Is there any alternative?

There is a black hole, we are told. A yawning one, that needs to be filled in, oooh, around 10 days from now, or we face some unmentionable doom. Fortunately, after a brief flirtation with Rule by Crazy Libertarian, the grownups are back, prepared to take tough-but-necessary actions such as (checks notes) raise income tax and cut future public spending, during a time of persistent economic weakness.

That’s one version.

Then there is another. “Fiscal black hole” is nonsense. In the elegant words of Jo Michell, all we are talking about is the “nominal difference between an arbitrary target and an imprecise and uncertain forecast”. We have set ourselves the challenge of setting fiscal policy at the level at which a single agency (the OBR) in possession of a single model and its best guess as to the behaviour of unknowable variables will conclude that another variable (Change in Debt/GDP ratio 5 years out) is around zero. Every pound short of that level is a “hole”? Nonsense

Or, as Chris Dillow in a blog on a similar subject says

Fiscal black holes… are not objective physical facts, but are subjective economist-made artefacts. This is partly because they are products of economic forecasts and any forecast, as Carsten Jung says, “depends hugely on the assumptions for economic growth, inflation and interest rates.” But it’s also because, as Ed Conway says, “they exist only relative to particular fiscal rules.”

Change the assumptions, change the rules, and the hole might double, disappear, or even become whatever is the opposite of a hole. So stop treating it like a fact!

There are good and terrible points being made on both sides of this. My thoughts are all a-jumble so I am just going to gather what I think are the strong points on each side and try to work out where I stand. Let’s start with the hawks.

Even the moderate fiscal conservatives feel vindicated by September. Their instinct is simple and consistent: there is a line you should not cross when increasing government borrowing. They think this line is always quite close, and it comes particularly close during times of rising rates and inflation. That we don’t know just where the line lies is really frustrating for said fiscal conservatives, leading them to be accused of crying Wolf! with no sign of the wolf. But in September, Kwasi Kwarteng and Liz Truss charged right over it, crashed the gilt markets, wreaked havoc on pensions and basically handed over control to the people who lend us money. For fiscal conservatives it is obvious: September turned the theory into fact – and they find it quite ludicrous that anyone might question the need to bring order to our future finances.

How much to tighten isn’t clear – this is an art, not a science But the fiscal conservatives believe we have chosen a pretty loose rule! To give the UK a full five years merely to get debt/GDP on a downward pathway is fairly lax – particularly given the target gets easier, the higher the debt/GDP ratio. And points about uncertainty and arbitrariness are facile. Forecasts are always given with large margins for error. So what? Things might get better, but they might also get worse! All we can say is that if policy was appropriate in March, we now have far fewer resources than 8 months ago, and much more to pay for, thanks to rising energy bills and interest costs. Oh, and economic growth is much slower …

On the subject of which, “but the economy is weak” does not give the doves a get-out call. Voices expressing incredulity at the prospect of future tax rises and spending cuts in the teeth of a recession have failed to notice the difference between deflationary and inflationary conditions. In the former – as in 2008-10 – extra government spending/higher deficits may replace the nominal demand being sucked out of the economy. During inflationary 2022, with resources stretched everywhere, every extra pound of spending forces the Bank of England to tighten more. In fact, that was pretty much was Truss and Kwarteng incompetently and spectacularly demonstrated.

In the view of the fiscal conservatives, the alternative to setting out a plan to deal with future deficits is to allow the market to expect higher and higher public debt as a share of GDP, into the future. This risks a dangerous spiral, as the market comes to suspect that higher inflation might be on the cards, which means higher nominal interest rates, a higher debt interest bill, more borrowing and so on. Faith in the currency evaporates, and soon the government has lost all control.

That’s their case. I think it is entirely internally consistent, and may even work politically – the Conservatives are never happier than when insisting all parties cleave to their tight-money policies too. It shoots more Labour foxes than Tory ones. This is why …

The opponents of blackholology have a right to be suspicious Own the language, and you get to own the policy space. Even if meant in good faith, anyone insisting only a certain set of answers can be good enough is closing down the debate. Every repetition of “fiscal black hole” is drowning out alternative ideas.

The fiscal conservatives are inconsistent on the subject of uncertainty. One minute we are told that we don’t know at all where some terrifying fiscal cliff-edge might lie. Next we are expected to believe that the Kwarteng Truss GiltClusterSplat was the scientific test needed to tell us exactly where it is – for anyone – to a fine degree, binding any future government. What if all what we learned was that a particular noxious brew of institution-flouting, unaudited tax-cutting, Laffer-worshipping recklessness, at a time of scary energy prices, was perfectly timed to wreck fragile market sentiment?

In fact, the whole idea of a cliff-edge is misleading – it is far too discontinuous Economics is mostly about marginal decisions, not sharp cliff-edges. This isn’t like reaching critical mass in a nuclear explosion, or a jenga tower collapsing on itself. The gilt market is £2trn of very tradeable paper, part of an international financial system that enables constant comparison with lots of very similar paper. Sure, markets can be irrational and there can be unexploded mines like “liability driving investment” (see Toby’s explainer). But this is about shifting prices, not black-and-white, live-or-die decisions. Yes, borrowing more might raise interest rate. That is a cost. But such costs should be weighed against the benefits you might gain from borrowing.

There is something deeply sub-optimal about a government being forced into producing new tax-raising and spend-cutting plans in a rush, during a time like this. Step back for a moment, and think about what this autumn of chaos has brought us. A few months ago, we might reasonably have expected the Chancellor, going into 2023, to have to deliver bad news to the country. We are poorer, and our needs are greater, and something has to give. But no-one, anywhere, was expecting this demand for a solid plan of tax rises and spending cuts, nailed down, by mid November! Mature, well-run economies are not dragooned into behaving this way. Forcing public spending and personal taxation to be more volatile in order that the Government Borrowing pathway be less volatile – that is kinda nuts. The Government is the one that has the greater leeway to be flexible!

What do I think?

I think “fiscal black hole” is terrible language, and can indeed represent an attempt to close down debate about the choices we still face. It is part of an understandable effort on the part of the government to reframe the terrible things they need to do as an regrettable, objective fact that they stumbled upon. “We found a fiscal hole, and alas we must fill it, like a grown up”.

But my verdict is that the UK is in that hole, and opponents of the language are missing out on the imperative to be properly, justifiably furious at how we have been driven into this hole. Don’t go around denying that governments for the next 5-10 years have a helluva mess to clean up – because they do! Focus on whose fault it is!

Perhaps another government could take more of a risk with the future fiscal situation until the great uncertainties of late 2022 have cleared up somewhat. We are in volatile economic times. Gas prices, the Fed, something may change. Bond markets will calm down, and realise we are not all crazed destroyers of institutions (see my piece). Maybe it would emerge that our situation is better than we (or rather the OBR) now reckons.

But it could be much worse, too, and because of the multiple risks the government took with the economy, it may not be rational for this government to take any more risks now. Conservatives may see it this way: restore stability at the cost of worse public services, and they may face the loss of 200 seats in 2024. Repeat the gigantic screwup of this autumn, and they could lose 300, and disappearing from politics altogether. Rediscovering the tough-choices politics of 2010 is maybe the best they can hope for.

Let none of this obscure the extraordinary scale of economic failure that reaching this point represents. The UK government is acting like it is running a developing market economy in the late 1990s, the kind with an immature financial system and untrusted currency, ordered by the Washington institutions to tighten both monetary and fiscal policy at once. What a dismal position for Britain to be in.

That we are in that position is the clearest failure of economic statesmanship in the UK’s modern history. Nothing comes close. It is not just the Truss episode but everything that led up to it. Allowing public services to be run on such a shoe-string for so long (see Stephen Bush’s favourite chart here). Blithely pushing for a Brexit deal that so damaged our long-term growth. Kidding the Party that it can always ask for tax cuts and be granted them. Encouraging a Trump-lite disrespect for good economic institutions.

