The US Republican company tax reform might be a good idea

I like to see the bright side. With the accession of Donald Trump as US President, alongside the Republicans controlling both houses of Congress, that is hard. Mostly, I simply hope that the process of challenge will make liberals stronger and harder. There is too much complacency in liberal thinking. And there is more cosying up to vested interests than we might like to think.

And among the flood of bad ideas coming out ot the new administration, there may be the odd good one. Reforming company tax might be one of them.

What I am thinking of are the plans proposed by Paul Ryan, the Speaker of the House of Representatives.  Liberals should support it, though alas many won’t because of who is proposing it, rather than its merits.  One part of the plan is to cut the rate of company tax to 20%, but reduce the number of deductions. This is an old debate. I am sympathetic to lower marginal rates and fewer deductions, though 20% is aggressive. I do not share the view that company profits should not be taxed, and that the burden of taxation should entirely be on distribution of profit instead.

There’s another old idea in the mix too: 100% write off of capital investments in the year the money is spent. Older British accountants like me will remember that we had that system here in the 1980s – called 100% capital allowances. It was the basis of many a tax avoidance scheme, and perhaps tilted the balance too much in favour of investing in plant rather than people. But there is some merit to it.

But the really interesting idea is the so-called “border adjustment”. This exempts from tax sales outside the US, and disallows as deductions spending on imports. This can be painted in different ways. To nativists this sounds like encouraging exports and discouraging imports. Alternatively it can be presented as a sort of value-added tax, which is well-established here in Europe. Neither presentation does it justice. It is not VAT, not least because the costs paying people is within its scope. And its effect on corporate incentives can be beneficial to the world economy rather than detrimental. It amounts to a constructive proposal to deal with a major problem: the taxation of transnational businesses.

At the moment companies are taxed by the location of profits, apportioned “fairly” using general accounting principles. This falls foul of manipulation through transfer pricing – what country-level subsidiaries within a transnational business charge each other. Thus when a multinational sells you something in Britain, it may treat as part of its costs the use of intellectual property based in a low tax regime, such as the Netherlands or Luxembourg. National tax authorities have been fighting a losing battle against abuse. The G20 recently adopted some new rules to reduce abuse, but this is sticking plaster to repair a fracture. It is best seen as an attempt by corporate lobbyists to stave off more radical approaches.

One such radical approach to reform corporate tax is unitary taxation. This method means that tax authorities assess a business’s global profit, and then allocate it to country based on the location of some combination of sales, employment or property. This is how US states tax the profits of US businesses, mostly allocating them using the Massachusetts formula. I have been advocating this for years internationally, but I have unable to persuade even the Liberal Democrats to pursue the idea.

Mr Ryan’s border adjustments are an alternative idea, and look simpler. In essence corporate taxes would be based on the location of revenues – something that would not be easy to distort. So, applied in the UK, Amazon or Starbucks would not be able to use spurious intellectual property charges to relocate profits to tax havens. Overall the scheme favours countries that have trade deficits (like the UK or US) rather than surpluses (like Germany or China), but that is no bad thing.

And probably unilateral action by the US is the only way much is going to happen. Multinational forums like the G20, and even the European Union, have completely failed to deal with this problem. Only the US has the power for unilateral implementation. Where it leads, others will be forced to follow. And post-Brexit Britain should be able to follow quickly.

Alas the power of corporate lobbyists in our democracies remains massive. They are masters of quietly undermining radical ideas and promoting “compromises” that have only superficial effects. Mr Trump is a sceptic, and that’s a very bad start. The hope must be that Mr Ryan will get his way in the inevitable horse-trading between the presidency and congress. Mr Trump may be sceptical, but he is not strongly against it either.

But even if this reform attempt fails, I hope that liberals everywhere will take on the challenge of corporate tax evasion with a radical approach, such as border adjustment or unitary tax. Alas I am not optimistic.

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Theresa May’s Brexit moves from tautology to oxymoron but makes the best of a bad job

An oxymoron replaces a tautology. Theresa May, the British Prime Minister is contemptuous of intellectuals that try to weave policies into a wider, coherent narrative. Instead she concentrates on a series of tasks, whose solutions may clash with one another. In her speech on Brexit last Tuesday Mrs May moved her defining slogan on from “Brexit means Brexit” to “Global Britain”. This last expression captures the essential idea that Britain can remain open to the world while being closed to it.

Predictably enough, the media coverage has been beside the point, lapping up the bait left for them left by the spin-doctors, without bothering to question the speech’s real meaning. Last week I said that the government’s strategy would be a hard Brexit via a soft one, with a General Election in between. That, more or less, is what this speech delivered.

The media has focused mainly on Mrs May’s stated destination after the exit process is complete. That was always going to be a very hard form of Brexit, given her insistance on two red lines: control over immigration of EU nationals, and escape from the jurisdiction of the European Court. This is a perfectly fair interpretation of last year’s vote. Some Brexit campaigners painted a picture of a “Norway option” of Britain staying in the Single Market while outside the political Union. But Remain campaigners, including me on many occasions, pointed out that this was nonsense. Mrs May is conceding to this obvious reality. A third red line is emerging: Britain wants to be free to negotiate separate trade deals with non-European countries, like the USA or China. So one of the main points interest of her speech was her hope that Britain could have a half-in/half-out relationship with the EU customs union. This looks very hard, but we can hardly fault it as an aspiration.

But, as I argued last week, the critical issue for Brexit is the transition, and Mrs May did have something to say about this. She talked of a “phased implementation” of Brexit: in other words, a transitional deal. She said very little about this, and nothing about how long the transitional period would be.  That is quite a big door she has left open.  This transition amounts to a soft Brexit for a limited period, and getting progressively harder over the years. This starts in 2019; there must be a General Election by May 2020, which will be quite early in the transition process. Politicians should be focusing on their stance in this election.

The strategy for Remainers who want to put off hard Brexit therefore becomes quite plain. The next parliament must prolong the transition process and renegotiate what comes afterwards. They will be caught in the same logical bind about membership of the Single Market, but they might be able to move the talk on to eventual re-entry.

But to reverse the tide of Brexit will require a shift in public opinion, with a large block of Leave supporters put off by the prospect of hard Brexit. At the moment, though, the acquiescence of Remain supporters looks more likely. This is helped by the behaviour of the UK economy since the vote. There is no sign of a serious economic impact, and forecasters are putting off their predictions of one. The chief economic effect of Brexit has been the lower pound, and this has been doing the job that advocates of floating currencies always maintained it would. Any loss of inward investment put off by Brexit has been made up for by other money tempted by the reduced price of British assets. It may be that property speculation is replacing business development and research, but in the short term what matters is the cash. And British consumers have seen no need to save more and spend less; consumer demand is robust. The balance of payments deficit may even be easing. My sense is that summer holidays in Cornwall are selling faster than usual. Britons may be worse off, but not enough for anybody to be seriously worried.

