Category: Politics UK

Reflections on general political developments and ideas in the UK

The next election is Starmer’s to lose

Chris McAndrew, CC BY 3.0 https://creativecommons.org/licenses/by/3.0, via Wikimedia Commons

It looks certain that Liz Truss will become British prime minister this week, and British politics will take a dramatic turn. It is surely an act of political suicide by her Conservative Party.

We are, of course, urged not to underestimate Ms Truss – as so many of us have in the past. And yet, Matthew Parris in The Times tells us that this is a mistaken sentiment – just as it was for Boris Johnson and for Donald Trump – also politicians who won the top job against huge scepticism of their fitness for the job. She really is as shallow and dangerous as she looks.

I agree. During her bid to persuade first Tory MPs and then ordinary Tory members to vote her into the job, she has backed herself into a difficult corner. Her fiscal policies are inflationary; her economic ideas delusional, and she has shown little aptitude for the negotiation and compromise that are essential to any successful political leadership. She is also a stiff and awkward communicator. She enters the job in the middle of an economic crisis – it is hard to see that she has much chance of a honeymoon period longer than a month.

It gets worse for the Conservatives. They have built their political appeal on the basis of being a safe pair of hands with the economy. Whether this claim has been justified is another matter: while the austerity policies with which the party was associated from 2010 until 2019 struck most voters as being careful and sensible, most economists regarded them as being inappropriate at best. Now that reputation for economic competence is under water. Recent polling shows a Labour lead on handling of the economy, as its does in overall voting intentions. This is very dangerous territory for the Conservatives – and Ms Truss is going to do nothing to improve it. The sort of tax-cutting fantasies that are popular on the American right do not play so well with floating voters here. And it is hard to see that inflation is going to improve much under her stewardship – not without a recession, which she is claiming that she can avoid.

Still, many observers think the Conservatives can pull things back. Ms Truss will hit the ground running, as she has had plenty of time to prepare. A new cabinet will be put in place quickly – and the current government lethargy will be replaced by energy and optimistic talk. There is bound to be a honeymoon bounce. Ms Truss might even go straight into a new general election. This would be perfectly justifiable, to give her a fresh mandate, rather than the flawed manifesto of 2019. The Conservatives have been planning for this possibility for some time, as new, and more advantageous constituency boundaries come into effect. They will likely be better prepared than they opponents. But the polling looks dire – and she and all her hangers-on will be dismayed at the idea of throwing away their coup so soon. Opposition is a dismal place to be for those used to government. Still there is a certain recklessness about Ms Truss, and I wouldn’t rule it out.

The main reason that people seem to think that the Conservatives might win the next election is a lack of belief in Sir Keir Starmer, the Labour leader. He is uncharismatic and cautious. It is hard to say what he stands for, and his polling is weak. But is this a Westminster bubble thing? Activists on the left like their leaders to be charismatic and radical – and so do the journalists and others who follow them. It is easy to see their disappointment. But FT columnist Janan Ganesh warns that this bias against the uncharismatic, also applicable to US President Joe Biden, leads us to underestimate them. Floating voters like their leaders to be reassuring and middle of the road – and, I would add, especially if those leaders are from the left. Radicalism is not a positive attribute. The Conservatives are walking into a trap.

The main equation for Labour is whether they will win the next election by themselves, or alongside the Liberal Democrats. The Lib Dem leader, Sir Ed Davey, is no more charismatic than Sir Keir, though he is more experienced. He has made a lot of the political running in the last few weeks on the energy crisis – a subject he knows well as a former Energy Secretary. Like Sir Keir, he is relentlessly un-ideoligical. He is not trying to move the debate to the areas that his activists want to talk about – such as Brexit – but focuses on the areas that are close to floating voters top concerns. The other issue that the Lib Dems have been able to run with is the water companies’ disposal of raw sewage into rivers and the seaside. The Lib Dems are doing well in many Tory heartland seats where Labour is weak. The public ground is being subtly prepared for a coalition – or cooperation at least – between the two parties – in a way that it wasn’t before the Lib Dem coalition with the Conservatives in 2010, which saw Lib Dem support collapse.

It is reported that the Conservatives are preparing a campaign based on defeating the “Coalition of Chaos”, compared with strong and stable one-party government. This follows the successful deployment of this line of attack in 2015, which nearly wiped out the Lib Dems – though it failed in 2017, to the extent that the Tories are likely to avoid the slogan “Strong and Stable”, the basis of the 2017 flop. This line might gain traction if it looks as if a Labour-Lib Dem alliance will not gain enough seats to prevent the Scottish Nationalist Party from holding the balance of power. The SNP will not want to let in a Conservative government, but they will demand another referendum on independence. Labour and the Lib Dems are going to need to think through their strategy on that front with care, and not just hope that the issue won’t come up. But will the prospect of another Scottish referendum scare English floating voters? Probably not enough.

Sir Keir’s strategy was a risky one. He has done nothing to motivate his own activists – and gone out his way to insult the socialist left, the source of Labour’s most energetic supporters. He is unable to project the flair of Tony Blair, who previously made a floating-voter strategy work for Labour. But the Conservatives are playing into his hands.

I am going to be offline for two or three weeks.

Targeting help to the neediest depends on knowing who they are

This week’s Bagehot column in The Economist suggests that Labour’s policy of freezing energy prices is bad policy (actually “silly”) but good politics. It says that Labour has been too tied to “wonkery” – the design of policies that are clever enough to solve problems without the need to confront awkward choices. Their new policy is a welcome break form the current Labour leader, Sir Keir Starmer. But I don’t think the policy is quite so silly – even if Labour’s suggestions about how the costs will be managed mainly are.

The challenge is huge. British energy prices, especially for gas, have shot up this year. But that is just a foretaste. Further steep rises are in the pipeline: the graphic above, showing annualised costs, culled from the New Statesman (featuring widely quoted projections from Cornwall Insight – who seem to be the only people making them) shows the problem. The median annual household income is estimated to be £31,400 after tax – so costs are rising from 4% to maybe nearly 14% of income for the median household, and it could be double this for the bottom quartile. Other costs are rising too, and, for most people, pay is not keeping up (many senior executives and our local refuse collectors excluded). The media has little difficulty in finding cases of extreme hardship – of people choosing between energy and food for example – and, apparently, not even being able to heat that food up. In one case publicised by BBC News, somebody was selling their furniture to pay their bills. And that is before the forecast price rises have gone through, and before winter brings in the need for heating. Overwhelmingly the public feel that the government should step in to relieve hardship – although how many Conservative Party members share this feeling, while they choose their next leader, is not clear. So far, so clear.

This is where The Economist‘s wonkery comes in. The view amongst Britain’s policy wonks is that help needs to be concentrated on those that need it most. Trying to cap the price for everybody, a policy widely favoured in other European countries, is regarded as a bad idea. For two reasons: first it wastes public funds on people that don’t need it, and second it blunts the market signal that people should reduce energy consumption, and so ease the imbalance between supply and demand that is causing the problem in the first place. This thinking has guided government policy to date. British energy prices have been allowed to shoot ahead of those in the rest of Europe – while the government is trying to target the bulk of its help to the neediest. But this bumps into a major problem. How can the government tell who to help, and who can get along without it? They have two main ways of trying to do this. The first is to help those already entitled to other help, such as Universal Credit – and the second is to ask people to apply for help, and then to assess whether they actually need it.

