UK economic policy – Page 6

The economy is for Labour what tuition fees is for the Lib Dems

If there is something that unites British Labour Party people, from rightist Blairites, to Brownites, through to the leftist Corbynistas, it is that the Labour government of 1997 to 2010 should not be held responsible for the financial crash of 2008/09, and the terrible state of government finances that followed. They are made indignant by Conservatives (and Liberal Democrats) who go on about how Labour is to blame for the financial mess the government left the country in in 2010, when the budget deficit had ballooned to over 10% of GDP. But the public finds the Tory line more convincing. And if Labour are to throw off this albatross, it will have to move on from its air of injured innocence.

There are two dimensions to this question. The first is a question of fact, or purports to be: how much responsibility did the Labour government actually have for what went wrong in the economy? The second is what is going on in people’s heads when they think of Labour and the economy, and how the party might address it.

On the first question, Labour have quite a few sympathisers outside the party. And certainly the direct line of attack made by Tories is not all it seems. The Tory narrative is that Labour went on a spending splurge in the boom years, which then proved completely unsustainable, leaving their successors choice but to implement austerity policies. Defenders of Labour’s record point out that there was no big government deficit before the crash. It was a relatively modest 2.5% or so in 2006 and 2007, and not regarded as irresponsible at the time. Nobody foresaw the financial turmoil, which originated in American sub-prime mortgage markets.

The Labour defence against this charge is mostly true. But not quite. Gordon Brown, as Chancellor (he became Prime Minister in 2008), claimed to operate government expenditure on a “golden rule” which meant no net borrowing over the economic cycle. But he had taken to moving the goalposts rather than applying the rule strictly. Had he followed his own rules as originally intended, there may not have been a deficit as the economy turned in 2007. But that only accounts for 2% of the problem. There was another 5% that came from somewhere else, allowing for a normal cyclical swing of 3%, and which cannot be blamed on Labour profligacy.

If you take a wider view, however, Labour’s defence becomes more difficult. British government finances were worse affected than other major industrial countries, from France to the USA, and much worse than some, like Canada. There are broadly two reasons for this. The first is that Britain had a bigger financial crisis, because it had a bigger banking sector, especially in international banking, and so was more affected by its collapse. The second is that tax revenues fell unusually sharply in Britain. Both aspects have government fingerprints on them.

Take banking. Labour lauded the rise of the international banks, and celebrated Britain’s “light-touch” regulation that helped bring this about. They gave RBS’s Fred Goodwin a knighthood for no other reason than that he had expanded his bank, recklessly as it turned out – there were none of the usual good charitable works to point to as supporting a general aura of public-spiritedness, as is customary in such matters. Meanwhile, Britain’s success as an international banking hub helped drive Sterling up and manufacturing exporters out of business. Mr Brown tried to wriggle out of responsibility by suggesting that he wasn’t responsible for banking regulation under Britain’s tripartite system of financial regulation (between the Treasury, the FSA and the Bank of England). This is pretty damning, because this system was of his own design, and it was clear that overall responsibility for making sure the system was working lay with the Treasury. It couldn’t be anywhere else.

Then on taxes, Mr Brown engineered a switch from taxes on income, and Income Tax in particular, to an array of other taxes, like stamp duty, that turned out to be about milking financial bubbles. At the time, his reduction of the basic rate of income tax to 20% was lauded as a triumph. This proved a colossal misjudgement, as it has proved politically impossible to raise income taxes, even in supposed more left-leaning Scotland.

On top of this, a broader claim can be made. The world financial crisis was not some storm that happened somewhere else with unfortunate consequences for Britain. Britain was the world’s leading international centre of finance; Britain’s bankers were at the heart of it, Two of Britain’s big banks, RBS and HBoS, collapsed, not helped a Britain’s own reckless mortgage lending, which also affected smaller banks, like Northern Rock and Bradford & Bingley. These banks had all adopted highly risky business models, whose main assumption was that global banking markets would be stable. Sitting on top of one of the most prestigious finance ministries in the world, and trumpeting his own reputation as a financial manager, Mr Brown and his acolytes can’t really escape the charge of incompetence for not appreciating these risks. And these risks were plan to some, including his Lib Dem shadow, Vince Cable, whose warnings were pooh-poohed.

Labourites are on stronger ground when they suggest that, once the crisis emerged, their government handled it well. It wasn’t pretty (amongst innocent victims of the government’s shoot-first approach were Icelandic banks and Britain’s own Lloyd’s bank), but largely stands up to scrutiny. Another argument is over whether the Tory/Lib Dem coalition that took power in 2010 was too tight with its austerity policies, compared to how Labour would have handled the same situation. Many independent commentators agree with at least the first part of that proposition, though I don’t.

So, I don’t think Labour were quite as innocent as they claim, even if much of the direct criticism is misplaced. But, in politics, such arguments actually count for little. A more important question is how the public perceives things. This is where Labour’s real problem lies. What the public sees is a classic hubris to nemesis story, which is one of the oldest storylines in humanity, and takes some rebutting. Labour’s problem is their boastfulness before the crisis. Labour appealed to voters because a Labour government meant “no more boom and bust”, unlike with the Tories. And then one of the biggest busts in history happened.

And there is trust issue here. Labour’s position is a bit like that of the Lib Dems over tuition fees. The Lib Dems vowed not to vote for an increase in student tuition fees before the election, and yet later that year they supported the trebling of fees. Many Lib Dems will give you a convincing intellectual explanation as to how this not nearly as bad as it sounds, and that anyway there was little they could do in coalition. But this cuts no ice with the public, because of the way the party presented their policies before the election.

Labour are onto an equally losing wicket if they try convincing the public that the economic crash of 2008/09 was not their responsibility. Ed Miliband, their leader at the last election, was quite right not to even try. Besides, the alternative argument that Labour were the hapless victim of world events hardly counters the public’s perception of the post-Brown leadership (Mr Miliband and his successor Jeremy Corbyn) of being nice but ineffectual. The usual advice for when you are in a whole is to stop digging. The idea that if the party had come out fighting, public perception would be swayed, is pure nonsense.

The only way forward is for Labour to acknowledge their responsibility, and put forward hard economic policies that show they are capable of taking tough decisions if in power. And that means they have to stop banging on about austerity and get tough with some of their own supporters. For now, though, there is no chance of that.

2016 is nothing like 2008, but there’s trouble ahead for the world economy

In my New Year post I did not write much about finance, but made some rather throwaway comments that the economy could take a turn for the worse in 2016. Having just read Martin Wolf’s rather sanguine piece in the FT, I hadn’t quite understood that my views were in line with conventional wisdom in the financial markets – and this not at all a position I like to be in. But pessimism is in, and reflected by lower share prices worldwide. This has filtered through to left wing commentators, like Will Hutton, who gleefully want to show that “austerity” or “neoliberalism” is leading to a repeat of the 2008 crash (though Mr Hutton is too good a writer to use those particular totems). This is definitely company I don’t want to keep. Time to dig a bit deeper.