This is something of a Brexit honeymoon. When will it end? That will happen when, or if, the costs of exit become more concrete, with job losses and travel restrictions in particular. The government will, as it should, try to put these off. There will no doubt be a big focus on protecting the British motor and aerospace industries, which are particularly vulnerable. Skilful navigation of these pitfalls could head off any serious backlash – and if they do the Brexiteers will have won the economic argument, so far as most people are concerned. That may or may not happen, but for now the endless speculations of doom from the Remain camp aren’t helping; it will the fate of real businesses and jobs that will win the argument either way.

But for the time being the focus will probably move away from business. The immediate focus of negotiations will be the terms of Britain’s exit – the divorce settlement, and not the basis of the future relationship. Probably the most combustible part of this will be the status of Britons resident in other EU countries, and vice versa. So far such media attention has focused on people from EU countries living in Britain, who have become embedded in British society. Most Brexiteers feel that they should have full residency rights, but the ability of Britain’s bumbling Home Office to design a bureaucratic process that can deliver this is very much in doubt.

Actually the more politically important case is British retirees who have moved to other EU countries (Spain is especially popular) and dependent on access to local health services. The government hopes that people who moved before a cut-off date (such as the referendum date) can preserve their current status. But the situation is not symmetrical, especially when you look at individual EU members. A deal should be easy with Poland, but what has Britain to offer Spain in return for continuing to look after a community that pays few Spanish taxes and demands increasing care costs? The prospect of thousands of British retirees coming home to use an NHS struggling to recruit foreign staff cannot be inviting.

It is with such matters that the British government will become absorbed over the next two years. It will be a hard slog, but Mrs May’s plodding, practical, task-oriented, anti-intellectual approach may be just what is required. Expect many more tautologies and oxymorons.

 

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Brexit makes the Nortern Ireland crisis harder to solve. That should make us worried.

Major catastrophes often arise out the disproportionately small. The First World War arose from a conflict between a second-rate power and a third-rate power over a tiny Balkan province. Some time before Britain’s referendum last year, I and some friends were speculating on the impact of a Brexit vote. I suggested that the it would be so far-reaching that some unforeseen complication might derail the whole process. Somebody suggested that the unforeseen complication was quite likely to come from Northern Ireland. I worry that she may have been right. It is not that I see Brexit being derailed, but I do sense that most people will deeply regret it. And I hope I am wrong.

What put me in mind of this was a bit of long overdue catch-up TV viewing, last week,  of a programme broadcast way back in 2014: The Long Shadow. This was by Cambridge Historian David Reynolds, and it dealt with the legacy of the First World War on subsequent history. In this programme (the last of a series of three) he dealt with the unbottling of nationalism, and the attempt to create states based on a dominant nationality. By 1918 it was accepted that multi-national states, like the Austria-Hungary were doomed to failure, and, indeed, were undemocratic empires.  Austria Hungary was carved up into supposedly coherent nation-states, as was the Ottoman Empire, and much of the Russian empire. But this had dire consequences. The nationalities that the people of Europe identified with (primarily based on language) did not fit into neat boundaries; minorities were everywhere. At first the small states, like Czechoslovakia tried to impose their own nationality on the minorities within their borders, by force if necessary. And then the Germans tried to impose their own idea of nationalism on the whole continent. Perhaps 40 million people were killed.

The European Union was created as a reaction to this. The feeling amongst its founders was that the idea of a nation-state was fundamentally flawed, and that states should be set within a transnational framework that fostered beneficial cooperation. The dilution of national sovereignty was not seen as a regrettable cost, but as the whole point of the exercise. For all its flaws, that remains the founding principle of the EU.

But it is not understood by the English, who have underestimated the European project at every turn. Before the First World War the United Kingdom, the state that the English dominated, was under stress. A highly controversial Home Rule proposition was in progress in Ireland, and the British government was consumed by the growing probability of a civil war there, as the Irish organised themselves into armed camps. So much so that ministers barely notice the emerging crisis in central Europe that was to bring the house down. Home Rule was also proposed for Scotland, and many Welsh were pushing for the disestablishment of the Church. The war seemed to heal these rifts in a common cause, as the nationalities fought side by side. And in Britain that is how things worked out; a Welsh nationalist (David Lloyd-George) became Prime Minister and talk of Scottish Home rule vanished. But in Ireland matters played out in a similar way to the rest of Europe. A civil war broke out, first as Irish nationalists fought for independence, and then within the new Irish Free State. And in Ulster, the Unionists set about imposing their will on the Catholic minority, much as the Czechs had done to the Sudeten Germans. 50 years later this blew up into the Ulster Troubles, in which thousands more were killed. This was brought to an end in the Good Friday Agreement in 1997, in part by using EU institutions to fudge the question of nationality.

The English never understood what was happening in Ireland, which so often upset their plans and their self-image as a democratic, peaceful nation. They just wanted it all to go away. To them the virtues of a nation-state were self-evident. The English had forged their own nation in the Middle Ages as a fusion between the French Normans and the Germanic Anglo-Saxons. The incorporation of Cornish, Welsh and then Scots into the national structure did not pose a serious challenge to their view of nationhood. The English assumed that these nations were assimilating happily enough into a new fusion: the British nation. The EU was looked on as a transaction of convenience, and when it trampled on British sovereign institutions, it rankled. And a so a majority of the English rejected membership.

But by then there was already trouble with this complacent outlook. The Scots increasingly resented how their own sense of nationhood was trampled on by the English. Devolution did not change English attitudes, which was the root cause of the trouble (though the English still think it is about obstreperous Scots). The SNP rose to power and only narrowly lost an independence referendum in 2014. That referendum only enabled the SNP to consolidate its power, as the Labour Party collapsed. The Scots were always more sympathetic to the transnational idea of the EU, and did not see the sovereignty of the British parliament as a sacred gift from God, or the pinacle of democracy, as English conservatives did. No doubt continued membership of the EU was one of the things that persuaded many Scots to vote for the union – and they strongly supported membership in the referendum.

Actually Brexit does not improve the transactional case for Scots independence. It implies separation from critical markets in England without the EU safety net, and at least a transitional period in a distinctly parlous situation. But there’s trouble. The genie of English nationalism is out of the bottle, and it has taken over the Conservative government, whose political future seems assured. This is an us-against-them world view, one of whose dominant concepts is “bargaining position”. Relations with the rest of the EU are seen through this lens; and so is that between the UK and Scottish governments. The English attitude to the Scots is “lump it, you have no choice”; the British government, which contains virtually no Scots MPs, makes no concessions to Scots sensibilities. Even further devolution to the Scots government is probably seen as a way of forcing it to take ownership of austerity. This complacency is not unlike that formerly shown by EU Remainers on membership of the EU.

