Economics & Finance – thinking liberal

Liberation Day 2: American turmoil

Trying to write a considered commentary on events in America is a hazardous business. Things will change even as you write. In the middle of preparing this article President Donald Trump executed a screeching handbrake turn on his tariff policy, having paused the higher tariffs for 90 days. This leaves it as a universal 10% tariff, with massive mutual tariffs remaining with China. Stock and bond prices bounced back sharply with a huge sigh of relief. The political pressure on Mr Trump evaporated. But the dust hasn’t settled, and on any other day the remaining tariffs would have constituted a major escalation; bond market troubles may well be more deeply sourced; questions remain over the direction of tariffs in future. Disaster still beckons.

The economist Paul Krugman, whose Substack I recommend, warns against the “sanewashing” of Mr Trump’s policies – the projection of a rational strategy when none is there. This will lead to disappointment. There is not a coherent strategy behind his tariff policy – it has conflicting goals, for a start – but it flows from strongly-held beliefs, and some of his advisers have a more coherent take on it. The most important of these is Peter Navarro, who wrote an article for the Financial Times recently; I would recommend reading it if you want an insight into the administration’s outlook.

Mr Navarro presents a long list of grievances: of unfair trading practices from America’s trading partners, which are leading to a hollowing out of the United States, and a system that is tilted against it. That has led to a substantial overall deficit, and huge individual deficits with many countries. Europe bans America’s chlorinated chicken; China manipulates its currency; Vietnam acts as a conduit for Chines goods; and so on. The “reciprocal tariffs” – now in suspended animation – are a quantification of these trade barriers; he does not explain that they are simply half the ratio of trade deficits to imports, subject to a minimum of 10%. This picks up on two ideas explained in my previous post. First is the “victim narrative” of trade deficits: domestic production has been suppressed by unfair competition, meaning that it cannot fulfil domestic demand, which is in turn sustained by capital transfers from abroad. These transfers are being used to buy up American assets, ceding control to overseas interests. The second idea he picks up on is that fair trade implies that there should be no deficit at at all between countries; any imbalance is therefore evidence of trade distortion – and so as the proposed tariff is proportional to the deficit – the fewer the distortions the lower the tariff. Lost in that is the fact that 10% is still a high tariff by current international standards, and that it applies even to countries with whom America is in surplus. Mr Navarro shows that there is enough evidence for his narrative out there if you really want to believe it. I don’t know enough about the man to understand why this is – just that he has held these views for a long time. Other narratives and supporting evidence is available. After all, if America is being ripped off, why does it have the most successful economy in the world?

Mr Trump’s thinking is broadly consistent with this, though without its intellectual gymnastics. His view is more akin the idea of Mercantilism. This idea was developed by the 17th-Century French statesman Jean-Baptiste Colbert, who was first minister to Louis XIV. Colbert was a brilliant administrator, and his ideas set the tone for European statecraft for a century. He suggested that trade was about maximising exports and minimising imports so that the country would accumulate wealth, which at the time could be equated to “treasure”, the banking system being pretty crude. This was the set of ideas that were unpicked by Adam Smith and David Riccardo more than a century later. The French economy at the time consisted of a state dominated by a substantial war machine (there was barely a year when Louis was not at war) financed by excise duties and taxes on the poor. An export surplus would have implied suppressed consumption by the aristocracy (the poor had nothing left to give), which I suppose was not really a hardship. So far as Mr Trump is concerned, exports imply money coming in; imports represent money going out – so surpluses are power, while deficits mean you are being ripped off. His business philosophy is very much that if you not ripping somebody else off, you are being ripped off yourself; the idea of mutual benefit does not compute.

But Mr Trump’s love of tariffs goes further than countering perceived trade distortions. He also wants an extra source of tax revenue that he can tell his supporters that foreigners are paying rather than them. In his wilder moments he dreams of this replacing income tax. After all, income tax was brought in at first, both in America and in Britain, to compensate for the loss of tariff revenue from free trade. Of course to generate substantial revenue then the US must continue to import lots of goods. His supporters suggest this might come about through the strengthening of the US dollar, as happened to some extent in his first term, to offset the cost of the tariff. The tension between this and reducing deficits and protecting US industry is obvious.

Another aspect of tariffs for Mr Trump is that he hopes it will turn the clock back to a time when America had a lot of manufacturing jobs. Many Americans have fond memories of when many working class people had reasonably well-paid and stable (and unionised…) jobs in manufacturing. According to the MAGA mythology these were the jobs destroyed by unfair foreign competition, so rebalancing means that they jobs can come back.

And yet another reason to like tariffs is that it allows Mr Trump to throw his weight around on the global stage and make deals. He gets high on what he sees as grovelling by foreign governments to reduce tariffs by dismantling trade barriers; he makes sure that his fellow Americans see their humiliation. Many of Mr Trump’s cheerleaders from the business world thought that this was the main point of his tariff talk, and that they were just a negotiating tactic. Just like Russia’s military buildup on the Ukrainian border in early 2022 was supposed to be something called “power diplomacy”. But the Liberation Day system is so comprehensive that it appears negotiation will be just around the edges. Anyway you can’t do 70 highly personalised bilateral deals at once. It is now unclear what future negotiations will be about. Will some countries be allowed to escape the 10% lower limit? Is it about modifying the suspended “reciprocal” scheme? Or will the focus be on the special regimes for cars and steel – as the British government appears to believe. Nobody, including Mr Trump, knows.

But problems are coming in multitudes. The first is that, whatever Mr Trumps says, tariffs are a tax on American consumers. Americans cannot avoid buying imported goods (often as components of more complicated things like cars), and prices will rise across a wide range of goods. America is less dependant on trade than many economies, but even so they will have a significant impact. There will be a temporary bump to inflation. The Federal Reserve might be induced to raise interest rates. I think that risk is overdone; it is a temporary adjustment, and unless a wage-price spiral is threatened, there is no longer term threat. Weakness in the wider economy reduces that risk. The main problem is political: Mr Trump suggested that he would cut prices rather than raise them. The MAGA faithful will accept that this is a short-term adjustment and that better times are around the corner; many other Trump voters will feel let down, or even betrayed.

Next the economy will weaken, perhaps to the point of recession. The problem here is less the extremity of this particular policy (which has been softened after all), but the perception of instability across the whole of American public policy, which has become dependent on one mercurial individual with little grasp on reality. Mr Trump talks of vast amounts of inward investment, as firms promise factories in America to avoid the tariffs. But long term investments require a stable economic outlook; companies will delay doing much until things settle down – which could take some time. Exports are likely to suffer too, from retaliatory action by foreign governments (and especially China) and from a loss of confidence in America generally. Foreign visitors, especially students, are alarmed by the arbitrary application of policy that can see visas revoked on a whim, and detention at the border. This might help reduce the current account deficit – but through making Americans poorer.

The questions really start to arise when trying to picture the American economy the Trump administration is trying to create. He wants to shield US businesses from competition. That means that inefficient businesses are given a lifeline, and more efficient businesses don’t need to try as hard. That is not a recipe for economic dynamism – and thus has been the experience of most highly protected economies in history. A partial exception has been Asian economies that have used protectionism as part of an industrial strategy to allow the build-up of new industries. There is no such strategy in America. To be fair, America is a naturally competitive economy, and large enough not to need foreign trade as much as others to keep it so. But still, high tariffs will make America less efficient and wealthy, not more.

And it is hard to see those old industrial jobs returning. Technology, more than foreign trade, was responsible for their demise, and there has been a Baumol shift towards services, as Americans see to bank productivity gains in manufacturing by consuming more services. A more rational expectation is that America becomes a powerhouse of modern manufacturing business, in highly automated businesses, which export much of their output. But that entails a level of investment that will not happen in the current chaotic policy environment – and tariff barriers are not a particularly good way to achieve it. President Joe Biden’s use of subsidies was a more realistic idea.

But am I overdoing it? Will it be a matter of disappointment rather than disaster? Well, maybe. But that will entail the Trump regime rowing back on its revolutionary mission. Anything is possible in Trump World.

First published on Substack 12 April 2025

Liberation Day 1: the economics of trade

It is hard to overstate the significance of President Donald Trump’s Liberation Day US tariff plan, announced last week. It is a rewriting of the world order – and America’s place in it. It’s going to take more than one article from me to explore its significance. This time I want to look at the general context – as this is essential to understanding how things might develop from here – and it is very widely misunderstood by even expert commentators. The president’s action looks like one of the most colossal acts of self-harm in history – but the impact on the rest of the world may not be as bad as many suggest.

Any discussion of the economics of trade must start with the idea of comparative advantage – first articulated by David Riccardo 200 years ago. It is one of the most powerful economic ideas out there, and it is also one of the most neglected. I don’t want to go back to Economics 101 here. Suffice to say that the theory shows that trade is driven by opportunity costs and not productivity. There is a limit to how much each country can produce – and if each one specialises where it is relatively the most efficient (but not necessarily in absolute terms) then production across the world is maximised and everybody should benefit. Differences in actual productivity are taken care of by exchange rate differentials. It is why equilibrium exchange rates do not conform to purchasing power parity. “Comparative Advantage” may sound rather like “Competitive Advantage”, and we may often make an analogy between a country and a firm (“UK plc”) – but they are very different things. In economics firms compete but countries do not – they optimise. Tariffs, meanwhile, distort pricing signals and lead countries to sub-optimise.

This theory does a wonderful job of explaining the world we see today – why there is so much trade, and why and how exchange rates differ from purchasing power parity (i.e. currencies buy different amounts of goods and services in different countries). What it doesn’t do is help with the sort of fine-grained predictions needed for economic models. That requires a very detailed understanding of economies and what the opportunity costs are – way beyond the capabilities of current economic data and analysis. Attempts to model it at an intermediate level, by looking at broad factors of production (land, human capital, etc.), have failed. In modern economics, if you can’t put it into a model, it’s no use at all. So while most economists have a general idea about comparative advantage, it’s a distant memory from their undergraduate days. They haven’t thought about it very much. Politicians and political commentators pick up on the general idea but garble it – falling into a fallacy of composition (assuming that the production side of an economy is analogous to a firm) and muddling competitive and comparative advantage.

