new economics – thinking liberal

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

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

The narcissism of small differences

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

Production is no longer central to economic performance

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

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

Most of the economy is non-essential

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

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

We have found the magic money tree

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

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

Hayek was right

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

To them that hath shall be given

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

Free choice doesn’t work well in a pandemic

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

So where does the leave us?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Tim Harford and “degrowth”: missing the broader point

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

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

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

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

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

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

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

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

Guest post: YOUNG PEOPLE HAVE PLENTY OF THINGS TO WORRY ABOUT. THE LONG-TERM EFFECTS OF THE CORONAVIRUS SHOULDN’T BE ONE OF THEM

Sorry for the lack of activity. I haven’t succumbed to Covid-19. I have just been exceptionally busy, not least with a house-move. And not just that: my Treasurer duties have been quite intense, and still are: I’m in the middle of an audit. I will recount my tale when things settle down a bit. Meanwhile it is my pleasure to publish this piece from John Medway.

A recent article in the Daily Mail raised the question of whether it might be better to accept a high death toll among the elderly from the coronavirus than to impose a huge financial burden on the younger generations by allowing major short-term disruption of the economy. Stephen Glover wrote (25 March 2020 ): “We have to ask ourselves a rather shocking question. Is it right that, in order to save the lives of mostly elderly people … the future lives of millions should be devastated?”

I must declare an interest here – I am elderly. To be fair to Glover, he doesn’t come down in favour of letting the elderly die off. He accepts an imperative to “throw the kitchen sink at the problem”. In any case, I’m going to leave aside the moral issue of balancing human lives against economic well-being. My view is that his prediction of long-lasting economic devastation from the coronavirus is simply bad economics. I don’t accept that we necessarily face years of austerity because of a generous approach to the temporary economic victims of the coronavirus.

The coronavirus episode will have some significant short- and medium-term economic effects. One is that resources are going to waste because workers are being made idle. This means that for a time, the economy will be smaller than normal and that on average we will be poorer for a short while. If the episode is prolonged and government support for businesses inadequate, there could be some lasting damage to the economy through premature retirements from the workforce, loss of skills and delays in training. These are real, medium-term effects but should be manageable. They should not mean that “the future lives of millions” will be “devastated”.

Glover’s main concern is not with short-term effects on the real economy – its ability to produce the goods and services we need or desire. It is rather with the sudden and huge surge in government expenditure, the loss of government revenue and rapid growth of government debt. “Let’s be in no doubt”, he writes, “that our country faces years of austerity that will almost certainly make the past decade look like a minor irritant.”

That would be true if an unreconstructed George Osborne were to return as Chancellor but I hope this is most unlikely. Thatcherites liked to portray the state and the country as a household whose expenditure was limited by its level of income or by its ability to borrow. This gave some cover for their aim of reducing the size of the state and passing as much of the public sector as possible to markets – an aim no doubt with a strong appeal to the sort of people who donate five- six- and seven-figure sums to the Conservative Party.

But a government does not always need to finance its deficit by borrowing. If, like the UK, it does not belong to a currency union, it can also do it, in co-operation with its central bank, by “printing” money – also known as “quantitative easing” or QE. The limit on the prudent printing of money is set (if not by ideology) by the perceived needs of the economy. If, once the coronavirus is beaten, the economy is held back by the inability of many firms and households to repay or finance their debts, an injection of liquidity through QE could solve the problem. This could be done through a generous welfare system and by offering cheap credit to basically sound firms in temporary financial difficulty.

It is, of course, tempting to think that governments can go on indefinitely financing their deficits through printing money. Some countries have done this, with disastrous results. The volume and speed at which money circulates needs to match the productive capacity of the economy or inflation results. As the economy recovers and nears its short-term limit, there may be a need to reduce rather than increase the money in circulation. This can be done by increasing interest rates, increasing taxes, reducing public expenditure or any combination of these. The important point here is that when printing money is an option, taxes are needed, not to pay for government expenditure, but to help keep the supply of money in the economy in line with productive capacity. In normal times, the notion that taxes are needed to “pay for” public expenditure is a useful approximation to the truth. But these are not normal times.

To a person who thinks in terms of public expenditure invariably needing to be paid for through taxation or other revenue, a sudden and enormous surge in government spending is deeply alarming. Glover’s alarm is perhaps because his perception of the nature of money, spending, borrowing and taxation is fundamentally different from mine.

