Politics UK – Page 52 – thinking liberal

Capitalism, crony capitalism and neoliberalism. What’s in a word?

Are the Occupy protesters on to something? Or is theirs just a hopeless battle against abstract nouns?

I have been rather exercised about some abstract nouns recently. First was the word “Neoliberalism” selected by Simon Titley of the Liberator as one of three Bad Ideas to have infected British politics over the last 30 years, sweeping along the Liberal Democrat leadership with the rest of the mainstream. The other ideas were the “Westminster Bubble” (the idea promoted by a lazy media that only ideas that have taken hold in Westminster matter), and that the Westminster elite have a monopoly of political wisdom (expressed by contempt both for grassroots activists). Neoliberalism had a starring role in the previous month’s Liberator when Mr Titley and David Boyle roped it into their narrative of what went wrong with British politics in their article “Really Facing the Future”. Mr Titley felt he had written enough already on the subject to explain what he meant by neoliberalism – unfortunately before I have been subscribing to Liberator.

Another tiresome abstract noun has been even more prominent: “Capitalism”. This has been the main target of Occupy. It was recently brought into further focus by Tory MP Jesse Norman in an FT article based on his pamphlet “The Case for Real Capitalism“. This pamphlet is not a particularly coherent or convincing piece of work, though to be fair he does say that a longer, and presumably better argued, version is in preparation. But by harnessing a couple of qualifiers (“crony” and “good”) he tries to make sense of capitalism, and brings neoliberalism into the picture too. It’s good place to start a probe into whether these words have any useful purpose.

In Mr Norman’s picture the world has been suffering from “crony capitalism”. He identifies various strands (e.g. “narco-capitalism”, taking it well beyond what I would call “crony” capitalism, which should really involve cronyism – business leaders being too close to political leaders. Still he does offer a workable definition of bad capitalism:

Crony capitalism is what happens when the constraints of law and markets and culture cease to be effective. Entrepreneurship and value creation are replaced by rent-seeking, and certain groups become enormously wealthy without taking risk. These factors in turn lead to long-term economic underperformance, and sometimes to social unrest.

Apart from the use of “crony” and the economics jargon of “economic rent” (which means profits accruing to a business over and above the opportunity costs of inputs) this is quite useful. Something that is recognisably capitalism – an economy based mainly on private enterprise – can look like this, and when it does, it is bad. But capitalism doesn’t have to be this way – hence Mr Norman’s employment of “good capitalism”. This version emphasises the need for free competition and the consistent application of the rule of law. But that by itself is not enough.

Mr Norman contrasts “good capitalism” with our friend “neoliberalism”, which does not have a moral dimension. Like Mr Titley, he does not bother to define neoliberalism. But from context I can identify it with what the FT writer and economist John Kay called “the American Business Model” in his 2002 book The Truth about Markets which was part of my Christmas reading. This elevates the simplifying assumptions of classical economics (rational behaviour, consistent and stable preferences, perfect competition, and so on) into a moral value system. In particular it idealises a ruthless focus on maximising personal gain in the framework of impartially enforced rules (property rights in particular). This way of thinking remains very popular in America, with the Chicago School giving it considerable intellectual heft. But it has never taken off in Europe, and Britain is very much part of Europe on this issue, as in so much else. The emphasis on personal gain – greed – and antipathy to social solidarity are too much for all but a lunatic fringe to accept. And that includes Conservatives like Mr Norman. Good capitalism has a moral dimension – and one that celebrates the virtues of hard work and social responsibility.

Meanwhile the use of “neoliberalism” on the British left (including Mr Titley) clearly does not conform to the definition that Mr Norman uses. Within its scope are swept Margaret Thatcher, Tony Blair, Gordon Brown and the “Orange Book” Liberal Democrats such as Nick Clegg. But none of these are or were Chicago School types. Apart from Mrs Thatcher, maybe, all see a huge role for government in our society and would expand its remit. But they have criticised the way producer interests have captured public services, profoundly undermining its quality.

Another issue needs to be mentioned here: and that is financial explosion in the UK and US that occurred in the period 1997-2007, and which ended so badly in the current crisis. This is closely associated with greed in the public’s minds, of bankers mainly, but also chief executives and (whisper it) all those ordinary members of the public that racked up credit card and mortgage debt. This is swept into the general idea of “capitalism” and “neoliberalism”. And indeed neoliberal ideas were used to justify the behaviour of many of the more egregious participants. But true believers in neoliberalism have little difficulty in shrugging such criticism off. To them what caused the crisis was excessive government intervention (e.g. by encouraging subprime lending in the US) and the failure to uphold proper open markets (through the implicit government guarantee of banking activities, for example).

