Monday, 22 September 2014

Misleading a country

When this happens (taken from a post by Jérémie Cohen-Setton), something has gone very wrong. The Euro was meant to increase growth, not create stagnation. So what, or who, is to blame?

Many outside the Eurozone, and a growing minority within it, will say the Euro itself. But that is not a very helpful response. Given the level of commitment to the Euro, it is the only correct response if there is no version of this currency union that can be made to work better.

Others will say that the only way forward is further political integration through a fiscal union. That seems like the political equivalent of going from the frying pan into the fire. The story of the Euro is as much a political failure as an economic failure. But I also suspect support among many economists for fiscal union is built upon a questionable premise. The premise is that the current difficulties arise because it is inevitable that Germany will put its national interest above the interests of the Eurozone as a whole.

This argument goes as follows. As a result of undercutting other union members, Germany has become too competitive within the Eurozone. This will be reversed. The ECB has an inflation target of almost 2%. Therefore in normal circumstances we would see inflation above 2% in Germany for some period. This is unfortunate for Germany, but those are the macroeconomic rules of the game in a monetary union.

However we are not in normal circumstances, because the interest rate set by the ECB cannot fall any further. As a result, Eurozone inflation is well below 2%. There is an obvious solution to this problem: replace monetary stimulus with fiscal stimulus. However, this is not in Germany’s interests: as a result of becoming too competitive, their economy is relatively healthy, and they do not want above 2% inflation. Therefore we need a fiscal union to impose fiscal stimulus on Germany. (There is a variant of this argument where we focus on the failure of monetary policy and German pressure on the ECB.)

It is natural for economists to reason this way, because we are used to thinking about rational self-interested individuals. But suppose the problem with German public opinion is not that it is being narrowly self-interested, but that it has been encouraged to think about this in the wrong way. There are two aspects to this. First, although Keynesian economics is taught in all universities, in appears taboo in much German public discussion. Under this anti-Keynesian view the chart above has nothing to do with fiscal contraction, so it must be all about the lack of ‘structural reform’ outside Germany. Second, German politicians are in denial about the implications of low German inflation before the crisis. Logically the only way Germany can avoid above 2% inflation is if the Eurozone as a whole goes through a prolonged depression, but as is painfully obvious from the comments on some of my recent posts, the German public is not told about this.

The two deceptions help reinforce each other. Germany says it is doing OK without the need for fiscal stimulus, so why do other countries need it? Of course Germany is doing fine because its period of relatively low inflation allowed it to uncut its Eurozone competitors.

Never underestimate the power of bad ideas, particularly if they have ideological roots. Here we have the two mistakes that led to the Great Depression being repeated. We look back at the 1930s and think if only they had known about Keynesian economics a depression could have been avoided. However the depression was as much about countries attempting to stick with the gold standard, and the problems with that were obvious at the time. Today we do know about Keynesian economics, but both mistakes continue.

It is possible to believe that balanced-budget fundamentalism is somehow hard wired into the German psyche, and I have personally experienced moments like that described in this comment to my earlier post that seem to confirm this. So I do not want to discount such explanations entirely, but I do wonder if a powerful motive behind this is just the same anti-state neoliberalism that you see elsewhere. Those on the right appear to have a greater distrust of economists and their theories. This may be true of popular attitudes (HT Tyler Cowen), but it is also the case of those running the country.

According to Der Spiegel, the three permanent secretaries running the German finance ministry have studied law rather than economics. Among the nine department heads seven are lawyers and just two are economists. While the balance between lawyers and economists has always favoured lawyers, it has apparently become worse under Schäuble (whose doctorate is also in law).

As a result of all this, it is not at all clear to me that the current problems of the Eurozone are all down to German self-interest. The case for additional infrastructure spending in Germany looks strong, as argued by Marcel Fratzscher, head of the German Institute for Economic Research (DIW). It would therefore seem more than possible to get Germany to take part in a Eurozone wide programme of additional public investment, which can be justified on a microeconomic/supply side basis as well as on macroeconomic/demand side grounds. All that stands in the way is the power of bad ideas, and its embodiment in the Eurozone’s fiscal rules.

Sunday, 21 September 2014

That referendum was fun. Shall we do it again?

