Britain after Brexit: Singapore, Switzerland or Japan?

What would Britain become if it left the EU after the Referendum on 23 June? To most campaigners for Leave this may seem an unfair question: they are not a government in waiting. To them EU membership is inherently bad, and we should sort out what the country is to become one democratic step at a time once we have decided to leave. But to many Remainers it is the lack of a coherent and convincing alternative vision for Britain that is one of the strongest reasons for staying in the EU. So it helps to think it through. One way of doing that is to look at the example of other countries.

One of the early alternative visions put forward by Leave advocates was Singapore. This is especially popular amongst businessmen. Singapore broke free from the Malaysian Federation in 1965 (it was expelled) and has prospered as an independent state. It now counts itself as part of the developed world, unlike the continuing Malaysia, which has advanced not nearly so quickly. Singapore made itself an easy country to do business in, and developed as a trading entrepot through, for example, very efficient port facilities. Meanwhile Malaysia became bogged down with the politics and corruption of a larger state, notably engaging in the politics of ethnicity.

Likewise Leavers say that Britain is bogged down with the politics and inefficient regulation of an entity that is too big and complicated to be efficient. Why can’t we be something nimbler and more entrepreneurial, like Singapore? There are many problems with this idea, of course, which is no doubt we don’t hear so much of it now. First is that in size and complexity Britain looks more like Malaysia itself, rather than Singapore, while the EU looks nothing like the Malaysian Federation, with its autocratic leadership. The second is that Singapore is run very autocratically itself: a firmly-led one-party leadership forces through its pro-business agenda in a way that Britain’s government can only dream about. What stops Britain from being like Singapore is less the restrictions of the EU, and more its own raucous and vibrant democracy. A common complaint of Leave campaigners is that the EU is not democratic; following the example of Singapore suggests that it is in fact too democratic.

Enter a second possible exemplar: Switzerland. Switzerland is prosperous and European; it is also probably the most democratic country in the world. Referendums are a very regular occurrence; Swiss people are constantly consulted. And they rejected joining the EU (and the EEA, a diluted version that includes Norway) exactly because it threatened its democratic standards. But the Swiss example throws up a couple of interesting problems. First, the country has found that the only way to make a proper democracy work is through a level of local devolution that is alien to Britain’s freewheeling ways. The central government is weak; most of the action occurs at cantonal level. This level of local government is actually quite intrusive; woe betide anybody that runs their washing machine late at night. A number of years ago many London firms threatened to migrate to Geneva in reaction to intrusive financial regulation; they did not follow through as their staff found the city a difficult place in which to live.

Well that is more interesting than a decisive argument over Britain’s choices. It may show that many Brexit campaigners have mixed feelings about democracy, but Britain can still choose to runs its affairs differently. The second problem is more difficult: in order to prosper, Switzerland has found it necessary to participate in EU structures to secure its part in the single European market. It must comply with many EU regulations, allow the free movement of EU citizens and even pay into the EU budget. There is a tension between these things and Switzerland’s democracy (especially over allowing EU nationals in to work), but Switzerland has been forced to compromise. The Leave case to the voters is based heavily on stopping the free movement of people and on stopping EU budget contributions; it follows that the country could not follow the Swiss compromise, and would sacrifice much of its prosperity as a result.  Indeed the Swiss compromise makes little sense – why not accept the EU structures and participate in their management in a way the Swiss are unable to? it is not as if we have such democratic traditions to protect. Indeed we might find some of the European structures useful to protect our citizens from our own government, elected with very unconvincing democratic mandates.

I think a third exemplar fits much more closely with where Britain would head if it left the EU: Japan. Japan is an island nation positioned just off a continent with which it has difficult political relationships. It values social cohesion beyond economic prosperity, which means that it maintains strict controls against immigration, even though its aging population is creating a crying need for younger workers. It would rather seek solutions in robotics. It is democratic, though not in the free-wheeling way that Britain has become used to.  But a post-Brexit Conservative Party could establish the dominance that Japan’s Liberal Democratic Party has achieved. The result would not be the business-friendly wonder of Singapore, but an even denser thicket of regulations and bureaucratic meddling than Britain has now, which helps to preserve social cohesion and stability, and protect the interests of established major businesses. In principle I think most of Britain’s voters would settle for this, even as they might moan (the Japanese do that too).

