I have always found psychological analysis of voting behaviour interesting, but was never sure where it led. So what if research suggests conservatives tend to desire security, predictability and authority more than liberals do, and liberals are more comfortable with novelty, nuance and complexity. These psychological differences may tend to make liberals more concerned about the welfare of minorities or immigrants than conservatives, but that has no bearing on whether it is right or wrong to care about the welfare of minorities.

Where it does matter, however, is in understanding what issues resonate with particular groups. Winning elections is normally presented as persuading undecided or floating voters to vote for a particular party. It is also important for political parties to get their own vote out by either attracting or scaring them. But it may be just as important to persuade the other side’s voters not to vote for their natural party, and instead vote for another party (not necessarily your own) or not vote at all.

A good example of the last point were the claims of antisemitism within the Labour party when Corbyn was leader. Precisely because those with socially liberal views tend to be more concerned about discrimination against minorities, this issue was ideal for peeling off what might otherwise have been natural Labour voters. In this post I want to suggest that the controversy over sewage being continuously released by the privatised water companies into rivers and onto beaches could become a voting deterrent for natural Conservative supporters.

One of the pretty robust findings linking political preferences to psychological traits is that conservative voters react more strongly to what we might call disgusting images or descriptions. As Kathleen McAuliffe describesin the Atlantic, “the brains of liberals and conservatives reacted in wildly different ways to repulsive pictures: Both groups reacted, but different brain networks were stimulated.” High sensitivity to disgust tends to go hand in hand with a “conservative ethos.” Whether this correlation reflects the reaction of disgust in general, or disgust to particular things, is an interesting issue but not relevant in the current context. What the research does seem to suggest is that Conservative voters, or more generally socially conservative voters, may be more affected by stories of sewage pollution than voters of a more liberal persuasion. [1]

Linking the pollution of beaches and rivers (and, after floods, even streets) to the Conservative party is very easy. Those immediately at fault are private water companies, but the privatisation of water has always been championed by the Conservative party as a clear improvement over public ownership. If the news is full of examples of beaches and rivers polluted by these private companies, alongside the usual leaks and occasional gaps in supply, the advantages of privatisation are far from obvious.

Of course just because water companies were privatised does not mean the government is powerless to act. The problem the government has is their actions seem to be more sympathetic to the water companies than the environment. In August 2021 Conservative MPs voted to make the release of sewage by water companies into the environment legal, and gave them until 2050 to completely deal with the problem. The government has also deprived the Environment Agency of the resources and leadership needed to effectively monitor water quality. They, along with previous governments, have sat back while the regulator allowed these companies to pile up debt in order to pay large dividends to shareholders, rather than use an era of low interest rates to invest in the infrastructure needed to avoid pollution.

Natural monopolies like water companies, where there is no competition or customer choice, have little incentive to invest in sewage treatment or fixing leaks. Regulators, without external pressure from politicians, may tend to go easy on firms because, in part, of the problem of revolving doors. One way to avoid this is to give groups who have an interest in better investment a say in what the regulator does. What you don’t do, and what this government has done, is pass legislation that removes what little legal incentive there was for water companies to deal with the problems they have created.

The pollution story also gets to the heart of those claims that Brexit allows the UK to make its own laws and decisions. While we were part of the EU, UK beaches and rivers gradually became cleaner in large part because EU regulations helped that happen. By ‘taking back control’, the UK government has now allowed water companies decades before we might return to standards we achieved whilst in the EU. The reality is that most of the EU regulations Leavers go on about are popular with many Leave voters, just not most Leave politicians and opinion writers.

With the government failing on major issues like managing the economy and the NHS, the problems of pollution of rivers and beaches might seem relatively small beer. Up until now, most of the political noise on this issue has come from interest groups (e.g. river fishing), ad hoc groups or individual campaigners (most noticeably Feargal Sharkey) rather than the main opposition parties. This is not to suggest that Jim McMahon, Labour’s environment spokesman, has been silent on the issue - he hasn’t. Starmer and the Liberal Democrats have also made statements on the issue; see also here. But just as the Conservatives used to get references to antisemitism into almost every statement they made about Labour under Corbyn, perhaps Labour need to do the same about how the government has allowed privatised water companies to pollute our rivers and beaches with sometimes very serious consequences(see also here).

[1] Of course these are tendencies, no more. It certainly does not mean that if you exercised by pollution in rivers or beaches you must be socially conservative!

The Autumn Statement saw yet more cuts in public services planned for after the next election in order to get the debt/GDP ratio falling after 5 years. One item of spending that is expected to be higher after the next election compared to previous forecasts is debt interest. In part this is a result of the Bank of England’s Quantitative Easing (hereafter QE) programme. This created a large quantity of what are called bank reserves (explanations to follow), which currently earn interest for the commercial private banks that hold these reserves at the short term interest rate set by the Monetary Policy Committee of the Bank of England.

The Bank of England didn’t start paying interest on reserves until2005-6. As long as interest rates were close to zero, or the quantity of bank reserves were much smaller than now, paying the short term interest rate on reserves didn’t cost very much. However after QE, and with short term interest rates climbing rapidly, they are costing not just the UK government, but all governments that undertook QE, serious sums of money. The money markets expect UK short term interest rates to stay reasonably high over the next few years, and as the OBR's forecast is based on these expectations this means that a significant amount of the austerity in the government’s current fiscal plan is a direct result of paying interest on reserves to commercial banks. The New Economics Foundation (NEF) calculatethat the banking sector could receive over £50 billion of public money by mid-2025 because of interest paid on reserves. [1] Hence the title of this post.

If this all seems rather puzzling, it is because bank reserves are not well understood, and many of the explanations you will find just make things worse (see this from Frances Coppolawho points to some all too common mistakes). To make things simpler I’m going to treat the Bank of England as part of the government (looking at what economists call the consolidated public sector). This is realistic, as any profits or losses the Bank makes end up being pocketed or paid for by the government. So I will talk about the government creating reserves and paying interest on them.

Why did the government create these reserves in the first place? After the Global Financial Crisis, short term interest rates hit their lower bound. Quantitative Easing (QE) was a programme where the government bought back some of its own debt with money the government created. The government has the ability to create money, either by issuing notes and coins (cash) or by creating reserves. I will not go into why they did QE, and how successful the QE programme was, because I and many others have written a lot about this already. Even if you think QE was a bad idea, as the Bank of England is understandably reluctant to sell all its holdings of government debt at once we are where we are.

Reserves are electronic money, in much the same way as your current account is electronic money that you use in, for example, online banking. Whereas you need to initially provide the bank with money, or get a loan from the bank, to create a current account, the government can just create that money. The amount of money created is the amount of the reserve held by the private bank. Private banks can only sell reserves to each other, so banks as a whole get no choice about how much reserves they collectively hold.

