Winner of the New Statesman SPERI Prize in Political Economy 2016

Friday, 21 July 2017

The politics of ignoring knowledge

Simon Tilford has a post where he explores the roots of Brexit in a kind of UK exceptionalism. He argues that “the underlying reason [for the Brexit vote] is the hubris and ignorance of much of the British elite, not just the eurosceptics among it”. I want to expand on that. I do not think this ignorance and hubris is confined to the UK’s role in the world. It also extends to an attitude to knowledge of all kinds, and I suspect it is possible to date when this began to the revolutionary zeal of the right under Thatcher.

The Thatcher government that gained power in 1979 were going to do away with what they saw as Keynesian nonsense, and run the economy using money supply targets. Treasury civil servants produced a forecast that said their policy would lead to a recession, and this turned out to be what happened. The forecast when it was made was dismissed by the politicians in government as the product of outdated civil service advice reflecting a failed consensus..

It is of course the prerogative of politicians to reject a consensus, particularly if there is a reasonable minority of experts who think the consensus is wrong. It is what happened next that was the problem. Monetarism was a monumental and predictable failure, but Conservative politicians and their supporters spent considerable effort and resources turning this failure into a triumph of Thatcher over an establishment civil service and academic economists. One example is the letter from 364 economists objecting to a deflationary fiscal policy in the 1981 budget. The right, and in particular the IEA, have successfully cultivated a belief that this letter was wrong when in fact it was right. The recovery (using the term as it should be used) was delayed by over a year by the 1981 budget. More generally the view was that social scientists or civil servants were probably antagonistic to the neoliberal project and could safely be ignored. They were, in Thatcher’s words, not one of us. [1]

The reality was that the Thatcher and later Major governments did subsequently often take note of what experts were saying, but the myth on the right prevailed. Before the Conservatives regained power in 2010, they thought very little of going against the advice of the majority of economists over austerity, although to be fair they were later supported in this by senior civil servants and the governor of the Bank of England. Policy based evidence replaced evidenced based policy. But this was the relatively sane wing of the party, as we discovered during the referendum campaign.

We know the EU referendum campaign largely ignored experts, whether they were economists, lawyers or experts in international relations. What I think surprised many is that the Leavers fantasy was not just a device to obtain votes, but actually reflected what the Brexiteers believed. Since the referendum the government has clung to the fantasy, and ignored or dismissed all the advice it was getting from its civil servants. (In two cases dismissed meant sacking or resignation.) As Steven Bullock says, the EU side are in despair that the UK has yet to work out a realistic position on many issues. Because large parts of the UK public, relying on the right wing press for their news, still believe in the fantasy, some in the main opposition party think their best strategy is to ape their opponents.

As a result, we are in a strange bifurcated world. One part consists of pretty well anyone who knows anything about the economics, politics or legal aspects of Brexit. They realise how hard Brexit will be, know how much damage it could do, and by and large think it will be disastrous for the UK. (Experts tend to recognise and respect knowledge in other areas.) The other part lives in a different world, the world of the media and politicians, where everyone still lives the fantasy.

In this respect, we are no different from what is happening across the Atlantic. Angus Deaton notes the tragic irony that in the year the great nobel prize winning US economist Ken Arrow dies, the Republican administration is ignoring one of his great achievements, which was to show why a simple market in healthcare will not work. The only ‘expert’ this Republican administration seems to recognise is Ayn Rand. If it is successful in replacing or sabotaging Obamacare, millions will lose coverage and thousands will die as a result. The experts (such as the CBO) who predict this are accused of inaccuracy by a White House that cannot even be bothered to check its spelling of 'inaccurately'.

May holding Trump's hand shortly after he became president was indeed symbolic. Those who justify ignoring experts often talk about them as ‘unaccountable elites’ who have ulterior motives in giving the advice they do. In reality ignoring expertise means dismissing evidence, ignoring history and experience, and eventually denying straightforward facts. It leads to the politics of barefaced lying, such as asserting that a new trade agreement can be negotiated in little over a year. [2] This disdain for knowledge is not a prerogative of the right: you can find it on the left among those who say, for example, that all social science is inherently value laden and therefore political. (Ironically often dismissing mainstream economics as a buttress of neoliberalism, the same economics that the right are so keen to discredit.) The difference is that that the knowledge dismissing right have power in the UK and US, and so we are suffering the consequences of their evidence-free politics.

[1] Sir Keith Joseph tried to abolish the Social Science Research Council.

[2] It seems finally that the government has accepted a reality that was obvious months ago to those who listened to experts. 



Wednesday, 19 July 2017

Should Labour triangulate over Brexit?

There are two schools of thought about why Labour is adopting a confusing and conflicting position over Brexit which is almost the same as the government’s line. The first is that Labour is simply confused and conflicted. The more interesting is that this is deliberate triangulation: sound slightly less enthusiastic about Brexit to keep its core anti-Brexit vote, but also not to antagonise its minority pro-Brexit vote. I do not know which view is correct, and it is possible that both are. To the extent that it is triangulation, is this the right thing for Labour to do? This question is related to a recent Guardian article where John Harris argues that although Brexit will be a disaster it has to happen.

If triangulation is how Labour justifies its own position on Brexit, the obvious question to ask is why they made so much fuss when their predecessors appeared to triangulate over austerity. Brexit, like austerity, will be extremely harmful for the economy. So what made triangulation (or appeasement, if you want to use a more pejorative word) over austerity a huge political mistake, but allows the same for Brexit acceptable?

If you take the position that political parties and politicians should always argue for what they or their members believe in, rather than adapting their positions to what is politically possible or smart, then there is indeed no difference. Those who said that Labour’s failure to campaign loudly against austerity in 2015 represented some kind of moral betrayal should, for consistency, be arguing the same over Brexit.