But at least nobody is killing each other. The worrying thing about Northern Ireland is just how little the politics has moved on since the killing ended. The Unionist First Minister Arlene Foster’s attitude to criticism over some rather dodgy financial goings on is to distract attention by upping the ante on sectarianism; her cohorts are happy to let her do it. The Ulster Protestant working classes are as entrenched in their anti-Catholic attitudes as ever, and this is putting pressure on the Irish Republicans to follow suit. Now the Northern Irish government has fallen – and attitudes are polarising.

The crisis in the province is not about Brexit. But Brexit is making it a much harder problem to solve. Irish Catholics are finding themselves in a country less tolerant of multiple identities, where community relations are seen in terms of bargaining position and multiculturalism is a dirty word. Could a return to violence improve that bargaining position? Meanwhile, most English people would probably welcome a reunification of Ireland as a solution to the many border issues thrown up by Brexit. That could easily push Protestant Loyalists to violence. It’s a combustible mix.

And what makes me gloomy is that I see no political leader in Westminster or Belfast with the vision, stature and charisma to move the nations of the United Kingdom onto a more constructive path. Especially when that constructive path almost certainly requires that the United Kingdom to remain a member of the European Union. But I hope I’m wrong.

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The shape of Brexit is becoming clearer. Don’t write Theresa May off.

I’ve given Brexit it a well-earned rest over the last month. It remains Britain’s leading political issue, but the commentary from all sides is completely unedifying. Remainers are mainly just whingeing, angry that we are were we are. I agree, but where next? This lets the Brexiteers off the hook: instead of being forced to be more specific about how to solve the many problems thrown up by Brexit, they can simply moan about the moaning and promote an unconsidered hard Brexit. And this is what most of them are doing, betraying a complete failure to understand the predicament that country finds itself in. Still, a little reflection shows us how things are likely to shape up.

Not that the government is giving us much clue. The Prime Minister, Theresa May is staying tight-lipped, though she has been offering hard-Brexit mood music. This is partly because that is the type of leader she is: she likes to weigh things up in private before committing herself, a characteristic that she shares with the German Chancellor Angela Merkel. That Mrs Merkel is one of the most successful politicians on our continent shows that many commentators are too quick to dismiss Mrs May. I think she could last.

The fact is that the government’s silence is not just a question of Mrs May’s style. There are sound political reasons for it. The Conservatives command but a narrow majority in the House of Commons, and the party is hopelessly muddled on the issue, as are Conservative voters. Any clear declaration of strategy will create a storm. When that time comes the government needs to be ready. Mrs May became prime minister by picking the right moment to attack after years of patient build-up in which her potential opponents each self-destructed. She no doubt hopes for something similar over Brexit.

The eventual strategy will be the product of an alliance of three critical minsters. Mrs May herself, the Brexit minister David Davis, and the Chancellor of the Exchequer Philip Hammond. The alliance between Mrs May and Mr Hammond goes back a long way; they operate in compatible ways. Mr Hammond is putting the soft Brexit side of the argument – about the need to prevent disruption to the economy and to protect inward investment. Mr Davis is an interesting character. He is an ideological Brexiteer, but he possesses an integrity that few of his fellow politicians can match, while remaining an intelligent man. So far these attributes have not helped his political career; he has been too much trouble, and easily outmanoeuvred by smooth operators like Mrs May’s predecessor, David Cameron. Mrs May showed good judgement in picking him as her minister for Brexit. He doesn’t give much away, but from what I have seen, he is steadily working through the different issues and options and weighing the pros and cons. Meanwhile other senior ministers involved with Brexit, the Foreign Secretary Boris Johnson, and the International Trade minister Liam Fox, are showing themselves up to be political lightweights not suited for these difficult times.

Given this background, we can divine what the government’s strategy is likely to be: a soft Brexit leading probably, but not inevitably, to a hard one. First of all the government will push to activate Article 50 of the Lisbon treaty, giving two years notice to formal exit. This needs to be done by March, because that’s what Mrs May has promised. There are sound political reasons for this: first it means that there will be no awkwardness over the European Parliament elections due in 2019; more substantively the formal exit will be completed in plenty of time for the General Election due in 2020. Incidentally, there is no evidence that Mrs May plans to expend precious political capital on trying to get round the Fixed Term Parliaments Act to hold an early election. The Labour Party is stewing nicely in its own juice and this mitigates much of the government’s problem with a small majority. It is highly unlikely that they will stage a recovery by 2020, rather than being completely hollowed out. An election now would be a distraction from the problem at hand.

The problem with an early invocation of Article 50 is that it leaves a cliff face on eventual exit – the so-called train-wreck Brexit. Actually delaying Article 50 may not help by much – the real problem is negotiating alternative trading arrangements, which formally can’t start until after exit. But there is an obvious solution to this: a transitional period after exit. In this period much of the current trading relationship would be preserved, and the UK would continue to make budget contributions. The spectrum of possible solutions runs from full membership of the EEA (European Economic Area – like Norway, Iceland and Liechtenstein) to simply membership of the customs union (like Turkey). The EEA option would be by some distance the simplest solution, but it would involve continued free movement of labour. That is surely a red line for Mrs May (though, I suspect, not for Mr Hammond). She has always taken a hard line on immigration, and seems immune to the economic arguments made for it. The Turkey solution would leave many markets not integrated, with high potential costs to some parts of the economy. She will aim for EEA market access with Turkey levels of free movement. She won’t get it, but that is what negotiation is about.

How long will the transitional period be? My guess is five years (i.e. up to 2024), though her initial bid might be just two. That puts the ball firmly in the court of the next parliament. The government will paint a picture of full exit from the customs union after 2024 in terms that will warm the heart of ideological Brexiteers. In that way Mrs May will paint herself as a hard Brexiteer. But there will be a general election before then, and if public opinion swings away from Brexit, the transitional deal can be made into something more permanent.

That’s what I think. It will remain formidably complicated – but it gives ground to both sides, and she can claim be implementing the mandate from the referendum, while giving everybody more time to think about how a standalone Britain should work. There will be meat for both factions in the Conservative Party – and Mrs May can present herself as a unifying figure. It might even work.

 

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New monetarism: a challenge to conventional economics

Followers of my blog may have noticed quite prolonged exchanges in the comments section between me and Peter Martin. We are both amateur economists so this kind of exchange helps to sharpen thinking, absent an academic or journalistic environment. In order that I might understand Peter’s critique better, he suggested that I view this video of Stephanie Kelton, professor of economics at the University of Missouri – Kansas City. Ms Kelton advocates a system referred to as “Modern Monetary Theory” or, sometimes, “neo-chartalism”. (I will use “neo-chartalism” henceforth as it is easier to write; the “neo” is needed because I think a lot has been added to the basic idea of chartalism). When, as I recently blogged, mainstream macroeconomic thinking is in a sad state, it behoves us to look at those challenging it. This is an interesting idea to pick apart.

The core idea is in fact quite an old one – the original chartalism dates from 1905 and its ideas can be traced back further than that. It is that money is a state artifact, and as such the state has much more latitude in its management than conventional wisdom allows. This is in opposition to the more conventional view that money evolved primarily as a means of exchange to facilitate a market economy, and that the state’s powers to manage it must be constrained or it will be devalued. It is also contrasted with an idea of money that is intimately linked to precious metals (“metalism”), which is a bit cranky these days.