It helps to think back to what happened in the last turndown, the crash of 2008 – as this is foremost on people’s minds. At the start of 2008 the banking system was in deep trouble, although on the surface things were quite calm, if gently sinking. “Holed below the waterline” was the description that I used at the time – alas I was not publicly blogging until three years later, or my reputation might have been made. Trust was breaking down because the banks were dealing a lot with each other, or off-balance sheet offshoots, rather than with the public or businesses. And things were starting to go wrong, beginning with US sub-prime mortgages. The huge tangle of interbank transactions and derivatives meant that nobody knew how the losses would play out or where – so everybody was tainted. Things kept superficially calm until quite late in 2008, when Lehman Brothers collapsed, threatening a chain reaction that would have brought much of the world’s banking system to a screeching halt. Since the banking system is at the centre of everyday life in developed economies the result could have been catastrophic.

That catastrophe was largely avoided, but only because governments bailed banks out to keep the whole system afloat. Even then the damage to the non-banking economy was severe, and government finances, especially here in the UK, were ruined. What was so alarming about the whole episode was that a fairly routine downturn in the business cycle infected part of the US mortgage market, which then completely disproportionately went on threaten the whole system. Defenders of Britain’s Labour government still can’t believe it was anything to do with them – though in fact ten years of complacent economic management had left the country highly vulnerable to such a chain reaction.

Why are people worried now? Well one thing that helped the ameliorate the disaster in 2008 was that emerging markets, especially China, were less badly affected, and in China’s case, government stimulus helped keep things afloat. Now that side of things is unravelling. The Chinese economy is slowing, and in the process it is undermining world markets for commodities such as oil, which presents the threat of widespread damage in the developing world. The Chinese situation arises partly because the country has hit an awkward point in the evolution of its development, and partly because their stimulus package after 2008 was largely wasted and bad debts are threatening its banking system. Indeed the whole soundness of China’s growth strategy is coming into question (its second, state-directed phase , rather than Deng Xiaoping’s original liberalisation from 1978).

This is serious, and no mistake. The role China has played in the world economy in the last quarter century is hard to exaggerate. What is happening there is much bigger than the US subprime crisis that was at the heart of the 2008 debacle. But it doesn’t have the same destabilising features that caused such a fierce chain reaction – which were in plain view as 2008 started. China is not at the heart of a cat’s cradle of complex derivatives sitting in off-balance sheet funds, with almost every international bank taking part. And the huge power of the Chinese state, and the depth of its financial reserves, means that the country’s financial system will collapse slowly rather than suddenly. The western banking system is a much soberer thing than it was in 2008 too, even if many left wing commentators would have you believe that nothing has changed. For these reasons 2016 does not look like 2008. A meltdown, or near meltdown, does not look likely.

But there could be a slower moving form of trouble. Secular stagnation, the affliction of the world economy I referred to recently, is here to stay. Western economies will slow. Worse things may be in store in the developing world. Share prices may well fall badly – many markets have been overpriced for some time.

And in Britain? In my New Year post I suggested that 2016 might be the year the economy here started to turn sour. That comment wasn’t based on any deep thinking. Britain is unusually dependent on the international economy, as is evident from persistent trade and current account deficits, and a value for Sterling that is hard to justify based on its “real” economy. So, with things going awry in the world economy, Britain might be vulnerable. The Pound could come under pressure; foreign investors could desert London’s property market causing a chain reaction; or a downturn in the City’s finance sector could do the same thing. On the other hand, capital flight from the developing world could benefit London in particular, allowing the country to weather the storm. Some left wing commentators have been trying to stoke alarm about the level of personal debt – but that doesn’t stand up to close scrutiny. Neither should we pay much heed to Labour’s economic adviser, David Blanchflower, who on the radio this morning suggested that Britain was less ready to deal with a crisis than in 2008, because interest rates were already rock bottom. That vastly inflates the effects of interest rate policy on crisis management. David Cameron’s and George Osborne’s luck could hold. I struggle to understand the alarmism on the political left – it will merely undermine its already shaky reputation for economic grasp.

it seems to me that 2016 will be the start of a good old-fashioned cyclical downturn for the world economy, with no more than the usual localised financial crises. Personally I think this will morph into a period of more prolonged secular stagnation that will put paid to economists’ lazy assumption that 1-2% rates of growth are a law of nature.

And that should pose some very challenging questions for the art of economics. But that’s a topic for another day. Meanwhile government bonds are a better bet than shares; cash is not a bad bet either; don’t mortgage up to your eyeballs in property; and interest rates aren’t going up.

Osborne uses an accounting trick to implement People’s QE

When Jeremy Corbyn, was running his successful campaign for the leadership of Britain’s Labour Party, he floated the idea of “People’s QE”. “QE” stands for Quantitative Easing, the means by which central banks try to loosen monetary policy in an economy without reducing interest rates – handy when interest rates are near zero. It attracted quite a bit of attention from economists, much of it quite approving. That is because the idea touches on one of the most important aspects of modern economic policy: the suggestion that governments can sustain quite big deficits simply by “printing” money. In the end we find, not for the first time, that the current Conservative government acts much further to the political left than it talks, as did its Conservative-Liberal Democrat predecessor.

Back in the 1980s, when monetary policy first became the height of fashion, we had uncomplicated views about what it was about. Although most money was in bank accounts, economists painted a picture as though it was all in notes and coins, and the various actors behaved as if they were kids spending pocket money (and even then was probably too simplistic…). They talked of a “money supply”, which could be manipulated, and the size of which affected spending behaviour. We are older and wiser now, though many economists and journalists still talk about “printing money”, even though physical money has almost no role to play, and bank accounts are different in very important ways. Even trained economists who should know better sometimes trip themselves up in this way. For example there is much excited talk about how commercial banks create money rather than the central bank – which turns out to be a red herring on reflection [That link from Paul Krugman includes a broken link to a masterful essay from James Tobin in 1963, read it here]. It is better to look on monetary policy as a series of policy instruments under the control of the central bank, which have not entirely knowable effects on the economy at large.

The most important of these instruments is the short-term interest rate the central bank charges to commercial banks in their interactions with it. These ripple right through the economy. But when they are very low, as they are now in the UK, it is very hard to lower them further. Some European banks are using negative interest rates without the sky having fallen in, but these negative rates aren’t very high – fractions of a percentage point. So how to “loosen” policy – that is encourage a greater level of economic activity? Here the invention of QE comes in, pioneered, as so much of modern policy, by Japan in the 1990s and early 2000s. This is often talked of as if it means printing physical money and handing it out to the kids to spend on sweeties. What it actually means is that the central bank goes into the market and buys bonds, usually government bonds, like British gilts.

How does that help? Well the people who held the bonds now hold cash instead, which they should spend on something else – which might include new capital investment, after it has changed hands a few times. And it might reduce bond yields, which will reduce long term interest rates right across the economy, and increase asset prices. This creates a “wealth effect” that might encourage the mass affluent to spend a bit more money on stuff that people make. Or all that could happen is that there is a merry-go-round of money chasing various flavours of pre-existing asset to create an asset price bubble. It’s not very clear what has happened to the Bank of England’s QE over the years. The bank produces various statistical associations as evidence that it has helped stimulate the wider economy. Others are sceptical.

Which is where People’s QE comes in. What if, instead of buying government bonds in the market, the money went into extra government spending, such as infrastructure investment, or even current spending. Because the Bank controls the currency in the UK, it can fund the government’s deficit without the need to borrow money from investors. It borrows money from itself. This amounts to supporting looser fiscal policy (i.e. government tax and spend), which should provide a more predictable stimulus to the wider economy.