If reserves are like the government’s current account, why does it pay interest on them to individual banks? You and I don’t pay interest on our current accounts. The answer is that paying interest on reserves is a relatively recent innovation in most countries, and was designed to ensure the government can continue to set short term interest rates for the economy as a whole. When interest rates were very low that didn’t cost the government much, but now it does. For the private banks, getting today’s short term interest rate paid on its holdings of reserves is a bit of a windfall.

Do private banks deserve this windfall? The short answer is no. The reason they are getting paid interest on these reserves is because it helps the government set short term interest rates, and not in return for any kind of loan from the banks. So why isn’t the government finding some way to get this windfall back from banks, just as it (reluctantly) set up windfall taxes for energy producers? The answer is that this government cares rather more about bank profits than public services, which is an example of something I wrote about last week.

To be fair, a bank might argue that it is providing some services when it holds reserves. Your bank does not ask you to pay interest on your current account balance: indeed some banks pay you interest on your main current account. Banks compete for current accounts partly because they get to use the money provided when they are set up, but this isn’t the case for reserves. There is an argument, outlined by Paul Tucker here, that over some long period paying interest rates on reserves might happen to compensate banks for the use of any service the bank provides, but this seems very unlikely. There is also the question of the services the government provides to private banks that are not paid for, which I discuss here.

So if banks don't earn the interest they receive on reserves, how should the government get that money back? Some have suggested a tax to reclaim at least some of this windfall private banks are currently receiving. The windfall tax should be based on the income banks received from interest on reserves over the past year, and could be set at 100% of that income. However creating a tax to claim back what is a subsidy seems rather convoluted, and calling it a tax hands those that oppose it an immediate advantage.

The alternative is to change the way monetary policy works, so the government no longer needs to pay interest rates on all the reserves it has created. I have seen two quite similar proposals. The first is to move to what is called a tiered reserve system. Under this interest would only be paid on marginal reserves, with the majority receiving no interest, as suggested by Karl Whelan here or NEF here for example. The second is to insist that banks hold a large amount of ‘required reserves’ [2] that pay zero interest, as described by Paul De Grauwe and Yuemei Ji here. The two schemes sound very similar, and they illustrate that paying interest on reserves is not necessary for the operation of monetary policy.

As either a windfall tax, or changing the way monetary policy operates so that interest was not paid on most reserves, involves the banks losing a large amount of money while interest rates remain high, you will see a lot of misleading arguments about why this should not happen. The silliest is that not paying interest on reserves is a form of default: silly because most governments didn’t pay interest on reserves until quite recently, and governments not banks choose the quantity of reserves. Another argument is that not paying interest on reserves is a tax on banks, and taxes create inefficiency. But why not call paying interest on reserves a distorting subsidy?

Although changing the way monetary policy operates is a more elegant solution than a windfall tax on banks, political economy factors currently favour the latter. Here we have to disentangle the Bank of England from the rest of government. The government may feel that it is up to the Bank to suggest changing how it does monetary policy, because otherwise it would appear that the government is forcing the Bank’s hand just to save money. Unfortunately the Bank in turn may be too influenced by private banks to do this in a hurry. So changing how monetary policy operates is unlikely to happen soon.

Of course in the UK our current government is also unlikely to impose a windfall tax on banks. It was eventually forced to impose a windfall tax on energy producers, but that was because consumers were paying the higher prices that energy producers were benefiting from. If Labour wins the next election it should not feel so inhibited, and should be more interested in getting better public services than giving a subsidy to banks. This suggests a windfall tax on banks to recover recent interest paid on reserves should be an immediate priority for a new Labour government.

[1] That is not the only sense in which the QE programme may end up costing public money (or taxpayers money, as the media often likes to inaccurately call it). The bank reserves created as part of the QE programme were mainly used by the Bank of England to buy fixed interest government debt (gilts), during a period in which interest rates on gilts were very low, so the price of gilts was high. Now the Bank of England has begun selling those gilts, and because interest rates have risen the price of those gilts has fallen, leading to capital losses. (As the FT headline misleadingly put it, Treasury bails out Bank of England.) However it should never be forgotten that during the period when short term interest rates were low QE saved the government a lot of interest it would otherwise have paid on its debt.

[2] The phrase 'required reserves' is in itself confusing, as the banking sector as a whole gets no choice over the amount of reserves they hold.

A cynical view would be that politicians always act in their own interests. [1] I think that is unrealistic, in that many politicians go into politics because they want to make society better. Nevertheless it may be interesting to look at why purely self-interested politicians might nevertheless also act in society’s interest. The obvious mechanism that might achieve this is democracy. It is in a politician’s own interest to be re-elected, and to gain votes a politician needs to do things that make people’s lives better. An important qualification, of course, is that they only need to make a proportion of people’s lives better, and this could involve making a small minority of people much worse off.

The imperfections of this mechanism are obvious, but it is also clear it works. Most politicians in a democracy work hard to garner favourable public opinion. Although general elections in the UK need only happen every five years, if it looks like a Prime Minister is not going to win in two or more years time MPs may decide to replace them, as we saw happen twice last year. The major proviso is that, just as advertising can sell you things you do not need, politicians can also fool voters.

One obvious limitation of a normal democracy is that voters only get to choose between political parties rather than individual policies. Under FPTP they in reality only get to choose between just two parties, which means a ‘bad’ government may still get re-elected if the opposition appears even worse. A clear example where a politician that has not tried or failed to improve society may nevertheless get re-elected is if they can find some issue which gains support despite these failures: fighting a popular war, for example. Another reason a bad government may be re-elected is if voters are fed misinformation by a biased media.

If we drop the assumption of self-interest, it may also be useful to think about different ways in which a politician can imagine they can help improve society. They may just believe, in David Cameron’s words, that they would be “rather good at it”, which may be a belief about competence at management and decision taking, but could also be about charming or fooling people. Alternatively they may believe they have a set of ideas that will improve society. Those ideas may or may not be part of a commonly shared ideology.

At the end of last year I wrote a piece in which I tried to think about why the government that began in 2010 appeared to be particularly uninterested in making society better, at least compared to the governments that began in 1979 and 1997. The evidence that they made society worse in economic terms is almost irrefutable: the UK’s poor growth performance over the last 13 years may be partly bad luck, but it is almost surely also a consequence of 2010 austerity and Brexit. I also suggested that, in failing to resolve today’s strikes or the NHS crisis, or in demonising asylum seekers, or starting new coal mines, or in being willing to "let the bodies pile high" during the pandemic, this government seemed to be putting political self-interest above national interest.