Whether the UK as a whole gets to choose whether to have a referendum on continuing membership of the European Union depends on the result of the general election in 2015. Given that we have this choice, it is worth thinking about similarities and differences between the EU referendum and the referendum on Scottish independence.

The key similarity is that the immediate economic consequences of independence in both cases are negative: according to John Van Reenen, even more so with the UK leaving the EU. In both cases nationalism will play an important role. I would argue that in both cases independence is seen by many as a means to a particular end. With Scotland, it was a way of ensuring that Scotland would not be governed by a right wing Conservative party. With the EU, it is a way of stopping large scale migration into the UK.

Is another similarity that the established parties are likely to be united in arguing against independence? There must be serious doubt about this. I suspect that Cameron has a strong preference for continued membership, and even that in his eyes the referendum is largely a political ploy to stop Conservative voters moving to UKIP in 2015. However Cameron also has a preference for remaining the leader of his party. He is very unlikely to get significant changes to the terms of EU membership before the referendum, including the free movement of labour. There are said to be between 50 and 100 Conservative MPs who will argue for leaving the EU whatever the outcome of Cameron’s negotiations. There are about 300 Conservative MPs at present. It is therefore possible that, once the negotiations have ended with little gained, a majority of Tory MPs will want to exit from the EU.

This leads to one clear difference between the two referendums. I think it is fair to say that outside Scotland few took the chances of a Yes vote seriously until the final weeks of the campaign. There are three reasons for thinking that will not happen with the EU referendum. First, UK public opinion has until quite recently shown a majority in favour of leaving the EU. Here are the polls conducted by YouGov.

Second, unlike Scottish independence, a majority of the UK press will be arguing for exit from the EU. Third, to make his negotiating stance credible, Cameron will have to at least give the impression that he might decide to recommend leaving the EU if he does not get significant concessions. As I note above, he will not have to try very hard.

This has an important implication which I think has been underestimated by many. Once the election result is known in 2015, if the Conservatives win there is a distinct possibility that the UK may vote to leave the EU. That kind of uncertainty is likely to be bad for non-residential investment, during a period in which we might hope that investment demand takes over from consumption as a primary driver of growth. We also know that, if the Conservatives win the next election, there will be a renewed fiscal contraction. With interest rates likely to be close to their lower bound, there remains limited scope for monetary stimulus to counter these influences.

So this is one important difference between the two referendums. Because most people were assuming a No vote until the last few weeks of the Scottish campaign, it seems unlikely there was sufficient uncertainty for a long enough period to have damaged the Scottish economy, and as far as I know there is no evidence that it did. In contrast, the two years of uncertainty from 2015 and 2017 is almost bound to be damaging for the UK economy.

Friday, 19 September 2014

Wishful thinking and economics

Economics is often called the dismal science, and the Scottish referendum showed why this description has stuck. The Yes side appeared full of hope and optimism about what could happen once the constraints of Westminster rule had been cast off, while the No campaign kept on going on about one problem or other, which usually involved economics.

The general meme is that this negativity was a tactical mistake by the No side, but it was a quite understandable mistake, because the economic problems were large and self evident. It is no surprise that the vast majority of economists thought Scotland would be worse off under independence (see here, or here, or here). They had looked at the numbers and issues, or looked at institutions they respected that had done so, and thought this does not look good. Even for some of those economists who are in favour of independence, like Joe Stiglitz for example, it is clear that the attraction is despite, rather than because, of the basic macro and fiscal numbers. (See also Adam Posen’s response.)

This is of course not new. Politicians on the right like to believe that tax cuts will pay for themselves, and it is boring economists who (mostly) point out this is not true. Politicians of all shades thought that austerity would not have much impact on output and growth, while the vast majority of economists knew better. One of the reasons for deficit bias is that politicians believe that their policies will galvanize the economy and raise the tax base, and most of the time the macroeconomy stubbornly refuses to be impressed.

Now it is tempting to say, given this evidence, that politicians will believe anything that suits them. But what the independence referendum showed us is that voters have similar problems. As the campaign progressed the stronger the Yes vote became, and there is some evidence that this reflected additional information they received. As I suggested here, the problem is that this information was superficially credible sounding stuff from either side, but often with no indication from those who might have known better of the quality of the analysis.