Mr Corbyn’s advisers developed the idea with the suggestion of administrative structures to channel the extra money into infrastructural investment. This puzzled some economists. There is no need for such engineering. All the government has to do is spend the money, increasing its deficit, issue bonds as normal, which the Bank of England then buys in the existing QE programme. If the Bank is buying bonds, the government is less beholden to the bond markets. In Japan, which has been practising QE on a massive scale, the government now issues little net debt to the bond markets, making large deficits sustainable.

But how does this work? Surely it is something for nothing? The answer to that is that it only works if there is slack in the economy, and the government steps in to create demand because businesses are investing less than the public is saving, creating an imbalance. If this is not the case, you can get inflation, which is what happened to Germany and Austria in the 1920s, Zimbabwe more recently, and is happening in Argentina now. Alternatively you get a asset price bubble. Which in the modern, globalised financial and trading system is in fact more likely for developed economies – though this seems to be a blind spot for many economists, who think that asset markets are too efficient for that.

But in the developed economies, including the US, the Eurozone and Japan, as well as the UK, there does seem to be scope to do this kind of stimulus. There is a lack of business investment, while, it appears, too much money ends up in the hands of rich people, who don’t spend it. Nobody knows how long-term this problem is, but it does look as if large government deficits are much easier to sustain than before. If the bond markets refuse to fund all of the deficit, then central banks can simply “print the money” as the popularisers would put it. Prominent British economist (Lord) Adair Turner (whom I am something of a fan of) suggested that this could be a long term policy in a recent book.

In Britain there is an accounting wrinkle which is having an important impact. The Bank buys government bonds, but it holds them rather than cancelling them, so that it can sell them should it want to tighten policy. So the government still pays interest on the gilts the Bank holds, and this used to count towards the publicly declared deficit. But the Coalition government changed the rules, so that it does not count the interest on the Bank’s holdings against the deficit. That reduces the fiscal deficit and allows the government to spend money on other things instead. Also the effects of QE on longer term gilt yields reduces the deficit projected by the Office for Budget Responsibility (OBR), which plays such a pivotal role in longer term government spending plans. According to the FT’s Chris Giles £22.4bn of the £27bn that the Chancellor, George Osborne, “found” to allow him to loosen austerity measures in the Autumn Statement resulted from these accounting tricks. This boils down to People’s QE, and Mr Osborne used it to fund his U-turn on tax credit cuts, amongst other things.

The problem, as Mr Giles points out, is what happens when the Bank feels the need to tighten policy in, say, a year or two’s time? Then the whole thing goes into reverse. Politicians have seen gain in blurring the distinction between fiscal and monetary policy. That could return to haunt them, at both ends of the political spectrum.

The Autumn Statement shows the conflict of short and long term Tory priorities

George Osborne, Britain’s Chancellor of the Exchequer, delivered his Autumn Statement yesterday. This is a very British piece of political theatre, delivered by somebody with a very theatrically British job title, that adds up to “Finance Minister”. In the statement Mr Osborne announced financial plans for the next five years of the Conservative government. It is a set-piece event designed to score political points and attract good publicity. The dust has not had time to settle, but some important issues are clear.

The main headlines were these: the government dropped the central part of its plans to reduce tax credits to top up the incomes of people working on low pay. It also withdrew plans to cut police budgets. Various other goodies were doled out; schools had their budget protected in real rather than nominal terms; there was more money for the NHS, and various investment projects. This was all part of a familiar game of managing expectations, which Mr Osborne now handles with competence. The reversal on police cuts was particularly well managed. The short-term politics has worked very well for the government, helped by the Labour opposition spokesman John McDonnell’s misjudged stunt using Chairman Mao’s Red Book.

But let’s step back a bit. The first point to make is that this exercise is one of completely false precision. The justification for a greatly reduced level of cuts to departmental spending (according to the FT’s Martin Wolf, from £41.9bn in pre-election March, to £15.6bn in post-election July to £7bn now) was a £27bn reduction in 2020’s projected borrowing. This £27bn figure is widely reported in the media, but it is nearly meaningless. It is based on economic forecasts which have almost no chance of being fulfilled – though at least they are produced independently by the Office for Budget Responsibility. That £27bn can appear out of nowhere in four months simply reflects this imprecision; it can disappear just as quickly. Personally I feel that the projection of a steady 2% plus of GDP growth, which underlies this forecast, is most unlikely to be fulfilled; it is an artefact of a deeply flawed process of economic modelling that still has a grip on conventional economics, because nobody has found a substitute.

So this needs to be taken in a broader strategic context. The government has two stated economic aims for the medium term. The first is that the state should run a surplus in the middle of the business cycle; the second is that overall government spending should be cut to about 37% of national income- low by postwar standards. Both are entirely arbitrary. There is a good case for a government deficit to fund investment, especially if the private sector is reluctant to invest its profits, which has been the story of the 21st Century so far. There is no convincing evidence that I know of to suggest that a lower level of government expenditure is more economically efficient.

But all this makes more sense if you think about the politics rather than the economics. And here the Statement was balancing long and short term aims. The long term aim is to crush an ecosystem of political bureaucrats in central and local government, and a range of agencies, consultancies and NGOs that hover around them. This is the principal power base of the Labour Party, and flourished mightily under the patronage of Mr Osborne’s predecessor but one, Gordon Brown. What is set to replace it is series of soulless, hollowed out agencies that are as easy to deal with as modern big businesses like phone companies (BT, TalkTalk, Virgin Media, etc) that are unable to manage complexity, so try to deny that it exists. The government’s new Universal Credit system is shaping up to be just such a nightmare. I see both sides of the argument here. I hate the old Labour bureaucracy and its hangers on with a passion, and I am not sorry to see it being dismantled (though a lot of excellent professional services are going too). But its hollowed out replacement lacks credibility, and at will be a partial solution at best.

The difficulties with this Conservative dystopia are apparent in the short-term politics. Welfare, security, health, education and social care are proving politically highly resistant, and hence the retreats evident in Mr Osborne’s statement. The Conservative fight to crush the opposition Labour and Lib Dems is going very well. But this is in large part due to Labour’s ineptitude. What if it woke up and led a serious fightback?.

The Conservatives’ drive to cut government budgets leaves them politically exposed. They stand a real chance of shutting Labour out of power for generations, but only if they secure the votes the working class and and the less secure middle classes. The changes to tax credits would have made these voters very angry. Mr Osborne’s U-turn is unsurprising – but leaves the question of how he managed to get into the mess in the first place. Meanwhile added demands of an ageing population on health and social care services is a challenge that will not go away. The extra funds found for these are unlikely to be equal to the challenge. And the problem of an economy polarising between low and high wages, while housing costs are escalating, is placing huge stress on welfare.

The hollowing out of the state at both national and local levels will continue apace. But a weaker than expected economy, and mounting pressure on health and social care services are likely to break Mr Osborne’s plans eventually. Whether the political opposition, outside Scotland, will be in any shape to exploit this situation remains open to doubt, however.

Is the world heading for a new financial crash?

Yesterdays’ Guardian carried an article entitled Apocalypse now: has the next giant financial crash already begun? by Paul Mason, who is Channel 4’s economics editor. The same paper carried an article last week by David Graeber: Britain is heading for another 2008 crash: here’s why. So it’s clearly becoming fashionable for left wing types to start spreading stories of doom. Could they be right?