Two insights get lost in all this. The first is that the theory has nothing to say about trade deficits and surpluses. In the standard exposition, exchange rates should adjust so there are no deficits or surpluses – though whether this applies country to country, or to countries across all their trading relationships is an interesting question that I’m unable to answer. I will come back to that. The second is that the benefits of trade are driven by difference – and that the more similar economies become the fewer gains from trade there will be. Let’s take a closer look at that in the context of the US and China.

In 1990, when trade between the two countries started to open up, the US was one of the world’s most advanced economies and China one of the least developed, after the failure of Maoist Communism. Most of China’s workforce was tied up in massively unproductive agriculture. Only a tiny proportion of America’s was in its hyperproductive productive agriculture. America had a massive comparative advantage in agriculture; China therefore had a comparative advantage in pretty much everything else that was tradable, apart from technologically advanced goods that were beyond its capability. To put this another way, China’s hideously unproductive agriculture sector meant that Chinese wages were tiny compared to America’s, which meant that even very inefficient manufacturing businesses were highly competitive. And so they had the basis of massively beneficial gains from trade. America exported agricultural products and advanced goods, while importing cheap manufactured goods. Both countries benefited from cheaper inputs.

So far, so good. But the situation was dynamic. Rural workers in China responded to the demand for extra manufacturing jobs; rural productivity improved. Chinese manufacturing invested; infrastructure was improved; productivity and wages rose. America and China converged. It follows that the gains from trade diminished. This has mostly been at America’s expense. Chinese goods became more expensive relative to domestically produced ones. Meanwhile, because productivity was advancing rapidly, in China the lost gains from trade were compensated for by gains from productivity. This has been replicated on a global scale as the dynamic between developed and less-developed countries. There were massive gains from trade in the early days, and a convergence between the two sides that has seen the biggest ever eradication of extreme poverty. But the gains from trade are now much less. This is one of the reasons that living standards in the developed world have struggled since the mid-2000s; access to ultra-cheap goods from the less developed world has drastically diminished. This development is almost unacknowledged by economists; the late great Paul Samuelson has been to the only one that I have seen to point this dynamic out – largely before it happened. Instead people are bewailing the loss of a system of global trade that delivered so much benefit in the past.

The world has progressed in another way. Manufacturing productivity has advanced steadily, mainly through automation, but also through better process management. This has tilted the balance of developed economies towards services that are largely untradable. This means that the impact of trade on developed economies is steadily diminishing.

This doesn’t mean that gains from trade have disappeared. Surely it still makes sense for Apple to make its iPhones in intermediate economies? But it does mean that strategic considerations are weighing more heavily than commercial ones. In particular both America and China are worrying about what would happen if war broke out between them – an increasing risk given China’s ambitions to absorb Taiwan. It also doesn’t mean that the reordering of manufacturing supply lines that the Trump administration seeks won’t be painful and disruptive for both America and its trading partners – especially those in East Asia. But it does mean that ultimately it will almost certainly be worse for America than anywhere else. I want to talk about the impact on America in more detail in my next post.

But what about trade deficits and surpluses? A current account deficit represents an excess of demand (consumption plus investment) over supply; a trade deficit has a slightly narrower definition – it applies to goods – but it is much the same thing. If demand can’t be met by local supply, you need to imports to make up. This, however, tells you nothing about what caused it. The victim narrative suggests that the surplus of demand arises because domestic supply is being driven out of business by competition from abroad. The economy then runs up debt (or sells its assets to foreigners) in order to maintain demand, which has to be supported by imports, and it all ends in ruin. An alternative, boomtime narrative is that consumers are on a demand binge which domestic supply cannot meet. Foreigners are happy to finance this because this booming economy provides opportunities to make returns. Trump supporters are scarred by the sight of business closures with the excuse of foreign completion being given, or outsourcing to cheaper suppliers abroad, and point to victim narrative. Trump critics point to low US unemployment and a healthy economy, and say that there is no obvious case that the supply side is being suppressed – and so lean to the boomtime narrative.

But there is a further dynamic. Some countries, including Germany and China, enjoy trade and current account surpluses as a matter of policy. They achieve this by, one way or another, suppressing demand so that the supply side can generate a surplus to export. This might be by underpaying their workers and letting businesses accumulate profits; it can be through governments over-taxing and leaving an unspent government surplus; or it can be through a conservative public forever saving for a rainy day. Why do governments let this happen? A surplus means that the country does not require foreign finance, and that generally makes the national finances easier to manage; for dictatorships, like China, that can be especially important. If some countries run a surplus, then others must run a counterpart deficit. This pattern can help fuel the victim narrative of deficits. The alternative view is that surplus countries are selling themselves short – they could charge more for their exports and/or allow their citizens to consume more – and that deficit countries are beneficiaries of this generosity – and should be sending the surplus countries thank you notes. Which narrative (and others are available) better fits the facts depends on the circumstances. One the one hand you might have a colony being exploited by its ruling power; on the other you could have an industrial powerhouse using foreign capital to build up its infrastructure and industrial base. You need to get beyond the raw statistics to work out what is going on.

There is an argument that all trade should be in balance, and persistent surpluses and deficits show distortions from “fair” trade. This comes up quite a bit for people trying to “sanewash” Mr Trump’s actions. He himself seems to have a much cruder understanding: a surplus means you are getting one over on the other side and building up wealth; a deficit means you are being ripped off and seeing your wealth disappear into foreign pockets. The idea that surpluses and deficits may simply be a reflection of supply and demand being out of kilter runs counter to this.

What role do exchange rates play in all this? Exchange rates should adjust to an equilibrium that allows trade and capital flows between countries to balance – letting the market decide. Countries can try to lean on the market by buying or selling reserves – but this only really works to manage short-term blips where governments think the markets are temporarily distorted. Monetary policy, fiscal policy and capital controls all affect the exchange rate, and can be used to fix exchange rates – but ultimately because these policies work because they affect supply and demand, and the capital flows required to finance them. You can get too hung up on asking what a “fair” exchange rate is.

What is the impact of the Trump tariffs on the world economy? In the short term there will be a lot of disruption, and we have only seen the start of it. There are two pressure points that will need close attention. The first is less developed economies that have been slammed with high tariffs: notably Vietnam, Thailand and Bangladesh. These do not have the resilience (or negotiating power) of bigger economies, such as China, Japan or South Korea. They may be able to divert to other markets, but long term damage looks likely. The second is in the financial system; this has been delivered a series of shocks by the Trump administration, of which Liberation Day is merely the biggest. A lot of bets made by intermediaries have gone sour and these could have ripple effects that start to endanger bigger institutions – this is what happened to Liz Truss’s government in the UK in 2023, causing its demise. A danger sign is that the price of safe haven assets, such as US Treasuries, has been sinking alongside riskier ones. An added risk is if China starts to dump its some of its substantial holdings of US Treasuries – which it might need to do to counter the disruption of trade. A new financial crisis might develop.

But this crisis is not the end of globalisation: it simply marks exit, or intended exit, of the US as a global trading power. The rest of the world can carry on trading more or less freely with itself – and that seems to be what they want to do. And in some respects America will continue as a global commercial power: Google, Meta, Apple, Microsoft and even Amazon will be disrupted but there is no fundamental threat to their business models. The globalisation of information will go on. The big question is who, if anybody, will take up America’s leadership role? China could curb its own tendency to bully; the European Union could have its moment.

In due course, however, I expect the Trump tariff regime will collapse, and America will come back into the world system as a diminished player. But that’s another story.

First published on Substack on 9 April 2025

American winter – calamity awaits the once-great country

I was wrong. Before last year’s US presidential election I said that it wasn’t the most consequential in a generation (or such longer period offered by breathless commentators); it would be no more so that the elections of 2016 (which could have done for Trump altogether) or 2020 (a weaker argument there…). A new Trump administration would soon sink into chaos and drift – a bit like Boris Johnson’s British government following the December 2019 election. In fact the new US administration is revolutionary; it is changing things as radically as the Roosevelt presidency of 1933. The election of Kamala Harris would have stopped this, and probably done for Trump for good – though who knows what would have been cooked up for 2024.

Even after the election I compared the new regime to Mr Johnson’s, though I also offered Hitler’s 1933 ascension into the chancellery as a comparison. This latter is now looking the stronger parallel. Hitler was no details man, but set a vision in which groups of underlings competed with each other to destroy the old regime, with varying levels of competence, though with more violence than the current US regime has shown so far. The chaos that I predicted has indeed come to pass, but it has not stopped the destruction. And the checks to presidential power that I had thought might come into play seem to have been neutralised. Congress has been bypassed, and the Republican majorities seem to be shrugging this off, and offering little challenge. The courts have been stacked in the new regime’s favour – as evidenced by the shocking extension to presidential immunity made by the Supreme Court last year. A doctrine of unchecked presidential authority is taking hold. Even states’ power, a cornerstone of the Republican anti-establishment rhetoric until now, is being undermined. Mr Trump’s underlings, up to the level of Vice President, openly talk of ignoring court rulings anyway; it isn’t clear what could stop them. It will be no surprise if moves are made to further undermine the democratic standards of elections.

Pretty much all of this was predicted before the election, with plenty of evidential support. While I was broadly right on the administration’s economic policies, unlike many who really should have known better, I failed to understand what was coming for the reordering of the state itself. Not all that is happening is necessarily bad. Many aspects of the state work poorly, and sometimes shock treatment – “move fast and break things”- is the best way to achieve radical change. The problem is I have no confidence in the good faith or competence of this revolution’s leaders. This is the contrast with Roosevelt. They are leading their country to a bad place.

It starts with a complete failure to understand how a modern economy works. The country’s large trade deficit is not a sign of failure – of being ripped-off by foreigners – but a sign of economic success. As Americans become more wealthy, demand for non-tradable goods and especially services grows; to make room for extra supply of these things the country must import more tradable goods and export less. This is easy to fund as the country is attractive to foreign capital. It follows that trying to reverse this, by balancing trade and bringing more manufacturing “home”, the gains will be reversed. America becomes poorer. It’s worse than that, because the government is trying to put the toothpaste back into the tube, and its policies, notably punitive tariffs, are likely to to cause economic harm with doing much corresponding good. Whether this is leading to recession is an open question, but inflation and stagnation are a stronger bet. It is not what so many Trump voters thought they were going to get.

