Tag: UK economic policy

Britain’s politicians are in denial – are the voters?

From the Office of Budget Responsibility: Economic and fiscal outlook November 2023

This week’s Autumn Statement by Britain’s Chancellor of the Exchequer, Jeremy Hunt, was a miserable affair, full of political chicanery with little to effort to tackle the country’s deepening problems. Worse yet, the opposition parties (Labour and the Lib Dems anyway), for all their huffing and puffing, are also unable to face up to these problems.

The Conservatives billed the set of measures as the biggest set of tax cuts since the 1980s. And yet the overall tax burden is rising as the freezing of tax allowances and thresholds will bring ever more people into tax or higher rates of tax, and increase the proportion of income people pay as tax. An even bigger problem is that the government has been using inflation to squeeze public spending, while services across the board – health, education, the police, the courts, and the list goes on – are clearly overstretched and in many cases breaking down – with collapsing buildings and rising waiting lists. The Chancellor offered not a penny to alleviate this crisis, while planning a further squeeze in the years ahead. Labour and the Lib Dems gleefully pointed out the first problem, but failed to address the second. They will stand by the announced tax cuts, while offering only gestures (taxing non-domiciled residents, or private schools, for example) to help fund public services. These tax-raising wheezes are nowhere near enough to match the scale of the crisis. Meanwhile all parties suggest that a bonanza of economic growth is coming to the rescue, without acknowledging the severe headwinds that will limit the country’s long-term growth prospects.

I am also highly sceptical of the one measure that seems to be getting widespread support – the full expensing of investment in machinery and systems against corporate profits. It is said that this will boost business investment, which is sorely lacking. It is in a fact the revival of a policy that failed in the 1980s, and was abolished by Nigel Lawson, the Tory tax-cutting Chancellor, who has been about the only holder of that post in memory that had a grasp of how the tax system as a whole worked and could be reformed. Back then it created a tax-avoidance industry and encouraged wasteful investment with fancy kit, rather than the thinking through of business processes which is the real key to improved productivity. That fiasco occurred at the beginning of my professional career as a Chartered Accountant, where I could see the nonsense it was creating up close. Alas the current crop of politicians and their advisers are too young to remember this. And it is of little use to new businesses, where the need is most acute, as these typically do not generate enough profit for this to be of use. What a silly waste!

Meanwhile the fiscal climate is getting a lot worse. Interest rates are rising at time that the size of the national debt is historically very high. If interest rates are higher than the overall rate of growth, and there is a budget deficit, then a debt spiral threatens, which, if it leads to an international loss of confidence in the public finances, could usher in a severe financial crisis. At the moment it is actually quite hard to understand how much of a problem this is. You should be comparing real interest rates to real growth rates – i.e. after inflation. But there are mixed signals on real interest rates. If you compare the nominal rate on government lending, it is if anything less than reported inflation – indicating a negative rate. But yields of index-lined bonds are positive and have risen sharply. Meanwhile the budget deficit is quite high – at 4% of GDP. It wasn’t so long a go when none of this seemed to matter. Interest rates were low, and the Bank of England’s Quantative Easing (QE) programme made large government debt look manageable. But conditions have changed. Inflation has made money much tighter – with interest rates rising, and QE going into reverse. I am starting to suspect a deeper change is afoot in the world’s capital markets. Earlier this century a number of countries ran large trade surpluses – notably China, Japan and Germany. This made trade and budget deficits more stable in countries like the UK and US, as the surplus countries had plenty of spare currency to provide funding. As the world’s trading environment is getting more difficult, this may changing – though it is not yet evident in public statistics. After over-reacting to fiscal risks in 2010, and moving into austerity too quickly, the opposite risk beckons. But the Autumn statement proposes tackling the budget deficit only slowly, leaving the very high level of net debt virtually unchanged. Politicians seem to assume that as inflation comes down things will simply go back to the easy financial environment that pertained before. This is complacent.

More from the OBR report – government plans make little impact on public debt

If that is complacency, the politician’s attitude to economic growth is outright denial, though some economists who should know better seem to be in the same place. It is assumed that the UK’s poor performance has an easily fixable cause. More investment perhaps, or encouraging more people into work, or perhaps lower taxes. Rachel Reeves, Labour’s Shadow Chancellor, blithely talks about sorting out public services through economic growth – even applying the first-person to the process, as if growth was the gift one individual, and not the collective result of many millions of decisions. International comparisons seem to show that Britain’s productivity lags against peers. All that we need to do is fix this, the argument goes, and we will unlock growth. Well it may be that a burst of catch-up growth that is obtainable – but I suspect that these comparisons reflect an irreversible de-industrialisation, when a swathe of high-productivity industries left the country in the 1980s and 1990s and will not return. But stepping back, most or all of the developed world faces a number of headwinds that reduce growth potential, and in some case send it into reverse:

  • Demographics: more people are retiring as lower birth rates take their toll. Immigration can make up some of the difference, but is politically fraught, and stresses housing resources.
  • Trade: as globalisation runs into reverse, gains from trade are turned into losses. The UK is spared the American obsession with “near-shoring” or the reversal of the off-shoring of industries – but we have our own demons unleashed by Brexit.
  • Overdevelopment. The increasing consumption of goods, a critical driver of past growth, is simply a phase in economic evolution that has clearly ended. People move on to improve their quality of life in other ways. Meanwhile massive increases to the productivity of manufacturing industry mean that its impact on the total economy is much reduced. All this means that lower productivity parts of the economy, including many public services, loom larger. Productivity gains are harder to get, and where they happen the result is not so much increased production, but a transfer of resources to low-productivity sectors.
  • The energy transition. The country needs to make big investments to sources and distribution of energy, and its more efficient consumption. While the end result is desirable, in the meantime this will push down consumption. This, in fact, applies to pretty much all forms of investment. The country has become used to high consumption and low savings – reversing this won’t necessarily reduce growth as it usually measured, but to many people it will feel that way.
  • Housing. One way of achieving growth, or at least burst of catching up, is to allow people to move to places where the most productive jobs are. But these areas lack enough housing to accommodate this. Britain’s house builders have growth rich on the skilful management of land portfolios, rather than the actual building of houses, which many are actually very bad at. They have no incentive to increase the pace of building. And if the pace is increased, skill shortages quickly become evident. And I haven’t even mentioned slow and restrictive planning processes. Politicians at least show some awareness of this issue, but action never matches the promises.

The days of steady economic growth over the medium to long term are over, whether we like it or not. The best we can hope for is a short-term spurt. There is plenty of potential for human wellbeing to improve, but this will manifest itself in other ways.

The central problem is the funding of public services and maintenance of social safety-nets. A combination of two things are required here. The first is higher levels of taxation – and mainstream taxes which directly affect demand, and not gimmicks around capital and wealth (the latter may help make debt more manageable, but won’t suppress demand and prevent inflation). The second is a radical reform of public services so that demand for them is reduced – reducing the level of social problems, so that we require fewer police, courts, hospital beds, etc – and managing those problems so that they are solved early rather than passed from agency to agency. Alas we have very little idea how to bring such a change about – though we can see that some countries do this better than us (Japan, Switzerland, Denmark perhaps). A radical reform of government is clearly a part of this, with less centralised control – but it needs much more than this: decentralisation by itself could actually make things worse. With the possible exception of education (which has become more effective rather than cheaper) the reform efforts made by our governments in the last twenty years have taken us in the wrong direction – from Labour’s over-centralisation, to the de-skilling and outsourcing of the Conservative and coalition years. Unfortunately the choice between the two approaches of higher taxes or radical reform is not a binary one. Reform will require substantial investment, and that is likely to mean higher taxes in the short term at least.

If our politicians are in denial about all of this, how about the public? They surely understand that public services are in a dire state – and that fixing this will not come cheap. But they are too wrapped up in their own personal struggles to spend any energy on demands for change. Politicians are in denial for a reason: they don’t just a lack imagination and perception, but they also know a voter-loser when they see it. Still, Labour are clearly presenting a more realistic prospectus than the Conservatives, even if it is based on wishful thinking. Their poll lead at least seems to show some wider awareness by the public at large. And we must grasp at that straw.

Why the language of economic growth is obsolete

Screenshot from the Bank of England’s Explainers

I apologise for not posting for some time. Feelings of futility and despair at politics have made gardening and painting model soldiers a more attractive pastime. I started an article last week, but this collapsed in a muddle. This time I want to step back and set current debates over the political economy in the broader historical context – to suggest that we need to adjust our expectations to profound changes to the way economies work. Above all this means letting go of ideas about economic growth and all the baggage that goes with it. The implications for our politics are profound.

Economists sometimes like to portray their discipline as the description of immutable laws. They show tables of statistics (or rather graphs – see above) going back centuries – with uniform metrics such as income, prices and productivity. The idea is to present the economy as a continuum, even if as the world behind it changes. This might lead us to think that the tools of economic management are of timeless relevance. What if Keynesian demand management had been discovered earlier! But this is really an attempt to project the present back into history. The world has been changing profoundly over the last three centuries and the economy with it. With these changes come changes to our ideas of what economic management is about, and politics with it. But the process is slow and complex, and it can be hard to appreciate it at the time. That’s why I think it is helpful to paint a picture of how things have changed in the past, to give an idea about how things might be changing again now. I like to rationalise the past into a series of epochs – but, of course, each each moved seamlessly into the next. This narrative is based on how things were in Western Europe in particular, and by extension its colonies in North America.

The first epoch was the Age of Subsistence, from Medieval times into the 18th Century, which was overwhelmingly agricultural and marked by stasis. There were important technological developments, and the changes to trade patterns also had important impacts. Textiles, mining and iron working played a role, leading to occasional local booms and some nice stone buildings for us to see today. There was sufficient agricultural surplus to support a number of cities and towns. But the overall picture was fairly static and based on agriculture, mostly of a subsistence nature. The vast majority of people worked on the land in a very low-productivity agrarian economy. The big political idea was that people should know their station and not get beyond themselves. The idea of abolishing poverty was considered to be delusional nonsense. God created a world ever divided between the aristocratic rich and the peasant poor, and that was that.

Then came the Industrial Revolution, which was initially based on textiles and agriculture. Farming became more efficient, not so much directly from changes in technology, as from the application of scale economies, with enclosures and evictions. Agricultural surpluses could be moved by canal, and the cash economy expanded. Labour moved to textile mills, where mass production techniques were developed. Also at this time slave labour was used in overseas colonies to produce such products as sugar, tobacco and cotton. Trade grew in importance and a substantial middle class emerged. Social mobility became more of a feature of society. A lucky few managed to climb from working class to middle class; an even luckier minority of middle class people aspired to the aristocracy. But the labouring classes saw no improvement in their lot. There was no move to reduce poverty. But the new middle classes questioned the ways of the governing elites and this had a profound political impact – most notably be the American and French revolutions – but also with such things as the anti-slavery movement in Britain.

