E.F. Schumacher's Small is Beautiful. That book, published in 1973, was one of the products of the previous period of doubt, and is a topic for a future post. But out of the book dropped a cutting from the Financial Times, dated 24 February 1977 by Samuel Brittan, one of that newspaper's most distinguished writers. It was a bit of a shock, because what it says is so similar to what people like Adair Turner, and me in this blog, are saying now. (Apologies: the scan isn't that great as the text is very small, and it defeated my OCR software, so it may not be that easy to read).

The article is a review of a book Social Limits to Growth by Professor Fred Hirsch, which is largely unknown these days (unlike Schumacher's), but not quite forgotten. Hirsch developed the idea of "positional goods", whose value does not arise from their consumption, but what they say about your social position. He noted that as societies get richer, the more important positional goods become. But ramping up production of these goods is self-defeating, as they then simply lose their value. He suggested that this poses a limit to how far economic growth can go. He also discussed the contradictions of market capitalism, and in particular that it depends on self-interest (some would say greed), but needs this to be constrained to avoid corruption and rigging the system.

Sir Samuel Brittan, as he now is, was one of my favourite economics writers: I read his columns religiously (alongside the American writer Paul Krugman), a process that helped me develop an interest in economics which eventually led to me giving up work and taking a degree in Economics at UCL in 2005. He might loosely be describes as a neoliberal, but above all he was rigorous in his thinking and not at all doctrinaire. He starts the article by posing the question about why economic growth and productivity had slowed, and reflecting on Maynard Keynes's essay Economic Possibilities of our Grandchildren (1931 - belonging to the previous period of doubt and introspection that Keynes did so much to resolve). What is economic growth for? Keynes predicted that at some point it would become pointless. Sir Samuel accepts Hirsch's analysis, and goes on to wonder about whether the market economy was really the paradigm that many idealists made it out to be. He concludes:

The main case for the market system is as a method of cooperation, which minimises coercion (e.g. conscription versus the price mechanism). But no one after reading Professor Hirsch can imagine that it promises a short cut to our economic nirvana or that it can manage without an economically literate public philosophy, which - 200 years after Adam Smith - we have still to evolve.

So what was happening in 1977 to provoke so much doubt? I remember it well: I was at university (studying physics and geology) and very politically engaged. In Britain it was the period of the Labour government of Jim Callaghan. Inflation was persistent; unemployment was high. The economy was dominated by large  industries, many of them nationalised, where union power prevailed. They were generally very badly run, especially the nationalised ones, partly because of union interference. Callaghan's tactic for controlling inflation was to do national pay deals with unions, who were grudging at best, and there was much industrial unrest. He, and his Chancellor Denis Healey, concluded that unemployment could not be tackled through expanding demand, as the conventional wisdom prescribed, referred to as "Keynesianism" as if Maynard Keynes could ever be pinned down to an -ism. Instead they adopted deflationary (i.e. austerity) policies to tackle inflation first. It was a turning point in British economic policy which is often ascribed to the Conservative Margaret Thatcher, who became Prime Minister in 1979.

But in the 1980s the economy picked up, with, apart from the odd wobble, continuous growth up to 2007, featuring steady productivity growth. So that poses an obvious question. Was the pessimism about the limits to growth in 1977 unjustified? And is my current pessimism, if it is correctly called that, justified now?

What was behind that quarter century of growth? In Britain, reform of the nationalised industries, most of which were privatised, was clearly part of it. But the deeper causes were the advance of technology, and the development of globalisation, which meant the increasing use of cheap inputs from Asia. These advances gave people access to advanced technologies that have undoubtedly improved lives. I remember desperately searching for phone boxes to make calls in the 1970s; nowadays almost everybody has a mobile phone, a product that was science fiction in 1977, but made cheap and accessible by technology and globalisation. But the growth was skewed. Whole industries, such as coal mines, were closed down or gutted. Those years are not remembered fondly in many areas of northern England or Wales, which were devastated (in common with many equivalent areas elsewhere in Europe and in North America). Most of the benefits of growth went to better educated middle class people, the yuppy generation, of which I was one.  And a lot, much more than in the previous half-century, went to a tiny elite of super-rich. Inequality rose dramatically up to 1997 in Britain; it has stabilised there since, but continued to advance elsewhere in the world, notably the USA. Progress for working class people was much more mixed. Globalisation, and the backwash of decolonisation, also led to a freer movement of people within and between continents, which built resentment amongst those who stayed with their historic communities. So when the good years came to an end with the crash of 2008, there were all the ingredients for a populist backlash. Moreover, when examining the pattern of growth, much of it depended on Hirsch's positional goods, or services which do not directly support increased human wellbeing (investment bankers, mortgage advisers, lawyers, accountants, cyber criminals and security specialists, and so on).

