Politics UK – Page 41 – thinking liberal

Brexit: an own goal for the Eurosceptics

It must have seemed like a good idea at the time. A while back a right-wing think tank, the Institute for Economic Affairs (IEA), launched a EUR 100,000 prize for a blueprint for Britain’s exit from the EU, the “Brexit”. The winner was announced last week, to not very much fanfare. You can read it here: Brexit Entry 170_final_bio_web. It is not surprising that our mainly Eurosceptic media have given it a low profile. It exposes flaws that go deep into heart of the Eurosceptic case. Better to stick with Nigel Farage’s meaningless soundbites. No doubt the Europhiles ignored it as its thesis is still Eurosceptic. That is a pity. This piece of work deserves to be taken seriously by both sides of the debate.

First, though: credit where it is due. This piece of work is a breath of fresh air compared to most of what comes out of both sides of the debate. It is calm, factual and objectively reasoned. It reflects well both on its author, 30-year old diplomat Iain Mansfield and the IEA. Bar one or two articles in The Economist, it is about the best reasoned thing I have read on Britain’s possible exit from the EU.

The essay answers the question of what would happen if Britain voted to leave the EU. It considers the various negotiations that would need to be made, and what these should aim to achieve. It has a stab at assessing what the economic consequences would be. Along the way it explains a lot of the facts that impinge on this (such as what is the difference between the EEA and EFTA?). This is a welcome change from the airy hopes and assertions usually made by Eurosceptics – and the equally airy scorn poured on them by Europhiles.

Its central idea is quite a sound one. Britain would not bring up the drawbridge and retreat into “Little England”, as no doubt some older Ukip supporters would like. The UK would establish itself as an open nation, promoting free trade. This reflects the economic liberalism of most modern Conservatives. They feel that membership of the EU gets in the way of the country promoting a economically liberal policy agenda.

There is one big gap in this work as a review of Britain’s options. There is no sense of industrial strategy. British business would flourish in a less regulated environment; we would trade more with emerging economies. That’s about it. Where are Britain’s comparative advantages? Which industrial sectors would we rely on – and how would these be promoted after Brexit? And the gorilla in the room: what happens to international wholesale financial services (aka the City) in the brave new world? It is easy to see both positives and negatives for the City – but how would these balance out? If there is one thing that makes other European nations exercised about Britain, it is the financial industry. Surely they wouldn’t hesitate to use a Brexit to make mischief?

There is also a quibble. He says that Britain should gain a net £10bn per annum in net contributions – though not straightaway. He says some of this will have to be spent on building capabilities that we have delegated to Brussels, such as trade negotiation and antitrust, but mostly it would be a gain. And yet he freely suggests the need for agricultural subsidies, and a host of inducements to entice in foreign direct investment (FDI). That £10bn is unlikely to last very long.

But that’s a detail. Three big problems stand out from this study. Has the British public signed up to economic liberalism and deregulation? Is the Brexit strategy trying to have its cake and eat it? And is it worth all that effort?

There is common belief on the right that Britons are a nation of freewheelers, and that the inveterate regulators in most other European countries are anathema. We are more like the Americans. Leaving aside whether Americans really are such freewheelers (you need a licence to be a hairdresser in many states), this is not well founded. Britons love to whinge about excessive regulation, to the extent that “Health & Safety” has negative connotations, but attempts at deregulation usually fail. Mr Mansfield wants a “Great Repeal Bill” to roll back and replace a host of product and labour regulations. That promises to be the mother of all political battles, and its outcome is bound to disappoint. Britons have as much affinity with Scandinavia as America – and you can’t move for regulations there, not least in Norway, which is not even in the EU. Indeed the sort of new Britain that many Tory Eurosceptics seek is a kind of right wing dystopia so far as most Britons are concerned.

More serious is the strategy for European trade that lies behind the Eurosceptic economic case. For all his thoughtful detail and realistic attitudes, this looks like a strategic flaw in Mr Mansfield’s strategy. The idea is that Britain gets free access to most European markets (he rightly suggests this would be unrealistic for agriculture, though); but that our industry will be more competitive because it can avoid large areas of regulation, especially for labour. And he takes this a step further, by suggesting that, with the help of some extra incentives like low tax rates, the country can retain its popularity as one of the top European countries for FDI – so that these incomers can export to the EU. This is known as having your cake and eating it. This strategy requires the cooperation of the county’s EU trading partners, who have a name for it: social dumping. And the fact that Britain imports more from Europe than it exports to it does not, in fact, give the country a strong negotiating position, as many Eurosceptics suggest. To his credit Mr Mansfield does not mention this last argument, and describes the British negotiating position as weak.

Which leads to the next problem. When you get into the detail of what has to be negotiated, Britain will end up giving concession after concession. Mr Mansfield suggests that half or even two thirds of the aquis communitaire (the body of EU laws and regulations) would have to be retained by Britain. The scope is massive. The overwhelming impression I get from reading this essay is the sheer size of what would have to be dealt with in a series of extremely tricky negotiations. All for what? Mr Mansfield estimates a range of impacts on the economy from -2.6% to +1.1%, with +0.1% as “most likely”. He observes that the case is more political than economic.

In only one area might the general public, as opposed to right-wing politicians, think that this might be worth it: ending the free movement of people, and especially labour. We would still need quite a free flow, but it would be easier to manage – and it would be easy to establish inferior rights for European immigrants. I suspect that the whole case for or against the EU will turn on this – and Europhiles badly need to sharpen up on the subject.

At the end Mr Mansfield refers to the examples of Canada and New Zealand as being successful countries in spite of being separate from nearby behemoths (the USA and Australia respectively). Interestingly another study on the benefits of EU membership, reviewed in this week’s Economist, uses a comparison with New Zealand to suggest that British incomes are 25% higher for having joined the EU in 1973. New Zealand’s economic record, in spite of (because of?) being a bit of test bed for economic liberalism, has been pretty underwhelming. It has recently being doing better courtesy of massive exports of agricultural products to China. Well New Zealand is a small country far away from anywhere – so comparing it with the UK is a stretch. But at least it has a decent export engine based on its natural resources (as does Canada with its mineral wealth). Britain’s oil is fading (and mostly Scottish anyway); it has been in agricultural deficit for a century; it is not an option to despoil swathes of countryside to dig out minerals for the Chinese market. We have the City, and lots of management consultants. Is this enough to build big export industry with the developing world?