You may ask: what should the opposition’s policy be? I haven’t the space, but I don’t think they should deny that there is a gigantic mess to clean up. There is one. Looking at the steaming wreck of what the other side has left them to deal with, they can have confidence that the passengers would now much prefer a different driver, whatever the route.

Captain Obvious strikes: they just should not have been in such a rush

Imagine you are a principled, small-state Conservative, and suddenly in September 2022 you are given your chance. What would have been the RIGHT way to go about it?

Let’s list some of the flinty but respectable views you hold.

  1. Growth: you think growth has been disappointing, and that forecasts for growth might legitimately be raised, with the right policies
  2. Tax: You always telegraph* how much you hate tax! Hate it! It is a moral thing. But you also have very firm views on how marginal tax rates are THE key variable in determining incentives to work, to work hard, and to invest
  3. Public spending. You don’t like it. See 2. But you also understand that public services are important, to voters above all. You are fairly tired of people telling you that these services will invariably become more expensive over time (cost disease, growing demand, a pampered sense that we deserve more and more every year) and think that actual, determined reform can address that.
  4. Regulation. It is often pointless, impedes economic activity and impinges on freedom.  Plus you have read your Mancur Olson and similar, and know that cancerous special interests can deploy concentrated political power to fix regulation into the system, for their own interests. In particular …
  5. Planning rules. Are the absolute worst.  Land is and forever will be one of the major inputs to the economic process, as well as a vital “good” for a decent life.  The way its supply is captured by insider interests is the economic-rent-seeking story of our age.  Fix that and good things follow.

Nothing wrong with that lot! Reasonable minds can differ on the matter of degree. I really don’t like 3, and by implication 2, for example.

Anyway, now you are sitting in Downing Street, day one, and a briefing from the Orthodox Civil Service team awaits you, to give you some sense of your options, and a historical recap.  Key points

  1. Public services. When Covid started finally to ebb, in 2021, the previous Chancellor raised future taxes and then carried out what felt like a generous spending review, funded by those taxes. Covid had generated backlogs and deficits throughout the system, hopefully addressed by this generosity. Later on, extra billions were raised through a 1.25ppts surcharge on NICs to relieve health and social care pressures.
  2. Cost of living. Even in the Spring, cost of living pressures were forecast to be extreme over the next 12-24 months.  Soaring energy bills caused by the spike in gas prices (the fault of Putin) meant a huge amount of further pain, if more action is not taken
  3. Economic confidence. Is wobbly.  Rates are rising everywhere in the world as central banks try to grapple with an unfamiliar conjunction of fast-rising nominal wages and prices, very weak consumer confidence, significant business uncertainty about future costs, and different economic blocs moving to different rhythms.  Rates are rising and mortgages already becoming much more expensive.
  4. Inflation kicker: the extra money announced for public services has been totally eroded by inflation, to the tune of £18bn.  Although revenues can benefit somewhat from inflation (through higher incomes), a lot of UK debt is index-linked, bringing an automatic spike in debt-interest costs. Whatever fiscal room we thought we had in March is now probably less.

You read all this conscious that everyone else thinks you hold a sixth view:

6. You believe in “sound money”. This is not well-defined, but has to mean a combination of: fiscal plans that do not spiral out of control; an independent monetary policy that does not have to be distorted by Treasury borrowing; a sedulous attention to the sentiment of the markets to your ideas.

And so what do you do?

Polly Toynbee has a neat phrase for the approach Truss and Kwarteng actually took: “Impossibilism …– to demand the impossible to break the system”.  An idea of Trotsky’s, apparently.  In this case, open a future deficit so large that the current spending commitments, implicit or not, just cannot be afforded.  It sounds similar to the Republicans’ perma-tactic, “Starve the Beast”. Alan Greenspan said the quiet bit out loud, according to Wikipedia. “”Let us remember that the basic purpose of any tax cut program in today’s environment is to reduce the momentum of expenditure growth by restraining the amount of revenue available and trust that there is a political limit to deficit spending.”

We know how it has ended.  The limit is not directly political, but market-financial.

Could they have delivered it? In my view, it was possible, but not through the starve-the-beast approach. Trying to start with the tax cuts and hope that this generates the growth to cover the rest is like a drowning man trying to save himself by pulling upwards on his boot-strings. The British won’t put up with you actually drowning the economy.  

The correct order would have been: first fix the immediate crises in public spending and living standards; then take your time delivering properly the smart public spending reforms and growth-boosting deregulations, and only then, when these can be credibly shown to be working, cut the taxes. If the reforms work, you have earned that space to cut the taxes. If they haven’t, then you don’t have the foundation upon which your tax-cutting aim was meant to be built.

I doubt it would have worked – I have explained elsewhere why I think planning reforms and tweaks to corporate taxes do not deliver that much growth, that fast. The irony is that I can imagine some of these reforms eventually happening – ideas like easier planning rules, and full expensing of capital investment – under a future government willing to take it slow. It will probably be a Labour one.

*see what I did

So, why aren’t we panicking about France?

Of the many reasons to read Marginal Revolution, one of the foremost is the 7th “rule for life” of Tyler Cowen, one of its co-authors: “learn how to learn from those who offend you”. The pile-on aimed at the Truss-Kwarteng Budget has been so uniform that it is almost offensive to read those wondering what the fuss is about, including Cowen himself. And a week ago, reading The Economist on France’s latest budget, he wondered whether France’s position is not the worse of the two, and yet the UK takes the “PR whacking”.

It is not just a PR whacking. French and UK bond yields tell the same story. From MarketWatch, while French yields have risen quite dramatically since early August, driven by the Fed’s policy (I am given to believe)…

the UK equivalent has really risen, and the gap between yawned considerably

Since I tend to respect the reactions of markets (which flipped out at the UK “mini” budget, lighting the dry tinder lying around in the form of this “LDI” strategy), I assume there are good reasons for this. But, as ever, Cowen has a reasonable point. In media, I had tended to characterise what Kwarteng sprung on 23 September in terms of a sheer quantity of bonds he had suddenly forced the market to bear. But read what France is putting out there, and the UK clearly isn’t alone. For 2023, E300bn of financing, about a half of that roll-overs. So it can’t be that simple.

Then why is it that the UK deserved panic, and France not? Here are my best late-night guesses, and all of these probably interrelate:

Sterling. Is a much smaller currency than the euro. France’s issuance relative to the entire euro area is not that massive. Related to this ..,

The risk of fiscal dominance/unmoored inflation France does not dominate Europe so much that its budget might on its own cause the ECB to shift its willingness or ability to control inflation. It is deeply weird even to think that the same might happen with the UK. But Conservative leaders have mused openly about the Bank’s target, and appeared to lump it in with an “orthodoxy” they wanted to assault – shortly before launching a budget so expansionary that it indirectly forced the Bank to act in the gilt market …

Current account/kindness of strangers. France’s current account is approximately in balance, whereas the UK is reliant on foreign funding, borrowing 8.0% off the rest of the world. Maybe we aren’t going to have a balance of payments crisis. But people do not HAVE to lend to us.

Direction of travel. Yes, France is a low-growth developed country, and so is the UK. But until recently (e.g. up to 2016) the UK was generally in a much better position, growth-wise. Brexit, principally, has led to a down-shift in growth expectations that is still being absorbed. A lot of the people who lent money to the UK did so thinking we were the sort of economy that sat at the heart of a giant trading area, and grew most years at around 2%. Now we ain’t.

The UK energy price rescue is much bigger than others Maybe read the Breugel analysis (chart below). And please remember this: we were only meant to have a mini-Budget because this enormous package had been announced – and my assumption was that this was so that the Chancellor could at least set out how he intended to fund this package.