Then there is foreign relations, though this may be less of a concern to most voters. The abrupt tearing up of treaties and promises is destroying trust, which will ultimately make things harder for America. Bullying works by picking weaker subjects off; it doesn’t work when you are trying to bully the whole world. The regime might achieve a ceasefire in Ukraine, and at least a temporary halt to the killing. But its bullying of Ukraine while soft-pedalling Russia boads ill for longer term results. Likewise the regime is giving succour to the Israeli hard right, whose ultimate aim is ethnic cleansing. That does not bode well for long term peace. It will also ultimately undermine dealing with other Middle Eastern regimes. In the Far East things are unclear. The Trump regime is full of China hawks, but Trump himself is more ambiguous. The China hawks are useful for the securing of better relations with Russia, something Mr Trump clearly wants. But he can discard them when it comes to Taiwan, and China may get its opportunity to make the island into its control, which would be a disaster for America.

And what of Americans welfare (pensions and healthcare) and government services? These are being run down, and run by Trump loyalists rather than people with competence. These will surely be weakened. Corruption is likely to take hold.

Meanwhile Mr Trump has a solid base of fanatical support. These are a combination of frustrated conservatives who love that their side is doling it out to the hated liberals, and crooks and chancers who spy opportunities to turn a profit. They will not acknowledge failure, blaming things that go wrong on an array of conspiracies and usual suspects. There seem to be enough of them to keep the regime going. Others will be afraid to speak out or act out of line. Freedom of speech may have been a conservative rallying cry, but, likes states’ rights and rule of law, they don’t mean it.

The question now is whether things will go badly or very badly. In the latter case democracy is subverted and the current regime retains and extends power beyond Trump’s four year term. A successor is found – and there are clearly a number of candidates. I don’t think this is likely. The regime will increasingly be hobbled by infighting, made more vicious by a record of failure. Mr Trump’s charisma will start to fail. Opposition will cling on in many states, and even the judiciary might draw a line.

But a winter approaches. This is not a good time to be an American.

First published on Substack

Are there modern lessons from slavery compensation?

In the 1837 the British government passed the Slavery Compensation Act, whereby slave owners were paid compensation following the emancipation of slaves in the British Empire. Recently I started to think about this given the repeated claims that governments can’t afford to do things: such things as extra defence spending, investing in the green transition, compensating WASPI women, and so on. The slavery compensation was substantial, but government finances weren’t derailed. Surely the question of affordability shouldn’t be reduced to the level of household budgeting? Sometimes it is quite safe for governments to spend freely without raising taxes. I did some gentle internet research. I was a bit shocked.

What shocked me was that nobody seemed very interested in how the British government was able to afford the compensation, or what the economic consequences of the scheme were. Instead they focus on political questions. More recently this has turned on the injustice of slave owners being compensated for an immoral practice, while the slaves received no monetary compensation at all. This, then, inevitably, gets tangled in the question of modern demands for slavery compensation, promoted by Caribbean governments in particular. You would have thought that the economic questions would have interested writers considering these issues, but apparently not.

The amount of compensation was £20 million. That was about 5% of GDP, by modern estimates (such things weren’t measured at the time). It was, apparently 40% of the Treasury budget – an oft-quoted figure though it isn’t explained whether that is the budget before or after the compensation. Overall government receipts at this point were about 10% of GDP. At the time government debt was about 150% of GDP, a legacy of the Napoleonic wars. There was no income tax, with government revenue primarily drawn from excise duties on imports (notably foodstuffs, including, notoriously, imported corn) and alcohol. So this was a substantial sum, paid when government revenues were highly constrained, and debt at very high levels. Much of it was paid through annuities (only finally bought out in 2015). This would have greatly softened the impact on government finances – but for the most part the receivers of compensation sold their annuities for cash, so the impact would have been significant on the economy as a whole.

What about this impact? I have seen two things mentioned. A television documentary I saw on the topic a while ago suggested that much of the funding was invested in industrial infrastructure, and railways in particular, and so helped promote the industrial transformation of Britain. The Wikipedia article I have linked above suggests that it contributed to a banking crisis – though since the main ones in Britain were in 1825 and 1866, it could not have been all that serious. I have been unable follow the reference to the article that suggested this.

A general survey of historic government finances by the Office for Budget Responsibility (OBR) fails to mention the episode. Income tax was introduced (or re-introduced, as it had been used in the Napoleonic Wars) in 1841, following the abolition of the Corn Laws, which reduced excise revenues. Government debt steadily fell until it was 40% of GDP at the outbreak of the First World War in 1914. This was primarily due to economic growth – the level of government revenue fell to about 6-7% until the Boer War in 1900, when it returned to 10%. This era saw little inflation – attributed to strict adherence to the Gold Standard.

A further modern article on the topic of how the compensation was afforded suggests that the debt for compensation was paid off by taxes from the freed slaves – with the author getting appropriately worked up about the injustice. It is very hard to see how that could have been the case. This looks like yet another example of economic illiteracy amongst commentators and historians. And that is as far as I was able to get. There seems to be no generally available study of the economic impact of slavery compensation. It appears to have been shrugged off at the time as well as later.

It occurs to me that ignorance about economic history is widespread and almost wilful. An example is the belief that Britain lived off its empire – that the relative wealth of British people was at the expense of poverty in the colonies. Economists that have tried to substantiate this idea have failed. Indeed the loss of Empire in the later 20th Century coincided with a period of significant growth. The economics of slavery is doubtless mired in similar ignorance. In this case though the impact of wealth made in the sugar and cotton trades, dominated by slavery in the West Indies and America, is very visible in such places as Bristol, Glasgow and Liverpool. Still, I doubt that anybody has attempted to construct counterfactuals with the use of free labour or alternative sources of trade. It remains a very influential political narrative – that British economic success was built on the slave trade. This is not wholly implausible (unlike the story of ex-slaves paying off the compensation debt), but surely the picture is far more complex. Germany had no slave trade but built an economy that became just as powerful as Britain’s in the 19th Century.

I was hoping to use the episode as example of how governments can make substantial financial commitments without having to raise taxes. That is hard to pin down as the financial system was very different. The government was able to make the settlement using perpetual debt – which is the easiest form of debt to service, though still requiring interest payments. That would not be done today. On the other hand, since most recipients appear to have sold their bonds, there would have a substantial cash injection into the economy. What was the impact?

The first thing to remember is that money is just a social convention: it’s not for real. It’s a lubricant and not a fuel. Overall what matters is how we use real resources – labour, infrastructure, and so on. Slavery compensation created a financial windfall without directly adding to resources – potentially boosting demand without any corresponding boost to the supply side. In a modern economy that could lead to inflation. In Victorian times it could cause financial dislocation – so linking it to a banking crisis is plausible, even if it is hard to pin down what the crisis actually amounted to.

If a financial windfall is not spent immediately, however, but simply banked or invested, then the impact on the balance of supply and demand is limited. If this translates into immediate investment spending, however, such as building railway lines, then the same problems may arise – depending on the exact circumstances. It is usually reckoned that a surge in investment spending is easier to accommodate and consumption, however – and it should, after all, lead to an increase in productive capacity. The idea of the windfall helping to propel industrial capacity and growth is therefore quite plausible. If the money is directed abroad, then it won’t impact the domestic economy either. The Wikipedia article suggests that this might have been the case for slavery compensation. But I find myself in a fact-free zone.

What of modern times? Government is much larger, with revenue at about 40% of GDP, and debt smaller, at about 100%. The currency is freely floating, but under domestic control – unlike the days of the Gold Standard. Inflation is a constant threat now in a way that it wasn’t then. There are two particular problems with large government spending commitments. The first is that the impact could be inflationary, if the recipients quickly add to overall economic demand without any corresponding supply boost. The most effective counter to this is to raise taxes to reduce demand by a corresponding amount – or “funding” the spending. But not all taxes are created equal here: capital taxes, or taxes restricted to the very wealthy, affect demand by much less. Alas very few people in the current political debate have grasped this – instead thinking of this as an analogous to household budgeting. A recent example of this debate is the green investment splurge initiated by President Joe Biden’s administration. This is alleged by Republicans to have caused an inflationary surge. And yet the increase in American inflation was hardly different to other countries that were managed much more conservatively.

The second problem with government spending splurges is on the capital markets. The government may need to fund the spending through raising debt. The capacity of the market to do so is limited, though nobody is sure by how much. The government can fund the debt through the creation of money too – but this creates problems of its own (leading straight back to the inflation problem). Also if a country, like Britain, needs to sell the debt to foreign investors there may be constraints. Ultimately the government may have to borrow in foreign currency to bring such investors in – something that adds hugely to the financial risks. Britain has never been forced to do this – but is that because the Treasury is run so conservatively? It was the financial markets that undid Liz Truss in 2023. But Ms Truss was particularly inept – and we should be careful about using this as a general warning about increasing government debt. There are solutions, other than raising taxes on income and consumption – capital taxes can be used to balance the books, or the markets can be convinced that the government will continue to have the capacity to honour the debt. This would be the case if the finance was to be used for capital projects with a good return – including boosting economic growth and tax receipts.

So let’s think about three examples where people are advocating the government boost spending: defence, green investment and the WASPI women. Defence is the most straightforward. Expenditure is likely to be fed back fairly directly into demand, without a corresponding increase in productive capacity. Economic resources are to be repurposed, from things like healthcare and consumption, to armed forces and munitions. This is likely to be inflationary if not supported by tax rises – and these need to be on income tax, national insurance or VAT to work properly. Or else by reducing public spending elsewhere. This is why it is such a political challenge for the current government. I have heard more than one commentator suggest that defence spending can boost growth – but alas that is more economic illiteracy. This is only the case if it is used to soak up spare capacity in the economy (which was the case in the 1930s, for example). This is doubtful now, unless there is a way of bringing back lots of people from sick leave and retirement. It is sometimes said that war spending has boosted the Russian economy – but inflation is growing there, so this growth is illusory. There is a lot of activity but people generally aren’t better off.

The green transition is another matter. Here the funding is being used on capital projects that boost infrastructure. For the most part these projects have clear economic benefits – especially when used to boost solar power, whose economic benefits could be substantial. Carbon capture and storage, used to prolong the use of fossil fuels, is an exception here: this looks like deadweight loss. The Labour Party suggested that it would raise £80 billion a year for a hugely ambitious programme – but then they lost their nerve and scaled back drastically. The number was a bit of a nonsense, admittedly, but the idea that the government could fund substantial green energy projects through borrowing is perfectly plausible. Of course to the extent that energy is a profitable business, a lot of this could be done through the private sector – but a lot of the infrastructure probably is best done through public ownership, and in particular the electricity grid. The government is being too cautious.