Both solutions are badly flawed. A problem on this scale is going to hit many people not entitled to benefits, which have become notably stingier over time. I have seen this problem in a different context: the supply of free school meals to struggling families. Many families need the help but are just above the threshold for entitlement. The problem with asking people to come forward is that many will refuse to as a matter of pride, while others who don’t need the help will try their luck, and need to be weeded out in some way, or else the system will subject to allegations of widespread abuse. This last has been the case with help for businesses in the pandemic. This problem is what I have called the Information Gap. The state does not know enough about individuals or businesses to tailor its policies to specific need. It either creates universal entitlements, helping those who are not in need, or resorts to a number of very blunt instruments, which often create political backwash.

The Information Gap is not just some technical problem that can be left to policy wonks to solve. It is one of the central problems of the modern state, and everybody in politics, wonk or not, should be aware of it. There are three general philosophical approaches to dealing with the Gap. One is to use the best efforts of the state to gather information and close the gap, compelling disclosure as required. This is the approach we associate with the Chinese Communist Party; it is highly paternalistic, and seamlessly moves into the state intruding into our private lives in unexpected ways. And the state never gets enough information to solve the problem properly. Its opposite is the libertarian approach. This suggests that the state should not involve itself in helping individuals at all. It should establish a system of security and property rights, and not much else. This thinking is popular n the political right, though not amongst populists. The third approach is solve the problem through a combination of universal entitlements and high taxes. This has recently been popularised through the advocacy of Universal Basic Income. Of course nobody, or almost nobody, advocates taking any of these three approaches to the extreme. Practical statecraft involves balancing all three approaches. Politically, though, we need to develop a sense of in which direction is the site needs to tilt at the current time.

Alas politicians rarely succeed by being honest about the difficult choices involved. Tory leadership contender Rishi Sunak seems to be suggesting that we take the more paternalist approach – but without being clear as to how the information gap is to be closed. His past behaviour in the pandemic suggests that we will accept a high degree of failure and try to shrug it off. His rival, Liz Truss, is suggesting a more libertarian approach – but without being honest about the widespread hardship and business failure that is likely to result. And now Labour is suggesting the use of universal entitlements – but without being honest that this will lead to higher taxes. All three are displaying a dependence on magical thinking. Labour’s “costing” of its new policy is laughable – but the economic illiteracy it is showing is the rule amongst serious politicians, not an aberration.

Personally I think Britain needs to move further along the universal entitlements and high tax route – an approach derided by Ms Truss, but one which the better-run European states favour. That does lead to further problems. Public services will require more discipline to improve their effectiveness, which I believe will have to come alongside decentralisation – with political accountability moving in parallel. That will require deep reforms that people may support in theory, but will resist in practice. Without reform, services will simply gobble up resources without becoming more effective. A further problem, shown in other European countries, is that tensions over immigration have to be managed. If entitlements are high, the public resents people it sees as freeloaders – and there is political mileage in stoking up that resentment, whether fair or not.

So that’s two cheers for Labour – and indeed the Lib Dems whose policies Labour seem to be copying. Alas I don’t see any sign that either party is going to be honest about taxes. But the public, surely, will start to see the need for hard choices. The careers of the two British politicians most egregious in suggesting that no hard choices are required – Boris Johnson and Jeremy Corbyn – have both ended ignominiously.

Tackling inflation means a recession

I remember Britain’s inflation crisis of the 1970s well. I was a teenager, just coming into political consciousness. I started subscribing to The Economist newspaper in mid 1974, between the two British general elections in that year. Back then I was a firm supporter of the Conservative Party, which then entailed being a Europhile. Disillusionment did not overcome me until the end of the decade. Inflation remained the dominant economic issue until well into the 1980s. But these days most people in political power, political or economic journalism, or with economic responsibility are from a younger generation, who have only read about those times. I don’t think they have quite understood what is happening.

A number of things jar. The first is that discussion often fails to take in the difference between real and nominal statistics. Nominal data is simply the raw figures expressed in currency. These become of limited use when inflation takes hold, if you wanted to compare prices and values over time. So the concept of “real” data, adjusted for inflation, was developed. GDP data is expressed this way now as standard – as is almost all material in standard economics courses. Still, there has been a fashion of advocating monetary authorities targeting nominal GDP, rather than inflation. The concern was that if both real growth and inflation were very low, then the economy should be stimulated, even though inflation might not appear to be a problem. For a developed country, I think, the suggestion was that the target should be in the region of 5% per annum – allowing for 2-3% inflation alongside a “normal” rate of growth of about the same rate. It is now running at about 12% in the UK, showing an extreme overshoot. That suggests a case for hard monetary tightening – though, to be fair, with inflation at 9% and projected to go higher, an inflation-only target does the same job.

And that, if you read most comment, is exactly what the Bank of England is doing now, with a 0.5% rate rise recently, the highest increase since it became independent in 1997, we are told. But the “real” concept applies to interest rates too. The real rate base rate, by my calculation is around minus 7%. I find myself asking how can that can be described as tight. More seriously, it suggests that cash savings are being eaten away at a rate of knots. Other investments, apart from residential property, don’t look a much better bet either. Wealth is being destroyed at a rate we haven’t seen since the Great Financial Crisis – though conservative investors would have done well out of that episode in a way that they are unlikely to today (unless they held substantial amounts of index-linked stocks). Of course, it is not hard to see why people seem so unconcerned. The political weight of borrowers, and especially those with mortgages on their homes, has always been greater than that of savers. And higher nominal rates imply more cash flow stress on mortgagees, when income may not be guaranteed to keep pace. Still, I find it a bit jarring that there is so little political pressure to raise interest rates. A backlash from savers may yet emerge.

A further jarring side to the current discussion is that so many seem to think that inflation and growth are variables that are more or less independent of each other. An extreme example comes from Liz Truss’s campaign for the Conservative leadership. She seems to think that policies to support growth, or stop a recession, are independent of policies to curb inflation. she was a bit shocked when Chairman of the Bank of England suggested that attacking inflation would affect growth. At the same time, one her supporters, Suella Braverman, suggested that the Bank is to blame for inflation getting out of hand, and should have raised rates earlier – apparently impervious to the idea that this would have dented the growth that ms truss seems to hold as a sacrosanct economic objective. But growth and inflation are two sides of the same coin. You can’t stop inflation without putting pressure on demand, which limits growth. That’s politics, I suppose, but such comments should be enough for Ms Truss, and especially Ms Braverman, to be laughed out of court. If you you are in favour of tackling inflation, you should accept the risk to growth, and even welcome it. If you think inflation will disappear of its own accord (because it comes from external sources such as oil prices), then you should say so outright. But if you do, you face a tricky question on pay. If pay does not keep up with inflation, then real incomes will shrink – which means recession. So, if you want to avoid that, you should be more supportive of public sector pay increases. No senior Tory is in favour of that. In fact a growing part of inflation now seems to come from a wage-price spiral. This is exactly what you would expect when unemployment is as low as it is, and many employers face problems with recruitment, not least in the public sector. That means that any policies that support growth will make inflation worse.

Still, this is not the 1970s. Then the main industries were heavily unionised, and the public sector was huge, including public utilities, the coal and steel industries and a big car manufacturer. The size of payrises were front and centre of economic management and political discourse; strikes were commonplace, and not subject to the heavy regulation of today. It was much easier for inflation to become entrenched. It was also hard for major businesses, and especially the public sector, to push through productivity-improving changes to working practices. Stagflation was the result. Today, inflation should be much easier to bring under control.

Today’s discourse on inflation is right about one thing: one of the critical issues is hardship inflicted on the less well off. Funnily enough, I don’t remember people talking about this in the 1970s. Perhaps there was less financial insecurity, and benefits were relatively more generous – that is certainly a popular narrative on the left, but I would like to see more evidence before accepting that to be the case. It may just be my tilted memory. It is certainly one of the biggest talking points now, though it is hard to know just how widespread the hardship is. There is certainly plenty of it, as we can see even here in leafy East Sussex.