Instead he chose the occasion to announce tax cuts that were even more expensive than the energy support! See this from the IFS

Effective debt maturity? Because so much (32%) of the UK debt has been bought by the Bank of England, the effective debt maturity is much lower than the simple weighted average of the bonds sold. See the OBR’s discussion of it here. The BOE is obliged to remunerate the holders of the reserves it has printed to buy those bonds at the base rate or thereabouts (I think the alternative would be much higher inflation…). That base rate is now on a steep upward ratchet.

Loss of respect for institutions. It is not just abstract arguments about the orthodoxy. The Chancellor literally turned down the option of having solid OBR forecasts out alongside his mini budget. It was like him turning violently off the road, slamming the foot on the accelerator, AND shutting his eyes – and ours – at the same time. This is just unnerving. Sure – banks etc can produce their own forecasts. We have the IFS too. But the sense that the government doesn’t want us or them to know the economic/fiscal implications of what they are doing is very unsettling.

So – yes. The UK is not the only country to be looking mid decade at 4-5% deficits and 100%+ public debt ratios. And as Tyler implies, and our government doesn’t like noticing, it has more room to raise taxes in future than France (Then again, France has plenty of room to cut state expenditure, such as through pensions reform). But with its own currency, giant current account deficit, sudden disrespect for its own institutions, poor inflation dynamics, and a central bank forced (admirably) to demonstrate its independence while handling financial instability, I don’t think it is such a mystery why people are het up about the UK, and not France so much.

(note: as this post makes obvious, I am not much of an expert in assessing fiscal risks. Worth reading Fitch on the two countries. Here is them putting UK on negative watch. )

They shout Houses, don’t they

All the attention following Kwasi Kwarteng’s “mini-Budget” centred upon the financial market reaction: cause enough bond market panic, bring about an emergency BOE intervention and yes, you will have our attention.  This, and a series of U-turns, ensures that this government’s reputation for economic competence is not likely to recover. Ever. Everyone was paying attention.  Particularly the people with mortgages.

Cue much lamentation from those free-market ultras willing to defend the package. How very unfair that a “febrile” market should overreact and in just a few hours taint for perpetuity a set of policies that is about so much more that just “cut all the taxes, who cares about the deficit”. We’ll never know, but I bet it is exactly what might have met a Corbyn government – “before you even let us nationalise all the utilities, the stupid markets showed us the red card! Didn’t they realise how well we would run the water industry?”

The key complaint is that the markets/media bubble/taxi-surfing think-tankers just hadn’t stopped to weigh the fantastic supply side reform buried within the market-terrifying package. Once you factor in the extra growth, there is much less to panic about, hardly anything in fact! I felt this was worth thinking about.

First point: it takes only a little back-of-envelope maths to realise that to eliminate a £45bn gap you need the markets/OBR to assume an insanely generous leap in growth from your policies. The OBR has never been so generous – not in response to policy announcements. This is not to say that the OBR hasn’t changed future growth forecasts by much more in the past (usually downwards – see the porcupine chart from this FT story)

But never because the Government has unveiled a new tax bung, Institute of Whatever, Growth Accelerator or so forth. The economic ship is too massive – it is only global currents and demand shocks that swing it around that quickly.  

Second, but what about the measures themselves, aren’t they good? Well, some of them might be. Maybe the investment zones will be brilliantly chosen to identify just where the growth will be positive-sum, not displacement, and electrify local growth incentives. Perhaps a little table-banging and corner-cutting will get infrastructure moving more quickly. A fresh, positive attitude towards economic migrants is certainly welcome. Of course, this is true of every budget, ever.

But the one that most interests me is the prospect of a massive increase in housebuilding, for the simple reason that it animates the widest range of properly respectable thinkers, on the left, right and middle (I have decided not to @ the lot of them). And because they surely have a point. Despite my labouring, a little trollishly, to amplify Ian’s refutation of the idea that a supply boom could solve housing affordability issues, I tend to think easier supply is a good thing, in most places and most markets. Certainly it is an odd economic model that hopes to build prosperity out of shortages and smaller markets*. I find it hard to see how the list of restrictions itemised in this impressive Economist piece, “Why Britain cannot build enough of anything” can actually help growth.

What I question is how much it might actually increase GDP. Consider these mechanisms:

Sheer increase in housebuilding activity. Let’s wrap some numbers around this.  Here, first, are the typical housebuilding numbers: about 200k, it was once over 300k per year

What does this amount to in terms of actual GDP? Here is the key chart from the ONS:

The whole industry was worth some £119bn in pre-pandemic times. Squinting at the above, building private houses is about £44bn or 2% of GDP. That appears to mean £200k per house, which sounds about right! Naively, if we raised housebuilding to 300,000 a year, on a pro-rata basis that figure might rise to £66bn, or 1% more GDP … for as long as it continued. If it turned out that we only needed a burst of extra building, then it would fall back again. Note: GDP, not GDP growth.

Is that a fair number? A couple of caveats. First, never forget that doing one thing means not doing another. In a full-capacity economy, you build more houses instead of doing other things. Perhaps you shift out of infrastructure or commercial building? Labour is constrained, and construction skills are hard to generate overnight. What about capital? Building a house requires some risk-seeking capital – would it subtract from capital used elsewhere? The example of the 1930s housing boom has been suggested to me – but that started with unemployment at 14%…

A smarter allocation of economic activity Great cities bursting with growth-y prospects are the first to hit their limits, and those limits stop them growing more. No lesser a personage than the former Chief Secretary has cited a well-known paper calculating how expensive housing regulations have been in the USA, through the “spatial misallocation of labor”.  Such constraints have apparently lowered US growth by a simply enormous amount. Truss suggested US GDP might be 3.7% higher – others have put it at much much more. H&M’s basic idea is “output can in principle be increased by expanding employment in high productivity cities at the expense of low productivity cities”. People are stuck in places where they are less productive than they might be, because they are stuck in the wrong place, because there aren’t houses.

This is a really intriguing possibility. In my interpretation, this means that we should be taking steps to allow Oxford, Cambridge and London to be much larger.  Apply some figures again. UK GDP per head is £36k; Oxford et al score £50k.  So shifting 3m people, say, out of the average and into a £50k bracket would in theory raise GDP by 3m x £14k or £42bn – a handy (again, one-off) rise in GDP by about 2% again.

Two obvious caveats, though. The first is the obvious political one: the growth idea expressed above is, in effect, to grow the Greater South East and shrink the rest. Insert your own mega-snarky point about levelling up right here.

The second, more geekily, is that there is academic doubt that simply moving to a high wage area makes you high-wage, raising national productivity.  This paper says

“Consistent with recent research from France, Spain and Germany, we find that two thirds of the variation in observed wage premiums for working in different CZs is attributable to skill‐based sorting. Using separately estimated models for high and low education workers, we find that the locational premiums for the two groups are very similar”

In English, “skill-based sorting” means the high-skilled (and therefore productive) sort themselves into the high-productivity locations you can see around you. It is not the Oxfordness that makes Brian or Melissa productive in Oxford, but the high skills Brian and Melissa already have, and which they take to Oxford.

I do not think this finding – if correct for the UK – is fatal for build-houses-for-prosperity, but it should warn us against the sort of naïve maths I performed above.  It does seem crazy that our most brilliant places should be strangled, and I doubt any available study can capture all the dynamic effects that are maimed before they can take flight. Planning frictions must wear away at all kinds of investment schemes – I heard too many examples from overseas investors to discount it. It would be daft for me to write a piece on Business Investment that makes Uncertainty the biggest culprit holding it back, and then brush off what must be a permanent source of it in this country.

But on houses specifically: what finally gives me pause is when I look around at other countries nearby and ask whether a housing boom produced the sort of permanent rise in productivity that we hope for.  Check out Spain (courtesy of tradingeconomics)

Or look at Greece or Portugal or Ireland. It doesn’t feel like a house building boom is necessarily the precursor to the sort of sustainable, higher growth we do indeed need. Better planning rules are definitely a good idea. Better local authority incentives so they want more houses would be lovely! More affordable housing, built with help from the state, would probably improve welfare – lower rents for landlords, more accommodation for the needy. There really is much to achieve here. But not, I think, £100bn more GDP in five or ten years’ time.