In recent article, Vagueness is a danger for eurosceptic demagogues FT columnist Janan Ganesh pointed out that the Eurosceptic case tends to fall apart when Euroscpetics try to spell out exactly what they think exit it all means. Mr Mansfield’s interesting and refreshing essay cannot hide this truth.

Does money really grow on trees?

A few months ago David Cameron, the Prime Minister, defending the government’s austerity policy said that “Money doesn’t grow on trees!”, a well used expression when discussing household budgets. The Financial Times economics columnist Martin Wolf responded that money did indeed grow on trees, and the money tree went was the Bank of England. Can Mr Wolf be right?

Mr Wolf was referring to the Bank of England’s policy of buying government bonds, known as Quantitative Easing or QE. One arm of the government, the Treasury issues bonds to pay for government spending; another, the Bank of England, buys them by simply adding to its reserves – creating money. Actually, the Bank doesn’t buy the exact same bonds, it buys others that had been issued earlier – but it amounts to nearly the same thing. The extra money ends up in the accounts of major investors such as insurance companies or pension funds, at home and abroad. Government spending has been financed by the creation of money. Hence money seems to grow on trees.

This type of financing is associated in the public imagination with disaster – such as the hyperinflation in Germany and Austria after the First World War, or more recently in Zimbabwe. In conventional economic theory an increase in money supply, if not matched by expansion of the economy, leads to inflation. But there is no increase in inflation in either Britian or the USA, which are both practising QE, and in Japan, where increasing inflation is actually a policy objective of QE, the increase in inflation is anaemic. So what is going on?

There are three problems with the conventional economic theory of money. First is that only trivial amounts of money are represented by notes and coins, whose circulation is controlled by the government. Instead we use bank accounts provided by commercial banks. Economists have tried to understand this type of money in equivalent terms to notes and coins. People bank money and the banks then lend it; the banks do not create money, though the central bank may. But further reflection reveals that this is not the way it works, as the Bank of England has recently admitted. It is the other way round: banks create money by lending it to people. With this more realistic idea of what money is, we can see that far from the money supply expanding with QE, it is shrinking as banks reduce their balance sheets after the boom years when they created money freely. You could then argue that QE is simply offsetting the shrinkage of credit from the banks, balancing the whole thing out. All will be well until the banks turn the corner and start creating money again.

But there is a the second problem. The overall supply of money, as far as it can be measured, does not strongly correlate with either the size of the economy or inflation, as monetary theory predicts. That’s because money doesn’t flow round the system at a constant speed. If you print banknotes, and people simply stuff the new notes under the their mattresses, the real economy doesn’t change. The electronic equivalent is people holding bank deposits which they don’t spend. That’s been happening a lot. Standard monetary theory, such as that put forward by people like Milton Freidman, is based on the idea that money circulates at a reasonably constant speed. But in fact people don’t behave that way.

But even if they did, there’s the third problem. Excess monetary expenditure does not necessarily lead to inflation; in fact in a modern developed economy it rarely seems to. Instead of people raising consumption which pushes up consumer prices and then pay, people spend it on assets or imported goods. Asset prices don’t seem to behave in a rational way, being subject to a price bubbles. In the modern globalised economy it is easy to import goods to satisfy any increase in consumer demand. And in any case the link between consumer prices and levels of pay has been broken. The wage-price spiral, at the heart of the way economists view the world, does not seem to happen in developed, globally integrated economies. Incidentally this is the problem that the recent aggressive monetary expansion in Japan (“Abenomics”) has bumped into; prices are edging up but companies remain reluctant to let wages follow suit, so that inflation simply makes people poorer. The concept of central banks targeting inflation as their main objective, the big idea of the 1990s, has simply led to complacency.

So the theory of monetary economics is in ruins. That does not stop usually quite economically sane publications. like The Economist, discussing whether central banks should adjust their inflation targets from 2% to 3%, or use nominal GDP as their reference point instead of inflation. This is rearranging the deckchairs on the Titanic (apologies for the over-used metaphor). Fortunately central bank professionals are highly pragmatic and they don’t seem to be letting the vacuum in economic theory lead them into being too dangerous, with the possible exception of Japan.

And the upshot is that in many developed economies, including the British one, governments can get away with the monetary financing of government spending, without much in the way of immediate adverse consequences. Money really does grow on trees! How on earth to understand this – and any not so benign consequences?

Well you have to recognise that money is simply a means to an end: a social construct to enable economic activity and regulate societal relationships. It often helps when thinking about an economy to take the money away and see what is going on in what economists call the real economy.

Let’s look at the real economic flows, which are at the heart of Mr Wolf’s analysis. The government is consuming more resources than it is receiving from taxation. This deficit must be supported from outside (you can’t print money in the real economy), and in general terms this is from two places: the private sector and outside the economy. The private sector, as a whole, is consuming less resources than it is producing and this surplus, in various direct and indirect ways is helping to support the government deficit. This is partly because people are working off their debts, but also because private businesses are hanging on to profits. Also the economy (in Britain and the USA in particular) as a whole is in deficit with the outside world: importing more than it exports. The government can safely run, or even increase, its deficit because it is balanced by surpluses by the private sector and the outside world.

But this is not sustainable in the long term, because persistent deficits lead to excessive debts, and the monetary economy breaks back into the real one. If the government has cleverly got out of financing its deficit with debt, it is simply passing on the affordability problem to somebody else. The assets being accumulated by the private sector and foreigners are not worth as much as they think. The government has avoided the risk of a solvency crisis by increasing the risk of a currency crisis or an asset price collapse. This may be localised, or it may be part of a gathering global financial crisis.