And there is something else: the technology that underlay the growth may have been secure and lasting, but its other foundations were not: the post-Keynesian economic consensus, and the availability of cheap Asian imports. In order to keep the economic engine rolling governments allowed the build up ever larger quantities of private debt. A liberalised financial system, regulated by floating exchange rates, that eased the flow of capital between countries, helped this process along. But this is unsustainable in the long run. At some point policymakers have to confront the macreconomic problem behind it: which is that we are trying to expand the supply of goods and services faster than demand. Without artificial, government-provoked stimulation, the economy sinks. This is what is meant by secular stagnation. Meanwhile, as the Asian economies catch up with the west, the availability of cheap imports, so important to growth in that period, is fast diminishing, and is not being replaced by the development of other regions of the world.

What people failed to see in 1977 was how much of an impact that technological change would have on people's lives, and how this would continue to improve human wellbeing. That potential for further improvement remains. But what the doubters were right about is that the conventional way that economists link human wellbeing to economic growth was breaking down in the developed world. It is now in complete ruin. But most policymakers are still in denial.

Have economists learnt nothing from the crash? Three fallacies that persist

It is approaching ten years since the collapse of Lehman Brothers. To most people this is when the great financial crash started, since it is from this point that the most serious repercussions started to take place. Personally I date it from the collapse of interbank markets more than a year before, but never mind. What was so shocking about the crash was that so few trained economists foresaw it. Or, lest anybody mistake that for mere criticism of forecasting skills, how so many economists aided and abetted the forces that destabilised the financial system, or at any rate, did nothing to head the crisis off. Ten years on and I am starting to wonder whether we are unlearning the lessons of the crash, and relearning the complacency that let it happen.

What shook me was an article in the Financial Times by long-standing correspondent Martin Sandhu - the devasting cost of central banks' caution. His suggestion is that central banks were too cautious in the aftermath of the crash, and as a result the recovery has been stunted. What struck me about this article is how heavily it is based on the economic conventional wisdom that helped cause the crash in the first place. It is as if economists like Mr Sandhu had learnt nothing at all. In particular it is based on three persistent fallacies that should by now be well and truly exposed.

Fallacy 1: the pre-crash trend growth rate was real and sustainable

Economics is a numerical discipline, and economists are more than usually susceptible to the delusion that numerical measures are more real than the complex world they describe. One case in point is something called the "trend growth rate". This is an average rate of growth taken over a long period of time. By its nature it does not vary much from year to year, but before 2008 it had been remarkably consistent in developed economies, at about 2% per annum. After the crash it fell, and a new, much lower trend has established itself. Mr Sandhu's contention is that the pre-crash trend was ordained by the laws of physics, and that the decline must represent a policy failure - which he lays at the door of central banks. The gap between where the economy is now, and where it would have been had the pre-crash trend persisted, is now very big - and it is the "devastating cost" of the article's title. This is a persistent idea, which I have heard from Mr Sandhu's FT colleague Martin Wolf too, though I suspect that he is starting to wake up to the truth. You also hear it from some left wing commentators who lay the blame at the door of "austerity" rather than central banks.

The persistence of the trend before 2008 is all the evidence that many macroeconomists need that it must represent some natural law: the steady advance of technological change on productivity. They did not think it was their job to ask more penetrating questions. But the cracks were showing well before 2008, and had economists spotted this, they would have seen that instead of the world continuing on its steady course, the risk of an economic crash was building up. The crash blew away froth that had been accumulating in the years before.