*someone tell the hard Brexiteers

You should buy and read Restarting the Future by Haskel and Westlake. BUT ….

I have on my real and virtual shelf a score or two of books – the Keepers – that help to anchor what I understand about the world, economics-wise. They range from histories and memoirs (Steering the Economy by Sam Brittan, The Time of my Life by Denis Healey), through classics and polemics (Keynes, Friedman, Smith, Popper).

And then onto the “colon” books: those with that punctuation in the title, usually written since the millennium. You know the form: “Blappity: why the blah of blah is going to bliff the bloo” or whatever.  Most of the genre ages like a fine pork chop.  Re-reading the “how the world is” screeds of, say, the early 2000s is an excruciating and horribly dull experience*. It is quite rare for many of them to be proper Keepers, to strike upon a topic that is timeless, principled, worked through with some solid theory, and worth picking up again. Like The Secret of our Success by Joseph Henrich, The Truth about Markets by John Kay, or Blunders of our Governments by Anthony King and Ivor Crewe.  

Stian Westlake and Jonathan Haskel’s book on intangible capital (Restarting the Future) belong in that category. Insofar as I have pondered intangible capital, it is because of them. Being a Keeper is not the same as a book being “right”, but reflects a tough rigour in the work that forces your mind to engage, chew over a topic, and ends up making it stick. Reading RTF, I gained a persistent sense of the authors not just promoting a theory but kicking its tyres – anticipating the caveats, exceptions and counter-examples, exposing them, toughening the argument rather than just rushing past. Often I started arguing with it in the margins, then found that three pages later they had anticipated my argument and taken it on. This happened continuously..

 A shamelessly simplifying summary would go like this:

Economies proceed from needing more labour and more physical stuff (land, machines, buildings) to the kind you can’t touch: ideas, improvements in organisational design, better designs and processes and knowledge. Nowadays, the successful companies are not defined by the solid things they own, but what they know, instantiated in their products, brand and superior efficiency. Slowdowns in the production of intangible capital have accompanied the slowing of productivity growth and probably helped cause it. In large part this is because the institutions vital to economic growth have not, yet, fully adapted to the features of intangible capital – its sunken-ness, synergies, spillovers and scale-ability.  And so here are some ideas for reform to put in place some of the right institutions and turn things around.

RTF ticks all the boxes. Its theme is enduring; you are going to need to know about this topic. It educates – not just about intangible capital, either: I would say its section on institutions in economics is the best introduction to that topic I have read. It has an argument, in fact many arguments, linking intangible capital to multiple features of the economy.  There is a sheaf of policy recommendations, stretching but not implausibly far from mainstream thought, such as improved incentives for equity investment, looser mandates for pension investment, and so on.

So what’s my beef? Why am I not simply wandering around with a placard saying “Do the Restarting the Future things”? Praying forgiveness for putting it so crudely, it is this: what if the rise of intangible capital is essentially, well, bad?

An odd thought: intangible capital is usually portrayed as an unambiguous benefit. If we ever crack nuclear fusion, cure cancer, design our cities more intelligently, or work out how to end gang violence, the ‘asset’ created is intangible. How can that be bad? More trivially, the investment in a new hit TV series or better smartphone design is intangible capital. None of the economic formulae linking it to growth has a negative sign.

But, as the authors themselves observe (see the point about rigour), there are non-benign features of intangible capital. As Schumpeter observed, companies invest and innovate to acquire a better monopoly position. Buy up the best spot and your shop can sell more. Invest in R&D and you will gain more market power. It applies as much or more to intangible investment than tangible. Authorities have established methods for dealing with this when it is physical. You don’t get to own all the bridges across the river or buy up all the oil wells or the best retail sites.  It is harder when it is something as elusive as a brand or an idea. Maybe it is impossible. You can’t crack down on, say, George Clooney monopolising the brand rights of being George Clooney.

Of course, most attempts to gain a monopoly position fail. The attempt may leave behind some useful innovation. But not all innovation is like curing cancer or cracking nuclear fusion.  In the authors’ words, “intangible investment is more likely to be zero sum or positional”.  This is a very important point! If his investment in his brand just means I must invest in mine to stay level, what has been created in net terms? Consider, say, restaurants, where competitors are ceaselessly investing and innovating to preserve some small advantage. Meanwhile, restaurant spending just rises with GDP. What do we make of all the zero sum investment to scrap over that barely-growing pie?

This market-power-seeking, zero-sum feature of intangible capital undermines, for me, the sense that its social returns necessarily exceed the private returns. This in turn undermines the great advantages elucidated by the authors – intangible capital being scalable, having synergies and spillovers – which render it automatically the kind of activity that economists say demands more investment. Maybe these three “S”s are not always present. My improvement in my company’s management doesn’t spill over to yours. Perhaps it undermines you, so that you need to match my investment just to stand still. “It is valuable to the owner only to the extent that it destroys value for someone else”, as the authors put it.  

Which leads me to my second concern: why does our modern economy need to invest so heavily in intangibles? A naïvely optimistic narrative portrays a world shifting upwards from having solved the essential physical challenges – feeding, clothing, shelter, health – into a pursuit of higher things – in the resonant words of the authors, “economic activity [that] is more freighted with meaning, with association and with emotional significance”.  Something redolent of Maslow’s hierarchy of needs.  Consider instead a bleaker interpretation: continuous investment in intangible capital is the price we pay for the ever-increasing complexity of the economy, its dominance by intermediate activities removed from the direct production of value.

Again – again!- the authors are there already.  Time and again they point out the complexity of modern economic systems – the one needed to produce net zero energy and its attendant new modes of mobility, for example. But I think they nail it even better when writing of the inauthenticity that seemingly taints so much of modern life, the sense that “our output is derivative and self-referential” or that our work does not produce “useful, tangible results” – the “bullshit jobs” thesis of the late David Graeber – and the abundance of fraud or near-fraud, get-rich-quick schemes and bubbles and so forth.

I devoured Daniel Davies Lying for Money on the beach this summer (another absolute Keeper) and its portrayal and analysis of how fraud-risk and intermediate, intangible activities have risen in tandem.. Very simple economies where everything is paid for on sight allow much less fraud. In contrast, increasingly complex societies with numberless parts connected by webs of trust generate inescapable trade-offs, between delegation, fraud risk, tiresome checking and economic growth (I really cannot summarise well – read his book).  What I concluded is that ever more investment in intangible activities is needed to keep the show on the road.  It is one facet of complexity. Tell any simple story of economic development, which starts with only farmers, then the creators of tools, then the traders and owners of rudimentary capital … and as the story develops you end up with more and more people divorced from primary production.  You start with a field of workers pulling up crops and end up with people advising other people on how to market the new company that helps to design new rules on the creation of financial instruments for capitalising the market in tools used to make other tools that help the guy pull up the crops. And when one of them does it so well that they can make a business out of it, it is capitalised. Intangibly.

For the starkest modern day example, we have all noticed how the financial sector takes a steady share of rising economic production. The annual amount spent on financial software runs into the high hundreds of billions. Maybe we get small shifts in efficiency, slightly lower transaction costs. Constant transfers of economic rent from one part to another. But mostly it feels like keeping-the-show-on-the-road money. Some people are richer. Are we all, though?

So. The optimistic account of burgeoning intangible capital is that it is a weightless, positive externality driving our ability to do things better. We need to find ways to generate loads of it.  The bleaker view is of it often being the gory tribute demanded by the ravening beast of our ever-more-complex and intermediated, inauthentic economy. It is the coin paid to the accountant needed to audit the value of the NFT assets underlying a crypto scam, the rent paid for the fancy office of the tax-break-lobbyist, and so on.

