The inflation condundrum: orthodox economics under challenge

Last week The Economist published a special report on the world economy by Henry  Curr, who took as his subject the strange behaviour of inflation statistics. This is a worthy topic, but, all too typically of that news magazine, he retreats from saying anything too radical. And yet radical thoughts are warranted.

This is because, when economic orthodoxy was reformed after the nightmare of the 1970s, inflation took a central role. The core tenet of this orthodoxy is that the main way of managing the booms and busts of a country’s overall economy is something referred to as “monetary policy”. I use quotation marks because the semantics of the idea have become a problem: what sounds like one thing ends up by being another. By and large it has come to mean, in the orthodoxy, the management of interest rates in the domestic currency. The idea is that by lowering interest rates (“loosening”), you increase levels of aggregate demand in the economy, and by raising them (“tightening”) you reduce it. This, it is suggested, is a much better way of managing the economy than through taxes and public spending (fiscal policy – at least this piece of the jargon is well-defined), whose effect on demand is more direct, but brings with it problems of political management. How do you tell when policy needs tightening or loosening? Well, inflation, of course. It becomes too high if policy is too loose, and too low if it is too tight. The ideal method of managing the economy is through an independent central bank with an inflation target.

Buttressing this belief is another one: that the primary driver
of inflation is public expectations. This was an important theoretical
development, largely driven the economist Milton Friedman, after the
“stagflation” of the 1970s destroyed the previous understanding that
inflation  depended on the tightness of
the labour market. Inflation expectations interact with monetary policy and the
combined result dictates how well the economy as a whole operates. If inflation
expectations are high, and monetary policy is tight, then you have high
inflation and high unemployment. In a well functioning economy the central bank
maintains inflation in a Goldilocks zone of about 2% while keeping economic
growth ticking over at some natural healthy rate driven by productivity and
changes to the size of the workforce, keeping unemployment low. The central
bank anchors public inflation expectations because the public know they will be
punished by high interest rates and unemployment if they start asking for big
pay rises. This is a caricature, but the point is that inflation is central to
the story.

Which means that when inflation starts to behave strangely,
the whole edifice is threatened. Or it would be if the power of orthodox
thinking did not exert such an iron grip on policy makers. Mr Curr points out
that inflation has indeed been behaving oddly, but fails to point out that this
undermines the evidence for orthodox economic beliefs, meaning that more
radical ideas need to entertained.

How is inflation behaving oddly? In the developed world, and to a lesser extent elsewhere, inflation is strangely dormant, and does not seem to respond to changes in interest rates or less orthodox monetary policy, and neither to fiscal policy, to the extent that it has been tried. He discusses some reasons why this might be. Globalisation might mean that inflation is dictated at the level of global economies rather than national ones; the link between wages and prices has been loosened; technological developments have so changed what we buy and how that measuring prices has become arbitrary. This analysis is fine as far as it goes. What it boils down to is that prices and wages are determined in a radically different way to the 1970s, which provided the evidence base on which the current orthodoxy is based. Then large trade unions and manufacturing businesses, such as car makers, loomed large over the whole process. Now both are much diminished, while a vast new labour reserve in China has entered the picture, exerting its influence in all sorts of direct and indirect ways. The giants of modern industry, Google, Apple and so on, employ very few people compared to the old days of Ford and General Motors, and most of their manufacturing, such as it is,  is done outside the countries where product is sold.

Common sense suggests that when the way economies function changes, you have to manage them in differently. Alas economists prefer the analogy that managing an economy is like driving a car: you don’t have to worry what is happening under the bonnet. What happens under the bonnet of a car has changed a lot since the 1970s, but you still drive it in much the same way. So it is with economic management, Mr Curr seems to say. Managing inflation expectations is still the central problem in his view. They are too low for monetary policy to work properly and need to be jogged up somehow. This probably involves more global coordination. He suggests that fiscal policy needs to play more of a role in economic management, and that central banks should target nominal GDP rather than inflation (an idea I first tread about over 40 years ago). But he dismisses the idea of Modern Monetary Theory (MMT), which gives fiscal policy a central role, as “wacky”. To my mind it is no wackier than the idea, popular among orthodox economists, that policy makers should raise the level of inflation so that negative real interest rates can become a tool of their beloved monetary policy.