A more political answer would be that in the case of Brexit triangulation worked, while for austerity it did not. In 2015 the election was all about economic competence, and Labour triangulation on austerity had the effect of conceding competence given the prevailing ‘clearing up the mess’ narrative. Of course Labour did not win the 2017 election, but they achieved during the campaign a surge in popularity that is virtually unprecedented. Labour supporters who are also anti-Brexit will tell you that this was because Labour made the election about austerity (or more accurately the size of the state) rather than about Brexit. If instead Labour had campaigned against Brexit, the election would have been a rerun of the referendum (as May wanted it to be) and because of the geographical concentration of the pro-EU vote Labour would have lost badly.

Even if you buy this, however, there remains a question of whether the triangulation strategy will continue to work, and whether it could have the unfortunate side-effect of ensuring Brexit will happen when otherwise it might be stopped. To assess this question, we need to take a realistic view of how the Brexit process is likely to evolve.

We know pretty well what the final deal will look like. It will be along the lines of the deal put on the table by the EU, together with a transition period during which we stay in the customs union and Single Market (and continue to pay for that privilege). We know this because the Article 50 process gives the EU the whip hand: the No Deal outcome, which is what happens if time runs out, is so much worse for the leaving country and there is no time to negotiate a trade deal. [1] As a result, to use a term loved by Conservative politicians but which in this case happens to be true, there is no alternative deal to be done.

The only risk before the election would be that the government would walk away. The election had made that much less likely. As there has been virtually no preparation for that outcome, it would bring chaos. This chaos would ensure that Theresa May’s successor lost any subsequent election. While the Brexiteers in safe seats might be prepared to see that happen, the rest of the party would not. Faced with a split in the Conservative party, Labour could not side with the government, as it would flip its triangulation strategy and lose a lot of its core support. As a result, a No Deal Brexit would fail. [2]

What this means is that we will leave the EU in 2019, but remain in the Single Market and customs union until both sides negotiate something else. Can a final deal of this kind be stopped? Logically you might think that MPs would realise that, compared to EU membership, all this deal does is mean the UK gets no say in the rules governing the Single Market and in addition we have to pay a significant sum of money for that lack of control! It is pure lose, lose, with the only positive (from a Leavers point of view) being the possibility of avoiding Freedom of Movement at some future date.

Unfortunately logic is something not normally associated with Brexit. In reality I suspect most Conservative MPs will agree to this (for the moment) softest of soft Brexits with a sigh of relief, telling themselves that they have fulfilled the will of the people with as little damage as possible. The triangulation strategy, which is essentially designed to prevent Brexit becoming a pro/anti party political issue, suggests Labour will go along with this. The only way either of these things might not happen is if public opinion turns against Brexit over the next year.

Will opinion move by enough to at least make it possible to get a vote for a second referendum through parliament? Who knows, but there are some structural factors against it. The first is the right wing press, which after all are the people who got us into this mess. The second concerns the broadcast media. Its operating model is based on a two party system, and if neither of these parties are making the case that our current difficulties are a result of Brexit then that case will not receive the exposure it deserves.

Here we get to why many of those who oppose Brexit are angry at Labour’s position. They feel that without a major party constantly reminding the public of the problems that Brexit is creating their chance of turning public opinion is much reduced. I suspect Labour’s response, if it was honest about what it was doing, would be to say that they will not risk the next election by taking a public anti-Brexit position. It is the Conservatives who got us into this mess, and they have to make the first move to get us out. The retort that Labour are reducing the scope of what they can do in government by allowing Brexit to happen has less force if we are staying in the Single Market and customs union.

This is related to the argument made by John Harris, which is that a vote to reverse Brexit would do nothing to reverse what caused the Brexit vote in the first place. If Brexit was stopped, UKIP would be given a new lease of life, and “the myth of betrayal ... would sit at the heart of our politics”. To recast what he is saying in my own words, you cannot undo social conservatism and the effects of economic deprivation, plus a decade or more of propaganda from the press, with a single vote of parliament. It is related to the earlier argument because Labour might say that they cannot reverse these same forces by a year of campaigning against Brexit before we leave.

Unfortunately there seems to be no reason why this state of affairs should change during the transition period. The government, committed to controlling immigration, will be determined to get a deal that ends free movement. Labour, to avoid immigration becoming too much of an election issue, will continue to triangulate. The best [3] hope I can see to avoid further Brexit damage is for Labour to defeat the Conservatives at an election, and quickly realise that they are better off staying in the Single Market and encouraging free movement. Which of course gets us back to why they are triangulating in the first place.

[1] It was designed in part to discourage countries leaving the EU. As David Allen Green suggests, there was a better way to leave the EU.

[2] We have gradually seen the government inching their way towards the EU proposals. (Remarks by Boris Johnson, like those of Donald Trump, are a distraction that it is best to ignore.) They are taking their time because the UK side has almost no power in the negotiations, and it is better to gradually concede to minimise any negative reaction among Brexiteers or the public. (Part of the problem here is that because the government still maintains a public stance that is pure fantasy, and the opposition wants to stay deliberately vague, the media feel unable to be straight on these issues with the public. It also requires effort to dispel fantasy with reality.)

[3] ‘best’ as in better than any other likely outcome.




Monday, 17 July 2017

The OBR’s risk assessment lacks context

In its recent report on fiscal risks, the OBR talks a lot about all the shocks that could make the government debt to GDP ratio rise again. It then says the following:
“None of this should be taken as a recommendation to refrain from particular spending increases or tax cuts, or to avoid particular fiscal risks – that would lie beyond our remit. And there are those who believe fiscal policy is still too tight, given the pace of economic growth and the looseness of monetary policy. But ….”

Should I be grateful for the second sentence, being one of ‘those’ who think that way?
I think the reverse is true. The OBR has played the tune the government wanted, but it is the wrong tune, and this now mature and independent organisation is capable of much better than this. I will first deal with a particular issue to do with monetary policy, and then talk more generally about the concept of ‘fiscal risks’.