For me this has always been the major argument for establishing fiscal councils - independent institutions who are charged with, at a minimum, scrutinising fiscal projections. Although the OBR (the UK’s fiscal council) has a remit that is quite narrow, we also have the highly respected IFS. In Sweden the fiscal council itself has a much wider economic remit.

Whenever I make this point, someone puts forward the argument that this is anti-democratic, or that I want economists to dictate decisions. This is wrong on at least two levels. First, my general argument is not specific to economics, but involves any area that involves technical expertise. Indeed, the case I make here is partly to avoid politicians using the views of a small minority of economists as cover. Second, the problem with democratic accountability as normally defined is that it is very weak: voters make one decision every five years that involves a whole basket of issues. I would suggest that charging an institution with a small set of tasks, where there is effective democratic oversight over the performance of that institution, can make that institution more accountable to the electorate than any politician doing the same.

In the case of Scottish independence, although we did not have a direct assessment of fiscal prospects from the OBR, that organisation’s oil revenue forecasts were used by the equally respected and independent IFS to point out the problematic outlook that an independent Scotland would face. Although the Yes side attempted to suggest that the OBR was part of the very Westminster elite that it wanted a divorce from, I suspect many voters saw this as independent analysis and were concerned by it. In a world where politicians can always find some experts to back their view, I suspect it is only through singular institutions like the OBR and IFS that the views of the majority of economists get to have some influence, and the economics of wishful thinking gets exposed.

Wednesday, 17 September 2014

Keynes and the Macmillan committee

This book, by Peter Temin and David Vines, has just been published. As you can see from the endorsements, I liked the book. In this post I just want to focus on a particular chapter, which was Keynes’s role as part of the Macmillan committee, an episode I did not know about before. Just as the book does so well, I want to draw parallels between the past and current events.

It is the end of 1929: UK unemployment was already high as a result of going back on to the gold standard five years earlier, and Wall Street had just crashed. The new Labour government was overwhelmed, so in the British tradition it set up a committee to recommend what to do, and Keynes was a member. As Temin and Vines note, although Keynes was at the centre of economic discussion at the time, he was also outside the establishment, as a result of publishing his attack on the Versailles treaty in the Economic Consequences of the Peace.

Keynes diagnosis of why British unemployment was so high linked returning to the gold standard at an uncompetitive level and the problems of downward nominal wage adjustment. The book’s description of how the then governor of the Bank of England, Montagu Norman, failed to see the problem is amusing - from a distance of nearly a century - but of course as the book points out this is exactly the ‘conversation’ that Germany is currently having with the rest of the Eurozone.

The obvious solution was therefore devaluation, and the book seems a little ambivalent about whether that was not much discussed because it was ‘off the table’ for political reasons, or whether Keynes and others thought that, having joined (which Keynes had opposed), Britain should stay the course. (Eurozone parallels again. Ironically Britain did devalue three months after the report was published, although as I note here, this was forced rather than a choice.) What Keynes argued for was instead increased government spending, but he failed to convince the committee that its impact on unemployment would not be crowded out. Here Temin and Vines attribute this failure not to the ability of the others to see the obvious, but to the fact that Keynes arguments did not fit with the model he was using, which was the model of the Treatise. They write: “the Macmillan Committee is of interest to us because Keynes’ presentations to it didn’t add up to a coherent view. Rather, they show Keynes thinking on his feet at a time when his ideas were in flux.” Those ideas ended up, of course, with the General Theory.

Finally, one thought of my own. When I was younger, I drew the wrong inference about the Great Depression. If only the General Theory had been written 10 years earlier, I reasoned, much of the agony of the Great Depression could have been avoided. Instead I should have focused on the gold standard. Not because this was more important as a cause of the world wide Great Depression - it well might have been - but because of what it tells you about the influences on macroeconomic policy.

Montagu Norman said to the committee “I have never been able to see myself why for the last few years it should have been impossible for industry, starting from within, to have readjusted its own position”. This was a few years after the General Strike of 1926! This was not someone lacking a coherent theory, but someone blind to the evidence and human nature, and enthralled to the ideology of the gold standard. No doubt being a central banker rather than a worker, or even an industrialist, helped this blindness. The lesson I should have drawn from the Great Depression is that a powerful ideology, in the hands of people remote from those adversely affected by it, can overcome common sense and evidence. 