There are big things to worry about in the British economy. One is the age imbalance in the population and the problem of caring for a growing elderly population – ironically, a problem that might be alleviated by a cull of the elderly population by the coronavirus if it gets truly out of control. The age imbalance is a problem in the real economy – the resources devoted to the care of elderly people. The problem is exacerbated by unfunded public-sector pension commitments, to which printing money will not be the answer.

More serious is the climate emergency. It is an emergency because global warming seems likely to prove catastrophic unless action is taken urgently to reduce carbon emissions. Governments generally show no sense of urgency and some (such as the US government) are in actual denial of the problem. The medium-term economic and social effects of dealing effectively with the climate emergency are likely to be far-reaching – for good or ill, depending on the attitude and skill with which governments and societies approach the problem. The price of failure could be one or more future generations of people for whom life is nasty, brutish and short.

Young people have plenty of things to worry about in the economy, society and environment that we oldies are bequeathing them. The long-term effect of the coronavirus should not be one of them.

The new economics: what does this mean for liberals?

My previous article on the changing world of political economy generated more interest than usual. It was, of course, a small dip into a large and complex topic. Given the interest shown, I feel the need to expand on it a bit.

The first thing to say is that what I am calling “the new economics” is based on standard economic principles, and the ideas aren’t new. The departure from political policy norms may be radical, but the departure from mainstream economic theory is not. This is partly how I have chosen to frame it. The heterodox idea of Modern Monetary Theory (MMT), popular in some parts of the left in the US and UK, is in fact not at all far from my new economics. But MMT advocates have, generally, chosen to frame their arguments as a radical challenge to conventional economics, and have a tendency to be very rude about mainstream economists. They have in turn drawn lots of rude comments from mainstream economists. A lot of this dispute, from both sides, is manufactured and I think that is a pity. Clearly some facts are in dispute, but it would be better to narrow these down and focus on the evidence rather than indulge in slanging.

Instead I take inspiration from people who are clearly on the mainstream spectrum. The main one is Adair Turner (whom I found going through some of my old papers was a Cambridge contemporary of mine: we were both members of the Conservative Association in 1976-1979). I haven’t read anything more than the Economist review of Dietrich Vollrath’s Fully Grown: Why a Stagnant Economy is a Sign of Success, but he is clearly another mainstream economist developing the same sorts of ideas. Mr Vollrath’s contribution is to bring rigorous numerical analysis to the table, where I have been plying with airy ideas.

Which brings me to my next point. A modern, developed economy will not show much in the way of GDP growth. We have become so conditioned to thinking that growth is a sign of economic health that this takes a lot of getting used to. But it is perfectly consistent with human wellbeing advancing. People may consume less stuff per head, but they can still have increasing levels of physical and mental wellbeing, and live in a nicer, friendlier and healthier environment. Mainstream economists have a tendency to suggest that people are being irrational if they consume less, work less, buy organic vegetables and have a healthier lifestyle, but the irrationality is theirs.

But a “stagnant” economy does bring a problem in its wake, and that problem is taxes and funding the public sector. GDP measures the size of the money economy, and the money economy is central to way governments operate. Indeed you can make a good case that money was invented so that the state could organise armies, build infrastructure and hoard surplus food. While the state could, and did, do this through forced labour and the appropriation of harvests and other goods, a system of taxation and wages is much more flexible. The rival idea that money was invented to facilitate trade is harder to sustain, though it used to feature a lot in economics text books. Of course the two functions of money, taxation and trade, fed off each other in a virtuous circle.

This all matters because there is no sign that the role of the state (in the broadest sense of collective public action) is about to diminish. The expansion of the state is one of the most important developments of the 20th Century, starting in large part with the creation of war economies, and then a dramatic expansion of the state role in education, healthcare and pensions and other welfare payments. To many on the right, this expansion of the state is seen as a hideous intrusion on human freedom that needs to be reversed. In fact it is a response to two important developments. The first is the tendency of capitalism to self-destruction, as noted by Karl Marx. If the capitalists succeed in creating too much profit, which is then hoarded, fewer people will benefit from the possibilities that the economy offers, and the system stagnates and collapses. If the state taxes those profits and hands them out to the less well off, this creates demand for capitalism’s products and the system is saved. (This is not the only way: capitalists being more generous with paying their workers has a similar effect, though it usually it takes organised labour to make this happen).

The second development causing the increased size of the state is the good old Baumol effect, which is the main driver of the new economics. The private sector is becoming so efficient that the relative cost of public goods is rising compared to what gets traded in private markets. Everything is more expensive in defence, law enforcement and healthcare. This issue is getting more acute. Public services are generally overstretched and many of their employees are underpaid. Stinginess on welfare benefits is creating knock-on problems elsewhere in society.