But Mr Curr avoids talking about two questions that really
need to be addressed. The first is that if inflation is anchored to a low and
fixed level, then what other consequences are there of an overheated economy?
And hows do they matter? An obvious one is a current account deficit (i.e.
importing more stuff than you export), but when some countries, notably in the
north and centre of Europe, seem to adopt a surplus as a matter of public
policy, that might not be so dangerous. The UK has been running a huge current
account deficit for years will little obvious ill-effect. It is all very
ill-understood. What is clear to me is that the answer lies in the complexities
of the global financial system. That much was shown by the financial crash
following 2007, and yet economists are strangely reluctant to take this on. The
orthodox belief about the financial system is along the lines that “it all nets
out to zero” and so they don’t need to worry too much about it. The crash was a
malfunction of the car’s engine that needs a mechanic to fix, and doesn’t
change the way you drive the car.

And this leads to the second question, which is what is the proper role and scope of monetary policy? There are some disturbing questions about the orthodox interpretation, which focuses so heavily on the short-term interest rate charged by central banks to commercial banks. The era of monetary policy has seen an explosion of private sector debt, which is one of the things that destabilised the system in 2007. The first question is whether this really is more benign than the explosion of public sector debt feared by those economists in the 1980s. It has promoted greater inequality between rich and poor, and between generations (since one of the collateral effects has been an inflation of the price of land, largely held by the elder generation).

In fact I think that monetary policy should not focus on inflation, but on financial stability as a whole. This is happening in practice, but the institutional mandate is unclear, which make it much less effective. Secondly I suspect that the MMTers are right that fiscal policy are right that fiscal policy should play the central role in the regulation of aggregate demand. Where they are wrong is ascribing inflation as the primary warning signal for overheating, for the same reason as this is wrong for monetary policy. If it provides a signal at all, it will be too late. They also seem blasé about the political risks.

Perhaps  Mr Curr’s article represents an incremental advance towards such a change in thinking. But it is hard not to be disappointed that orthodox economists are so little interested in the evidence for their core beliefs and unwilling to subject them to more fundamental challenge.

Modern Monetary Theory: a silver bullet for the left?

I have been reading the Economist regularly since 1974. I would find it hard to live without it. But I’m generally disappointed with the modern paper: its analysis lacks penetration, and its default setting is a mediocre version of neoliberalism with a few softened edges. But one of its regular columns stands out: Free Exchange. This discusses new thinking in economics in an open way that does not dismiss challenges to the conventional thinking that dominates the rest of the paper’s coverage. Last week it took on an idea that is increasingly fashionable on the left in America: Modern Monetary Theory (or MMT – its advocates love their TLAs).

This new strand of thinking on macroeconomics winds conventional economists up quite a bit, including those like Paul Krugman who are usually considered to be on the left. This is mostly because MMT’s advocates are deliberately provocative, disregarding a whole series of economic conventions, such as the use of mathematical models, and a complete lack of interest in finding common ground.

So what is MMT? I have discussed it here before, but in essence it suggests that the purpose of taxes is not to raise funds for public spending, which can be done by “printing” currency, but to stop the economy from overheating and the currency suffering from unacceptable levels of inflation. This is a reversal of the modern “neo-Keynesian” consensus (which I will call NKC since TLAs are clearly the thing), developed in the 1990s and still maintaining its grip, which suggests that the job of taxes is to fund government spending, while the job of monetary policy is to police inflation.

MMT has been seized on by the left (for example by Congresswoman Alexandria Ocasio-Cortez) because it suggests that the conventional arguments for austerity economics are bogus. Governments (or at any rate those that have their own currencies) don’t need to worry about budget deficits as long as inflation remains dormant. The magic money tree exists and is ready to nourish an expanded role for the state. Interestingly here in Britain the Labour leadership, represented by shadow chancellor John McDonnell, has resisted taking up MMT, in spite of entertaining other innovative economic thinking. I’m not entirely sure why that is, but Mr McDonnell is acutely aware of the dangers of his party being painted as wacky with the nation’s finances.

