Economics & Finance – thinking liberal

Rishi Sunak shows a sure touch with 2021 Budget

Yesterday Rishi Sunak, the British Chancellor of the Exchequer (though that job title belongs to no other country so far as I know), showed why is considered to be the country’s top performing minister after Boris Johnson, the Prime Minister. It was Budget Day; he got most things right, while putting off a lot of decisions for another day.

The central issue for the government is, of course, dealing with the pandemic. His decision was to continue with a whole raft of fiscal support measures, such as the furlough scheme, until the end of September. This is well after the vaccine programme is supposed to have brought society back to normal, sort of. This shows that Mr Sunak has learned from his mistakes. Last year he was too eager to hurry things back to normal and withdraw fiscal support. Like his boss, he seems to have effortlessly risen above the mistakes of 2020.

But how is this to be paid for? Government finance does not work like household finance, and especially not for a medium-sized developed country with its own currency, like the UK. Mr Sunak has simply added the costs to the national debt without any serious plans to repay it. After dealing with short-term support for the stricken economy, Mr Sunak’s next priority is to show how he will stabilise government finances in the new, shrunken, normal by reducing the budget deficit. He did this by freezing tax allowances and raising the rate of corporation tax (from 2023). The former will allow the government to benefit disproportionately from incomes increasing through inflation. This allows the Conservatives to stick to their pledge not to raise personal tax rates, nowithstanding the hurricane that has hit the economy.

A lot is missing from this plan. Public spending plans have not been changed once the emergency subsides, though it isn’t hard to see many ways in which the stress on public services will rise; some are painting this as strategic choice for a return to austerity, but surely it is too early to say for sure. The long-promised solution to social care funding did not materialise. The temporary increase in Universal Credit, which many want to make permanent, has been prolonged only until 30 September. There were various gimmicks under the heading of “growth strategy”, i.e. measures to encourage business investment, but nothing major. Tax advisers will indeed get an economic boost, especially from his 130% capital allowance scheme for “productive” investment. So the Budget was not the long-term strategic rethink many had been hoping for. The big question is whether the government has such a rethink in mind at all, or whether it is saving it for later. Saving it for later would be perfectly sensible in the current fast-changing environment. A lot of criticism is focused on these missing items, however. Another line of attack, notably from the Liberal Democrats, points to gaps in the emergency support, especially for smaller businesses. This is valid, but it is a bit late for a government rethink.

The leaves two bigger questions: is it sensible to put off dealing with the expanded national debt? And is it sensible to raise the rate of Corporation Tax? My answer to both is “yes”. The limits to government finance are very tricky to assess. On the one extreme we have countries like Argentina, constantly overdoing it and stuck in a world of inflation and debt crisis; on the other we have Japan, whose mountainous public debt and frlarge budget deficits are simply shrugged off. A large national debt needs to be refinanced over time, as the bonds that finance it mature. For now this is cheap and there are plenty of buyers. But that can change; interest rates can rise; investors can be scared off. There’s no sign of this at the moment, but this debt will be with us for a long time. Can’t the Bank of England take on the debt that the markets can’t digest anyway? Yes, but this is a bad idea if inflation is in the system, especially wage inflation. But some wage inflation is good – it is the process by which living standards increase, especially in poorer households. Another problem is if the country requires a lot of foreign currency (the position Argentina got itself into); this is a risk if the country has a large current account deficit. But there are no warning lights flashing on either inflation or currency needs. If that changes the government might need to raise taxes further – but not yet.

And as for Corporation Tax, the government’s reversal of strategy is spectacular. Starting with the Coalition with the Lib Dems in 2010, the rate has been steadily reduced to 19%; the plan now is to bring it up to 25%. This rise is widely portrayed as an attack on business. But that isn’t the right way to look at it. As a tax on profits, rather than on sales, employment or property occupation, it is a very efficient tax. The incentives to run a business efficiently remain unchanged by the rate. It is better regarded as a tax on capital. It is certainly one of the things that companies look at when deciding where to locate a business internationally – but it is still quite competitive at 25%, and basing attractiveness to business investment on tax rates is an invitation to footloose capital, not secure growth. Capital is already cheap, and the story of this century has been the rise of rewards on capital compared to labour. This looks like a good place a tax hike. There are problems with the tax, especially in its treatment of foreign trade and borrowing, but the rate is surely not too high.

Politically, though, this Budget is part of a general revival of the Conservatives’ fortunes. Mr Johnson and Mr Sunak are often painted as rivals, and doubtless they are, but so far this year they are working well together, promoting a narrative of a sure-footed, cautious but fiscally generous recovery from the pandemic. Labour, who had opposed the rise in Corporation Tax, are floundering.

The pendulum swings rapidly in politics, but Rishi Sunak is showing a sure touch. Later this year, as his bluff is called on public spending, it will be interesting to see what he and the rest of the government do.

Rethinking economics – what we should learn from the pandemic but probably won’t

I recently published some thoughts on the economics of the pandemic. This wasn’t one of my more coherent offerings, but somehow I needed to break the ice. I wrote about the short-term question of government stimulus. I made a throwaway remark about the pandemic throwing up deeper issues as well. I want to open the box on these, because I think the pandemic has shown the poverty of conventional economics. So here are some early observations

The narcissism of small differences

Economic commentary used to be about small changes to the economic aggregate statistics, such as GDP or productivity. That didn’t prepare us for the earthquake that came. There are some big things happening in the world, and the risk of a pandemic is only one: there is climate change, nuclear proliferation, bottlenecks in global production processes (microchips, rare earth minerals, etc), but we tend to overlook these in a quest for small gains here and there. It seems like an avoidance strategy for not confronting the bigger questions of our time. Above all we need to break away from our obsession with monthly or quarterly or even annual GDP growth. Alas even during the crisis commentators are trying to compare quarterly GDP figures between countries, at a time when they are surely unreliable, where differences in statistical methods between countries are not well understood, and when timing differences between countries on the evolution of the epidemic matter a lot.

Production is no longer central to economic performance

We depend on food, clothing and many manufactured goods, but these represent a diminishing proportion of the economy. Or, to put it another way, these activities only occupy a minority of workers. Manufacturing, by and large, has had a good crisis. Clearly it has been bad for some things, but it has been good for others (computers and PPE for example). Our roads and ports have stayed busy with goods being moved to and fro. But this has still left economic devastation. And yet economic commentators still tend to talk of manufacturing as being central. They fret about barriers to trade, the effect of bottlenecks on inflation, and stagnant productivity. And yet developed world economies have moved on from these things.