This moved, in the 19th century, to the Age of Heavy Industry. This saw the rise of railways and steel. Infrastructure (railways, ships and sewers for example) and armaments became the centre of attention. Right though until the middle of the 20th Century, economic success was measured in terms of the rise of heavy industry. Hermann Göring’s statement that “Guns will make use powerful; butter will make us fat,” summed up the way that most people thought about economic policy. Stalin’s building of Russian heavy industry at the cost of millions of lives was generally considered to be tough but rational. But improving the lot of the poorest did start to command political attention, as working class movements rose. Sanitation improved, free education was offered to all, and a welfare state started to emerge. This age culminated during the Second World War, which was largely decided by industrial production. But it quickly morphed into the Age of Light Industry. Many of the technological developments forged in the war, such as plastics, turned out to have applications in consumer products. And the need to switch away from war production offered the opportunity to greatly expand the production of mass market consumer goods. Pretty soon mass consumption was considered to be the top priority for the political economy. The concept of economic growth was developed to reflect this and the prospect of abolishing poverty. The West won the Cold War because the Soviet empire could not compete in the production of consumer products, and its leadership lost confidence in their raison d’être.

Something else profoundly important developed alongside the consumer economy: the rise in the role of the state. The state greatly expanded in wartime, intruding into all aspects of life. People noticed that rationing meant that austerity in the nation as a whole did not mean that the poor had to starve – indeed nutrition for the poorest improved in Britain. This vindicated a role for the state in providing a social safety net, with health insurance, unemployment pay, expanded pensions and so on. Productivity was high enough for agriculture and consumer goods that there was room for a growing state sector. Politics became managerial, with politicians promising to offer prosperity to all. Social mobility exploded.

But the world has moved on. Many noted a major change in political and economic thinking in the 1980s, following he economic travails of the 1970s. There was a push-back on the growth of the state and on organised labour. De-industrialisation started to take hold as productivity continued to advance in manufacturing. The rise of Asia, starting with Japan, offered gains from trade as cheaper manufactures could now be imported. But growth in consumption still dominated expectations. Manufacturing industry was still considered to be the core of the economy, much as agriculture would have been in the 18th Century.

How things have changed… More from the Bank of England article

To understand how things have changed, consider a few things about the world around us, in developed economies. First are the signs of saturation in consumer demand. Of course there are plenty of people struggling with the basic necessities – but they are a minority. Meanwhile people buy cars absurdly over-specified for their needs, and leave them parked outside their homes doing nothing most of the time. People buy clothes to wear once or twice before they are discarded. Much of people’s wealth is spent chasing things that are not made – notably land for homes, even if just for temporary residence rights. A lot of “consumption” is in fact about the acquisition of status symbols.

Then there is the idea that consumption is actually bad for us. Environmental degradation is one example; climate change is another. And then there is health. Highly processed foods, where agriculture and manufacturing meet, are clearly damaging to our health, and one reason that life expectancy is now in decline. And yet to economists they are ideal commodities: based on high productivity and promoting over-consumption, and thus with beneficial economic impacts. Better off people increasingly choose products that are healthier with reduced environmental impacts (though still prone to massive over-consumption) – but these imply reduced productivity – the biggest crime there is in the Age of Light Industry.

And then there is changing meaning of “quality of life”. Once this meant being able to consume commercially produced things to the maximum extent. But increasingly this is taken to mean working less hard. People take earlier retirement if they can – notwithstanding that many are physically able to work for longer (your blogger is guilty as charged). The recent pandemic has led to an explosion of demand by employees to work from home – even if it means being paid less. Evidence mounts that this reduces productivity, but most employers are forced to compromise. Working longer – or expanding the workforce – is, after raising productivity, one of the core strategies of a growth economy, and it is being thwarted.

Consider health care too. This comprises a growing share of the economy (in some places it employs more than manufacturing, I suspect). But it is is peculiarly ill-suited to the sort of quantitative analysis that likes to see things in terms of output and productivity. New therapies are developed; these solve problems that were unsolved before – but often require a greater level of inputs. Demand is insatiable; the share taken of the total economy grows.

And economic growth is slowing, much to the worry of economists. Many of these point admiringly to the more “dynamic” American economy – but Europeans question whether small holiday entitlements, poor life-expectancy, terrible inequality, and high environmental degradation are actually worth it. What if slow growth is the result of the freely made choices by those welfare-maximising agents, beloved of classical economists? Economists and politicians have to adapt to the reality – rather than try to make people behave according to an outdated model. This was the terrible strategic mistake made by British prime minister Liz Truss’s catastrophic regime.

The overall narrative is easy to see if you are willing to look. Technology has so advanced, and environmental imperatives have so grown, that a focus on people’s true interests and wellbeing does not involve increased levels of consumption – and will often lead to reductions. Investments in new, cleaner energy infrastructure will create jobs but not lead to economic growth in the sense that we have understood it since 1945. But where this leads is harder to discern. Politicians are right to worry about the lack of growth. Demand for public services remains high, but the economic model for managing supply and demand is breaking down. The current model is that people pay taxes, which limits demand for private sector goods, allowing economic space for public services. But if demand for private services stagnates or declines, while that for public services expands, this means that taxes have to rise. That is a political challenge – the connection between what you personally pay in tax and how you personally benefit from publics services is a weak one. That becomes even harder if the size of the workforce stagnates or declines because people would rather not work, and have sufficient savings to fulfil that desire.

So far politicians, economists and, indeed, the public at large cannot imagine a way of meeting the crisis in public services without stoking economic growth. The Labour leader, Sir Keir Starmer, says that growth is at the heart of his strategy for government. But it won’t work. And this fact, and its consequences, will dominate politics in the coming decades.

Advances in technology give us the opportunity to continue advances to human wellbeing, even while reducing harmful impacts on the environment. But assuming that this will come abut through economic growth is mistaken. We need a new language to describe the economy. In future posts I will try to develop ideas about what his actually means.

The mood darkens on inflation, but there is no sign of a sensible political debate

Yesterday Britain’s state statistical agency, the Office for National Statistics, released inflation figures for May 2023. The headline figure of 8.3% was unchanged from April, but the “underlying” rate (CPI excluding energy, food, alcohol and tobacco in the above chart) continued to rise. Commentary on the BBC Today programme and in today’s Financial Times was notably dark. There seemed general agreement that the Bank of England would have to increase interest rates, and keep them higher for longer than previously expected. And indeed the Bank raised rates by a full 0.5% later in the day; 0.25% had been widely expected.

Until now two overlapping narratives about inflation had been prevalent among the commentariat. The first, call it “global shock” is that the rise in inflation since 2021 has been essentially a temporary one – driven by higher oil and gas prices, and exacerbated by the war in Ukraine, which affect all developed economies. The thinking was that these would either reverse or get baked in (i.e., drop out of the 12 month statistics). When the prime minister Rishi Sunak set out his five main priorities at the start of this year, halving the rate of inflation came top. The general view at the time was that this target would be achieved without any government action so that the Mr Sunak could take credit for a statistical artefact. While it was popular to criticise central bankers for thinking that inflation would be “transitory” when it first started to rise, it hasn’t stopped many people from thinking that themselves subconsciously. The second narrative, “supply shock”, was a bit more subtle: it was that inflation this time was a supply-side phenomenon and not resulting from excessive demand. The upshot is that the solution is not to crimp demand by raising interest rates, but to wait for the supply side of the economy to correct – indeed raising rates would only reduce the investment needed to fix the problem. The supply side issues referred to included the energy crunch, but also the repercussions of the covid-19 pandemic on supply chains.

These narratives are breaking down, especially as the rate of price increases in services persists. This seems directly related to rising levels of pay, which have also come through in the statistics. While some academics suggest that the “wage-price spiral” of 1970s fame is no longer a major dynamic (see here in The Economist), there seems to be what The FT’s Chris Giles calls a “ratchet”. Pay rates increase in response to energy prices, and this feeds into service costs, which in turn might lead into further payrises. Meanwhile supply side issues do not seem to be sorting themselves out; labour shortages are ongoing. This seems to be particularly strong in the UK. Various things catch the blame for this: EU nationals going home after Brexit; lack of flexibility in the post-Brexit immigration system; more chronic illness; people retiring earlier than expected: take your pick. What is now clear is that if inflation is to be limited something has to be done to limit demand.

At this point the economic illiteracy of the political class becomes evident. Many hang on to the idea that responsibility for managing inflation rests with the Bank of England alone. Some seem to believe that this can be done in some kind of immaculate way without hurting economic growth, or at any rate that there was an opportunity to do this if the Bank had reacted to initial energy price shock sooner. The previous Prime Minister, Liz Truss, seems to have held this view, and now a number of government advisers are briefing the press along these lines. In fact the Bank was following a firm consensus shared by the government, and the political stink that would have arisen if it had tried would have been a sight to behold, with the “global shock” and “supply shock” narratives being widely trumpeted. Now at least people are understanding that “if it isn’t hurting, it isn’t working”, an idea that was widespread dung the last inflation crisis in the 1990s. And yet the hurting seems to be concentrated on one particular group: home-owners with mortgages. Well there are others: public sector workers, where the government is fighting hard to limit payrises, and people living in rented accommodation, as rents are on the rise (although the reasons for the rental problems seem to be complex, with interest rates only one factor). Many others, such as people who own their homes with mortgage paid off (like me) are under no special pressure. All this does not seem to be especially fair.

The political debate around this is laughable. Labour’s priority is to try and blame the crisis on the Conservatives. And yet they cannot point to a clear “told-you-so” moment to show how they might have done anything differently. Neither are their ideas on tackling the crisis now conspicuously different. They give the impression that they would be easier on public sector pay, but not how they would manage the fiscal consequences of this. Their very limited tax raising ideas to cover extra spending would do nothing to manage demand in the economy. The Lib Dems suggest a hardship fund to help the most pressurised home-owners; this is not as mad as the thoughts of some Tory backbenchers to offer tax relief to all people with mortgages – but would still need to be balanced with a tax rise that hurts demand, which various forms of tax on excess profits would not. Supporters of Liz Truss would focus more clearly on various supply-side problems, like the need to build more housing, but wreck this with their advocacy of lower taxes. Instead of this hot air, two particular ideas should be current in political circles.