Our macroeconomic institutional architecture is based around what I have called the consensus view about macroeconomic policy. This consensus involves what economists call an assignment. The stabilisation of output and inflation is assigned to independent central banks operating monetary policy. Fiscal policy should be confined to managing the government’s deficit and debt, and to help it with that task there should be a combination of fiscal rules and independent fiscal institutions (aka fiscal councils, like the OBR).

In a consensus assignment world, the job of a fiscal council is to stop deficit bias: the tendency clearly observable in some countries before the global financial crisis for deficits to creep up over time. In particular, when all is going well and the deficit appears not to be an issue, it is their job to tell the government to 'fix the roof while the sun shines’.

As I and others have noted many times, this consensus assignment has an Achilles Heel, which is that nominal interest rates cannot go below a number close to zero, the so-called Zero Lower Bound (ZLB). In the absence of some mechanism to allow interest rates to become significantly negative, that ZLB problem means that sometimes fiscal policy makers have to help monetary policy in its stabilisation role. The simple consensus assignment breaks down.

Although most academic macroeconomists recognise that, our institutions find it hard to do so. Monetary policymakers in the UK and Eurozone find it very difficult to say that they have lost their main instrument, and that therefore they can no longer reliably do their job. It seems that our fiscal council, the OBR, has similar problems.

We are currently at the ZLB. The most immediate risk we therefore face is that we are hit by a negative shock and monetary policy is unable to respond effectively. Hence the quote from their document above. But as far as I can see that is it. In their section in the Executive Summary on the risk due to a recession I would have thought the ZLB problem was worth at least mentioning, but it does not appear. Indeed I’m not sure the term ZLB or liquidity trap appear anywhere in the document.

I’m sure the OBR would in defence say two things: assessments of fiscal risks generally look at risks to fiscal sustainability not macroeconomic stabilisation, and their remit precludes them from talking about alternative fiscal policy paths. This is all true. The Treasury wanted a report that would enable them to say we must continue with austerity because of all the risks identified by the OBR. The Treasury also wrote the OBR’s current remit. 

But the OBR is supposed to be independent. Just because the government tries to pretend that there is no Achilles Heel to the consensus assignment, that does not mean it has to go along with that act. In particular, it will (I hope) have noted that the main opposition - which came close to defeating the current government - has a fiscal rule that explicitly says that fiscal policy needs to switch from stabilising debt to stabilising the economy when interest rates are at their lower bound (like now). In this context, I think something beyond a single sentence alluding to the ZLB would have been appropriate.

Tony Yates said similar things yesterday. He also made another important point: a key role of government in many areas is to be a risk absorber. It assumes risks, because it is beneficial to take risks away from individuals or individual generations and spread them more widely, and often the state is the only institution that can do this. In addition, its deficit and debt should be a macroeconomic shock absorber. Given all that, why exactly should we be concerned if various shocks increase government debt? That is what is supposed to happen!

To put the term risk and attach it to some level of debt or deficit, giving us ‘fiscal risks’, is questionable. It is a bit like saying their is a risk that your central heating will come on if it gets cold: that is not a risk, but why it is there. The OBR would no doubt respond that the government has a mandate in terms of a deficit or debt target, and it has been asked to look at risks that this may not be met. But that should not stop an independent OBR from asking more fundamental questions.

Implicit in the idea of ‘fiscal risks’ is either a belief that there is an optimal level of debt which is below current levels, or a view that there is some level of debt so high that markets would start worrying about the government choosing to default. If we are worried about a debt burden on future generations, does it make sense to put all that burden on a current, already disadvantaged, younger working generation? Unless these key issues are addressed, all the risk assessment the report undertakes is meaningless, or worse still just provides support for the government’s misguided policy. It is time the OBR stopped being constrained by its remit, and started providing the public with a useful framework in which to think about ‘fiscal risks’.

Friday, 14 July 2017

Why German wages need to rise

An interesting disagreement occurred this week between Martin Sandbu and the Economist, which prompted a subsequent letter from Philippe Legrain (see also Martin again here). The key issue is whether the German current account surplus, which has steadily risen from a small deficit in 2000 to a large surplus of over 8% of GDP, is a problem or more particularly a drag on global growth.

To assess whether the surplus is a problem, it is helpful to discuss a key reason why it arose. I have talked about this in detail many times before, and a similar story has been told by one of the five members of Germany’s Council of Economic Experts, Peter Bofinger. A short summary is that from the moment the Eurozone was born Germany allowed wages to increase at a level that was inconsistent with the EZ inflation target of ‘just below 2%’. We can see this clearly in the following chart.

Relative unit labour costs, source OECD Economic Outlook, 2000=100

The blue line shows German unit labour costs relative to its competitors compared to the same for the Euro area average. Obviously Germany is part of that average, so this line reduces the extent of any competitiveness divergence between Germany and other union partners. By keeping wage inflation low from 2000 to 2009, Germany steadily gained a competitive advantage over other Eurozone countries.

At the time most people focused on the excessive inflation in the periphery. But as the red line shows, this was only half the story, because wage inflation was too low in Germany compared to everyone else. This growing competitive advantage was bound to lead to growing current account surpluses.

However that in itself is not enough to say there is a problem, for two related reasons. First, perhaps Germany entered the Eurozone at an uncompetitive exchange rate, so the chart above just shows a correction to that. Second, perhaps Germany needs to be this competitive because the private sector wants to save more than it invests and therefore to buy foreign assets.

There are good reasons, mainly to do with an ageing population, why the second point might be true. (If it was also true in 2000, the first point could also be true.) It makes sense on demographic grounds for Germany to run a current account surplus. The key issue is how big a surplus. Over 8% of GDP is huge, and I have always thought that it was much too big to simply represent the underlying preferences of German savers.