The chartalist view is that money’s primary function is as a voucher with which to pay taxes. It stems from the need of states to commandeer resources to fulfill its functions; this it does through the imposition of liabilities on citizens, which we call taxes. It uses currency values to denominate these liabilities, and then puts physical currency into circulation so that they can be settled. It does this in the first instance by paying its servants and suppliers in this currency. Since everybody needs currency to pay taxes, it quickly evolves into the primary medium of exchange for the whole economy. This allows a banking system to develop for the provision of credit, which in turn facilitates the evolution of money from precious metal coins, to vouchers for precious metal, to fiat money not backed by anything at all. The utility of fiat money, which people not so long ago would have been quite unable to comprehend, is perhaps the ultimate vindication of chartalism. Money is simply what the state says it is; it needs no greater authority than that. And it follows that the state need never run out of money, because it can create all it needs.

This narrative of money is compelling. Historical research comprehensively refutes the idea in old economics textbooks that money somehow evolved from a barter economy. Indeed the core chartalist narrative of money is now so widely held that it is fair to call it mainstream. I doubt that most modern economics textbooks repeat the barter myth. That states can create all the money they need (usually, and misleadingly, called “printing” money) is old news, though, and, indeed, has been an enduring theme of economic debate since the hyperinflation that followed the First World War in Germany and Austria. The chartalist view on this is distinctive: the act of the state creating money does not of itself devalue it: that depends on the context in which it is done. The problem in post war Germany and Austria was that reparations were making unbearable demands on these states.

But this narrative tells you little by itself. It is what neo-chartalists build on this foundation that sets them apart from other economists. My main disappointment with Ms Kelton is that she spends too much time revelling in the brilliance of the initial insight (including a very useful idea of a pyramid of exchange, which explains why local currencies are unlikely to succeed), and too little in explaining where she thinks it leads and why. In trying to explain it I will identify ideas that are implicit in what she says, rather than part of an explicit structure.

The next key idea, and the one that makes neo-chartalism truly distinctive, is that fiscal and monetary policy should form a unity. The best way of putting more spending power into an economy is for the state to loosen fiscal policy – to spend more or tax less; the best way to cool an economy down is to tighten fiscal policy. Fiscal policy directly affects the amount of money flowing in the economy. And a looser fiscal policy can always be supported by the creation of more money. This is very different from the pre-crash consensus, which suggested that fiscal and monetary policy should often pull in opposite directions – with only a marginal role for fiscal policy at all. And even after the crash the British coalition government had a policy of tight fiscal policy balanced by loose monetary policy. Chartalists say this was a mistake: fiscal policy should have been kept loose up to the point where economic capacity was fully utilised, with monetary policy providing support as required; only then should the brakes be jammed on (although may impression is that they  are reluctant to admit that the brakes should ever be jammed on – I may be being unfair).

Here too, I think that neo-chartalists are onto something. I was coming to a similar conclusion, albeit by a different route: the application of the Mundell-Fleming model for open international economies. Ironically Mundell-Fleming is an old-school idea, and regarded with suspicion by neo-chartalists (for example Professor Bill Mitchell of the University of Newcastle, NSW, a leading chartalist). Mundell-Fleming suggests that a floating exchange rate neutralises fiscal policy; but not if it is harmonised with monetary policy. Under a fixed exchange rate system, monetary policy automatically harmonises with fiscal policy, and even amplifies it. The neo-chartalists are surely right that monetary policy by itself is a very inefficient means of managing demand compared to fiscal policy – but it can be an important adjunct to it.

Perhaps the difference between me and the neo-chartalists is that I think the aggressive use of fiscal policy leads to state management of exchange rates,which is not, incidentally, necessarily a fixed exchange rate, and certainly not a currency union. But that is a discussion that needs to be taken elsewhere.

A third key building block of neo-chartalism is that a powerful, fully sovereign state is a force for good. Ms Kelton regards the sacrifice of sovereignty involved in the creation of the Euro with near disbelief. Why on earth would anybody want to do something so stupid? This marks neo-chartalism as a political idea of the left, and its faith in a strong state as the instrument of democratic will. The right view a strong state with suspicion or hostility – as something that uses its power to escape democratic control and further the interests of the state sector at the expense of everybody else. To see the importance of this aspect of the debate, you only have to look at Zimbabwe, where the state’s ability to create money has been a critical way for Robert Mugabe’s regime to retain power; in order to curb the political excesses of the Zimbabwe government it was necessary to adopt the US dollar as currency. Now that Mugabe is on top, he is trying to create his own currency again – but to secure his political status, not to advance the Zimbabwean economy. Strengthening the state’s power on money creation will place a real strain on democratic institutions. Things look all very easy when the state needs to create money to stimulate: but can it be trusted to reverse course when the economy overheats? History suggests that governments tend to deny that an economy is overheating until long after inflation has set in. The Argentine government of Cristina Fernandez even went as far as politicising the state statistics bureau to cover up inflation statistics. In Britain we may remember the stagflation of the 1970s, or, more recently, Gordon Brown adjusting his fiscal rules just when they called for tightening. I think this is a big problem, but not necessarily an insoluble one.

Interestingly there is a divergence of opinion on the radical left here.  People such as the former Greek Finance Minister Yanis Varoufakis think that there is virtue in the idea of a supra-national system for the management of money – a sort of new Bretton Woods – that would curb a state’s power to create money. It is no coincidence that this view comes from somebody used to the challenges of managing a small country, whereas Ms Kelton hails from the USA, which in effect has its cake and eats it by controlling a world currency while remaining a sovereign state.

There are some further ideas important to the construction of neo-chartalist policy:

  1. A optimal private sector (i.e. the aggregation of net private consumption and net business income) should operate at a surplus – i.e. they should be net savers. Excessive private sector debt follows if they are net borrowers, and that is destabilising; public debt is much safer because the state can create the currency to repay it. The private surplus must be balanced by either or both of an external surplus (e.g. net exports) or a public sector deficit. Since not all economies may have an external surplus, this means that it will often be the case that a permanent budget deficit is perfectly healthy (with the US and UK economies being examples). An inappropriate budget surplus could lead to a private sector debt boom – which is what happened to President Clinton’s USA in Ms Kelton’s view.
  2. Sovereign states with control over their own money have nothing to fear from an external deficit – which implies that the state or private citizens must obtain funding from foreigners. The key is that the country must borrow in its own currency – so that it can create the money to repay it. That a country might be forced to borrow in foreign currency is a major weakness in the whole edifice, I think. It is far from clear why exporters from surplus countries should always be in a weaker bargaining position than importers from deficit ones, and so be forced to accept the importer’s currency.
  3. The developed world is suffering from a chronic lack of demand. Neo-chartalists follow pre-crash neo-Keynesians in believing that the key indicator of excess demand in an economy is inflation (as opposed to asset prices or trade deficits). And since inflation does not appear currently to be a  threat in any major economy, there must be plenty of scope to expand fiscal policy. Neo-chartalists do not appear to take seriously the idea that their may be darker forces at work in the economy, reducing economic potential – something that I have long argued. Ms Kelton produced a graph to illustrate where the US economy could be by projecting forwards its growth rate from before the crash – something guaranteed to leave me spitting with fury! They also seem to have little truck with the “Austrian school” idea that a certain degree of slack is required in an economy in order to sustain the forces of creative destruction – and that recessions may be positively beneficial.