But if by running a deficit the government is staving off a wider economic disaster, or even bringing the country back to the path of economic growth, it is opting for a lesser evil. Mr Wolf argues for continued government deficits, financed by QE if necessary, on just these grounds. Austerity will simply precipitate the economic crisis rather than buying time to fend it off. He has a strong belief in a “trend rate” of economic growth of about 2% per annum which can be readily unlocked and get us out of jail.

That’s where I disagree. That trend rate may sound a small number, but it is in fact a very large one for an economy that is fully developed (China can grow faster because it is catching up). A special set of circumstances combined in the period 1945 to about 1990 or 2000 to make it seem normal – but we are in a slow growth world now.

So keeping government deficits going using QE to bypass the bond markets caries risks. The main priority for governments is to reduce their countries’ vulnerability to future crises and improve their resilience. That means rebalancing. Between public expenditure and tax; between rich and poor; between imports and exports; between financial engineering and productive investment; between young and old; between environmental degradation and restoration.

Government deficits may or may not play a role in this rebalancing process. For what it is worth I think the British government has it more or less right in terms of its overall austerity policies. QE may or may not be helping. But any money plucked from trees will, to mix metaphors, go off if it isn’t spent wisely.

Why Labour are losing the election in 2015

According to press chatter, there is mounting worry amongst those that surround Ed Miliband, the leader of Britain’s Labour Party. I don’t know anybody in this elite circle, and I can’t offer an opinion on whether this is true. What I can say is that it should be. After ducking hard choices when the going was good, he is now in real trouble.

The immediate cause of the Labour wobble, if that is what it was, was the poll bounce for the Conservatives after the recent Budget by the Chancellor, George Osborne. The previously secure Labour lead simply vanished. This poll bounce disappeared as quickly as it came. Clever charts showing that it was part of a longer-term trend look premature. But it did show that Labour support is not solid, and that the Tories are not quite as terminally unpopular as many suggested.

But what really convinces me that Labour are in deep trouble is this exclusive piece in yesterday’s Independent, highlighting an article Mr Miliband had written for the paper. Here’s the first paragraph:

Ed Miliband has promised to rescue Britain’s struggling middle classes by boosting their living standards as he warns that the “cost-of-living crisis” will last for at least another five years.

This seems to be part of a bid by Mr Miliband to rebuild his electoral standing; today he is launching a policy about devolving more power to “super-City” regions, building on a policy developed by the Liberal Democrat leader Nick Clegg, as he will not say.

This political drive builds on two themes that Mr Miliband has been developing. The first is “the squeezed middle” – a deliberately vague reference to people who feel they are neither favoured by government handouts, nor part of the rich elite. It is interesting that this seems to have migrated to “the struggling middle classes”, when it might just as easily refer to working classes (if you get beyond the bureaucrats’ tendency to use the term “working class” to refer to people who are not working, and entitled to state support, as an alternative to the word “poor”). The second idea is “the cost of living crisis”, referring to the fact that for most people incomes have not increased as fast as prices over the course of the last government.

No doubt Labour’s polling shows that these ideas cover a large swathe of generally unhappy people, who might therefore be sceptical of the government’s record. The problem is how to appeal to them. Almost by definition, these people are out of the scope of state benefits. In fact they tend to resent the size of the state benefits bill, apart from the old age pension, whose cost they tend to underestimate. They are not employees of the state, a separate and distinct constituency, even if they share some of the same problems). So how to address their standard of living? There are two ways: tax cuts and a stronger private sector economy. On both counts Labour’s credibility is behind that of the Coalition.

The best sort of tax cut to reach the squeezed middle is a cut to personal allowances, i.e. the point at which people start to pay tax (including its National Insurance equivalent, something all parties seem happy to ignore). But the Coalition has already been increasing this quite aggressively, mainly at the expense of higher rate tax payers, some of whom are now claiming to be part of the squeezed middle too. Worse, it is one of the few policies that is closely identified by the public with the Liberal Democrat part of the coalition, which Labour is extremely keen to denigrate – they have picked up a lot of ex Lib Dem voters. They have floated the idea of a 10% tax band, which is just a less efficient way of delivering the same policy – and has uncomfortable echoes with one of the last Labour government’s policy mistakes.

There is an even bigger problem with taxes. Labour has to convince voters that it will not put taxes up to pay for an expanded state. That means signing up to a series of things, like a cap on benefits expenditure, that will be unpopular with core Labour voters, and not even particularly sensible from the point of view of economic management.

But tax cuts are a fairly minor palliative. What would really cheer voters up is the prospect of incomes rising in the private sector. The trouble is that Labour has done nothing to dispel its reputation for being anti-business. Quite the opposite. Mr Miliband’s view is that there are good businesses (“producers”) and bad ones (“predators”). Wages are being squeezed by the predators to benefit their top managers and shareholders. So his anti-business policies are directed at these predators (banks and energy companies to the fore), while helping the producers. This argument is not entirely without merit, but it is a tough sell. And in practice it is pretty much impossible to create policies that discriminate successfully between the two classes of business, and all those that inhabit the grey zones in between. The result is that Labour’s policies designed to address this problem, such as the devolution to the cities, don’t look as if they will deliver much of a boost to wages in the short term – even if they are perfectly sensible. And sensible policies are liable to get matched or pinched by the coalition parties anyway.

The Conservative counterattack to Labour will point to the fragility of the current economic recovery, and say “Don’t put all this at risk”. Of course one thing that could put the fragile recovery at risk is the Conservative plan for a referendum on the EU. But does Labour want to go out with all guns blazing on that issue? Perhaps I underestimate Mr Miliband, and that is his plan. But so far he is happy for Mr Clegg to take the lead on the issue. In fact you could not inaccurately describe Labour’s emerging strategy as “I agree with Nick”. A liberal, centre-ground stance that wants more devolution from Westminster, but with a strong attachment to the EU.

So Labour is embarking on an impossible task to convince the electorate that it can out-do the coalition parties at their own policies. This won’t work. But what it will do is to de-motivate their core constituencies of public sector workers and the squeezed bottom, as I might call the voters suffering from benefits cuts.