But this creates a political challenge. Public services need to be funded through taxes (it is possible to have a theological debate on this with MMT advocates, but let me duck that for now – without taxation public spending leads to inflation). People are generally willing to pay quite a bit of tax, but this comes at a political cost. Politicians have tried to sidestep this through economic growth. If the money economy is growing, then the state collects more money while keeping the tax rates the same. Those familiar with Baumol thinking will realise that this always was flawed thinking, as productivity in the public sector lags that in the private sector. But now we are in the stagnant phase of our economic evolution, the argument collapses completely.

That points to the raising of taxes, and all the political problems that come with that. But behind this there is a bit of a puzzle. For now state budget deficits look quite sustainable, as do higher levels of state borrowing. The fear is that deficit spending will create inflation, and high levels of public debt create financial instability – and that the risks are higher if the economy isn’t growing. But there is no sign that inflation is close to be awakened in developed economies, while monetary policy can be used to manage high levels of government debt, provided that you are borrowing in your own currency, and inflation is dormant. Meanwhile private sector demand for public debt remains very healthy. So just when do we need those higher taxes?

That is the central problem at the heart of the modern political economy. I don’t have an answer. But longer term there are three important things about a liberal approach to the new economics that I do hold on to:

The government’s extra flexibility on fiscal deficits and debt should be exploited through investment programmes, creating assets that can be separately financed if necessary. These include social housing and renewable energy infrastructure. We need to be more careful with hospitals and transport infrastructure, but there are doubtless opportunities there too.
The day when extra taxes will be needed to fund more public services will arrive. When it does the level of public accountability will need to improve substantially. This points to the need for a profound devolution of power, and especially the power to raise taxes, backed up greatly improved public governance.
Meanwhile public services will need to be more efficient and effective (which is not the same as being more productive in my vocabulary). That means a profound switch to preventing and solving problems rather than service delivery and ticking boxes. That will require specialised services to work in a much more integrated way with much more delegated authority – and that means that services. mainly, need to be more localised. Which, of course, fits neatly with point 2.

I think this could be the basis for a grand bargain between liberals and either the left or, even, the right. The signs that either end of the political spectrum, or indeed liberals, are up for this are mixed. But there are some stirrings. On the other hand unscrupulous forces of the right or left could exploit the extra flexibility on public finances to line their friends’ pockets and consolidate political control while pretending to address the needs of “ordinary people”.

The rules of political economy have changed. Mainstream politicians and commentators haven’t noticed

Before the great financial crash of 2007-2008 there was a solid consensus as to the sorts of economic policies governments should pursue. In fact the underlying realities have been changing for some time. These new realities now dominate in developed economies, and yet the political mainstream hasn’t caught up. It is one of the reasons that populist politicians, not least Donald Trump, are doing relatively well when they defy the old rules.

What were those rules? First is that GDP growth is a critical indicator of economic wellbeing, and that increased productivity is the driver of this. Politicians should push through “supply-side” policies that improve productivity, which will allow income per head to grow, and with it individual incomes and wellbeing. With productivity apparently in the doldrums since the crash, especially here in Britain, there is much shaking of heads. Before the crash economists had thought something they referred to as “trend growth” of about 2% per annum was practically a law of nature. Many still think its disappearance is a failure of policy.

Second, governments must maintain a prudent fiscal policy that does not allow high levels of public debt to pile up. Public spending must be paid for through higher taxes. High levels of public debt can destabilise an economy, it was thought. This went alongside the idea that if public spending was not restrained it would be wasted, and cause low productivity.

Third: free trade is essential to a healthy economy. This follows from basic economics: the principle of comparative advantage. During the years of rapid globalisation of trade from the 1980s to the early 2000s, this idea received a terrific boost as new Asian economies entered the mix, with comparative advantage particularly evident in basic manufacturing. This generated huge gains in trade for both developed and developing economies.

And fourth, interest rate policy is the right way to manage the business cycle to ensure that recessions were smoothed out. This replaced the older post-war idea that fiscal policy was the right way to do this. Interest rate policy (or “monetary policy”) allowed the private sector to expand and contract as required, through an efficient market mechanism, rather than inefficient government direction.

What changed? First of all, the conventional wisdom on monetary policy, which evolved after the old system of fixed exchange rates and capital controls, known as Bretton Woods, collapsed in the early 1970s, led to an explosion of private debt. While policy makers liked to think that the policy was sustainable, there was a clear trend towards higher private debt and lower interest rates. This contributed to the great financial crash. Now interest levels can’t go lower, and people worry more about financial stability. This means that monetary policy is pretty much done for as means of regulating the cycle, with fiscal policy coming back into the picture, sometimes disguised as monetary policy with such ideas as “quantitative easing”.