There are several aspects to this, and I will try to be brief. First is that the sort of productivity growth that economists fondly believed is happening everywhere, was always confined to fairly narrow sectors of the economy, and those sectors are themselves narrowing. In particular it applied to agriculture and manufacturing: industries where you produce stuff and ship it. And yet the importance of these industries to developed economies is steadily diminishing, in a phenomenon called the Baumol Effect that is taught in Economics undergraduate courses, and which should have been no surprise. The true drivers of a modern economy are in services such as healthcare, where technological advance does not tend to advance productivity in the sort of way that is captured by economic statistics.

Second, in the ten years up to 2008 much of the rate of growth depended on globalisation, and in particular the use of cheap labour in the developing world, notably China. This was strikingly evidenced in the fact that the prices of many manufactured goods actually fell in the period. This was not a case of advancing productivity: it was the exploitation of another basic economic idea whose implications few modern economists actually seem to understand: that of comparative advantage. The problem is that where this arises because the developing world is catching up with the developed world these gains are temporary and actually go into reverse eventually. That was what was starting to happen before 2008 as Chinese wage costs relative to American and European ones started to close. It was not sustainable.

And third, much of the growth, especially in Britain, depended on industries whose economic benefits were actually doubtful, and where productivity measures are similarly flawed. Two sectors stand out. One is finance; not only are the actual benefits to human well-being from its output hard to understand, but much of the reported income turned out to be downright false. That is the main reason why the crash had such a drastic effect on GDP figures in 2009, as bank bailouts were needed to replace non-existent assets created by this fictitious income. That should be reasonably obvious, though I'm surprised by how few commentators pick this up. More subtle is the problem with a second sector reporting productivity growth: business services. This is things like lawyers, accountants, consultants and architects - particularly important in Britain. The problem here is that these do not provide services to end users but to other businesses. Which leads to the question, how can you say that these industries were becoming more productive when there is so little evidence of productivity gains in the industries they were advising?

Fallacy 2: consumer price inflation is the main evidence of unsustainable growth

In the 1970s developed economies overheated, and this led to an inflation price spiral, as consumer prices and pay rates chased each other. This wasn't supposed to happen under the Keynesian economic regime that most of the world used at the time, because unemployment was increasing too. This was a huge shock to the economics profession (a much greater shock apparently than the 2008 crash), which led to a brand new policy framework. This led to an obsession with consumer price inflation. If you keep this at some Goldilocks level, of between 1% and 3% per annum, then nothing too much could be going wrong, people thought. This was made the sole performance target for many central banks, as it meant that economies were neither overheating nor underperforming. Other things, like the level of bank lending, asset prices and balance of payments imbalances didn't really matter. This was central to the neo-Keynesian consensus.

If this was ever valid, it was rendered obsolete by the advance of globalisation in the 1990s and 2000s. Wages became detached from consumer prices. Capital flowed freely between the world's economies. Especially in Europe the movement of labour from one country to another became freer. There were many ways an economy could overheat without consumer price inflation becoming affected. Asset prices (real estate, shares or even bonds) could inflate into bubbles; dangerous levels of unreal assets could build up within the financial system; a destabilising level of migrants could cross borders. All of these things happened in Britain in the run up to 2008, and yet because inflation remained in the Goldilocks position people thought everything was fine, and that all these other things would just sort themselves out. Many still believe this; it is one of the few things that unites all factions of the Labour party, which was in power at the time. Likewise Mr Sandhu persists in suggesting that consumer price inflation was all that central bankers needed to worry about after the crash - and because it has shown no sign of taking off, there has been plenty of scope to pump things up.

Fallacy 3: monetary policy is an effective way of regulating demand

This was another part of the neo-Keynesian consensus. Prior to this the conventional wisdom that fiscal policy (taxes and public spending) was the best way to help a flagging economy or cool an overheating one. But after the failures of the 1970s it was felt that this got too tangled up in politics to be effective, and would lead to an excessively big state. Instead the job could be given to central banks, through changes to interest rates and other things like Quantitative Easing. These things were referred to as monetary policy, conjuring up the quaint image (not discouraged by economists) that it was about the printing of banknotes.