I want to use the points above about motives and democratic constraints to explore in more depth why the government that began in 2010 stopped even trying to act in the national interest. In the earlier post I speculated that ideology played some role. All three governments (1979,1979,2010) signed up to a broadly similar neoliberal ideology, but the contexts were very different.

The government under Thatcher can be thought of as pioneering basic neoliberal ideas, initially within a society (and even party) where there was some strong resistance to those ideas. These new ideas were therefore being continually challenged and argued for, their strengths and weaknesses tested. The economic arguments for privatisation, reduced union power and reducing the top rate of tax were real and serious, even if you think there were stronger countervailing arguments. Whatever the merits of those ideas, by the end of Thatcher’s reign and during Major’s, the major opposition parties had largely accepted these key innovations.

The Blair/Brown government wanted among other things to introduce changes that would reduce poverty, like tax credits, the minimum wage, sure start and so on. Later on they were able to raise taxes to expand public services, and in particular the NHS, which had been steadily underfunded under the previous government. This has been called this neoliberalism with a human face, and it was broadly popular. In particular, even by 2020 only a small minority of people wanted to reduce public spending on health, education and welfare in return for higher taxes, and far more wanted the opposite.

Both governments, therefore, fought and won elections based on economic ideas that were not obviously nonsense, and which at least turned out to be popular among a majority or near-majority of voters. Labour under Gordon Brown lost power not because of incompetence at handling the economy, or the unpopularity of his economic views, but because the finance bubble - facilitated by both governments - finally broke in the United States as he became PM.

Although a larger state, and particularly a well funded NHS, were popular among voters, they were not accepted by the Conservative party at large (MPs, members, donors and the press). Before the Global Financial Crisis Osborne had been forced to promise to match Labour’s spending plans, but this was an example of voters forcing an opposition’s hands rather than an ideological conversion. The Global Financial Crisis allowed Osborne to return to the idea of a smaller state, by elevating deficit reduction as the major macroeconomic goal of the government.

If Osborne and Cameron believed this was a sensible policy, they were simply ignorant of basic macroeconomics, which suggests fiscal expansion not contraction in a recession where interest rates cannot fall further. Perhaps the idea was just too attractive for them to question. Once in government, however, and as Osborne cut taxes alongside spending, the policy surely became deceit if it hadn’t been to start with. The key motivation for focusing on the deficit was to reduce public spending.

Deficit deceit was required because of the popularity of ‘neoliberalism with a human face’, and in particular the level of spending and taxes we ended up with under the Labour government. The Conservative government was in the small minority that wanted a smaller public sector and lower taxes. As an opposition Cameron and Osborne had lost this battle of ideas, so they planned to get what they wanted by the back door, which was by manufacturing an urgent need to reduce the deficit and to achieve that goal largely by cutting public spending.

The 2010 government therefore started and continued until 2016 with its central economic policy being based on at best ignorance and more probably deceit, in pursuing an underlying goal they knew was unpopular. Whatever you might think of the Thatcher or Blair governments, that cannot be said of either. In most cases they were prepared to argue for the economic goals they wanted to achieve.

Brexit, like austerity, was based on at best ignorance (‘there will be no economic downsides’, more money for the NHS) and more probably simple lies. For many Conservative MPs, it too involved deceit, with the real aim to deregulate from EU labour and environmental laws.

In both cases (austerity and Brexit), we still see neoliberal ideas being pursued, but now they were pursued surreptitiously rather than argued for at the ballot box. It is not surprising, therefore, that after some time when the impact of either policy became clear they would also become unpopular with a majority of the public. Because the deceit involved doing things that economists knew would create economic harm, then economic growth suffered.

A basic idea of neoliberalism was that a smaller government and lower taxes, together with reduced regulation, would help the economy grow faster. But neither Cameron nor Johnson were unlucky that neither happened. By 2010 the evidence against the idea that only small states or deregulated states could grow strongly was overwhelming. The Global Financial Crisis (GFC) alone should have made politicians question the idea that less ‘red tape’ is always better. The strong and steady growth of many large and small European countries with higher levels of taxation than the UK or US, and indeed strong and steady growth under a Labour government before the GFC, should have led any politicians who respected evidence to question the social benefits of pursuing low taxes and deregulation, let alone trying to achieve those policies by the back door.

This is why in my earlier piece I called austerity and Brexit an intellectual failure. The failure is easy to understand, however. Low taxes and deregulation were still in the interests of a small but wealthy minority, who could fund political parties and think tanks, a few of whom also owned major newspapers. For most politicians on the right, there was little incentive to try and rethink neoliberal dogma after the success of the Labour years and the failure of a deregulated global financial system. Those that tried would not have been successful because their message was unpopular within the party. As I have argued elsewhere, the influence of money and media ownership can turn parties of the right away from their early conceptions of neoliberalism as an ideology designed in the interests of business generally, into neoliberal platitudes becoming a cover for government in the interests of a wealthy few. The election and subsequent demise of PM Truss exemplified this transformation of Thatcher’s neoliberalism into something more resembling a plutocracy.

There remains an important question to answer, however. If democracy was doing its job, the deceit behind austerity and Brexit should have been exposed, and the politicians pursuing the deceit should have failed at the ballot box. So why, after five years as Prime Minister and Chancellor, did Cameron and Osborne win a majority outright in 2015? Why were the lies of the Brexiters not clearly exposed when they were first proposed? To regular readers this is old ground so I’ll only give one sentence answers to both. By 2015 the mainstream media had almost completely adopted the ignorance that was prioritising the deficit, despite the weakest economic recovery on record and stagnant real wage growth. In 2016 the broadcast media, and especially the BBC, preferred providing balance to providing knowledge. In both cases, the democratic constraint on self-interested politicians failed.

Unfortunately there is a dynamic involved in these particular failures. If a party that wants to represent the interests of a wealthy few at the expense of society as a whole sees how the media can fail to hold it to account, it will naturally devote itself to trying to make this happen again. It encourages that political party to see itself as apart and above the rest of society, including society's own laws. That in turn can lead to widespread corruption, which is another feature of Conservative  led governments that began in 2010. 

[1] By own interests, I do not mean their own personal interests. A self-interested politician unconstrained by democratic pressure may still act in the interest of friends, donors or future employers.

An issue that is likely to preoccupy economists for some time, and which I have written the occasional post about, is whether 2010 austerity led to a permanent reduction in UK output. Permanent is probably too strong a word, but we can safely substitute ‘output today’ for ‘permanent’. Let’s start by redrawing a chart I have shown many times, which contrasts the path of UK GDP per capita with its pre-Global Financial Crisis (GFC) trend to show the extent of the sea-change that appeared to happen after the GFC. (Looking at GDP alone understates that sea-change, because GDP growth in the latter half of the period was supported by much higher immigration. GDP per capita is also more relevant for individual incomes.)