An economy where services matter more than anything for the supply of jobs, and health and care services in particular, needs a different mindset from one based on factories and products moving around on lorries.

Most of the economy is non-essential

As we locked down, we drew a distinction between essential and non-essential supplies and services. The former turned out to take up a surprising small share of economic activity, and it wasn’t hard to keep the show on the road. And much of what we deemed essential has a dubious claim to that status (garden centres? – of course that doesn’t mean that there aren’t very good reasons for keeping them open). That is good news because it shows that there is more resilience in modern society than we thought. But it should make us reflect on whether we have our priorities right for the non-essential parts of our lives. Their action should be about providing wellbeing both to those using and supplying them. How well do they actually do this?

It also turned out that essential workers included a lot of people of rather lowly status in our society. Hospital cleaners; care home workers; supermarket shelf-stackers – all of whom tend to be paid as little as possible. The habit of calling these and other workers “low-skilled” has rightly been challenged. It is a stark reminder that a modern developed economy often rewards the ephemeral while taking the essential for granted.

We have found the magic money tree

The government has been called upon to open the floodgates of public finance, with a “what it takes” approach. The budget deficit has duly expanded into unthinkable territory. The sky hasn’t fallen in. Inflation and interest rates remain low. In fact there are no signs of financial stress at all, unless you count rather bubbly markets in financial assets. Doubtless that is partly because of the extraordinary economics of lockdown, when so much private spending and investment has been suppressed, leaving room to finance government spending. But we have much more flexibility on government finance than many thought we did, especially when we control our own currency.

If this looks too good to be true, it probably is. But we don’t really know what the vulnerabilities are. How do we know when we are overdoing it? For my liking economists are too focused on inflation. The consequence of overdoing things could as easily be some form of financial crisis that makes people poorer.

Hayek was right

We are supposed to be living in an information age, but governments, and everybody else, are blundering around for the lack of information. Governments can’t devise efficient schemes to help businesses in lockdown, even though they can afford them, because they have no good way of knowing which businesses need help, and how much. The result is that many are getting generous help they don’t actually need (including a lot of fraudsters), while many more that need help aren’t getting it. This information gap brings to mind the neoliberal ikon Friedrich Hayek’s argument in “the Road to Serfdom”. The most effective way of transmitting information in a complex society is the use of free markets. Government attempts to close the information gap result in oppression and corruption. The truth of that is evident in China, which has done most to gather and act on information about its citizens.

To them that hath shall be given

But the injustice of leaving matters to free markets is also very apparent. At first I was a bit sceptical by reports that poorer people were being hit hardest by the pandemic. People always say that, regardless of the facts. But it is very clear that people in poorer communities with less stable jobs have suffered more than anybody else. The big problem with free markets is that so many people lack the wherewithal to take part properly. This helps make the case for ideas like Universal Basic Income. The US scheme of giving handouts to everybody has been very helpful to the poorest, though it has also led to excessive gambling on financial markets by retail investors.

Free choice doesn’t work well in a pandemic

Libertarians have been very exercised by what they see as excessive government restrictions to individual choice. They feel the people should be left to make their own choices about the risks they want to run. Such critics have been made to look very foolish more than once. People may be able to make choices about personal risk, but they are ill equipped to assess the effect of their behaviour on others. The idea that the vulnerable should hide while leaving everybody else to take their chances doesn’t fit the complexity of society, where vulnerable people depend on others, or are forced to go out to earn a living. Instead of confronting these realities many libertarians instead tried to deny the facts, suggesting that covid-19 was similar to flu. This is another sign that unfettered free markets don’t provide efficient outcomes in many circumstances.

So where does the leave us?

What strikes me first and foremost from this is that we have become slaves to chasing marginal benefits while the planet is in crisis. As societies we could do a lot more to change the way we do things to address the dangers we face, without damaging health and wellbeing beyond some short-term disruption. “It will damage the economy,” is not an adequate reason for not acting. And the notion that economic growth is a prerequisite to positive change is false, in developed countries at least.

Government action is clearly part of the solution, but most successful action will come through individual initiative, with the action of free markets playing a central role, alongside a strong civic society that is able to challenge and complement government action. And it means that economists must move on from a focus to one focused on broader wellbeing.

Will we do this as life starts to return to normal? I wish I could be optimistic.

The economics of the pandemic: don’t panic

One of my favourite subjects in ten years of blogging has been economics. But for the last year I have hesitated. There has been a lot to write about, but somehow I did not have the confidence to say anything. A couple of weeks ago I got as far as writing an article, but it just meandered. But this week I have been bombarded with different opinions on the impact of the pandemic and what to do next, so I feel I must try to make some sense of it.

Most recently there were a couple of articles in the FT. There was an interview with economist Dani Rodrick, in which he urged that the left should make up for its attachment to neoliberalism in the 1990s and 2000s and meet the challenge of right-wing populism with a sort of left-wing populism. The focus of this should be the creation of decent jobs (the populism bit being the blaming of everything on plutocrats and bankers). He has certainly hit on something important, but to me left-wing populism brings to mind the late Hugo Chavez, and the creation of useless jobs given to political cronies, the running down of productive industries and bankrupting the economy on welfare programmes used to shore up politically compliant communities. This is where the policies of Labour’s former leader Jeremy Corbyn would have led in my view (he is a fan of Chavez after all). On the same day the neoliberals fought back with a piece by Ruchir Sharma, a banker, who claims that emerging market economies have responded to the crisis by pressing forward with supply-side policies, rather than splurging on stimulus. These are IMF-style programmes without the IMF – he points to China and India, amongst others. With developed economies resisting such reforms, he says these emerging economies will be better placed to overcome the shock. This is an interesting take on what is happening, but the conclusion is facile. Developed economies are at the productivity frontier, and they are not in need of many neoliberal reforms (with some exceptions such as Italy) – I agree with Mr Rodrick here, even if his picture of left-wing populism sends shivers down my spine.