The first is that we could manage the demand side of the economy more fairly through raising taxes. By this I don’t mean the various tax gimmicks that opposition parties try out which could raise funds without hurting most people (windfall taxes, taxing rich people’s perks, non-doms, and so on) – as the “if it’s not hurting, it’s not working” mantra applies here too. It means putting up taxes on the big three – income tax, VAT or National Insurance. In practice, that means income tax. National Insurance lets rich pensioners off; VAT is too hard to explain when trying to fight price raises, at its short-term effect is to increase inflation. To be fair, the government is raising income tax by refusing to raise allowances and thresholds, causing “fiscal drag”, though they don’t want to draw attention to this. But more needs to be done – and if it was, there would be less pressure on interest rates.

The second idea is to suggest that inflation might not be such a bad thing after all, if it means a rebalancing of pay to those currently earning less. This would flow from policies to limit immigration of lower-skilled workers, for example. The corollary of this would be to temporarily raise the Bank’s inflation target, and to find ways of cracking down on profiteering by businesses (so that the benefits of laxity went to the workers, not business owners). That, incidentally, is a bit harder than it might seem, as one of the side-effects of inflation is to create false profits from the time lag between paying for inputs and billing for outputs. That would be a distinctly socialist approach, but surely no madder making mortgage holders bear the brunt of the fight against inflation. A bit of dialectical debate around this idea, and that of tax rises, would do no harm. But both are politically toxic.

High inflation, and increasing hardship for a growing number of people, is the result of multiple problems in the British economy. Strong political leadership will be needed if the outcome is to be a fairer society – which it could be. Alas no such leadership is in sight.

Brexit: the capitalist advocates have been proved wrong

Picture: Institute for Government

The third anniversary of Britain leaving the European Union caused of a spate of comment in the media a couple of weeks ago. For me it was a moment of great sadness, but I’m trying to move on – though I still wish political destruction on every politician that advocated it. But it is as good a moment as any to reflect on what has happened.

Opinion surveys show that people who voted to stay in still think they were right to do so. They think that the arguments made in favour of staying in have been borne out. Some of those who voted to leave feel they made the wrong choice, though. But mostly they don’t – they think that it is too early to tell, or that the opportunities have been mis-handled, or they are actually happy with they way things have unfolded. What unites most from both sides is a sense of gloom, and a lack of confidence in the government. Another thing that seems to unite both sides is a wish not to reopen the debate.

In terms of the economic statistics it is very hard to isolate any economic effect of the change, especially when the Covid pandemic, the war in Ukraine, and the escalation of energy prices is confuses the picture. There is abundant anecdotal evidence that smaller British businesses have given up exporting to the European Union, or indeed to anywhere. But the aggregate trade statistics don’t paint such a clear picture. Investment has fallen since the referendum result: Brexit is an obvious culprit but it would be hard to prove it.

But if we step away from the economic statistics, some things are becoming clearer about Brexit. It isn’t too early to look at how the reality is working out against the vision. There never was a single vision, though. I can see three main ones: the globalist case, the isolationist case and the socialist case. The globalist case is the closest to the one the government espouses. This regarded the EU as a barrier to trade and free enterprise, for two main reasons. Firstly it entailed a substantial regulatory burden, covering not just products, but the way they were made (for example labour and environmental standards), and this raised costs. And second the EU raised barriers to trade with countries outside the union, which included rapidly growing markets in Asia in particular. Britain could be a country of free-wheeling (or even buccaneering) enterprise. Sometimes this was called “Singapore on Thames” – apparently by people who had little idea what of Singapore actually is – though doubtless an authoritarian, technocratic one-party state with a taste for intrusion into private life actually appealed to many of them.

It is becoming clearer by the day that this idea is nonsense. British people draw comfort from regulation, and every attempt to lighten the burden is met by howls of protest. And it is far from clear that changing regulation will have an economically beneficial effect in more than a few limited areas. Indeed it seems to many that life outside the EU involves more red tape, not less – for imports and exports, travel and immigration. Meanwhile almost all trade deals so far struck with countries outside the EU are little different from what the country had inside. The exceptions are Australia and New Zealand, which will have little impact, and probably not much that is positive for British businesses (but maybe better for British consumers). Doing deals with China, India and America – the big prizes, has proved much harder than envisioned. Brexit supporters are now talking darkly of a conspiracy of Remain-supporting establishment types undermining progress – but a lot of the trouble comes from their on side (especially so far s reactions with India and China are concerned). But the logic never was very convincing. The kindest suggestion is that it is 20 years too late – perhaps there would have been more to play for when globalisation was going full throttle, rather than in its current gentle retreat.

But it is unlikely the most people who voted for Brexit shared this vision. They were drawn to an idea of Britain that was less integrated with the world around it, not more. This was focused on one idea in particular: “control over our borders” – limitations to immigration, rather than the free movement within the union. Supporters of this idea, like Nigel Farage of Ukip and the Brexit Party, did not point to any other countries as a model: Britain was one of a kind. Perhaps some people thought of Australia, a fiercely independent Anglo-Saxon heritage nation, with strict immigration rules. Suggesting an “Australian-style points system” to manage immigration received widespread approval, even though few people understood it or its implications. Another model might be Japan. Japan is an island that trades with its giant continental neighbour, China, but emphatically maintains its distance politically. It limits immigration, and, whisper it, prides itself on ethnic homogeneity (unlike modern Australia). It is also a highly successful country, that scores well on many indicators of quality of life. Economic growth in the last thirty years has been anaemic, but that only invites the question of what economic growth is for.

How is Britain doing under this isolationist vision? Free movement of people between Britain and Europe is now gone; many people from other European countries have left, and immigration from there is is now a trickle. All immigration is now subject to bureaucratic controls. If labour shortages have resulted, then this may simply be a first step towards giving local workers more opportunities. On this vision, things are going much better. There are three problems, though. One is an influx of refugees and others arriving in small boats on the Kent coast. I don’t think anybody had expected this to be so much harder to manage outside the union than within it; but the country can’t simply deport people back to France as it could before. This has turned into a major headache, especially for the authorities in Kent, and there are no convincing solutions that don’t involve doing a deal with the EU, which would involve accepting many more refugees legally, and undoing one of the perceived benefits of Brexit to isolationists. It is possible to take a bigger view of this: even allowing for this influx the country is taking fewer refugees than before. Unfortunately for the government, people supporting the isolationist view tend not to get such things in perspective. It is undoubtedly disorderly – though chicken feed to what Italy or Greece have to deal with.

A second issue is that, notwithstanding the hurdles, immigration has not reduced overall. Instead of people arriving from the EU, they are coming in from elsewhere. Fortunately for the government, the public seems much less stressed by this than by the boats. It is a relatively orderly flow of people after all, and by and large they are going into better-paid (or “high-skilled”) jobs that the economy needs, or paying extortionate student fees. But it does complicate the scorecard. The government can’t claim reduced immigration as a Brexit achievement. Indeed, every idea for reducing numbers, like cutting back on foreign students, looks like self-harm.

The third problem is that real wages are in steep decline, as inflation runs ahead of increases in pay. And the government is aiding and abetting this by putting maximum pressure on public sector pay. Brexit was supposed to increase wages by stopping low-skilled immigration. Perhaps supporters of the isolationist case, often retired, aren’t so bothered. But it is a long way from the case made for Brexit at the time of the referendum.

All this is indicative of a hole in the heart of the isolationist case. Australia has abundant natural resources it can exploit (or pillage, if you prefer – sustainability is not high on the Aussie agenda); Japan has a manufacturing industry that is still world-beating. There are world-beating bits of the British economy, but not enough. Nostalgia won’t bring back Britain’s once world-class manufacturing industry. Coal, oil and gas are in steep decline, if not dead. And some of the successful bits of the economy, like global financial services, benefit few, in the wrong parts the country, and have a distinctly dark side (the country was very popular with Russian oligarchs for a reason). The country has been running a current account deficit for over two decades, and, notwithstanding the depreciation of sterling, it isn’t getting any better. This turns out to be more sustainable than many economists thought – in the sense that it does not seem to be leading to the sort of financial instability that other deficit countries (like Argentina or Turkey) have suffered. But it does seem to be affecting the country’s terms of trade – though it is statistically hard to pin this down. According to one calculation the country’s real effective exchange rate is 83% of what it was in 2005 (i.e a fall of 17%). British people can buy less foreign goods and services with each hour’s earnings than used to be the case. There isn’t enough high-productivity, export-generating industry in the country. This problem has its roots in the relative industrial decline of the 1950s to 1970s, and the hollowing out of the the manufacturing economy under Margaret Thatcher. This largely pre-dates membership of the EU, and arguably was made worse by it. But somehow it was easier to cover the cracks within the Union.

The third case for Brexit I mentioned is the socialist one. This case has not yet been tested. According to this the EU is a capitalist-designed, anti-democratic system that prevents governments for taking their economies in a socialist direction. Not all (or even most) socialists followed held this view – hoping to reform the union from within – but its logic is solid enough. Holders of this view are fiercely defensive of national sovereignty – their aim being to take democratic control of the country, and drive through radical reform from there. Their economic reform ideas are not particularly popular (though perhaps not that unpopular either), but their ideas about national sovereignty are widely shared. Ironically, since the main advocates of Brexit were at the more aggressive end of capitalism, it is perhaps socialist policies that present the main national opportunities after Brexit. These will not fix the country’s export problem – export industries, other than mining or drilling perhaps, tend to need capitalist leadership succeed. But it may set in train a fairer distribution of income and wealth. I suspect that there is a hybrid of modern socialist and liberal ideas that could lead to a thriving society – and perhaps it is easier to pursue that path outside the EU, though I doubt it would make all that much difference. Other European citizens would be at least as interested in such ideas as the British are. Alas there are too few people anywhere who are pushing in that direction.

Is Liz Truss right about the “economic establishment”?

UK Treasury: Picture by Carlos Delgado, CC BY-SA 3.0, https://commons.wikimedia.org/w/index.php?curid=19020165

Last weekend former British prime minister Liz Truss reentered the public sphere with an essay in the Sunday Telegraph, and an interview with The Spectator, publications that are both relatively sympathetic to her cause. This has occasioned much derision in the wider media. While I share much of this derisive view of her, I’m not going to join the chorus – it’s been said too well by others. Ms Truss has simply reminded most people why they dislike her so much. I want talk about the issues she raises, both in terms of economic policy, and how it can be implemented in Britain’s institutional environment.