The trouble is that Labour hoped to get the best of both worlds after Mr Miliband was elected. That they could adopt a “Blair-lite” strategy that allowed an appeal to the centre ground, while at the same time harnessing the wave of anger from their core voters at the government’s austerity policies, which, incidentally, allowed them to harvest a lot of Lib Dem voters. But Blair-lite lacked credibility as soon as the economy started to revive. There was a choice to be made for either Blair II, an unashamed dash for the middle ground, including an apology for the record of the last government’s economic policies (though that would have been too much for Mr Blair himself). Or they could have gone for unashamed social democracy, making a case for higher taxes, a bigger state, and less aggression on cutting the deficit (isn’t going for a balanced budget just willy-waving after all?). The first of these two choices might well have destroyed the party, given the depth of anger over “The Cuts” – but the second choice was never properly debated or confronted. It would have been perfectly respectable and courageous – even if expanding the state back to the size it was in 2008, or even 2010, would have taken a very long time.

The Conservative General Election campaign has not got started yet. They will allow Ukip their moment of glory in this year’s Euro elections, then quietly mug their voters by stoking up fears of Labour. Labour’s credibility will fall apart, and they will have increasing trouble fending off Tory attacks and keeping their core supporters loyal.

If I was advising Ed Miliband, I would be worried.

The European elections are a victory for proportional representation

They look like a colossal waste of effort. Elections to the European Parliament take place every five years, and turnout in Britain, as in much of the rest of Europe, is dismal. Few understand what the European Parliament is for. But last night’s debate between Liberal Democrat leader Nick Clegg and Ukip’s Nigel Farage shows that things are going in an interesting direction. These elections are contributing more and more to the wider process of politics in this country.

The most important thing about theses elections is that they are held using proportional representation (PR). Parties in practice need to get over 10% of the vote in a particular region to get represented – but that still gives parties with a broad but thinly spread appeal a much better chance than parliamentary and even local council elections. The vote share won by the two parties that dominate conventional elections, the Conservatives and Labour, is dismal. This is adding a new dimension to the political debate because it offers voters a greater choice.

The conventional way of politics in the UK is to tell the voters that the real choice is between just two parties. Which two varies depending on where the election is being held, but mostly it is between Labour and the Conservatives (though Scotland is a big outlier here). This serves to close down political debate to a few carefully chosen swing issues that appeal to marginal voters in marginal constituencies. Minority views are dismissed as being irrelevant. But this line of campaigning does not work with PR. And the European elections are the only ones held under PR for most English electors (Scottish, Welsh, Northern Ireland and London Parliament/Assembly elections are held under PR).

The most obvious beneficiaries of this have been to the Lib Dems, the Greens, and, above all, Ukip. Ukip is a right wing insurgent party that represent political views that are as far away from mine as you can get while still being a respectable political party (unlike the openly racist BNP, for example). But it speaks for an important minority of mainly English voters who feel oppressed by the current political system, and ignored by the main parties. The EU is an important focus of that discontent, as is what is seen as excessive immigration. As an aside it often draws its strongest support from areas that are relatively unaffected by immigration – but that does not stop it being a popular scapegoat. The issues are linked: free movement of people is a vital plank of the EU project.

The Conservative and Labour parties would rather these issues were suppressed. They represent inconvenient divisions within their own ranks and put their internal cohesion under stress. And that led to last night’s debate. Ukip and the Lib Dems take clear sides, and are quite happy to slug it out in public. And the public gets to hear a proper debate. That is a very important part of the democratic process. Floating voters may not have learnt much from the verbal slugging match, which I judged to be a score draw (with plenty to please both sides), but it at least would have drawn them into the issues.

Where is this heading? In the great scheme of things I don’t think the direct European Parliament elections are a great success in closing Europe’s democratic deficit. I think its original configuration as a forum for delegations from national parliaments was a better one. But for as long as it is the only national election held under PR, it is serving a useful purpose. The right answer is to use PR for national parliamentary elections, but alas that aim remains very distant. PR for local elections may be a more realistic intermediate step.

Meanwhile it will be very interesting to see if the interest stirred by these debates will affect turnout at the elections. But even if they do not (I will only believe it when I see it) they are doing something to close Britain’s democratic deficit.

French lessons for British social democrats

Opposition has brought a certain coherence to the British left. There is nothing like a hate-figure being in power to bring about a sense of unity. And the idea that runs through the left’s thinking on the state is social democracy. But last weekend’s electoral disaster for the French Socialists, and the rise of Marine Le Pen’s National Front should give them pause. The left is becoming is becoming disenfranchised from the working class.

What do I mean by social democracy? It is the coming together of several elements. The first is the conventional understanding of western democracy and the rule of law – in contrast to a more radical revolutionary style. The second is a grudging acceptance that the private sector is the primary motor of the economy – but heavily managed to prevent its excesses damaging society, including strong protection for employees’ job security. Next is strong, national government, setting standards that apply across the whole country, rather than the chaotic and inconsistent approaches that come from bottom-up policy. Then there is a faith in large public services, covering health, education, railways and much more. A strong social, state-funded safety net is added to it. And it is all funded by high levels of taxation, with a strong progressive element.

In Britain I have noticed that a historical narrative has built up around this idea. Social democracy’s breakthrough moment was the Labour government of 1945 (after the perceived success of the country’s state directed war effort). Something like a consensus built up around it, as economic growth allowed the scope the social democratic system to be extended. Then disaster struck in 1979, when a new breed of politicians, the “Neoliberals” were allowed to take over. Mrs Thatcher’s government started to dismantle the social democratic apparatus. Tony Blair’s Labour government wasn’t much better. But at least Mr Blair’s public sector “reforms” were balanced by Gordon Brown’s creeping extension of the scope of public services. In 2010 the Tory-led coalition of Tories and the neoliberal wing of the Liberal Democrats has continued the dismantling process. But the neoliberal ideology is a demonstrable failure – leading to the financial crisis and escalating inequality. The new Labour leadership, under Ed Miliband, has shown interest in reviving the old social democratic system, but it is being urged to be more radical. Social democrats within the Lib Dems hope that the party’s current leadership will be up-ended and the party will never again be associated with Tory government.