In summary: the neo-chartalists are re-writing the conventional wisdom on what money actually is, and have useful things to say about the role of fiscal policy. But beyond that my first reaction is that it is a modest idea that has pretensions beyond itself. It seems applicable in some contexts, but not as a general rule. And yet neo-chartalists are a valuable part of the dialectic from which a new economic synthesis will form. They do not deserve the disdain with which conventional economists treat them. Indeed many of the ideas I have briefly discussed here are a well worth a revisit. I want to dig further into to the topics raised in this blog: the role and management of state power; the relationships between public, private and external balances; managing an economy in the wider world; and demand management vs deeper economic forces.

A discipline that still reserves a place for real business cycle extremists, surely has a place for the new monetarists too.

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Back to realpolitik: only the promise of prosperity will ensure the return of liberal diplomacy

Yet another ceasefire has been arranged in Syria’s civil war, although this morning it looks close to collapse. The difference with this one is that the US and the EU have not been involved in its negotiation. And, not coincidentally, it does not include the Kurdish forces. It is the result of a rapprochement between Russia, Iran and Turkey. It looks as if this is the shape of things to come: a world where there is only the faintest pretence that countries should look out for the needs of people outside their own borders.

It looks like the death of an idea: liberal diplomacy. For liberal diplomacy, and its cousin the ethical foreign policy, the object of diplomacy, and the use of military power, should be to create a better world. A world of peaceful relations and prosperous trade, where human suffering is the responsibility of all. In its place we are left with the idea that countries should pursue their interests, and seek whatever advantage they can. There is an old name for this approach: realpolitik. It was the way most countries ran their affairs before the First World War, with only a few prominent dissenters, such as the British Liberal leader William Gladstone.

How it resolved in that era was that countries were ordered into a small number of great powers, able to conduct independent foreign policy, and project their power over a sphere of influence. Then came minor powers, nominally independent, who did the best they could in the spaces left behind, and finally subject nations – colonies, protectorates and such, managed by great powers, and sometimes minor ones. It was a system established at the Congress of Vienna in 1815, after the fall of Napoleon. It was taken for granted that major powers would use force to pursue their interests – and that their only constraint was avoiding wars between themselves. This did not always work. From 1853 (the Crimean War) to 1870 (the Franco-Prussian War) there were a series of short wars between European powers. But, compared to previous periods of 99 years, the years from 1815 to 1914 were remarkably peaceful for Europe. But it had its dark side. The great powers exercised their might with little restraint within their spheres of influence. It was a century of colonial oppression. The weakness of the Chinese empire was cynically exploited: amongst other things the British used force to maintain the opium trade there; the death and destruction wrought in Belgian Congo is probably the biggest blot on a cynical century. And in the end the prevailing matter-of-factness about the use of warfare led to the European powers to drift into a catastrophic war in 1914.

After 30 years of war and an unstable interwar period, in 1945 the world moved into a different order: the Cold War. The Cold War resurrected the idea of realpolitik, but between just two great powers: the United States and the Soviet Union. And these powers projected their power within their respective spheres with an ideological slant: promising to promote peace and prosperity amongst their allies through their political philosophies. But the failure of the Soviet system to deliver its promises became so obvious that it collapsed from within in 1990. This ushered in the period of liberal diplomacy that now seems to be coming to an end. It was not without its success. Perhaps no period of 30 years in human history has seen so many people lifted from abject poverty – as the countries left behind in earlier phases of development took advantage of a peaceful, trade-friendly world (and ,some might say, the enlightenment of neoliberal economics).

What caused it to fail? I think there were two main problems. The first was that the United States, which emerged as a hegemonic power, became tempted to abuse its position. Many Americans felt that their country should use its massive military power impose its will in a manner more explicitly to favour its narrow interests. These were led by the Neo-Conservatives who gained influence in the presidency of George Bush from 2001 to 2008, and reached its apogee with the US invasion of Iraq in 2003. The Neocon strategy was dressed up in the language of spreading peace and democracy – but this convinced nobody. The feeding frenzy of US businesses following the invasion of Iraq was shocking. Other countries, especially Russia and China, resented what they saw as an abuse of raw power, and drew the lesson that they too should advance their interests by building military power.

But the election as US president in 2008 of Barack Obama might have saved the day. No US leader has been as faithful to the idea of liberal diplomacy. But by then it was too late. The financial crash of 2007-2008 had fatally undermined the authority of liberalism. The winning idea of liberalism was that it was the surest route to prosperity. That was how the US won the Cold War, after all. But after the crash, people lost confidence in it. The economies of the developed world stagnated. Amongst those who lost confidence were many American people themselves: Donald Trump won the presidential election by promising to go back to realpolitik. But authoritarians from Vladimir Putin to Recep Tayyip Erdogan, to say nothing of the Chinese Communist Party, saw that they had nothing to lose by pursuing an authoritarian path. And liberal diplomacy without the promise of economic prosperity simply looks like weakness.

So what happens next? The objective of the nascent Russian-led Syrian peace process looks to be first to persuade the Syrian Kurds to submit to the authority of the Syrian government. Russia no doubt also wants to wind down its presence. They also hope that the Sunni rebel groups will either submit or be crushed, except those allied to Turkey, who can expect some form of autonomy. That leaves the question of Islamic State, but the US will help with that. This way forward may bring an end to the civil war, but at a terrible cost. We had hoped for a less oppressive government – instead we will no doubt have to confer status onto one of the most vicious regimes in post-1945 history.

The main uncertainty in this new world of realpolitik is how the new US government will interpret its national interest. The main ideas that are emerging are: the identification of US interests with those of Israel, including a vigorous pursuit of Iran; renegotiation of trade deals to reduce access to US markets; the finishing off of Islamic State’s control of territory in Iraq and Syria; and some kind of engagement with Russia. This does not look particularly coherent, and neither does it look particularly rigorous in following the US national interest – so how it will play out in practice is anybody’s guess.

Meanwhile China will proceed to consolidate its influence in Asia as America reteats. Russia’s main aim for now is to weaken and lift the economic sanctions imposed on it. Russian leaders probably want to establish all the countries of the former Soviet Union in its sphere of influence – but just how far it will be prepared to go in that aim is moot.