Ms Truss’s starting point is what is widely seen as the UK’s dismal economic performance since the great financial crisis of 2008-09. Economic growth has been dismal, and if Britain has been able to maintain the pre-crisis trend of growth, then, according to Tim Harford in the Financial Times, it would be a staggering 40% better off. She attributes this to policy mistakes – a view that seems to be widely shared, even if not many agree on what those mistakes were. Personally, I differ from this – I think that the lack of growth is a reflection of adverse economic conditions, which started before the crisis – principally demographics and a changed world trade environment, made worse by Britain’s lack of a strong manufacturing industry. Liz Truss’s solution is to go back to policies popularised by the US president Ronald Reagan in the 1980s, and often attributed to Britain’s Margaret Thatcher too, though in fact she was much more cautious. These are mainly a matter of tax cuts, especially for businesses and the well-off, and deregulation. What she particularly favours is to proceed with tax cuts without regard to short-term effects on the public budget deficit, in the belief that an expanding economy will make things good in the longer run. She was always reluctant to talk about cutting public spending, and in the case of defence, advocated a substantial increase.

Her views on tax are largely magical thinking. Tax cuts might directly stimulate growth by increasing demand, but not as efficiently as many other policies, such as more generous state benefits, and not at a time when inflation is running riot. Lower corporate taxes might attract inward investment – but they are not widely thought to be a major factor, especially when the country’s politics seem so unstable. To her credit, though, apart from tax cuts, she advocated supply-side reforms that stand a much better change of promoting growth. These included easing immigration rules and making it easier for parents of small children to reenter the labour market. These weren’t popular in her own party, though. In her speech to the Conservative Party conference she decried an anti-growth coalition – which it struck many observers as being mostly her own party. However, her supply-side ideas had nothing like the heft to make more than a small difference to the country’s growth rate. Tax cuts (or forgoing tax increases) were her only big idea.

She has a second huge blind spot: inflation. She does not appear to understand that this usually arises from excess economic demand – and therefore that taming it requires deliberately crimping economic growth. She persistently seemed to think that inflation was somebody else’s problem – in particular the Bank of England’s. I find it astonishing that somebody whose degree course included economics (PPE at Oxford) can have thought this way. Everything interacts with everything else, and if you are the head of government, you are ultimately responsible for all the tools of macroeconomic management. What individuals do with their personal time may not be government’s problem; what public institutions do most assuredly is, even if they are run at arms length.

But amid all this foolishness and and failure to understand how things actually work, she did touch on something that is true. She railed against the “economic establishment” (the Sunday Telegraph unhelpfully added “left-wing” to this in their headline, but she neither said that nor meant it). She was particularly vehement about Treasury orthodoxy, which she saw at first hand in two years as a Treasury minister. The power of this orthodoxy undermines, usually fatally, any attempt to implement policy that contradicts it. That included her fiscal policies. They didn’t have her back when things got rough, and they forced an about-turn on most of them. What is a bit less clear is how Ms Truss fits the people controlling the world’s financial markets into this orthodoxy. She and her supporters are trying to blame the derivative based policies used by many pension funds for creating an unstable situation, about which nobody warned her or her Chancellor, Kwasi Kwateng. The Bank of England, also part of the orthodoxy, should have handled this better, they suggest. Rather interestingly, when she describes these polices as allowing the funds to invest more in businesses rather than bonds, they sound like just the sort of pro-growth idea she should be supporting. Of course the real problem here was the imperious arrogance with which she and Mr Kwateng treated financial markets. And as for the Bank of England, it was widely known that it was struggling to manage markets because inflation had caused a reversal of its loose-money policies, especially Quantitative Easing, upon which markets had come to depend..

I have some radical economic ideas of my own, though quite unlike Ms Truss’s. These are that Britain is far too centralised, and that responsibility for the many trade-offs required in financial and wider policy need to be radically decentralised. It’s not surprising that people oppose housing or industrial investments in their local area, when they will not be accountable for the benefits. The tough decisions are made in Whitehall, leaving with nothing else to do but complain. But this is part of the Treasury orthodoxy too – they don’t want a chaotic decentralisation, with corrupt nobodies taking decisions without the Treasury having ultimate sign-off. When the government wanted to distribute funding for its “Levelling Up” agenda, it didn’t distribute funds for disposal by the city regions and councils, it made these institutions put in bids for the imperious mandarins to pick from. To be fair, government leaders seem a bit embarrassed about this, and say there will be changes in future. But how did they allow this in the first place? And what credibility do their promises to do things differently next time have? The Treasury will undermine any effort they make to reform things. It is now reported that the Treasury is refusing to authorise any capital projects proposed by the Department for Levelling Up. The Treasury isn’t all in the wrong here: the levelling up funding was originally envisioned by former prime minister Boris Johnson as a politically directed slush fund to help win marginal constituencies. The power of the orthodoxy is that it is often right.

So the “economic establishment” would undermine my ideas for reform just as surely as they did Ms Truss’s. It’s a real thing. Any serious attempt at political reform therefore has to take on the orthodoxy and beat it. It can be done. Mrs Thatcher did it, and, to some extent, so did Tony Blair and Gordon Brown for Labour in the early 2000s, especially with their radical expansion of health funding (and it required both of the double-act to do it). It took these leaders years and all their political skill. The remarkable thing about Liz Truss is that she thought she could break the Treasury in an afternoon, based on a mandate she had won from 100,000 or Conservative Party members.

And that is the point. We need political leaders who understand the orthodoxies and how to challenge them – people with political skills high and low. The current government possess few, if any, people of that description. Do Labour? I really don’t know. I haven’t been that impressed with Sir Keir Starmer, their leader, or Rachel Reeves, his Shadow Chancellor. But I could be wrong – they are becoming more effective. One opposition politician I am sure has the necessary heft and skill is the Liberal Democrat leader Ed Davey, having honed those skills as energy minister in the coalition government of 2010-2015. Perhaps he will get another chance.

The British Left needs to moderate its obsession with austerity

I’m not reviewing this book, but title reveal the left’s attitude to austerity

As a Liberal Democrat I’m often described as being on the political left. One word shows that this is far from true: “austerity”. To people on the left, especially in Britain, this word brings up a visceral reaction. To them austerity is the quintessence of evil: the crushing of all attempts to promote the public good, perpetrated by a brutal government out to protect the interests of the rich. But to me austerity is a government policy that is often necessary – and is part of a healthy tension that keeps the state efficient. Still, I always like to understand the arguments of people I disagree with, and when I saw a link on my New Statesman email to an article by William Davies entitled Fascism’s liberal admirers, I thought I’d take look. The sub-title was Austerity is a fiction designed to uphold capitalism – and it has a dark history. The pretext (I would not call the article a review) for the was a book by Clara Mattei called The Capital Order – How economists invented austerity and paved the way to Fascism. The subheadings demonstrate what I mean about the left’s attitude.

Which is why I was expecting a lot of nonsense – and by and large that is where the article ended up. But along the way it constructed a narrative that was fr from nonsense. The book is about the rise of Fascism, and how the pre-Fascist government in Italy in the 1920s was being pressured by Britain (as a creditor nation) to adopt austerity policies. The British ruling establishment had taken on the austerity narrative after the First World War, and was delighted when the Fascists in Italy followed through with these policies after they took power. Ms Mattei’s and Mr Davies’s point is that this narrative came about as a reaction to a socialist narrative that the success of war economies showed that there was an alternative to market capitalism, with economies led by, and substantially owned by, the state. Revolution was in the air. The capitalists needed to stamp this thinking out, and they aggressively promoted pro-market policies and a rolling back of state intervention. It was not a narrative based on economic necessity, but one developed to protect vested interests. It is but a short step for Mr Davies to suggest that this is what has been happening in the 21st century, following the financial crash of 2008, and now – with the fall of the Liz Truss government. That, historically, support for austerity led capitalists to embrace Fascism shows how they will turn on democracy to protect their interests, and economics is just camouflage. The fight against austerity is the fight to preserve democracy.

There’s something in this. Pretty much all economic policy, whether capitalist, socialist or anything else, is a conspiracy of vested interests: people try to persuade the public at large that their ideas are for the public good, using any argument that they think might gain traction, spurious or otherwise. That is how large, complex societies get anything done. Truth is incidental. And, though I’m not an expert, I think that the British ruling establishment over-reacted to the prospect of more socialist ways of working in the 1920s, and their arguments in support of the package of policies that Mr Davies calls “austerity” do not stand the test of time (though economies in the 1920s swiftly moved to growth after austerity – and it was not until the depression of the 1930s that the narrative seriously came to be questioned). After all they did something quite different after the next war, and capitalism (and wider society too) has never flourished more. It is a stretch to say that the same applies to 21st century episodes of austerity in Britain and the Eurozone, but there is a case to answer. Many of the justifications put up by the supporters of austerity policies were nonsense. So if you want to believe that austerity is always and everywhere economic nonsense promoted by self-interest, you will always find plenty of evidence. That is the insight I gained by the article. Evidence, but not proof.

The resources required to make an economy work are always limited. The bottom line is that economic policy will always be limited by resources, and that the more efficiently those resources are used, the more successful an economy will be. There are times when it pays a government to spend money to do things that are useless. Keynes wrote of getting people to dig holes and fill them in again; Hitler ramped up spending on armaments. That is when the economy is running slack and needs pump-priming. The people digging holes or making tanks spend their wages buying other things, creating a virtuous circle of job creation. Austerity is a bad idea at such times. But when the economy is running at close to capacity, or overheating (as is the case in most developed economies in 2022) then that logic disappears. If anybody, anywhere is employed doing things that don’t enhance society, it is means that the economy is running less efficiently than it should. If the government is running inefficiently, then austerity policies can be justified to cut waste, and move people from doing useless things in the public sector to being more useful in the private one. That is the basic intellectual case for austerity. And it is why governments of all economic stripes, capitalist and otherwise, will often carry out austerity policies. For example, Cuba’s socialist government after Soviet subsidies were withdrawn in the 1990s.

It goes deeper. All human organisations have a tendency to become complacent, and settle into inefficient ways of working to minimise internal conflict. In private enterprise this tendency is tempered by the need to compete, and by downturns in the business cycle. I well remember this from my work days. Things would seem to be going well, and then there would be a crisis. Savings had to be made, usually, eventually, entailing job losses. Workers were disappointed and often angry; but the overall effect of this stop-start was a more healthy, efficient and focused organisation. Some good things might be lost in the process, but that was outweighed by the reduction in waste and follies curtailed. The public sector is generally insulated from such commercial pressures, and so has an even greater tendency to become inefficient. Bouts of austerity act as a check on this, and force managers to focus on what needs to be done – though they won’t thank you for it.