And then we have some writing about President Joe Biden’s proposed massive stimulus for the US economy (£1.9trn is the headline). Left-wing commentator Robert Reich launched into enthusiastic support on Facebook. The Economist thinks it goes too far, and should be better targeted, echoing criticism from former adviser to President Clinton, Larry Summers. They fear that it will trigger inflation, and then rising interest rates, and a financial crisis. Meanwhile, also in FT, Gillian Tett has written about the remarkable stance of Chairman of the Federal Reserve Jay Powell, whom she thinks is being far to aggressive on the length of time he suggests interest rates should stay low. Meanwhile there is a lot of fretting about signs of overheated financial markets, with the popularity of crypto “currencies” like Bitcoin eliciting much angst.

There is quite a lot of agreement that governments are right to spend to support the economy, but a big concern on how far this should go. Critics of stimulus worry about setting off inflation. But conservatives have cried wolf on inflation many times in the last few years, and yet it remains stubbornly low. Most commentary on inflation misses the mark.

What is inflation? It is a devaluation of the currency, so that the same nominal units income or savings buy less, but that a fixed nominal amount of debt becomes easier to pay off. The focus of commentary tends to be almost entirely on the first, measured by overall movement in consumer prices. But if wages do not rise to match prices, then debts are not depreciated. It isn’t really inflation, in my books, but a structural adjustment. The three main reasons for this can be worsening terms of trade (i.e. imports becoming more expensive, usually because the exchange rate is depreciating), a decline in productivity, or a shift of bargaining power from labour to capital. None of these require the same policy response as inflation proper (i.e. higher taxes or reduced public spending, or higher interest rates). And in the 21st Century consumer prices and wages have rarely moved in line with each other in developed economies. Before the financial crisis of 2007-2009, wages trended ahead, largely because of improving terms of trade from cheap imports, mainly from China. After the crisis wages have usually failed to keep pace with prices, as the terms of trade moved against developed countries (Chinese products stopped getting cheaper), unmasking a steady process of the balance of advantage moving from labour to capital. All this is very different from the later 20th century, when most of the current theories of economic management were developed. Then wages and consumer prices usually moved in lockstep. The breaking of the link between prices and wages is one of the critical things to understand about the modern economy.

So what happens when demand runs ahead of supply? Inflation remains stuck because rising prices choke off demand, because wages for most people do not keep up. The typical response is for imports to rise. At least that is what I suspect from the limited times where this has happened in the 21st Century (I believe Britain in the mid noughties was a case in point). But a feature of modern developed economies, especially since 2007, has been a chronic lack of demand, while conservative government fiscal policies were the accepted wisdom.

So what will happen if President Biden’s stimulus gets going, with the Fed minded to keep interest rates low? I don’t think it will lead to more than a slight increase in inflation, largely because of the disconnect between prices and pay, but also because of the nature of the recovery. The Economist refers to some supply bottlenecks, such as in microchips, but these relate to distortions in demand arising from lockdowns. Assuming that the US comes out of lockdown, then the main rise in demand will be for services, rather than such manufactured goods, where there seems to be quite a deep pool of unemployed or underemployed labour. And doubtless imports will rise too, and the US dollar will strengthen relative to other currencies. Also much of the excess demand will be funnelled into asset markets, so the current distinctly bubbly markets could well continue. If there is trouble it will come from some kind of breakdown in financial markets. But they do not seem to be as vulnerable as they were in 2007. All this rather supports Mr Reich’s optimistic outlook. As the stimulus plays out things become a lot less predicable, but that is a couple of years away and not necessarily unmanageable.

What should the British government do? It has run up an astonishing budget deficit in its largely successful attempt to keep the show on the road in the crisis – unemployment is remarkably low I the circumstances. According the Economist the deficit is nearly 20% of GDP, the largest of any of the economies it follows. But the same statistical table shows something rather interesting: that the current account deficit to has fallen to 1.3%, and is unremarkable by international standards. Not long ago it was one of the highest. This, together with very low interest rates, suggests that there is no financial crisis, and therefore no need to panic, as the country did in 2010, when the budget deficit was 11%, though the current account deficit was a bit higher at 2 to 2.5%. The government’s main problem is its own rhetoric about government finances.

How quickly could things turn nasty in the UK? We are much more vulnerable to a financial crisis than the US, because we lack financial clout. But again we look much less vulnerable than in 2007. A big question is what happens if the current account goes sharply negative again. That is not necessarily unsustainable (it can be financed by selling property to foreigners). But if world interest rates should start to rise then problems might spiral. But my guess is that the country is safe for a couple of years at least.

There are some much deeper economic questions emerging from the covid crisis, which point to a major change in direction for economic management. These should occupy us more than short term government finances.

Are buoyant stock markets a sign of financial trouble ahead?

I have written before about how well many stock market indices have performed, notwithstanding the pandemic. That good performance has continued, with the US S&P 500 reaching record levels last week. This is puzzling, and might be a sign of a crisis in the making.

What is clear is that few, if any, of the world’s economies are going to shake the crisis off quickly. A rapid partial recovery from the depths of the lockdown is more than plausible, but it is hard to see things getting all the way back to normal. Consumer demand, the main driver of modern economies, looks to be dented for the long term, as many of the public, older people in particular, remain cautious, even if most lockdown restrictions are completely lifted – which they won’t be. You can take a horse to water, but you cannot make it drink. And, of course, a lot businesses are going to fail because of the lockdown, meaning that a lot of people will be put out of work. Meanwhile many businesses and public agencies will suffer a significant loss in productivity as safety measures continue to be in operation. While that might benefit jobs, it implies reduced living standards too, which will also make it hard for businesses to bounce back. The prospect of a vaccine being universally available is distant. The whole world cannot eliminate the virus like New Zealand has done, at the expense of cutting itself off from the rest of the world.

So if the economy is unable to bounce back to where it was in December 2019, why are stocks doing so well, after they fell so far earlier in the year? The obvious answer is that investors have taken leave of their senses, falling for optimistic stories peddled outside the mainstream media. Well I have seen such craziness take hold, back in the late 1990s with the tech boom, but this does not look like it. There must be a more rational explanation. I can think of two, and neither are good news.