What is clear to me is that a recession of some sort is required to bring the economy under control. That means a reduction in overall living standards – and public policy should ensure that this burden mainly falls on those on middle and upper incomes. And that points to higher taxes and more “handouts” – at least in the short term. Alas our probably next prime minister is saying the opposite.

The relentless rise of Liz Truss

Hardly for the first time in my life, I have got something wrong. In my recent post on the Conservative leadership contest I suggested that Rishi Sunak would prevail over Liz Truss. This was based on the thought that Conservative members were more sensible than they are usually portrayed to be, and that they would react against the apparent recklessness of Ms Truss – t and favour Mr Sunak’s better presentation skills. I have badly underestimated Ms Truss, as I now think she is unstoppable, but I’m hardly the first person to do so.

Monday night’s TV debate showed why. Mr Sunak badly needed to portray Ms Truss’s economic plans as reckless (an opinion which I share), and especially that they could send inflation and interest rates up. He got his point across pretty successfully. In the process we found him talking over his opponent repeatedly with the confident male assurance that far too many of us have seen senior men do with female colleagues. Would he have done that with a male opponent? You bet he would – he was desperate to convey his message. So it probably wasn’t sexism – it was the opposite, not making concessions to Ms Truss’s sex. But it was a very bad look, and looks matter. Ms Truss held her line firmly; the waves broke over a rock. She had ripostes prepared, and she used them. Mr Sunak’s plans were contractionary (er… that goes with taming inflation); it was all Project Fear (a clever reference to the Remain campaign’s warnings of the economic consequences of Brexit – which have largely been proved right, but which Mr Sunak could not point out); it was all Treasury conservatism and “bean-counting” (true enough – but not actually relevant in this context). She surely did enough to cast doubt in Conservative members’ minds about Mr Sunak’s plans. Meanwhile Mr Sunak’s behaviour neutralised his actually rather impressive confidence and command.

This is a race between the tortoise and the hare, that we have so often seen played out in politics. The patient plotter quietly and relentlessly pursuing their ambitions, while their flashier opponents fall apart one by one. John Major; Gordon Brown; Theresa May – (you can go back further – Jim Callaghan; Ted Heath; Clement Attlee). Like all of these, Ms Truss has endured massive amounts of sneering criticism on her journey upwards. Apart from Attlee, though, none of them were particularly successful once they achieved the summit of their ambitions.

I have in fact met Ms Truss. It was before she was an MP, when she was attending a Lib Dem conference in the later 2000s on behalf of Reform, a think thank devoted to new ideas for public services. We exchanged pleasantries, but I don’t remember much beyond that. Reform’s ideas were (and still are) definitely centre-right – and more to the right in those days of New Labour. They favoured the conversion of state schools to academies, for example – something of a red herring in policy terms. As I remember they had better ideas elsewhere – they had a god line of constructive criticism. This part of Ms Truss’s career tells us two things. First is that she is fluent in the world of think tanks and policy debate. She is repeatedly portrayed as being a bit dim: this is far from true – but it is harder to shake the accusation of shallowness. The second thing this tells is us is that she is a professional politician, and knows no other trade. She was in her late 20s at this stage – was elected to parliament in 2010 and quickly became a junior minister (in 2012), reaching the cabinet in 2014. To be fair, she did train as a management accountant (i.e. a qualified bean-counter, like me, though working in business rather than in the profession) – but she did not take up any serious professional or management role. Her whole life seems to have been political – with politically active parents, and active with the Liberal Democrats at university, before taking up with the Conservatives. She paints this as a political journey, rather than opportunism – and I’m happy to take her word on this. I’m told she was never a left-wing Lib Dem, and the Conservative Party is in the long run a happier place for economic liberals – though deeply out of fashion in the 1990s. But a political career was clearly always on her mind.

Where does this leave us? We have no reason to doubt her conviction to a particular political philosophy (unlike Boris Johnson, for example) – that of being an economic liberal. But her attachment to particular policies never seems to be very strong. She knows all about how to win power, but her ideas about how to exercise it have less “bottom”. This isn’t all bad – disaster can happen when a particular politician has an idée fixe, which they pursue obsessively regardless of evidence. A particular disaster was Andrew Lansley, the first Health Secretary in the coalition government of 2010, who implemented an over-engineered reform of the NHS when it was already suffering reform fatigue. Ms Truss might have the flexibility to change course when things go wrong. The danger is that her yardstick of success is less about actual achievement than the political mood. She is not a conviction politician like Margaret Thatcher. If she was, she would have been completely thrown by Brexit, which she energetically opposed, and now supports with equal energy.

Getting the top job, if she succeeds, is going to be a big shock for her. You can’t get away with sleight of hand. If the economy goes seriously wrong, for example, she can’t simple vanish and blame somebody else. She may be comfortable with rapid changes of course, but she would then find it harder to persuade people to trust her. She is a poor public speaker, verging on disastrous. This was one reason that many people, including me, never took her chances of rising to the top seriously. She simply did not look the part.

As my readers will know, I think her ideas for tax cuts will be disastrous. They will hinder the fight against inflation, which will lead to increasing interest rates. They are a gamble that you can fight inflation without damaging economic growth. Given the obstacles the country is experiencing international trade and labour markets, not least by Brexit, this looks unrealistic. She may well be forced into austerity policies, including public service cuts just as an election looms.

So if I was a Conservative member I would choose Mr Sunak. But Ms Truss has been running this race for much longer than him. And it shows.

NHS failure is hurting the economy. Only higher taxes will break the cycle.

Last Friday I read a rather shocking article in the FT by John Burn-Murdoch pointing out that, uniquely amongst major economies, the number of inactive people of working age in Britain is still rising even as covid subsides. In the EU the number of inactive people has already returned to below the pre-pandemic trend line; in the US the number of inactive people is still above this trend line, but it is falling. About 300,000 people are missing from the UK workforce. The author draws a connection with NHS waiting lists, where a similar number of people have been waiting for more than a year for an NHS operation to deal with a chronic condition. You don’t have to accept the exact causal link between between these figures to understand that a poorly functioning health system affects the size of the economy. The scale of pain implied by the backlogs in NHS care, and the difficulty people have in accessing it, including primary care and mental health services, should make this enough of political priority. But even those who say the economy trumps all else should be taking notice.

Two important insights about the current British economy seem to elude many commentators. The first is that the dominant factor affecting the size of the economy, and hence economic growth, is the number of people that are in work. As I discussed in my recent post on Dietrich Wallrath’s book Fully Grown, this factor trumps all others, and in particularlar changes in productivity. It follows that anybody who cares about growth should focus on this factor above all else. It is why childcare policies are so important, to say nothing of immigration and retirement. It follows that the persistent shrinkage in the UK workforce through the covid pandemic must be an important contributor to the country’s lack of economic performance. The second insight is that Britain is facing a supply side crunch, which is why unemployment is low at the same time as inflation is becoming widespread through the economy, and not just focused on things like energy costs. And following Brexit, international trade (and migration) is much less of a safety valve for imbalances between supply and demand. This means that anything reducing the size of the workforce really matters. And that makes the state of the nation’s health doubly important.

It is evident that Britain is experiencing a health crisis. The NHS is failing to deal with the pressures it is under, and as for policies to stop people getting ill in the first place, that gets scarcely any attention at all. The surge in demand, combined with pressure on supply, arising from the pandemic has broken a system that was already under stress. The direct effect of the pandemic – in terms people getting ill – does not seem to differ all that much from many other countries. The issue is that other country’s health systems seem to be more resilient.