The GFC appeared to lead to an immediate and sustained loss of 10% in income per capita, and rather than that gap shrinking during a subsequent recovery (as it had after all previous recessions) the gap grew to be around 15% by 2019. Both figures are well above calculations done at the time of the GFC which suggested a permanent output loss of around 5% at most.

The first point to make is that there were signs that underlying growth was slowing before the GFC, particularly if you allow for the excessive growth in the banking sector before the GFC, so using a constant trend line exaggerates the amount of lost output, by a small amount in 2010 but by much more in 2019. But there is no doubt that a significant puzzle remains about why the 2008/9 recession led to such a large permanent loss in output.

Output growth is all about productivity growth, and the decline in the growth in output per head or output per hour since 2010 is well documented (the UK ‘productivity puzzle’). A key way that productivity growth occurs is through investment (‘embodied technical progress’), so if investment was substantially lower as a result of 2010 austerity then this might account for some (certainly not all) of the productivity shortfall.

Below is a chart of the share of business investment in GDP. I look at business investment so as to exclude investment in housing and the public sector.

Investment always falls by more than GDP in a recession, so its share also falls. A notable point we can make immediately is that the investment share did eventually recover to pre-GFC levels by 2016, but has subsequently fallen as a result of Brexit. Whether the share would have risen above the pre-GFC peak without Brexit, as it did following the 1980/1 and 1991 recessions, we will never know.

The chart below compares how the investment share evolved in three recessions and recoveries. (indexed to 100 at the start of each recession, and plotted from two years before that date.)

In the 1980/1 recession the business investment to GDP share fell least, by around 8%. In 1991 the business investment share fell more sharply (by over 15%, although with a bit of a delay), but it recovered rapidly. In 2008/9 we saw similar sharp falls in the investment share, but with a more protracted recovery.

How much potentially productivity improving investment was lost in each recession? Suppose we average the investment share in the three years before each recession, calculate how much the investment share was lower than this average during the recession, and then accumulate these losses in investment share up until it regained that pre-recession average. After the 1980/1 recession the investment share had recovered to its pre-recession average by 1985, with an accumulated loss of only 2%. After the 1991 recession the share had recovered by 1996, with an accumulated loss of 4%. Following the 2008/9 recession, it took two additional years for the investment share to regain its pre-recession average, with an accumulated loss of nearly 7%, which amounts to losing the best part of a whole year’s worth of business investment.

The following chart looks at the growth in productivity (output per hour) from the start of each recession.

Output per hour recovered more rapidly following the 80/81 recession than the 91 recession, perhaps reflecting the larger fall in investment in the latter. What stands out, of course, is that the recovery in productivity following the 2008/9 recession was almost non-existent by comparison. That suggests that lower business investment is associated with lower productivity growth, but it also points to other factors contributing to low growth after the GFC recession, as there was still plenty of business investment going on but productivity hardly improved.

If we accept that lower business investment can result in lower productivity growth, then it also follows that anything that delayed the recovery from the 2008/9 recession is likely to have led to more postponed or delayed investment projects, and therefore almost certainly to less productivity growth. Without austerity, the 2008/9 recession might have looked more like the 1991 recession, with a rapid recovery to a higher level of GDP by 2016.

I have made the point before that productivity improving investment often requires output growth to make it happen. Without output growth, a firm needs to trade off the cost of investment against the future reduction in costs the investment will generate. In contrast if demand is growing, the firm will probably want to invest to meet that demand anyway, and so the trade-off largely disappears. In other words how much firms initially invest in productivity improvements will depend on how much they expect output to expand after a recession.

As I have already noted, after the 2008/9 recession firms could reasonably expect a period of reasonably strong growth. Output had fallen by nearly 5% between 2007 and 2009, so there was still the potential for above trend growth. That appeared to be happening, with GDP rising by 2.4% in 2010. However these expectations were dashed over the next two years, with growth of only just over 1% in 2011 and just under 1.5% in 2012. At that point firms might have revised down their expectations about future demand, and delayed productivity enhancing investment projects.

The Chart below looks at the growth in output per hour during and after the 2008/9 recession

Productivity fell in the recession as it always does, as firms try to hang on to at least some of its workforce. But in 2010 productivity rebounded as the recovery started. The collapse in productivity happened subsequently, as this early promise of a quick rebound from the recession was dashed. Austerity, and in particular the large cuts in public investment in 2011 and 2012, played a key role in reducing output growth in 2011/12.

I therefore think there is evidence that austerity, in creating an unusually protracted recovery in aggregate demand from the GFC recession, did have a negative impact on productivity growth and therefore a persistent negative impact on output supply. What we cannot know is how long that negative impact on output supply would have lasted in the absence of Brexit. Without Brexit, perhaps business investment would have stayed at 10.5% of GDP, and the productivity enhancing investment projects that had been delayed after the weak recovery from the GFC would have finally been undertaken.

If an economy gets hit hard by a global economic shock, it seems reasonable to hope for an almost full recovery fairly quickly if policymakers do the right thing. Hit it hard again as that recovery starts, and any recovery is bound to be more delayed and may not be as complete as it might have otherwise been. If you hit it with a third big negative shock less than a decade after the first, then it is much more likely that the first two shocks will leave lasting scars.

John Burn-Murdoch’s articleentitled “Britain’s winter of discontent is the inevitable result of austerity” justifiably got considerable attention on social media, or at least as much as any article published just before Christmas can. It was noteworthy because it presented data on various measures of public spending and real wages compared to the same data for similar countries. In almost every case, spending and real wages in the UK started in 2010 near the average of similar countries, but since then has fallen to the bottom of that group.

The article closes with the following paragraph:

“Lives lost, earnings lost, years lost. Unlike Trussonomics, austerity is a slow and silent killer. For the best part of twelve years, the Conservatives sowed the seeds. This year they’re reaping the harvest.”

The terrible impact of austerity on public services, including the NHS and social care, cannot be denied. Of course, it is frequently denied. The favourite denial of the moment used by Conservative politicians is the pandemic, but here the article has the perfect response. If you run a public service like the NHS with barely the minimum resources required to produce a normal service (or ‘efficiently’, as the government might say), then there is no spare capacity to deal with emergencies like the pandemic. The pandemic is not an excuse for the current collapse in the NHS, but instead exposes for all to see the harm that was being done by underfunding over the previous decade.

Of course the signs that the NHS was being steadily deprived of funding was evident well before the pandemic hit, for those that bothered to look at NHS performance data. Waiting times for operations or emergency care were steadily rising. But unfortunately most of the time many prominent political journalists did not look at the data, but instead parroted the government line that the NHS was ‘protected’ from cuts.