But the timing is often difficult to decide. It is not always easy to tell if an economy is running slack or close to capacity. There is an argument to be had about that in Britain in the 2010s. But the real problems happen over resources transferred between countries. Economies are often sustained by using resources provided by other countries. But this creates international obligations – as well as the temptation to profligacy. If people in one country supply resources to people in another one, they do so because they expect to be repaid in some shape or form, usually profitably. If it turns out that poor economic management (or any other problem) puts the repayment in jeopardy, then the creditor countries will often insist on austerity. This is not always the right thing to do, but the basic premise that the debtor country is consuming more resources than it is producing, and needs to adjust to something more sustainable. This can be a capitalist conspiracy, but it doesn’t have to be. The politics around it get messy with truth, as usual, a casualty; creditors accuse debtors of profligacy – debtors accuse creditors of gratuitous cruelty. Some governments practice austerity simply to prevent getting into this sort of situation – the socialist president of Mexico, Andrés Manuel López Obrador, is an exemplar of this.

All this is common sense. Austerity – and this is best understood as cuts to government spending, rather than raising taxes – can simply be about the management of finite resources in a changeable environment, and doesn’t have to be ideological. So why do the British left react so violently to the idea? I’m not sure how deep the history goes. The New Labour of Tony Blair and Gordon Brown of the mid-1990s embraced austerity, but they were hardly of the left – but the left seemed happy enough to keep in tow. I think the issue originated from the coalition government of 2010. In the five or so years before this, the state payroll, direct and indirect, had expanded considerably. Many parts of the state had become very inefficient. At the time I could see this in both education (I was a school governor) and health (I was following health affairs closely, as I was looking for a job there). In both areas I could see over-complicated management structures and performance grids, and lightweight policies implemented to placate some lobbyist or other. Capital funding was tied to a bidding process that required the use of consultants on both sides. The bidding process was a matter of verbiage – the trick being to find the right trigger phrases. I read my borough’s bid for primary school expansion (which was successful), and it seemed to carefully saying nothing at all – but it was the work of many senior people, with external advice. In the NHS, funding was driven by something called “World Class Commissioning” – a vastly over-engineered superstructure designed to provide employment to consultants and middle managers. I could go on. The writing was already on the wall before Labour lost the election of 2010, as the crash put government finances under strain, but the government had been slow to apply austerity. Not so the incoming Conservative-Lib Dem coalition. They put in place a vicious programme of spending cuts. Suddenly a whole class of public sector employee found their livelihood at risk – and worse, political leaders were suggesting that their endeavours had all been a waste of time. That triggered an angry backlash. And just as the right tends to be controlled by the interests of capitalists, the left tends to be controlled by the interests of state employees.

By and large the angry people were university graduates trained to look for abstract principles to make sense of events. So instead of just protesting against the concrete adverse effects of particular cuts, they spied an abstract idea to focus their anger on: austerity. Austerity was evil; the cuts were not necessary but ideological. Many economists criticised the cuts as excessive, causing a needless recession and economic wasted resources – and this was seized on as evidence of the evils of austerity. As this line of thinking developed in the usual echo-chambers of social media and friendly journals, it morphed into the idea that austerity is always and everywhere evil. Mr Davies’s article shows how entrenched that thinking remains.

And that is a problem. The left seeks to achieve political power, and to do so democratically they must persuade people that they can be trusted. But most people’s attitude to austerity is pragmatic: sometimes it is required. Most people probably have their own hobby horse of perceived government waste that austerity could be used to sort out – though there will be no general agreement on what these actually are. A class of politicians that cannot let the idea that austerity can ever be justified pass their lips are going to find it very hard to win that trust. And yet it is more than easy to campaign convincingly against specific cuts – at a time when so many public services are wilting under pressure, and the public safety net is obviously inadequate in many places. The politically sensible thing to do is to allow for austerity in theory, but oppose it in the here and now: or to follow the example of Gordon Brown who advocated austerity in the mid 1990s, but once in power and having established public trust, launched the expansion of the British state.

The left are part of the Labour Party, but do not control it. The Labour leadership understand well enough the politics of all this. Polls show that they are maintaining credibility on economic management. The left’s obsession with austerity in the abstract undermines their political influence. Which means the advocacy of any good ideas they have is weakened. In a world when many long-held beliefs are being challenged, the left should challenge this shibboleth.

What does a high-wage economy actually mean?

Labour shortages mean that the pay of refuse workers is advancing

It turns out that the leaders of Britain’s Conservative and Labour parties agree on quite a lot. The latter, Sir Keir Starmer, gave a quite a weighty speech to the Confederation of British Industry this week – which did much to help his gravitas as prime-minister-in-waiting. What has drawn most attention is his opposition to excessive immigration (not clearly defined, of course) and commitment to making Britain a high-wage, high-productivity economy. This was one of the main planks of Tory policy in at least the last two general elections, and still is – in contrast to integration with the European Union’s labour and product markets. Many in the CBI want a more flexible approach to immigration (to say nothing of more integration with the EU) – but they weren’t getting it from either leader.

The politics are obvious. Immigration is a touchstone issue in Britain, as it is in much of the world. The public thinks that the ruling elite were too relaxed about immigration and this was one of the main factors behind the populist backlash of the last decade, and the Brexit referendum result in particular. Labour are less trusted by the public on the issue, and so need to show a visibly firm line, or they won’t win back the voters that have deserted them since their last election victory in 2005. And the idea that choking off cheap labour from abroad will raise living standards is superficially plausible. In fact it was one of the more plausible claims made by the supporters of Brexit. And having done Brexit, I can understand how mainstream politicians feel the need to try and make the idea work.

But how does political necessity fare against reality? Most people seem to have very little idea of how the high-wage economy is actually supposed to work. It’s a bit like the “Australian-style points system” to manage immigration, which most people think is a jolly good idea, without having much clue about what it actually is, and how it compares to alternatives. The main target audience for economic policy ideas seems to be property-owning retired folk in the English North and Midlands (and in the English South and Wales, to be fair), who have little direct stake in a modern, functioning economy – which is all somebody else’s problem. Meanwhile they insist that there is “no room” for more immigrants – and fear that it erodes English national culture. There is therefore no particular need to explain the actual impacts of policy.

The overall economic theory is clear. If we can raise economic productivity, there is more money per head to go round to support higher wages. By choking off the supply of cheap labour from abroad, employers will be forced to use the available resources, i.e. local workers, more productively. There are two basic problems with this line of argument. The first is that higher income per head on average does not guarantee higher income for everybody. An imbalance of power in the labour market leads to high pay for the powerful at the expense of the powerless. The hope is that cutting immigration strengthens the bargaining power of less powerful. Academics argue about whether it is true – but it is not hard to find anecdotal evidence of just this. A shortage of lorry drivers following Brexit has recently driven up their pay – and with it incomes workers in related fields, like refuse collection. Still, we shouldn’t forget, as Tories sometimes do, that better wages depend on the bargaining power of workers.The second problem is that productivity is only part of the equation – the proportion of working people, or working hours per head of the total population, is critical too. In fact in a modern developed economy it is probably more important – and it has been falling due to demographic pressures, the propensity of older workers to retire on their savings, and (perhaps) lack of access to health care for longer term and mental conditions. Immigration raises the ratio of working people in the short and medium term – which is why so many people think it is a good idea.

Still, let’s put these problems aside, and try to imagine what a high-wage society looks like. It is in fact not too hard to find such societies. They are usually located in spots in the developed world with a low population density. These are often tourist hotspots and it is mainly as a tourist that I have visited them: in Australia, New Zealand, Western Canada, Norway and Switzerland. The first thing you notice is that there aren’t many workers. If you are on safari in Africa, you will get a tour guide and driver as a minimum. In Canada and Australia the same individual does both roles. Go into a shop and there are few people to serve you. And there aren’t many shops. At hotels you carry your own bags. You get something of the Tesco automated checkout phenomenon. Self-service amounts to higher productivity for Tesco, but all they are doing is making you do more work for yourself. An experienced cashier is much quicker. In a high-wage economy you may find yourself eating at home instead of at restaurants – or inviting friends for drinks at home rather than trying to find a bar. The cost of services involving human contact is relatively higher.

So where are the workers? Not so many in the tourist spots, though there will be people delivering high-end products or services at quite a cost. They are mostly somewhere else, delivering highly productive goods or services. In Australia and Canada there is mining; in Norway there is oil; in Switzerland there is sophisticated manufacturing (chemicals and such) and banking. These are linked to exports, so that high-wage countries tend to be high-exporting ones, usually running trade surpluses.

Here’s the key. Some gains to wages for the less well off can be made by reducing profits and cutting top-level pay. But not enough and not sustainably. A large proportion of workers need to be employed in highly productive fields. If businesses simply raised prices to pay for higher wages, we end up where we started by putting so many things out of the reach of less well-off workers. But high productivity industries in the modern era are very productive indeed. They don’t employ many workers and usually need exports to to be sustainable.

And so we can start to see the characteristics of a high-wage economy. Workers must have strong market bargaining power, generally by being in short supply. There must be a strong, highly productive core to the economy, generating a substantial export trade (overall trade doesn’t need to be in surplus in theory – though in practice this often seems to be the case). And most people will have to put up with doing more things for themselves, as the price of services is high – and especially in rural areas. Taxes are also likely to be quite high to to support public services such as health and education – as a strong state underpinning of these, and an effective social safety net, is all part of the ethos – and supports the strong bargaining position of workers generally.

In Britain the problem is obvious. Labour shortages are improving the bargaining position of workers. We are moving towards a self-service economy as these labour shortages sweep through the hospitality industry amongst others. But what of the highly productive core? Here we are faced with a fleet of ships that have sailed. Fossil fuels are depleted and anyway a problem in the zero-carbon future. The country’s manufacturing has been hollowed out – the trade deficit is of very long standing. Financial services provided a lot of punch in the earlier years of the 21st century, but are going through rough patch in the 2020s. Brexit is widely blamed, but in truth the problems are wider. A lot of the strength of the mid-noughties turned out to be fictional – and it was very centred on London. The country needs to look to the future, and not try to recreate old glories. Here the parties do differ a bit. There doesn’t seem to be a coherent Conservative strategy at all. Their basic idea is to create fruitful conditions for investment and sit back and wait. Liz Truss, Mr Sunak’s predecessor, did lend some coherence to this approach. She wanted to create a low-tax, low-regulation haven for footloose international businesses. This idea quickly collapsed, leaving Mr Sunak plying platitudes about innovation. His government looks increasingly paralysed by internal divisions and unable to implement any decisive strategy.