Tuesday, 16 September 2014

UK attitudes on the size of the state

This is a follow up to my post on shrinking the state, but actually it is about something I found when thinking about the Scottish independence referendum, so let me start there. If Scotland votes for independence, it will be because enough Labour voters voted Yes despite Labour’s support for the Union. It seems quite clear from the Scottish Nationalists’ pitch in these closing weeks that the appeal to these voters is that by voting for independence you can ensure you never again have a Conservative government.

Yet there is a puzzle here. England and Scotland are not so different in terms of political attitudes. This is true across a wide range of issues: Scots are only a little more to the left than the English. Furthermore, as John Curtice and Rachel Ormston show here, this difference has not noticeably increased over the last ten years. Let’s focus on the specific issue of the size of the state. Here is the proportion of people who thought taxes should rise to increase spending on health, education and social benefits in each country.

The proportion is generally higher in Scotland, but not by much, and it has been falling in both countries over the last ten years.

When I saw this data, I wondered about what was missing from the chart. Respondents were given two alternative responses: the level of taxation should be less, or it should stay about the same. Here is the same question for the UK as a whole (source: British Social Attitudes survey).

The interesting result is how few people want lower taxes - always below 10%. The changes involve shifts between more spending and taxes to no change, rather than to lower spending and taxes.

In terms of movements over time, it is interesting to compare this with data on the levels of UK government spending and taxes, over a longer period than I gave in my previous post.

 If you think about the turn of the millennium as being the end of the Thatcher era, then the Thatcher years saw a reduction in the size of the state, whether measured in terms of taxes or spending. From the previous chart, it looks like this was against popular opinion at the time, because we saw a sustained rise in the proportion of people wanting a larger state in the 1980s. This proportion started falling over the same period that Labour were increasing the level of public spending, which again makes sense. So there is little evidence of a change in public attitudes here: the state was too small in the 1980s and 1990s, and it began to move towards a level the majority desired during the last Labour government. There is absolutely no public mandate for any renewed shrinking of the state.

Which prompted this thought. As public attitudes either side of the border are not so very different, and given these particular attitudes about the size of the state, perhaps the relevant question is not why the Conservatives and UKIP are so weak in Scotland, but why are they so strong in England? As John Ruddy notes here, in the mid 1950s the Conservatives won over 50% of the Scottish vote. What happened since then was not a collapse at the expense of Labour, but at the expense of the SNP and Liberals.

Perhaps a better way to start thinking about what has been happening is as follows. The big change over time has not involved public attitudes, but the political position on economic issues of the Conservative Party. Just like the Republicans in the US, it has moved substantially to the right, beginning with Thatcher, and continuing under Cameron. Just as with the Tea Party in the US, there is a sizeable minority that wants to go further. However this rightward shift does not reflect majority opinion, and so when enough alternatives exist - as in Scotland - votes have drifted away from the Conservatives to more moderate centre right parties. In a two party system like the US, or with a voting system that favours the two main incumbent parties like the UK, that cannot happen.

Monday, 15 September 2014

David Cameron (from Wikipedia 2100)

Prime Minister of UK (including Scotland until 2014) from 2010 to 2017. Widely seen as the catalyst behind the renewed decline of the UK, after a brief respite in the 30 years previously (see entries for Margaret Thatcher and Gordon Brown). On becoming Prime Minister in 2010, embarked on a fiscal austerity programme which delayed a recovery from the Great Recession until 2013, accelerated the privatisation of public services and encouraged social hostility to immigration and the poor.

This proved to be a decisive factor in Scotland narrowly voting Yes to independence in 2014. (The other was his decision not to allow a third option for greater devolution.) His administration was then bogged down in negotiations with Scotland for the next two years, which caused increasing bitterness between the two countries. In the UK election of 2015 the SNP captured many Scottish Labour seats, but refused to form a coalition government with Labour, allowing Cameron to continue to lead a minority government with tacit support from the LibDems and (initially) UKIP.