In doing this these journalists played their part in being responsible for one of the most insidious deceits of the 2010s. I wrote about it back in 2015. The first deceit is in the definition of protected. A natural way of thinking about protection would be to keep NHS spending constant as a share of GDP, or at least constant in terms of spending per head. The way the government defined protection was constant in real terms, which with an expanding population meant less spending per head, and a shrinking share of GDP. The second deceit was to ignore the many reasons why this natural definition is not a good one. NHS spending has increased as a share of GDP since the 1950s, just as health spending in most countries has increased, because of an ageing population and many other good reasons. Health spending therefore needed to increase as a share of GDP just to maintain existing services at a reasonable standard. In most of the 2010s the government reduced rather than increased health spending as a share of GDP, so the service steadily deteriorated.

Were the many political correspondents who repeated the lie in the 2010s that NHS spending was being protected aware of these points? If not, then they were pretty bad at their job using any standard definition of journalism. The lie that NHS spending was being protected was repeated so often as fact that voters naturally wondered why their access to the health service seemed to be getting worse. If it wasn’t lack of money, some reasoned, it must be because of the ‘waves of immigration’ they kept reading about in newspapers. Government ministers said much the same: another lie that ignored the fact that the more people who work the greater the taxes available to fund additional spending. For this and more general reasons, it is not hard to understand why austerity was followed by the political populism of Brexit.

Public discussion of public spending cuts since 2010 is littered with lies and misdirection of the ‘protected’ kind. When I last took a comprehensive look at public spending data two years ago, Johnson was promoting the idea that austerity was at an end. What this meant in practice was some small increases in spending in a few areas. So Johnson brought the policy of constantly cutting all areas of public spending to an end, but if you talk about an end to austerity it sounds like you are completely reversing what had been done since 2010. It was a classic piece of misdirection, again repeated in much of the media. In reality the likely increase in health spending between 18/19 and 22/23 only matches the increases of the Thatcher/Major administrations, and remains below the 55-78 average.

Johnson encouraged this misapprehension with talk of 40 new hospitals - just one more lie. The reality of investment in the NHS since 2010 is clearly shown in one chart from the Burn-Murdoch article. The grey area includes all the data from comparator countries, and the dotted line is their average.

The FT article shows a similar pattern for UK real wages, in PPP terms, compared to comparator countries. Although it was less dramatic than in health spending, real wages slightly improved compared to similar countries under Labour, but since 2010 the UK has been heading towards the bottom of this league. This reflects general trends in economic performance since 2010, as I have often noted. Those trying to portray events since 2010 as just the latest chapter in an uninterrupted century of UK economic decline are also guilty ignoring the data, as Adam Tooze has recently emphasised.

Are the declines in UK health spending and real wages relative to other countriesconnected, as the closing paragraph quoted above of the Burn-Murdoch article suggests? To be fair the case is not made, and because austerity after 2020 happened in most similar countries to varying degrees the connection is not obvious. I think it is highly likely that UK real wages would be significantly higher today if Osborne had not cut public investment in the middle of a recession, but the same would be true in other countries that also undertook spending cuts after 2010.

However there is a similarity between developments in UK real wages and health spending which Burn-Murdoch does point out. The stagnation in real wages has been evident for a decade but it takes a cost of living crisis created by high food and energy prices to make that decline evident to those who don’t look at data, just as the pandemic has exposed the underlying fragility in the NHS. Once again the media has played a large part in hiding this reality until recently, with talk among Conservative politicians of a ‘strong economy’ going unchallenged for years when the opposite has been true.

In both the case of public spending and real wages, large parts of the media were complicit in hiding the truth from the public by repeating or not challenging the lies coming from the government. I think a large part of this stems from adopting the view, as much of the media did from 2009 onwards, that reducing the deficit was the primary and most urgent goal of macroeconomic policy. Once you accept that myth, which had little to do with macroeconomic reality, then it seems pointless reporting about the consequent declines in public services, and the economy must be strong because the deficit was coming down. It was why I had no hesitation in calling my book “The Lies We Were Told”. 

But I want to end on a more positive note. The best journalists have always made sure what they wrote or said was firmly based on facts, and I think we are now seeing more prominence being given to data-based journalism, exemplified in the work of John Burn-Murdoch at the FT and journalists like Ben Chu on Newsnight and Ed Conway on Sky.

For much political and economic discussion, being able to access and understand data is at least as important as the ability to write well. There is a phrase about damn lies and statistics, but the best way to call out misleading statistics is to just present the data. [1] Political journalists in particular need to write less about who is up and who is down, and instead to start filling their column inches with charts of data. If that had happened more often in the past, then it wouldn’t have required a pandemic or cost of living crisis to reveal to everyone what was happening to the health service and real wages.

[1] An anecdote does not prove anything, but I cannot resist this one as a footnote. During the flooding in late 2013, I wrote a few posts (e.g. here) on its links with austerity. At the time Cameron was claiming that spending on flood prevention had not been cut, and the media was doing its ‘he said, they said’ thing. My articles were based on official data that clearly showed spending on flood prevention had been sharply cut as part of austerity. Yet to my knowledge no one in the media showed that (publicly available) data. That is called hiding the truth.

As a result of these posts, two years later when further floods occurred Newsnight contacted me thinking I was an expert on flood prevention. I’m not, but I implored them to just show the data on which my articles had been based, which I knew would be more powerful than anything said in a talking heads discussion. They did, and this made impossible any attempt to deny spending on flood prevention had been cut under austerity.

The UK is currently suffering a level of strike action not seen for decades. There is a simple reason for most of that - it is government policy. Take the continuing strikes in the rail industry. According to the Financial Times two weeks ago: “Employers had planned to offer a 10 per cent pay rise over two years to the RMT union, but were blocked by the government, which controls the industry’s finances, according to three people familiar with the matter” by adding tough new conditions at the last minute.

Or take the unprecedented strike by many nurses. Nurses have seen a large cut in their pay relative to those in the private sector since 2010. The government’s current pay offer will see that continue. Quite simply, nurses are being forced to strike because the government insists on reducing their standard of living compared to private sector workers as well as making their working conditions more intolerable. Now if for every nursing vacancy there were hundreds of applications then you could make a case for lower pay, but the opposite is true, partly because many nurses are leaving the NHS. It is a similar picture across the public sector.

Of course the government tries to assert that none of this is true. Instead they like to pretend that they are on the side of poor suffering Joe Public, and also like to claim that somehow it is the Labour opposition’s fault that we are seeing all these strikes. Given the level of misinformation we have in this country many (although for nurses certainly not a majority) will believe them. The reality is that the government thinks these strikes will work to their political advantage in returning some core Conservative support they have lost in recent months. In other words, they are making these strikes happen, despite the inconvenience this will cause and the damage it will doto the country, because they believe it’s to their party's political advantage.