But there is one key problem behind all this. The authoritarians taking over leadership of the world powers understand realpolitik and the consolidation of power. But they do not have an answer to economic prosperity. Each country, including Russia, Turkey and even China, is threatened by economic stagnation or worse. That fate also awaits the United States if Mr Trump prevails on protectionism and the Republican deficit hawks prevail on budget policy. That will undermine their authority in the long run, though no doubt the ruling elites will still prosper.

If liberalism, ethics and humanity is to return to world affairs, then its advocates need to show that it is the surest route to economic prosperity. Absent that, the world faces a grim prospect.

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Macroeconomics is becoming a pseudoscience, and that’s not good for us

Recently the FT’s Wolfgang Munchau referred to an article by prominent US economist Paul Romer, The Trouble with Macroeconomics, published in September 2016. Mr Munchau used it as an argument to rethink the conventional wisdom of macroeconomic management, such as independent central banks and inflation targeting. I agree we need a rethink, but Mr Romer’s article is the wrong jumping-off point for that idea. Instead Mr Romer shows that academic macroeconomics has lost touch with the real world.

Mr Romer references the Trouble with Physics an article from 2007 by Lee Smolin. At this time there was a lot of nonsense going on in theoretical  physics, in particular with the idea of string theory. String theory attempts to be a theory of everything, and at its core is a lot of hard mathematics. But it makes no verifiable predictions and, indeed, seems to avoid areas where there is any danger that data might challenge it. It is more metaphysics than physics. And yet it commanded a sizeable academic following, including a number of big hitters – or at least it did in 2007.

Mr Romer suggests that something similar is happening in academic macroeconomics. People are creating elaborate models whose complexity runs well ahead of any data that can test their relationship to reality. This is covered up by sophistry and obfuscation. By itself this is not so strange, except that people are reluctant make public criticisms of these models, and the often prominent academics whose names attach to them. And yet that process of criticism is the stuff very of science. This makes it a pseudoscience – something that adopts the outward language of a science, but where a core set of beliefs and people are beyond criticism. (There is, of course, always a core set of beliefs in any system that are beyond challenge, including science, but I am talking about something wider here).

The prime target of Mr Romer’s criticism is a theoretical system referred to as the real business cycle. This was developed in the 1980s, and commanded supporters such as Chicago Nobel laureate Robert Lucas. It suggests that government actions, such as fiscal and monetary policy, have little effect on the real economy, and that the business cycle is almost entirely driven by changes to technology, a macroeconomists’ way of saying “just noise”. The real business cycle was presented to me as an economics undergraduate in 2006 as a curiosity that was so silly that it didn’t need comment or study. I can think of no serious piece of economic policy in recent years, and certainly since the financial crash of 2008, that makes reference to it. So it was a surprise to me to read that it remains the subject of serious academic support in the US – and that other serious academics look the other way rather than criticise it.

While Mr Romer spends most of his paper taking apart models based on the real business cycle, he makes it clear that this is a general problem, affecting Keynesian models too. And in particular the Dynamic Stochastic General Equilibrium (DSGE) models that are used for economic forecasting, and so hard-wired into economic management. Economists like to create huge models with lots of variables, and then pump huge amounts of data through them. But it is mathematically impossible to identify, that is to fix, the variables without building assumptions into the model about how they relate to each other – which the model is then unable to test. The models are therefore more a product of their assumptions than a test of those assumptions against data. Mr Romer complains of a conspiracy of silence not to undermine the fragility of all this. This ressembles string theory and other hobby horses of theoretical physics – though these days I read a lot about constructive work going on in physics, as scientists grapple with the problems of dark energy and dark matter. Also I think theoretical physicists are much more transparent about what they are doing – so far as I can see they aren’t even pretending that what they do is useful, except in some abstract sense of advancing the boundaries of human thought. Macroeconomists are dishonest by comparison.

How has all this come about? I don’t think it helps that macroeconomics has been politicised, and in the highly polarised environment of US politics. Real business cycle models are beloved of the right, as a basis for cutting government down to size; DGSE models are liked by the left, as the basis of fiscal and monetary intervention. Pretty much any important development in macroeconomics is parsed for its political significance. Neutrality does not seem to be an option – and yet cloaking policy prescriptions in academic mumbo-jumbo make them look more authoritative, and so demand for academic economists remains strong. US academics used to knock seven bells out of each other (the famous dispute between “salt water” and “fresh water” institutions) – but no doubt they now realise that this just devalues the whole discipline, and so the different schools ignore each other instead. Besides, they both rely on similar conceits.

How much does this matter? Those involved in the practical business of running economies have long since ignored real business cycle theory. Econometric models are used, but with a great deal of caution. Alternative ways of constructing models might be fruitful (for example Kingston’s Professor Steve Keen suggests the use of non-equilibrium complexity theory, as used in meteorology) – but these are liable to suffer from same identification problem. The future is inherently unpredictable. Practical economists can get on with the job without help from an increasingly irrelevant academia.

And yet there is a clear crisis in economic management. Too many people in developed economies feel left behind, fueling political instability that will not help economic management. The authority of the western democratic and inclusive system of government is waning as a result. If academic macroeconomists coud somehow change the direction of their discipline, rather than resorting to obfuscation to insist they were right all along, and deluding themselves that massive computer models are telling us anything useful, then the outlook would be better.

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Syria is the biggest blot on an awful year

2016 is not over yet. And one of my bugbears is people reviewing the year before it is finished. Sometimes life delivers a finale in the last week. Who can forget the Boxing Day tsunami? Older readers may remember the Soviet invasion of Afghanistan in the last days of 1978 – an event which changed everything. But surely there is nothing that can possibly happen in the last few days of 2016 that can redeem it – though things could happen to make it even worse. If Jesus Christ was to make his second coming, and call out Nigel Farage and Donald Trump for the evil that they have perpetrated, nobody would believe it was the real Christ, and nothing would change.

Brexit is, of course, the event that most colours my view of 2016, as it is has the most direct impact on me. It has plunged my country into years of bad-tempered, divisive politics and an administrative quagmire for no obviously good purpose, and given has licence to the intolerant to deliver their bile in the name of free speech and democracy. And the election of Donald Trump as US President does similar things – a campaign built almost entirely on untruth and false promise.

But rumbling behind this is Syria. This is not a new story, but one that took an evil turn in 2016. And unlike Brexit or Trump, it has been killing and maiming many thousands of people, and displacing millions. Its effects ripple through to Europe and the rest of the world. The fall of Aleppo to the Assad regime shows the collapse of liberal intervention, led by President Barack Obama, and the triumph of the evil methods of Bashar Assad, supported by Vladimir Putin’s Russia and Iran’s hardliners. It seems that there is nothing we can do to stop the spread of evil without crossing the red lines that liberals have drawn – about the ethical use of force, and intervention on purely humanitarian grounds. We must kill innocent people and ruthlessly pursue national interests in order to achieve anything, it seems.