Most analysts naturally point to his promise of a referendum on EU membership as his biggest mistake. In the short term this meant that UKIP’s success in the 2015 election was as much at the expense of Labour as his own party. But his decision to recommend voting Yes to continued membership in the EU referendum in 2017 led to an attempt to unseat him as leader which narrowly failed (see entry on Boris Johnson), and then large scale defections of MPs from his party to UKIP. Campaigning under the slogan ‘If Scotland can do it, so can we’, and with the support of large sections of the press, UKIP leader Nigel Farage achieved a very narrow majority to leave the EU, forcing Cameron to resign. Some argue that the Scottish independence decision was critical here, as he would have won the referendum vote if Scotland had stayed part of the UK. A few argue that the decision to break up the BBC and allow partisan broadcasting, and in particular the rebranding of ITV into FOX-UK, was a more important factor in losing the EU vote.

There is some dispute as to how much Cameron himself is to blame for these events, or how much was the work of his Chancellor (and his successor as Prime Minister) George Osborne. There also remains some controversy over whether the inability of the economy to make up the ground it lost during the recession was due to the initial austerity plan, renewed austerity after 2015, controls on immigration or the uncertainty created by the referendum itself and subsequent EU exit.

It is a great irony that the only leader of this period whose current reputation is lower than Cameron’s is his opponent in the Scottish independence debate Alex Salmond, now widely known in Scotland as the Great Deceiver. Scotland’s own economic decline following independence was far greater, following a collapse in oil prices and the loss in UK markets when Scotland joined the EU.


Sunday, 14 September 2014

Shrinking the State

More on George Osborne’s plans, courtesy of the OBR’s latest publication. (Campaigning for a UK Fiscal Council was one of my better calls - just imagine if you had to rely on today’s government for this kind of information.)

Consider three points in time: 2001/2 (when the UK budget was last in balance, and still largely reflecting the actions of the previous Conservative government), 2007/8 (pre-recession, under Labour), and 2018/9, when George Osborne also intends us to be back in balance. The first chart actually comes from the OBR’s historical database, which only covers the broad aggregates. (It would be fantastic if this database could include more disaggregated information.)

This shows total government receipts (taxes) and expenditure (spending) as a percent of GDP. The two lines meet at the start and end. In 2007/8 we had a budget deficit of 2.6% of GDP. At the time that seemed a bit on the high side: something between 1.5% and 2% would have kept the debt to GDP ratio constant. (Budget balance implies a falling debt to GDP ratio.) For this post the point to note was that the Labour government chose to use this fiscal loosening to increase spending rather than cut taxes.

The Conservative government plans to do the reverse. So does that mean that it is just trying to undo the increase that occurred under Labour? The answer is no, and this is where the OBR’s latest report comes into its own.

Their chart shows how we get from the deficit of 2007/8 to the small surplus of 2018/9. (There is, as I note here, no good macroeconomic reason to aim for a surplus.) The cuts in spending are not just the size of the 2007/8 deficit - they are much larger for two main reasons: higher debt interest and higher ‘welfare’ spending. The reason for the higher debt interest is straightforward: debt is much higher because of the recession (and to a small extent the fiscal stimulus in 2009). Although academics often assume that higher debt interest is paid for by raising taxes, a more ‘neutral’ approach would be to raise taxes and cut government spending. Osborne plans to just cut spending.

The increase in welfare payments is probably not what you might think it is. The report’s Table 5.7 shows it is not higher unemployment benefits or income support: by 2018/9 unemployment benefit is the same as in 2007/8, and income support is 0.5% lower as a share of GDP (which is the main reason why poverty will increase over the next five years). Housing benefit is 0.3% higher as a share of GDP (partly reflecting depressed real earnings), but the main reason is the state pension, which is almost 1% higher as a share of GDP. This represents both an increased ‘caseload’ (more pensioners) and a more generous value of pensions themselves. Although the numbers suggest that here too Osborne plans to pay for this additional spending by cutting the size of government, he has indicated that he hopes to reduce this increase in welfare payments by some, as yet undeclared, means.

So this is why the reduction in the size of the state planned for 2018/9 is much more than reversing Labour’s increase: in fact, if welfare cannot be cut further, to decrease its size to “probably to the lowest share of GDP since 1938” (p128). In this particular respect, therefore, this government plans to go well beyond anything Margaret Thatcher ever attempted. I suspect when some people write that this Conservative party is more right wing than any since the war, many reading think this is hyperbole. On this metric at least, it is simply fact.