My aim here is not to challenge this flawed narrative, though I choke when I’m told that privatised industries like energy, telecoms, water and even the railways all better run when under public ownership. I want to draw parallels between this social democratic vision of society and France. For surely the country where these ideas have been carried through most thoroughly is France. Of course the Left would rather talk about the Scandinavian countries, Denmark and Sweden especially. But these are small, homogenous countries which do not make good parallels – and never mind the often rose-tinted spectacles.

But France is a big, diverse country like Britain. It’s anti-capitalist attitudes are deeply embedded. It combines a very efficient private sector with a strong central government run by a very well-educated and brainy elite. More than half the national income is paid in tax. And in 2012 the Socialists were swept back into power in a landslide. But now the economy is sliding and the Socialists are deeply unpopular. The working classes are defecting en-masse to the anti-establishment, anti-immigrant, anti EU National Front. What are the lessons?

But first a word of caution. It is commonplace for Anglo-Saxon commentators to write the French economy off as a basket case. It is not. Slow growth is probably an affliction that all developed economies will have to deal with. It was no accident that France weathered the 2007/09 crisis better than most developed economies – and just how secure is the new growth in Britain and the USA? Still, it has some big problems.

There are important lessons for the left in both strategy and tactics. Strategically the toughest lesson is than not all neoliberal inspired ideas are rubbish. The world economy is changing, thanks to trade and, above all, to technology. National economies must adapt to this. Developed economies are already highly dependant on global trading – shutting it off would mean a step backwards and reduced living standards. Accepting it means that industry has to reshape, causing job losses in obsolete industries. The neoliberal approach of letting market forces shape the change, by allowing struggling business to go bust and not getting in the way of new industries to take their place, is the quickest and cleanest way of adapting to this change. Fighting it means declining tax revenues, which means putting pressure on the public services and the social safety net. By pretending that there is an alternative to the globalised market economy, all the left does is build up false expectations about what can be achieved. That is the first cause of the Socialist failure in France. Too many on the British left don’t understand this basic, strategic problem.

The tactics are just as important. In France the Socialists have become part of a distant elite, remote from struggling working-class communities. They are full of clever intellectual answers, but they don’t feel the pain. Hence the appeal of the National Front. The British left too is too attached to its own intellectual sphere, sustained by Westminster think-tanks, and various left-wing publications – as well as intellectual cells in universities and (to a lesser extent) insulated public services like schools and hospitals. Strategy is set by using opinion polls and focus groups, not by politicians in the hard grind of finding solutions for hard-pressed local communities.

There is a tactical blind alley here. The focus group approach is telling politicians to respond to working class (and much middle class) anger by taking a tougher line on immigration, the EU and so on. To be fair on the left, they are resisting this temptation. But it isn’t just the pollsters and focus groups that are pulling politicians in that direction: any politician who spends serious time with the public understands that the pollsters aren’t making this up. The problem is that pandering to this anger also leads to false expectations; for very good reasons the politicians can’t deliver, and if they did the public would not like the result.

How to win back working-class communities while staying true to liberal instincts? Well you won’t find the answer in grand reforms and new laws promulgated in London or Paris. It isn’t about crafting the right sort of attack material to wound the right. It is about politicians winning trust by getting out into their local communities, meeting people and facilitating solutions that people can see. The choice of the word “facilitating” is important. It is about helping people to help themselves, not creating new government schemes (though these have a place). It is about mediating between different interest groups, not stoking up fights. People are much more realistic than many give them credit for. They appreciate honest facilitators and mediators more than people who just stoke up anger. But they are suspicious of elites that would rather talk to focus groups than their local electors, or who want to make their name with some new national reform – rather than helping to sort out a local housing estate, or bring together local ethnic groups.

It’s a hard road, but it is one the left must embrace if they are to avoid the fate of the Socialists in France.

Pensions, savings: sensible steps forward

This week’s UK Budget has revealed the usual muddle amongst politicians, journalists and the public over the whole issue of pensions and savings – with opinion strongly favouring several flavours of having your cake and eating it. This masks some profound and sensible reforms carried out by the coalition government.

First version of the cake. We like people to save. But we want them to spend to promote economic growth. We worry that a large part of the population will become dependent on the state and taxes because they save too little. But when they do, as in the early part of the 2008/09 crisis, we bemoan that fact that people aren’t spending and so causing economic slump. So interest rates crash to the floor in an attempt to reduce savings and increase consumption (alongside the vain hope that companies will be encouraged to invest more).

Next version. We want people to save more to not be dependent on the taxpayer, but we also want target state spending on the less well off, and tax the rich to pay for it. So we encourage people to save, and then confiscate the proceeds.

Another version of this is that we love the idea of exempting pension saving from tax but think that people who have accumulated sufficient savings for a reasonable pension (a million pounds for a pension of £35,000, for example) are part of a rich elite whose broad backs should carry the largest burden.

There is a genuine dilemma at the heart of this of course. For that reason a lot of hope resides in get-out-of- jail-free cards. One of these is strong economic growth. But that requires lots of people to work – which means retiring later and allowing immigration. We are clearly entering an era of low growth, thanks to demographics, personal preferences (i.e. people choosing unpaid leisure over work) and the changing nature of technological advance and the global economy. Remarkably few people have tried facing up to the consequences of this. Even some intelligent economists think that “trend growth” is a law of nature. Another get-out-of-jail-free card is that rising property values will compensate for lack of saving. Collectively this cannot make sense, but it has worked for many individuals, who therefore don’t engage with wider worries about the future.