All of which renders the words “capitalism” and “neoliberalism” as useless abstract nouns. There is little consistency in their use between the different political factions; their use by one faction is misunderstood by the other in an endless cycle of talking at cross purposes. The Occupy movement seems particularly bad at this.

To make headway in the political debate we need to move on from the abstract to the practical. What is the best way of providing health and education services? What should the scope be of social insurance? How can we get private businesses to invest more in the future and distribute their profits (or economic rents if you prefer) more equitably?

Religion, morals and the flight from rigorous thought

Last Friday David Cameron, the Prime Minister, gave a speech on the 400th anniversary of the King James Bible, which got a sprinkling of coverage in the weekend press. In it he sought the help of Christianity and church leaders in helping to restore the country’s lost moral values, as evidenced by the summer riots, and Banking and MP’s expenses scandals.

My point isn’t to criticise this speech – I just don’t know where to begin – but to ask what such a speech says about modern politics. In terms of intellectual rigour it wasn’t even trying. But many people, and especially those of conservative instinct, will agree with its sentiments. A nostalgia for higher moral values in the past; linking the country’s identity to the Christian faith; the feeling that s stronger standing of religious faith amongst other people will improve the country’s way of life. The speech was no attempt to lead public opinion; it was following it. Some commentators pointed out the political conventional wisdom against “doing God” – but this was not doing God, it was doing a warm fuzzy glow around the idea of religious faith and moral values. As such it has not damaged Mr Cameron’s standing.

Such lack of acuity in a senior political leader is something relatively new in Britain, I think. It brings to mind Roy Jenkins’s remark about Tony Blair, in many way Mr Cameron’s role model, that he was “not a First Class intellect”. Very clever, but I bit fuzzy. It is impossible to imagine William Gladstone producing a speech like this one, or Margaret Thatcher, come to that.

This is a matter for regret. Surely our political leadership should aspire to, well, leadership? – and try seriously to argue their cause and persuade the country about their vision for the way forward. Even people who do not agree might see the force of the logic. Instead we get a few half-baked ideas designed appeal to supporters’ prejudices.

And as for improving the standards of behaviour on our estates and boardrooms alike, this is just hot air. Bad behaviour in these places, or their ancient equivalents, is absolutely nothing new, and does not correlate to a lack of religious standards – it has been known to permeate religious establishments. And high moral standards have been the excuse for the infliction of much cruelty and injustice (think of the treatment that used to be meted out to unmarried mothers) in a way that, ironically, contradicts what Jesus Christ himself taught. Religions don’t offer clear moral guidance, they offer a menu from which adherents pick and choose, and then claim the authority of heaven (think of the 9/11 bombers, West Bank settlers, Apartheid Boars, and so on).

Behaviour is a real enough problem. But our Prime Minister just leads a national whinge. He should aspire to more.

Is this the Eurosceptics’ Moscow moment?

Nearly 200 years ago, in September 1812, Napoleon reached the maximum limit of his nominal power when he entered Moscow with his army drawn from right across Europe. His empire covered France, Germany, Poland, Italy, much of Spain (his lieutenants were in the process of driving back an advance by Anglo-Spanish forces that had temporarily liberated Madrid) and now much of Russia, including its Asiatic capital. But he could not hold it; by the year’s end he had been forced to abandon Russia altogether, his army destroyed, and he was completely crushed within a year and a half. For the Russians 1812 had proved a time of incessant retreat, as they avoided battle until just before Moscow (at Borodino), where they lost and were forced to abandon Moscow without a fight, but ultimately a year of triumph.

Is this a fair metaphor for the British Eurosceptics in their moment of victory at the British veto at last week’s EU summit? Certainly their triumphalism is unbearable. Bill Cash was described by one of our outraged local Lib Dem members as “the cat that got the cream.” This follows one long process of retreat by British Europhiles as they conceded the political initiative to the sceptics, practically without a fight, time and again.

But the initial reaction of leading Lib Dems was strangely sanguine. Nick Clegg was initially quite supportive of David Cameron. On Friday night the deputy parliamentary leader, Simon Hughes, painted a positive picture to party members at a social event which I was attending. Mr Clegg has changed his tune today, of course. Whether that is because of the sceptics’ reaction, or because further details of what actually happened at the summit have emerged (for a flavour of this read the Economist’s Bagehot blog) I cannot say.