Mr Graeber is not a professional economist (neither am I, I should make clear); he’s an anthropologist, in fact. He has written engagingly on financial matters though, notably his book Debt: the First 5,000 years. His enthusiasm is for the big picture and the global explanation. I found his book a huge let-down because he was incapable of analysing more recent financial events at any level below sweeping generalisation.

And so it is this time. His central argument is that enthusiasm for governments to cut their financial deficits means that private debt, at less affordable rates of interest, will pile up. The key strand of evidence is this graph, which shows public, private and external deficits:

He notes that it is symmetric, because it is based on an accounting identity. So, if the external balance is constant, which it roughly has been, any reduction in public deficit must be matched by an increase in private deficit. Ergo, we are simply swapping public debt for private debt. And since, as everybody knows, the crash of 2008 came about because of excessive private debt, another one is inevitable. He calls this the Peter-Paul principle (ie. robbing Peter to pay Paul).

Oh dear! It’s hard to know where to begin. As anybody with an understanding of mathematics will tell you, accounting identities don’t tell you as much as you might think. They are tautologies: you can’t use them to predict anything useful about the world. I remember, back in the 1980s, another accounting identity, this time on money, growth and inflation, getting people into trouble, as monetarists used it to “prove” that inflation and growth depended on money supply. Alas all it showed was how uselessly elastic are the concepts of money supply and velocity of circulation. A moment’s thought tells you that Mr Graeber’s argument must be flawed. He is suggesting that the amount of debt in the economy remains fixed – and yet it clearly goes up and down. Actually, the amount of debt is fixed – it is a net of zero! For every debtor there is a creditor; gross debt, however, must be independent of the sizes of the sectoral balances. The Peter-Paul principle is not the great taboo of economics as Mr Graeber suggests. It just doesn’ tell you very much. Not nothing, as the FT’s economics writer Martin Wolf, has shown – but it has taken him in a different direction. He suggests that if government austerity is not matched by extra private sector spending, the economy will shrink. An altogether more subtle point.

Mr Mason’s line of argument is sounder, in that it is based on more factual evidence rather than airy assertions. His line of argument is that aggregate debt has continued to rise, but the world economy has stalled, so that debt will be unrepayable, and so there will be a financial crisis. But this is still lightweight fare, based on aggregated data, which may be unreliable, and not on the specifics of who owes what to whom. The problem is that the world financial system is a very complex thing. It very hard to attribute cause and effect – or rather it is all too easy, it is just impossible to prove that you are right. The financial crash of 2007/2008 came about with the convergence of a number of things, of which the reckless build-up of private sector debt was only one (rising oil and food prices, reckless use of off-balance sheet finance by banks, persistent trade surpluses from China and oil states, a false sense of security from central banks – to name but a few).

One thing we can say is that the world in 2015 is very different from that of 2007, when the last crisis started. It is commonplace in left-wing circles to suggest that nothing has changed in the world of international banking since the crash. Well some banks are making money again, and some bankers are taking outrageous bonuses. But there are many fewer of them; there is much less profit sloshing around. The banks have been forced by regulation and bitter experience to be more prudent. Off-balance sheet finance, at the heart of the 2007 crisis, has been drastically reined in. And the world financial situation is very different, with low oil and commodity prices, a fading China, and the US fast becoming self-sufficient in hydrocarbons.

But that may not offer us much reassurance. We may not be heading for another 2007/2008 but we could still be heading for something nasty. There are four things that could be a sign of trouble:

There are asset bubbles in some places. What is referred to as “emerging market” assets are the most spoken of: debt, shares and property located in China and various parts of the developing world. But there are others: London property and US shares come to mind. Some suggest that developed government bonds are in a similar bubble, as their prices are historically high, but Japan has shown that these prices can stay high for a very long time indeed.
Central banks are running with ultra low interest rates, meaning that the main arm of monetary policy is not available. Quantitative Easing (QE) is problematic. This leaves them without the firepower to deal with a crisis as it emerges – or so many people think. In fact the dynamics of monetary policy have moved well beyond textbook theories about money supply and inflation expectations, leaving us unable to understand how things work.
The maturing of China and the rise of shale oil and gas in the US have changed world financial and trade dynamics fundamentally from the pattern of the last two decades. I suspect the new pattern is more stable than the old one in the long run – but any such change tends to cause dislocation. It may, for example, become much more difficult for many countries, including Britain, to finance their deficits (the blue bit in Mr Graeber’s graph could shrink).
International politics has become more fractious, making international deals more difficult to do. And populists from left and right are making it harder for governments to intervene to stabilise financial markets – often portrayed as bailing out bankers at the expense of ordinary taxpayers. That will make any future banking crisis harder to manage.

So I share some of Mr Hunt’s and Mr Graeber’s worries. I have my own airy narrative. Since the the Bretton Woods system of fixed exchange rates and gold underpinning was broken in the 1970s, by President Nixon who needed to fund the Vietnam war without raising taxes, the world has been addicted to an increasing cycle of debt. Some of this debt might be regarded as lubrication for the wheels of capitalism. But also there seems to be a bit of Ponzi scheme about it, with debt being repaid by the issue of yet more debt, rather than through substantive economic advance. In the long run, that cannot be stable. And yet it may take a long while yet before the trouble starts to show up.

The tax credit row: ignorance and obfuscation are rampant

Britain’s tax credit row reached a milestone last night with a government defeat in the House of Lords. As I said last week, it doesn’t show British politics in a flattering light. Then I complained about the failure of the government’s critics to tackle the financial implications. But ignorance seems to be wilful on both sides. What is the row really about?

First, we need to understand what tax credits are. There are two systems: Working Tax Credits (WTC) and Child Tax Credit (CTC). WTC amounts to £1,890 to £4,525 per annum, plus more for those with disabilities. It starts to be withdrawn when income is above £6,420 and the rate of withdrawal is 41%. In other words, for every £1 you earn above £6,420 your benefit is cut by 42p. CTC is for parents responsible for children. This amounts to a basic £545pa plus £2,750 per child (plus extra if the child has disabilities). For those in work these amounts are added to WTC and withdrawn at the same rate. For those not claiming WTC, withdrawal starts at £16,105 (I’m not sure how that works, and why you would be in work and not claiming WTC, but I’ll leave that for now).

So what were the proposed changes? There are two sets. The first is due to be implemented in April 2016. The withdrawal threshold for WTC is to be cut to £3,850; for those only on CTC the rate is cut to £12,125. The withdrawal rate is increased to 48%. The second set of changes will be made in 2017 to CTC. The £545 family element will be withdrawn, and the benefit per child will be limited to two children. These elements will apply to new families, not those who are currently claiming.

So what do the changes mean? First: the basic amounts of the benefits are not being changed, until the changes in 2017, and the latter do not cover existing claimants. This allows the government to say that it the Prime Minister David Cameron was not lying when he said that “he did not want to cut” CTC, during the election campaign. But, of course, the changed withdrawal rules mean that the benefit is being cut for everybody earning more than £3,850. The impact will be concentrated on lower earners, who will face a high marginal rate of tax, starting at 48%, and rising to 60% as National Insurance kicks in, and then 80% as Income Tax joins the party. This creates something of a poverty trap effect, reducing the incentives to work. But then again, the tax credits are not being abolished, and workers do keep some of their extra earnings.