2016 (so far) has been an excellent year for Vladimir Putin. Earlier in the year I drafted a post comparing him to Napoleon, and urging the rest of the world to emulate his Nemeses of the Russian Prince Kutuzov and the Austrian Prince Schwartzenberg in undermining him and destroying him. (I do not rate Waterloo as the decisive event in the fall of Napoleon – had he won that battle he would have been beaten soon after). For some reason I never posted it; I would have looked foolish if I had.  Russia has not become bogged down in Syria, as I was forecasting. Mr Putin proved too clever for that. The Russian military has developed tactics for dealing with insurgencies that are economical and effective. They include the indiscriminate bombing of civilians and the targeting of schools, hospitals and anybody who seeks to aid the suffering. These are tactics that liberal democracies find unethical – but we will not intervene to stop their use. Our doctrines of non-intervention make our actions predictable, and that has been exploited by the chess-playing Russian regime. The political left, so critical of much milder tactics when used by the US, stay silent. The right try to divert people’s attention to the lesser evil of the Islamic State terrorist network, pretending that it is an existential threat, and that we should ally ourselves with Assad, the Russians and Iran to suppress it – not caring about any innocent lives destroyed by this pursuit of national interest.

The worst of Syria is that all approaches look hopeless. I have been advocating non-intervention by the West, leaving it to regional actors to sort the problem out. But that simply leaves the door open for other actors, like Russia, to intervene on the side of evil, while the interminable suffering continues. Humanitarian intervention? This is treated as a political act and prevented or attacked by the Assad regime and the Russians so that those interventions tilt the balance in their favour. And yet military intervention would have led to a quagmire that would not have made things obviously better. Our allies would quite likely have turned out to be just as nasty as everybody else. We can, with some justice, shrug and blame others for the problem -there are no shortage of culpable suspects) – but that won’t stop the suffering.

So there seems to be not much more that we can do that watch, helping refugees where we can. Russia will no doubt seek an exit – though its campaign looks to have been quite economical, it will still cause stress to that country for no obvious tangible benefit. The new Trump regime will be left with the puzzle of how it continues the campaign against IS without goving succour to Iranian hardliners, whom it loathes. Maybe some kind of political settlement will be achieved which leaves Assan in place, but allows other factions space.

But the outlook is dismal. The era of liberal intervention, which started in the 1990s with Tony Blair in the van, is well and truly over. The Middle East has proved too big a task for it. But the policy’s virulent left wing critics cannot claim victory – they have been exposed as vacuous complainers with no interest in any alternative strategy for alleviating suffering. The western liberal democracies are diminished. That may not be a bad thing of itself, but we must hope that other powers come forward, able to look beyond narrow self-interest. They must understand that creating a stable and prosperous world is in everybody’s interest, but that it cannot be delegated to just the US and its allies. That is slim hope indeed.

Syria represents the worst of an awful year.

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Why did the dollar rise with Trump but the pound fall with Brexit?

If you are part of the conventional liberal “elite” like me, 2016 has been marked by two colossal acts of democratic self-harm: Brexit and the election of Donald Trump. It is easy to understand why the pound sunk after Brexit. By why has the US dollar being doing so well after the election of Donald Trump as president? It is a useful lesson in macroeconomics.

The first thing to say, though, is that the way most of the media cover such market movements is unhelpful. They talk of sentiment and emotional judgements made by anthropomorphised “markets”. These may provide a satisfactory story line for a journalist, but they yield no real insight and no predictive power. They are simply projections onto past events. But very often, and this is no exception, far more satisfactory explanations are available, based on the way money flows through economies and financial markets.

Take Brexit. The obvious explanation is that markets (sticking with the anthropomorphism for now) take a dim view of Britain’s prospects amid the confusion and uncertainty thrown up by Brexit. But by itself that explanation is inadequate. The fall in Sterling was not matched by falls in stock markets (after an initial wobble) and other markets which also depend on future economic prospects. In fact there seems to be much more of a wait-and-see approach by the people and institutions who set market prices.

But wait-and-see is not so neutral. The UK runs a substantial current account deficit (5.7% of GDP according to the Economist, the highest of the 43 countries in its data table – and the second largest in money terms, at nearly $150bn in the last year). That means that the country is consuming much more than it is producing, which in turn means that the country is spending more pounds than it is getting back from exports, etc (or spending more foreign currency on imports than it is getting from exports). This deficit must be made up from the capital account – by investors buying UK assets of one sort or another (or Britons selling off foreign assets). Wait-and-see means that foreigners are more likely to defer making investments, which reduces the demand for Sterling on capital markets, causing its price to fall. This makes UK assets more attractive, UK exports more competitive and imports less attractive. All perfectly textbook.

So, what about the US? This country has a current account deficit too (2.6% of GDP which is $488bn in money terms, the largest current account balance in any direction by some margin, in the Economist table). Surely there is a lot of waiting and seeing to be done here, as Mr Trump’s policies, shall we say, lack clarity? But there are a number of differences with the UK. The first of these is that the US is an economic superpower, which dominates global financial markets, with the dollar used as the top reserve currency. It is much easier for the country to draw in investment that the aging middle-ranking country that is the UK. It has much more secure access to liquid, short-term funding. And with a huge domestic market the outlook for its businesses look less precarious than that for British ones.

But the most important difference is that, for all Mr Trump’s lack of clarity, what is known about him, and the Republicans who control Congress, points to a loosening of fiscal policy. This mainly takes the form of tax cuts. This increases the demand for dollars, because it will increase spending in the US domestic economy. Exactly how remains to be seen. On one version US corporations will repatriate foreign profits and invest in infrastructure. This is all uncertain – but Mr Trump and the Republicans in Congress certainly agree on tax cuts, especially for the wealthiest. And this happens at a time when most people are convinced that the US is running at close to capacity – so there is no question of fiscal laxity being complemented by monetary laxity, which would allow the increased demand for dollars to be met by extra supply. Indeed the Federal Reserve is in the process of tightening policy, and increased interest rates this month.

This economic dynamic is often not appreciated – that in a world of freely floating currencies and open capital markets, loose fiscal policy leads to an appreciation of the currency. But there are plenty of examples if you look for them. When Germany unified in the early 1990s, it involved a considerable relaxation of fiscal policy – which caused the Mark to appreciate, and a crisis in the European Exchange Rate Mechanism in 1992 that forced Sterling to leave, shredding the credibility of John Major’s Conservative Government. My Economics lecturer at UCL used the British government of the mid-noughties as another example – the government ran a larger budget deficit than was warranted at that point in the economic cycle, at a time when banking laxity had already led to excess demand in the economy.

The effect of fiscal policy on a floating currency is part of what is known by economists as the Mundell-Fleming model, proposed independently by economists Robert Mundell and Marcus Fleming, leading theorists of floating currencies. It is one of the reasons that floating currencies are not quite the free lunch suggested by many Anglo-Saxon commentators. It means that a floating rate tends to neutralise fiscal policy (just as a fixed rate neutralises monetary policy). As a currency appreciates, the current account reduces (or deficit gets larger), and any increase in aggregate demand is lost across the world economy. Unless monetary policy operates in the same direction (including “printing money” to monetise the budget deficit), in which case you are in effect operating a managed exchange rate policy. This often ends in inflation or default.