The problem for Britain is that Japan’s economy is based on a strong industrial base. This is a historical oddity that would be very hard for Britain to replicate starting from where it does now (though would perhaps have been feasible starting from where it was in the 1950s). The businesses at the core of Japan’s success are mature ones, like Toyota, which has become the world’s leading motor manufacturer, alongside Germany’s Volkswagen. These businesses are not growing – indeed Japan’s economy has been in the doldrums since the 1990s, but they nevertheless provide Japan with financial security. Japan’s government is not dependent on foreign investors as Britain’s is. To replicate Japan’s success would require a rebalancing of Britain’s economy, led by a substantial devaluation of the pound, and several years of pain as living standards were squeezed.

Are Britons really up for this? The country has already advanced far further down the road of multiculturalism than Japan could conceive of – a legacy of its Imperial history rather than of EU membership. Britons have got used to their holidays in the sun, and the country’s relationship with its continental neighbours has always been more integrated than that of Japan’s with China and (to a lesser degree) Korea.

But if Britain votes for Leave – which is having the better of the referendum campaign so far – they may find themselves following the Japan road, with much less benign results than Japan has been able to achieve. That is a good reason to vote Remain.

Japan: are there lessons for other developed economies?

A while ago I wrote that the radical economic policies of Japan’s new government under Shinzo Abe would be an interesting experiment for the world. They were much lauded by austerity sceptics, such as Paul Krugman, who drew attention to aggressive monetary policies and fiscal stimulus, which they were advocating for other developed economies. I was sceptical. But early results have exceeded expectations. There is a good analysis here from the Economist, which also discusses the new government’s nationalist tendencies. Is this evidence that the austerity policies being pursued by much of the rest of the developed world are mistaken?

My scepticism when I last posted was based on two things. First that the policies hinged on companies raising wages, when their profits were under pressure. Second was that, based on Mr Abe’s previous form, I did not think that structural reforms to Japan’s economy would be pursued with vigour. On both counts it looks as if I was too pessimistic. This means that Japan’s economy might well get a sustained period of growth, and that it will reduce the burden of government debt. But applying its policies to other developed economies is problematic. There are three reasons for this.

The first is that for longer term success it is still the element of structural reform that is critical. Mr Abe refers to his programme as “three arrows”, in reference to a Japanese folklore story that you can snap the shaft of a single arrow easily, but not three held together. These three are monetary easing, fiscal stimulus and structural reform. Austerity policies in Europe and America are firmly based on structural reform: especially in reducing the size of the state. Opponents of austerity tend to want to halt or slow down structural reform. Some say that it should wait until growth is resumed; others would rather avoid the reform process altogether. The three arrows approach would in fact promote reform, alongside the monetary and fiscal palliatives, and, indeed, the more considered critics of austerity do say this. But here there is a problem: Japan does not have an oversized state, so cutting back government expenditure is not a major reform priority, as opposed to opening the economy up to more competition and reforming corporate taxes. In Britain, France, Italy, Spain and so on the size state has run beyond what the economy can sustain, and so it has to be cut back, which in turn drains demand from the economy in the short term. There is good reason to doubt whether fiscal or monetary stimulus, beyond their current levels, are compatible with the need to shrink the state.

There is a second important difference in Japan. Its economy has a trade surplus and (which is linked) a savings surplus, albeit temporarily challenged as it has to import energy while its nuclear programme is in abeyance. That means that a fall in the exchange rate, as has happened to the Yen, will generate an immediate bonus to businesses, easily outweighing the extra costs imposed on the economy. This allows companies to put wages up. The savings surplus also means that the economy is not dependent on borrowing from overseas investors, who might be shaken by such currency depreciation. This is not the case with the austerity economies. Where their exchange rates have fallen, as in Britain, this has simply contributed to the squeeze on consumers without benefiting business to anything like the same degree.

Mentioning the exchange rate brings me to a third observation. It is that a lot of Japan’s success so far has less to do with with the country’s actual economic policies than with the effect of announcements on the zeitgeist. Implementation has hardly started, and yet the exchange rate has already plummeted and stock market risen, which is having the necessary warming effect, and set off a virtuous circle. The same can be said, in reverse, for austerity policies in the West, of course. But where reforms are necessarily painful, this is almost impossible to do. Economists have long been reluctant to admit the role of psychology in macroeconomic policy, and have let it in only gradually (through such ideas a inflation expectations). Governments and central banks have long known it – and Mr Abe’s government is acutely aware. The question for Europeans, in particular, is whether further aggressive monetary easing, linked to higher inflation expectations, combined with some fiscal stimulus would lift the zeitgeist and get the economies moving again. We have reason to be sceptical.