Now let’s consider some difficult facts. I have already mentioned that economic growth is likely to be much lower in future. The next difficult fact is that private pension saving has collapsed in the last 25 years. Generous final salary schemes have been replaced by inadequate money-purchase schemes. It is now use just blaming Gordon Brown’s tax raid on pension schemes in the later 1990s for this (or Mrs Thatcher’s ill advised liberalisation of pension selling before that) and some are prone to do when you mention this. This at worst mildly accelerated a growing trend. The economics of businesses supporting these pension schemes became toxic even without the tax changes. This means that, as a generality, most people will not now have adequate private sector pensions. Instead as they approach retirement they will have accumulated a few tens of thousands of pounds in probably several schemes.

The next difficult fact is that the economics of long-term saving are toxic for all but the very well off (liquid assets of over £0.5m, say). The poor face the prospect of losing entitlements to state benefits if they accumulate wealth. Everybody will see any savings eaten away by costs which, even without a host of rip-offs, will always weigh most heavily on those with smaller savings. It becomes perfectly rational for a lot of people to not to bother with pensions savings – unless you count trying to own your own home.

When you consider all this, the attraction of tax funded state pensions become clear. That is why the current government has been right to make it reasonably generous, notwithstanding criticism form the right that we can’t afford it. It was also right to make this pension independent of private saving.

Now, what about the tax treatment of savings? To simplify, there are three groups of tax privileged savings. The first is domestic property. To buy your own home you pay out of taxed income and stamp duty on the purchase price, but the gain is exempt from tax. The second is Individual Savings Accounts (ISAs), which, like property, are paid for out of taxed funds (subject to an annual limit) but income and capital gains are tax free. And third are pension plans, for which contributions are exempt from income tax, but it is taxable on drawdown.

The first and last of these are problematic. Domestic property because its tax exempt status has made it a highly attractive investment – but instead of this fuelling much in the way of building new, efficient property, it has simply driven prices up, making ownership out of reach for many younger people and driving a wedge between families with property and those without. Pensions are a problem because that particular route for providing tax exemption makes for maximum complexity. In fact they have become so hedged about in rules that most people don’t understand them.

ISAs, on the other hand, have an elegant administrative design which makes them easier to own than even taxed assets. They also have more chance of channelling investment into more productive parts of the economy.

Here’s why this week’s proposed reforms make sense. Currently money purchase pensions are forced to buy annuities, except in some carefully crafted circumstances, which tend only to apply to the better off savers. The original fear behind this annuity rule was the worry than pensioners would blow their savings quickly and then throw themselves into the arms of the state. But the state of private pensions is such that most people will rely on the state anyway, and most pension pots are so small that the amount of income that would be derived from an annuity would be derisory (and, presumably, a lot of value would be lost in administration costs). And those with larger pots are likely to be prudent with their wealth. If done properly, this will simplify the pension system, and make private pensions more attractive.

Extending the ISA allowance is more controversial. Many simply view this as benefiting the wealthy, as nobody else can save up to the £15,000 a year limit. There is some truth to this, but it will help level the playing field between financial investments and owning your own property. Since it is unthinkable to tax capital gains on homes, it may help to make other assets comparable in their tax status.

A lot of nonsense has been uttered as commentary: fears over people blowing money on cruises and fast cars – or rushing into buying property. My main worry is that the reforms will make it easier for better off people to save for their children, to pass on at death. This could reinforce the effect of inherited wealth, which is already growing. There may be mounting pressure to reduce Inheritance Tax.

But overall this looks a sensible step forward – and actually quite brave. It is surely no accident that unlike its predecessors the current government’s Pensions Minister, Steve Webb, really knows his stuff, and has been kept in post for the whole period. Liberal Democrats can take pride that he is one of theirs. There is strong political consensus in his reforms, and no party political benefit. But it is nice to feel that our party has contributed something useful to the process of government.

Liberal Democrats: pragmatic policies – small steps to a liberal future

We ended the Liberal Democrat conference today on a high note. Nick Clegg gave one of his best conference speeches, in confident form. We are now learning what this “centre ground” strategy means in practice. Mr Clegg did not utter the dread words in his speech at all. Instead he talked freely about Britishness and liberal, inclusive values. He painted an optimistic, happy picture, to contrast with the sour, pessimistic one that dominates so much of politics now. This went down predictably well with the faithful, but it is a sensible strategy in the wider political debate too. It answers the question “What is the point of the Liberal Democrats”.

The centre ground bit came in the policy programme. In yesterday’s immigration debate, the party talked inclusive, but toned down official policy – for example dropping the idea of a path to legality for illegal immigrants. On the constitution we talked about the Single Transferable Vote, and job shares for MPs. Sweeping reform, including top-down devolution to the English regions, was dropped. The party no doubt still believes in the bigger ideas, but it realises they have to be achieved in small steps. We don’t call it centrist – we call it small steps to more liberal future. But centrist is what it actually is.

So the party’s rhetoric is firmly liberal and optimistic. It helps that Ukip has come on the scene to help define what the party is not. The idea that the real political battle in Britain (well, England) is between the liberal, optimistic Lib Dems and the fearful, pessimistic Ukip is, of course, fanciful – though not on the critical issue of Britain’s place in the wider world. But it helps give the party definition. The majority of Britons may not be liberals, but neither do they feel threatened by them; they are a good second choice. And since democratic politics is largely about compromise and coalition, second choice often comes out on top.

It is a long, long road to return to electoral success for the party. In May in reality it more a question of trying to stave off disaster. The party’s previous tendency to protest, and being all things to all people has lost it a lot of credibility, especially amongst working class voters. The media remains dominated by Labour and Conservative allies. But it is a start, and party activists left york in good heart.

Scotland: the problem is English complacency

The temperature is steadily rising in the debate over Scottish independence on 18 September this year. Today the three main Westminster parties will say no to a currency union between an independent Scotland and rump Britain. Last week the UK Prime Minister David Cameron made an emotional appeal for the union. But still not enough searching questions are being asked by the English on what this all means for them.