The first is that not all companies’ share prices are doing well, and the rise in well-publicised indices is based on large companies who are expected to do well out of the crisis. Companies like Amazon, Microsoft or Alphabet (i.e. Google). When businesses fail, others benefit. The crisis will provide stronger companies with opportunities. The stock market indices are not a representative cross-section of businesses in the economy, but a collection of the bigger ones. But for this to justify such a high level of price gain, it means that investors think these businesses will be able to take advantage of their market dominance to raise prices. In other words, the wreckage left behind by the crisis will lead to widespread price-gouging, which will benefit the companies represented in the indices. This would be bad news because it means that yet another dent in productivity that will reduce living standards of everybody except the lucky. I don’t think this is very likely, but it is plausible that this is what many investors think will happen. There would be parallels with the tech boom of the 1990s if so.

The second possible explanation for high stock prices is an idea I have read in quite a few commentaries. It is that investors “have nowhere else to go” except to put money into shares. In other words, there is a savings glut, and the alternatives to shares look a worse prospect. There is plenty of reason to think that there is a savings glut. Many people are saving more as a result of the crisis, because there are fewer opportunities to spend, while incomes are being propped up by government support schemes. Meanwhile businesses, with a few exceptions like pharmaceutical companies, are cutting investment due to uncertainty. More saving plus reduced investment means a glut. And many people have suggested the world economy has been stuck in a chronic savings glut for the last couple of decades anyway.

The main alternative investment to shares, if you are are looking for a home for trillions rather than mere billions of dollars, is bonds. But interest rates on public debt have been cut to minimal, even negative, levels as part of the monetary response to the crisis. This means almost no prospect of a positive return either from interest payments or capital gains (which would require interest rates to fall even further). Some private companies have bonds offering higher yields (i.e. ratio of interest to price), but that is because of a higher risk of default. These do not look an attractive prospect in the current environment.

Which leaves either keeping the money uninvested in bank accounts, or investing in shares. A lot of people are keeping their money in cash, but this suffers a similar problem to bonds: low interest and no capital gain. Which leaves shares, whose price then rises because demand exceeds supply. That does not necessarily mean that shares offer a better return in the long run. Most investment decisions are not made by people for their own money, but by middle men such as investment managers. They need a good story rather than a sober assessment to justify their decisions. One advantage of shares is that it is very easy to spin a story, and picking crisis winners, as well talking up a rebound, might be just such stories.

But the savings glut explanation is bad news. It is not a stable situation because it implies that demand is being sucked out of the economy. This is one of the standard principles of Economics that is taught in undergraduates’ first year (the so-called Economics 101). It is what caused economic depressions before the economist Maynard Keynes showed that governments could offset this with deficit spending. Governments are indulging in deficit spending to an extent that is unprecedented in peacetime, but the rise in stock markets seems to be showing that they are not doing enough, or rather that their interventions are being parked in savings rather than spent.

How might this play out? The financial system is under a high level of stress. Levels of private and public debt are very high in most of the major economies. Private debt is the most likely breaking point, both in terms of bond default and bank bad debts. This vulnerability plays out in different ways in different countries, but the USA, the EU and China all look vulnerable this time in their different ways. Britain has its own vulnerabilities too, with a high current account deficit, a badly managed epidemic and full departure from the EU about to impact later in the year. This could then lead to a more widespread financial calamity.

The Great Financial Crisis of 2008-2009 was preceded by over a year of unreality, when the nature of the crisis was exposed, but markets were in a sort of stunned disbelief. It was like a supersaturated solution waiting for speck of dust to start a mass crystallisation: the Lehman Brothers collapse was the speck of dust. I was scared enough in 2007 to move my pension fund into index-linked government stock – so I’m not using hindsight here. The situation now is different, but I think the same sort of unreality is present. This will be a very different crisis if it comes.

I don’t think that most countries will suffer a 1930s style depression. Governments will have to intervene big, but they can and look ready to do so, though this will be more complicated in the EU. My prediction is that this will not just take the form of measures to stimulate demand, but interventions to keep businesses going.A lot of wealth will be destroyed. It will be a great moment to be a socialist.

Have I finally succumbed to cabin-fever? I have noticed more than one columnist I respect going a bit off the rails (look at Matthew Parris in The Times this weekend). I will have to leave that to you to judge!

The post-growth economy has arrived. It’s time people accepted that

The idea that economic growth should be the top political priority, after keeping people safe, became established in the 1950s, and has become so imbedded in political thinking that it is now taken for granted. But it’s a bit like Wil E Coyote running over a cliff; we may not realise it yet, but the ground has disappeared from under this notion. We need to focus on different priorities, in rich countries anyway.

What is economic growth? It is the expansion of the money economy through the ever increasing consumption of volumes of paid-for goods and services. It focuses mainly on Gross Domestic Product (GDP), a measure of aggregate income, adjusted for inflation. This (and the related Gross National Product: GNP, more used in the earlier days) only started to be measured consistently in the 1950s. Prior to that economic policy focused more on things like unemployment and the balance of payments, with growth only being an implicit goal. Focus on growth led first to the widespread use of Keynesian demand management within a system of managed exchange rates and capital controls in the 1950s and 60s, and then on the management of interest rates within a world of free capital movements and floating exchange rates, since the 1980s. It is the one element of continuity between these two very different worlds.

Why is there a focus on growth? I think there are two main groups of advocates. The first are public policy expansionists who wanted to secure growing amounts of tax revenues upon which to build the state system, as well as to reduce the need for welfare safety nets. It is probably fair to say that these dominated the earlier growth period.

The second are the rentiers. By rentiers I mean those seeking “economic rent”, or making money without making anything (such as renting out land). The more money there is sloshing around the more opportunities there are for rentiers. These include people with investments, workers and owners in monopolies that overcharge, many senior managers, and so on. These are much more than the top 1% of the wealthiest, and include people with a substantial stake in property (such as owning their own home) or other assets. In other words not just profiteers, but those who want and expect the value of their house to keep going up. The rentiers have been in the driving seat since the 1980s, since post-Keynesian (or Neo-Keynesian) economic policy became general. There is a bit of a paradox here: rentiers make growth harder to achieve, and in fact are one of the causes of slower growth, but they adore the policies designed to promote growth.