Labour’s big idea is the green economy (something promoted by the Lib Dems and Greens too). This entails a massive investment programme designed to transform the country’s infrastructure as well as develop export industries. This is a good idea, but a lot of the work involved (home insulation for example) is not high-productivity. And there is intense competition for the rest – batteries and wind turbines for example. Still, it doesn’t do to underestimate British inventiveness, and public-private partnerships in this area surely provide part of the answer. Also renewable energy does offer high productivity, without the need for exports. There are other ideas. I have often talked about health care and related services, where Britain has a promising base – and where the NHS offers world-class data for developing new treatments – as the covid episode showed.

But there is a gorilla in the room that the politicians don’t want to talk about. This isn’t Brexit (though they don’t want to talk about that either). This has created problems for developing export industries – but other EU members are further down the path of developing exports and British industries struggled to compete with them in the single market. Britain’s trading problems got worse within the EU, after all, even if there were compensations. The gorilla is public sector pay – especially if we include the issue of social care. High wages mean high levels of pay in the public sector. Not all public sector jobs are badly paid, but the pressure of a tight labour market is putting public services sector under pressure. Staffing shortages are rife in many parts of it. Meanwhile part of the government’s anti-inflation strategy is to hold back public sector real pay levels – which is making matters worse. The answer is either to shrink the public sector or to raise taxes. Of course the politicians hope that an explosion of high-productivity private sector jobs (with associated tax revenue) will come to their rescue. But it won’t happen in time, if it ever does.

This is a tough place to be in, so it’s no surprise that our politicians are slow to confront the truth of it. I have to admit that it is forcing me to rethink some of my assumptions. But I do think that the vision of a high-wage economy is worth pursuing. The main alternative being offered by those interested in social equity is a universal basic income paid by the state. I am deeply uncomfortable with that idea for a number of reasons. Given that, here are two things to be thinking about.

The first doesn’t involve any great rethinking on my part, but remains politically toxic. We need higher taxes. This is not just on various soft-spots and loop-holes in the wealthier parts of the economy – schemes that are predestined to disappoint. Higher taxes need to affect most people. This is because public spending will have to rise to accommodate higher public sector pay – and we need to manage down the level of demand in the rest of the economy to help stabilise it, to say nothing of limiting the need to borrow money on world markets. Of course public sector productivity can be improved (though I prefer the word “effectiveness” to “productivity” – as a lot of the solution is lowering demand by forestalling problems), reducing the need for spending. But our political class, our civil servants, and the commentators and think tankers that critique them, have almost no idea how to achieve this. They are stuck in an over-centralised, departmental mindset. What is needed is locally led, locally accountable, cross-functional, and client-centred services – an idea that is so alien to British political culture that most people can’t even imagine it. So we can’t count on that idea and must settle for replacing the dysfunctional with the merely mediocre, with no cost-saving.

The second idea is even more contentious, and I haven’t properly thought it through yet. It is that inflation is an essential part of the process of readjustment, and we have to tolerate it to a degree – provided that the source of that inflation is a rise in pay for the less well-off. As somebody who grew up in the 1970s, I hate inflation. I think it undermines trust between the state and the governed. I have never subscribed to the view of liberal economists that it can be a tool of economic management. But there have to be exceptions. One example was Ireland in the 2000s, as that country worked through its economic transformation as it integrated with the EU economy, which did involve a spurt in productivity. Wages rocketed, driving inflation up. Ireland was in the Euro, so there was no ability for the currency to appreciate to ameliorate the effect. This was the only way for the country to reach the sunlit uplands – which didn’t stop the European Central Bank from criticising it – something my economics lecturer at UCL said was absurd.

Britain’s position is different from Ireland’s. We haven’t had that productivity spurt. There is nothing to drive an appreciation of the currency. But we want wages amongst the less well-off to rise. Price rises are part of the adjustment – with inflation acting as a tax on the wealthy, as part of a redistribution process. Meanwhile we need to drive capital investment – most renewable energy is very capital intensive, for example – as are most of the ideas for developing higher productivity. That means keeping interest rates low. Which won’t happen if interest rates are jacked up to combat inflation. And, as suggested already, to the extent that inflation needs to be managed, higher taxes are a better way to do it.

This is quite a progression in my personal thinking (and thank you to regular commenter Peter Martin for helping me along the way – though doubtless we still disagree). But trying to get to the fairer, more sustainable society we seek is going to require many of us to change our thinking – and put up with some things we don’t like.

Britain’s economic difficulties have deep roots

The Comet airliner was world-beating British design before a crash in the 1950s allowed US aircraft designs to dominate the market. The British aviation industry never recovered.

Our new prime minister, Rishi Sunak, says that Britain faces a profound economic crisis. I don’t disagree – few will. Neither do I disagree with his statement that hard choices lie ahead. I almost certainly will disagree with him what the right choices are. We are entering a period when politics matters. But we need to understand more about the mess and how we might progress.

Liz Truss, Mr Sunak’s predecessor, presented a clear narrative to explain the country’s economic ills. A timidity in the British ruling elite, abetted by the “abacus economics” of the Treasury, has stifled private enterprise, leading to a bloated public sector accompanied by low economic growth. She saw that a combination of lower taxes and deregulation could correct this, deliver economic growth, and that, thanks to the wealth thus generated, the country would be able to afford an acceptable level of public services and welfare safety net, together with improved state pensions. She thought that she could kick start the process with tax cuts. The overarching narrative may or may not have substance, but the timing was all wrong. The result was the shortest prime ministerial stint in British history.

Ms Truss was rare in offering us a clear narrative. Mr Sunak will not make that mistake. Clarity divides, getting in the way of the coalition building that successful politics demands. But a clear narrative helps the rest of us decide which policies to support. I will attempt one of my own.

My story starts in the middle of the last century. Britain was an industrial powerhouse, with a strong belief in free trade, though this regularly caused political controversy. Before the Second World War, though, this was marred by widespread poverty; the country had not found a good way of spreading economic (or any other) wellbeing across the whole of society. And then came the war. The necessities of the war ushered in a period of massive state intervention that followed a lot of the principles of socialism. Food was rationed, but people were amazed that levels of nutrition improved, as the diets of the poorest in society improved. Meanwhile the British war economy produced wonders of production and ingenuity, combining state direction with private initiative. People saw that a new way was possible, and this was brilliantly articulated by the Labour leader Clement Attlee, who reassured the middle classes with a particularly British slant on socialism, and Labour won an overwhelming parliamentary majority in 1945. He ushered in a period of profound welfare reform and the nationalisation of key industries. Labour lost power in 1951, but the landscape was so profoundly changed that most of the reforms were supported by a political consensus.

There followed two decades of what many regard in hindsight as a golden age. Economic growth was rapid, living standards advanced, poverty reduced and life expectancy dramatically extended. Many transitioned from working class to middle class. An expanding working population and an industrial revolution in the development of consumer products were the drivers. But all was not well. Other countries were doing better. Britain was steadily losing its place among the front rank of industrial powers, to America, to Germany, and even to Japan. Each of these countries turned into export powerhouses, while Britain, relatively, declined. What was happening? Poor management and a relative lack of investment were to blame, along with some bad luck (the crash of the Comet airliner in the 1950s dealt a body blow a world-leading aviation industry). A lot of this had to do with the fact that large parts of the industrial heritage was now under public ownership, and this increased as industries, notably the motor industry, started to fail and led to a clamour for government intervention. The government either starved nationalised industries of investment (the water industry for example), or squandered unbelievable sums on ill-conceived investment programmes (notably nuclear power). There were exceptions to this general mis-management, of course, such as the switch from coal gas to natural gas for domestic use. But by and large decisive management was replaced by consensus-building and political grandstanding, and the constraints of government financial management. By the 1970s nationalised industries were a by-word for bad management. Meanwhile the private sector was weighed down by high marginal rates of income tax (top rate 83%, or 98% for investment income by the mid-1970s) and corporation tax (52%).

The 1970s were a time of profound economic crisis, with many parallels to now. Energy costs rocketed with two Middle East crises following the Arab-Israeli war of 1973 and the Iranian revolution of 1979. Inflation took off, and policymakers struggled to respond, as this came alongside rising unemployment (which we don’t have now, or not yet). In 1972 the Conservative government of Ted Heath tried to break the deadlock with tax cuts and more public spending (I can still remember the party political broadcast promoting this – I was 14), in a move reminiscent of Ms Truss’s failed budget. This quickly collapsed into disaster, and the government was locked into a confrontation with the miners’ union, amongst others. Harold Wilson’s Labour government of 1974 did not make things much better. Unions were able to block any serious economic reform.

In 1979 came the election of Margaret Thatcher and the Conservatives. Mrs Thatcher brought with her a new economic philosophy of reducing the role of the state. She started to reform the nationalised industries preparatory to privatisation. She cut marginal rates of income tax (though putting VAT up to maintain the overall tax take). At first things seemed to be going very badly. Inflation persisted, unemployment climbed, and nationalised industries played havoc with government finances. But by 1982 things were getting better. She received a political boost from the Falklands war, while Labour seemed to be imploding. A new party, the SDP (which I joined and have never left), offered a diversion, but failed to break Britain’s electoral system, even in alliance with the Liberals. Mrs Thatcher won a landslide majority in 1983, and quickly became politically more secure. Inflation was tamed and economic growth returned. This period remains a matter of bitter controversy. Many say that her success was based on the exploitation of North Sea oil. This was clearly a factor but her economic reforms, especially the privatisations of the energy, telecoms, steel and motor industries, clearly helped. Another factor that proved of benefit, though perhaps more so later, was the development of the European Single Market, of which Mrs Thatcher was one of the architects. Prior to this European product and labour markets had been badly fragmented. The European Economic Community had tackled tariff barriers, but non-tariff barriers remained high. These were progressively dismantled, so that Europe could follow America in the benefits of a large domestic market for many goods – and labour. Britain became a favoured European base for American and other countries. But while this progress was happening a lot of industries, notably the coal industry, collapsed under foreign competition and changing production technology. This has coloured Mrs Thatcher’s memory ever since – as she saw no reason to soften the blow as swathes of the country went into industrial decline.