Governing in a way that harms the country but boosts your flagging popularity is a good measure of political and moral bankruptcy.

But strikes are not an isolated example in an otherwise sea of policies the government is enacting to benefit the country. Take one of the most pressing issues of the moment, which is the crisis in the NHS. UK citizens are dying who would otherwise have lived because ambulance waiting times have sky-rocketed, A&E departments are overloaded and delays for many basic operations are at record levels. A key reason for this is a lack of beds and infrastructure, made acute by the number of patients being treated in hospitals with Covid, together with an inability to pass on patients to social care

Neither is an excuse for the government to do nothing! On the contrary, dealing with both is what any government is there to do. But where is the government action to create more NHS beds, and the staff that goes with them, following the emergence of Covid? What are the government’s plans to deal with the crisis in social care? Once again, by refusing to pay NHS staff more, and failing to provide the resources to attract more people into social care, the government is actively making things worse.

The new Prime Minister made a big speech announcing a new policy last week. But it wasn’t about the NHS or social care, or the growing poverty caused by the cost of living crisis. Instead it was about people crossing the Channel in small boats, mostly to claim asylum in the UK. Shortly afterwards some died trying to make that crossing in icy waters. Yet, as Lewis Goodall points out in this excellent summary, Sunak’s speech did not contain the one policy that could solve the problem of small boat crossings at a stroke, which is for the government to provide a means for asylum seekers from wherever they come to claim asylum safely.

Once again, the problem of Channel crossings is a problem of the government’s own making. By failing to provide any safe route for asylum seekers from all but a few countries to claim asylum in the UK, they create the demand for small boat crossings and the smuggler gangs that facilitate this. Why don’t they want to provide a safe route for asylum seekers? Because they want less asylum seekers in the UK compared to most other comparable countries. While some countries that have the same goal erect high barbed wire fences on their borders, we have the English Channel.

Those in the Conservative party, if they were being honest, would say they were just doing what their supporters want. Those in the Labour party who do not point out the truth about Channel crossings would say the same about the voters they need to attract to win the next election. There is some logic for such claims, because the UK’s FPTP voting system and our right wing press bias policy towards the interests of those who just want less people claiming asylum in the UK. But if this is the politicians’ excuse, why lie about it, and call those making the Channel Crossing ‘illegal migrants’? It means politicians are going beyond what they need to do to represent these voters. They are not only helping to put people’s lives at risk just for party political gain, but they are distorting or concealing the truth from those they represent. [1]

Take the biggest crisis facing the world today, climate change. What does the current government do? Opens a new coal mine. A government that lets people die just to win votes, or puts the future of humanity at risk for a bit more money today, is a good indication of political and moral bankruptcy.

It seems the government has given up on the business of governing, and instead its actions are determined only by what gains their party a few more votes. You might be cynical and say it is ever thus, but I think this is wrong. Whatever you might have thought about her vision, Margaret Thatcher did have ideas about how to make the UK a better place. Some of that might have been destructive, like reducing union power, but it was also constructive, like helping to create the Single Market for EU trade. There were of course some policies designed just to win votes, like selling council houses for example, but there was also a clear set of new ideas about how to improve the economy and individual opportunity.

The same is true for the Labour government of 1997-2010. Gordon Brown could list the many ways it had made lives better through specific policies in a conference speech. It too had a vision. If we call the vision of Thatcher neoliberalism, we could call Labour’s vision neoliberalism with a human face. Yet it is hard to imagine Rishi Sunak giving a similar speech about the achievements of Conservative led government since 2010. Austerity left the UK permanently poorer, put UK public services in a dire state, and yet UK taxes are at a record high. Brexit has bought further economic misery but hasn’t brought any benefits worth listing in a conference speech, with even immigration at record highs.

To describe all three governments as embodying neoliberalism misses these key differences, and therefore misses the political and moral bankruptcy of the current government. Yes, it still spouts neoliberal platitudes, but they have increasingly become clichés designed not to try and make the country better off with more opportunities for its citizens, but instead used as a mask for funneling money to friends, donors or potential future employers. So the UK’s private water companies are protected at the expense of sewage in our rivers and on our beaches. Energy companies are allowed to keep their record profits if they invest in producing more climate warming oil. Private companies with the right political connections are paid over the odds with public money to provide unusable PPE, then paid with public money to store it and then other private companies are paid with public money to dispose of it. I have described all this as a transition from neoliberalism to a form of plutocracy elsewhere.

Once we see austerity as the huge mistake it undoubtedly was, we can see that the bankruptcy of the current government did not start after a referendum in 2016, but from its very start in 2010. Wanting less public services and taxes without changing what the public sector does turned out to be as foolish as it sounds. With this, and nonsense like Britannia Unchained, Conservative ministers took the platitudes of neoliberalism [2] and thought that together they made a coherent and realistic vision, yet they remain in denial that this pursuit has done nothing but harm to the UK economy.

All this represents an intellectual as well as a political and moral failure. A failure to see that growth under Labour before the financial crisis matched that under Thatcher, and also more than matched growth in other G7 countries, yet with better public services and without the advantages of growing North Sea Oil revenues. A failure to recognise that increasing taxes to bring NHS spending up to European levels was popular. A failure to learn from the fact that the Global Financial Crisis reflected a lack rather than an excess of government regulation. All these showed at the very least the limitations and dangers of unbridled neoliberalism, yet these lessons were ignored

This intellectual failure didn’t end once the Conservatives were in power. After unjustly blaming, with the invaluable help of their press, immigrants for many of society's problems in opposition, Cameron set up immigration targets he either couldn’t hit or wasn’t willing to hit, yet his party used immigrants as a scapegoat for the effects of austerity. This played into the hands of populist Brexiters, who only had to link immigration to free-movement to make their case. After Brexit it seemed that the exclusive motivation of Conservative MPs became power for power’s sake, exemplified by the election of Boris Johnson. His own moral bankruptcy does not need retelling, although it is worth noting that public money is still being used to defend his lies over Covid partying.

When a government refuses to use our money to pay nurses a decent wage or relieve severe rationing in the health service, but instead spends it on defending the obvious lies of a disgraced former party leader, that is a pretty clear sign of political and moral bankruptcy.

It is true that the Covid pandemic would severely test any government. But the current government, including the current Prime Minister, failed that test repeatedly. Long term planning for a pandemic in the form of stockpiles of equipment was allowed to become useless under austerity. Once the pandemic started, an initial hope that the pandemic could just be ignored led to little contingency planning, yet that hope was scuppered once data arrived. Over the summer of 2020 Sunak championed spending public money that helped create a second wave of infection, and pushed Johnson to listen to a tiny minority of experts who were against lockdowns. Johnson himself, under the influence of some newspaper owners, began to distrust the centuries old methods of dealing with pandemics, so scientific advice was frequently ignored and lockdowns delayed. Tens of thousands died unnecessarily as a result.