Almost all the developed economies in the world are experiencing difficulties. It is easy to fall in with the idea that this must be for similar reasons and that the solutions for each economy are similar. In fact each major economy is unique. And the differences between Japan and the others is amongst the largest. Abenomics may work for Japan, but that does not mean they will work anywhere else.

Monetary policy is a useless collective noun

At the time of the financial crisis of 2007 and 2008 it was commonplace to say that modern economics, especailly the macroeconomic variety, was in crisis, and needed a fundamental rethink. Alas, the vested interests of established economists have prevailed. Very little rethinking has occured, and this mainly tweaking rather than anything big. This is most striking in the area of monetary policy. The debates now going on in Japan and Britain remind me of the academic papers and discussions that I read about while an economics undergraduate at UCL in 2005-08. Circumstances have changed (in Britain anyway) but not the economics.

Economists of complain that amateurs are guilty of the fallacy of composition: to assume that was is true for a household, say, is also true of all households grouped together in a single economy. It may sensible for a single household to save more of its income to repay debt: but if a whole economy tries this at once, it could be disastrous. But economists are guilty of their own fallacy, though one for which I have not found a commonly used name. I will call it the fallacy of collective nouns. It is idea that by collecting together a group of disparate elements and giving them a name, that you have created a new entity that allows you to ignore its component parts. Most macroeconomic concepts are such collective concepts: GDP, inflation, and so on. Such collectives are useful only up to a point, and then you have you have to look at their component elements. And yet most macroeconomists, even very intelligent and distinguished ones, can’t bear to let go of their collective concepts and carry on using them long after their usefulness has ceased.

This is clearly the case with the idea called “monetary policy”. The conventional idea is that an economy has something called a “money supply”, which can be manipulated through policy instruments under the control of a central bank. In turn this money supply affects the behaviour of the people that form the economy with fairly predictable effects on things like consumer prices,wages, investment and output. All of this is very questionable in a modern economy. It is much more helpful to think of the particular components of “monetary policy”: central bank interest rates, state purchases of its own and other bonds, bank regulation, and so forth, and how these affect the various parts of the economy acting through the financial markets.

The conventional economic thinking runs something like this: the economy (Britain and Japan in particular) is stagnating with relatively low levels of inflation, but high or rapidly rising levels of government debt. In order to pay back this government debt you need to break out of the stagnation and grow, or (whisper it) let inflation make the debt more affordable. To do this you need to “loosen” monetary policy and increase the supply of money. With more money in their pockets, people go out and spend more, leading either to growth or inflation. To do this the central bank lowers interest rates, and where this does not work, use other measures like Quantitative Easing. Cue lots of debate about the relevance of inflation targeting and its alternatives (nominal GDP targets for example), all well within the comfort zones of economists.

There are very many problems associated with this line of reasoning. It is far from clear what money is. However it is clear that commercial bank accounts form the most important part of it, and this is a function of commercial bank policies, not those of a central bank, whose influence is increasingly marginal. It isn’t clear that large bank balances lead to increased spending, least of all on constructive economic things like consumption or proper investment (as opposed to chasing up the value of assets in fixed supply). Rising prices do not necessarily make debt more affordable: that requires rising income for the people holding the debt. And it goes on.

All the verbiage around “monetary policy” is clouding the issue. There are two problems being faced the British and Japanese economies: weak output and excessive debt. Weak output in turn has two components: using spare capacity (i.e. that created simply because of slow demand) and strucural problems. In Britain there is a big argument about how much of the problem is spare capacity and how much is structural. If it is largely spare capacity then simple macroeconomic solutions may have merit: you just need to boost confidence a bit to lift demand. But even here it is not self evident that any of the loose money policies will be much help. In Japan there seems to be even less spare capacity.