In fact the gap between MMT and the NKC is not as big as either its advocates or its critics suggest – much of it is linguistics. This is something that the Free Exchange columnist grasps, instead of falling for the wind-ups on both sides:

Speaking with MMT’s adherents is sometimes like watching a football match with friends who insist the ball remains stationary while every other element in the game, including the pitch and goalposts, moves around it.

The Economist Free Exchange 14 May 2019

Behind the kerfuffle the MMTers are onto four truths that conventional economists should be perfectly able to understand.

First: conventional monetary policy, which primarily operates through manipulating interest rates, is at best a blunt instrument for managing the economy, and at worst positively destabilising. It depends on managing levels of private debt, and often allows it to build up to excessive levels by promoting asset bubbles.

Second: public debt is much less destabilising than private debt, provided that it is denominated in the country’s own currency. Indeed many countries are able to sustain levels of public debt that used to be thought of as impossible – Japan being a prime example.

Third: fiscal policy (i.e. managing levels of public spending and taxation) is a much sharper instrument for managing the economy than monetary policy. It is much easier to direct extra demand to the weaker parts of the economy where is is less likely to cause problems. It may also be easier to direct extra spending towards productive investment (for example in clean energy or social housing) rather than inflate bubbles and the pay of unscrupulous intermediaries like bankers.

Fourth: across the developed world there is much greater headroom for additional government spending than is commonly supposed. This is because of a phenomenon referred to as “secular stagnation”, described by such conventional economists as Larry Summers, who describes MMT as “voodoo economics”. When the Financial Times’s veteran economics writer Martin Wolf thinks that the British government should borrow more to spend on clean energy projects because of secular stagnation, you should know something is up.

So MMT certainly has something going for it, once you look past the wind-ups. What are the problems? It is being embraced as an answer to austerity policies, with the suggestion that spending more on public services and benefits does not mean putting taxes up. But MMT doesn’t say there is unlimited scope for extra public spending – it says this is limited by the resources that the economy has access to. But there is little discussion about how you tell that an economy was is living beyond its resources – simply that this would lead to inflation. Supporters of the NKC suffered a similar complacency because of low inflation levels before the great financial crisis of 2008. Doubtless eventually excess would lead to inflation, but in a globalised economy there is likely to be financial instability first, perhaps driven by foreign currency borrowing. With record levels of employment and a large trade deficit it is not self-evident that the British economy isn’t at the limit already – though if extra public spending was carefully targeted it would stimulate production rather than cause prices to go up or imports to increase.

Which leads to a political issue. Under any economic theory it is clearly the case that governments can borrow too much, and that eventually printing money causes more problems than it solves. At worst this leads to cases where ruling elites and their supporters continue to live well and entrench their power, while the rest of the country becomes impoverished (think of Zimbabwe and Venezuela at the extreme, or the lesser cases of Turkey now and Argentina under the Kirchners). That is why developed world governments operate within political constraints to stop them spending too much. MMT is being used as an argument to remove those constraints, and that would end badly unless they were replaced by robust alternatives. This does not seem to be a conversation that the supporters of MMT are taking on.

There is a middle way. If, as Mr Wolf suggests, government borrowing is directed to support investments that will help economic wellbeing in the long run, then the risks of the economy going out of control are much lower. And if these investments can be biased towards areas where local economies are weak, that is even better. That means institutional controls are needed to ensure that current spending and taxation remains within limits, and to ensure that investment projects are worthwhile. But such institutional constraints are anathema to the left.

If something sounds too good to be true, it usually is. MMT is a useful challenge to stale conventional thinking on managing the economy. But even if its supporters are right that the economic arguments for austerity are flawed, we should not be blind to the political problems of giving governments too free a hand to spend as they please.

The Euro at 20. Why is it so popular?

Featured on Liberal Democrat Voice

It is 20 years since the most ambitious European integration project came into effect: the common currency, known as the Euro. Europhiles (and I am one) would do well to understand the successes and failures of this project, as they pose important challenges to the future of European integration.

British Europhiles, of course, have a wonderful way to distract themselves from such searching questions: Brexit. Most will admit that there are problems, and that changes need to be made, but then they swiftly move on to talk about the latest nonsense put about by supporters of Britain’s exit from the EU. But what happens when Britain eventually does leave? Or what happens if, against the odds, Brexit is stopped? The political initiative will swiftly move back to the Brexiteers, and they will pose hard questions about the way the EU works. Questions to which few Europhiles have convincing answers. We rightly accuse Eurosceptics (most of them) of harking back to a fictitious golden age. But Europhiles are becoming as bad: the years before the 2016 referendum are acquiring a rose-tinted glow. We should be able to do better than that.