I’m glad to see the IMF agrees. It suggests that a current account surplus of between 2.5% to 5.5% represents a medium term equilibrium. That would suggest that the competitiveness correction that started in 2009 has still got some way to go. Why is it taking so long? This confuses some into believing that the 8% surplus must represent some kind of medium term equilibrium, because surely disequilibrium caused by price and wage rigidities should have unwound by now. The answer to that can also be found in an argument that I and others put forward a few years ago.

For this competitiveness imbalance to unwind, we need either high wage growth in Germany, low wage growth in the rest of the Eurozone, or both. Given how low inflation is on average in the Eurozone, getting below average wage inflation outside Germany is very difficult. The reluctance of firms to impose wage cuts, or workers to accept them, is well known. As a result, the unwinding of competitiveness imbalances in the Eurozone was always going to be slow if the Eurozone was still recovering from its fiscal and monetary policy induced recession and therefore Eurozone average inflation was low. [1]

In that sense German current account surpluses on their current scale are a symptom of two underlying problems: a successful attempt by Germany to undercut other Eurozone members before the GFC, and current low inflation in the Eurozone. To the extent that Germany can make up for their past mistakes by encouraging higher German wages (either directly, or indirectly through an expansionary fiscal policy) they should. Not only would that speed adjustment, but it would also discourage a culture within Germany that says it is generally legitimate to undercut other Eurozone members through low wage increases. [2]

From this perspective, does that mean that the current excess surpluses in Germany are a drag on global growth? Only in a very indirect way. If higher German wages, or the means used to achieve them, boosted demand and output in Germany then this would help global growth. (Remember that ECB interest rates are stuck at their lower bound, so there will be little monetary offset to any demand boost.) The important point is that this demand boost is not so that Germany can help out the world or other union members, but because Germany should do what it can to correct a problem of its own making.

[1] Resistance to nominal wage cuts becomes a much more powerful argument for a higher inflation target in a monetary union where asymmetries mean equilibrium exchange rates are likely to change over time.

[2] The rule in a currency union is very simple. Once we have achieved a competitiveness equilibrium, nominal wages should rise by 2% (the inflation target) more than underlying national productivity. I frequently get comments along the lines that setting wages lower than this improves the competitiveness of the Eurozone as a whole. This is incorrect, because if all union members moderate their wages in a similar fashion EZ inflation would fall, prompting a monetary stimulus to bring inflation back to 2% and wage inflation back to 2% plus productivity growth.    

Wednesday, 12 July 2017

Why recessions followed by austerity can have a persistent impact

Economics students are taught from an early age that in the short run aggregate demand matters, but in the long run output is determined from the supply side. A better way of putting it is that supply adjusts to demand in the short run, but demand adjusts to supply in the long run. A key part of that conceptualisation is that long run supply is independent of short run movements in demand (booms or recessions). It is a simple conceptualisation that has been extremely useful in the past. Just look at the UK data shown in this post: despite oil crises, monetarism and the ERM recessions, UK output per capita appeared to come back to an underlying 2.25% trend after WWII.

Except not any more: we are currently more than 15% below that trend and since Brexit that gap is growing larger every quarter. Across most advanced countries, it appears that the global financial crisis (GFC) has changed the trend in underlying growth. You will find plenty of stories and papers that try to explain this as a downturn in the growth of supply caused by slower technical progress that both predated the GFC and that is independent of the recession caused by it.

In a previous post I looked at recent empirical evidence that told a different story: that the recession that followed the GFC appears to be having a permanent impact on output. You can tell this story in two ways. The first is that, on this occasion for some reason, supply had adjusted to lower demand. The second is that we are still in a situation where demand is below supply.

The theoretical reasons why supply might adjust to demand are not difficult to find. (They are often described by economists under the jargon word 'hysteresis'.) Supply (in terms of output per capita) depends on labour force participation, the amount of productive capital in the economy, and finally technical progress, which is really just a catch all for how aggregate labour and capital combine to produce output. A long period of deficient demand can discourage workers. It can also hold back investment: a new project may be profitable but if there is no demand it will not get financed.

However the most obvious route to link a recession to longer term supply is through technical progress, which connects to the vast literature under the umbrella of ‘endogenous growth theory’. This can be done through a simple AK model (as Antonio Fatas does here), or using a more elaborate model of technical progress, as Gianluca Benigno and Luca Fornaro do in their paper entitled ‘Stagnation traps’. The basic idea is that in a recession innovation is less profitable, so firms do less of it, which leads to less growth in productivity and hence supply. Narayana Kocherlakota has promoted this idea: see here for example.

The second type of explanation is attractive, in part because the mechanism that is meant to get demand towards supply - monetary policy - has been ‘out of action’ for so long because of the Zero Lower Bound (ZLB). (The ZLB also plays an important role in the Benigno & Fornaro model.) However for some this type of explanation currently seems ruled out by the fact that unemployment is close to pre-crisis levels in the UK and US at least.

There are three quite different problems I have with the view that we no longer have a problem of deficient demand because unemployment is low. The first, and most obvious, is that the natural rate of unemployment might be, for various reasons, considerably lower than it was before the GFC. The second is that workers may have priced themselves into jobs. In particular, low real wages may have encouraged firms to use more labour intensive techniques. If that has happened, it does not mean that the demand deficiency problem has gone away, but just that it is more hidden. (For anyone who has a conceptual problem with that, just think about the simplest New Keynesian model, which assumes a perfectly clearing labour market but still has demand deficiency.)

The third involves the nature of any productivity slowdown caused by lack of innovation. A key question, which the papers noted above do not directly address, is whether we are talking about frontier research, or more the implementation of innovation (for example, copying what frontier firms are doing). There is some empirical evidence to suggest that the productivity slowdown may reflect the absence of the latter. This is very important, because it implies the slowdown is reversible. I have argued that central banks should pay much more attention to what I call the innovation gap (the gap between best practice techniques, and those that firms actually employ) and its link to investment and aggregate demand.