If there is one image that sums up the moral bankruptcy of the current Conservative party for me, it is the massed ranks of Conservative MPs in the summer of 2021 sitting on the crowded government benches with hardly a face mask to be seen, even though the government’s own advice at the time was to wear masks in crowded indoor places. It was just like partying in No.10, except it involved nearly all Conservative MPs in an unashamedly public way. Here were our elected representatives putting their own personal convenience, vanity or warped ideologyabove the interests of those around them, and by implication above the interests of those they represented. The Conservatives have been labelled the nasty party with much justification, but since 2010 they have become a party whose only aim seems to be to look after themselves.

[1] At the end of the day it’s a policy that makes a minority suffer, and a few die, so that some voters can feel happier. The primary responsibility for those policies lies with the politicians that enact them.

[2] For example 'government should get out of the way', reward the 'wealth creators', or 'regulations hold back business'.

Labour’s current policy on Brexit is designed to help them win power. There is nothing the government and their press would like more than to suggest Starmer intends to undo Brexit, and so the policy of “making [hard] Brexit work” is tailored to remove any credibility from such a claim. However the moment Labour wins power other considerations come into play.

In power Labour becomes responsible for the health of the economy, and Brexit has undoubtedly brought severe damage to the economy and average incomes. Starmer knows this, which is perhaps why he added “at this stage” when sayingjoining the Single Market would not help growth. In power he will not be able to avoid two clear truths. The first is that, Northern Ireland Protocol apart, the economic effects of being more cooperative with Europe within the context of Johnson’s hard Brexit are small. The second is that the gains from joining the EU’s customs union and, even more so, their single market are certainly not small, just as the costs of leaving both have not been small.

The dangers of alienating those voters who still identify with Brexit will remain, or more generally worrying those voters who fear that changing the Brexit deal in a fundamental way would paralyse the government just as the Brexit referendum did. However the size of the first group will diminish over time, in part becauseof simple demographics. The size of the second group will also diminish if Labour manages to handle negotiations with the EU over more minor matters with little fuss.

In addition, as Stephen Bush notes, “a Labour government would free up vast swaths of civic society and lobbying organisations, many of which think that Brexit is a disaster but feel they have to pussyfoot around the topic to remain on Downing Street’s Christmas card list”. I noted two weeks ago that we had passed a turning point, where the costs of Brexit had become so evident that the broadcast media felt compelled to start talking about them. With the focus on a Labour rather than Conservative government, there will be fewer voices defending Johnson’s Brexit deal and many more pointing out its problems.

Indeed, it seems likely that one of the last groups to change their mind on Brexit will be the Conservative party. This, combined with this trend in public opinion away from either believing in Brexit or fearing its modification, means that at some point support for Johnson’s Brexit deal (or something even harder) will become an electoral liability for the Conservatives. As it becomes clearer that Brexit has reduced living standards and held the economy back, an attachment to the policy will be associated with a party that wants to keep the country poorer.

There is therefore a tipping point in public opinion, when suggesting Johnson’s hard Brexit deal needs to be thrown in the dustbin of history no longer becomes a political liability but a political necessity for Labour. Some may think we have already reached that tipping point, but two key factors suggest otherwise. The first is that FPTP helps Brexit supporters, and works against those who want to change Brexit, because the latter are concentrated in cities. The second is that Brexit regret does not necessarily imply a wish to change Johnson’s Brexit deal, because the prospect of reopening the Brexit question reminds many of the three years after the referendum.

It may seem hard to imagine passing this tipping point, because before we get to that tipping point the opposite is true, hence Labour’s current commitment to making Brexit work. But the big Brexit divide cuts both ways, so that when enough voters see Brexit as a mistake that needs a fundamental correction it will become politically advantageous to argue for that correction, and a political liability to oppose this. Then the costs for the Conservatives of championing a policy mainly favoured by the elderly that incurs serious economic costs will finally come home to roost.

Labour are unlikely to reverse their current Brexit policy immediately on taking office. They should instead immediately start discussions with the EU about “making Brexit work”. It is important that such discussions start quietly and without diverting attention from more immediate concerns. It would for the same reason be an obvious political mistake to raise expectations about what such negotiations can achieve, because any economic gains that follow will be small. But the existence of a tipping point for public opinion on Brexit means not only that Labour need to be prepared to switch from making Brexit work to changing Brexit during their time in government, but also that it is in Labour’s interests to do anything it can to hasten the arrival of that tipping point.

The Conservatives ability to tag Miliband’s Labour party with economic incompetence was crucial in winning the 2015 election, and Johnson’s Brexit deal can do the same for a Labour party once it holds power. It is therefore in a Labour government’s interests, assuming we have one in 2025, to be as open and honest as possible about both the economic advantages of the alternative ways of softening a hard Brexit, and also about what is and is not possible in terms of any deals with the EU.

That raises the question as to when Labour should begin to suggest the possibility of going further, which in practice will almost certainly mean rejoining the EU’s customs union and/or single market? Should this happen during Labour’s first term, or its intended second term?

The point at which Labour changes from doing what it can with a hard Brexit to changing Brexit will depend on many things beside the tipping point in public opinion, such as the pressure from domestic events and willingness on the EU side of the table. Two other factors are worth noting here. The first is the likely lag between any agreement (which itself will take time) and the economic benefits that would follow. If one of key reasons for a Labour government to change Brexit would be to benefit the economy and therefore household incomes and public services, the sooner this happens the better.

This suggests moving as quickly as is feasible to join the EU’s customs union. While the economic benefits are probably less than being part of the single market, it would remove some of the paperwork that small businesses in particular find is a barrier to exporting to the EU. It would also provide a good excuse to revise or end the few genuinely new trade deals obtained by Liz Truss, which seem lopsided to the detriment of some UK sectors. There may also be some gains to be made through alignment of standards, cooperation in research etc.

In assessing the likelihood of the UK joining the single market we need to consider a second factor influencing timing, and that is the behaviour of the Conservative party in opposition. If the Labour government benefits from the economic recovery that follows from the current recession, then - as with the last Labour government - the Conservatives will have to focus on social rather than economic issues. Just as with the last Labour government, immigration is likely to be their most effective issue.

Attitudes to immigration have been changing over the last decade, but it remains the most potent social issue among potential Conservative voters. Furthermore, how important those voters feel that immigration is compared to other issues depends a great deal on how much coverage it is given in the Conservative press. That in turn will depend on whether the Conservatives are in power or not. [1] Newspaper stories about immigration or asylum seekers are therefore likely to begin to increase under a Labour government, and public concern will rise along with it.