Perhaps the most important change, though, was that productivity in manufactured and other tradable goods has advanced so far that they have ceased to have such an important role in the economy as a whole. This is known as the Baumol effect, and it is something I have been banging on about for ages. The modern economy is in fact dominated by things like health care, social care, and services, with status goods and land also playing a larger overall role. The old conventional wisdom around productivity doesn’t really work here.

On top of this environmental degradation, and especially climate change is posing a question that was always there. Is producing and consuming more and more stuff actually advancing human wellbeing? We all need to eat and wear clothes, but do we need to get through quite so much as we do? And yet an economic mindset in which consuming stuff is central to the way we measure wellbeing refuses to die.

A couple of other factors are worth mentioning. First is that the Asian economies are developing fast and converging with the western developed ones. This means that there are fewer gains from trade available, and that the globalisation boom is over; indeed many of those gains will actually reverse as the two worlds converge and comparative advantage diminishes. Second modern industry is not as hungry for capital investment as it used to be. This is partly to do with the Baumol effect, as the relative size of capital intensive industry shrinks, but also to do with the nature of modern technology, which uses more human capital. There are fewer opportunities in the private sector for savings to invest in, at any rate for things that aren’t outright speculative. The main cause of the great crash was an excess of private sector speculation as the relative scale of productive investment diminished.

So what does all this mean? First that it is OK to play fast and loose with fiscal policy. High levels of public debt are quite sustainable because the availability of private investment is diminished. Public debt is safer than private speculation. This is clearly evident in the USA and Japan. In Britain it is a little less clear because the country has a high current account deficit, meaning that is more vulnerable to international changes of mood – but surely there is much more scope than the government is currently using. Second, it is much less damaging than before to play fast and loose with trade policy. Once again Donald Trump is taking full advantage of this. His trade policy is mostly economic nonsense, but he can get away with it. Likewise Brexit is likely to be less dire for Britain than many predict – though the potential upside for “global Britain” is very slim. Trade just doesn’t matter so much, and the opportunities in Asia are disappearing.

All this is good news for populists. Mainstream policy needs to catch up. Policymakers need to drop their obsession with GDP and productivity, and start looking at wider quality of life instead. This includes the prevalence of poverty (I prefer not to focus on inequality, though that is clearly part of the picture), mental health problems and the environment. There needs to be a bigger drive on public investment, but not so much on roads, railways and airports, but on hospitals and healthcare therapies, social housing, and sustainable energy. There is scope for increased private investment here too, but the public element is vital.

There are other ideas, such as universal basic income, though I personally don’t favour this. But a rethink of state benefits is surely important. My instinct is for stronger set of social interventions to reduce poverty and its malign effects, rather than trying to make the problem go away by spraying money everywhere.

How does this work politically? It should be an opportunity for the left. And indeed Britain’s Labour manifesto in last election wasn’t quite as daft as it looked – in theory anyway. Bernie Sanders is making headway in the US in spite of defying conventional wisdom. But politics isn’t just about economics, and the left don’t really seem to grasp the demand for increasing personal autonomy. Besides so much of leftwing activism seems to be a rage against efficiency. Productivity may be an overrated issue, but the need for efficient and effective services remains as vital as ever.

Liberals, meanwhile, are badly compromised by their attachment to the old conventional wisdom. They have not yet found a new vision. Personally I think there is an opportunity for a grand bargain between the left and liberals, but there is no clear sign of this emerging. Meanwhile the political right has a clear opportunity. In the US they seem to be wasting it by failing to recognise that an efficient and effective state is critical to the future. They are failing to face up to the challenge on healthcare and the environment. In the UK the picture is different. The Conservatives are interested in courting more liberal-minded voters, and have not abandoned the idea of reducing carbon emissions, for example, or investing more in healthcare.

But at the moment the new rules of economics are providing more opportunities for the unscrupulous than they are to those genuinely want to make the world a better place. it is no wonder that the political centre is in such a mess.

What can we learn from 1977? The need for fresh economic thinking

Economic thought follows a 40 year cycle. It starts with a period of doubt, as the conventional wisdom appears inadequate; this lasts ten to twenty years. A new way of looking at the economy then emerges and this leads to a period of confidence and optimism, lasting twenty to thirty years. And then optimism collapses into another period of doubt as the orthodoxies fail. Currently we are in a period of doubt, which started ten years ago. That was also the case 40 years ago. A chance discovery has just brought this home to me.