At least Mr Cameron’s remarks were directed towards the English, though the British media ignored this and only sought reaction from Scottish politicians and voters. He urged the English to support the union and tell their Scottish contacts that they did not want them to go. Unlike Mr Cameron, I have no Scottish family heritage. But I love Scotland and, like him, feel that if it went its own way an important part of my national identity would be diminished. But if such sentiments are to cut any ice north of the border, we English have to ask some searching questions as to how it has come to all this.

The problem is that Mr Cameron’s (and my) feelings don’t seem to be shared by many of our fellow English. Many seem to have a rather sour attitude towards the Scots, who should be less hostile and more grateful. This is all of a piece with hostility towards the European Union. Many English want to blame foreigners for their problems, and to inhabit a world where the English can ignore them except to the extent that they provide beach holidays (not something that Scotland scores on…). This reveals a paradox at the heart of the English identity. We see ourselves as an island nation, who should be control of our own destiny. And yet any greatness that the nation has aspired to has been achieved by the country playing a full part in the wider world.

We might ponder this as we approach the centenary of the 1914-18 war. There was a definite view in 1914 that we should just let the “Continentals” fight it out amongst themselves. And yet most people understood that German domination of Europe would imply German domination of Britain too. And so this country played a full part in a European continental war for the first time since the days of Marlborough 300 years ago (if you discount the largely naval and economic contribution o the Napoleonic wars), with results that can be seen in war memorials in practically every village in the country.

What has this got to do with the Scots? The Scots have always shown a better understanding of their place in the wider world – a sensitivity that comes from being a smaller nation, no doubt. They have contributed to the British nation as a whole, and still do. Can a lesser Britain, without Scotland, aspire to be treated as equals with France and Germany? Or will we take our place with the next tier, Spain and Poland? Or just be lame duck major power like Italy? It would not just be a loss of resources that would diminish the country, but a loss of prestige.

And yet Scotland is a very different place to England, with a separate identity that far outweighs that of any region of England, and which is more coherent than that of other parts of the Union: Wales and Northern Ireland. (Even if some Scots nationalists exaggerate these differences and their own coherence). The English nevertheless have a tendency to treat the place as a simple extension of England. This was at its most egregious under Margaret Thatcher in the 1980s and 1990s, when she used Scotland to pilot her pet Poll Tax idea. This problem persists, as we see from the imposition of the Coalition government’s benefit reforms (aka benefit cuts), to which Scots feel they have not consented.

Devolution has not a stable answer to this tension, though it has helped. The problem is that it is not symmetrical. There is no equivalent devolution of power to England, which is run directly by the UK government. Scottish (and Welsh) politicians aspire to run parts of the English government, like health and education, and they are thus drawn into English domestic politics rather than their own. This simply feeds English confusion and resentment as well as diminishing Scottish and Welsh domestic politics.

A new constitutional settlement is needed for the United Kingdom. I have already described what I think this should be (Time to Think of England: an English government and parliament meeting somewhere other than London). It is depressing that such ideas are not getting an airing. The biggest threat to our union is English complacency and conservatism.

Labour are in serious trouble

Not long ago Labour supporters seemed very confident. Their lead in the polls pointed to a comfortable majority; the electoral system was loaded against the Conservatives; they (in their own minds) had won the argument on austerity. It was a good moment to move to the political left and drop the Blairite obsession with the political centre. But now Labour’s poll ratings are sinking, and the Tories catching up. The 2015 election increasingly looks like a stalemate or worse for Labour. What can they do?

And it is not difficult to see the source of Labour’s problems: Britain’s reviving economy, and rapidly falling unemployment. This is not running to the Labour script – which was that austerity policies doomed the British economy to stagnation and misery. It used to be that Labour’s Shadow Chancellor, Ed Balls, sounded easily the most economically literate of the front-bench spokesman of either side (challenged only by the Lib Dem Business Secretary, Vince Cable). Now he sounds panicky and flustered. His arguments, that the recovery is shallow because it is based on consumption rather investment and exports, is technically correct but irrelevant. Labour’s alternative policies of fiscal stimulus were promoting an equally shallow recovery. Labour has no serious ideas on how to promote investment and exports. Meanwhile, the rising economy is giving government spokesmen more confidence: Lib Dem Treasury Secretary Danny Alexander sounded more in control of the economic arguments than he has ever been on the radio this week, managing to pick apart arguments presented by the FT’s Martin Wolf. The Tory Chancellor George Osborne, always more interested in politics than economics, is not wasting any opportunity to skewer Labour using much less sophisticated arguments.

Labour started their damage limitation strategy last Autumn by their leader, Ed Miliband: to try and change the subject. First there was the “cost of living crisis”, focusing on the failure of pay to keep up with prices. Now it is the top rate of tax, where they want to restore the 50% rate rashly reduced to 45% by the Coalition in 2012. Labour’s policy is popular, and the criticism coming in from business groups is unconvincing. These lobbyists say that reducing taxes, especially on the better off, is what is need to awaken dormant business investment. And the government has duly cut taxes (that top rate, and also the rate of company tax) without investment budging. The trouble is that Labour’s policies sound unfriendly to businesses, and therefore likely to stall growth and cause general taxes to rise.

It gets worse for Labour. The energy that drives their activists comes from opposition to austerity: fighting cuts which are seen as mean-minded and ideological. The theory was that the fighting the huge government deficit should be left until later, when the economy was growing. That “later” has now arrived. So how will Labour cut the deficit? Being specific about this, as they will have to be by 2015, will cause huge angst and disillusionment amongst their core supporters.

And in any case Britain’s electoral system is not so weighted in favour of Labour as some supposed. There is a pro-Labour bias in the distribution of seats it is true, but there is also a pronounced benefit to incumbency. When it comes to asking which seats the party will have to capture to win an outright majority it looks hard going. Battersea, the seat where I live, is a case in point. The Conservatives took it off Labour in 2010, but it looks very difficult for them to win back. In the last 3 years I have heard nothing from Labour, but regularly from the Tories; residents aren’t being given the impression that Labour are in contention. The hard fact is that modern politics, with fewer volunteer workers and high postal costs, is an expensive business. Labour surely do not have the money to capture enough marginal through trench warfare tactics in the marginals. They need a national landslide effect, such as they achieved in 1997 under the hated Tony Blair.