All this shows that there is no absence of ideas about how a great recession and a slow recovery could have lasting effects. If there is a problem, it is more that the simple conceptualisation that I talked about at the beginning of this post has too great a grip on the way many people think. If any of the mechanisms I have talked about are important, then it means that the folly of austerity has had an impact that could last for at least a decade rather than just a few years.






Monday, 10 July 2017

Measuring the impact of austerity

Ben Chu has a good article disposing of some of the nonsense ideas associated with austerity (which refuse to die, because they are useful to politicians, and much of the media is generally clueless). Perhaps the most silly, which I encounter a lot, is that the UK has not really endured austerity because debt has been increasing, or some other irrelevant measure has been rising.

If trying to reduce the deficit - what economists call fiscal consolidation - had no adverse effects on the economy as a whole it would not be called austerity. Austerity is all about the negative aggregate impact on output that a fiscal consolidation can have. As a result, the appropriate measure of austerity is a measure of that impact. So it is not the level of government spending or taxes that matter, but how they change.

An obvious measure to use is the change in the deficit itself, generally adjusted for changes that happen automatically because output is changing. I have used that measure many times, because it is produced by the OBR, IMF and OECD among others. But it is not ideal, because the impact of changes in taxes on demand and therefore output is generally smaller than the impact of a change in government spending, because some of any tax increase comes from reduced saving. (This is also true, but perhaps to a lesser extent, of government transfers.)

There is no simple way of dealing with this measurement problem, because the amount of any tax increase people will find from their savings will depend in part on how long they expect taxes to be higher. As a result, some people prefer to focus just on government spending to measure fiscal impact (although the data you will easily find is government consumption, and as fiscal consolidation normally involves cuts to government investment it is important to add that on). However it is also possible to apply some simple average propensities to consume from tax cuts and transfers to get a fiscal impact measure.

This is what the Hutchins Center fiscal impact measure does for the US.


These are not multipliers (so are different from what the OBR does for the UK, for example [1]), but just the direct impact of government spending and taxes on aggregate demand and hence GDP. The average total impact is something like 0.4%, so this would be fiscal policy that was in this sense neutral.

Compare the mild 2001 recession with the much larger 2008/9 recession. In both cases during the recession fiscal policy was strongly counter-cyclical, helping to reduce the recession’s impact. After the 2001 recession ended, fiscal policy continued to support the recovery for around two years: these were the Bush tax cuts. The recovery in GDP was reasonably strong: growth from 2003 to 2005 of 2.8%, 3.8% and 3.3%.

In 2010, we had a much deeper and longer recession, but the fiscal support was only marginally greater than 2001, despite interest rates being stuck at their lower bound. On this occasion fiscal support was strongly opposed by the Republicans. It continued for another year and a quarter, and then became strongly contractionary from 2011 to 2015. GDP growth was slower than in the previous recovery, despite the deeper recession: from 2010 to 2014 2.5%, 1.6%, 2.2%, 1.7%, 2.4%. This is not surprising, as fiscal policy was reducing GDP by around 1% during 2011,2012 and 2013, rather than adding the normal 0.4%.

The speed and extent to which austerity was applied after the Great Recession was very unusual: the textbook says secure the recovery first, allow interest rates to rise, and then worry about government debt. There was no economic justification for switching to austerity so quickly after 2010: the motivation (as in the UK) was entirely political. It produced the slowest US recovery in output since WWII. (This is a very useful resource in comparing US upswings.) As I showed here using simple calculations, if total government spending from 2011 had remained neutral instead of becoming sharply contractionary, US output could easily have got close to capacity (as measured by the CBO) by 2013.

To subtract 1.5% from GDP would not matter if something (consumption, investment or net exports) filled its place. But that will only happen by chance or because of a monetary policy stimulus, and monetary policy was stuck in a liquidity trap. This is the real crime of austerity. Decreasing demand and output just when the economy is beginning its recovery from the deepest recession since WWII is as foolish as it sounds, but to do this at just the time that monetary policy was unable to effectively fight back is macroeconomic madness. As I will argue in later posts, it looks increasingly likely that this has made us all permanently poorer.

[1] If somebody publishes similar estimates for the UK, please let me know. Personally I think it makes more sense to publish data like this than use a multiplier based analysis, simply because these measures are more direct, and involve fewer ‘whole economy’ assumptions. Crucially, there are no implicit assumptions about monetary policy being made. It would be interesting to know why the OBR decided not to take this approach.





Saturday, 8 July 2017

Against Charisma

I’ve written about the popularity of Labour’s manifesto, which should more accurately be described as expanding the state rather than ending austerity. But I thought that Labour would do badly in GE2017 despite this, because Jeremy Corbyn was so unpopular as a potential Prime Minister before the campaign.

I still remember reading many, many years ago about Weber’s three forms of authority (as we macroeconomists do), and feeling a visceral distaste for authority due to charisma. Although Weber intended it as an alternative to authority based on law, I read it as an electorate choosing their leaders according to their charisma or personality within a democratic system (the extreme form of which is populism). It offended my rationalist outlook, and my view about what politics was about. As Tony Benn used to say and I believed, politics should be about issues not personalities.

And in my youth it was possible to believe that authority through charisma was something advanced democracies had indeed grown out of. After all, Edward Heath became Prime Minister, Alec Douglas Home almost beat Wilson and Richard Nixon almost beat Kennedy. Perhaps at the time I should have noted that in each case the leader who did well even though they appeared to lack charisma happened to be from the right.

My view that advanced democracies had grown out of the need for their leaders to have charisma fell apart in the age of first Thatcher and Reagan, and then Blair and Bill Clinton. I also began to see how the right wing media ruthlessly exploited perceived character flaws. I think Ed Miliband would have made a fine Prime Minister, and Hillary Clinton a fine President (both far better than those who beat them). However their lack of the exceptional charisma of a Blair, Bill Clinton or Obama allowed their opponents to make mountains over perceived deficiencies in their character.