Last weekend I was staying at my father’s house, and picked up his copy of E.F. Schumacher’s Small is Beautiful. That book, published in 1973, was one of the products of the previous period of doubt, and is a topic for a future post. But out of the book dropped a cutting from the Financial Times, dated 24 February 1977 by Samuel Brittan, one of that newspaper’s most distinguished writers. It was a bit of a shock, because what it says is so similar to what people like Adair Turner, and me in this blog, are saying now. (Apologies: the scan isn’t that great as the text is very small, and it defeated my OCR software, so it may not be that easy to read).

The article is a review of a book Social Limits to Growth by Professor Fred Hirsch, which is largely unknown these days (unlike Schumacher’s), but not quite forgotten. Hirsch developed the idea of “positional goods”, whose value does not arise from their consumption, but what they say about your social position. He noted that as societies get richer, the more important positional goods become. But ramping up production of these goods is self-defeating, as they then simply lose their value. He suggested that this poses a limit to how far economic growth can go. He also discussed the contradictions of market capitalism, and in particular that it depends on self-interest (some would say greed), but needs this to be constrained to avoid corruption and rigging the system.

Sir Samuel Brittan, as he now is, was one of my favourite economics writers: I read his columns religiously (alongside the American writer Paul Krugman), a process that helped me develop an interest in economics which eventually led to me giving up work and taking a degree in Economics at UCL in 2005. He might loosely be describes as a neoliberal, but above all he was rigorous in his thinking and not at all doctrinaire. He starts the article by posing the question about why economic growth and productivity had slowed, and reflecting on Maynard Keynes’s essay Economic Possibilities of our Grandchildren (1931 – belonging to the previous period of doubt and introspection that Keynes did so much to resolve). What is economic growth for? Keynes predicted that at some point it would become pointless. Sir Samuel accepts Hirsch’s analysis, and goes on to wonder about whether the market economy was really the paradigm that many idealists made it out to be. He concludes:

The main case for the market system is as a method of cooperation, which minimises coercion (e.g. conscription versus the price mechanism). But no one after reading Professor Hirsch can imagine that it promises a short cut to our economic nirvana or that it can manage without an economically literate public philosophy, which – 200 years after Adam Smith – we have still to evolve.

So what was happening in 1977 to provoke so much doubt? I remember it well: I was at university (studying physics and geology) and very politically engaged. In Britain it was the period of the Labour government of Jim Callaghan. Inflation was persistent; unemployment was high. The economy was dominated by large industries, many of them nationalised, where union power prevailed. They were generally very badly run, especially the nationalised ones, partly because of union interference. Callaghan’s tactic for controlling inflation was to do national pay deals with unions, who were grudging at best, and there was much industrial unrest. He, and his Chancellor Denis Healey, concluded that unemployment could not be tackled through expanding demand, as the conventional wisdom prescribed, referred to as “Keynesianism” as if Maynard Keynes could ever be pinned down to an -ism. Instead they adopted deflationary (i.e. austerity) policies to tackle inflation first. It was a turning point in British economic policy which is often ascribed to the Conservative Margaret Thatcher, who became Prime Minister in 1979.

But in the 1980s the economy picked up, with, apart from the odd wobble, continuous growth up to 2007, featuring steady productivity growth. So that poses an obvious question. Was the pessimism about the limits to growth in 1977 unjustified? And is my current pessimism, if it is correctly called that, justified now?

What was behind that quarter century of growth? In Britain, reform of the nationalised industries, most of which were privatised, was clearly part of it. But the deeper causes were the advance of technology, and the development of globalisation, which meant the increasing use of cheap inputs from Asia. These advances gave people access to advanced technologies that have undoubtedly improved lives. I remember desperately searching for phone boxes to make calls in the 1970s; nowadays almost everybody has a mobile phone, a product that was science fiction in 1977, but made cheap and accessible by technology and globalisation. But the growth was skewed. Whole industries, such as coal mines, were closed down or gutted. Those years are not remembered fondly in many areas of northern England or Wales, which were devastated (in common with many equivalent areas elsewhere in Europe and in North America). Most of the benefits of growth went to better educated middle class people, the yuppy generation, of which I was one. And a lot, much more than in the previous half-century, went to a tiny elite of super-rich. Inequality rose dramatically up to 1997 in Britain; it has stabilised there since, but continued to advance elsewhere in the world, notably the USA. Progress for working class people was much more mixed. Globalisation, and the backwash of decolonisation, also led to a freer movement of people within and between continents, which built resentment amongst those who stayed with their historic communities. So when the good years came to an end with the crash of 2008, there were all the ingredients for a populist backlash. Moreover, when examining the pattern of growth, much of it depended on Hirsch’s positional goods, or services which do not directly support increased human wellbeing (investment bankers, mortgage advisers, lawyers, accountants, cyber criminals and security specialists, and so on).