Why should this be the case? The main reason is surely that the country does not spend as much on health care as other developed countries. In an ONS study on comparative health spending based on 2017 data, only Italy spent less per head among the G7 countries. This study also pointed out that the proportion of the spend that was publicly financed (about 80%) was amongst the highest – though in the Nordic countries and Japan it was higher. The two countries in the OECD with the highest overall health spend per capita, Switzerland (about 40% higher than the UK) and the US (about double) had amongst the lowest public contributions. This points to the central paradox of the NHS: the arrangement of care being free at the point of use, combined with an effective monopoly of state provision, causes the country to spend less on health rather than more – because it makes private contribution harder. Why would you pay for treatment that you can get free? You aren’t allowed to top up NHS care with your own money to get better treatment or priority. But if people are driven to use private care because the NHS is inadequate, private care infrastructure starts to undermine the public one – and the universal consent that is the basis of the NHS starts to break down. This has already happened to dentistry and optometry. A recent BBC study has shown that more and more people are going private out of frustration with NHS waiting times, in many cases causing significant financial hardship. So this is a growing threat.

Britain probably took a wrong turning with the design of its health system in the 1940s. Other countries have found a better balance between public and private finance, and deliver better health outcomes overall – though the US shows that you should not equate health spend with health outcomes. But that is a useless insight. It is inconceivable that the country moves to one of the public insurance-based systems (Netherlands and Australia are often spoken of as exemplars) that seem work better. There is only one way to solve the problem and that is to expand the public budget to take up a higher share of the national income. This was the solution hit upon by Tony Blair when he was prime minister in the early 2000s – which it must be said was one of his most successful insights, even though it went against political orthodoxy – he had to outmanoeuvre his chancellor Gordon Brown bring it about. The problem, of course, is how to fund it (or, if you are a follower of Modern Monetary Theory – how to prevent the policy being inflationary). When Mr Blair pushed the policy through, the country was going through a largely illusory period of economic growth, and no hard choices were required as tax revenues were buoyant. But a big problem arose when the bubble popped in the Great Financial Crisis, and much of the government’s tax revenues vanished. Since then governments have sought to protect the size of the NHS budget, but without letting it reflecting increased demand arising from the higher proportion of older people. Meanwhile other public services that affect demand for the NHS, like social care and public health, were squeezed. Meanwhile the country’s growth prospects were dented by those same demographics, to say nothing of the ending of cheap Chinese imports and Brexit, and various other headwinds. The inescapable conclusion is that core taxes (Income Tax, National Insurance, and VAT) must go up to provide health services with the resources they need to meet public demand.

Only shadows of this awkward political choice seem to be affecting the Conservative leadership debate. Rishi Sunak defends the recent rise in NI on the basis that it is needed to fund the NHS to help overcome its covid backlog, and then to improve social care. But this extra funding is inadequate. Liz Truss persists in suggesting that taxes should come down immediately, and stay down, as this will unleash growth and higher tax revenues overall. Though she doesn’t suggest cutting spending, it is not hard to see that this is where that path leads. Both place hope in productivity miracles in the health system to square the circle. Neither want to touch the idea of intrusive regulation to help the country avoid health hazards such as junk food. This position is not necessarily incoherent. Many conservatives think we should push health choices and their consequences out of the public realm and into that of individual responsibility. Such people would not be unhappy with the rise of a two-tier health system with the rise of private care increasingly dealing with the requirements of the better off. It is, of course, a policy that dare not speak its name.

And yet Labour, and the Lib Dems for that matter, are no better. They may accept the ethos of an effective and properly funded public health system, including preventative health interventions (though tastes for this vary) – but they will not say that this requires core taxes to go up. It is easy to blame devious politicians, right, left and centre for this failure to confront the hard choices about the national health. But the problem clearly goes deeper. Conservatives don’t talk about strangling the NHS in the name of individual agency, and Labour doesn’t talk about serious tax rises to boost health funding, because each of these policies would be politically suicidal. The political system crushes minority political views, which both of these are, in the all-or-nothing electoral system. The public has no apetite for political straight talking of this sort. It’s been hard enough to get people used to the idea that stopping climate change means changing our way of life. Health policy, or the awkward choices it entails, does not get anything like this attention. Initially leadership on this kind of issue is required from outside the main political parties. But I hear nothing.

And so we face the prospect of a vicious circle, with the health system and the economy bringing each other down.

No, tax cuts won’t deliver economic growth

Elizabeth Truss – UK Parliament official portraits 2017
Photo: Chris McAndrew, CC BY 3.0 https://creativecommons.org/licenses/by/3.0, via Wikimedia Commons

I’ve been away on holiday for the last week, near Bakewell in the beautiful Peak District of Derbyshire. So I haven’t commented on the race to succeed Boris Johnson as leader of the Conservative Party – which under the UK’s unwritten constitution means the automatic assumption of the office of Prime Minister. I did watch (most of) the two televised debates. You will have to take my word for it that I was predicting that the final two would be Rishi Sunak and Liz Truss even as Penny Maudaunt was the 58% betting favourite to win the whole thing.

As I write, Ms Maudaunt may yet make it to the final two, to be decided by party members, and even Mr Sunak’s place there is not guaranteed. But let’s assume that things turn out as I predicted. Which one is likely to win overall? This is hard to predict. YouGov have made a valiant attempt as polling Conservative members, but to get their sample they are fishing in a large lake for a rare fish. Their polling suggests that Ms Truss has a comfortable lead. This fits with most commentators’ prejudices of the Tory membership, as most think they will prefer Ms Truss’s more ideological pitch – or may even be worried by Mr Sunak’s ethnicity. Actually I’m not so sure, and I expect Mr Sunak to prevail in the end.

These two candidates were always the strongest in the field of seven candidates left after Jeremy Hunt was eliminated. They have both held one of the great offices of state (indeed Ms Truss is still Foreign Secretary), and they are both well grounded in the sorts of choices governments have to make. The other candidates have come up with interesting debating points but show little evidence of actual grasp. Meanwhile both Mr Sunak and Ms Truss have come closest to putting forward coherent policy positions – and they clash. Mr Sunak has taken the continuity position, of keeping taxes and spending much as they are, and defending the various measures put forward to relieve hardship as the cost of living crisis takes hold. This makes sense as he was Chancellor of the Exchequer until very recently. This has been heavily criticised by Ms Truss. She says that the tax rises (National Insurance is going up, alongside Corporation Tax rates) will cause recession. Instead tax should be cut in the short term, to generate economic growth. Inflation should be curbed by the Bank of England – whom she suggested were in large part responsible for inflation in the first place.

Three questions are posed by this challenge. First, will tax cuts generate growth? Second, can Britain afford more public debt? And third, is the fight against inflation best left to the central bank? The first question is in fact quite complex one – and politicians of left and right often try to hide in the complexity to justify populist policies of lower taxes or higher spending.

There are a number of ways that tax cuts can stimulate growth. The most direct is by allowing people to spend more (assuming that it isn’t accompanied by public spending cuts) – which helps take up economic slack. Donald Trump’s tax cuts worked like this, at least to some extent. But there is very little sign of slack in the UK economy. Indeed this is one of the causes of the inflation crisis. Tax cuts will either fuel inflation or suck in imports (and the country is running a current account deficit). A second mechanism for tax to affect growth is by drawing in more capital – fixed or human – by improving incentives. The case for this is strongest for Corporation Tax – as this is something multinational companies factor into their choice of where in the world to invest – but there is little evidence that it is a big factor in the UK. But Corporation Tax is a very efficient tax, and low interest rates are keeping costs of investment generally low. There is in any case a big time lag between any tax cut and any change to investment behaviour – it will have little effect on whether the country avoids recession this year or next. The question of incentives for income taxes is much less clear – it is a classic essay question for first-year economics students. Lower taxes make work more rewarding increasing the incentive to do more, but also the could reduce the need to work to fund your chosen standard of living. If tax rates are very high (for example, the top rate of 83% current when I was calculating payroll deductions in 1976) the chances are that the former predominates – but the case is much harder to make at current levels. Tax cuts won’t help growth, especially in the short to medium term.