I can’t help thinking that what policy makers really mean by “loose monetary policy” is higher wages. Increasing consumer spending power through increasing wages will lift confidence, and even if it is not based on increased productivity, it will make debts easier to pay off, including public debt through higher tax revenues. This lurks behind a lot of the talk about greater tolerance for inflation. But in Britain we have the wrong sort of inflation: rising import costs through a lower pound, and increased government charges. This really isn’t helping. If policymakers want higher pay it would be better to throw away the weasel talk about loose money, and talk about pay. There is some evidence for that in Japan, but this only serves to show how difficult the policy is in practice.

The Japanese government also deserves some credit for the fact that it is not advocating looser monetary policy by itself, though you wouldn’t guess that from much of the coverage here. It is one of three prongs, the other two being fiscal stimulus and structural reform. There is plenty of scope for structural reform in Japan, and this gives their economic policy some hope for ultimate success if they follow it through. But it is the prospect of quick and easy solutions through fiscal and monetary policy that is exciting people.

In Britain a chronic trade deficit shows major structural problems, no doubt partly as a result of reduced North Sea oil. This requires the economy to be producing different things, not just more all round. Loose talk using economic collective nouns is making this harder to see and address.

Abenomics: why it doesn’t look good for Japan’s economic experiment

A few years ago, as the Greek crisis unfolded, an Economist blogger suggested that its austerity programme would be an interesting experiment. Did the then fashionable idea of austerity growth have any validity? The answer to that experiment seems to be a clear no, though now doubt there are get out clauses. Now a very different economic experiment is taking place in Japan, after the election of Shinzo Abe and the Liberal Democrat Party last December. It is popularly referred to as “Abenomics”.

Abenomics, described by the Economist here,  has three elements: increased infrastructure expenditure, looser monetary policy (through focus on a higher inflation target), and “supply-side” structural reform. This coordinated nature of the policy is one of its most important aspects. Here in Europe we are used to fiscal policy pulling one way, while monetary policy and structural reform pulls in the other. All this has “Keynesian” economists like Paul Krugman in raptures (I used the inverted commas because no self-respecting economist accepts that label, it’s just common sense after all, though their political supporters love it). Japan has been stuck in the economic doldrums for two decades, and these economists feel that at long last the country might be digging its way out. Better still, success in Japan will show that these policies can be applied in other developed economies. But this analysis is deeply flawed – a case of macroeconomic blindness, a sort of failure to see the trees for the wood.

Look again at Japan. Its unemployment rate is currently a shade over 4%, having fallen from a peak of 5.5% in 2009. Compare that to the UK’s rate, which has hovered around the 8% mark since 2009, compared to about 5% before the crisis. This does not suggest a huge amount of slack in Japan, even allowing for distortions in the way it measures its unemployment. Growth will have to come about either through productivity growth or new people entering the workforce (e.g. through immigration). There is plenty of scope for both. Japan may have some of the world’s most efficient companies, but these dominate its export economy only; there is a lot of inefficiency in domestic markets. Japan has long eschewed immigration as placing an unacceptable strain on its social infrastructure. All this depends on the third prong of Abenomics, structural reform. And yet the government already seems to be going slow on this, afraid that the public will disapprove, with bad consequences for upper house elections due later this year.

In fact what Abenomics really seems to be about is to make government debt more affordable through setting off inflation (specifically of incomes, and hence tax revenues). Japan’s inflation has been very low, and negative for much of the stagnant period. Even this may not work – economists understand little about how inflation actually comes about, assuming that it is some kind of endogenous variable in that depends on such things as aggregate demand and money supply. Instead the policy may simply lead to state bankruptcy – though that is no doubt a long way off.

What are the implications for the rest of us? The justification for “Keynesian” policies in most developed economies, including th UK, remains intact because our high unemployment shows that there is quite a bit of slack, though we don’t actually know how much (the 1970s stagflation crisis arose because economists too readily assumed that unemployment meant economic slack). But they are not the answer to raising long term growth rates. And Japan’s agonies with inflation and government debt may well foreshadow future dilemmas our own governments will face.

What arrogant economic commentators, like Professor Krugman, need to accept is that economies are the sum of freely made choices of individual citizens, excercised through both markets and the ballot box, as they try to shape the world they live in. They are not the creation of governments and policy makers playing with their economic toolkits to win prize for the biggest d**k growth rate. Japan’s stagnation is the result of choices that Japanese people are making about the sort of place they want to live in, one which consideres wider factors than monetary income. Get over it.