And there is something else: the technology that underlay the growth may have been secure and lasting, but its other foundations were not: the post-Keynesian economic consensus, and the availability of cheap Asian imports. In order to keep the economic engine rolling governments allowed the build up ever larger quantities of private debt. A liberalised financial system, regulated by floating exchange rates, that eased the flow of capital between countries, helped this process along. But this is unsustainable in the long run. At some point policymakers have to confront the macreconomic problem behind it: which is that we are trying to expand the supply of goods and services faster than demand. Without artificial, government-provoked stimulation, the economy sinks. This is what is meant by secular stagnation. Meanwhile, as the Asian economies catch up with the west, the availability of cheap imports, so important to growth in that period, is fast diminishing, and is not being replaced by the development of other regions of the world.

What people failed to see in 1977 was how much of an impact that technological change would have on people’s lives, and how this would continue to improve human wellbeing. That potential for further improvement remains. But what the doubters were right about is that the conventional way that economists link human wellbeing to economic growth was breaking down in the developed world. It is now in complete ruin. But most policymakers are still in denial.

We need new economic thinking based on wellbeing and sustainability

If the political right and left can agree on one thing, it is the centrality of conventional economics – the quest for economic growth and rising productivity. For a few moments after the great crash of 2008/09 people suggested that conventional economics had had its day. But it just bounces back. And it fails to address the real needs of 21st Century society.

The right, the centre-right and even the centre-left remain entranced by economic liberalism, which the left refers to sneeringly as neoliberalism. This focuses on markets as the most efficient way of processing information on human wants, and that carefully designed incentives are the key to public policy in areas where markets fail. The centre-right and the centre-left are divided over the scale of government, but even the centre-left are wary about putting up tax rates, as a disincentive to work. The financial crash has not shaken their confidence, beyond showing the need to get banking right, though they are quietly putting even that thought on the back burner. If anything undermines confidence it is growing inequality. And yet while overall economic growth keeps going, at least in Britain and the US, they see no reason to question the foundations of their thinking.

That the left is as attached to the old economics as the right may seem surprising – they often claim that capitalism has failed and must be replaced. And yet their various policies need plentiful taxes, and they need a growing money economy to deliver this. They have received a boost from such conventional economic luminaries as Paul Krugman and Joe Stiglitz, who emphasise Keynesian fiscal expansion, and are critics of what the left calls “austerity”. Indeed opposition to austerity is now the rallying cry of the left. That this implies subscription to a prosperous capitalist economy is a paradox that does not seem to trouble them.

There are two basic, and linked problems with all this. Firstly that, for a variety of reasons, the potential for economic growth is sharply reduced in the developed world. Policies aimed at stoking it up are doomed to failure – usually in the form financial bubbles. Second is that it is largely addressing the wrong questions.

What are the right questions? Simple. How to promote human wellbeing. How to secure the future of the planet.

Consider human wellbeing first. Conventional economic theory puts the idea of “utility” at its heart. Utility is shorthand for the point of it all. But it doesn’t waste much time asking what this is, it just assumes that there is a hidden force behind market demand whose implications can be modelled with some relatively simple mathematics. And yet human wellbeing must surely be the point of all, and it is well worth taking a detached look at what this might be. This is, in fact, a flourishing field of study in modern economics – though it has failed to touch what I have called conventional economics.

This study highlights how important are things that are not easy to integrate into the market economy, and not related to quantity of consumption of goods and services: family life, local communities, public goods, and so on. After certain basic needs are met – sustenance, shelter, health care – higher levels of consumption do not securely lead to better wellbeing. And so an ever higher level of overall consumption – the central tenet of conventional economics – ceases to be important. This is actually quite obvious if we look around us. Public policy types might bang on about the need for ever greater economic productivity to promote our wellbeing, but this seems far from most ordinary people’s minds. The great modern invention is the smartphone – but its big impact is on how we run our personal lives, not how we participate in the conventional economy. People seek out goods produced in environments of low productivity (organic goods, hand crafted clothing, etc.) because they confer higher status, or carry some other aura. And so on.