But the initial relief at the summit result shown by Mr Hughes has some logic behind it. A treaty would have required ratification by the UK parliament, and demand for a referendum. This sort of battle plays to the sceptics’ strengths – strong support by the press and a widespread wariness of extra EU power. A referendum on a treaty change is the battle the europhiles least want to fight. The sceptics can deploy a “have your cake and eat it” argument for a no vote – a vote not against the Union as such, but to protest against “Brussels”. There will be no such battles now. If there is a referendum it will be about whether we stay in the EU at all.

Instead the sceptics’ position might start to come under the sort of scrutiny that it has hitherto lacked, and be shown to be no more tenable than Napoleon’s hold on Moscow. The summit has started that exposure process. The sceptics’ armchair negotiators have said that we can use the British veto to negotiate major concessions, the “repatriation of powers”; but Mr Cameron proved unable to do this. It has also been said that we were not isolated in the EU, and we could lead a gang of pro-market non-Euro members. This against has been shown to be a hollow idea, as Germany has greater influence over these potential allies than we do. Indeed a horrible spectre emerges, that the British blocking tactics make many of the EU’s institutions irrelevant while the other countries set up alternatives over which the British have no say. The sceptics often complain about Britain shackling its fortunes to a corpse – but the corpse could be the official EU structures, rather than the European project itself…and that would be an outcome entirely of our own making.

And further eurosceptic fantasies will soon be exposed. Their aim is to set up some sort of free-rider relationship to the Union, where British products enjoy free access without to European markets without our businesses having to comply with those pesky social regulations. Some think the country can do this within the EU, using opt-outs, others that it can be done outside it, in the European Economic area (like Norway, Iceland and Switzerland). But this requires the other 26 countries to agree with it. All of them. Why should they?

Just as the Eurozone optimists are having their ideas tested to destruction in a gruelling series of financial crises, so the eurosceptics might find themselves on the wrong side of the argument. In both cases it is clear that the only tolerable escape route involves further European integration, not less. Perhaps, like Napoleon’s collapse in 1812, it will happen quicker than we think.

The difficult truth about payday loans

The top story on the BBC Today programme this morning was about the expansion of so called “payday loans”, drawing attention to the shockingly high interest rates such loans entail (1,700% APR is typical). This was hooked onto some research by insolvency group R3, which thereby got massive free publicity (Christmas came early for some PR person); the BBC web story is here. Even the sober Financial Times runs the headline “‘Legal loan sharks’ target urban poor“. This coverage makes me very uncomfortable. Time and again middle-class do-gooders and commentators fail to understand the grim economics of being poor – and their interventions usually make things worse.

What are payday loans? They are short-term loans (less than a month) for smallish amounts (typically £100s). The timing and amount is related to typical paydays, hence the name. Looking at moneysupermarket.com the typical charge is £25 for a one month loan of £100. They are provided by in a reasonably transparent way by public companies, rather than in the informal economy.

How to think about this? When providing financial products (similar logic applies to savings savings) it is easiest to think about three components. The cost of the money; the risk of default; and the labour input. The first two are well understood by everybody, and are directly proportional to the amount and length of time borrowed or saved, and can be understood as a rate of interest. The third is usually ignored, because if your are well-off it doesn’t amount to very much in the scheme of things. Labour input is the cost of actually providing the product (including distribution, admin, computers, and the rest); it is not proportionate to the value of the product, but to its structure, the number of transactions, and so on. If you are dealing in millions of pounds it is negligible; but if you are borrowing (or saving) the odd £100 it is not. £25 is a massive rate of interest for a £100 borrowing, but a run of the mill cost of labour input for a single transaction. If you don’t have much money labour input is highly significant; it destroys your savings and ratchets up the cost of borrowing.

If the loan is genuinely short-term then it doesn’t look unreasonable, in fact. What are the alternatives? An unauthorised overdraft at your bank will cost way more than this, since British Banks have lighted on this as a way of cross-subsidising “free” banking. And forget trying to get an authorised overdraft, which might well come with an arrangement fee, etc. And it is a much better deal than the real loan sharks in the informal economy. Credit cards (if you can get one) may be a better deal if you are careful. In fact you could look at payday loans as welcome competition in the lending market.

Much of the criticism of this type of product centres on people who use this type of finance for longer term needs, rolling over each month. This is a very bad idea and leads to even worse hardship, but is really right to ban this sort of product on the basis that it can be misused? Cars kill hundreds (even thousands) of people each year, but this doesn’t mean we stop the public from driving them. Much of the criticism is unbearably patronising.