Which is why we need to think about the Euro. It is central to the whole European project. Britain opted out: but that was an early sign the country’s fatally semi-detached status within the union. If Britain leaves and then wants to come back in, it is unlikely that the EU will let us opt out again. It will be a test of how serious we are.

And it is likely to still be there in the 20 or 30 years time when Britain might be ready to consider re-entry. One of the most important things we have learnt from the currency’s first 20 years is that it is a survivor. Anglo-Saxon economists have sneered at the Euro from when it was first mooted. First they said it would never happen, nearly up to the day that it did. Then they said it would fall apart: this reached a crescendo after the Greek crisis in 2010, when one after another fringe zone economy got into trouble. And yet not a single country has dropped out. We need to understand why it has proved so robust, especially when in almost every other way the currency has been a disappointment.

It is, of course, technically very difficult for a country to leave the common currency. You have to develop a brand new replacement currency. Difficult, but far from impossible; plenty of people have thought about it, and come up with various approaches. Countries could do it if there was the political will. But there isn’t, not even in Greece. The hard fact is that the common currency is popular amongst ordinary working people. Polls show that this popularity fluctuates (it is on a bit of a high right now), and it can be a bit of a political scapegoat. Populist politicians in both France and Italy have complained about it (with the full support of those Anglo-Saxon economists), but the closer they get to actual action the more their courage fails. Marine Le Pen in France has had to backtrack; those Italian leaders in the League and Five Star Movement are likely to make the same journey.

It’s not hard to see why. To ruling elites and economists a currency is a means to an end, rather than something in itself. They tend to have a “use it or lose it” attitude to it, and think a little bit of inflation is a jolly good thing. Nothing illustrates the patronising attitude of these elites towards the majority of those they serve better. To most people the currency is a sacred bond of trust between the state and the citizen. Since time immemorial, when kings used to put copper in gold coins to pay for wars and their own high living, this gap between the perceptions of the elite and working people has created resentment by the ruled of those than govern them. For most Europeans, especially those in weaker economies, the Euro is a much more secure store of value than any local currency that would replace it. Especially since the entire purpose of those populist politicians in ditching the currency is so that they can devalue it, and secure the supposed wider economic benefits that would flow from that. And for those that borrow money rather than save it, the interest rates for the Euro tend to be lower too, so even they win out. The relationship is more complex for northern economies, like Germany’s, that might see a currency of their own rise in value. Indeed in these countries the Euro is not so popular. But it helps drive an export-led economy and secure jobs. Interestingly, Britain is at the intersection of these two groups. It’s fair to say that most ordinary people would rather trust British institutions to run their currency than European ones. And neither do export industries play such a great role in providing stable jobs as they do in Germany or the Netherlands. Scepticism about the Euro is more understandable here.

We should be careful not to overstate the popularity of the Euro. Amongst younger workers, in Italy say, who are struggling to find stable employment and save money, the Euro is not popular. But savers form the political bedrock of most developed nations. And to them the stability of the currency is no small thing. The rise of Nazism in Germany is often attributed to the failure of democratic institutions to prevent hyperinflation; conservative monetary policies are still a given in that country. Perhaps after preventing foreign invasion and keeping the streets and homes safe from criminals, people see maintaining the currency is the most important duty of a government: even higher that producing a healthy economy, which, after all, is mostly down to individual work and enterprise, not governments.

The European institutions have fulfilled that duty with respect to the Euro, in many cases better than the national governments that preceded them. So the currency remains broadly popular, and ways will be found of ensuring its survival as long as it holds its value. But in many other ways those Anglo-Saxon economists have been proved right about the Euro. It has not delivered the other economic benefits promised on its creation. Indeed the robustness of the currency can be seen as a trap, or a prison, preventing political leaders from delivering prosperous economies. Why this should be, and what can be done about it, has become one of the top priorities for European leaders. That is a topic I will consider in a further article.

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.