One of the driving forces of change was globalisation. Increasingly the Far East became a source of cheap industrial imports. This started with Japan, and then moved on to South Korea and Taiwan, amongst others. Falling import prices became one of the chief sources of improving living standards, but it hastened the decline of former industrial heartlands. By the 1990s we see taking shape some of the main outlines of the current British economy. The country became a major net importer of manufactured goods, only partially offset by a booming service industry. At this point the books were being balanced by net oil exports. But some areas of the country were doing much better than others.

Labour under Tony Blair took over in 1997. Mr Blair sought to maintain much of the Thatcher legacy, but with an important difference. After 2001 in particular he expanded the public sector, through expanding public services such as health and education in particular. In these years a powerful myth took over the British political class. You could solve the conundrum of getting Scandinavian-level public services and welfare with American tax levels though allowing economic growth to expand level of tax receipts. But the politicians failed to understand the source of Britain’s growth in the early 2000s. This was largely driven by three factors. The first was an acceleration of globalisation, enabled by internet technologies and driven by China. I remember looking at the components of Britain’s consumer price inflation, which was about 2% per annum. The prices of manufactured goods were falling; this allowed 4% inflation in many services to be balanced out. And pay tended to follow the services figure, staying consistently ahead of overall inflation, and so leading to improved living standards. The second factor was a dramatic increase in European immigration. By the early 2000s many parts of the country were experiencing labour shortages. The baby boom was over, and the process of bringing women into the workforce largely complete; pension schemes were only slowly catching up with increased life expectancy and the proportion of retired people was growing. But the European Union at this point admitted Eastern European countries with a workforce that wanted to improve its living standards by working abroad. Poles and others flooded in and the demographic crisis was averted. Inflation was kept at bay, the second major component of growth. The third factor was the rapid expansion of financial services, and especially the banking industry. Many banks made big profits, giving the City of London the air of a boom town, inflating the property market, and generating significant capital taxes. Pretty much all the increase in recorded productivity in the early 2000s came from the banking industry, alongside “business services” (management consultants, lawyers, accountants and others feeding off the banking boom, as well as juicy public sector contracts), and the now-declining oil industry.

None of this was sustainable, and the moment of truth arrived in 2007, when the world banking crisis developed. Those big banking profits, and the productivity gains that came with them, were exposed as fiction, and the industry experienced massive write-offs. Meanwhile the globalisation boom peaked, as China sought to improve its own living standards rather than those of westerners. The public increasingly turned against European immigration. And the decline of North Sea oil continued apace.

So in this account the slow growth that followed the crash arose not from a failure of government policy (be it austerity in the left’s account; or excessive tax and regulation in the right’s), but from the exposure of demographic forces that were always present, and the passing of globalisation into a new phase that was not producing gains in living standards. And two further things were added after 2015: the decline of North Sea oil turned precipitate, and Brexit, after the referendum in 2016. Brexit has raised the cost of imports (especially if you attribute the depreciation of the pound that coincided with it, though I’m inclined to believe that much of this was in the pipeline anyway), made exporting harder, reduced the attractiveness of inward investment, and caused many immigrants to go home and made immigration harder. On that last point it is worth observing that the country has made up the shortfall in European immigrants with people from other countries, and in any case the European labour market is becoming tighter. But the labour market for immigrants became much less responsive to short-term demands. All round Brexit has added to the friction of running a business, rather than causing an immediate catastrophe.

To these troubles we must now add two more. Firstly the gas and oil price spike, exacerbated by the war in Ukraine, and secondly the rise in world interest rates. The energy price rise is a double whammy. It is helping to stoke up inflation, which causes economic damage in its own right, but also causes nominal interest rates to rise, which disrupts the economy in further ways; and the public expects the government to shield at least some of us, or even all of us, from the effects, causing a massive outlay in government spending. Rising interest rates make mortgages more expensive, which causes further hardship, and also disrupts a finance sector that has grown complacent on low interest rates.

The problem is this. Britain has a deep structural deficit in the trade of manufactured goods. We are heavily dependent on imports for our standard of living, and exports are nowhere near enough to cover this. We now have a substantial trade deficit on energy too, made worse by the Ukraine crisis. We still have a trade surplus on services, but nowhere near enough to cover the gap. Inward investment is sluggish, and anyway broader troubles in the world economy limit the possibilities. This means that the country as a whole has to borrow heavily from abroad – whether this is to fund the national debt or the private sector. Rising interest rates makes that more expensive. Crashing the pound would help exporters, maybe, and inward investment, almost certainly – and since nearly all the debt is denominated in sterling. would not make those debts any harder to maintain. But that would feed through to consumer prices, and destroy the economic strategy of the last few decades of consuming cheap imports.

There is a striking comparison to be made between Britain and Japan. Both are island nations with challenging demographics. Both have an uneasy relationship with their continental neighbours, on whom there is a degree of economic dependence. Japan has long set its face against immigration, an attitude that is prevailing Britain too. Japan has also been suffering economic stagnation, but it is not so obvious that the people living there mind, as economic wellbeing is spread widely. Something like Japan is what many of Britain’s Brexit supporters aspire to. But there is a crucial difference. Japan remains an industrial powerhouse, and produces a substantial trading surplus. They do not depend on inflows from abroad to keep the show on the road. That means the government has a huge amount of flexibility in borrowing money to meet its needs. Abacus economics is dead. It is living proof of the Modern Monetary Theory (MMT) idea that the debate on government deficits and national debt is beside the point. Japan is in the position that Liz Truss seemed to think Britain was in when she promoted her tax-cutting and free-spending budget. But even under MMT consumption cannot outlast production forever, and inflation is admitted as a constraint. That is where Britain now is, and the government has little choice but to bring its budget position under control. The pressure is not extreme, as it has been for countries like Argentina or, in a rather different context, Greece in 2010 – but the trajectory needs to be clear or otherwise market interest rates will rise further than they otherwise would, with difficult repercussions.

That’s for now. But what should the country’s longer term strategy be? Ms Truss, and indeed Mr Sunak, subscribe to vision of what might be called a “buccaneer” strategy. They present a picture of the country being a haven for freewheeling businesses, attracted by low taxes and able to out-manoeuvre over-regulated competitors in Europe and elsewhere. But buccaneering has its dark side – the original buccaneers were licensed pirates, legal in their home domain and criminals elsewhere, after all. Britain would need to develop its already burgeoning function as a haven for grey and even darker money, from kleptocrats and criminals across the globe. The trick to this, as we have learned, is not so much lax laws on such things money laundering, but weak enforcement. Most Brexit supporters would likely connive at such a strategy, if not openly support it – on one condition: that public services are made more effective, and the state pension is improved – they are probably less fussed abut other aspects of welfare spending. This is where the main political battles are going to come in the next few years – as it is far from clear that such things can be maintained without increasing taxes.

Liberals recoil from such a strategy, but they will agree in principle to another strategic objective – that of energy security, and reducing the dependence on fossil fuel imports. There is a disagreement, of course, on whether that means developing the remaining domestic fossil-fuel opportunities. But, in principle at least, most can agree on the development of renewable energy, with the storage and grid upgrades that will be needed alongside it. One thing that helps is that this can largely be financed by foreign borrowing and equity investment – as the linkage of investment to financial returns is easy to make.

If liberals can agree on the need to turbo-charge the development of renewable energy, what alternative can they present to the buccaneer strategy? We can’t go back to being an industrial powerhouse with a strong export industry. That ship has sailed. We can make modest gains, but we can’t reverse more than half a century of decline.

I can’t see a single big idea, but a number of smaller ones might add up to a strategy. The drive for renewables should be tied to a more general mission to decarbonise the economy. This should drive a whole series of investments and reforms that will help renew life generally. The country should aim to ease trade with the European Union, which will mean accepting EU regulation in lots of areas. But we should be wary of relaxing immigration rules. The public seems to be happy with immigration by and large, if it is closely regulated. That means bureaucracy and friction, but in a democracy we have to work within the constraints of public consent. The government should also help develop industries where the country looks internationally competitive. Healthcare is the most promising area – I think the idea of cooperation between the NHS and private entrepreneurs to develop new treatments has much potential. The relatively unified state of health records is an opportunity, though bringing challenges with it. Also public services need to become more effective. That means shifting towards solving problems rather than simply repairing the damage after the event. This in turn means a stronger emphasis on prevention, and getting the various different services working together more closely. It is hard to see how this can work without more localised leadership and accountability – serious decentralisation and devolution. A further idea is political reform – through electoral reform, and reforming the House of Lords. This is as yet a bit of a long shot. For all public discontent about the state of politics, I see little groundswell for changing the system , as the was case in New Zealand in 1993, for example.

But we are going to have to get used to two two things alongside all of this. Taxes will need to rise, and economic growth will continue to be sluggish. This is the opposite to what Ms Truss was trying to achieve. That is not the end of the world. We can still achieve an improved quality of life and an environmentally sustainable way of being. That is a simple consequence of where the country stands as demographic forces assert themselves, and after the country’s mishandling of its industrial legacy over the generations.

The cake has gone: the revenge of Treasury orthodoxy

Boris Johnson promised us that we could have our cake and eat it. So we ate the cake. When his successor, Liz Truss, went to the cupboard to look for it, she found that it was all gone. The transition from the bounty of tax cuts and energy subsidies promised by Ms Truss when she took charge to the austerity being promised just a few weeks later is one the most dramatic policy reversals I have ever seen in Britain.

During her selection campaign for the leadership of the Conservative Party, Ms Truss railed against “Treasury orthodoxy”. This, she said, was responsible for the country’s strangled growth since the financial crash of 2007-09. She knew what she was talking about since she had served as Chief Secretary at the Treasury for a stint in 2017-19. This was a widespread complaint. I heard it made by Lib Dems during the coalition years, especially as many ideas for long-term investment were shut down. The complaint was much more virulent from Labour supporters, for whom “Austerity” was the root of all evil. It is interesting to see these usual suspects being joined by the libertarian right, who have elevated high tax levels to the same heights of evil that the left has for austerity.

It is important to distinguish Treasury orthodoxy from economic orthodoxy – though most people seem to do just this. Treasury types are steeped in economic orthodoxy: you won’t get away with the “lump of labour fallacy” (the idea immigrants, for example, take away people’s jobs) if you talk to one of them. But it is tempered by an older belief, dating back to Gladstone and beyond, in “sound money”. They do not like to see high levels of government borrowing, leading to creditors being able to dictate policy. The divergence between Treasury and economic orthodoxy was especially evident in the coalition government of 2010-15. Many orthodox economists argued that austerity policies were at best overdone, or at worst completely wrong-headed. They suggested that there was significant slack in the economy, and that policies that reduced demand were a self-inflicted wound (whether there was as much slack in the economy as they thought, and whether the austerity policies were as destructive, are questions for economic historians). They produced as evidence more generous US policies at the time, leading to less economic hardship. The Treasury thought otherwise. In 2010 coalition ministers were scared witless by warnings of dire consequences in financial markets if austerity programmes weren’t followed. Both Tory and Lib Dem ministers accepted this basic premise, while quibbling with the details. The previous Labour government under Gordon Brown and Alistair Darling had as well. Almost all serious economic commentators now suggest that this was a serious mistake – and that the market position was not nearly as precarious as suggested.