Can Britain afford to borrow more, meaning that it is easier to cut taxes without cutting spending too? The Conservatives promised not to do this in their 2019 manifesto. But Ms Truss suggests that we can get round this by classifying a chunk of debt as “Covid debt” to be paid off over a longer time frame. Mr Sunak says this is nonsense. Running a budget deficit in a country that controls its own currency isn’t necessarily a bad thing – it does not work like a household budget. If there is slack in the rest of the economy it is almost a national duty. And there is the argument that if the markets can’t stomach it, you can simply create the shortfall as money. But this can be inflationary, and there comes a point when the providers of finance insist on lending in other currencies. Britain has not been in anything like this danger zone since the early 1980s, when deficits from nationalised industries caused havoc to government finances. Inflation has made the picture more complicated, and debt levels are historically high (in part thanks to the covid crisis). But Ms Truss is probably right on this one – if you can deal with the arguments on inflation.

And here Ms Truss says the Bank of England can take more of the strain in turning the tide. Indeed she has suggested that the bank is partly to blame for the inflation crisis in the first place. In one of the debates she suggested that the Bank’s mandate should be modelled on that of the Bank of Japan. It is hard to credit this. The only way that the bank can fight inflation is to raise interest rates. This restrains growth – indeed the policy makes no distinction between restraining growth and restraining inflation – it tackles one through the other. From somebody who is suggesting that the problem is a lack of growth this is an extraordinary line to take. Further, the inflation problem has largely been brought about by problems on the supply side of the economy (oil/gas problems, Brexit, covid and a spate of early retirements in the workforce). It is hard to see how higher interest rates would have helped. It is simply a shallow attempt at blame shifting.

But none of the leadership contenders have wanted to confront the economic reality of Britain’s position. Britain’s workforce relative to its total population is shrinking due to demographic changes. Those same changes are placing public services under greater pressure, especially in health and social care. There are no soft spots on public spending – squeezing local authorities and benefits merely puts other services, especially the NHS and police, under yet more pressure. We have cut too much on defence. There is no productivity bonanza that will make public spending more affordable – or to be more precise, improvements in productivity are affecting a shrinking share of the economy, and cannot be expected to provide a get-out-of-jail-free card. All that points to higher taxes, or taking the country down the route of high inflation and currency and debt crises. By suggesting that he will only look at tax cuts once inflation has been dealt with, at least Mr Sunak has one foot on the ground. In the land of the blind, the one-eyed is king.

Funnily enough I have more sympathy with the Tory position than most on the left. Public spending (and taxes) should be subject to continual challenge. It is lazy to shrug our shoulders and suggest that nothing can be done. it is better for people to make their own choices n expenditure. There is a huge challenge in making public services more effective and accountable. But fantasy economics does not help.

Why do people still support Boris Johnson?

Readers of this blog will know that I have never admired Boris Johnson, Britain’s outgoing prime Minister. There are many layers to my dislike. His embrace of Brexit is, of course, a starting point. But his laziness, undermining of trust, indifference to truth and the incoherence of his governing agenda can all be added to this, amongst many other things. He is everything I dislike in a leader. He is not nearly as evil as Vladimir Putin (Mr Johnson was careless with human life in the pandemic, but he did not set out to destroy it in the pursuit of imperialism), and somewhat less evil than Donald Trump (Mr Johnson is not a climate change denier or a racist – and he never quite got as far as wanting to subvert elections) – and there are worse people in British politics, such as Nigel Farage, and one or two of Mr Johnson’s choices for ministers: but nobody worse has made it to British Prime Minister before. And yet a sizeable number of people in Britain regret his passing. This phenomenon needs to be understood.

It is hard to tell how many people remain Johnson supporters. The BBC has taken to the use of vox pop as a journalistic technique – going to different parts of the country to assess how people are reacting to events. As journalism it is quite effective – but as a way of judging what people are really thinking it has little value. The samples of interviewees are not random, and those televised are subject to heavy editing. An opinion poll or focus group it is not. Still the BBC seem to have had little difficulty in finding Boris supporters wherever they go. They seem to be older, middle class and predominantly female (which may reflect who they could find on a high street in office hours…). Some newspapers, like the Daily Mail, think there are enough of them to provide material to bolster their views. But opinion polls and by elections (notably the one in the Tory heartland of Tiverton & Honiton in Devon) demonstrate that Boris supporters are heavily outnumbered by people that share at least some of my views of the man.

All commentators have a tendency to paint caricatures, or archetypes, of types of voter to simplify a complicated picture and provide narrative fluency. I am going to try the the same thing by painting a picture of the sort of person who took to Mr Johnson in 2019, and now feels let down after his ejection from power. It is the lower middle class voter. This person is much despised, by both those from the upper middle classes (like me) and working classes. But they are numerical substantial and often electorally critical. This was clearly understood by Margaret Thatcher and also by Tony Blair – the two most electorally successful politicians of the postwar era – although they used this insight in different ways.

What are the characteristics of this group? Middling educational attainment and a degree of financial security; self-employed in small businesses, or employed in supervisory or middle-management roles. They are important users of universal state services and benefits, and especially the NHS and the state pension – but not targeted interventions to help the more needy. They are anxious to maintain their social status, and worried that their limited financial security could be undermined by inflation, higher taxes or a collapsing property market. There is something of a paradox here: they are quite secure, but their political attitudes are dominated by insecurity. This naturally leads them to conservative views, but not the sort that seeks to cut back universal entitlements. Immigration and ethnic minorities are often a touchstone, though many of them belong to ethnic minorities and have immigrant heritage. They are deeply suspicious of smooth-talking liberal types – but very happy to follow higher class people who seem to share their values. The description “radical” is not rated as a recommendation, as it is for those on the political left.

This, of course, is an oversimplification. There are no hard edges with this group, which includes people who most would regard as working class and upper middle class. Many many who fit the socio-economic description have more liberal attitudes. But the shorthand suits my purpose.

This group was successfully brought on board by the Brexit campaign, though in truth they did not need much convincing. Theresa May saw the group as critical, both to secure heartland Conservative seats in better-off areas, and to switch a lot of Labour seats in the Midlands, north England, and Wales – the “Red Wall”. She failed in 2017, but the strategy was vindicated by Mr Johnson in 2019. Quite how the Red Wall seats switched is open to debate. The normal narrative is that conservative Labour supporters switched. An alternative narrative is that the working class voters stayed at home, giving the opportunity for more motivated middle class voters to carry the day. Another factor was that Mr Johnson did a better job of sweeping in Nigel Farage supporters from fringe parties, such as Ukip, who successfully exploited lower middle class voters.

Mr Johnson has not been universally popular with lower middle class voters since the 2019 election. By and large they were not covid lockdown sceptics, and many were scared of the disease – so the government’s often lacadaisical handling of the pandemic upset many. The misbehaviour of the prime minister’s office during the lockdown will also have been upsetting. On the other hand Mr Johnson has taken care to stay true to these voters – more care than with most things. He has delivered tougher immigration controls. It does not seem to matter that immigration numbers have stayed high – it is clear that tougher controls are inflicting pain on both travellers and businesses – and this shows that the government is serious. The Rwanda deportation scheme was tailor-made to appeal to these voters. Indeed, pretty much all government policies described as “divisive” by government critics are seen by them as their voice being heard for once. They are untroubled by Mr Johnson’s violation of conventions and legalities – which tend to be seen as a conspiracy to keep the liberal elite on top. And unlike Conservative MPs they do not have to live in close proximity to the Prime Minister, so they can be more indulgent of his misbehaviour, and more believing of the lies and denials.