And yet this idea has not stood up to the test of time. Quite apart from the fallacy of using inflation as the main performance indicator, monetary policy affects many other things than consumer demand, and in fact has led to a build up of dangerous levels of private debt. The political pressures to keep interest rates low, especially if inflation is low, quickly become unbearable. And not just political pressures. Increasing interest rates can destabilise the banking system. Such increases may have provoked the pre-crisis in 2007 that in turn led to the main crisis. Monetary policy has no brakes.

Here the left wing critics of economic policy, who think that fiscal policy should do more of the work of regulating demand, are on stronger ground. But would politicians have the guts to tighten fiscal policy when needed? The vehemence of left wing criticism of austerity, and their denial that the pre 2008 economy was overheating, suggest that fiscal policy too lacks effective brakes.

Are we heading for a new crash?

There are some worrying signs, with the build up of private debt, and with reckless fiscal policy in the US. But we are not seeing the same reckless advance of "financial innovation" that proved so devastating ten years ago. Not in the developed world anyway: China looks a bit different, though the awareness of the central authorities there is a strong contrast to the denial of many western leaders before 2007.

But some trouble is surely ahead. Perhaps then economists will start to break out of their bunker and start viewing the world as it really is, instead being a construction of outmoded statistical aggregates.

The new economics: 5 new issues should we be worrying about

Last week I identified five issues we don't need to worry so much about in modern economics. Symmetry demands that I balance this with five issues that we should be worrying about more.

That's much harder because there are a lot more than five things that are very important. So I need to thin down the list. First I have excluded things that people are already very preoccupied with, such as inequality and poverty. They may be important, but I want to show how thinking needs to change. Besides I suspect that the solutions to many such issues will be indirect rather than arising from pulling them apart directly. I thought hard about whether to include environmental sustainability, or greenhouse gas emissions in particular, as this would be a really good place to start modern economic policy. But that isn't new, and many economists are already wrestling with it. What I can say is that moving away from a focus on increasing production and consumption is part of making this problem easier to solve.

And I have also exclude issues too nebulous to approach systematically. This includes the topic of human wellbeing. We absolutely need to be thinking about wellbeing, and break out of the thinking that we can use measures of income or expenditure as a proxy. But trying to construct alternative measures and focusing on them instead is the wrong way to deal with this.

Anyway here's my five:

1. Private debt

This isn't exactly a new issue, though economists have often struggled to know what to do with debt. I remember in pre-crash days (and even afterwards) people suggesting that macro-economists could ignore debt levels since all debt cancelled out - one person's debt is another's asset.  In fact debt was always at the heart of monetary policy, which has been at the heart of macroeconomic management since the 1980s.

This was when the idea of regulating aggregate demand (and the business cycle) through public fiscal policy and public debt, often referred to as "Keynesianism", went out of fashion. Instead, the theory went, you could do something similar by manipulating interest rates. A lower interest rate would encourage people to bring forward investment plans and raise demand when the economy was running slack. Likewise, if inflation looked like an issue raising the rate could rein in demand. Although this clearly meant using private debt to regulate aggregate demand, economists were very shy about saying so. They kept on talking about the money supply instead, clinging to a picture of people using banknotes to settle all their transactions, whose supply was regulated by printing presses.

It was not until the crash of 2008-2009 that serious doubts were raised about this in the economic mainstream. In fact interest rates are a very imperfect way of managing aggregate demand, and high levels of private debt create financial instability. The crash itself was more complex than that - a lot of the problem was financial institutions lending to each other to generate fees and bonuses. Low interest rates were only part of toxic mix. But most mainstream economists still seem to think that private debt is a good way to regulate demand, provided banks are sufficiently regulated.

An alternative view of debt, put forward by heterodox economists such as David Graeber (if I can call an anthropologist that), is that it is the root of all evil - an instrument whose sole purpose is to dehumanise and enslave. This idea is not without merit, but a modern economy has come to rely on debt to carry out three things in particular which are more constructive. The first is to allow businesses to invest in capital projects which in turn make the economy more productive. A second, sometimes overlooked, is to provide working capital as a lubricant that keeps the wheels of a complex economy in motion; most business to business transactions are on credit. And thirdly it allows private individuals to buy assets by spreading payment over their useful life. Debt also helps private individuals deal with temporary cash flow problems, though this can lead to serious social problems with loan sharks, and I don't think this role is an important part of a functioning economy.