There are two things we must learn from this. First is that finance for the poor is more about transaction costs than interest rates and rates of return. Longer term borrowing can be extortionately expensive; savings, including most pension plans, deliver much lower returns than those for better off people. It’s part of the poverty trap that is not widely recognised. And it’s one of the reasons why the welfare state is so important in developed societies.

And the second thing is that it is vital for everybody, and especially those on lower incomes, to understand finance much better. School teaching on “financial capability” is essential. Everybody needs to be numerate.

But well-meaning regulation, such as that which has pursued payday lenders in the United States, is a likely to make matters worse. You can’t legislate away the laws of physics.

George Osborne, Ed Balls and the confidence fairy

Paul Krugman, the economics Nobel laureate and New York Times columnist, likes to talk of the “confidence fairy”. It is a critique of right-wing “supply side” economists, who advocate cutting back on taxes and public expenditure and reducing government regulation. These counter the criticism that such policies suck demand out of the economy and cause unemployment with the idea that confidence in the soundness of the government’s policies would boost business investment and consumption, and so create jobs. But such beliefs have no more substance that a belief in fairies.

Mr Krugman believes in solid government management of aggregate demand of a type that is often called “Keynesianism”. He was bitterly critical of the Obama government for not trying to enact a much bigger stimulus programme in 2008, at a time when the usual criticism was that he was spending to much. These same arguments are emerging in the UK between the Chancellor of the Exchequer George Osborne and his Labour Shadow Ed Balls.

To be fair, Mr Osborne and his supporters, especially the Lib Dem ones, never made much use of the confidence fairy in the sense that Professor Krugman uses it. The confidence they that they had in mind in supporting austerity was that of investors in government bonds, and the scary consequences of losing it. But ultimately Mr Osborne does believe that business and consumer confidence will provide the economic growth and employment he seeks. But what fewer people understand is that the policies advocated by Mr Balls and Professor Krugman require the confidence fairy too.

Let us consider the logic of the “Keynesian” stimulus. Cut VAT as Mr Balls suggests and put this money in consumers’ pockets, who go out and spend it, creating jobs, which create further demand. The Keynesian multiplier (no need for quotation marks here) does its stuff and £10bn of government stimulus might increase total demand in the economy by perhaps £20bn in a year. But then what? The extra demand has helped offset the cost (so the £10bn direct cost has been reduced to perhaps £6bn), but the national debt has still gone up. But growth drops back to zero (or worse) unless there is yet another stimulus package of yet more tax cuts or government spending programmes. To the extent that these measures are temporary (such as the temporary tax cuts advocated by Mr Balls, or the job programmes and extensions to unemployment benefit favoured by Professor Krugman) then the whole process goes into reverse, multiplier and all. And if the programmes aren’t temporary, the government structural deficit has just got a lot bigger. Unless the confidence fairy waves her magic wand.

And it is this boost in confidence that lies behind the case for government stimulus. It is reinforced by the metaphors used to describe it, such as “kick-start”, “getting the economy moving” or the word “stimulus” itself. A catalyst that improves confidence and hence gets businesses to invest and consumers spending more and saving less. And the results would indeed be magical. By spending and borrowing more you would reduce borrowings in the medium term by more than a strategy based on austerity. But without the fairy it works no more than the supply-side policies do. The problem is deferred and made worse, not solved.

So can such a stimulus boost confidence? In the right circumstances it certainly could, such as those induced by a temporary external shock, perhaps literally as in an earthquake (one of the reasons why earthquakes seem to do such little damage to an advanced economy). And here there is a genuine divergence of view. Mr Balls, who perfectly literate economically, does not believe that the British economy pre crisis was fundamentally unsustainable, and so thinks that it should be relatively easy to recover the lost ground. In economist-speak the British economy has plenty of spare capacity. A number of professional economists, including the FT’s Samuel Brittan, one of my heroes, seem to agree. But government economists and many others, apparently including the independent Office for Budget Responsibility, disagree. The previous economy was over dependent on debt spending by consumers and government and cheap imports, sustained by an overvalued exchange rate and financial support from abroad that can no longer be counted on. Mr Brittan thinks that the lower capacity of the economy is a self-fulfilling prophesy (i.e the longer the economy is depressed, the more difficult the recovery), but personally I think that the 2007 economy was in a very bad place, and was always going to take a long time to sort out.