The first critics of growth were environmentalists. An early example was E.F. Schumacher in his book “Small is Beautiful”, which made a deep impression on the my parents in the 1970s. Environmentalists pointed out that growth implied the consumption of ever increasing amounts of natural resources, and damage to the environment, and that this was not sustainable. This was not entirely true, as economic activity became more efficient, reducing its impact on the environment. Many of Schumacher’s predictions turned out to be nonsense, and yet when I look back from now to the 1970s I am struct by how much we have destroyed; and then there is the rapidly emerging climate crisis.

A second group of critics might be called “lifestylers”. These people have rejected the need to work ever harder to consume ever larger amounts of stuff. At first these could be dismissed as eccentric hippies – but people who retire early come into this category, and that became a widespread life objective from early on. Since then the expression “work-life balance” has become popular among younger people. The interesting thing about lifestylers is that they don’t usually object to economic growth in principle (they may be rentiers after all), but their economic choices make achieving economic growth harder. They vote against economic growth with their feet.

The third important group of critics are conservatives: those that object to the changes that growth brings, such as the closure of old-fashioned businesses, outsourcing abroad or the growing use of immigrants. While some supporters of Brexit claimed to do so to improve Britain’s growth prospects, the Remainers cut little ice with their arguments that Brexit would slow growth down. Most Brexiteers simply thought that it was a price worth paying to send the immigrants home.

All three groups have been steadily gaining ground, and then into the mix has come the Coronavirus crisis. It is quite sobering to see how much economic activity people regard as “non-essential”, and how rapidly people are happy to reduce consumption when health and wellbeing are at stake. As we climb out of lockdown, we happily pile restriction upon restriction onto businesses to make them safer. There will be an inevitable cost to this, making it an impossibility to get back to the level of GPD prevailing before the crisis. Now even people who favour growth in theory will be unable to accept the price in practice. Furthermore, after the sobering experience of life being turned upside down in weeks, it is likely that people will save more and consume less to improve their financial resilience.

But abandoning growth as an objective means a profound change to the way our political class makes public policy choices. It is not surprising that so many of them are emulating Wil. E Coyote. What are the new priorities?

I put jobs first because that must be the focus of the recovery from the Coronavirus crisis, and it is urgent. It used to be argued that jobs had to follow growth. This isn’t nonsense: job creation schemes not based on sound economic principles will fail the end. But the link between jobs, and especially the sort of jobs that give people security and self-respect, and growth has become a lot weaker. Government interventions need to focus on jobs first, while still considering sustainability. The idea of a government-sponsored job-guarantee scheme is certainly worth a closer look. There are many potential pitfalls in such an idea, but for my money it is more promising than the much-touted idea of Universal Basic Income. It is important to make the point that an economy without growth is not an economy without jobs.

Second in my list is sustainability. This has both environmental and economic senses. Economic sustainability will need to be rethought, especially if people start to consume less and save more. This will mean that much higher levels of government debt will be sustainable. Environmental sustainability should be the main guide public investment. There is a lot of work to do to make our economy environmentally sustainable, but we should not delude ourselves that this will necessarily increase GDP.

Third is inequality. There is a lot of poverty in our society, and if the cake isn’t getting bigger then poverty will only be tackled by making somebody else poorer. This is a notoriously difficult problem, but some countries manage it much better than others. A job guarantee scheme could play an important role. Another important point is to tackle rentiers, through taxes and promoting competition.

And finally in my list (I could go on) is government effectiveness. In a low growth economy, the ability of governments to tax is limited, and a lot of resources will be consumed in addressing inequality. It follows that governments should use their resources more effectively. The public sector is rife with its own class of rentiers, from consultants offering to implement “world-beating” systems that don’t work, to defence contractors using national security to cover up waste, to excessive union power stopping managers from managing. We need to develop a culture of effective, delegated public sector management, accountable to a reworked political system.

Low growth has arrived, however much policymakers may dislike the notion. It is imperative that the political elites of rich countries reorient themselves to the new reality.

Universal Basic Income – why it doesn’t deserve the hype

To judge from my Facebook news feed and Twitter updates, the idea of Universal Basic Income (UBI) is gaining traction on the political left and centre-left. The extraordinary measures being undertaken by governments to prop up economies hit by Coronavirus and associated lockdowns somehow make it look less outlandish. In Britain the idea is getting closer and closer to being official policy for both Labour and the Liberal Democrats; it is already there for the Greens. I have always been a sceptic, and I still am.

The attraction is easy to see, and the crisis has highlighted its virtues. It is one answer to the massive information gap that lies between governments and the citizens they serve. This makes it impossible to target aid accurately to those in need. Government schemes like the furlough scheme leave many gaps, are subject to administration delays or injustices, and doubtless pay lots of money to those who don’t really need it, including fraudsters. On the other hand, attempts to target better involve humiliating procedures to verify need, which are often administered by officials that seem to take pleasure in the exercise of petty power for its own sake – and who are not empowered with discretion to use common sense nor accountable for the human results of their work.

This information gap has two main causes. The first is privacy, whereby we deliberately limit the information we make available to the authorities, or anybody else. The is one of the core aspects of what we understand by freedom, and all psychological benefits that come with empowerment and autonomy. But there is also the sheer scale and complexity of the information problem. Even in countries unworried by the idea of privacy, like China, face colossal problems trying to understand individual people’s needs, and often resort to arbitrary rules.

UBI is income that everybody is entitled to, on the minimum possible qualifications (such as nationality; there would likely be some form of age-based entitlement too). This would eliminate the need to provide targeted help in most cases, its advocates argue. In particular it would not depend on whether the citizen is working, and could replace unemployment benefit, or, in the UK, Universal Credit. There is no need for the state to gather data on income and work status in order to check entitlement.

Some support for this idea has recently come from Finland, where a randomised trial was carried out between UBI and unemployment pay. It was found that UBI did not reduce the incentive to look for work, while significantly improving the wellbeing of those receiving it. One worry about UBI, especially if it is substantial enough to replace entitlements to benefits, is that a significant number of people would give up the search for work, because they would not need it. But advocates point out that the incentive to work is improved because people keep all the extra earnings (subject to taxes), rather than having benefits withdrawn. The Finnish study provides some interesting evidence here.

But if the incentives argument falls away, there remains the question of how the state manages to pay for it. There is a dilemma here. The higher the rate of UBI, the more it can replace other benefits, and so deliver the advantages advocates want to see. In the UK Universal Credit is an obvious target, and so is the basic state pension. And yet as soon as it reaches this sort of level, the state outlays required to cover it become massive. Of course there are savings. Since the state pension is already a more or less universal entitlement, there may not be much extra outlay. Tax free allowances on pay could be withdrawn. But the gap remains massive.