How about the WASPI women? This case is closest to slave compensation. The WASPI women were those adversely affected by in an increase on pension age, equalising it with men. They claim that they weren’t informed of the change in time to do anything about it. I haven’t been following the debate in detail, though I am instinctively sceptical of the merits of their case. Still, many politicians, including those leading the current government, have expressed support for compensation in the past. I see that an amount of a bout £60 billion has been suggested – or about 2.5% of GDP. As a one-off cost this does not have the same implications as increasing defence spending, for example. In particular it is unlikely to have a huge immediate effect on demand. A lot of the money will be saved and invested. The people concerned are retired, and doubtless want to improve their lifestyle, but they are also likely to be conservative about it, and save much of it initially. It is unlikely to do much for economic growth, however, though to the extent that the funds are used for investment, there might be some benefit; if people use it to stop working, however, there would be a negative impact. The whole thing is probably much more affordable than it looks – not unlike the slavery compensation.

Alas we will not have a sensible debate on this. Doubtless the government fears that if it gave ground on the WASPI women, it would give a boost to many other aggrieved parties (those in leasehold flats, for example). Still the costs of economic illiteracy are great indeed if governments are needlessly constrained.

Is Rachel Reeves looking backwards or forwards?

Her growth ideas are a blast from the past

I have never really warmed to Rachel Reeves, Britain’s Chancellor of the Exchequer. She hid behind a wooden exterior without revealing anything beyond carefully-crafted PR messages. Still, she was eminently qualified for the job (more so than most of her predecessors) and she has helped transform Labour’s credibility, when her predecessor in the shadow role, Annaliese Dodds, was floundering. I also want to keep my inner misogynist in check: I bristle at a certain type of smartly-dressed, carefully presented, armour-plated, middle-class Labour female politician that has been prominent since New Labour days in the 1990s. I have been giving her the benefit of the doubt.

I forgave Ms Reeves when she announced the withdrawal of the pensioners’ winter fuel payment (or the means-testing of it, to be precise) leading to a blizzard of vituperation. I still think that it is a good policy, even though it is now clear that its political presentation was disastrous. And when she quickly settled many public sector pay disputes I thought this showed evidence of some welcome risk-taking in trying to fix longer-term problems against short-term financial pressures. Her first budget, though, was underwhelming. The only thing that was remotely bold about it was increasing the cost of lower paid employees through adjustments to employers’ National Insurance contributions, and raising the minimum wage. This seems to be a move against employers trying to solve problems with cheap labour. And the budget was sold with a patently dishonest narrative, that the government had discovered a black hole in the country’s finances. The black hole is real enough: but Labour had known its basic contours long before the election: these had been set out by pretty much every intelligent commentator, including, for example, the Institute for Fiscal Studies. Labour simply chose not to call it out.

My reaction to the budget seems to be widely shared – it helped sustain a negative zeitgeist around the economy, which is discouraging investment. Lacklustre GDP statistics (which in reality are pretty meaningless as a performance indicator) supported the negative mood. Ms Reeves has then decided that she needed to lift the mood a bit, with a string of public appearances pushing the idea that the government will not compromise in its search for growth. The good news is that this extra exposure at last seems to be breaking down her woodenness and she has been more inclined to answer questions rather than just spout pre-prepared sound-bites. The bad news is that what she is communicating is pretty disappointing.

Clearly Ms Reeves is anxious to get across the message that the government is really, really keen to encourage investment by reducing red tape. This is a popular theme right now, with the Trump administration trumpeting the message in America, and The Economist has a long article on the subject this week. I have a lot of sympathy. Most regulation is badly designed and implementation is usually even worse. Bureaucrats (in both private and public sector) lay on cautious over-interpretation, and then spend their time chasing innocent minor infractions and slowing down worthwhile projects, rather than tackling the harms that the regulations were designed to prevent. Sometimes this is a necessary evil, but surely we should aspire to do much better. Alas, all this is popular thing for government ministers to say, but there is a huge creditability gap, as they rarely deliver anything worthwhile. And that is especially true of Labour politicians. Their core supporters adore regulations (they are often the ones tasked with managing them) and any worthwhile deregulation hits stiff political resistance. Ms Reeves clearly knows this and realises that she needs to make an unpopular gesture to show that she means business. So she chose airport expansion, and expansion of London’s Heathrow airport in particular.

This has a great deal of symbolic value. Heathrow expansion has been a political football for as long as I can remember. Its advocates have always justified it in terms of “growth”, and there is a fierce NIMBY opposition. These can be presented as London elitists – but there are no obvious beneficiaries to the project outside the country’s richest region. Driving this through would be a signal achievement, showing that the government really does mean business.

There is a plausible economic case to be made for expanding Heathrow – The Economist makes an attempt this week, based on its value as a hub airport for Europe. Ms Reeves failed to make it on her media round. This included an extended interview with Justin Webb for the Today Podcast. In it she insisted that the potential impact on carbon emissions has been neutralised since it was last reviewed by the use of biofuels. Well there are ambitious targets for the greening of aviation fuel globally – but these lack credibility and look more like a smokescreen for the aviation industry. There is no way that Britain’s pressurised agricultural sector could produce these fuels itself. The Economist doesn’t even try to suggest this (though another article suggests that Brazil might turns itself to this fuel, if it can find sufficient investment); it just says that the use of electric ground vehicles (a lot of the pollution comes from the ground, apparently) and the diversion of flights from other other ports mean that the impact on carbon emissions is reduced. I don’t understand why Ms Reeves chose to make her central argument on such tricky ground.

I am personally unconvinced by the economic case for Heathrow expansion, even though it is no longer in my backyard (though Gatwick is, but that’s another story). I have a more quotidian worry. The new runway would cross London’s orbital M25 motorway, which would have to go through a tunnel underneath. The western M25 is a critical road artery (pretty much unavoidable if you want to travel to western parts of the country from here in East Sussex); it has already been badly disrupted by the rebuilding of its A3 junction. That work will barely be finished before it would again be disrupted by the construction of the tunnel. That will have its own impacts on economic activity. That’s small beer – but the prospect of re-launching the expansion programme for the managers of Heathrow remains a very daunting one – and notwithstanding government support for the next 4 years – they may not be willing to risk another failed project.

What is striking about Ms Reeve’s dash for growth, though, is how retro it looks – and not just Heathrow. The infrastructure projects are concentrated in the already prosperous South East (including two more airport expansions) and the government promises to play fast and loose with environmental objections. Gone is the idea of “Levelling up” or a “Northern Powerhouse”, to try and secure growth by helping less prosperous regions catch up. These ideas were admittedly Tory – but they helped keep the so-called Red Wall of seats in the North, Midlands and Wales in play. Labour won these seats back in their landslide, and it is striking that the government is leaving them out of its flagship programme, given that these same seats are subject to a surge of support for Reform UK. But it represents economic orthodoxy (the prevailing culture in the Treasury after all) – and thus the government’s seriousness about the whole thing.

That’s striking because the government is still pushing back against two other bits of orthodoxy. It won’t seriously engage with the EU about substantive trade integration for fear of reopening the Brexit wounds (this time in deference to that Red Wall). And it continues with its ambitious strengthening of workers’s rights; orthodox economics would suggest that this will discourage investment. Businesses are now hoping that they can pressure the government into watering these down. They may well make headway.

All this is rather depressing. Some of the ideas are perfectly sound, and it would be really encouraging if the government could push them through – the Oxford-Cambridge corridor (including rebuilding a railway line stupidly closed by Beeching in the 1960s, in accordance with the then economic orthodoxy), and a further lower Thames crossing. But a retreat into old-fashioned orthodoxy feels like the government is trying to revive a lost past, rather than providing a vision of a hopeful future.

Perhaps that’s unfair. The government is desperate to try and create a more hopeful zeitgeist. Attempts to try and paint a more hopeful and optimistic vision, around green energy for example, have fallen flat in its absence. One of the government’s ideas for regional development involves reorganising local government. also the government sets great store by the gutting of planning laws (and the local government reorganisation into bigger units may also have the aim helping drive through planning applications). These will take time to yield results. Ms Reeve’s budget will increase public spending over the next year, and this should rev things up a bit. Once the mood shifts to something better, it may be time to be a bit bolder.

Perhaps so, but my abiding impression is of a Chancellor who lacks a bold vision of a new, modern economy, and is unduly reliant on the conventional wisdom of her Treasury civil servants. I hope I am wrong.

First published on Substack

Liberals must rethink the state to renew their appeal

Were the neoliberals right after all?

People on the political right are still enjoying themselves now that Donald Trump has assumed the US presidency. Unlike his first term, but much as was forecast, he has established real momentum. He has surprised even me in how he has managed to bend his narrow majorities in the legislature to his will – in contrast to his last presidency. Opponents seem largely stunned into silence. Even The Economist is trying to put a hopeful gloss on things. But it is not enough to predict that this is hubris before a fall: the alternative liberal and left narratives have been shattered. How are they to be replaced?

The Trump euphoria puts me in mind of two episodes, one from the recent past, and one from history. The recent one, which I have already written about, is Boris Johnson’s landslide victory in December 2019. This was accompanied by much hubris, which rapidly unraveled for the same reasons that Mr Trump’s will: impossible promises and valuing loyalty over competence in senior appointments. Such euphoria is common – I can also think of Joe Biden in 2021, Barack Obama in 2009 and Tony Blair in 1997. All led to various levels of disappointment, notwithstanding some genuine achievements. Opposition appeared muted at first on these occasions too. Interestingly, there was no euphoria last year when Labour achieved a landslide victory after 14 years of Conservative-led government in Britain.

The other episode is much darker because it did not precede a fall: Hitler’s assumption of power in 1933. Hitler’s democratic mandate was a weak one, but he used his access to the levers of power ruthlessly to generate momentum that won over some of the sceptics and many of the undecided. He used this momentum, including the propagation of many fascist narratives, to dismantle the checks and balances of the constitution and secure his power. It took twelve years and the worst war the world has ever seen to dislodge him. There are elements of this in Trump’s accession: he has shown disregard for the constitutional order; he relentlessly promotes false narratives; he commands a party that is intensely loyal to him personally; there is a willingness to threaten violence to get his way. But Mr Trump is no Hitler – he is much more driven by personal narcissism; he is less shaped by a racist narrative (though he’s happy to co-opt many who are racist); he is more influenced by a libertarian narrative, quite unlike the Nazi one; he appears to genuinely dislike war, even as he likes to issue threats, where Hitler saw war as destiny. And he is much older and time-constrained. And the USA in 2025 is not Germany in 1933 – democracy is much more deeply embedded, government is much less centralised, people are much wealthier, and there is no shadow of a major military defeat. But some very bad things could happen. In the end, though, this brand of politics is likely to get weakened and collapse as it will self-evidently be unable to deliver. Hitler had the opportunity of a Keynesian expansion of the economy to transform incomes and jobs; Mr Trump does not.