Of course the problem for the Conservatives is that there are not enough Johnson loyalists left. They were never enough of them to win based on their votes alone, and Mr Johnson has badly alienated pretty much everybody else. Mr Johnson’s successor will have the tricky job of reassembling the electoral coalition. But if these lower middle class voters stay at home in numbers, or are tempted to vote for fringe parties again, the Conservative Party stands little chance of winning the next general election. Which is why liberal voters can expect little relief from the new regime.

Can the monarchy cope with modern politics?

Bonfire consumes Isfield’s Jubilee beacon, 2 June 2022

The Queen’s Platinum Jubilee has been a happy event in our East Sussex village. On Thursday evening we lit a beacon, and then, this being East Sussex, we burnt it in a bonfire. On Friday afternoon we had a lovely street party. Today it was the village fete, where I won a bottle of whisky in the raffle. There is also a treasure hunt and a scarecrow competition.Everybody was in the mood for a celebration.

But what are we celebrating? Nominally it is Queen Elizabeth II’s remarkable achievement of reigning as monarch for 70 years. And she certainly commands a lot of respect and affection among the villagers here. Most of the bunting features patriotic union jacks. But for many it more of a question of “any excuse for a party”, especially after two years when local events and activities have been badly disrupted. In the grim days of 2020 (when we moved into the village), it was a common sentiment that we should have a big party when it was all over. It isn’t really all over, but for many this is the party. The theme of a number of the scarecrows (which are meant to reflect aspects of the Queen’s reign) were the heroes of the pandemic. Other than that it is mainly pop stars; the Yellow Submarine won.

We haven’t been watching the national events on television, beyond summaries on the news. But that, and the BBC radio coverage, was bad enough. The thing I most hate about monarchy is the obsequiousness that surrounds it. And the BBC, along with many others, is laying it on by the shovel load. This is an ancient tradition, though. The obsequiousness doubtless goes back to our Anglo-Saxon kings of the Dark Ages, and perhaps the Celtic chieftains that preceded them, and it unites them with Persian and Chinese Emperors, Russian Tsars and Thai kings. The strange thing about our monarchy is that the tradition of obsequiousness has outlasted the political power that the institution wields. It makes me yearn for a republic – though that does not always solve that particular problem.

It is a moment to reflect on the institution. The British seem to be quite pragmatic about it. The reason usually offered in the monarchy’s defence, given that few accept that it is divine will, is that it works. Britain has a long-standing and functioning democracy. The monarchy has been part of the web of institutions that has upheld it. It is not obvious to most that republics manage these things any better; the country’s one attempt at being a republic in the 17th century is usually regarded as a failure. Meanwhile all the pomp adds a certain dignity to proceedings. It is surprising how often people justify it on the basis that it is a tourist attraction.

But does it work really? The overwhelming impression of the institution’s standing is one of political weakness. Its actions are dictated by a series of written and unwritten conventions which are designed to keep the institution away from any kind of political controversy. According to Netflix’s highly engaging drama The Crown, the institution has an enduring horror of Edward VIII, the uncrowned monarch of 1936, and Elizabeth’s uncle, who nearly destroyed it. Edward saw a more dynamic leadership role for the monarchy, which included a distinct sympathy for fascism. This drama does suggest that the Queen was a bulwark against any kind of undemocratic coup, even if led by aristocracy and institutionally embedded types. Just how close the country has ever been to such a coup I don’t know, though.

There is something to be said for a weak titular head of any institution. The French and American model of combining the role with that of chief executive is not obviously better, as the role becomes too strong, reminding us of what we dislike about the old political monarchies. Then the obsequiousness was driven by real fear, along with ambition. But if the titular head becomes too weak, there is too little check on the chief executive role – which politically in Britain is that of the prime minister.

This matters more than it might in Britain because the other checks on the prime minister are so weak. Nominally he or she is the creature of a democratically elected parliament. And this is true up to a point. Right now our prime minster is running scared of his Conservative Party backbenchers, who may even be able to oust him from power. But this drama reveals something rather worrying. Constitutional checks on the executive can depend on the internal rules of political parties – which lack proper democratic validation. And there are times when the prime minister has complete mastery over their party. And then there are very few other checks on their power at all.

We had a rather scary reminder about this in the period from 2017 to 2019 when the Conservatives did not have a parliamentary majority. At first Theresa May cobbled together an agreement with the Democratic Unionist Party of Northern Ireland (the DUP), and secured a parliamentary majority – the country’s principal means of democratic validation. But, as relations with the DUP proved rocky, and rebellious factions emerged within the Conservatives, Mrs May’s government relied less and less on parliamentary validation. The parliamentary session was prolonged so as to avoid the necessity of a Queen’s Speech, and endorsement of the premiership. The government relied increasingly on executive powers without consulting parliament. Finally Mrs May’s position became untenable and she resigned as Conservative leader. She continued to be prime minister while the party chose a new leader, and then resigned from that office once Boris Johnson was chosen as her successor. She then advised the Queen to appoint Mr Johnson as prime minister, and the Queen complied. What is so wrong with that? Mr Johnson did not command a parliamentary majority, and he had only be chosen on the basis of his party’s internal leadership election process. Mr Johnson then assumed all the massive executive powers of the British state without ever asking parliament to validate his authority. In fact he went to extremes in order to avoid such a validation. In the end he asked for parliament to be suspended so that he could govern without democratic interference, based on the thinnest veneer of a pretext. It was not the Queen that stopped him. It was the Supreme Court. The Court has since been attacked for standing in the way of the will of the people – when its actions were actually based on the opposite notion – that of forcing the government to be accountable. And yet I have heard few people try to defend the Court. Mr Johnson’s version of history risks being accepted by default.

And then there is the elephant in the room. Parliament’s claim to represent the will of the people is a weak one. The electoral system means that governments are usually elected based on a minority of votes. Well perhaps what counts is whether the system used has broad popular consent, and people abide by the results. That is mostly true, with the important exception of Scotland. But how long will this continue? What puts the system at risk is political polarisation. Then parties want to win elections by any means necessary, and then use that power to implement an ideological programme – ignoring the idea of broad political consent, upon which a system such as Britain’s depends for democratic legitimacy. Once that happens there are few institutional checks on the executive – and certainly not the monarchy. And it does not even need a majority of voters to achieve such a result.

That is certainly true of the Conservatives under Mr Johnson. The party’s leaders actively seek “wedge issues” to divide the country and motivate its supporters. It was true of Labour too under the leadership of Jeremy Corbyn. Its new leader, Sir Keir Starmer, is taking it in the opposite direction, of being an un-ideological party of broad consent. The party that he leads is less sure that this is the right course, having 9in their eyes) come so close to success under Mr Corbyn. Polarisation has already deeply infected the politics of America. France seems dangerously close to it too. An elected head of state, separate from the executive, might act as a check on an overly divisive executive. In 2019 tan elected president might have been able to insist that the prime minister secure a parliamentary mandate or see if somebody else could, and failing that, call an election. That would have been the democratically proper way to proceed.