Some on the left wave all this away, based on the insights offered by Modern Monetary Theory (MMT), which basically suggests that budget deficits can be funded by borrowing or printing money, and so traditional ideas of balancing budgets are old hat. Now I’m not as rude about MMT as most conventional economists seem to be, but it does seem to have encouraged the sort of magical thinking I last remember being widespread at the time of the tech boom in the late 1990s (“losses are the new profits”). The problem is that UBI would potentially unleash a wave of extra consumer demand across the economy, which could lead it to overheat and break down, through inflation or a debt crisis (because of the need to borrow foreign currency to buy imports sucked in by the excess demands). That is unless demand could be dampened down in some way, i.e. taxes raised. This is not a question of just taxing wealth, and top pay either. This may be a good idea anyway, but it is not likely to have a big enough impact on demand to head off trouble. Some combination of increases in basic income tax, national insurance and VAT will be needed too. This needs to be discussed more openly by the idea’s advocates.

But my reservation goes deeper. To me UBI seems to be trying to shortcut the sort of interventions that our society needs. It is an attempt to give people money in the hope that their problems will go away. That may work for a lot of people, but we will still be left with a vast residue of people with more complex needs, which a basic UBI does not begin to solve. I prefer solutions based on a highly devolved interventions by empowered professionals, able to tailor solutions across the whole range of public services from health, to housing, to law enforcement. The way to bridge the information gap is through people intelligently examining individual needs and crafting complex solutions. This will entail a judicious mixture of conditional and unconditional benefits. Our public services have been going in the opposite direction for two decades or more, as successive governments have sought to take the humanity out of public services and replace it with targets that turn out to be meaningless. By focusing so much on UBI, we are distracting attention away from the real crisis in public services.

The craze over UBI illustrates one of the biggest failings in a our politics. The search for simple, if radical, ideas instead of trying to understand the humanity of our society, and going about the messy and painful business of adjusting to this reality.

Tim Harford and “degrowth”: missing the broader point

In his weekly column last Friday, Tim Harford criticised the concept of “degrowth” now being promoted by some environmentalists. But I think he’s missing the main point.

Degrowth, as presented by Mr Harford, is the idea that the stopping of economic growth must be part of the policy toolkit towards creating a sustainable economy. As such he thinks it is misguided.

His reasoning is sound. The current Coronavirus epidemic has halted and reversed economic growth, and that has indeed has been mostly beneficial to the environment, by reducing carbon emissions for example. But the environmental effects are not proportionate. Even this scale of disruption is not enough to deal with the climate crisis, for example. Much deeper changes are required. Much better to focus on these instead, rather than being diverted into arguments over growth. He further argues that the idea is too blunt an instrument to deal with the environmental crisis, and that policies need to be much better targeted to be persuasive.

I agree on both counts. But Mr Harford quotes one supporter, Ricardo Mastini, as defining degrowth as “the abolition of growth as a social objective.” Put like that, I don’t think it can happen soon enough. Economists and policymakers are far to focused on growth, and its companion, productivity. They need to abandon this if they are going to help with the transition that the global economy surely needs. For conventional economists, the idea that growth will reduce to zero or even reverse is very scary. Our entire financial infrastructure seems to built on an assumption that we will keep growing. There is also an assumption that in order to find the resources to deal with environmental and social ills, the best way is to divert the proceeds of growth. And as growth has slowed in the developed world, these economists are getting increasingly anxious. They moan loudly about low productivity growth and try to find culprits. Instead they should be trying to think through the implications of slow, zero or negative growth, and the best way of promoting public policy in that environment. If that means big changes to the financial system and policy framework, then we have no time to lose in working out what those changes should be.

The first thing that economists need to appreciate is that the main reason that growth is slowing is through the freely made choices of people based on a rational appreciation of their needs. It is not some kind of disease that needs to be cured. That would apply whether or not an environmental crisis was engulfing us. Productivity gains apply to a shrinking proportion of the economy; consumption of goods is long past rational saturation. Productivity improvements in one part of the economy are balanced by losses elsewhere as people pursue less intensive lifestyles (think organic farming), or demand more expensive healthcare treatments. That is the way things are. Get used to it.

Meanwhile, chasing after productivity can be positively damaging. Direct environmental damage is easy to see, for example as modern agriculture decimates biodiversity. But it is also more subtle: the systematic hunting down of resilience in the name of improving efficiency is one of the reasons that the Covid-19 epidemic has been so destructive.

This leaves society with two huge problems. The first is changing lifestyles to the environment to recover, rather than degrade further. The second is to reduce inequality and the piling up idle financial resources while too many others pile up debt. This is what economists need to be thinking about, rather longing for steady economic growth.

To me “degrowth” is about changing the conventional policy mindset. And that is an urgent task. More people need to be talking about it, not fewer.

Suddenly then gradually is how the economic downturn will be

On Friday (1 May) I was astounded to hear that the US stock market index S&P 500 had its best month since 1987, after its dramatic fall in the earlier months of the year. I was aghast when I further thought I heard that it had recovered practically all its lost ground in 2020. That reinforced an impression that many people are in denial about just how bad things are, especially in America.

Some notes of caution before readers rush to sell their American shares, or short the index. The S&P 500 was in fact still 13% below its starting point at the end of April, and fell nearly another 3% on that Friday. I probably misheard a comment about the tech-heavy NASDAQ, which was just 2% down. The movements of share prices arise from dark forces, whose nature only becomes apparent long after the event, if ever. Newspaper headlines attributing movements to some coincidental event (on Friday it was trade relations with China) are just speculation. There may well be a much more rational explanation for the stock index level other than delusion. Though it still looks like a long-term “sell”.

The impression of delusion was heightened by statements, from the President among others, that the USA is past the peak of the virus outbreak, and many states are relaxing their lockdowns. In Britain the Prime Minister, Boris Johnson, has been saying the same thing about being over the worst, though still very reticent about relaxing the lockdown. Economically at least, however, the world’s troubles have only just begun. The troubles are in several layers.