Before the 2017 UK General Election (GE2017) campaign, things seemed to be going the same way. Labour was unpopular, mainly because Jeremy Corbyn was extremely unpopular. He had real charisma, but only it seemed among his loyal supporters. This unpopularity was translated into votes in the local elections just a month before GE2017. It was for this reason that the Conservatives decided to run a presidential type of campaign. So what changed in a few weeks?

Part of the answer was Labour’s manifesto, which because of the leak (?) a week before, and because of general election rules for broadcasters, got extended coverage. It was popular because it was clever: money was spent on items that would have immediate appeal to the voters who were likely to respond and vote (rather than what might have been - in some eyes at least - worthier causes). The decision to borrow only to invest blunted the normal attack lines, and I suspect many voters no longer cared too much if ‘the sums didn’t add up’ because austerity had past its sell by date or they were happy to pay something towards these items of spending anyway. (Of course this didn’t stop me getting rather cross with those who seemed to make a fetish out of the need to balance the budget.)

Although all this came as a surprise to some commentators, it did not to me: one of the things I got right was that austerity’s appeal was time limited. Just a year ago it looked like internal divisions would drown out the message. This didn’t happen because of an impressive, and to me unexpected, display of unity after Corbyn’s second election. But I was still concerned that his perceived lack of charisma would trump issues, and the polls and May local elections did nothing to admonish that fear. It seemed that although Labour’s policies were popular, their leadership mattered more. As Stephen Cushion notes, this idea that personality trumped issues was often reinforced by broadcasters using Vox Pops.

So what changed? Does charisma really not matter any more? Unfortunately I suspect not. Instead what happened was that voters, particularly younger voters, discovered another side to Theresa May. May looks good in controlled situations: soundbites and speeches to the faithful. When she lost control after the launch of the Conservative manifesto, she looked evasive and robotic. The independent media, who tend to pounce on weaknesses, focused on this rather than the ‘old news’ about Corbyn’s past. [1] What is more, the qualities that May seemed to lack were exactly those that a much more confident Corbyn displayed: genuine passion rather than robotic spin. It was May’s inadequacies that allowed many voters to see Corbyn in a different light.

If this story is right, it suggests charisma and personality are still important in elections. Just look at how well Ruth Davidson did in Scotland. I continue to think this is unfortunate, because people greatly overestimate how much they can accurately judge people from limited contact with them, whether it is in an interview for a job, for a place at university or being a prime minister. Cameron exuded confidence and competence as only the product of a top public school and Oxbridge can, but his faith in his own abilities did the country great harm in allowing Brexit to happen. People had decided based on limited and filtered information that Corbyn was hopeless, and now (particularly following the Grenfell fire) they can see his qualities, but I'm not sure they are much nearer knowing whether he will be a good or bad prime minister. 

Weber seems to have had a soft spot for charisma, but he died before Mussolini and Hitler came to power. I have no doubt that the personality and abilities of a leader matters. But quite how a politician’s personality interacts with events to determine whether they make good for bad decisions is something that is only really possible after the event (for a brilliant example, see Steve Richards). I can only think of only one occasion where I correctly guessed that a politician’s personality made him totally unsuited to high office, and the fact that millions of people came to the opposite conclusion about Donald Trump I think makes my case against charisma.

[1] I think this is important. The idea that the Labour manifesto and its presentation were foolproof is incorrect: journalists could have easily run with confusion over restoring benefit cuts, or over optimistic tax receipts. But on the whole independent journalists, quite rightly, chose bigger fish to fry.



Thursday, 6 July 2017

Austerity Confusion, or why the Tories are trapped by austerity

What do we mean by an end to austerity? There seem to be two meanings being used currently. The first, used by Conservative politicians in particular, is equivalent to what economists call fiscal consolidation: cutting spending (or raising taxes) in order to reduce the deficit (as a share of GDP). However when Labour say they will end austerity, I think they mean something even simpler: to stop (and reverse) cuts to government spending as a share of GDP.

The confusion has been compounded by two factors. First, Conservative Chancellors have mainly used cuts to spending rather than tax increases as part of their austerity programme. Second, they have also justified cuts to spending that were needed to finance tax cuts (corporation tax, inheritance tax etc) as austerity, which is a clearly not fiscal consolidation and is simply a reduction in the size of the state.

How do I know Labour do not mainly mean ending fiscal consolidation when they talk about ending austerity. Just look at their GE2017 manifesto. That involved various increases in current spending financed entirely by higher taxes (including corporation and inheritance taxes). This manifesto, which helped gain them such rapid popularity in the GE2017 campaign, was a proposal to increase the size of the state.

I explore in a shortcut piece for the London Review of Books how this ambiguity is a serious problem for the Conservatives. Even if they ended austerity completely (made no further attempts to reduce the deficit), Labour would be able to offer a much more attractive fiscal package to the voters because Labour are prepared to undo the tax cuts the Conservatives have made over the last seven years. 

How do I know such a package would be attractive? Here I reproduce my favourite chart from the latest Social Attitudes survey that I talk about in the LRB piece.


The ‘neoliberal’ line is in yellow at the bottom. In 2010 nearly 90% either wanted to keep the size of the state the same or increase it. It is why the Conservatives were forced to use what I call deficit deceit - pretending cuts to the size of the state were about cutting the deficit - to pursue neoliberal goals (see my last post). By using deficit deceit to reduce the size of the state, when concern about the deficit was bound to wane, the Conservatives have condemned themselves to current unpopularity as voters realise what they are losing.

Why didn't this stop the Conservatives winning the 2015 General Election? Here is a YouGov poll that explains why.