Doubtless this is what gave Ms Truss the courage to take on the Treasury, though her central idea that tax cuts can be paid for through the growth they stimulate, especially when unemployment is at a record low and inflation on the rise, was a challenge to economic orthodoxy as well. She noted the substantial “headroom” in forecasts by the Office for Budget Responsibility (OBR) earlier in the year – doubtless brought about by stealth tax rises through holding tax thresholds down. She also noted that government debt levels were not as high as other some other big developed economies. So she appointed her close ally Kwasi Kwateng as Chancellor of the Exchequer, and his first act was to sack the leading Treasury civil servant, with talk of replacing him with an outsider.

It fell apart with startling speed. In the popular telling the “Markets” struck back, causing mortgage rates to shoot up. This has wiped out any feelgood factor brought about by tax cuts and energy interventions amongst a key constituency of Conservative voters. The talk about the power of Markets is a convenient shorthand, but oversimplifies things a lot. Media coverage as been very muddled. At first a lot of attention was focused on the pound – which at one point nearly sank to parity with the US dollar. But it was the gilt (government debt) markets that caused the mortgage rate problems. I think this took a lot of people by surprise, including, perhaps, our political leaders. In the common understanding interest rates are determined by the Bank of England, which was not due to meet until early November – so people probably expected any crisis on the mortgage front to approach slowly. In fact Bank of England decisions are only one factor amongst many – and mortgage providers need to look forwards at potential future rises. Then a crisis blew up with the liability matching policies in certain pension funds. I have read two tellings of this crisis. In one the pension funds had been indulging in reckless speculation camouflaged as prudent management of future cash flows; in the other prudent management was caught short by a temporary liquidity crisis dictated by the way certain financial markets are structured. The Bank of England rode to the rescue, but a temporary tiding over of a technical crisis was presented by many as something much broader. The Bank’s attempts to communicate what it was doing and why didn’t really help. Neither did Mr Kwateng’s attempts to shrug the whole thing off.

The muddle made things worse. The pound recovered, but gilt markets have not made life for mortgage providers any easier. But what has now been revealed to the world is what the point of Treasury orthodoxy is. Financial markets are complicated things, and they can affect the public in a number of ways. As with any market, they are the meeting place of people with many different agendas. If mismatches occur they can be destabilised quite easily. The Treasury tries to manage things by making orderly, predictable demands, and not pushing its luck. It builds up a reservoir of confidence which means that it can respond to emergencies. The timing of Ms Truss’s attempted coup could hardly have been worse. Rising inflation, low unemployment (showing limited capacity to expand the economy) and the energy crisis, coming after the trauma of the pandemic and alongside the destabilising effects of the Ukraine war, all pointed to this being a particularly delicate moment. Ms Truss’s attempt to blame the demise of her strategy on the markets is a bit like the Captain of the Titanic blaming the iceberg for the loss of his ship. Except that this was no stray iceberg, the government was steaming full-steam ahead the middle of a known iceberg belt.

Now the government, having destabilised things, is having to work very hard to restore order. Treasury orthodoxy reigns triumphant. The new chief civil servant is an experienced insider; an experienced senior politician has replaced Mr Kwateng as Chancellor; most of the tax cuts have been withdrawn; public spending cuts are back on the agenda; the energy price intervention has been scaled back. There was even talk of not raising the level of the state pension in line with inflation – the Treasury has long hated the so-called “triple lock” on pensions.

The dust hasn’t settled, but the effect of this change is chilling. It isn’t just tax cuts that have been put on ice – but hopes by politicians on the left of raising spending on public services and benefits now look much harder to fulfil. Suddenly Britain looks like a lonely nation living beyond its means in a hostile world. Hard choices lie ahead.

As the Tories implode, do the holes in Labour’s position matter?

In my last post, published on Sunday, I suggested that the British prime minister Liz Truss and her Chancellor Kwasi Kwateng should have been pleased with how their budget was going down. The messaging was clear, and the opposition response muddled. By Monday, though, the story had moved on. Bond and currency markets were giving the statement a spectacular thumbs down, and there was a whiff of panic in the air. The panic has passed, but it is evident to almost everybody that the pair have dug their party into a very deep hole. Today the Bank of England announced that it would be forced to finance a portion of government debt through money creation. It’s not a good look.

The market rout begun on Friday, especially in the gilt markets – but on Sunday Mr Kwateng clearly felt things were going well enough to double down on his tax cutting plans, and suggest there were more cuts to come on. But by Monday he was forced to try and calm things down, with promises a proper plan for national debt. Faithful supporters have been doing their best to mount a rearguard action, though no minister has put their heads above the parapet. They have tried to deflect the currency problems onto the US dollar, which doesn’t explain the sharp devaluation since Friday, evident against even such currencies as the Turkish Lira. All suggested that there was more to come to make things better. Tory MP Andrew Bridgen suggested the government might like to cancel the flagship HS2 rail project; John Redwood, a veteran MP who is somewhat more economically literate, said that the government was about to reveal a tranche of supply-side reforms, so the markets hadn’t seen the full picture. These messengers were helped (on BBC radio at least) by the lack of economic grip of their interviewers, who did not press them on the obvious gaps in what they were saying. The BBC also helped when remarkable criticism came in from the IMF, by highlighting their comments on inequality -rather that the much more damaging criticism that the budget threatened to create a recession rather than head it off.

The darkening mood was no doubt caused by the prospects for mortgage rates. The reason that markets stabilised was that traders came to appreciate that interest rates would go up in reaction to the budget. Mortgage providers reinforced this point. Commentators quickly showed that increases to mortgage payments for homeowners would quickly overwhelm any extra cash coming from tax cuts. And this is a critical group to Conservative electoral prospects. The criticism by government supporters of the Bank of England not raising interest rates earlier (“asleep on the job” according to Mr Bridgen) doesn’t really help here. Once the government’s ability to finance itself comes into question it has no attractive option to dig itself out. Monetary financing at a time of inflation is hardly going to stabilise things. Reversing the tax cuts would be a humiliating retreat which could taint the Conservatives for a generation. Spending cuts on the scale needed would alienate a large part of the party’s base, as would letting interest rates rip (though a different part of that base). Supply side reforms would have to be big and spectacular to reassure markets. Release immigration controls? Re-enter the EU Single Market or Customs Union? Stop Russian sanctions and invite oligarch money back?

What makes things worse for the government is that they were warned well in advance. During his leadership campaign former Chancellor Rishi Sunak warned Conservative Party members that handling the energy crisis and making tax cuts did not go together. Ms Truss poo-pooed this as “Treasury orthodoxy” which had ended up in years of sub-standard growth. There is certainly a baleful aspect to Treasury orthodoxy that requires intelligent challenge – but the Treasury also has experience of navigating the treacherous world of government finance. FT columnist Janan Ganesh says that the government has fallen into the trap of trying to apply policies appropriate to the United States to a medium-sized archipelago whose currency is not used as a global reserve. Success in running British economic policy is a delicate balancing act which depends on maintaining confidence, not thumbing your nose at the rest of the world.

What of Labour? They can hardly believe their luck. The initial response was fumbled. They went on about the tax cuts for the rich (and the abstract idea of “trickle-down economics”) – leaving the much bigger charge of being reckless with the country’s finances muted. But by Monday, with their party conference in progress, they started to find their feet. Their shadow chancellor, Rachel Reeves, delivered a worthy speech, in which she gave emphasis to financial stability. She also started on an alternative growth narrative that did not depend on tax cuts – through green investment and such. It is important that the Tories are not allowed to win the growth argument by default, of which there was a distinct chance, so ruthless and repetitive has been their messaging.

This has been complemented by an orderly conference, with its leader, Sir Keir Starmer, clearly in control. Dissent has been modest. I listened to two interviews by senior members of the party’s socialist wing: John McDonnell and Diane Abbott. Neither created trouble (and Mr McDonnell was distinctly more in command thad than Ms Reeves). The party was able to develop a narrative of a government-in-waiting.

Still, there are two big problems with Labour’s stance. The first is that they lack an alternative fiscal policy. They only said that they would reverse the higher rate tax cut, which has little fiscal impact – and said would not reverse the national insurance and basic rate income tax reductions. So how would they try to fill the evident gap? We just got obfuscation. When challenged about how the party was would maintain spending on the NHS and social care, Ms Reeves suggested that there was no problem because Mr Kwateng said so. They are trying to accept the fiscal package and disown it at the same time. To be fair, they did not say anything about not increasing Corporation Tax, and they have suggested higher windfall taxes on energy companies. But surely they are going to need something more. Tony Blair and Gordon Brown, who the leadership would like to emulate, solved a similar problem in the mid 1990s by adopting an austerity stance on spending – shadowing the Conservative government’s spending plans. This would take the party out of its comfort zone – but something like this will surely be necessary.

The second big problem is engagement with the European Union, as pointed out by Danny Finkelstein in The Times. The party understandably does not want to reopen the Brexit debate. But how to create a credible path for the country outside the union while shadowing so many EU policies on worker protection and the environment? This surely creates a competitive weakness. Mr Finkelstein thinks that the party, once in power, would surely be forced into a closer trading relationship, sacrificing many of the sovereignty gains as a result.

So Labour is trying to have its cake and eat it. Boris Johnson could get away with that, but it is harder to see that Sir Keir can. However the hole that Ms Truss has dug for her party is so deep that it probably doesn’t matter.

UPDATE, 30 Sep 22. The first quarter’s current account deficit was reported by the FT as being over 8% – compared to the 3% figure which I took from The Economist. According to the FT report (which dated from before the statement), this was making gilt markets nervous. This makes sense, though I would prefer to know exactly where the funding vulnerabilities are rather than relying on these broad aggregates. All this shows that there was lots of evidence that Mr Kwateng (and Ms Truss) were skating on very thin ice before the statement, but they chose to ignore it. Mr Kwateng’s decision to keep on digging the hole deeper in Sunday media interviews is quite astonishing.