The first issue is that the virus has proved itself to be both very infectious and deadly, and it is still very far from beaten. The relaxation of restrictions in the USA is most likely to result in a surge of infections that will overwhelm the hospitals in the states where it happens. This is a complex business, and some US states may not in fact be very vulnerable, because their populations are very dispersed and populations relatively static. But that does not apply to many of the states relaxing restrictions, such as Georgia. In Europe each country is wrestling with how to relax the lockdown, without reigniting the crisis. Only a small number of states (and not in Europe) seem to be able to relax lockdown significantly, and that only by drastically limiting travel in and out. It will be impossible to get back to normal until a freely available vaccine or cure is found and distributed en masse. That’s a long way off.

The second issue is that this crisis is a global one; no country will be able to bounce back and lead the recovery. In the Great Financial Crisis, a relatively small number of countries took the initial brunt (the USA and Britain mostly); others (in particular other European countries) suffered in the aftershock, but while the initial impacts had stabilised. Across the globe countries were able to launch a massive stimulus to use up the spare capacity created by the crisis, with particular credit to both the USA and China. This will not happen this time; both of these countries have had suffered severe shocks to the supply sides of their economies, which limits their ability to carry out effective stimulus. States across the world are intervening massively to limit the economic damage of the pandemic, but this is strictly damage-limitation. Reversing much of the damage already done is another matter.

And this leads to a third problem, which is the biggest of all. The world is coming to the end of one of its 40-year growth cycles, and the crisis is about to cause a deep unravelling of the growth model that drove it. They old tricks don’t work any more, just like Keynesian stimulus did not work in the 1970s.

The current growth cycle began to take off in the 1980s. It was driven by three main things. The first was continued productivity growth by developed world businesses, partly through the application of new technology, and partly by a ruthless cutting away of “slack” regardless of whether this represented waste or sensible resilience. One feature was the extensive use of outsourcing, and the stretching of supply chains. The main problem with this steady transformation of business was that the rewards were skewed towards the owners of capital and the top managers and their advisers, and not most of their workers. The second growth driver was steadily increased consumer spending, driven by steadily increasing private sector borrowing, in turn linked to increasing property valuations. This allowed the mass of consumers not benefiting so much from the productivity gains to nevertheless keep growing their consumption. The problem with this is that it is not sustainable in the long term – but as the saying goes, tomorrow never comes. The third factor was the entry of the less developed Asian economies as a source of cheap labour. Japan was the first, followed by Korea and Taiwan, and then China and India. It is important to note that this development was not exploitative for the most part. Those Asian economies benefited hugely, which allows those taking a world view to say this 40 year cycle has been by far the most beneficial to humanity (if you gloss over environmental impact). What was happening is explainable using the ancient economic principle of comparative advantage, and benefited both sides. What people did not appreciate at the time, and for the most part still don’t, is that these gains are time-limited. As the developing nations catch up, their labour increases in price, and so the developed world ceases to benefit. And so it has been as China in particular closes the gap.

The whole system is now unravelling at speed. Just how much developed world industry has been relying on reduced resilience to get next year’s increase in profits is only now becoming clear. As an illustration this Economist article on the US meat industry shows how scary it can get. And, of course, reliance on cheap foreign labour to keep prices down looks like a bad bet too, as hospitals scramble to find masks and gowns to protect their workers. But the most worrying development in terms of its potential impact is that the shock will puncture the ever growing cycle of consumption, debt and property values.

What this amounts to is a prolonged and almighty economic slump. Demand management through government stimulus will only help so far because the crisis is killing productivity and supply. What will emerge from this is hard to say. Many hope that it will be a kinder, more sustainable and more equal economic system. But there are other possibilities of course. I have written before that there will be a huge impetus to get back to familiar world of before, and this will undo many of the short-term hopes raised by the crisis. But over the longer term something better is possible.

“Gradually and then suddenly,” is the famous Ernest Hemingway quote about bankruptcy. With this crisis it will be the opposite.

Will the Euro survive the Coronavirus crisis?

So far in this astonishing episode, the world’s financial systems have held up well. Remarkably, lessons have been learned from the Great Financial Crisis, both in the behaviour of policymakers, and in the resilience of banks. But many claim that the Euro is especially vulnerable. Are they right?

The crisis so far has not been good for the egos of the Europocrats. The response has been led almost totally by the governments of its member states. It turns out that the EU really is just a free trade area after all. When something more important than trade comes along it has nothing important to do. And when its leaders at last got together to sort out a financial response, the outcome was pathetic, and spoiled by the sort of bickering shows that there is little solidarity amongst the member states.

Yanis Varoufakis, the former Greek finance minister, called this out on BBC Radio 4. The most important part of the EU’s infrastructure, the Euro, has turned into an instrument of oppression. The rich northern states, notably Germany and the Netherlands, were vetoing any serious aid to the most afflicted states, such as Italy and Spain, while not allowing them to help themselves. He said that German leaders should level with their public: the Euro was really good for their economy, but to keep it going they needed to be more generous to other members. The Italians, in particular, are throughly disillusioned and could provoke an existential crisis for the zone.

There is plenty of truth in what Mr Varoufakis is saying, but nobody should bet on the dissolution of the Euro just yet. Critics of the system miss two things. Firstly, as this week’s Buttonwood column in The Economist has pointed out, the European Central Bank (ECB) has learned a lot from the previous crisis and has now become the EU’s most effective institution, and not bogged down by the bickering that undermines the more overtly political arms. It has, amongst other things, rushed to buy up debt from Italy and Spain, thus greatly assisting a strong fiscal response to the crisis. This has the effect of mutualising their debt by stealth. The ECB has learnt the art of doing just enough to keep the Euro going, while being unable to fix its deeper flaws.

The second point is more subtle. It is wrong to suggest, as Mr Varoufakis does, the Euro is in effect a plot by Germany to rob Italy. It is better understood as a conspiracy between German workers and Italian savers. The Germans get plentiful and secure jobs, because their currency is held down, allowing its industry to run a surplus. Italian savers get more buying power for their money in a currency that is stronger than their own would be, with less risk of inflation. The victims are Italian workers, whose firms struggle to make progress with such a strong currency, and German savers, who lose buying power. It is arguments between these victims that drive the acrimonious politics of the Eurozone. Politicians like to blame an outsider, so German ones like to blame lazy Italian workers for low returns by their savers, and Italian ones like to blame the Germans for screwing their businesses.