I get carried away.  Trying to return this to rigorous thinking: I think these acknowledged features of intangible capital mean its value may need to be questioned more than the tangible kind.  The authors observe repeatedly how hard it is to finance, lacking the solid collateral of its physical rival. When I reflect upon its nature, I am less surprised, and wonder if it is financed just as much as it should be, by venture capital.  Sure, it slowed down when the economy slowed in 2008-10, but the direction of causality is ambiguous. Crater spending on everything, and some of it will be the intangible capital part.

At risk of making this post too ambitious, I therefore see the rise of intangible capital as related to another important recent finding – Thomas Philippon’s argument that the growth of TFP is additive not geometric. Dieter Vollrath discusses this and links it to complexity – “You could think of the severe decreasing returns as embodying an idea like complexity. As we accumulate more and more ideas, they make us more productive, but each new idea has to interact with so many other ideas that the gain in productivity gets smaller and smaller.” New things must interact with an ever-growing body of old things, and to make it work you need giant intangible investments – not to add anything extra, but just to make them work.

The authors once again summarise it best is a short bit on page 68: “there may also be an effect on TFP growth not from the slowdown of intangible investment growth but rather from its historically high levels”.  We are in an intangible-rich economy.  Intangible-rich economies are harder to grow than simpler, physical economies. Producing lots more intangibles doesn’t feel like growth because often it isn’t, not in the sense of addressing lots of serious needs that need addressing.  

Does this quibble undermine the book? Not really. For a start, it is encyclopaedic in its reach – this overlong post has barely touched on it.  And while I differ from the authors in how I see the immediate problems facing the world – this year of all years, they feel extremely physical – the topic of reforming our institutions to address the current nature of the economy is basically the right one. It is how to think about the modern world. Even if we haven’t actually ascended to an ethereal, intangible plane, the task is about how to innovate, organise and cooperate to meet the 21st century’s unique and daunting problems. I don’t think there is a better place to start than here. 

My noodlings on business investment, somewhat personal reflection

Today I published my latest piece for the Institute for Government*, on the UK’s continuous failure to grow business investment.

The straw man I often imagine myself attacking is a policy wonk with a mental picture of the economy like a boardgame, where the Wonk gets to choose how much Investment to do. Then the investment happens, and he/she gets growth, at some kind of cost. (however it isn’t entirely a fanciful portrayal of policymaking; leaf through the memoirs of various postwar spads and ministers -I recommend Sam Brittan’s “Steering the Economy”, also anything by Alec Cairncross, the memoirs of Denis Healy, Roy Jenkins perhaps …- and you find that ministers genuinely felt they could control investment. The limiting factor was the state of the external balances; gold draining away when they ran demand too hot. But it was also bad investment, often. A topic for another day. )

Anyway, my fundamental gripe is that people think investment is easy, that doing more of it is a slam-dunk, and how to do more of it is, if not trivial, then at least not one of the harder topics. Lower the tax on investment, subsidize the financing of it, cut interest rates, it will just happen. The trouble is, for long periods we have done some combination of that and it hasn’t happened, including long periods like 1997-2007 when the economy was in a pretty enviable shape. And from my other experiences in life – former adviser to the PM and before that the Business Secretary; as a writer for the Lex column at the FT – this lack of appreciation undermines good policymaking.

Unfortunately, this leads to my policy recommendations being somewhat bitty. Encouraging more business investment is an *outcome* of good policy – it is not a policy lever in itself. My ideas are frustratingly close to sounding like “do your job better, government, and stop ****ing about!”. Each investment decision is a sharp and risky move, to some extent. It uses money that shareholders would usually prefer to have back. On the Lex column the boss used to tell us: “your job is to look at the CEO’s latest plan to invest the surplus cash on his balance sheet, and if he isn’t making a very strong case, tell the clown to give the money back”.

The fundamental insight that most miss out or pass over is this: investment is hard. Most of the ideas to put money into new goods, in order that those goods can create even more goods in future, are going to be bad. Finance directors demand a projected internal rate of return of 10-15% for a reason – getting it right is difficult, you need a large margin for error. And this is the same reason the Treasury doesn’t just sign off everything that comes along, shrugging that you win some, you lose some. If they didn’t provide actual, sceptical scrutiny – remember, we are in government offices here, there is no market to discipline you – then you lose some, you lose some more. You don’t want your investment screening technique to be “did a Spad like this?”

The bland assumption that all investment is good – because at a high economic level, more K means more Y (output) – makes for simple-minded policymaking, shared on Left and Right. The K needs to happen for a good reason. The government’s job is to assemble the array of those reasons, including factors as diverse as the state of the macro-economy, the health of the jobs market, skills, financial stability, and countless micro-conditions specific to the business and its project. Sometimes, as in energy, healthcare, transport and other areas, the government’s actions create the investing environment, and there is no shortcut to the advice needed to make that work better. I helped create the Grand Challenges under Theresa May to start on this approach. It was ceaseless work

This is why Brexit caused such harm to investment – it simultaneously threw a spanner into the works of a thousand intricate calculations. These thoughts are also related to my intuitions about why it is hard to raise economic growth rates (read this). Our current growth rates require the constant, market- and Treasury scrutiny of £400bn or so of annual capital investment. The historical return on capital you witness is only as high as it has been because of that scrutiny. If you *were* able to act like the Policy Wonk playing Economic Growth, the Boardgame, and just make investment happen like a medieval emperor, that investment would be bad. It would be cathedrals and fine art and gold washbasins and chariots, or a Senate Launch System. And while that is the argument ad absurdam, acts that distort in favour of more investment than we currently see will shift to more and more marginal projects. A fifth hotel where you only need four. That sort of thing.

Better, in my view, to make the objective reasons to invest more solid. Improve your policymaking! Stabilize the macro economy and business environment. Introduce mechanisms to deal with the missing markets and technological valleys of death. And so on and so on.

Anyway, those are the background thoughts to my piece. If you want to go straight to the pdf, here is the link. Here is my tweet thread.

*it is, I think, the fifth since 2019: something on Bailing out for a No Deal Brexit, then how to think about Covid bailouts, then Industrial Policy, a breakdown of our productivity collapse, now this.

Umpteen reasons I am so uncertain about growth 

It is almost fifteen years since I first blogged about growth. My opinions have become more and more uncertain since the earliest “just boost demand already” days.  Since then I have contorted in all sorts of ways. Here are some barely connected thoughts. 

Having opinions on growth is a little bizarre. The more I have read and thought about GDP, the more uncertain and sceptical I have become. Uncertain, because it is easy to find paradoxes, contradictions, arbitrary judgments of definition; sceptical, because with such a slippery concept it is plain bizarre that anyone normal might have a strong opinion about it. You don’t see GDP, it is numbers in a spreadsheet.  So when people profess a strong view about its trend, my first reaction is often “really? How?”. You don’t have an opinion, you just think you have. How can you have a clear view on whether the UK’s potential ability to combine future labour, capital and technology into additional economic product will grow at 1.5% or 2.5% in ten years’ time? 

This must sound like a cop-out, or worse: an introduction to yet another of those tedious diatribes about there being more to life than money, growth and GDP.  So onto some of the things I find weird. 

Shifting relative prices through time There are wildly different trajectories for the productivity of different activities through time.  Being a concert pianist, waiter or hairdresser is not much more efficient now than in 1900. The ability to discover information, light a dark room, watch a drama or communicate across a continent has increased exponentially. Shifting relative prices tie these things together, and fix what we see as the actual value of what is produced. So the price index for casting a lumen of light has collapsed exponentially; even since the millennium, some deflator for IT-sector output has been cut by 90%. 

I find this marvellous and unsettling at the same time. Depending on how you choose to fix value, you can paint a fantastical and almost entirely useless picture of continuing massive growth. Just value an Internet search at the pre-Internet cost of learning something, or an email at the cost of sending a letter. 