But then a small voice suggests something else to me. Perhaps the monarchy is helping the country avoid polarisation. The Jubilee celebrations are striking for for the way they are bringing Britons together. Diversity is celebrated. Perhaps the country is stepping back from polarisation after the nightmare of the Brexit years. The Labour Party has become more popular with the country at large after Sir Keir’s change of direction, even if few have enthusiasm for it. Mr Johnson’s wedge issues are failing to get traction. If the monarchy has a single message, it is that we should all get along together as a country (and also to get on better with other countries too).

In that perhaps the institution is a beacon of hope. Let us hope it is not consumed by the bonfire of party politics.

Tackling the inflation crisis will require a change in the political narrative

The picture shows my rubbish bin last Thursday, our normal collection day. It had four weeks of rubbish in it, and was put out more in hope than expectation that it would be collected by the limited service in operation. It wasn’t. Our bin men have been on strike for a month, with no sign of a settlement in sight. It is just one facet of the inflation crisis that is engulfing Britain, and much of the rest of the world too. It has now reached the top of the political agenda. But just what can, and should, politicians do?

When I last posted on this, I contrasted two forms of inflation. One is a degradation in the value of the currency – the process of the prices of things generally going up, without relative prices between different things changing (and especially between consumer prices and wages). The other is a process of the economy reaching a new reality, typically because supply difficulties are reducing the standard of living. If the supply of oil, for example, is substantially reduced, and its price rises as a result, we have to consume less. Assuming that there are no cheap substitutes, then there is nothing that will stop society being poorer. How society should respond to either sort of inflation is different. In principle, the first can be stopped by processes of economic management (though whether it should be, or at what level, is another matter). Responding to the second sort is a question of distributing the pain – nothing will stop us being poorer, in the short term at least. Of course the second sort of inflation often leads to the first – if people respond by trying to avoid pain altogether by raising wages and benefits across the board. That is how the inflation crisis of the 1970s got going.

The inflation that is hitting Britain is mainly the second sort – prices rising as a matter of economic adjustment. This is driven mainly by three things: increased trading and labour costs as a result of Brexit (counting changed immigration patterns as part of that process, and the reduced availability of cheap labour – though some of that may well have happened without Brexit); the disruption of supply chains following the covid pandemic; and the war in Ukraine, and especially its impact on hydrocarbons, to be followed by its impact on foodstuffs. In the short term the question for public policy is how the pain can be shared equitably. Trying to escape the pain through increased wages and government handouts will simply stoke up the second sort of inflation.

This is not easy territory to pick through for public policy. The first question is whether inflation is an evil at all, or when. Many economists don’t feel that it should be, up to a point. Inflation makes it easier to make adjustments to relative prices (and especially reducing wages compared to consumer prices), and it also allows the possibility of negative real interest rates, reducing the possibility of a zero-bound trap. This idea weighs heavily on theoretical macroeconomists – the idea being that the lower limit on nominal interest rates is zero – which means that it is possible that interest rates can’t be eased when they should be – causing a recession. When I was an economics student in the mid-noughties I read lengthy discussions led by liberal economists such as Paul Krugman suggesting that Japan was caught in just such a trap and that it should implement radical policies to raise its inflation rate (some of mr Krugman’s ideas on how to do this were quite barmy). I have never been comfortable with this. The public does not share this equanimity with regard to inflation. To them the currency is a sacred bond of trust between the citizen and the government. The citizen trusts their savings to the financial system so that they can be used for investment; the government ensures that the currency maintains its value so that the citizen can spend the money later. Inflation is theft by complacent ruling elites – a transfer of wealth from honest savers to devious borrowers. Liberal economists tend to completely underestimate this sentiment, and the idea that inflation corrodes trust in the system of government. The popularity of the euro, for example, in France and Italy is reflection of this. Populist politicians who seek to take their countries out of the euro find that it is a sort of political third rail. Marine Le Pen and Matteo Salvini have both been frazzled on this. Liberal economists tend to think that the euro is an affront to sensible economic management, but to many it has restored their faith in money and civic governance.

So politicians need to take inflation seriously. But that leaves a conundrum. The two main methods of squeezing it out of the system are also unpopular. The first is holding back wages. That stops prices spiralling, allowing inflationary shocks to work their way through quickly. The second is raising interest rates. This should reduce borrowing and investment, deflating the economy and reducing the pressure on both consumer prices and wages. Raising interest rates can be popular with a certain class of conservative savers – but it also tends to dent property prices and cause unemployment, which give a sense of economic mismanagement. A third method of dealing with inflation is less talked of: increasing taxes to reduce the level of consumption. This faces some fairly obvious problems when used on consumption taxes such as VAT – as it just raises prices further; income taxes are more equitable, but hardly a popular alternative.

The British government has some things going for it when it comes to overcoming the inflation surge. The first is that wages are so far lagging consumer prices: by 7% compared to 9%. Moreover a lot of the 7% reflects one-off bonuses. The second thing is that tax rises are crimping people on middle and higher incomes, which in principle should reduce demand. National Insurance rates have gone up and the threshold for higher rate tax has been frozen, creating a fiscal drag effect. This should give the government some scope for alleviating hardship without raising demand excessively. There are three things the government needs to think about doing.

The first is raising benefits for the least well off. The inflation adjustments made to benefits was based on numbers prior to the main surge, and so are inadequate to meed the increased energy and food costs, never mind all the other costs that are going up. The most obvious thing to do is to raise Universal Credit, for which there is a precedent during the covid crisis. This would be costly, but it would also be the best targeted measure that they could devise. There are other benefits complementary to UC, which, apparently, are technically harder to increase. But it is hard to take this seriously as a reason not to act. The basic state pension is also another place to look. The government, however, is very reluctant to commit to serious increases here. The reason may be political – the recipients of these benefits are unlikely to be Conservative supporters (except the state pension). Instead the government has been looking at other benefits, and committing much less money than these measures would require. The rumours are that something is in the works.

The second issue is public sector pay. According to the ONS this has been increasing at the rate of only 1.2%. The government has raised the minimum wage by 6.6%, but otherwise is wants to keep public sector wages down. This would certainly serve to keep demand pegged – but just how realistic is it? My bin men aren’t the first to go on strike – and neighbouring local authorities have been forced to pay a lot more than they had planned. And they are still on strike after being offered an increase this year of “up to 17%” and parity with workers from neighbouring councils. Rail strikes are threatened. There is a staffing crisis in the NHS. If private sector pay is allowed to shoot ahead of that in public sector, there will be recruitment and retention issues. It is not hard to see serious trouble ahead.

The third issue is levying a windfall tax on oil and gas producers, who are making massive profits, and maybe other energy providers too. Economically this is something of a sideshow. A tax would not affect levels of consumption in the economy by much at all. Still, it is useful political theatre and reduces the pressure on national debt – though just how important this is remains hotly debated. The government is reluctant to do this, though the reasons offered look pretty weak – at least as far as the major public companies are concerned. Apparently the government is now trying to link such a tax to levels of investment. That is a theoretically sensible approach, but hard in practice.

Meanwhile the government, and many of its MPs, hope that they can cut income tax before the next general election, likely to in the autumn of 2023, or the following spring. This looks like a neoliberal delusion – a failure to understand the inevitable rise in the scale of government spending in the face of demographic and other pressures. Still, that delusion still seems to have powerful followers.

But the real hot potato is wages. Inflation the moment is primarily caused by supply disruptions that make us poorer. The more we try to keep levels of pay rising at the same pace as consumer prices, the longer the inflation crisis will persist. The biggest headache is in the private sector. The government has little influence over this, but the more pay rises there, the worse the pressure will be on the public sector. This is shaped by the zeitgeist. And here the narrative from the government – and other politicians – is muddled. There are no grave messages that the country is being hit hard by a number of things outside its control, and that we must grit our teeth to get through it. Instead the government wants to portray the economy as in fine fettle, and also that we should expect wages to rise as we move to high-wage high-productivity post-Brexit economy. Government politicians don’t want to admit that the economy is in fact in trouble. The opposition wants to suggest that it is all the result of incompetence that can be put right quickly with a transfer of power. They doubtless hope that the pressures will have eased by the time this transfer takes place.