So the Euro’s losers drive the day to day politics, but as soon as it looks as if they might succeed in their goal of causing the collapse of the Euro, the winners, German workers and Italian savers, hoist it out of trouble with a twitch upon a thread. The clearest example of this is Marine Le Pen’s tilt at the French presidency. Her bid featured resentment at the Euro, and it got her into the final round against Emmanuel Macron, but it rapidly collapsed when, in one of the debates, she floated the idea that France might leave the Euro. French savers, many of them older voters sympathetic to Ms Le Pen’s anger at liberal elites, suddenly realised that there could be a cost to their protest and deserted her. Something like this effect will happen in Italian politics if anti-Euro politicians get too much traction there.

So the Euro is safe but the politics is grim. What is needed are two things: more enlightened self-interest from northern leaders, and more willingness to embrace economic reforms by southern ones. The big trading surpluses by northern countries mean that they could easily be more generous to their southern neighbours by buying their goods and services or through direct aid (though lending them money simply builds trouble for later). Each of the southern economies has economic inefficiencies that their leaders should do more to tackle. In Italy it is excessive petty regulations to protect economic vested interests. In Spain it is lack of labour market flexibility. In Greece it is a failure to collect enough tax, especially from the better off. Until they tackle these they will always be supplicants and politically vulnerable.

For all that, the Euro has some very challenging times ahead (as do the US dollar and the Chinese Yuan, for differing reasons). Italy could easily be faced with a banking crisis, at a time when the attempts to mutualise banking risk across the Eurozone are incomplete. The acrimony will continue.

And this will set the EU on a trajectory that makes it more and more resemble the Holy Roman Empire. This was a tangle of German states, led by an Emperor with little practical authority. It was much despised by Enlightenment thinkers, and finally brought to an end by Napoleon. But it was the foundation of the strong commerce and devolved administration that makes Germany (and Austria) such successful states today. This is something Anglo-Saxon observers almost never understand.

Covid-19 will not make the world a better place

In these strange times I have been thinking a lot about the meaning and consequences of it all. I’m not alone. With so little else to do in lock-down many others are thinking about the effects of Covid-19. Alas this effort is as unproductive as so much else that is going on right now.

For contrasting ideas compare these two pieces. In the New Statesman philosopher John Gray explains Why this crisis is a turning point in history. For him it marks the reverse of globalisation and the return of the nation-state as the dominant idea in political and economic organisation. On the other hand in The Times there is Matthew Parris who explains why We say everything will change but it won’t. For me Mr Parris is much more on the money, but then I have never liked Mr Gray, a very clever man who somehow always seems to miss the point.

The remarkable thing about almost all the predictions of change is that they are expressions of wish fulfilment. Environmentalists say that we will stop travelling by air and learn to value the environment we have so despoiled through largely pointless economic activity. Socialists say the crisis is a vindication of socialist organisation at the expense of markets and capitalism, and that we cannot return to “Neoliberal” ways. Nationalists say that it is all the fault of outsiders and countries will raise borders and expel foreigners. Critics of the European Union say the crisis proves its uselessness and will prove terminal for it. The Economist suggests that the crisis will be good for big companies and herald a period of consolidation and takeover (to be fair that newspaper does not openly advocate such consolidation as a good thing, but its bias in favour of bigness is very evident). Critics of Donald Trump say the crisis means his presidency will end this year. And so on. Perhaps with the crisis having so badly disrupted people’s expectations for how the year would progress, there is some kind subconscious compensation mechanism which leads them to conclude it will hasten what they were always advocating. There must be a silver lining to all those dark clouds.

A lot of these thoughts have merit, but we need to adjust the seasoning. One of the deepest instincts of humankind is conservatism and a desire to recreate better times in the past. When all this is over there will be an overwhelming wish to go back to how things were before, which will be seen as a sort of golden era. This may take a little while to emerge, as a lot of people have been genuinely scared by the idea they could be contaminated by their neighbours. But a lot of infrastructure is simply falling into disuse rather than being destroyed. The planes and airports are still there. Many airlines will go bust, but their assets will be bought up on the cheap by stronger airlines and new ones. Dirt cheap fights will be on offer and, alas for those of us who think it is mainly pointless and destructive , things will get back to something like what they were.

Still, a number questions are worth posing. The first is whether we will treat this affair as a nightmare to be put behind us and forgotten, or whether we will take real steps to make ourselves less vulnerable to future pandemics. Much of history points to the former conclusion, as Mr Parris points out. But one of the interesting things to emerge is how much better East Asian countries have proved to be at handling the pandemic. This applies as much to China’s Communist dictatorship as to Taiwan’s and South Korea’s vibrant democracies. The reason seems to be that they have had major scares before, such as SARS. So perhaps western societies will learn too. Also it may prove very hard to beat this virus. An effective vaccine, the silver bullet we seek, might prove elusive. That would mean that we would have to build longer-lasting systems to fight it, and in particular tighter surveillance of people’s health so that outbreaks can be detected and isolated quickly. This will not be dismantled so quickly.

A second question is how the world’s financial systems will cope with the surge in government spending required to confront the disease and to soften its economic effects. Each of three pillars of the world system is going to be put under immense strain: the US dollar as the world’s principal currency for reserves and international transactions; the Euro and the European financial system; and China’s opaque and highly manipulated system. Here in Britain our financial system looks a lot healthier than it did during the great financial crisis, but it cannot fail to be impacted if these other pillars start to falter.

And then there are things that people should be pondering but are not. The first are lessons about the most effective structure and governance of the state. Here in Britain we are seeing a lot of muddle, and many missed opportunities. A lot of these derive from excessive centralisation, which stops the government from making the most of many smaller organisations that could help unblock the bottlenecks in the supply of tests and personal protective equipment, for example. Instead people will probably conclude that the system was not centralised enough.

There is also a deeper philosophical question about our society. The lockdown shows how little of our economic activity we actually need to keep ourselves alive. Most economic activity is only of marginal worth when set against the big issues of life and death. Perhaps we should rethink our obsessions with economic growth and productivity, and instead try to build a society that is safer, more resilient, more sustainable and happier. But if that thought ever starts to get traction it will soon be crushed in our desire to put the nightmare behind us. I can’t yet see much of a silver lining to this cloud.