But there is a trap lurking in the promotion of wellbeing economics. Some want to reduce human wellbeing to numerical measures that can be used as a sort of replacement GDP. And yet the key to human wellbeing is human agency. It is something we must all learn to acheive for ourselves in our own way. The use of numerical measures implies that it becomes the responsibility of public policy makers – and that will be ultimately self-defeating. Public policy is better directed towards limiting human misery and providing basic needs – and not taking direct responsibility for human happiness. It is vital that people learn to take responsibility for their own lives, and not just blame everybody else for their problems.

And then there is environmental sustainability. The threat to the planet that we inhabit from excessive human consumption should be obvious to all. The threat to the atmosphere from an imbalance in carbon emissions is only the most immediate and serious aspect of this. And yet a public philosophy based on ever higher consumption cuts across this. Of course the unit impact of that higher consumption can be moderated. Energy efficiency is hardly incompatible with economic growth. And reduced environmental impact and economic growth are not necessarily incompatible. It is just very unhelpful to keep focusing on consumption for its own sake.

What difference does all this make? Here are thoughts, each of which needs to be explored in greater depth – something I hope to do in future blogs.

The state can’t keep growing. Tax revenues are dependent on the money economy (indeed you can argue that the whole point of money is to pay tax). If that’s not going to grow, and we can’t assume it will, we must find better ways of solving our problems than expanding the state’s resources. I think that means a more joined-up and localised approach, drawing strength from local communities.
We need less debt. Debt as currently conceived is a dehumanising process that increasingly leads to financial bubbles. Finance should be based much more on risk sharing instruments such as equities. We should approach this by steadily reducing creditors’ rights, as well as bearing down on the tax privileges associated with debt.
We need to rethink housing tenure. Our homes are central to our feeling of wellbeing. But clearly things are wrong. Property ownership seems to be privileging a lucky few. In the rented sector too much power is put in the hands of landlords to trash the lives of their tenants. Somehow we need to improve tenants’ rights while ensuring that there is a sufficient supply of decent homes.
We also need fresh thinking on employment. The employer-employee relationship is too often exploitative. And yet flexibility of employer-employee relationships often leads to a more efficient use of resources (consider Uber and its ilk).
We should stop worshipping scale. Large organisations, from government agencies to big companies seem to be privileged. We lazily assume that scale leads to efficiency. It sometimes does. But too often it simply destroys local knowledge and human relationships.

I could go on. Tackling these problems will require reform of political institutions and public services, as well as the system of legal rights in which our society works. But a future where we are both happier, and reduce the strain on our environment is surely attainable. I think this is a fundamentally liberal idea – but it is possible to build broader political coalitions behind reform. But we badly need to move on from the staleness of the current political debate.

Wanted: a new approach to economic management. Liberals should lead the way

The 1940s fighting the 1980s. There is something desperately stale about the debates over economics in the Labour Party right now. It is a battle between two approaches that have run their course. Meanwhile, on the Conservative side, the 1980s approach is unchallenged. On the principle that these things change every forty years or so, we should be setting our sights on something fresh. What will it look like?

Followers of David Boyle will recognise this narrative. The 1940s ushered in the era of social democracy. This featured economic growth through increases in mass production and mass consumption. An aggressive private sector was balanced by a growing state sector, both in terms of state services and transfers to the less well off. National governments reigned supreme, operating within an international system of fixed exchange rates. Keynesian economic management was unchallenged. Many important national issues were settled by negotiation between government, employers and trade unions – the balance between the three varied from country to country.

In the 1950s and 1960s living standards in the developed world – mainly the USA, West Europe and Japan – advanced steadily across all levels of society. But in the 1970s things fell apart. Environmental constraints took the gloss off the idea of ever upward consumption, especially of energy – as oil prices escalated. The Bretton Woods exchange rate system collapsed, taking the lid off disciplined monetary management. State run services became monstrously inefficient. State bureaucracy was vast and notorious, with not a little taint of corruption, especially (in the UK) over public housing. Arbitrary and misconceived development projects abounded. A massively expensive foray into nuclear power was perhaps the most egregious in this country – a huge waste of public resources for which nobody has ever been held to account.

This led to an economic crisis as the government wrestled with unreconcilable demands, ushering in a period of simultaneous inflation and high unemployment, supposedly impossible under the conventional Keynesian economics of the time . In Britain a major feature of this crisis was a rampant trade union movement, which openly flouted the rule of law with its use of mass strikes and picketing to support inflationary wage increases. Government finances became unsustainable, with the IMF having to stage a rescue in the late 1970s.