But, in the developed world at least, debt is mostly used for other things than these three, and in particular it is used to support speculation, and to generate income for middle men (aka "financial engineering"). Lending to private individuals to support property purchases spills into this economically useless territory. Some suggest that easy money is creating more demand for residential property more than society really needs.

In short, private debt has a useful role to play in the economy, but at current levels it is a source of financial instability and tends to exacerbate inequality. Policymakers need to start distinguishing between useful and dangerous debt, and clamp down on the latter. Alas they show little interest in doing so.

2. Low pay

One of the features of  modern economies is the spread of low paid or insecure jobs. Economists have traditionally been pretty relaxed about this. They assume that it is a temporary problem that will rectify itself quickly, and it must be the fault of a poorly functioning labour market. But it seems to be a big problem is in the less regulated labour markets (such as the USA and Britain); the more regulated markets tend to have high unemployment instead. It is one of the driving forces behind the suspicion of immigration, and the feeling by working class people of being let down by the elite. Technological change seems to be making this worse.

But the traditional economists are right up to a point. Solving the problem is not about throwing away market economics, such as creating lots of high paid but useless jobs in the public sector, or arbitrarily high minimum wages. These would create more problems that they solve. Neither am I convinced by the fashionable idea of topping up low-paid workers income with a universal basic income. The point is to find ways of giving ordinary workers more power. Such power comes from one thing: a shortage of workers compared to the opportunities available.

The public sector surely has a role in this. An expanded public sector with meaningful and skilled jobs (teachers, nurses,social workers) may well be part of it, but the public sector does need a bit of rethinking before we can turn it into an instrument of economic engineering. I am intrigued by ideas of job guarantees to take surplus workers out of the market - though I can see many ways this could go wrong. Should lifelong liberals accept that managing immigration flows is a part of it? Maybe, but allowing workers opportunities to work in other countries may be part of the solution too. The truth is I'm pretty short of answers, but the point is that we need to be looking at ways of tilting the job market in favour of the disadvantaged, without creating either mass unemployment or pointless jobs.

3. Economic clustering

Economists have long noticed that successful businesses tend to cluster together geographically, creating a pattern of a small number of prosperous islands amid a general sea of poverty and disappointment. In Britain this is a very serious problem, and we are not alone. Various attempts have been made to address this, including regional subsidies, pushing public service institutions out to struggling regions, creating deregulated freeports, and so on. They almost always disappoint. The extra money pumped into the poor regions flows straight back to the rich ones. Meanwhile the poorer areas become hotbeds of disillusion and discontent.

Economists don't seem to be very interested in solving this problem, to judge by the articles I read in The Economist. These largely take the line that clustering improves productivity and should be encouraged. We should concrete over the green spaces in prosperous areas areas, and build more homes there - while bulldozing the empty homes elsewhere.

But what I can't help noticing is that the problem is worse in some places than in others. France and Britain, for example, but not nearly so much in Germany, extending into Austria and Switzerland, or in Scandinavia. The big difference between these healthier regions and neighbouring Britain and France is political structures, both now and historically. Greater Germany, if I may call it that, and Scandinavia, have much more decentralised political structures, going back through history. Centres of political power attract economic clusters. We need to understand that better. By reorganising our politics we may alleviate the problem. And maybe technology will one day start to undermine the current successful clusters.

4. Intellectual property

In the new economy intellectual property, such as copyrights, patents and so forth are becoming much more important. Unfortunately, the idea that such property rights over ideas is a something innate and sacred is being accepted lazily by politicians, quietly egged on by business vested interests who like to pretend they are fighting for impoverished artists and inventors. This needs some serious pushback, because intellectual property rights are being used by the rich and powerful to oppress the rest of us. It is also used by multinational businesses to manipulate profits into low tax jurisdictions.

Intellectual property rights do have a socially useful purpose - to help reward and stimulate creativity.  But they should only be as strong as necessary. I'm intrigued by the idea that intellectual property costs should not be tax-deductible (I think similarly for loan interest...). Doubtless this is too extreme to work, but there may be intermediate ideas better prospects. And what about making intellectual property non-transferable? That would stop patent trolls, an activity that no social merit at all.