In 2015 more people blamed Labour that the Conservatives for spending cuts. This was translated into views about economic competence because the Conservatives, with the help of mediamacro, made reducing the deficit the key variable in judging economic policy. We are now in a period where this narrative still has an influence but it is no longer enough to win an election. The Conservatives dare not throw it away because many voters still believe it. They have become trapped by their own austerity policy and the reduction in the size of the state that went with it..




Monday, 3 July 2017

Was Neoliberal Overreach Inevitable?

In June 2017 a member of the hard left of the Labour party, reviled by the right and centre for his association with left wing leaders and movements around the world and for his anti-nuclear views, in a few short weeks went from one of the most unpopular party leaders ever to achieving the highest vote share for his party since Tony Blair was leader. While this unexpected turn of events was in part the result of mistakes by, and inadequacies of, the Conservative Prime Minister, there is no doubt that many Labour voters were attracted by a programme that unashamedly increased the size of the state.

Contrast this with the United States. A Republican congress seems intent on passing into law a bill that combines taking away health insurance from a large number of citizens with tax cuts for the very rich. Let me quote a series of tweets from Paul Krugman:
“The thing I keep returning to on the Senate bill is the contrast between the intense hardship it imposes and the triviality of the gains. Losing health insurance -- especially if you're older, low-income, and unhealthy, which are precisely the people hit -- is a nightmare. And more than 20 million would face that nightmare. Meanwhile, the top 1% gets a tax cut. That cut is a lot of money, but because the 1% are already rich, it raises their after-tax income only 2 percent -- hardly life-changing. So vast suffering imposed to hand the rich a favor they'll barely even notice. How do we make sense of this, politically or morally?”

Or to put it another way, 200,000 more deaths over the next ten years for a marginal increase in the after tax income of the 1%. This is no anachronism created by a Trump presidency, but an inevitable consequence of Republican control of Congress and the White House.

Although these two events appear to be in complete contrast, I think they are part of (in the US) and a consequence of (in the UK) a common process, which I will call neoliberal overreach. [1] Why neoliberal? Why overreach? Neoliberal is the easy part. Although some people get hung up on the word, I use it simply to refer to the set of ideas associated with Ronald Reagan and Margaret Thatcher in the 1980s. That includes the goal of reducing the role of the state in many areas of society, including its role in either replacing or regulating markets and taxing individuals (see Kansas), particularly reducing taxes for the well off.

Overreach is more contentious. I use the term because I think, in the UK at least, the period from the 1990s until the global financial crisis could be described as a stable neoliberal hegemony. By this I mean that governments largely accepted the transformations that took place in the 1980s, even when Labour or Democrats were in power. Of course changes did occur. In the UK Labour were prepared to involve the state in alleviating poverty in ways that Thatcher never contemplated, but Labour’s concern did not extend to the other end of the income distribution, and the income share of the 1% continued to rise. They were prepared to see an expansion in the size of the state to meet a natural increase in the demand for health, but they also experimented with bringing in market elements into state provision. However none of these changes compared in size to what went before or came afterwards. (As Tom Clark argues, Labour did not change the [essentially neoliberal] political discourse.)

This period was also characterised in the UK and US by macroeconomic stability: inflation had been contained, perhaps through the delegation of monetary policy to central banks, and growth remained strong such that the high levels of unemployment seen in the 1980s gradually disappeared. This was the ‘great moderation’.

It was undone by a major flaw in the neoliberal project: the self-destructive nature of an unregulated financial sector. The reaction to that, if the left had remained in power, might have been greater controls on finance and perhaps some attempt to reduce inequality (as the two are related). But the left lost power, and we got what I call neoliberal overreach.

Neoliberal deceit in the UK

By 2008 the conversion of the right in the UK to neoliberal ideas was largely complete. This meant that they were determined to continue where Thatcher had left off. But they faced what appeared to be an insurmountable problem: voters wanted the NHS (and other public services) and they wanted more of it partly because they were getting older and wealthier. The recession gave the right the opportunity to continue the neoliberal project by deceit, using two mechanisms.

The first was austerity, which I have talked about many times, but alas what I and other macroeconomists say has so far reached only a small minority (a minority which, importantly, includes the Labour party). What I call deficit deceit was the pretence that we needed above all else to cut spending (that would reduce the size of the state) because otherwise the markets would not buy the government’s debt. There was never any real evidence to back this story up, and plenty to suggest it was nonsense. The fevered imagination of some market participants who turned out to be wrong does not count as evidence. But the politics to make deficit deceit possible was all there: a recent financial crisis, consumers cutting back on debt themselves, a Treasury worried as Treasuries do, a central bank head who acted as central bank heads often do, and a Eurozone crisis that mediamacro made no attempt to understand.

The second deceit was immigration. Elements in society are apt to blame immigrants at a time of rising unemployment and falling real wages, and terrorism gave this an extra twist. The right and their supporters in the press had decided before the crisis that they could exploit fears over immigration to their advantage, and after the recession this became a more powerful weapon. They talked about how immigration was responsible for reduced access to public services and falling real wages, and they promised to bring levels of immigration down. It was deceit because those in charge knew full well that immigration benefited the economy in various ways and as a result they had no intention of really controlling it. But, as with austerity, the deceit worked: so much so that an already weak opposition appeared not to know how to respond.

Some may disapprove of the language I use here. Should a normally sober Oxford macroeconomist talk about political parties deliberately deceiving the electorate? It is not a view I have adopted lightly, but when a Chancellor repeatedly argues that public spending must be cut to meet deficit targets at the same time as reducing inheritance or corporation tax, or a Prime Minister continually repeats the lie that immigration reduces access to public services, what other conclusion can you come to? They could get away with this deceit because academic economists (the majority of whom know that austerity would reduce output, and that immigration improves the public finances) are largely ignored by the media.

Austerity and the deceit required to achieve it was neoliberal overreach in the UK. Austerity quickly became a disaster because it was done at just the wrong time, when monetary policy was unable to offset its effects. That hurt the economy a lot. Whether GDP was reduced by a few percentage points temporarily or permanently we may never know for sure. But for the political reasons I have already outlined, combined with feeble opposition, the Conservatives got away with it sufficiently to win a general election in 2015.