Bargaining power is good and bad. A key consequence of these shifting relative prices is how professions that see no persistent tendency to become more productive (say, a high-class lawyer) nevertheless gets to partake in economic growth, the result of productivity gains elsewhere. (see William Baumol’s cost disease).  But not everyone does to the same extent, whichis often a reflection of bargaining power. The top lawyer, banker or lobbyist somehow keeps up, the miner or social care worker does not. I am forever tickled by this insight in Ryan Avent’s book about human scarcity (or otherwise): better to be in a low productivity business proximate to high economic demand and with some protective walls around you. The artisanal cheesemaker theory of prosperity. 

Lots of innovative/investment effort goes into enhancing bargaining power, not productivity. The branding genius who finds a way to make teenagers love the same mass-produced sneaker for a higher price. The investment in high-rent offices to telegraph prestige to your clients.  The first lesson in MBA school is Michael Porter’s Five Forces: fight off the threat from substitutes, new entrants, existing competitors, suppliers, customers. Invest in protective walls so you can keep a profit.  It captures the tension that drives the economy forward. But GDP is often higher when the monopolists are winning! Being able to charge a lot more for a product than you put in is value-added. In contrast, really successful innovation can have a first-order effect of lowering GDP. If an activity such as maintaining a bank’s leger once needed 1000 sweating clerks, and now requires a simple software programme, the effect might be a smaller direct GDP footprint.

Market size matters for potential GDP, do we discuss it enough? The gap between US and UK productivity is longstanding and much commented upon. There are plenty of reasons for it. The most convincing I know is the size of the US market, which brings home a really important factor for productivity – operational gearing. Finding a bigger market for the same fixed asset base is the simplest way to get more bang for your buck. Hence also the magic of export-led growth, and one of countless reasons to be pro free-trade. I think this is under-emphasised in the “People, Capital, Ideas” schema that Sunak pushed, a good expression of the orthodoxy. 

Productivity growth was more reliably strong when manufacturing was pre-eminent. At first this feels odd. Physical activities have real resource limits that you don’t see in more intangible services. It takes ten times more steel to make ten cars than one. Assisting in the sale of 10 houses should not take ten times as many estate agents. But the highpoint of (Western) growth coincided with the highpoint of manufacturing, and I can think of good reasons why.  Physical processes are amenable to constant improvement. Innovations like electricity, computerisation, containerisation, the assembly line, just-in-inventory management all have a long way to go. Tradable goods are very hard to hide from competition, the great driving force. So there is reason to think that the grand shift from manufacturing being 30% of the economy to 10% (and future 5%) must have consequences.

Hence a nagging feeling that the shift to a more intangible economy is not good for GDP growth. The excellent book of Westlake and Haskell deserves a much fuller appraisal than this one point. My hazy concern: intangible investment is less spillover-rich and therefore less growth-rich than one might imagine. It isn’t all inventing Google (which obviously the authors explain). Often it is about company’s own private productivity enhancements, or reputation or brand, and I don’t see it spreading all over the economy like, say, a new invention. On the input side, I can easily picture intangible capital as a fast-depreciating asset. Consider the trillions that the the financial sector must spend software just to keep the wheels turning. It is also subject to cost disease – intangible investment is human-heavy. All unquantified thoughts, but they mean I see no contradiction between “growth in productivity may be slowing” and “we are heading into a more and more intangible economy”. 

Another wrinkle that bugs me: how should we think about the concept of (what I call) fake GDP? What is the right approach to value, for example, all the incomes that were generated in the ecosystem around a busted cryptocurrency? It now turns out it was just a few thousand fools throwing real or fake money at one another, consulting, meeting, emailing, writing software, and now it is all bust. Was it real GDP at the time, and now not? Never real in the first place?

I wonder how much of the economic activity that led up to 2007-8 should be revisited as “not actually GDP”, and whether our growth trends before 2007 were not sustainable – but how? It wasn’t shown through inflation …

And what about demand? For about 10 years I felt that the slow pace of demand growth had caused low productivity. See the point about operational gearing: underemployed resources are less productive. Now we are seeing an inflationary episode, does that mean I was wrong? Or should we be MORE optimistic now, knowing that every productivity gain will free up labour resources that the economy is more likely to need?

GDP/consumer surplus is not as fungible as being a single figure in a spreadsheet implies. Think about the challenge of elderly care. Care homes are incredibly expensive: property costs plus labour costs in a risky environment. I may once have felt good about the prospects for technology to improve this radically: the aged relative surrounded by iPads, remote delivery of services, constant connection. Now I’m aware of how irreplaceable are the services of younger people. Technological advance in one part of the economy doesn’t just translate into higher welfare in another part. Cheaper video streaming doesn’t solve loneliness or the need for physical nursing. What you need is a political means by which the surplus production is transferred from advancing to stagnant sectors.

Any longer-term growth pessimism I have, in summary, is fuelled by concern about how a more services-heavy, aged, environmentally-challenged world can use innovation to address its problems, when innovation is often geared towards #rent-seeking, the provision of low- or zero-marginal goods, meaningless growth in consumer surplus, and not the really hard constraints in energy, the environment and human services. But since the UK is not at the frontier, this is only partially relevant – we can surely do better.  And I have a very crude thought on prospects for that, to which I now turn. 

So what can public policy do? Escaping the average is hard

A friend told me that a prominent former Cabinet minister read my blog about why you can’t just “unleash growth” and liked it. It made me think, however, about  how I would respond if this statesman asked me for actual positive ideas, and whether I am just in the “too hard” camp. Well, this is what I think:

  • There are good ideas that can increase potential GDP. Every government should be trying to promote them, and fight the opposite sort. If you want a representative list of the sort of buffet from which future Growth Ministers might graze, take this lovely blog* post from Tom Westgarth and Andrew Bennett (hat tip, Stian Westlake
  • If (straw man?) anyone is suggesting such a list can get us to 2.5/3.0% growth then my questions would be about baseline and about scale.  

In terms of scale, I made this point in the earlier blog, and will again in a business investment piece. Do not underestimate the vast stock of what is already there, and the relatively small flow of what you are adding. If you increase government investment by a massive £20bn, that is still very small compared to the £4.6trn of existing UK capital.  If you do something truly wondrous about skills, remember that there are 30m+ workers, most of them out of the education system. It is an oil-tanker. 

In terms of baseline, let me try to put it figuratively. Suppose the pessimistic view is the OBR’s – that we are heading for 1.5% annual GDP/head growth. And then the optimist comes along with his growth-boosty things.   This is how I imagine an optimist seeing it:

“You thought growth was stuck at 1.5 – but what if we carried through my good ideas of building more houses, boosting R&D and something or other with data? NOW what do you think?”. 

And my response is: don’t you think any good ideas were in the baseline that got us to 1.5? 1.5 is a pretty good growth rate by historical standards, and will have included a lot of policy improvement. It is a lot higher than we have recently enjoyed, despite this being the era of the Smartphone and the Internet – two wondrous general purpose technologies. Do we know what the OBR assumes the government will do for the next 20 years – is it assuming no good policy whatsoever? Maybe it doesn’t have all your ideas (maybe they aren’t all good) – but maybe a lot of other ones.

Keeping it figurative, this is how I instead picture the job of the embattled, pro-growth policymaker in government, thinking about the ideas coming along: 

Even this is idealistic. The ideas do not sit independently (so you cut taxes, but have to cut investment too, making it a wash). And they are not neat dots, but smeary puddles. Your idea to create a giant investment bank? It might help things, it could badly mess them up! 

The point I am laboriously making: you think it is a game of pushing two or three big Pro Growth policies, and maybe fending off a few bad ones? I wish! Politics isn’t pro- or anti-growth, that is way too simple (though read Duncan on this). Politics is above all hectically busy. It is busy doing hundreds of things that are pro- or anti-growth, and you need a tireless machine to be fighting the bad ones, pushing the good ones (this is why you need the Treasury. They stop bad stuff!) But there are many, many bad ideas, and your good ones each require effort. On average,  if you left the politicians alone, they will do bad things. And so, in the end, like any game of multiple dice throws, you need to be very lucky to do much more than hit the middle of the bell curve. 