So my guess is that inflation will persist. Public sector strikes will multiply, and interest rates will start to rise much more rapidly that the mainly token changes we have seen so far. Avoiding this will require strong political leadership of the type we are unlikely to get from anywhere.

An economic storm is coming – could this favour the Lib Dems?

Image: Whoisjohngalt, CC BY-SA 4.0 https://creativecommons.org/licenses/by-sa/4.0, via Wikimedia Commons

A bull market ends when the last bear has been beaten into submission. It felt that way last autumn. In 2020 I was astonished when, after an initial fall in response to the emerging covid crisis, financial markets bounced back and then became positively buoyant. How was this a rational response to the the catastrophe enveloping the world? But the bull market just went on.

Then last autumn I started to read articles suggesting that investors must fundamentally re-evaluate asset prices upwards. The argument was based on the idea that interest rates were fundamentally lower than historically, so we shouldn’t be using historical comparisons of yield and other such ratios, which were pointing to over-valuation. This felt a lot like the last bear caving in. There was certainly something crazy about financial markets at the time – shown not least by the craze for crypto-currencies. All this was reminiscent of the insane world of the tech bubble at the end of the 1990s. Loss is the new profit, and so on.

There is something very odd about the way the interest rate argument is used to justify high valuations. The logic is superficially soound. Anybody with a training in finance is familiar with valuation models based on a discount rate – which is the rate you should receive by investing your money in a zero-risk alternative. The lower the discount rate, the higher the valuation. But lower interest rates also suggest low rates of return on investing your money. So how is that investors get richer when returns fall? Common sense would suggest that a world in which the risk-free rate of return on investment is near zero (or negative after inflation) is one that is going to hell in a handcart. Something, somewhere is not making sense. In fact we should be expecting profits and rental incomes to stagnate or fall, and this should undermine valuations.

But asset prices are not set by the use of logically rigorous financial models. They are set by the laws of supply and demand. The modern economy is generating a lot of funds for investment, but there is an unwillingness for investors to use this for good old-fashioned projects that might generate a cash surplus at a future date. That leaves too much money sloshing around in bank accounts or low risk assets such as government bonds. That keeps low-risk returns down, and it also means that banks are willing to loan money at low rates of return. This generates demand for assets that might generate a return at expense of risk (though still not those boring real-economy projects, apparently). This does not necessarily lead to an asset-price bubble: investors could just be more patient. But it clearly has.

Central banks can do something to restore order by pushing commercial banks to raise interest rates, in their role as their regulator and the banker’s banker. For the last three decades they have chosen not to, using various arguments either to deny that there is a bubble, or to say that it isn’t their job to act against it – instead focusing on consumer price inflation and unemployment. It is difficult theoretical terrain, but it is hard not to see politics and the vested interests of the finance industry behind this.

What bursts bubbles? It is when the funds dry up and more people want to sell riskier assets than buy them, while demand often exceeds supply of less risky assets, causing a scramble. This is usually the result of chickens coming home to roost – high risk investments carry a high risk, after all. The great financial crisis (GFC) of 2007-09 was started by defaults in the US property market. It doesn’t help that in the modern world “funds” is a fluid thing and not the movement of fixed quantities of money as we might intuitively expect. This gives scope for chain reactions that can be global in reach. In the GFC this was truly spectacular and served to expand a minor crisis in US sub-prime real estate into a global banking catastrophe. That was the result of uncontrolled financial engineering across developed economies in the previous decade. There was something of a Ponzi scheme collapsing – but to this day supporters of Britain’s Labour government, which was an active supporter of the country’s role in building the Ponzi scheme (aka world-class financial innovation), insist it was nothing to do with them because it was all about US real estate.

The asset price bubble is clearly bursting now. The proximate cause is inflation, causde by widespread disruption to the supply side of the economy – which I discussed last week. Amongst other effects this is causing central banks to radically change course. Interest rates are starting to go up – though not by very much so far, given the levels of inflation. Perhaps more immediately threatening to markets is that Quantitive Easing (the central banks buying up bonds to keep long term interest rates low) is now moving into reverse. This upsets the balance of supply and demand in asset markets. Meanwhile the convergence of disasters affecting economic supply, from the war in Ukraine to covid in China, are clearly destined to make the world poorer, and this affects how people value assets.

The burning question is just how big will this financial crisis get, and what will its consequences be? I will focus on the UK – as we may find that things unfold quite differently in different countries. On the one hand the financial system is not as dangerously wound up on itself as it was during the GFC, limiting the chain reaction. The world banking system does not look in imminent danger. On the other hand, the outbreak of inflation knocks away one of the props upon which the financial system has been based for 30 years or so – the prospect of ever-lower nominal interest rates. This suggests that the crisis will be slower but longer-lasting. The most sensitive part of this is house prices. In the GFC prices dived rapidly as the financial system froze over and it became very hard to arrange mortgage finance. But conditions quickly eased, and prices bounded back. This time it looks as if nominal interest rates will rise steadily and may well stay up. This will impact new mortgages rather than existing ones, as most mortgages these days are fixed rate. So prices are likely to decline more slowly, but the effect could last longer. It is hard to tell about the wider economy. It depends n the state of business finances. If a harsher financial environment causes widespread bankruptcies, we could experience a significant recession. Otherwise things will be much slower moving and the economy will experience a long period of doldrums.

What will the political impact of these be? The accepted story of politics since the GFC is that the crisis provoked a backlash against metropolitan elites, which were seen as having caused the crisis and escaped its worst impact. It was the political right which managed to exploit this the best, with the rise of populist policies. In Britain this focused on Brexit. The Conservatives were the ultimate beneficiaries. Politically the old liberal elites have taken a pounding, though, and they are not such an obvious target for a backlash. An obvious culprit for the trouble is Brexit but the main opposition parties, Labour and the Lib Dems, are reluctant to invoke the B-word. Their sense is that Britons (especially the English) are reluctant to re-enter the polarisation and political warfare set off by the referendum in 2016. They were accused of trying to overturn a democratically fair decision, and many politicians in these parties have taken this message on board. Anyway, both parties want to win back voters who supported Brexit, as well as those who do not want to reopen the wounds.

But as yet I do not see a clear alternative line of attack. What should the government be doing to face the crisis that it is not? It is not obvious to the public whether the answer is more or less austerity. Swing voters tend not to been drawing non-pension benefits, which look inadequate. As yet there does not seem to be a tide of anger about the failure of the state pension to keep up with inflation. Immigration has failed to present as a burning concern to most. The opposition has to content itself with complaining that the government is incompetent and out of touch. But the public has to be convinced that they would do a better job.

But the point is that public anger is likely to gather pace, and it will attach itself to something – but we don’t know what yet. Where will angry, property-owning former Tory supporters go? Labour has not been positioning themselves for these voters since the departure of Tony Blair in 2007; it may forgotten how to. This could yet be a propitious moment for Lib Dems, who are increasingly focusing on this demographic. They have been courting these voters in by elections and local elections, with some spectacular successes. It is early days. No clear national narrative is emerging from the party. But it is too early for that. They need to understand how resentment at failing house prices and a stagnant economy translates into specific demands. But for the first time in a long time, the period the party spent in coalition with the Conservatives in 2010-15 might be an asset. From the vantage point of 2022, with some selective memory, many Tory voters might remember this as a golden age.