But such an insight is little help to liberals. Mr Trump’s victory marks a serious defeat. The actual margin may have been small, but he was a manifestly unsuitable candidate, promoting extreme policies. He has a base that accepts pretty much all of what he says – but he also persuaded many millions of less committed people, who saw through his schtick but nevertheless still thought he was a better bet than the liberal alternative. And the momentum following his victory will have only consolidated his support. After his first victory in 2016 there may have been a “Did we really mean to do that?” moment amongst many who voted for him. There will be few doubts this time – indeed people will be anxious to prove to themselves that they made the right choice. The relatively muted liberal (and left) response is warranted. This is a necessary step on the path to renewal. In 2017 there was denial and anger; now we are in negotiation and depression. One of the things that I have learnt since my idealistic 20s is that all lasting change must go through these stages of grief. You must get beyond the anger, but that path leads through depression. You can speed the process up but you can’t avoid it. So depression now is a good sign – it means that people understand how serious the problem is and are a step closer to renewal.

I find myself thinking back to 2017. Then, in the aftermath of the Brexit referendum, Trump’s first victory and the rise of the far-right in many European countries, I pondered how to save liberalism from the rising tide of populism. But the mainstream response was less to reflect on failure, and more on the call to resist. Denial and anger won. Emmanuel Macron won a remarkable victory for liberalism in France; Joe Biden was elected in America on 2020; Boris Johnson’s populist coalition fell apart almost as soon as it had been created. But then Mr Trump came back harder and wiser. Mr Macron came unstuck not despite his attempts to promote serious economic reform, but because of them. Mr Biden’s path of hope and denial was no more successful than Mr Macron’s telling of hard truths. Sir Keir Starmer’s Labour Party may have won in Britain, but he secured only 34% of a relatively low turnout, with the populist Reform UK surging. And now his government finds itself prisoner of its denial of the problems that the country faces.

The problem is that the world has changed. The economy has changed so much that a reordering of government and society is required to meet it. Current ways – with a substantial government payroll and vast social safety net – were based on a growing economy, which allowed an ever increasing tax take, and an ever-increasing workforce as the baby bulge worked through its working years and women were drawn into the workforce. The production side of the economy steadily expanded, allowing the state to expand, and especially to provide services and benefits to older people. But the baby bulge is joining their ranks – they are now living much longer previous generations too. Those older people, either retired or winding down productive work, are delivering a double whammy – exiting the productive, taxable economy, while demanding ever more resources from the state. To sustain this in the traditional way, requires a combination of three things: increased productivity, gains from trade, and immigration. But productivity gains are harder to get, and require unpopular disruption; the opportunities for gains from trade have diminished; and immigration is creating social stresses, especially in housing, where in most countries supply is not keeping pace with demand. The result, right across the developed world, is economic stagnation and widening government deficits. This may not be as unsustainable as many pundits profess, but it can’t go on indefinitely. The capital required to keep things running, from domestic savings or from trade surpluses in the less developed world (notably China) must have limits.

There are opportunities as well. The two big ones are clean energy – and especially solar power – and information technology (including, but not restricted to, AI). Also the need to reduce over-consumption in developed countries can be linked to a compelling case to protect the environment, especially from climate change. Further developments in life sciences also offer the prospects for improved length and quality of life: not just from more effective treatments and procedures, but also from a better understanding of how to live healthily.

The right are currently thriving on a diet of denial. They think that good, and improved, standards of living can be sustained without higher taxes, adaptation to clean technologies, or higher levels of immigration. But they have no coherent plan for doing this and are heading for disaster. They are in denial and anger, while liberals are in negotiation and depression. What does renewal look like?

The first thing to say is that the political left has proved an utter failure and is imploding. These have been liberals’ traditional allies – and indeed in America most people make no distinction between liberals and the left. The left has lost its connection with working classes – not keeping pace with how these classes have changed. Instead their base is government workers, and workers in non-governmental organisations which are mainly sustained by governments. They have a huge stake in maintaining the size of government, and giving the government more to do through creating and enforcing rules and regulations. This amounts to managing social problems rather than solving them. This was evident in the left’s shrill opposition to “austerity” in Britain following the great financial crisis of 2007-09, and especially the policies of Conservative-led governments from 2010. This is increasingly unsustainable. Furthermore the left has disappeared into a rabbit hole of identity politics focused on ethnic minorities in particular. They have developed a new language – “cultural appropriation”; “white privilege”; “micro-aggressions”; “critical race theory” – which they seek to impose by regulatory fiat, meaning that majority communities feel they are constantly treading on eggshells, while minorities are encouraged to express offence at a broader and broader range of things. Challenge is suppressed (“cancelled”) rather than taken on. I suppose the hope was that regulations would lead and hearts and minds would follow. But instead they have created stress and people are reeling – including increasing numbers from minority communities. Many are cheering Mr Trump’s roll-back of DEI (Diversity. Equity and Inclusion) initiatives, and not just those on the hard right. It is not that the aims of DEI are wrong, but that they seem more of a job-creation scheme than a solution.

Just how far the left appreciates its failure, and how much they are stuck in denial and anger, I don’t really know. But it is clear that the left is losing political traction everywhere. They may yet be part of a liberal-led political coalition, but they are not enough to defeat the right. Liberals need to distance themselves from the left and attract the centre-right, who will become rapidly disillusioned with the radical-right.

What does that mean? I think it means that liberals need to take a more robust and critical view of government – seeking to make it much more effective and efficient. I am taking care not to say that it should shrink – but it does need to achieve more with the same level of resource, and retreat from areas best left for people to work out for themselves. Fundamentally that means trying to create a better-ordered society with healthier lifestyles – so that fewer public services are needed to fix problems. Funnily enough this is pretty much exactly what the British Conservative leader, Kemi Badenoch, is saying – though she is much better at diagnosing the problem than offering any coherent solutions. In policy terms I think we can see a number of specifics, thinking especially of the British perspective:

The drive by the government to improve efficiency by the application of AI is half-right – but it is in danger of being a solution in search of a problem. The objective should be to re-engineer public services holistically – with AI and other technologies enablers. Otherwise we will simply automate bad practice. The key is to break down departmental silos – with solutions based on the needs of people rather than a collection of abstract problems.
The NHS presents a particular problem. No amount of reengineering is going to allow it to keep pace with increased demand. And trying to solve those problems without addressing social care, as the government seems to be trying to do, is nonsense. Vastly more resources are needed for social care and health services – especially if we are to rely less on cheap labour imported from abroad. This means higher taxes or a much enlarged private sector, or some combination of the two. Funnily enough the last government, between Boris Johnson and Rishi Sunak, made an important step in that direction with their hypothecated National Insurance. Reversing this may have been may have been Liz Truss’s most consequential and most destructive achievement. Now mainstream politicians seem unable to face up to the challenge. That has to change.
Taxes will surely have to rise on exactly the “working people” that the current government is trying to avoid raising taxes on. These taxes are the most economically efficient for a number of reasons. My vision of a smaller state is based largely on reduced demand for its services (except health); but this will take time to achieve and there will be short-term costs. Achieving all the required investment through additional borrowing presents some big risks.
The current government is right about many of the things it wants to do. Investment must continue in clean energy infrastructure, requiring NIMBYs to be dealt with more robustly. Social housing must be expanded – as lack of availability of housing is behind so many social problems. Deregulation may be helpful but it would be better if this was part of a vision of more effective overall governance than an invitation for lobby groups to peddle their hobby-horses. I am less convinced about expanding air travel, though.
The UK needs to re-embrace the European Union. This will have to be gradual – focusing on making trade more efficient. For all the Union’s many flaws, economic integration with our closest neighbours is one way to make the economic activity more effective, and we will need all effectiveness we can find.
Mass immigration, however, for so long the safety valve for the British economy, will need to be brought down. It is creating too many stresses and does not provide a long-term solution. That is the main reason why both taxes will need to rise and public services made more effective and efficient. Politicians should start making that connection with the public. Lower immigration does not come for free.
The private sector – and capitalism – must be embraced as the most efficient way of reconciling supply and demand. But there must be minimum levels of income so that all have a degree of consumer power. And monopoly capitalism must be closely watched. Some services are genuinely better provided by the state.

It strikes me is how much overlap there is here with old neoliberal ideas, which emphasised smaller government, a less regulated private sector and lower taxes. I don’t think lower taxes can be part of the equation, because of the demographic pressures, especially in a lower-immigration environment. And neoliberals were more relaxed about migration. Neoliberals are an object of loathing by the left – who are inclined to suggest that capitalism has failed, without providing any idea of an effective alternative. This is another reason that liberals need to break free of the left until and unless it goes through its own process of renewal.

And what is the vision? It is of a well-ordered society with low levels of crime, inured into healthy lifestyles and carbon-negative. Nobody should struggle to secure some level of decent housing and other basic needs, provided that they make a positive contribution to society in some way. I don’t think that is impossible, but we have a long way to go. Perhaps above all liberals need to think more about what this vision is and how it might work. Only then will we have a persuasive case to make to people who do not currently think of themselves as liberals – on both right and left.

This post was first published on my Substack account.

Reasons to be cheerful

Copilot does “Light at the end of the tunnel”

The human brain seems hard-wired to pessimism – often called realism. There is indeed much to gloomy or worried about at the moment. Quite a bit of it is talked up here: don’t get me started on the subject of economic growth! But it is always helpful to challenge oneself, and in this season of good cheer, I thought I would give it a go. So here are five things that give me hope.