The average. It is a tyranny. 

*I am not endorsing all of these blog ideas. They feel like they are scattered across my bell curve, entirely uncosted (as the authors acknowledge) and in many cases require the kind of statist intervention that just isn’t executed well. Am particularly amazed at the call to plonk so much mass transit everywhere. But it is a good buffett

Unseriousness did not start with Johnson

One of the legacies of the soon-to-be-former prime minister (STBFPM) is a somewhat scrambling of the political spectrum.  As Ian Mulheirn observes, the fiscal approach he precariously allowed is far from right-wing, at least neutering the standard Labour attack on under-funded public services.  Remember, he supported higher taxes to pay for more money for the NHS and social care. But his was also a government proud of an appalling deportation policy, clumsily picking culture war fights, and damagingly nationalistic in trade policy.

Hence I found myself drawn to a different political line: that of seriousness. This might stand for a certain principled consistency on policy matters – are you liberal about immigration or not? Do you support action on climate change, or do you think wind turbines couldn’t knock the skin off a rice pudding? Which oped really represents your view on the EU? But it is also a style of governing. Talk to enough people about what it is like to work with a politician, and you can pick up indications, such as “he is interested in what actually works”, or “she read her box meticulously”. (You may be rightly appalled that this is such a distinguishing mark).

Very few politicians are judged on whether what they caused to happen made things better – they don’t hang around long enough, and the case is usually disputed.  But some act as if they will be so judged.  Many others appear to judge policy by the sound it makes coming out of their mouths (“policy by mouth-feel”): whether it gets them through parliamentary questions or gives them a good rebuttal line. Another sign is when they are known to go with whoever last spoke to them. Then there are those too quickly convinced of a position who love the sense of being decisive that accompanies an impatient refusal to dive into the policy detail.  I see this as a sort of intellectual nihilism – “oh, this is hopelessly complicated and no one really knows the right answer, so let’s just back whatever horse sounds plausible”.  

Maybe some of this is knowingly cynical – we may not know the right policy, but neither does anyone else and no one can pin it on us.  This contains a barely hidden disdain for the entire policymaking function. “These wonks, they make everything too complicated when the answer is really obvious.  It just needs me, the Decisive Politician, to ride in and Get On With It”.  I may have labelled this the Paradox of Nuance.   You will have your own favourite example (“Just cut the civil service by 20%/Build More Houses/Double R&D and spread it around/Invest to Boost the Economy/End Short-Termism by making Buybacks Illegal/Set up a giant investment bank/etc etc”)

The past three years have seen a mishmash of all these flavours of unseriousness.  Setting out rules for a pandemic and then not following them with sedulous care deserves mention for being the one that finally cut through to the public. But Brexit was the gold standard, the ultimate example of a policy where the details were meant to follow. Don’t we just want control of our borders, laws and money? I would also include Levelling Up; a worthy objective and now dressed up with a White Paper stuffed with theory – but it was launched without a definition, a methodology or even much of a budget. Then there was the disrespect for institutional constraints, and the tunnels, bridges, yachts and other monuments.

While the departure of the STBFPM may finally mark the ebbing of this tide of unseriousness, his arrival did not start its flow.  In 2011 the Cameron-led coalition government (in which I was a spad) thought a smart growth policy towards Europe was to produce a short pamphlet called “Let’s Choose Growth” and hand it around. Seriously. I remember sitting in the room where my boss, Vince Cable, somewhat shamefacedly handed a copy to a bemused looking Michel Barnier. Europe was about to wrestle with the existential dilemmas of a single currency unbacked by a fiscal union, and he was having to look at a PDF full of exclamation marks. The same Downing Street thought the way to encourage more socially conscious behaviour in the corporate world was … by putting another PDF called “Every Business Commits” on the chairs at some Business in the Community event. “We cut your taxes, now you must Improve Skills and Create Jobs.  Also do more car sharing”.  In similar vein, there was a bizarre suggestion to scrap most business support and replace it with a new organisation called Start Up Britain – no doubt worthy enough, but all business support?

OK, OK, I know: this reflects one particular maverick whose shenanigans I was forced to write about in 2015. The spasms above were mostly annoying but nothing more – usually someone could stop them. Pity the single official whose job was to ‘do’ Every Business Commits. But there were so many other examples. The attempt to change employment rules with a review led by a single, party donor businessman (detailed at more length in this IFG pamphlet).  The hasty and politically charged decision to scrap the Audit Commission. Getting rid of the RDAs and Government Offices in the Regions, before we had even asked what would take their place in case, you know, serious economic disruptions took place in the Regions.  In fact, the whole attitude towards austerity was shot through with an unserious, details-to-follow approach.  The timetable itself, I was told, was determined by the simple rule that it should be done with a year to go before the next election. The departmental pain allocations – 0%, 10%, 20% or even more – were determined in a way that seemed ultimately unserious. No sense of what each spending function needed, just crude headline numbers that had to be made to work.  Want to stop further education being cut to zero? You had better raise tuition fees on HE.  The whole method by which spending for unprotected departments was determined was mad, and led to the Conservatives publishing headline fiscal plans that just literally couldn’t work (see my workings here).  Going into the 2015 election, the Bagehot columnist called Cameron’s approach “wilfully slapdash”.

I only really experienced the last 12 years of government. I don’t know if things were better under Labour. I do vaguely remember stupid moments, such as “British Jobs for British Workers”. But even in their wrong decisions they appeared serious, an impression reinforced by those of their advisers I have met. One of my first wonk experiences: in 2008 I helped to staff a seminar intended to update “Options for Britain”, a book written in the 1990s that was highly influential for the incoming Labour government. My main memory of it is how dense and worthy and serious it was. Boring, even. The way politics should be.

So let us hope the tide is beginning to ebb.  But the way so many of the candidates to be our actual Prime Minister have launched with a vow to cut taxes, without any explanation for how to fill the gaps, is not encouraging.  The STBFPM may have looked at his school rival and predecessor and assumed that winging it is fine. I hope his successor isn’t of the same mind.

 

I don’t think John Major was more unpopular than Johnson

So I saw this tweet from the esteemed John Rentoul

and thought it worth pushing back a little. I remember the mid 1990s very well; they were a formative time for me politically, as I voted Conservative in 1992 and New Labour in 1997, I felt part of a very big movement indeed.

(obviously watch the event too)

And what I strongly remember was that while there was a gigantic movement against the Conservatives, politically, Major himself was generally regarded as OK. Much mocked, seen as weak, sure – but always seen as personally alright. But we are often reminded that even though Johnson has now hit a nadir (so far) of Minus 46, this is not as bad as Major reached.

What does the data say? Ipsos Mori has net approval data going waaay back that allows us to put this in context. First, let us look at the raw polling data for that time, and it is spectacular.

For years, pollsters had the Labour party consistently on OVER FIFTY, and the Tories regularly struggling to break 30. Now, we all know that the 1992 polls had badly exaggerated Labour’s chances, and people talked a lot of Shy Tories, so Conservatives felt they still had a chance. But these were spectacular leads, all the time. And they were reflected in the Government and Prime Minister approval ratings. In June 1993, 10% of respondents approved, and 84% disapproved, of the Government’s performance. The figures for Major himself were 19 and 74, so minus 55 (I think he hit a personal nadir just after Blair got to power, at minus 59).

But the government was consistently less popular than he was, on this measure. And although that is a normal pattern, Major’s popularity relative to his government’s was pretty good. Let’s see how he looks, compared to Cameron and then Johnson. All on one chart:

Dotted lines are the governments, solid lines the PMs. For true blue Major, there was always a pretty large gap. So, too, for Cameron most of the time. For Johnson, he enjoyed a giant gap at the beginning, when everyone appeared to hate the government but had hopes for the new guy …. but that appears to have disappeared by June 2020. And since then, the two have moved in lockstep.