This points to one of the tensions in Mr Trump’s economic policy. Fiscal laxity will lead to a widening trade deficit – exactly the opposite to what he promised on campaign. That will tend to force him into protectionist policies, which in turn could create a doom-loop of global proportions. Many believe that we have the makings of another global financial crisis, especially given developments in the Chinese economy – for example read this from Yanis Varoufakis.

But another tension could be that Mr Trump’s fiscal stimulus proves ineffective. The rich people and corporations that benefit from the tax cuts save most of their winnings; planned infrastructure spending is lost to political friction; and Congress insists on dismantling the social safety net, especially Medicare, sucking demand out of the system by hitting the less well-off. That would mean that growth is disappointing, breaching another Trump campaign promise.

But that’s in the future. For now participants in the financial markets are readying themselves for more demand for dollars, and weaker demand for pounds. They aren’t taking a view on the wisdom or otherwise of either Brexit or the new US regime.

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The Labour Party is not dying, but it is in retreat

To judge by the stories coming up in my Facebook feed, you would think that Britain’s Labour Party was in its death throes. The party is further away from winning national power than ever, but it is far from dying. Something more subtle is happening.

The chatter arises from the two most recent parliamentary by-elections, where Labour’s vote has crashed. I have written about Richmond Park already – this was a straightforward squeeze to get the Tory out. A week later came Sleaford and North Hykeham – and this is much harder to explain away. This is a safe Conservative seat in Lincolnshire, which voted heavily for Brexit (unlike Richmond Park).  The Conservatives lost a couple of percent in vote share, but Labour crashed by 7% to 10%, from second to fourth place behind Ukip (whose vote share fell by 2%) and the Lib Dems (who increased by 5% to 11%). Various other candidates scooped up an unusually large 11% (up 5%), including a Lincolnshire Independent who took nearly 9%.

The first thing to say about this result is that it is a remarkable victory for the Conservatives, a year and a half into this parliament. While Whitney and Richmond Park showed that pro Remain voters distrust the party, in pro Brexit seats (which are in a hefty majority in England and Wales) there seems to be no problem. It seems likely that they are picking up votes from Ukip, while losing a few Remainers to the Lib Dems. This seems to explain Ukip’s lacklustre performance in what should be home territory for them. But Ukip and the independents clearly picked up votes from Labour.

And thus come the predictions of Labour’s demise. Their lack of a clear message on Brexit, the main issue in British politics for the foreseeable future means that they are being squeezed by both the Lib Dems and Ukip, and will not be able to hold the line between the two. Voters sceptical of Brexit will be attracted to the Lib Dems; enthusiasts for Brexit will be tempted by Ukip or the Conservatives. Meanwhile Labour members’ attention is being drawn by its internal politics, as far left activists led by Momentum, fresh from their victory of re-electing Jeremy Corbyn as their leader, try to take control at all levels, and dictate the candidate selection process. The spectre of the party repeating the collapse it has already suffered in Scotland in England is raised. Amidst all the chatter, though, it was instructive to read Andrew Rawnsley in the Guardian. He describes how Labour veterans are consolidating their hold on the Labour organisation through solid, grassroots organisation. Momentum, an awkward alliance of veteran hard leftists (many expelled from Labour) and younger idealists freshly recruited to politics, is, in fact, losing momentum. Internal splits within the pressure group have been widely reported.

The truth is that in much of the country, Labour does not face a serous political challenge, and in a few places it is mounting a serious challenge to the Conservatives. The threat from from the Lib Dems is grossly exaggerated. The Lib Dems have barely begun to claw back their standing amongst both metropolitan leftists (who will not forgive the coalition with the Conservatives and the breaking of the party’s pledge on tuition fees) and working class voters of all ethnic groups. Richmond Park showed that such voters may once more hold their noses and vote tactically for the Lib Dems, but this logic does not affect areas where Labour is already strong. The Lib Dems seem to be mainly picking up Conservative Remainers – and that may help Labour rather than hinder it. Certainly in the area of London where I live the Lib Dem revival, such as it is, is evident in Tory areas, and there is no evidence of it all in the poorer estates.

Ukip threatens more, with an appeal to white working class voters, an important part of the Labour coalition. Labour seems unable to craft a message that appeals to these voters, or not without upsetting other important parts of the coalition, such as ethnic minority voters and metropolitan liberals. But Ukip is not a well-organised party. It lacks maturity. Furthermore its culture celebrates the awkward squad – the oddballs and angry types – from which it is hard to forge a cooperative team, as can be seen from the farcical attempts to replace Nigel Farage as leader. Liberals have a big advantage here – having a predilection to listen and cooperate. Ukip’s new leader, Paul Nuttall, is rightly focusing on Labour voters, but delivering a credible challenge will be an uphill struggle. They do not remotely present the scale of threat to Labour as the SNP have in Scotland.

And we must remember that Labour remains strong in large parts of the country, particularly London. They have plenty of members, strong local party organisations, and councillors. They have the ability to reach out to voters person to person to establish local bonds of trust. The party was not strong in either Sleaford or Richmond Park, so the results in these seats say little about how the party will perform in its strongholds. Around where I live the party is comfortably winning the local by-elections – and is as strong as I have seen it in 25 years or so.

So Labour is long way from dying. But it does seem to be in retreat in areas where it was not so strong in the first place. The Lib Dems do seem to be picking up here, resuming their role as the main challengers to the Conservatives in rural areas, to judge by a steady record of success in local by-elections (with another good set of results last night). As last week’s Bagehot column in the Economist points out, Britain’s political geography is fragmenting, with the country becoming a patchwork of different political contests. Labour will find it very hard to break out of its strongholds, as Lib Dems, Ukip and the SNP consolidate their hold on other areas.

Can Labour break out of this dynamic and regain a national appeal? It has been done before, in the 1990s by Tony Blair. The party’s current leadership, hopes to do so, with a re-launch promised. It hopes to pick up on an anti-establishment mood, using Mr Corbyn’s  persona and a left-wing policy platform. We will see. Labour’s problem is less its policies than a perceived lack of competence, something that Mr Corbyn’s persona will do nothing to correct. The public may yet be attracted to radical left-wing policies in these strange times – but the platform is being developed in a process of members talking to themselves (which activists optimistically regard as “democracy”) rather than engagement with a sceptical public.

Meanwhile, the Conservatives have little to worry about from Labour. Their main worry is the internal tensions in their party arising from Brexit – a process that will be quite unable to sustain the expectations placed on it. As doubts over Brexit grow, the party’s support is bound to melt. That will be the big political opportunity. The Lib Dems and even Ukip are readying themselves for that moment. There is little evidence that Labour are. But the party is far from dying.

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