1. Solar Power

Solar panels are a truly transformative technology, in ways that we are only slowly starting to appreciate. It is a distributed technology, which requires little infrastructure of itself (though of course to transport its output large distances does require substantial investment). It doesn’t require much maintenance once installed, as there are few moving parts. It reduces marginal costs of energy to very little. And advances in battery technology make its one major drawback – that it only produces when there is sunlight – much more manageable. It is an economic proposition that fossils fuels are finding it harder and harder to compete with. Thanks to these technologies China is already ahead of its decarbonisation goals. It is indeed thanks to China that the technological advance has been so swift. It is the underlying economics of solar power that makes decarbonisation a feasible proposition, and one that is developing its own momentum. Wind power has some of the same features, but many more difficulties. We should not be placing tariffs on Chinese exports of solar panels or batteries, but saying “thank you very much” and importing all that they can produce. Domestic production will catch up in time.

2. The bad guys can’t deliver

Our modern era is sometimes compared to the 1920s and 1930s, which saw the rise of the Nazis, Fascists and Stalinism. The rise of the far-right today is often compared to these movements. But the context is very different. Then there was much unused economic potential, thanks to misguided (as we now see it) conservative economic policies, and industrial technology that provided a ready and highly productive use for relatively unskilled labour – and much untapped demand for that technology’s output. Fascist regimes could readily produce dramatic economic results by unleashing infrastructure investment programmes – and even by building up armed forces. This would come to be called “Keynesian economics”. The results gave these regimes popular legitimacy. This was especially dramatic in Germany and helped Naziism to become an embedded ideology. No such opportunity exists in the 2020s. Advanced technology does not produce lots of new jobs – or not of the right sort. Labour markets are already quite tight, so that expansionary fiscal policies, and excessive military spending, produces inflation, and not lower unemployment. Instead, the policies of today’s near-fascists result in cronyism, corruption, inflation and general underperformance. That undermines their legitimacy.

Playing for the biggest fall is Vladimir Putin’s Russia, however much he manages to achieve in Ukraine. Russia has a massive demographic problem, with a very low birth rate. The war is making that much worse. Mr Putin’s obsession with pollical control is resulting in cronyism and the suppression of initiative: this is not good for economic efficiency – while sanctions arising from the war reduce Russia’s options. Instead, Russia is heavily dependent on hydrocarbons. See 1. above. Events in Syria show how quickly an excessively tyrannical regime can crumble – and shares elements with the fall of the Soviet regime.

I hesitate to call China evil in the same way as Russia. Its leadership is much more able, and recognises the need to keep corruption in check and for economic efficiency. It has some impressive achievements to its name (see 1. above). But it remains an imperialist power, and actively tries to undermine the West. It too has a demographic problem, and it is finding that an obsession with political control comes with increasing costs. It does not present a shining alternative to western ways, as it once thought it did.

3. Information technology

I am thoroughly sick of the hyping of artificial intelligence (AI), and the way it is crowbarred into any topic you care to name. But it is part of an astonishing development of information technology that will transform our lives in ways that we barely understand. I don’t think it translates into increased productivity in the smooth way that some talk of. As with most technologies it will have to change the way we work and think about things before it will have a real impact. But it should improve economic efficiency and human wellbeing in the longer run. My hope is that it will make some of the public service challenges developed countries face more tractable, reducing the pressure on government finances.

4. The developing world

A lot of the progress made by the developed world in the later part of the 20^th Century and the first years of the 21^st comes down to the opportunities provided by less developed countries in East Asia. As these countries developed their economies, they presented trading opportunities and gains from trade with the developed world. This has run its course, and has actually gone into reverse, as East Asian economies converge with developed world ones (and in some cases have joined that developed world), reducing trade gains (a process which, of course, has been enormously beneficial to those East Asian economies). This has been a regular hobby horse of mine as this piece of basic economics is so widely under-appreciated, even by economists who should know better. And yet there remain two large areas of the less developed world which have yet to advance properly: South Asia (notably India) and Africa. Might not the development of these economies provide further opportunities for mutual benefit?

This is far from straightforward. The East Asian model saw the transfer of workers from subsistence agriculture to manufacturing industry, mass producing consumer products for export, in exchange for a different suite of products and services from the developed world. That model is surely done. Manufacturing technology is so advanced that there are too few jobs at stake, and the developed world’s appetite for “stuff” is surely approaching saturation – although we should remember that potential markets include those East Asian economies, including China, too. To advance, the South Asian and African economies must move the workforce out of agriculture. India has made important strides, but has yet to seriously tackle agricultural reform. But what should surplus agricultural workers do? Here I’m struggling a bit, but I’m sure that 1. and 3. above are part of the solution. It may be that their development will be less dependent on exports. At the moment, their biggest economic impact arises from the export of labour though emigration, affecting Europe and the Middle East in particular (also America, where immigrants also come from Latin America – which is less of a development opportunity). This has mutual benefits but the stresses in host countries are showing, and this is not sustainable in the longer term.

Of course this effort must be led by the developing countries themselves, and not as part of a paternalist relationship with the developed world – as the East Asian progress owed little to the West except in the cold, hard mutual benefits of trade. There is a lot of baggage here but it is in the developed countries’ interests if they are to take their people out of poverty.

5. Liberal values become world values

I’m on fairly safe ground on the first three of my choices; number 4 is a bit shaky. This one is a bit of outrageous optimism. The later 20th Century was a post-colonialist age. Colonialism by the big European powers was pretty much over, though colonialism in Asia by Russia and China lived on. But the pall of colonialism hung over those European powers and still dominated political narratives. Newly independent nations blamed all their ills on their colonial past, and sought compensation in some form or other from the former colonists. They adapted the narrative somewhat to put pressure on the USA too as some sort of “neo-imperialist”. Meanwhile the developed world – the Western powers, consisting largely of those ex-colonisers, espoused liberal values as being universal ones, and criticised others when they fell short. These two narratives got tangled up, and many less developed countries accused developed countries of imposing alien values to their own advantage, and accused them of racism on top.

This all has another narrative: the West remained extremely powerful after decolonisation, and even more so once it had seen off its Communist rival the Soviet Union. Developing countries needed to plead their case to get aid and assistance; the Western powers never let their liberal values get in the way of self-interest, leading to accusations of hypocrisy that were often justified. Then some of these developing nations became more powerful. China worked its way into superpower status (in large part through trade with the West); other countries, like Iran, became more assertive. The anti-liberal movement gained momentum. Liberal values were Western values, and were a new way of promoting a kind of moral colonialism.

The result was ugly. The number of oppressive regimes grew. Medium-sized powers felt free to interfere in regional affairs, allowing a series of awful civil wars to take root. Western liberals feel beleaguered. And they are criticised at home, by conservatives who are fed up with what they see as the trashing of their countries’ history and culture; and by the left who promote anti-colonialist attitudes, and indulge in identity policies among minority communities that would not be tolerated by those minorities if they were in the majority..

And yet the West’s critics still look to the West for leadership in such matters as combatting climate change. “It’s your fault,” they suggest, “so you fix it.” China, by now the biggest contributor to world pollution and climate change sits idly by, though at least they are developing post-carbon technologies – see 1. above. India persists in its victim mentality, apparently unable to see that with a billion people they can’t just complain from the sidelines.

But this is breaking down. The rise of the populists, and especially Donald Trump, means that the West is retreating from its leadership role. And yet the West still looks to be one of the best places to live in the world. Few would say that of China – and especially if you don’t happen to be Han Chinese. And problems such as climate change change and civil wars rage on, with less developed countries as their main victims. This is creating something of a leadership vacuum, which the less developed countries need to fill. And their favoured narratives are losing traction. East Asian countries that have transitioned to developed status did this largely through their own efforts, assisted by free trade with the developed world. They had to move on from the victim mentality and take on proper agency of their own. It is not that African and south Asian countries are necessarily wrong about the damage of colonialism and slavery, but that their obsessing about this is no basis for building a prosperous future.

Meanwhile Western values and the moral high ground don’t look so bad. Capitalism has proved to be the only viable route to prosperity. The cynicism of non-Western powers, like China and Iran, to say nothing of Russia, is very evident, and has hardly promoted world peace. They are not creating great places to live (even if China’s progress must be acknowledged, it compares unfavourably with places like Taiwan). China may be free of Western hypocrisy, but that just leaves its naked self-interest unvarnished – as it develops its very own brand of hypocrisy. Western values really do have a universal application.

This would be good news because if we see a better quality of leadership from non-Western countries, then global problems will become more tractable. They will push forward harder on de-carbonisation, starting at home; they will be less free about arming rebel movements among their neighbours. A bit more humility on the part of Western countries would certainly be appropriate, but people being what they are, that will not be forthcoming.

When reflecting on this I am reminded of one of the courses I studied in my final year at Cambridge, when I was studying history. It was on the philosophy of international relations and led by Professor Harry Hinsley. How do you achieve peaceful international relations? One line of argument suggested that you needed a dominant power to act as a sort of policeman. Another suggested that you needed an empowered supra-national authority. The first is an uninviting prospect, the second is clearly infeasible, and leads to the problem of how that world authority is to be accountable. A more hopeful idea is that if the world was divided into autonomous nations, whose sovereignty ended at agreed borders, then those countries would learn to live with each other out of self-interest. This was in effect the system that Europe developed after the Seven Years War in 1763. Europe didn’t banish war, but the periods of peaceful relations lasted longer than before. The problem was that wars become harder to stop once started. I would like to think that the medium-sized nations of the world – Turkey, Saudi Arabia, United Arab Emirates, Iran, Israel in particular – will start to learn this lesson. Also that the newer great powers – China and India – will realise that they must play a bigger leadership role if world problems are to be tractable. And that neo-imperialist powers, Russia and to a lesser extent China, realise the futility of their enterprise and start to focus on the real needs of their populations. None of this necessarily involves embracing liberalism – but somehow I feel that it leads there.

Hope springs eternal

Good news tends to happen slowly and it isn’t newsworthy. But there is no denying that the world is entering a rough patch. Economic growth has run out of road in the developed world – as at last even the FT’s Martin Wolf is starting to appreciate. He says that this is causing the current political dysfunction, but it’s worse than that. The US is widely admired for delivering the best growth story, and yet the dysfunction is as bad there as anywhere. Actually the changes required to generate growth are as painful as trying to live without it. But the march of technology and scientific understanding goes on – and we don’t need conventionally understood economic growth for the world to become a better place. Think of a place where people don’t consume any more on average in developed countries (though with a more equal distribution), but who live longer, healthier lives, and where there is much less crime. A world where greenhouse gases in the atmosphere are steadily being reduced, where extreme poverty is being pushed back, and which is not so blighted by armed conflict. Apart from the beating back of poverty, none of these things needs economic growth – and the growth required to combat poverty is required only in less developed countries. This advance can be ecologically sustainable. I have not lost hope that the world can get much closer to such a vision.