But even if you don’t accept this, there is another problem. The extra confidence induced by a stimulus package can be overwhelmed by outside events, such as the Euro crisis. The UK economy, much more than the US one, is dependent on the world economy and is open to such shocks. Right now looks the wrong time to bet on a calm world economy.

Markets aren’t people – BBC’s Peston is taking anthropomorphism too far

Yesterday there were some rather worrying developments in the market for Euro area bonds, affecting even French and Dutch government stock. This caught the journalists on BBC Radio 4 off guard, including the famed Robert Peston. They quickly fell into the lazy habit of describing the markets as if they were thinking and breathing people, albeit in a plural form, like “Bond markets looked on the Italian government’s plans sceptically and yields rose over 7%”. This formula is usually used to link the movements in market prices to some new information or news event, regardless of whether any such link is actually significant. The idea of this mythical person or people breathing down the the necks of governments is clearly an attractive way to communicate a point. The trouble this morning was that there was no such easy link to make…which led at least one commentator to go a bit apocalyptic, that “the markets” had lost faith in the Euro completely and were expecting it to break up. This was more or less where Mr Peston ended up.

I have always hated this anthropomorphism of markets, which is by no means confined to journalists – market participants clearly enjoy the false sense of power it gives them. But markets are not people, they are mechanism by which buy and sell orders (in this case for securities) are resolved by striking a mutually acceptable price, often by computers these days. When nobody is buying or selling much, and market makers have to quote prices, then indeed human sentiment plays a major part in price movements. The market makers are usually part of a small and social group where collective sentiment can develop and they don’t mind telling outsiders. Journalists can find out what these sentiments are by talking to a couple of people. In this case the anthropomorphism does bear some resemblance to reality.

But as soon as the real money enters the market, then all this sentiment is mere chatter. And it often takes a bit of time for the real reasons for market price movements to emerge. People have to guess, and journalists usually go no further than to tap into the chatter. What moves the money? There are whole variety of things, many which economists would not recognise as rational – like a fund manager simply dumping shares to avoid an awkward situation with a client. Or, sometimes it can be plain errors. Then, of course, with so much automated trading it can simply be the unforeseen interaction of computer algorithms- as happened in the notorious “flash crash” in May 2010.

So what happened yesterday? I don’t know, of course. But the best explanation came to me via the Economist’s Buttonwood column, itself quoting one Michael Derks at a company called fxpro. In essence the Euro zone recapitalision of banks is having some malign effects. The idea was that banks should reserve more capital against their assets, so that they are better able to withstand losses. Reasonable enough (and vital to bring incentives at banks back into the real world, in my view), but banks can comply by dumping assets instead of increasing capital. That is what many banks are doing, and they are choosing relatively liquid government bonds to dump – including those of the French and Netherlands governments, as well as the usual suspects of Italy and Spain. It is a battle to prevent bank ownership being diluted, not a considered opinion on the future of the Euro.

Mr Peston should have known better, and helped his listeners try to understand what was going on, instead simply plugging this lazy and narcissistic drivel Shame on him!

Occupy: a difficult bandwagon to ride

There was a strained moment at last night’s dinner at the National Liberal Club for the London Liberal Democrats, when the party was challenged by a member over the Occupy protests at the City of London. Both the guest speaker, Paddy Ashdown, and the Mayoral candidate, Brian Paddick, said that the act of protesting was a wonderful, liberal thing to do, and that the party should engage with the protesters (and indeed has), but that there was too little in the way of constructive proposals for the party to take on. Given that the anger that drives the protests is shared widely across the population, this seems a rather inadequate response. But politicians of all stripes struggle to say much more.

The Labour leader, Ed Miliband, has tried to ride the bandwagon. It chimes well with his appeal for greater morality in commercial life. This line seems to play quite well with policy wonks and political professionals, but just seems to underline Mr Miliband’s lack of grounding in the gritty “real” world – a lack which, of course, he shares with most politicians of all parties. His ideas share with David Cameron’s “Big Society” a complete inadequacy when faced with the big issues highlighted by the protesters.

It is easy enough to accept the core of what the protests are about. There has been a lot of irresponsible behaviour in world finance which has helped bring about the current economic crisis; these financiers still seem to be attracting outrageous levels of pay; and taxpayers still underwrite the whole show. After this, however, practical politicians have to deal with four difficult facts in the search for policies.