The government’s chief advertised mitigation measure is raising the national minimum wage. This should put more money in the pockets of the poorest workers, provided employers don’t cut their hours. But much of the benefit of this will go to workers not claiming tax credits, and it will do little to alleviate the hardships of those worst affected. There seem to be two strategic aims. The first is to transfer some of the economic burden of lower wages to employers. There is a suggestion, for example, that employers are paying lower wages because they know that tax credits will make up some of the difference. The evidence that this effect is important is weak, however. A second strategic aim, not doubt, is to reduce the poverty trap element of the changes – so that workers are pushed through the levels of pay at higher marginal tax rates faster. The problem with these strategic aims that the new levels set for the minimum wage are arbitrary. Much of the cost will have to be borne by small and marginal businesses that can ill afford the cost – they may well choose to cut hours paid, and so undermine the policy.

The worst of the interventions in the debate, however, come from some of the suggestions made as to how to mitigate the effects of the changes. These have centred on raising the thresholds at which Income and National Insurance are paid. This is obvious nonsense. It may be clever to mitigate the withdrawal of a universal benefit by using targeted ones. The mitigation will cost less than the original change would save. To suggest the opposite, which is what these ideas amount to, is plain stupid. Worse, the poorest earners are not even paying these taxes, so exempting them will not help. And yet the BBC interviewer on the Today programme this morning sounded surprised when his interviewee pointed this out to him. This is wanton ignorance. The ulterior motive for these “mitigations” is to provide tax cuts to the better off, not to help the poor and struggling.

Moving on. Here are the points that should be being made in this debate, and either aren’t being made, or are being made by too few people:

The government’s changes are tackling the symptoms of the disease of low pay and poverty, and not its causes. Raising the minimum wage may help, but not by much, and could backfire. The real problems arise from the economic pressures that cause lower wages, and from increasing housing costs that make that poverty harder to bear. The risk is that the savings made from cutting tax credits will ultimately be overwhelmed by the less direct effects of poverty on the state. Instead of making it easier climb out of poverty these changes make it harder.
The cost of tax credits will fall if lower incomes rise. The whole design of tax credits is that their costs fall as the need diminishes.
The 2017 proposed changes, are more harmful and ill-considered than the 2016 ones. Clearly the thought is that the level of benefits is encouraging poor families to be larger. I don’t think any strong evidence is being put forward to justify this. It looks positively vindictive.
The government’s policies are not a vindictive attack on the poor, but an attempt to rebalance the system to something that is more sustainable in the long term. But they are a gamble. They are making several changes at once, without a base of evidence to support them. It is these risks that should be the focus of the debate.

Personally I feel that the basic, original, design of tax credits is reasonably sound. The fact that they are costing much more than originally planned is a problem in itself, of course. But it is also an alarm bell – it points to even deeper problems in our society. If we take away the short term cost to the taxpayer, it does not mean that this problem has been solved. I would tackle the funding problem through taxes on the better off (loosely defined, not just chasing the slippery very rich). But the real energy needs to go into alleviating the causes of tax credits. Nobody is talking about that at all.

Saving tax credits means raising taxes. I’m OK about that.

The current political storm over the British government’s proposed scaling back of tax credits is not showing politics at its best. On one side a cynical Conservative government is pushing through changes will make the poor poorer and reduce social mobility. On the other we have opposition grandstanding that has no interest in suggesting alternatives. I despair.

First of all, what is the fuss about? Tax credits were introduced by the Labour government in 2003. They are a way of providing means tested benefits to those already in work, but on low incomes, and especially those with children. They are designed to taper off as income grows, so that claimants will always benefit from any increase in earned income. They are copied from a US idea, but they have been Britannicised so that they can operate within the country’s system of taxation at source, PAYE. In America claims are made at the end of the tax year when tax returns are filed; the UK use a monthly system.

Originally the problem with tax credits was the operation of the monthly calculations. Inevitably the information they used was often out of date, and so many claimants were faced with clawback claims, for which they were not prepared. We hear much less of this these days. Nowadays the problem is the cost. Claims about this vary, but it was always expensive, and, with low paid jobs multiplying, it has grown sharply. And yet they are well targeted to those most in need, especially families. They do not penalise work, so many means-tested benefits do, while costing much less than universal benefits.

During the coalition years of 2010 to 2015 the government trimmed back tax credits, in particular they tapered off the withdrawal more sharply. Previously incomes up to around £40,000 (from memory – this figure may well be incorrect) could claim something, but this has been reduced. Now the government proposes to reduce tax credits even more harshly, and especially for larger families. It estimates that the savings will be between £4bn and £5bn. That will cause real hardship for many families that include working people. In fact, the very “hard-working families” that we got so sick of hearing about from politicians at this May’s election. The cuts will also be a setback for attempts to give children from poor families a better start, and so reduce inequality.

For all that there is a certain honesty about the plan from the Conservative Chancellor George Osborne. The government’s financial deficit is running at about 5%, far higher than it should at this stage in the economic cycle. During the election the Conservatives made it very clear that they wanted to balance the budget. They also made it clear that they would do so by making cuts to benefits. They were very coy about where these cuts would fall, and even suggested that child tax credits might not be affected – but there really is no other way to make their plans work. This is what politicians do in a democracy: vaguely promise “tough” measures before an election; implement them soon after, and hope the fuss has blown over by the time the next election comes around. A lot of publicity has been attracted by a Conservative voter saying that she felt very let down – but I’m afraid that’s political naivety. If the issue was that important to her, she should have voted for somebody else.

The government are honest, by the standards we have to apply to politicians (no truly honest politician would get elected), but misguided. But a lot of the opposition is a nonsense. It amounts to no more than a collective yelp of pain, and wishes for the government to “reconsider” without offering any kind of escape route. This is particularly annoying from Conservative MPs. They offer no alternative. The various mitigations proposed, such as raising the minimum wage, or tax thresholds, are badly targeted and won’t help much. Tax credits are the most efficient way of doing what they do. Any change is going to make things worse. There is no clever wheeze that will make the problem go away.

The opposition parties: Labour, the SNP and the Lib Dems are at least a little more honest than the Tory moaners. Labour initially got itself into a tangle, but soon put that right. I personally dislike the way these parties (and especially Labour) treat the status quo as a sacred thing to be “defended”, and any change that makes people worse off as tantamount to robbery. It’s still somebody else’s money. If systems of benefits, or public services, aren’t doing what they are supposed to, they should be changed, even it makes some people worse off. Still, that’s what politicians do. And in this case I think they are right. There is so much evidence that poverty in early life ruins chances later, which is why benefits focusing on families are a good idea. The system could be improved, no doubt, but not in a way that makes it any less expensive.

But these parties still should be clearer on what they think the government should do instead. All three of those parties have said they want the fiscal deficit reduced. They make an exception for capital spending – but tax credits is patently not that. Neither are they advocating cuts anywhere else (with exception of nuclear weapons systems, in some cases, but they usually want to increase spending on conventional forces instead).

Neither is it realistic to appeal to economic growth. This is not something that can be turned on and off like a tap by politicians. If it was the Conservatives would have that tap in the “on ” position already. Keynesian stimulus, which may have been relevant in 2010-2012, does not apply at this point in the economic cycle.