A Budget that poses as many questions as it answers

This week Rachel Reeves, Britain’s chancellor of the Exchequer, delivered the first strategic Budget the country has had since George Osborne’s in March 2016, unless you count Kwasi Kwarteng’s short-lived effort in Autumn 2022. Mr Osborne’s effort was, of course, simply maintaining the strategic course he set when he first became Chancellor in 2010, and on which doubled-down in 2015 once he’d dispensed with his Liberal Democrat coalition partners – a strategy usually referred to as “Austerity”. That was to shrink of the British state’s footprint, reversing the trend established by Labour, especially from its second term starting in 2001. Ms Reeves is reaffirming the role of the state, but whether that is simply consolidation or a decisive expansion remains unclear. What is over is the firefighting, bluff and pretence of the years 2016 to 2024; there is now a serious engagement with the challenges confronting Britain.

Mr Osborne’s budget of 2016 was quickly overwhelmed by the Brexit referendum in the following June, which saw a new prime minister, Theresa May, and Chancellor, Philip Hammond. They rejected the Osborne strategy with a turn against Austerity. But the mess left by the referendum result was not conducive to clear strategy, as nobody really understood what the result meant. Was it the creation of a small-state “Singapore on Thames” as many senior Brexiteers wanted, or just a grumpy turning inwards? Any chance of the new government coalescing around a coherent strategy was destroyed when it lost its majority in the snap election of 2017. A new government emerged under Boris Johnson in 2019, but his strategy was to have his cake and eat it – to avoid any difficult choices: a strategy not to have a strategy. Liz Truss and Mr Kwarteng took over in 2022, and although they did appear to be strategic, their efforts collapsed almost before they had started. The Rishi Sunak and Jeremy Hunt regime’s only strategy was to try to survive until their political fortunes turned. They pushed through cuts to National Insurance based on fictional forecasts of future government spending. It was fundamentally unserious.

Labour’s first job after taking power in July was to restore those public spending estimates to some kind of reality, without sparking the kind of panic over fiscal probity that Mr Kwarteng had done. They made this job much harder because they chose to humour the Conservatives’ fiction on the public finances rather than challenge it. They promised not to raise taxes on “working people”, and specifically not Income Tax, National Insurance or Value Added Tax. Since taking power they then suggested that they had discovered a surprise “black hole” of over £20 billion, or perhaps £40 billion. But mostly this was known about before the election – and repeatedly pointed to by the Institute for Fiscal Studies. But no political party addressed the issue properly – not the Lib Dems, Reform UK or the Greens, never mind the main two parties. All said that public services could be maintained based on implausible taxes on other people, or equally implausible cuts to benefits. Ms Reeves decided that raising employer National Insurance was not too egregious a breach of election pledges, and went for that. This raises the overall tax take to its highest ever level as a ratio to income, but well within European levels. Whether this really means the largest extent of the state ever, I suspect, depends on how you treat benefits, which is more of a negative tax than a part of the state apparatus, and which have been steadily creeping upwards. But looking ahead beyond the next two years, Ms Reeves continued her predecessors’ fictions on public spending, and cut safety margins to nothing, in order to demonstrate medium term financial targets were being met.

That was because the Office for Budget Responsibility (OBR) forecast meagre growth. Labour’s plans had always been based on improved economic growth – but they cannot give the OBR anything solid enough to raise their forecast. A lot of growth comes from the zeitgeist, out of reach to policymakers and economic forecasters alike. And many of the government’s pro-growth policies have yet to be worked out. Landing a big extra tax burden on businesses in the short term, moving to workers medium term, leaves a bit of a credibility gap there, and it’s hard not to think that Ms Reeves is relying on a positive change to the zeitgeist to get her out of the hole.

Still, the government was never going to solve its economic challenges in one go. This budget is seen as a necessary first step, setting a credible baseline from which to move forward. To me that is a convincing enough narrative, but one that clearly leaves many questions. I have already mentioned growth. Social care is an issue that overshadows all health and welfare spending – and even the Tories attempted to tackle it on occasion – but it has so far been ignored by the government. The government wants to increase the efficiency of government services – but so has every government I can remember: what makes this time different? And many stretched government services, notably those within the remit of local government, are getting little if any extra funding: how sustainable is that?

The one thing going for the government is that expectations are dismal – it will not be so hard to beat them. They aren’t making the mistake that Mr Johnson made in 2019. A good run of luck could change the climate completely.

For me the jury is still out on this government. This Budget isn’t a bad start by Ms Reeves, but many more tests are to come.

The American economy’s success is driving the toxicity of its politics

“Don’t bet against the American economy,” says The Economist in a recent special report. I understand where that sentiment is coming from. Over the years I have read many prophesies of doom, or at least of decline, for that economy, and often found them persuasive. On each occasion they have proved false. Two thoughts have struck me from this report: first that America’s success can’t be replicated by Europe, and that Europeans shouldn’t try; and second that America’s economic success, paradoxically, lies at the heart of its toxic politics. It is that last paradox which might cause the American success to unravel, as, to be fair, the report acknowledges.

My first insight flows from the principle of comparative advantage – a core economic insight originally articulated by David Riccardo in the 18th/19th Century. It is part of Economics 101, and is the critical idea about what drives international trade, and why such trade is mutually beneficial even if one economy imports stuff that it could make more efficiently for itself. It’s all about opportunity costs, as more modern language than Riccardo’s would have it. At a strategic level the theory of comparative advantage has massive predictive power – explaining so much of the world economy as we see it, including, for example, why exchange rates don’t match purchasing power parity. But as you try to get into more detailed, and tactically useful, predictions, economists have been unable to turn it into anything more precise, in spite of one or two attempts. Therefore it is left out the economic models that drive so much of the work of economists, and it does not progress beyond Economics 101. That is why so many economists, not least writers at The Economist, often forget that it is there and seem ignorant of how it actually plays out. So far as I can see, the great (and late) economist Paul Samuelson is one of the very few economists of modern times to properly have internalised its implications. He it was who pointed out that as undeveloped economies converged with advanced ones, the gains from trade between them would diminish, at the expense of the advanced economies. This does much to explain the relative economic stagnation of advanced economies since the financial crash of 2007-09, compared with the era of rampant globalisation before it (which happened after Samuelson died, having forecast it) – though there are other factors, not least demographics. And yet this is never mentioned amid the wringing of hands about the backlash against global trade, which is generally blamed on politics alone. And yet the invisible hand is so often behind the politics.

I have a another insight arising from Riccardo’s thesis. America’s recent success compared to Europe, as The Economist‘s report points out, is based on high-tech industries, where productivity has soared, while it has plodded elsewhere. This success is surely based on the scale of America’s market, and the relatively lack of legal and cultural barriers to trade and the movement of labour. This is clearly a source of comparative advantage over Europe – though not to China, which has a very similar advantage. This means that the relative productivity of the tech sector compared to others (making aircraft, for example) is always going to be greater in America than in Europe, apart from a few specialist niches. That will drive America to specialise in hi-tech industry, while Europe’s direct competitors will diminish – to the benefit of both, as an Economics 101 student can readily explain. If this the way of the invisible hand, then why does The Economist (and such luminaries as Mario Draghi the EU éminence grise with an economics training) spend so much time bemoaning Europe’s lagging hi-tech industry and urging it to to try harder? Economically literate politicians, like Mr Draghi, often do this sort of thing because it is a convenient argument for policies that are actually about economic efficiency in general . Journalists in more sophisticated publications have no such excuse. Europe is never going to match America, or China for that matter, in some areas and it will be a waste of effort trying. Meanwhile they are doing well enough exporting the many products where they do have comparative advantage – Europe does not operate with a large trade deficit, after all. Of course European leaders must keep trying to improve economic efficiency, and perhaps watching America will act as a spur, but a clearer understanding of the workings of comparative advantage would mean better-directed public investment.

Back to America. The Economist does not fail to attribute some of America’s success to an entrepreneurial zeitgeist – but it points to more solid factors too. First is that it has comparative advantage in industries that happen to be highly productive – not just in hi-tech, but also oil and gas. The former advantage stems from the size and flexibility of America’s product and labour markets – something that only China matches (India seems to be closer to Europe in this respect); the latter from a geological endowment. That’s all very well, but it creates tensions. The successful industries take off, but the corollary is that many others are left behind – and through the laws of comparative advantage – become less internationally competitive (as the dollar strengthens, and as they have to pay workers more to compete with the more productive sectors). This creates what Donald Trump calls “American carnage” – the flip side to economic flexibility, as factories close and more productive workers flee to the booming parts of the country. How much the imbalance between globally successful industries and the mainstream is driving high inequality is an interesting question. The Economist suggests that the poorest quintile has seen significant income growth in recent years with tighter labour markets – but in the middle of the income distribution there may be more stagnation – as the higher income groups continue to do fabulously. But if things happen quickly in America, the human cost is going to be high. Rapid growth breeds “carnage”.

A further source of advantage, according to The Economist, is access to large numbers of immigrants, and not least those flooding across the southern border. This seems to act as a lubricant: jobs get filled more quickly in the growing parts of the economy. Europe has immigrants too (though not China) but finds these harder to integrate. And yet this is a central driver to the country’s toxic politics.

And so the rapid change to the structure of the US economy, and the flood of immigrants that its success attracts, are driving a sense of dislocation among Americans, which in turn is driving the highly destructive direction of US politics. This is placing all its critical institutions under threat. Four dangers lurk in particular: the capture of US institutions by a big business elite (“rent-seeking” in economic jargon); rolling back international trade through tariffs and other measures; clamping down on immigration; and finally macroeconomic instability arising from public finances going out of control.

The concentration of big business, leading to capture of the political system and the corruption of institutions to protect established business from competition (often in the name of social stability), is a familiar process. We see variations of it in many places (although sometimes, as in Russia and Hungary, the relationship between political leader and business elite is more complex) – and , indeed, it is alleged to have happened in America in the late 19th Century. The concentration is happening in America now, as is the business elite’s dabbling in politics (most egregiously by Elon Musk) – but The Economist does not think it is leading to significant anti-competitive practices. Competition between the major hi-tech companies remains intense and the pace of innovative product development is hardly slowing. We might raise eyebrows about the way money buys influence in the US, but it does not appear to be a big threat to the US economy.