First: world finance may have failed, but capitalism hasn’t. To many of the protesters world finance is simply the purest form of capitalism and its failure represents the failure of the whole capitalist system. Well greed and profit seeking, familiar parts of the capitalist way, had a lot to do with it – but as much of the problem was uncapitalist politics. Governments borrowing too much money to develop public services; interfering with the market to extend home ownership (especially in the US); China’s distinctly uncapitalist but de-stabilising trade policies, to name but three factors. The real problem was politicians trying to tilt capitalism to their own ends, even if these ends were quite laudable. There is in fact no substitute for capitalism if we are to maintain the living standards in the developed world, and to roll back poverty in the devloping world. Interfering with the workings of free markets is likely to make matters worse, not better.

Mention of politicians brings in the second awkward fact. The public (especially in the developed world) is at least as much to blame for the economic crisis as the bankers. Excessive borrowing was widespread, as was pressure on politicians to ride the boom and expand government. It wasn’t only the bankers that were being greedy. It is natural enough to blame the bankers, saying like children, “It wasn’t my fault, he made me do it!” – but this isn’t very helpful in the search for solutions.

And a third awkward fact is that banking and finance, apart from the greed and the excess, carry out a vital world function. The process of linking savers to borrowers, which is essentially what finance does, is vital for economies to develop and poverty to be fought. It is absolutely no coincidence that the growth in world finance in the last couple of decades happened at the same time as the biggest progress against world poverty that we have ever seen. And the beneficial effects of world trade that finance facilitated completely dwarf the well well-intentioned works of government aid and charities. The problem is that the bankers simply creamed off too much of the benefit for themselves.

Which leads naturally to the fourth, and awkwardest fact of all: the bankers are holding a lot of hostages. We need bank lending to keep productive industries going. Governments needs finance to keep public services going. In the UK, and especially London, world finance includes many perfectly productive jobs which we can ill afford to lose. Vindictive policies will hurt us all.

But finance does need to be tamed. But doing so is a slow process which requires a great deal of patience. There are two key sets of reforms, neither of which are quick:

Separate investment banking from utility banking. There are many abuses in utility banking, but the really dangerous stuff is in investment banking, and allowing investment bankers to run utility banks is a recipe for total disaster. The Vickers Commission’s reforms are an excellent start here – and seem to be leading the way globally. The investment bankers are patiently trying to undermine them – but politicians and the public need to stay on their case.
Make investment banking much less profitable. It is the profits that drive the excessive pay – and policy needs to focus on the causes of the disease rather than wasting time on the symptoms. There are two main causes of excess profits: lack of competition and the failure of organisations to bear public costs (for example of the public’s underwriting of the banking system). In investment banking, it is the second of these that is the most important (in retail banking it is the first…), and the most effective way forward is raising capital requirements. This is being done, and banking profits are duly under a lot of pressure. At first it will be the shareholders who feel the pain – but in due course it will be bankers pay, as shareholders get fed up with their overpaid servants.

Actually progress is rather good. We don’t need gimmicks like the “Tobin Tax”. we need vigilance and patience. I am proud of the way the Liberal Democrat ministers have been keeping the pressure up (Vince Cable is the star, but Nick Clegg is clearly on side). The bankers are waiting for the Occupy bandwagon to move on. It will, but I hope and trust that the Liberal Democrats will still be on their case.

The tricky politics of an EU referendum

Last night’s drama in the UK parliament over the call for an EU referendum is over. Will it all blow over? For now, maybe, but the issue will come back. Wise politicians will be thinking ahead about what they should do when it does. For David Cameron, it looks like trouble.

The starting point is that there is mounting pressure for a referendum on the European Union in the UK. Why should this be? We operate a representative democracy, after all, and the issues are complex – not the sort of thing that referendums are supposed to be particularly good at sorting out. But there is a substantial body of public opinion who believe the country’s membership of the Union is an outrage to our constitution. This has always been so – but while in the 1970s these were overwhelmingly older people, scepticism is now more widespread. The Tory Eurosceptics who entered Parliament last year are a younger breed, and to many a focus on Europe has reached obsessive proportions.

This scepticism has been fanned by the press. Why? Clearly newspaper proprietors don’t like the EU for their own reasons – but surely it goes deeper than this. The EU is an easy target for our frustrations, in much the same way as ethnic or religious minorities used to be. They don’t answer back. Exploiting this is one way to sell newspapers. Add to this the growing frustration with the Union right across Europe, and the steady fading of European idealism, and you have a ready explanation for rising scepticism.