The only way to convincingly square the circle is to raise taxes. Of course the far left think they have the answer here: to crack down on tax avoidance and evasion, and to reform corporate taxes. Closer examination reveals these ideas to be chimerical. That still leaves the idea of taxing the rich harder. But the rich are slippery. There are still some things that can be done: taxing land, in particular, and tightening inheritance tax, rather than loosening it, as the Conservatives are doing. I wouldn’t bet on these ideas yielding much new money quickly though.

To have real credibility in “defending” tax credits, the NHS, local government spending, the police, or any other aspect of expenditure, politicians will not carry conviction unless they are prepared to raise one or more of the big three taxes: Income Tax, National Insurance, or VAT. Alas on this all parties are silent.

But such is the importance of tax credits to me, that I would indeed support the raising of one of the big three to keep them in being at current levels. I just wish the governments’ critics would say so too, and so start some real debate about the country’s fiscal priorities.

4 liberal themes on economics and public services: my contribution to Lib Dem Agenda 2020

Agenda 2020 is the consultation exercise being carried out by the Liberal Democrats to set the framework of policy in the period up to 2020, when we next expect parliamentary elections. At this stage the idea is to keep the thinking at quite a high level. This is always quite hard for political activists. We somehow got onto VAT on tampons in the consultation exercise in Bournemouth. Then again, I’m always saying that political types on the left are too abstract. I haven’t submitted the following contribution yet, but the idea is to be strong on general direction, with only a few pointers on the detail. I’m afraid that it’s still a bit longer than my normal posts.

Economics, public services and wider Liberal Democrat policy

Economics and public services should be at the heart of any political narrative. Too often in the Liberal Democrats both topics have been neglected. The party has opted for a simple middle ground between the Conservatives and Labour. The 2015 General Election was no exception, at least as far as the headlines went. The time has come for a much more robust narrative. Here are some ideas on what this might look like.

The story so far

After 1945 the great Liberal thinkers Maynard Keynes and William Beveridge founded a post war consensus on economic management and public services. This was based on the state taking responsibility for managing the business cycle through fiscal policy, and a greatly expanded set of state services, funded by much higher taxes (compared to pre-war levels), to fulfil a series of new entitlements, designed to ensure that everybody obtained a basic level of wellbeing. These ideas were taken on by the Labour and Conservative Parties, and developed into an overbearing state, which also took over a series of failing businesses, from railways, to steel, to even aero engines.

By the 1970s the state had lost control of its finances and the country was heading for towards economic collapse. Public services had been captured by vested interests, with very little regard for their users. In reaction to this emerged a new conventional wisdom, initiated by Margaret Thatcher and expanded by Tony Blair. This new thinking was again based on liberal principles, and it is often referred to as “neoliberalism”. The idea was that citizens should be empowered as buyers in a market economy, with the state stepping back to provide only basic services and a basic safety net. Much of the regulation of the business cycle would be taken up by monetary policy, so as to reduce the role of the state. Marginal rates of tax on income were cut, though overall levels of tax increased, if anything.

Probably not coincidentally, this change to public policy was accompanied by dramatic shifts in technology and global trade. Society changed substantially, mostly for the better. Living standards advanced, life expectancy improved, and pollution was cut. But now the country, in common with the rest of the developed world, seems stuck. Most economic growth just benefits a rich elite; businesses hoard excess earnings rather than invest or pay their workers more; property prices escalate. The number of badly paid jobs rises; most younger people are shut out of decent jobs and decent homes. Demand for health and care services grows, while public resources do not keep pace. And prosperity is restricted to a small number better-off areas, especially in the south east of England.

Liberals should worry. Power is being concentrated among a wealthy elite of people connected to big businesses. This trend Is abetted by a highly centralised national government that would rather deal with these large businesses, or else large public agencies like the NHS, than directly with the public. The power of the markets works for many people, but it is failing many more. Many people have inadequate leverage in the markets for jobs and homes in particular, leaving an unequal power balance in both domains. This state of affairs breeds fear and insecurity, which in turn leads to the rise of the political extremes of right and left, which threaten social cohesion.

In the meantime thinking on economic policy has not caught up with these profound changes. Most economists still think of the economy in a highly centralised way, in terms of aggregates across the whole economy, rather than the fate of its component parts. And thinking about productivity is stuck with ideas appropriate to manufacturing industry and economies of scale – and not to the efficient use of the human resources the country actually has to hand, in an economy increasingly dominated by personal services. The left rails against a series of pantomime villains, but resists any serious progressive reform of public services. This old thinking simply concentrates more power and wealth into the hands of a well-connected elite. Public services are dominated by functional silos based on political empires, not people’s actual needs.

We need fresh thinking, and my suggestion is to organise this around four liberal themes.

Liberal theme 1: green growth

Green growth means the advancement of human wellbeing while reducing the consumption of physical resources, especially non-renewable energy. The twin objectives are to ensure that everybody has the chance to live a healthy and fulfilling life in a comfortable environment, while easing the stress on the local and global environment. There are two aspects to this: developing and implementing technologies that are more environmentally efficient, and breaking the idea that ever increasing consumption is the path to improved wellbeing. This requires a profound change in outlook – though one that is already taking place.

Green growth may or may not entail economic growth as currently measured. That depends on how advanced wellbeing is reflected in the monetary economy. In the short to medium term it entails a substantial level of investment, in more efficient homes, power infrastructure and transport infrastructure, as well as research and development. If properly carried out these investments will entail improved economic growth. Longer term growth requires the harnessing of human resources more effectively. This means a wider distribution of information management and decision making, or:

Liberal theme 2: small is beautiful

Large organisations, be they businesses or government agencies, are one of the main threats to green growth and liberal values. They concentrate power in the hands of the elites that control them, leaving the majority of their employees disempowered, and unable to react most effectively to the world as they find it. The elites are geographically concentrated, leading to geographic concentrations of power and wealth, and the hollowing out of communities elsewhere. This hollowing out leads to a waste of human resources, which must be tapped if green growth is to take root. Furthermore, large commercial organisations have a tendency to hoard surplus earnings (often abroad) rather than invest them, acting as a further drag on the economy.

Of course large organisations also play a vital role in any efficient economy; they are the best organisational form to take on some functions. But these are not as many as often supposed. A liberal government must change the legal and regulatory environment so that it favours large organisations less. This will include reforms to political structures, banking and taxes.

It will also entail a substantial reform of public services:

Liberal theme 3: public services that solve problems

It should be obvious that the main reason that public services are inefficient is that they do not work together to solve people’s problems. Housing, mental health, addiction, crime and poor physical health are very often bound together in one person’s feeding on each other – and yet we persist in trying to deal with each of these issues separately, in separate chains of command all the way to Cabinet. Often the key is making all the relevant services work together in such a way that the user moves to a better way of life, with less call on the public purse. Usually what happens is that the relevant agencies work against each other.

Public services should be organised to meet the needs of people, and solve problems rather than playing pass the parcel. This should be the foremost area for the development of policy, based on best existing practice. There may be a number of possible approaches. Some of things are clear, however:

Changes will be easier to implement if responsibility for public services is more localised and more integrated.
Some form of empowered professional intermediary will usually be required to assess the users’s needs, to coordinate the different agencies and, where needed, to negotiate the compliance of the user. Empowerment will mean some form of budgetary control. This means a step back from the current tendency to disempower and de-skill such intermediaries, like social workers and probation officers.
Large scale functional outsourcing will usually take services in the wrong direction. Repeated tendering also leads to a dumbing down, a tendency to gloss over more complex issues. The greater use of local social enterprises may well be a better approach in a framework that ensures proper accountability.