Here, finally, is a slightly geekier way of seeing it. Taking the Tory lead over Labour on the horizontal, and PM net approval on the vertical, you can see that Johnson appears to have broken a recent pattern for the Conservatives of having more popular leaders than they are as a party. The big red triangle is the last reading.

I am not an expert like Rob Ford, Matthew Goodwin, Will Jennings et al, so I don’t know how enduring the switch of working class voters to the Conservatives is. And I don’t know what we can learn about how a leader taints a party from this. The worry for Conservatives is that rather than Johnson catching up with their (relative!) popularity as a party, the party catches up with his relative unpopularity instead …

My view? John Major was not more unpopular than Johnson. The only times he scored lower, the pollsters would have been hitting the same sampling errors that put Labour on 55-60% for voting intention. His party was off the scale unpopular, and that tainted him.

Lord Frost, and whether/how lower trade makes us poorer

I am very far from being any kind of an expert in trade. My policy is to rely on comparative advantage; spend less time on it and rely on others to do the work, more efficiently.  My familiarity with the topic goes only as far as some of the obvious signposts: apart from Ricardo’s comparative advantage, a knowledge that geography matters (double the distance, half the trade, or something), some vague awareness of what Paul Krugman showed (a combination of agglomeration and economies of scale lead to a lot more international trade than you’d expect from pure CA) – and whatever I can pick up reading Trade Secrets by Alan Beattie et al, and rubbing shoulders with the experts at the FIG.

I ought to know more – as someone who has banged the drum for a closer trading relationship with Europe, and tends to agree that friction will cause productivity problems. As a lazy gotcha polemicist, I have tended to quote Nigel Lawson on the advantages of being in the Common Market – increased competition in a larger market forces business to “wake up or go under”.  I have also relied on the OBR, which has documented the fall in trade post EU and (Box 2.5) says “this reduction in trade intensity drives the 4 per cent reduction in long-run potential productivity we assume will eventually result from our departure from the EU”.

Anyway, I had parked this in the “issue settled” box, till I read Oliver Lewis’s encomium to Lord Frost on ConHome and his recommendation that we all read Frost’s speech of February this year, which he said should be “a key source for future historians of this period” – which seems reasonable. Frost is a significant figure, this is what he thought, and he sets it out quite seriously.  And, talking of Brexit studies that foresee a fall in productivity from less trade, it has this bit:

But, in brief, all these studies exaggerate – in my view – the impact of non-tariff barriers they exaggerate customs costs, in some cases by orders of magnitude. Even more importantly, they also assume that this unproven decline in trade will have implausible large effects on Britain’s productivity. Yet there is at least as much evidence that the relationship is the other way around – that it is actually productivity which drives trade. The claims that trade drives productivity are often in fact based on the very specific experience of emerging countries opening up to world markets, beginning to trade on global terms after a period of authoritarian or communist government – these are transitions that involve a huge improvement in the institutional framework and which make big productivity improvements almost inevitable. And I think the relevance of such experiences drawn from that for the UK, a high-income economy which has been extremely open for over a century, seems highly limited to me.

So I thought I would try to trace back why the OBR feels so confident asserting the opposite.  Starting with the most recent EFO, we have that quote above, which is preceded by the statement that “Since our first post-EU referendum EFO in November 2016, our forecasts have assumed that total UK imports and exports will eventually both be 15 per cent lower than had we stayed in the EU”.  But dive back to November 2016, and this is what the OBR said:

exiting the EU will reduce growth in exports and imports during the transition to a less trade-intensive economy. We have not modelled the effect of specific post-exit trading regimes, but have instead drawn on a range of external studies to calibrate a downward adjustment to exports and imports that we assume would be complete by 2025. We have assumed that exports and imports are similarly affected, so that the effect on net trade and GDP growth is broadly neutral. We have not revised trend productivity growth lower explicitly to reflect lower trade intensity (as the Treasury did in its pre-referendum analysis) given the lack of certainty around this link

My italics.  So they (correctly) foresaw lower trade, but did not back then use this as the reason to lower productivity, and see the link between trade and lower productivity as less well understood. Instead, they lower their estimates for productivity growth because of the sharp drop in business investment (see this much-noted tweet).

Eighteen months later, they addressed this question in a standalone piece – which, while mentioning many of the common sense reasons openness leads to productivity gains (less competitive pressure, less knowledge transfer) actually foreshadows some of Frost’s caveats.  Studies that link increasing trade to increasing productivity have seldom covered Brexit-like moments where trade is actually reduced, leading to this arch observation: “one of the ways in which increased openness is thought to increase productivity is through knowledge spillovers, but reducing openness by introducing trade frictions should not lead businesses to forget what they already know”.

Yet, by November 2020, discussing the risk of last year’s no deal scenario (there have been so many), the OBR writes

a ‘no deal’ Brexit could reduce real GDP by a further 2 per cent in 2021, due to various temporary disruptions to cross-border trade and the knock-on impacts. As these abate, the longer-term effects of lower trade intensity continue to build such that output is 1.5 per cent lower than our central forecast after five years, and 2 per cent lower in the long run

With a trade deal in the bag, the next (March 2021 EFO) keeps with its cut to productivity growth, but now pins it more specifically on services

the introduction of non-tariff barriers in services, which accounted for 42 per cent of the UK’s exports to the EU in 2019, is far more significant. It is this channel that accounts for much of the long-term reduction in productivity, in line with the findings of some of the studies that informed our previous assessment

I looked for the studies, and found this by the World Bank – which looks like an excellent paper, but is largely concerned with (what looks like quite correct) predictions about the fall in trade because of Brexit.  For the links between that falling trade and productivity/living standards, I had to look in ITS footnotes, and found this: “Dhingra, Swati, Gianmarco I. P. Ottaviano, Thomas Sampson and John Van Reenen. 2016. “The Consequences of Brexit for UK Trade and Living Standards” – which states the effect very baldly – “In the long run, reduced trade lowers productivity” – and lists familiar effects (reduced competition, smaller size of markets, less incentive to innovate).  It is another excellent paper.

But here I find myself at a dead end.  The Dhingra et al paper is pre-referendum, essentially, and the OBR immediately after the referendum decided not to count these dynamic effects. I am not sure why they didn’t, nor do I understand why now they do, in light of that earlier acknowledgement that the discussion is much less settled than in other areas. 

In the meantime, Lord Frost has stated the Brexiteer position quite baldly: paraphrasing, “We don’t think reduced trade with the EU does in fact hurt our productivity, and all the evidence out there in the real world is in fact about different scenarios to this”.  The second bit may well be right – no other country has ever done anything like Brexit.

So I end this with a plea. I tend to think the connection between damaged trading links with the EU and lower productivity should be pretty strong.  We have lower trade, less investment since the vote, and we have had poorer GDP outcomes. It is all very suggestive. But Lord Frost captured the blithe, Brexiteer contrary view well: this stuff is all for other economies, other situations (and fails to capture the benefits of our new, free-wheeling nature).  Does anyone have any more up-to-date and definitive study that I can look to?[1]              


[1] Since starting this, I found this paper https://www.wto.org/english/res_e/reser_e/gtdw_e/wkshop18_e/manova_e.pdf which finds that “exogenous shocks to both export demand and import competition generate large gains in aggregate productivity. Decomposing these gains, we that both trade activities increase average productivity, but export expansion also reallocates activity towards more productive, while import penetration acts in reverse” – but I am otherwise impressed by how little strong evidence there is out there.

We can also see that businesses that trade are more productive – https://www.ons.gov.uk/economy/economicoutputandproductivity/productivitymeasures/articles/uktradeingoodsandproductivitynewfindings/2018-07-06 – but selection effect?

Freethinking Economist

Economic advice. No longer special.