It all looks very different, of course, once you are responsible for running the government. Here the thought of operating outside the EU, or even taking a detached stand within it, looks plain silly. And so you have a tension between the governing elite and a substantial body of public opinion. A referendum campaign seems to be one of the best ways of bringing this to a head. A campaign in the right circumstances has the support of many Europhiles too. They are sick of their steady retreat in face of the Eurosceptic onslaught, and long to turn and fight, even at seemingly hopeless odds – like the British soldiers retreating to the Marne in 1914.

So far so good. Now it gets complicated. Europhiles want a straight in-out referendum. This would force pragmatic sceptics, including large parts of the Tory hierarchy, into the “in” camp. To them, this is the basic question of principle anyway. Trying to have referendums on carefully negotiated treaty changes is a misuse of this method of democracy. Extreme Eurosceptics would be happy enough to go along with this, convinced as they are that the country would be much better off out, and that the public would rally to their cause.

But pragmatic Eurosceptics don’t want this, for exactly the reason that the Europhiles want it. What they aim for is a changed relationship between the UK and the EU – and that a pre-emptive referendum on an in-out question would weaken their negotiating position. For them the main job of a referendum is to put a spanner in the works of the EU itself, by blocking any changes they dislike to the treaties. Pretty much everybody accepts that a UK referendum would have rejected any of the previous treaties (Maastricht or Lisbon in particular – though the former might have been quite close, in my view). The idea of a three way referendum, with a renegotiation option, in yesterday’s motion was an attempt to win over these pragmatic sceptics. But it didn’t really stand up to close examination – one of the bigger reasons why the motion fell so heavily.

But it is possible to see a the outlines of a deal coming out of this. First negotiate a new deal with the EU, then have an in/out referendum on its outcome. Sounds simple enough, but the renegotiation idea is fraught. Is it a new deal for Britain, or a more general rebalancing of Europe? I think the government has in mind the latter, drawing in allies from across northern and eastern Europe. The idea would be to use the Eurozone crisis as leverage. If the Union’s constitution needs to be changed to make the Euro work, then this can be made conditional on other changes.

The trouble is that it is difficult to understand what the shape of this deal might look like. To the the EU core members (Germany, France, Italy and so on) the EU constitution is carefully balanced, with a free trade area on the one hand, and regulation to prevent a disorderly race to the bottom on the other. Besides a treaty change will have to go through referendums right across the Union – a nightmare as European politicians learn that a rejection of a treaty can earn them extra goodies.

And so the risk is that the government returns from the “renegotiation” without very much to show for it, and then be forced to hold a referendum on it. The prospects for a Britain-only renegotiation are even bleaker, as our bargaining position is so weak. This will place the pragmatic sceptics, like David Cameron and William Hague, in an impossible position. Yesterday’s debate has reduced their room for manoeuvre, as the Economist’s Bagehot column points out. They will have to produce something relatively soon.

One of Mr Cameron’s main achievements has been to de-toxify the issue of Europe for the Tories. But the issue could yet return to destroy him, his government and his party. It will be the greatest test of his leadership.

Inflation and the British economy

There is an excellent article in today’s FT by Chris Giles. Unfortunately this is behind the FT paywall so I don’t think clicking through will help most of my readers.

Mr Giles considers what has gone wrong with the British economy over the last year – since growth forecasts are being consistently revised downwards. Two explanations are often offered – “it’s the Euro crisis” or the government is cutting “too far, too fast”. In fact both are wide of the mark. The simple fact is that while rates of pay have stuck broadly on forecast (2% increase), consumer prices have increased by more (over 5% compared to just over 3%). The gap is plenty enough to explain the lowering of real terms growth.

Why have prices shot ahead of forecast? Mainly external factors to the British economy – oil prices, global prices for food and clothing and so on. I really don’t like calling these price rises “inflation”. Inflation suggests a degrading of money which, inter alia, makes debts easier to afford. But incomes aren’t keeping up, so debts aren’t eroding by more than the 2% a year or so that incomes are rising. Similar considerations apply to government debt – taxes largely depend on income. VAT is an exception – but many benefits (like pensions) are linked to the rate of increase of consumer prices – so the national debt doesn’t get any more affordable.

The economic pain of these external price rises is being spread widely. Surely the Bank of England is right not to tighten policy – which would only cause unemployment and concentrate the pain on an unlucky few. Our comparatively low rate of unemployment, compared to previous crises of this economic scale, is one of the wonders of the British economy.