The backlash against foreign trade is a more substantive concern and especially the advocacy of tariffs. This seems to be mainly driven by Donald Trump – and as such it is one of his most distinctive contributions to economic policy – but the Democrats are copying him. It is hard to see how such policies will do much to help the American public – their main effect will be to raise costs. However it may not do much damage to the main drivers of US economic health: the technology giants and the oil and gas industries. It is not good news for the rest of the world, however, especially Europe.

Anti-immigration will also probably not hurt as much as it could – unless Mr Trump is actually tries to fulfil his campaign rhetoric about mass deportation. The Economist is also quite sanguine about the impact of public budget deficits, which few politicians seem to be taking seriously. There remains little threat to the US Dollar as the world’s preeminent currency, and hence the ease with which dollar finance can be obtained.

Still, there does seem to be an unhealthy cycle here. Growth in the American economy remains robust, but it is driving US society apart. Politicians and commentators alike focus on the choices at the next election, always described as the most important in modern times. But neither side is able to deliver a killer blow to the other. If Mr Trump wins next week’s election, his movement will have to find ways to survive his departure, amid the inevitable chaos of his administration. If Kamala Harris wins it is hard to see that she can convince Trump supporters that she is taking America along the right course, continuing to fuel the destructive radicalism of the right. One way or another this political toxicity will surely affect the astonishing robustness and resilience of the US economy that is one of its main drivers.

National finances don’t work like household budgets. That doesn’t help Labour

Government finances are under water. OK, a weak link but I’m bored of AI images and public domain photos. Bosham in Chichester Harbour this weekend, by my own hand.

Taxation and public spending is very much on the political agenda here in Britain. The Chancellor of the Exchequer, Rachel Reeves, is claiming that there is a £22 billion black hole of unfunded spending commitments in the government finances, left by a Conservative government addicted to brushing problems under the carpet. There is much talk of how her Labour government might raise taxes to plug this hole and meet expectations of improvements to public services and the social safety net.

This makes it a good time to ponder the economics of all this. Public debate encourages us to think of the state’s finances in terms of a household budget: public spending must be covered by taxes, or else the national debt gets out of control, which in due course could mean throwing the country to the mercy of foreign creditors, or burden future generations. This narrative has the merit of being easy to communicate and sounding like common sense. Try telling voters that this is not how things work, and they will immediately become suspicious. The US Republicans, to my knowledge, are the only politicians to have succeeded with a different narrative: the so-called “Laffer curve”, whereby tax cuts pay for themselves through economic growth. Former British Prime Minister Liz Truss tried this out on the British public in 2022, but it went very badly. Her supporters argue that his was actually through bad luck – but most politicians now treat the idea of “unfunded” tax cuts or spending commitments as politically toxic, as well as economically unwise.

The Laffer curve is in fact just one argument against the household budget narrative – but it is not a huge departure from it. Households may borrow to invest, so states should be able to so as well. If a budget deficit leads to a future increase in revenues, or lower costs, then surely it is sustainable? Labour tried to make this case with a proposal for massive investment in clean energy infrastructure – but lost their nerve as the general election loomed. Joe Biden’s administration is actually implementing such a programme in America, but the public there are resolutely sceptical. You have to believe that the future benefits are for real – and the public is generally unbelieving. Not without reason, as the processes of accountability are weak.

A further, and well-established, argument against the household budget narrative might be called the Keynesian critique. This follows the argument originally put forward by the great economist Maynard Keynes, after stringent budgeting by governments during the Great Depression of the 1930s made things worse. If there is spare capacity in the economy – a typical feature of recessions – then it makes sense for the government to run a deficit to raise demand and employ unemployed workers, creating a virtuous circle of growth – and stopping a potential doom-loop of savings leading to reduced demand leading to further savings. Governments should use taxes and spending to help manage overall demand, to ensure that the economy runs at an efficient level of capacity. This idea is very popular on the political left, who generally assume that the economy is always working below capacity – but it is not always easy to tell if there is spare capacity. Many people thought that high unemployment in the 1970s meant that there was spare capacity then – but generous fiscal policy simply seemed to stoke inflation – “stagflation”. In fact the escalating price of oil, amongst other things, meant that the economy was in a period of transition, which caused the high levels of unemployment without a ready supply of potential new jobs. I thought something similar was happening in Britain after the great financial crisis of 2007-2009 – and that this was the justification for the 2010 coalition government’s austerity policies (which were rejected by the left with religious fervour). The pre-crash economy had been too dependent on fake gains in financial services and related business services, meaning that it wasn’t just a case of managing aggregate demand, but allowing for a degree of restructuring, which takes longer. I don’t think anybody else made that argument. Supporters of austerity used versions of the household budget narrative, while most economists said that austerity was the wrong policy because aggregate demand was weak. I still think I was right – though by 2015 the case for further austerity had largely gone, meaning that further cuts made by the Conservative government from that year were excessive.

A final critique of the household budget narrative is made most prominently by advocates of Modern Monetary Theory (MMT). They point out that where countries control their own money supply (which is the case for Britain and America, though not the Eurozone), then they don’t need to worry about the national debt, because they can just create the money to fund it. This, in fact, is exactly what many governments did during the period of Quantitive Easing (QE) in the 2010s. For some reason, MMT is regarded as heterodox economics, and its advocates akin to heretics by conventional economists. I have never entirely understood this – it has always seemed to be a matter of politics rather than substance. Some MMT advocates delight in attacking orthodox economics, not always with secure logic, and this no doubt creates a backlash. Nevertheless MMT economists such as Stephanie Kelton produce well-argued work which is thought-provoking in a good way (this article in the FT gives a flavour). The central proposition is that the limiting factor for fiscal policy is inflation, not debt. While inflation in the developed world appeared dead and buried in the 2010s, MMT became popular on the left, as it suggested that large budget deficits were sustainable, supporting their argument that austerity policies were primarily “ideological”. In the 2020s, with inflation back in the picture, we don’t hear so much about MMT, though their analysis remains just as valid. My personal scepticism of MMT is that its advocates don’t tend to think enough about the difficulties of managing a small open economy, which has to manage its economic relations with other economies (and exchange rate policy in particular) – a situation that fits the British economy more than the American one.

What all these insights point to that there are two important constraints to fiscal policy rather than simply whether there is enough money: inflation and foreign debt (if we accept the MMT argument that domestic debt isn’t a problem if inflation is under control). Low inflation is central to a country’s feeling of economic wellbeing. I would suggest that maintaining the value of the currency is one of the sacred duties of the state – and governments play fast and loose with this at their peril – though most liberal economists are more relaxed about this. And foreign debt can interfere badly with a sense of national sovereignty. The reason that the recent left-wing Mexican president Manuel Lopez Obrador was so keen on limiting government expenditure was exactly that: a fear of foreign debt (and an example of how austerity is not always a matter of right wing ideology). Where governments have dormant inflation and little need for foreign debt (through a current account surplus), then budget deficits can run wild – this is the case with Japan, for example. In Britain things are considerably trickier. The country now has an inflation problem, and a long persistent current account deficit, which complicates managing the national debt. It is hard to know how much of a constraint the latter problem actually is. It hasn’t been tested to destruction since the 1970s (if you discount the Truss episode), when the government called in the IMF, though some suggest this was just political theatre. The country has had no trouble in financing itself from abroad in its own currency. The country’s dependence “on the kindness of strangers” is a popular scare story put up by officials of the Treasury and the Bank of England to keep politicians in their place. And yet, like inflation in the early 2020s, you don’t know if you’ve gone over the limit until it’s too late. It was a debt problem that did for Ms Truss’s bid for freedom, after all. That was a dislocation in the domestic debt market because of some technical issues with pension fund financing. I have oversimplified things by referring to “foreign” debt – but the presence of foreign investors affects the disciplines required across the whole market. That episode showed that management of the national debt has to be strategic – it is not a simple matter of ramping up a budget deficit and seeing what happens.

Meanwhile, I suspect that inflation in Britain remains a serious problem, in spite of the headline rate returning to 2%. In the public sector the government is no longer able to resist above-inflation payrises: you can only defy the market for so long – this is a large part of Ms Reeves’s black hole. That may ripple through to the wider labour market, as the previous government feared. Meanwhile there is enormous political pressure to reduce levels of immigration – and it isn’t just politics: high rental and property prices, in part driven by immigration, is causing serious hardship, and disappointed expectations amongst younger people. Politicians talk of encouraging a high-wage high-productivity economy, not dependent on cheap immigrant labour, and it might be that the country is in transition to just such a destination. But all economic transitions involve bumpy rides, and inflation is often part of that journey. That matters because under the country’s current economic governance, the Bank of England will not reinstitute QE, and make government debt easier to swallow, when there is a threat of inflation. And while reforming economic governance might be a good idea, in the short term it would carry a heavy risk of the destabilisation of financial markets.

So, with a clear menace of inflation, and more difficult markets for government debt, the government is likely to have to raise taxes. And here politics has created a further problem. Easily the most effective taxes are Income Tax, National Insurance and Value Added Tax. These are effective because they have a large base, meaning that small percentage increases have a big impact, and because they have the most direct impact on aggregate demand, helping the management of inflation. And yet Labour has ruled out increasing these taxes (other than through the “stealth tax” of freezing tax-free allowances). There was, in fact, a political consensus on that policy: no party is suggesting that there should be any increases – which is seen to add hardship to those already suffering from higher inflation. That leaves various flavours of capital taxes or wealth taxes. These have the political advantage of primarily affecting the better off, but they help with the national debt rather than inflation – their impact on demand is limited. And they are often evaded by people with tax advisers. That is the big problem with the idea, popular on the left, that increased state spending can be financed just by taxing the rich – such a policy would be inflationary and likely to underperform its targets.

Something has to give. The government will struggle on with continued austerity and increasing some fringe taxes, hoping for a growth bump. But growth is bound to disappoint, inflation will refuse to die, and interest rates will remain uncomfortably high. One commentator has written that it will not be until a second term that Labour will start to seriously address how the country manages the state – through some combination of higher (and doubtless reformed) taxes and reduced state ambition. If the Conservatives remain in a mess, that may become politically feasible. Up until now Sir Keir Starmer’s aim has been to secure an election victory, and to impose a more serious style of political governance. That is a start but it is not enough.