Public services should help with some of the most difficult problems relating to poverty; but this has to be in a wider context wealth and income distriubtion. We also need:

Liberal theme 4: redistribution to correct imbalances

A well-ordered, liberal society might not require the redistribution of income and wealth. And liberals dislike redistribution for its own sake – different levels of wealth may simply reflect freely made choices over how to balance accumulating money with other things life has to offer. But in our society imbalances of wealth and income pose a threat. The less well-off are denied the opportunities that should be theirs. Excessive wealth can be used to buy political influence and monopoly power, reducing choices for others. The accumulation of wealth may also lead to excess savings and economic stagnation. Liberals must embrace redistribution, albeit warily.

Redistribution needs to work at two distinct levels: personal and geographical. The wealthy must be taxed on both income and assets (land, in particular), and the worse off must be compensated through access to benefits and rights to state services, especially housing. Children must be a particular focus of redistribution as early years are critical to life chances.

Also funds must be redistributed from wealthy regions and districts to those less well off, to offset the negative network effects of clusters of wealth.

At both levels redistribution arrangements must be designed so as not to create dependency. Those less well-off should be encouraged to improve their lot – but at the same time the level of redistribution must fall as the need for it falls. Systems of redistribution based on universal rights (like the state pension) have their place, but have limits too. Truly liberal systems of redistribution will require careful design.

A policy programme to match

At this stage the idea is to sketch out broad political priorities, and not detailed policy programmes. I do not believe that in most cases a radical departure is needed from adopted Liberal Democrat policy. The high level emphasis will need to be rethought, however.

The main policy implications of taking forward the four liberal themes are:

Political reform, and especially the devolution of power to regions and districts. This is essential to create the right political environment. This may be combined with a new federal settlement for the UK and reform of the House of Lords. Electoral reform is important to ensure a plurality of power – but the priority must be to implement proportional voting systems at local level rather than at Westminster. A further important strand of political reform should be restricting the influence of wealthy individuals and organisations, especially through political donations.
A programme of green investments must be instituted, including high quality social housing.
With public service reform the emphasis should be on bottom-up initiatives – but national funding structures will have to be reviewed to facilitate this.
The tax and benefits system will need to be re-examined. The Lib Dem commitment to increasing personal allowances must be rethought, as it is inefficient as a redistribution policy. Restoring tax credits is a higher priority. Taxation of land in some shape or form makes sense, though we may get no further than reforming Council Tax.
On overall fiscal policy it is best to manage down expectations of additional government spending – though the principle that the government (including local governments) can borrow to invest must be clear.
The banking system must be reformed to allow new, locally-based lenders to come into play. Investment in the “real economy” should be encouraged to create new assets, While avoiding a merry-go-round of existing assets.
The UK should act internationally through the EU to curb tax avoidance, especially by large corporations. Trade agreements and relations with the EU should be viewed through the prism of promoting smaller businesses, and not simply advancing the interests of large multinationals.

Of course there are many more important policies that have a bearing on the economy and public services – not least reducing the level of carbon emissions. But overall such a policy platform should be quite distinctive from the orthodoxies of right and left, and yet fully in tune with modern times.

Labour changes the meaning of austerity

So far, so good. That’s my verdict of the remaking of Labour under its new leader, Jeremy Corbyn. I’ll say more about the big picture later in the week, after Mr Corbyn’s speech later today. This time I want to focus on economics and the performance of the Shadow Chancellor, John McDonnell, who spoke yesterday.

Like Mr Corbyn, Mr McDonnell is a serial rebel and a political outsider – and he is very much Mr Corbyn’s right hand man. That is why he was given the job of Shadow Chancellor over the much more politically correct Angela Eagle. Both Mr McDonnell and economics are central to the Corbyn project.

The first thing to note is the new regime’s ambition in taking on economics. The previous leader, Ed Miliband, was a bit embarrassed to talk about economic policy. He did not try to defend the previous Labour government’s economic policies, nor seriously criticise them for matter, in spite of the opprobrium being dumped on them by the coalition parties. He was late in developing his own economic proposals, and when these came out, they appeared to be “austerity-lite”, and not seriously challenging the government’s narrative.

Mr McDonnell, on the other hand, wants to take control of the economic narrative. He is enlisting the help of heavyweight economists to both support his own plans, and to undermine the government’s version of events. In this he is capitalising on a remarkable fact. Academic economists have been very critical of government policies and “austerity” generally. Indeed government policy seems to be more based on 200 years of Treasury orthodoxy than modern economic insight. This is an opportunity to undermine the government’s reputation for competence, and make it look ideological.

Labour is still left with the two paradoxes of anti-austerity economics that I referred to in a previous post. The first is that by opposing austerity Labour will have to make its peace with the global financial markets that it so despises. Mr McDonnell tackled this head-on in his speech, and in an interview with the Guardian newspaper last weekend. He has nominally adopted the government’s trajectory for reducing the UK’s fiscal deficit, with its aim of bringing it into surplus by 2020. With a huge rider: he will exclude borrowing to fund capital investment. Depending on how loosely “investment” is defined, this is perfectly sensible public policy, and not, in fact, very different from Mr Miliband’s. It reduces dependence on international finance – remembering that the Bank of England’s Quantitative Easing policies may come to the government’s aid if the economy takes a turn for the worse.

There is, of course, a problem. It means signing up to austerity as most people understand it. And yet opposition to austerity remains his rallying cry. One of the many weaknesses of the left is its love of abstract nouns, especially as things to oppose – austerity, neoliberalism, inequality, and so on. Ordinary working people don’t understand what they are on about, but the activists work themselves up obsessively – and at the moment austerity is public enemy number one. But Mr McDonnell and Mr Corbyn have an ingenious answer to this: just change the meaning of “austerity”.

To them, the word now applies not to tightening the government’s finances overall, but to cuts and tax rises that might affect low and middle income workers. There will be cuts, said Mr McDonnell, but not to the numbers of policemen, nurses or teachers. Instead the cuts would be to “corporate welfare” – tax breaks to businesses, as well as raising taxes on the rich. He was careful not to be too specific about all this.

There are some pretty solid grounds for scepticism here. Mr Corbyn has brandished the figure of £93 billion for corporate welfare, a figure conjured up by the Guardian. Mostly these are allowances or direct support for investment, exports and research and development – all things Labour will want to encourage. And the small print of the Guardian’s report suggests not that this is low hanging fruit waiting to be plucked, but that it is, to switch metaphors, a rather overgrown hedge that can be trimmed a little. There is reason to doubt how easy it will be to target other measures to raise taxes, or clamp down on avoidance, without collateral damage to the small and medium sized businesses that the economy so needs. This is what undid Francois Hollande’s Socialist government’s attempt to do much the same thing.