4. Effective public services

This sounds obvious, but I am really struck by how few economists understand how different public services are from private ones, and how they must often be managed in a completely different way. It is no wonder that they are so badly managed. On the one hand public services have been managed without any incentives to be efficient, and becoming useless, conservative bureaucracies who have lost touch with their purpose. This is why so many of us with memories of the 1970s and 1980s are so suspicious of calls on the left to re-nationalise railways and energy services. On the other hand, if you run public services like private businesses they lose touch with their purpose in a different way. They try to avoid or pass on the difficult cases, or try to turn them into lucrative repeat business instead of solving problems; they hollow out key performance indicators so they become a meaningless game; they soon learn to manage their political masters rather than their customers.

But highly effective public service can be done (London's primary schools for example, though the current government is trying its best to undermine and destroy their achievements). Ultimately we need to understand that public services are about solving complex problems using skilled professionals that engage with their users as human beings. Creating institutions that can do that, and identifying the more from the less effective ones, is something that should be engaging economists and policymakers much more.

Conclusion

I have gone on enough. But I hope I have shown why I think that fresh thinking is needed as our society moves through its next phase of economic development.

The new economics: five things to worry less about

Featured on Liberal Democrat Voice

Reading Adair Turner's lecture on the implications of robotics on the economy has been an inspiration. Following my blog last week, I want to develop the thinking to try and get a better focus for liberal policymakers.

The first point to make is that although the current kerfuffle is around the advance of machine learning and artificial intelligence, this only builds on trends that became important in the 1970s. This was when the previous spurt of growth, based on a huge expansion of consumer goods and services, was coming to an end, in the developed world at least. This I have called the the Age of Light Industry. It featured a virtuous circle of increasing consumption and the creation of middle-ranking blue and white collar jobs. Economists lazily assumed that this was the natural flow of technological progress. It broke down partly because consumption started to reach saturation (few people need two fridges), and partly because technological development became more about making businesses efficient than developing new products for consumers.

And we should not assume that advancing technology automatically makes things better for the majority. Lord Turner drew on the example of the first industrial revolution (the Age of Textiles in my schema), when technological improvements drove up productivity in agriculture and the textiles industry, destroying a lot of artisanal jobs. These jobs were replaced by lower paid and less skilled jobs, such as low-skill factory hands, or domestic servants for the newly enriched farmers and factory owners. The result was widespread destitution. Lord Turner shows sympathy for the Luddites, who are these days usually vilified, who tried to fight this trend. This was in the later 18th to earlier 19th century, and it wasn't until the later part of the 19th century that things started to get better for the working classes. This was in part because demand for factory jobs rose with the development of heavy industries (railways, mines, steel, ships, armaments, and so on). But it also arose because of political reforms, and an adjustment by political leaders about how economics had changed: for example the realisation that social security for the masses was affordable.

We need these things now: political reform, and a waking up to the new realities of economics. One way to make this point is to consider the things, central to mainstream economic policy making, that we don't need to worry so much about. Here are 5.

1. Average productivity

I don't need to say much more on this after my post on Lord Turner's lecture. Improving productivity matters for individual businesses and public agencies. But we can't expect statistics on the economy as a whole to tell us anything very useful, because new jobs are beiong created in low productivity services (think personal care) or in arms races that don't add anything overall (cyber crime; designer goods; ever bigger yachts; hi-tech weaponry).  Unfortunately this means that growth rates in the money economy are liable to be slow, which poses questions for how to fund public services and social safety nets.

2. The national debt

Two features of the new economy should change the way we think about public debt. First is that businesses generally need less capital, as more value comes from intellectual property than capital equipment. You can see this by looking at the modern giant firms: Google, Apple, Facebook and so on - and compare them with the old ones - GE, IBM, General Motors, etc. That reduces the need for business capital. Also the new economy is concentrating surplus wealth amongst a minority, who will inevitably want to save and invest much of their earnings. So the savings go up and investment opportunities go down. As Maynard Keynes would have told you, this is a recipe for recession. But government debt can fill the gap. Instead of putting their money into businesses, or fuelling property bubbles, the rich can buy government bonds instead. And while the need for business investment falls, the same can't be said for public investment - there is still plenty of call for that (schools, railways, and so on). Developed world governments are finding it comparatively easy to sustain a much higher level of debt than they previously did. Japan has led the way, as with so many aspects of the new economy. National debt there is now over 200% of GDP, when the conventional wisdom quite recently was that 90% was a practical limit. And the budget deficit is 4.7%, compared to a growth rate of 1.1%, so it's still going the wrong way, with barely a murmur from anybody.