Populism and anti-neoliberalism

The deceit over immigration was also key to a second disaster: the vote to leave the EU. Although the case to Remain in the EU was led by the Prime Minister and Chancellor, neither could combat anti-immigration rhetoric with a positive case because of their earlier deception. For this reason alone you could also label Brexit as a consequence of neoliberal overreach. More importantly, factions on the right that actively campaigned for Brexit did so in part because they believed they could only achieve their regulation free neoliberal nirvana by doing so.

As Jan-Werner Müller writes
“The image of an irresistible populist “wave” was always misleading. Farage did not bring about Brexit all by himself. He needed the help of established Conservatives such as Boris Johnson and Michael Gove (both now serve in Prime Minister Theresa May’s post-election cabinet). Likewise Trump was not elected as the candidate of a grassroots protest movement of the white working class; he represented a very established party and received the blessing of Republican heavyweights such as Rudy Giuliani and Newt Gingrich.”

It would be wrong to say that Brexit or Trump represent an evolution of neoliberalism. Both promote strong restrictions to trade, and so it would be more accurate to view Brexit as a split within neoliberalism. [2] What is clearer to me is that populism is a consequence of neoliberalism as reflected in the policies of the political right. In the UK immigration was used as a scapegoat for the impact of austerity, which fuelled the Brexit vote. In the US one of the first acts of Reagan was to repeal the Fairness Doctrine, which led eventually to the precursor and cheerleaders for Trump: talk radio and Fox news. In addition neoliberalism demonises any kind of regional or industrial strategy designed to alleviate the impact of globalisation.

Why was it Corbyn who led the revolt against austerity in 2017 rather than Miliband in 2015? One obvious explanation is that the more ‘moderate’ left in both the UK, much of Europe and the Democratic establishment in the US had become compromised by neoliberal hegemony. Instead it required those who had stayed faithful to socialist ideas together with the young who had not witnessed the defeats of the 1980s to mount an effective opposition to austerity and perhaps neoliberalism more generally. [***]

I am less familiar with the details of US politics, which are clearly different in some ways from the UK. The way the Republican party has co-opted both race and culture to their cause is different and clearly crucial. But there are plenty of similarities as well. Both countries have had austerity combined with tax cuts for the rich. Both countries have a right wing media which politicians can no longer control, leading to Brexit and Trump respectively. Bernie Sanders, like Corbyn, came from nowhere preaching socialism, but unlike the UK the established Democratic party halted his rise to power.

Was Overreach Inevitable

I’m not going to speculate whether and by how much this neoliberal overreach will prove fatal: whether Corbyn’s ‘glorious defeat’ marks the ‘death throes of neoliberalism’ or something more modest. Instead I want to ask whether overreach was inevitable, and if so why. Many in the centre ground of politics would argue that it would have been perfectly feasible, after the financial crisis, to change neoliberalism in some areas but maintain it in others. It is conceivable that this is where we will end up. But when you add up what ‘some areas’ would amount to, it becomes clear that it would be hard to label the subsequent regime neoliberal.

I think it is quite possible to imagine reforming finance in a way that allows neoliberalism to function elsewhere. Whether it is politically possible without additional reforms I will come to. If we think about populism, one key economic force behind its rise has been globalisation (see Dani Rodrik here for example). If we want to retain the benefits of globalisation, then counteracting its negative impact on some groups or communities becomes essential. Whether that involves the state directly, or indirectly through an industrial strategy, neither of those solutions is neoliberal.

Then consider inequality. I would argue that inequality, and more specifically the extreme wealth of a small number of individuals, has played an important role in both neoliberal overreach (in the US, the obsession within the Republican party with tax cuts for the wealthy) and populism (the financing of the Brexit campaign, Trump himself). More generally, extreme wealth disparities fuel political corruption. Yet ‘freeing’ ‘wealth creators’ of the ‘burden’ of taxation is central to neoliberalism: just look at how the loaded language in this sentence has become commonplace.

Indeed it could well be that gross inequality at the very top is an important dynamic created by neoliberalism. Piketty, Saez and Stantcheva have shown (paper) how reductions in top rates of tax - a hallmark of neoliberalism in the 1980s - may itself have encouraged rent seeking by CEOs which makes inequality even worse. Rent extractors naturally seek political defences to preserve their wealth, and the mechanisms that sets in place may not embody any sense of morality, leading to the grotesque spectacle of Republican lawmakers depriving huge numbers of health insurance to be able to cut taxes for those at the top. It may also explain why the controls on finance actually implemented have been so modest, and in the US so fragile.

The other key dynamic in neoliberal overreach has to be the ideology itself. In the UK surveys suggest that fewer than 10% of the population favour cutting taxes and government spending to achieve a smaller state (see my next post). There is equally no appetite to privatise key state functions: indeed renationalisation of some industries is quite popular. Yet the need to reduce the size and scope of the state has become embedded in the political right. Given that, it is not hard to understand the motivation behind the twin deceits of austerity and immigration control by Conservative led governments.

The dynamic consequences of extreme inequality and an unpopular ideology both suggest that neoliberal overreach may not be a bug but a feature.

[1] Reasons why this discussion might focus on the US and UK are discussed here.

[2] Among those who voted for Brexit, the two main groups were social conservatives who had a social rather than economic fear of immigration and the left behind who were deceived into thinking it was the EU and immigration that was behind their plight rather than neoliberalism itself. Liberal leavers may amount to little more than a few MPs and small businesses. Even among Conservative MPs, it is not clear that neoliberalism was the key factor in determining their position on Brexit.

***Postscript 06/07/17  It came out after I had written this post, but this article by William Davies expresses much better what I was trying to say in this paragraph.