So what to do? A change in leadership is out of the question, especially as the most popular alternative, David Miliband, Ed’s brother, is out of contention. A ruthless reshuffle of the front bench might help, but only if it went alongside a wider change of strategy. I think promising more money for the NHS, struggling to keep up with demand, would play to their strengths. But they would have to have credible tax policies to back it up. Taxing just the very rich won’t quite cut it. But taxing a wider body of people would totally undermine their rhetoric on the cost of living. They have dug themselves into a real hole.

Their best bet may just be to keep calm and hope the Tories self-destruct. They show every sign of wanting to do so over the toxic issues of Europe and immigration. Labour’s best chance of benefiting from this tendency to suicide is to appear moderate and centrist. Not a good moment to lurch to the left.

And what of the Liberal Democrats? About half their voters at the 2010 election deserted them for Labour. The polls that show Labour sinking do not show any real benefit for the Lib Dems. But if the contradictions of Labour’s criticism become exposed in the next year or so, then they may get their opportunity. The centre ground, though treated with justifiable suspicion by many of their activists, is a sound place for them to stick to for now.

Britain’s improved growth points to more government austerity

The UK economy has improved dramatically in the last six months. This is one of the most important developments in British politics. This week’s good news on employment is just part of a wide spectrum of measures showing the economy’s improving health. Economic commentary, with its narcissistic obsession with monetary policy, has concentrated on the implications for interest rates. But a more important question I whether the economy’s recovery is sustainable. And the answer to that seems to be… not yet. And while it isn’t government austerity has to be the priority.

The political debate around the economy has focused on the wisdom or otherwise of the government’s austerity policies, designed to fix the country’s massive gap between public expenditure and tax. The Labour opposition suggested that there should be less austerity, and even some temporary tax cuts to try and push the economy into a virtuous circle of growth. But the country is now embarked on just such a virtuous circle without the need for any fiscal stimulus. Additional private consumption is the main cause of this stimulus, according to the latest bulletin from the Office of National Statistics (ONS). This shows that the Labour policy might well have worked (i.e. that a bit of stimulus could set off a virtuous circle), though in the event proved unnecessary.

So intellectually developments have far from proved Labour wrong. But they are the big political losers. Labour’s policy might have been sensible in the circumstances, but they also suggested that the Coalition’s policies were doomed to failure, which has proved not to be the case. It gets worse for them. This level of growth undermines the case for any reduction in austerity polices – which could cause inflation. And yet their hard-core supporters have been rallying to the idea that the cuts in government services and benefits are ideological and unnecessary. Labour have switched their attack to the cost of living, which is still running ahead of personal incomes, but this too runs the risk of being undone by events. Politics is a momentum business, and all it would take is a general improvement in wage levels before the election in 2015 to sink their propaganda offensive. Their poll lead has already shrunk.

Meanwhile press attention has switched to the Bank of England, which has embarrassingly been taken by surprise by the growth spurt. It is not long ago that it suggested that unemployment would not fall to 7% until 2016 – we are nearly there now. I find the focus on monetary policy very irksome though. It allows commentators to pontificate well inside their comfort zone, and talk about short-term developments in financial markets. But, as longer term followers of my blog will appreciate, I think that the usefulness of monetary policy is exaggerated, and the theory behind it has been comprehensively shredded.

Instead the big question should be sustainability. Mainstream economic commentators don’t seem to be that concerned by this. Their analysis is based on the idea that sustainable growth depends on whether or not growth exceeds the trend rate. This trend rate, about 2% per annum, is the average rate of growth since the 1950s, and is primarily driven by a steady increase in productivity. Up to 2007 the UK economy was neatly conforming to this trend. Then the recession hit, putting it well behind the trend rate, with a lot of catching up to do. This sort of commentator often mentions a large gap between the current size of the economy, and what it would have been if it had stuck to the trend – with the implication that this gap is a matter of policy failure. Chief amongst these commentators in my eyes is the FT’s Martin Wolf. In a recent article he dismissed the idea that growth up to 2007 was unsustainable.

This is macro blindness: a failure to question the neat patterns created by aggregate economic statistics. In my view the UK economy cannot sustain a growth rate as high as 2% in the long term, hasn’t been able to do so since perhaps 2000. The reasons are demographics, the changing impact of technology, and a reversal of the gains from trade achieved with the rise of China and India. The main evidence, not mentioned by Mr Wolf in his article, was provided for me in a lecture in 2007 by Professor Wendy Carlin, my economics tutor at UCL. It is the combination of an appreciating real exchange rate and a wide trade deficit. This provides an illusion of growth, but it is not supported by the advances in productivity that are required to sustain growth in the longer term. It was not fashionable to say this at the time, but it proved prophetic. Productivity, incidentally, is an almost impossible factor to measure satisfactorily, and can only really be inferred indirectly. It is my feeling, not sustained by hard analysis, that a lot this growth illusion was from the reduced costs an increasing amount of goods, and some services, bought from China and India, and an important element of that trade deficit. This boost to the economy had “temporary” and “reversible” written all over it.

And the bad news is that the current spate of growth has suspiciously similar symptoms. The trade balance reported by the ONS deteriorated from under negative 2% of the economy in mid 2013 to over negative 3% in November (the latest data). I don’t have direct figures for real exchange rate (a rather tricky calculation), but sterling has appreciated since a low in about March. There seems to be no offsetting productivity gain, since employment figures have been very positive (a very good thing, in spite of some economists moaning about productivity). So we’ve just reverted to the unsustainable growth patterns of the early 2000s, without the benefit of cheaper imports to sustain living standards.

What, of course, we need to see is a rebalancing of the economy to something more sustainable. This will show through in increased levels of investment (still low) and a stronger trade balance. The confidence engendered by the recent spurt of growth may help with this. Meanwhile the government’s austerity policies need to be strengthened, if anything – otherwise the economy will be even less sustainable. Grim news for politicians of all persuasions.