Five Eurosceptic fallacies

I caught a bit of last night’s Radio 4 Analysis programme driving home from a meeting, on Euroscepticism in Britain. One speaker (I didn’t catch who) suggested that the case for Britain being in the EU was mainly economic – that we could put up with a bit of lost sovereignty because we were being hitched to an economic powerhouse that would do our economy good. This he said, was now clearly nonsense. In evidence he said that the EU used to be 26% on the world economy and now it is 18% (I may have misremembered the numbers). “We are being chained to a corpse.” I was apoplectic. But it is typical of the drivel that is being spread across our media. It’s worrying that so few people bother to argue back.

Let’s clear the decks with some points of general agreement. The Euro is in crisis, and this crisis could lead to an economic disaster. This in some measure results from severe mismanagement of the currency by the EU’s leaders, aided by the European Central Bank (ECB). The stock of European institutions is low in public eyes, not just in Britain, but across most of the continent. This has something to do with a democratic deficit – with the institutions wielding power with little apparent democratic consent.

But it is possible to accept all this, and to think that the EU, and even the Euro, is fundamentally a good idea, and that Britain would be mad to consider leaving it. The country may even be forced to join the Euro – though that event is surely a long way off.

Let me try to help the feeble defenders of British membership by elaborating four critical fallacies behind the Eurosceptics’ arguments, and fifth that is a bit more arguable.

First fallacy: there is such a thing as “just” a free trade area. It often said the the country joined something that was just a free trade area, but this has morphed into something else. But free trade across borders is a complicated business – and not just a matter of border controls and tariffs. Its implications quickly reach into vast swathes of ordinary life. Most of the US Federal government’s powers rest on its right to regulate interstate trade. And the unhappy experience of the North American Free Trade Area (NAFTA) shows how politics gradually undermines transnational free trade projects that do not involve a significant pooling of sovereignty.

Fallacy no 2. Britain is being ripped off by the rest of Europe because we have a trade deficit with them. This leads to the idea that outside Europe we would get a sweetheart deal (like Norway of Switzerland, or at least in popular myth) because they need us more than we need them. But the British trade deficit arises from the chronic mismanagement of the British economy, which led to a prolonged period (since the late 1990s) where the Pound was too high for many of our export businesses to be competitive. This uncompetitive exchange rate has now been reversed, and so our trade balance with the EU will correct. And as for bargaining power, there is a fatal flaw to this line of reasoning: the relative size of the UK against the rest of the EU. EU trade is a major part of our economy; UK trade is not a major part of the EU economy.

Fallacy no. 3. Being outside the EU means that we don’t have to comply with EU regulations. This is largely true of the labour market, it has to be said. But far from true of product markets – since we need to sell our products in the EU. Also, if foreign manufacturers are forced to comply with separate British product standards before they can export here, they will either charge us extra or not bother. If you are in any doubt about this ask a Norwegian or Swiss about how much better life is without the burden of EU regulations. You will get a lecture about how they have to comply anyway, without any input into how they are made. This is of particular relevance to one of the areas where Britain has a competitive edge: financial services. Our representatives in Europe are forever batting back ideas for new rules that would disadvantage the City; I wonder what would happen if they weren’t there any more?

Fallacy no 4. We would save money by leaving the EU, because we are a net contributor to the EU budget. This is an illusion. We may pay less in net contributions, but we would pay more in tariffs And if we charge more tariffs in return? Any economist will tell you that this is a road to nowhere. Our net contribution is a small price to pay for access, and, besides, some of it helps to develop new markets in the Union’s less developed countries.

Fallacy no 5. Britain would have been worse off by joining the Euro at the start. This contention is unprovable, as is the opposite: that we would have been better off in it. The Euro, of course was badly managed. But so was the Pound. While the Euro was going on, the pound shot up in value, destroying many of our exporters and creating a big trade deficit. Borrowing ran amok, as did, to a lesser degree, government expenditure. When it all blew up, it left the British economy in a terrible state, one that it will take many years to recover from. Won’t the devaluation of the pound help our recovery? Yes, but it should never have got that high in the first place. What would have happened if we were inside the Euro? Almost certainly no better – except that our problems would have been more transparent, so we might have started to fix them a more quickly. My point: an ugly mess either way. Look at our Eurozone colleagues and the British economic performance does not look stellar. A floating currency is no free lunch.

Of course there is a lot wrong with Europe and the Eurozone. That does not mean that this country is better off outside. The best case for a referendum in this country is that it would force supporters of the Union to make the case more forcefully, and expose the fraud behind the anti-EU case. But on their performance to date, who can be confident of that?