Of course this leads to an important question, to which there remains no clear answer. When is there too much national debt? And how big a budget deficit is sustainable? Roughly speaking, when a country has to borrow in a currency other than its own, it is likely to hit trouble. Japan still doesn't; it helps that it does not need much foreign currency because it runs a current account surplus. Britain does not have that luxury, but the government still has no need to borrow in foreign currency.

This is important because governments can expand their own currency supply (unless they are in the Eurozone, another story), which gives them a useful lever in managing their debt. Clearly there are limits to how much it is wise to use this power - but those limits are not as severe as people thought..

And it makes little sense to drive down levels of government debt, which some conservative politicians like to do, or did before the era of Trump. There is much kerfuffle about it being irresponsible to let future generations pay for our current profligacy - but future generations will have access to highly productive technologies.

3. The dependency ratio (aka the demographic time bomb)

There is much worry that a higher proportion of older workers and retirees will drag down a future economy. Some suggest steps to increase the birth rate to counter this; it is also offered as a reason to allow high levels of immigration. But, as Lord Turner points out, if the new technology is destroying good jobs and creating poor ones, there is something to be said for fewer workers and a higher dependency ratio. Besides, it is not hard for people to retire later if that's what the economy needs.

4. Global trade

Even before Donald Trump decided to inflict his ideas about international trade on the world, the volume of world trade was in decline. People fret about this because expanding global trade was an important source of economic growth in the 1990s and early 2000s. But things have changed. As China's economy matures, it has less need to produce cheap exports. This is not particularly good news for developed economies, who are having to replace those cheap imports with something a bit more costly, but that is a temporary problem.

Longer term, increased automation will reduce the relative value and volume of traded goods. Traded goods are among the first things to be subject to automation. And as production gets more efficient, their value as a proportion of the total economy declines (this is the Baumol effect, a favourite of mine). So trade will be less important.

Technology develop will also reduce the need to trade in the first place. It will become easier to produce things closer to home, since cheap labour will be much less of a factor, and intellectual property is more mobile than a skilled workforce. I also have a hunch that much new technology will reduce economies of scale, making one-offs cheaper (think about 3-D printing), which undermines a nother reason for trade.

Mr Trump's trade wars are still an act of self-harm. But, a bit like his reckless approach to the US national debt, he has the forces of history on his side - a big difference between now and the 1920s.

5.Inflation

Since the 1970s economists have been obsessed with inflation. The idea was that if demand across an economy outstripped sustainable supply, inflation would result - so it was a critical indicator that things were in balance. This developed into the idea of an ideal Goldilocks rate, not too high and no too low, as a central ingredient of sound economic management. It became the key, sometimes only, target for central banks' monetary policy.

In fact the forces that determine prices and inflation are more complex than this, and new developments are taking it further from this idea. There are other ways for excess demand to play out, such as property bubbles and other forms of financial instability. One explanation for the financial crash of 2007/2008 was that excess demand, especially in both the US and the UK, had been allowed to develop, taking the world financial system to breaking point. With theirs eyes fixed on a stable inflation rate, most economists failed to see the crisis developing.

This is important, because if I am right about point 1 on national debt, there will be a temptation for governments to stoke up aggregate demand. They might think that this is perfectly sustainable if inflation remains low - but something else is likely to go wrong instead. Meanwhile an obsession with central bank inflation targets is wasted energy. Interestingly enough, the best example of this is again Japan. There the issue is that inflation is below target. But no matter what policymakers do, the effect on the rate of inflation is minimal.

Conclusion

So productivity, national debt (and budget deficits), the dependency ratio, global trade volumes and inflation don't matter as they used to. That's quite a change. What what should we be worrying about instead? I will return to that.