The crisis of the 1970s brought about the rise new thinking. This I will call “neoliberalism”. This word has become something of an all-encompassing hate-word on the political left, which has drained it of much of its meaning – but it remains a convenient term. Neoliberalism encompassed a wide variety of perspectives from the far right to the centre-left. It was essentially a rebellion against excessive state power. The state’s attempt to manage the economy was doomed to fail, they said, because of inadequate information and distorted incentives. In its place they advocated solutions based on markets – seen as the most efficient way of to reconcile information on supply and demand – and carefully designed incentives. Taxes should be cut to improve incentives to enterprise and hard work. At its heart was a liberal idea: personal choice should be at the heart of everything.

In Britain neoliberal thinking took off with the administration of Margaret Thatcher, who came to power in 1979. It was given a new lease of life by Tony Blair and Gordon Brown’s New Labour project, as they tried to combine a large state with neoliberal principles of management. How successful , or not, all this was is a matter of deep controversy. But in the early to mid 2000s things seemed to be going well enough, with a record of continuous, steady economic growth and generally improving living standards. Then things started to fall apart with the financial crisis which started in 2007, the aftermath of which still seems to drag us down.

But the styles of economic management only tell part of the story. Behind them lie important important developments in technology and patterns of world supply and demand. In the 1950s technology delivered a host of mass-produced household products, from cars to fridges to brightly coloured fabrics, which provided the basis of both expanded production and consumption. By the 1970s the markets for these products were becoming saturated, with a greater focus on quality and status rather than quantity. From the 1990s the world saw the rise of globalised supply chains, and the explosion of information technology. While economic growth in the old developed world can be questioned (much of it went to a rich elite, or went up in smoke in the crash), there was astounding growth elsewhere, notably in South Korea, China and India. This latter growth followed the adoption of neoliberal policies (though alongside a strong state) and is better evidence of their efficacy than progress in the old developed world.

But regardless of how successful they were, many think that neoliberal ideas have run their course. They do not offer an adequate template for future economic management. Low pay or unemployment is rampant; property values disappear out of reach to most younger people, unless they are helped by parents; large swathes of the country seem stuck in permanent depression; many public services, especially health, are cracking up under increased demand with which the tax base cannot keep up. Meanwhile questions of environmental sustainability persist, especially as it is clear that current levels of global carbon emissions will eventually kill the planet. It is not clear how neoliberal policies will be able to meet these challenges. And many neoliberal ideas look like downright failures – especially financial liberalisation and the attempt to manage public services through markets and numerical incentives.

So it is not surprising that many on the left look back fondly to the heyday of social democracy, conveniently forgetting its failures and the underlying circumstances that made it feasible (expanding demographics; low manufacturing productivity; and so on). But ultimately this is even less convincing. It is quite laughable that the left refers to itself as “progressive”. So what will the shape of the new economic management be?

The first point to make is that the point of it all is improved wellbeing for the general public and especially the least fortunate. We need to completely detach this from the idea that improved wellbeing is based increased levels of consumption of physical things like food, raw materials and energy. This may be so for the poorest in society, but that is a problem of distribution. Most people have more than they need, and many grotesquely more. This is a simple observation, but given how much of the current economic debate revolves around increasing levels of consumption and raising productivity, it does point to the need for a new mindset. Incidentally, reduced consumption of physical things is not necessarily incompatible with conventional economic growth – but focus on growth is not helpful.

The second thing to observe is that improved wellbeing will come from stronger individual empowerment, and stronger local communities. This is common sense, but it is supported by plenty of academic research. It seems to me that the main barriers are unequal power relationships, and dysfunctional services. And these in turn come about through an excessive concentration on specialisation and scale. The neoliberals were right about big, boneheaded national governmental institutions – and even their imitators at more local levels. These are incapable of the effective coordination required to help most people in need. But so many of our private sector choices seem to be based on similar inhuman systems – national and international chains incapable of responding to the needs of whole people. The advance of these institutions is hollowing out local communities while failing to deliver what people really want.

This requires a new management approach that is less focused on national and international institutions, and more on the health and wellbeing of people and their communities. I will build on this in future blogs.

But one thing is very clear. Such a new approach is fundamentally a liberal one. The conventional left, in both its “hard” (think Jeremy Corbyn) and “soft” (think Ed Miliband or Andy Burnham) forms is still to attached to national institutions to be controlled by a small, enlightened elite and serving a grateful nation. Conservatives may be suspicious of the state, but they are very attached to large commercial corporations and global financial markets, which are surely part of the problem and not the solution. There is some hope in the Green movement – though its British incarnation needs to reverse out of the hard left blind alley in which they currently find themselves. But political liberals, especially those who understand community politics, are the closest to reaching the answer. I want to help move them along that path.