But it isn’t nonsense either. Big business, and the pampered elites that run them, are not a benign force these days. They contribute to the hollowing out of much of the economy by destroying middle ranking jobs and sucking the soul out of towns and villages away from the main commercial centres. They also siphon profits out of the economy rather than reinvest them. Labour will do well to be wary of big business, unlike the earlier regimes of Tony Blair and Gordon Brown. But finding policies that will tilt things against big business without damaging the wider economy will not be easy. I think that tax treatments for intellectual property and debt interest are a better place to look than the Guardian’s corporate welfare list. And international cooperation on corporate tax avoidance will help (especially if we can move to unitary taxes, such as the US states apply among themselves). But such policies will take time.

All this takes us into the territory of my second paradox for anti-austerity economic policy. It calls for more economic growth, and yet bears down on much of the private business that will be needed to generate it. This will be the next challenge for Mr McDonnell and his colleagues. It is fair enough to bear down on many businesses, especially the giants. But Labour also needs to show encouragement and support for more positive businesses, through investing in support infrastructure, improving access to credit for genuine investment, improving public procurement, and through reducing the burden of petty regulation. As yet I see no sign of this – but it is early days.

I remain highly sceptical of the new Labour project. But its leaders have made a competent start, and there is undoubted fresh air. The floor is still theirs.

Political reform is the acid test for Corbyn’s Labour

British politics has suffered a massive earthquake with the election of Jeremy Corbyn as Labour leader. There is a lot of dust; there will be aftershocks. But what can liberals say at this point?

Let us for now take this development at face value. There is an upsurge of public support for Mr Corbyn amongst people desperate an alternative narrative to “austerity”, and for a political party with real left-wing values. Let us say that the half a million or so people who took part in the party’s election process are not mainly London clictivists, but will join Labour’s campaigning by making phone calls, knocking on doors and donating money, from London to Leeds and from Bristol to Glasgow. Let us also say that Labour will not be riven my infighting but will mobilise behind a concerted attack on government policies.

If this happens there will be real momentum behind Labour. It will take the wind from the sails of the Green Party; Tim Farron, the Liberal Democrats’ new leader will find it very difficult to attract people to his party through returning to left-wing campaigning. Many working class Ukip voters will consider returning to Labour, now that it has rejected the establishment consensus. Labour will start winning by elections against all comers.

All this would throw down the gauntlet to liberals who reject the government’s creed of economic liberalism. If it looks as if this reinvigorated Labour party might make headway against the Conservatives, do liberals support them in the hope that a transfer of power will be good for the country? Or do they think this new movement is fundamentally wrong, and has to be stopped at all costs? There seem to be three groups of issues that could decide this.

The first is Britain’s place in the wider world and defence. At this point it is very unclear what Labour’s new stance will be. Mr Corbyn himself has been associated with some very extreme views, such as that Britain should leave NATO. It’s pretty safe to say, though, that Labour’s policy line will be more moderate than this. But surely it will oppose just about any foreign military intervention, and the the odds are it will come out against renewal of Britain’s Trident nuclear weapons systems. Not so long ago these views would have been considered so extreme that no respectable politician should entertain them. But now there is a good case to be made. There seems to be little point in such heavy-duty and expensive nuclear armaments, which will be dependent on US support. There is a respectable case for more limited nuclear weapons, or even complete nuclear disarmament. Likewise foreign military intervention doesn’t seem to be making the world a safer place. They provide no answers to filling the political vacuums that are the real threat to stability. If Labour starts to support leftist regimes that do not support political pluralism, such as those in Cuba or Venezuela, then that will be another matter. But I don’t think Mr Corbyn will be able to take his party to those positions. So liberals may not be given enough reason here to oppose the movement.

The second groups of issues is economics. This is central to Labour’s new appeal, as cn be seen by Mr Corbyn’s appointment of left-winger John McDonnell to the role of Shadow Chancellor. It will define itself through a bitter a bitter opposition to “austerity”. It will oppose this they mean cutbacks to benefits or public services, or raising taxes on anybody but a rich elite. They are also opposed to any serious reform of public services, apart from moves to a model of state-owned command and control organisations, staffed by union members on permanent contracts. Two ideas are offered to make this economically viable. The first is a sort of semi-digested Keynesianism, which suggests that their policies will stimulate demand and so economic growth and, through this, extra tax revenues. The second is that there are vast amounts of extra tax available from taxing the rich more, clamping down on tax avoidance and evasion, and attacking “corporate welfare” – tax breaks and subsidies for businesses.

I have commented on these ideas before. For now all I need to say is that there are two paradoxes at the heart of this economic programme. The first is that, almost by definition, rowing back on austerity means a greater dependence on global financial markets to provide funding – printing money is not a long term strategy. And yet these markets are treated with contempt. The second paradox is that their policies depend on a healthy private sector economy to deliver economic growth and tax revenues, and yet they also want to make life more difficult for the private sector, and encourage businesses to take their investment elsewhere. No left wing government, from Francois Hollande’s Socialists in France to Alexis Tsipras’s Syriza in Greece, has found an answer to these paradoxes. The anti-austerity programmes of the former were sunk by the need to attract private sector investment, and the latter by the need to keep borrowing money from abroad without a clear prospectus for paying that money back.

But, if in the end governments will be forced to their senses by the dictates of markets, perhaps we can tolerate a little short-term economic chaos? We can, after all, be sympathetic with the idea of using the tax system to effect redistribution of wealth. That depends on the third group of issues: political reform.

The Conservatives now control the government because the current political system is weighted in their favour. Liberals favour a more pluralistic system, with greater checks and balances. To achieve this we need political reform in a number of areas. Will Mr Corbyn’s Labour Party support these, or simply offer vague platitudes like his predecessor, Tony Blair? That will be, or should be, the defining issue for liberals. What are these areas?

The first is political finance and the reach of big money. The UK is not anything like as bad as the US – but that country points to the dangers. Laws start to be dictated by corporate vested interests – a particular problem in public services outsourcing, and intellectual property. Mr Corbyn’s Labour Party will surely be much more serious about this than its predecessors.
Next is devolution. This means not just protecting the settlements in Scotland and Wales, but promoting further devolution to English regions and councils – including revenue raising powers, and the coordination of public services. There is reason to be suspicious of Labour intentions here – though since Labour also control England’s major cities, there might be some constructive tension. I have not forgiven Andy Burnham’s scepticism of the devolution of health services to greater Manchester.
Then there is the House of Lords. Will Labour support complete abolition, or replacement by an upper chamber with real powers? Personally I think a new upper chamber should be part of a new constitutional settlement for the UK, taking it to a more federal structure. But a proportionally elected revising chamber would be acceptable. Which brings us to:
Electoral reform. This really is the only way of promoting political pluralism in the long run. We need a system based on some form of proportionality, such as the Single Transferable Vote (used in Northern Ireland, and indeed the Irish Republic) or the Alternative Member system (used for the Scottish and Welsh Parliaments and the London Assembly). We have to be careful here; there is real public scepticism about this. And moving to PR at national elections is a big step. But a firm commitment to PR for local elections is an essential accompaniment to serious progress on devolution.

Will Labour deliver on these? I would be most surprised if we get anything more than a few warm but vague words. For the hard left consolidating political power is the whole point and purpose of politics, and they want to monopolise it. They don’t accept pluralism except as a way of identifying enemies. The can’t accept that empowering the people can mean anything other than conferring the mandate of heaven to their own political elite. There are pluralists in Labour, but on political matters the Blairites and the hard left are remarkably close together. If Jeremy Corbyn strikes out on a different line, then the movement he has started may yet be a worthy revolution.