It is therefore immigration, rather than attitudes to Brexit per se, that is likely to be the main barrier to Labour trying to negotiate membership of the Single Market, because of course that membership requires free movement of labour within that market. The best way Labour have to moderate this Conservative weapon is to move to some form of PR for general elections, for reasons noted above. There may be other means of making free movement politically acceptable, as Peter Kellner suggests here.

None of these arguments guarantees that Labour will or will not try to negotiate to join the Single Market, but they do suggest that negotiations to join the Single Market will be one of the last stages in the long road back from Brexit.

However this should not stop Labour being honest about the economic costs of leaving the EU’s single market, and therefore the benefits of joining. Chris Grey suggestsan interesting additional idea, which is that Labour suggests that it would be unwise (or the EU might be unwilling) to consider the UK being part of the Single Market until there is cross-party agreement that this should happen. This would have the political benefit, for Labour, of emphasising the economic costs of the Conservative’s continuing attachment to a hard Brexit.

To summarise, the existence and proximity of a tipping point on public opinion about Brexit means it is important for any Labour government from 2025 to be open and honest about Brexit’s economic costs and what can and cannot be achieved in negotiations. It also means that it is quite possible to see Labour moving beyond ‘making Brexit work’ once they have power, although rejoining the Single Market remains the most difficult move in political terms.

Once the tipping point is passed, believing in a hard Brexit will become a serious political disadvantage for the Conservatives. Yet what is difficult to imagine is how they will escape from what will become a serious drag on their popularity. Johnson and others have made Brexit part of the Conservative party’s DNA. The conditions that make me confident in saying that no Conservative government will change a hard Brexit for at least a decade also make it difficult imagining them renouncing the policy in opposition. Perhaps it will take many years in opposition for MPs, but also crucially party members and the owners of the right wing press, to realise what a liability Brexit support is for them.

[1] The exception was during the Cameron government, but I don’t think it would be overly cynical to say that this had a great deal to do with Brexit, which the press favoured and Cameron did not. The data supports this, with the number of articles mentioning immigration rising rapidly from 2013 until 2016.

Ever since I can remember, I have advocated tactical voting. This post tries to make that argument in the context of different motivations for voting. As this is not my area of expertise please let me know of anything I have missed.  

Why do people vote? Do we vote in an instrumental way to (help) achieve some outcome, or do we vote in an expressive way to say (often just to ourselves) something about our own views. From my own experience in talking to people, many do vote in an expressive way. Even where the effective choice in a First Past The Post (FPTP) seat is between just two parties (X and Y), and where the voter happily acknowledges that on all counts X is a better choice than Y on all issues they care about (X>Y), you will often hear people say that they still couldn’t vote for X because of their policy on one particular issue. It doesn’t seem to matter that Y has the same policy as X, they nevertheless choose either not to vote at all, or vote for another party that doesn’t have that particular policy, rather than vote for X, even though X>Y and only X or Y can win

This attitude makes little sense (but see below) if voting is instrumental, but does make sense if voting is expressive. There was an even more extreme case of this in the last UK General Election, where some people suggested to me that they couldn’t vote for Labour because Labour was not formally in favour of continuing EU membership, or they didn’t trust Corbyn on Brexit. They would vote LibDem or some other party instead, even if they were in a marginal Lab/Con constituency. It was more extreme because it was almost inevitable that Brexit would happen if Johnson won, while it was far from inevitable that it would happen if Johnson didn’t win, even if, as I suggested here, Labour got an overall majority. In this case people were voting in a way that, from an instrumental point of view, would make them worse off.

Expressive voting is one reason why it makes sense for the opposition parties under FPTP to not field candidates in seats they have no chance of winning in the next election. Even if the parties cooperate informally, there is nothing stopping expressive voters voting for the party closest to their own views even when that party has no chance of winning. I’ve seen it argued that such actions by political parties are bad because it ‘reduces voters choice’, but in reality it only reduces the choice of expressive voters. Unsurprisingly, as most party members are likely to be instrumental in their attitudes, most Labour members (e.g see this poll) would favour not putting up candidates in seats where doing so might split the anti-Tory vote. From an instrumental point of view, this majority is entirely correct.

Instrumental voting is very different from expressive voting. If voting is instrumental, it makes sense for your vote to have some purpose beyond self statement, which usually means voting for party X even if you don’t agree with everything X stands for, simply because the realistic choice is between X and Y and you prefer X to Y. In most cases (but see below) instrumental voters will vote tactically, because that is the most effective way of using their vote.

However instrumental voting is subject to a problem that is often called the ‘paradox of voting’. The problem is the chances that your vote influences the outcome are negligible. To use the language of economics which is quite descriptive, the voter is ‘small’ relative to the electorate in a constituency, so their own vote is hardly ever critical in deciding the result. The ‘paradox of voting’ could also be called the insignificance of the individual voter argument, where insignificance means very small indeed. Note that this paradox only applies to instrumental voting, and not expressive voting.

I remember one General Election trying to persuade someone to vote LibDem in a LibDem/Con marginal. They objected that it was a waste of their time because their vote would be insignificant, but they did it just to please me. The LibDem candidate ended up winning by 10 votes. I triumphantly said to the person I had persuaded to vote, look your vote did matter, to only be told that if they hadn’t voted the LibDem candidate would still have won by 9 votes, so it was they who had been proved right.

Instrumental voting can be rescued from this insignificance paradox by talking about the payoff from your side winning. If the benefit to you of the party you vote for winning is sufficiently large, this can offset in expected benefit terms the very low possibility of your vote being decisive. However that is not the route I want to go down. Instead I have a more fundamental problem with the paradox of voting.

The insignificance of the individual voter argument casts voting in individualistic, expected utility terms. I think that is the wrong way to look at it. Voting is instead a social activity. We can see that quite simply from the fact that large numbers of people do vote in an instrumental way, despite their individual insignificance, so either they are being irrational or there is something else going on. As economists like to think that most people are not irrational I think we can conclude that something else is going on.

You can see why there is a social norm that we should try and vote from imagining a contest between two parties, one of which had rational policies and the other had irrational policies. Rational people prefer the rational party and vice versa. As most people are rational, the rational party should win, but if all rational people decided it was irrational to vote because of the paradox of voting, the irrational party would win, and the rational people would be worse off. Whilst the insignificance of the individual voter argument works for the individual alone, it does not generalise to society. [1] It may not make sense voting as an individual, but as part of society (or as a member of a class) it certainly does. There is evidencethat most people do see it as a social duty to vote.

Seen in this light, as I think it should, expressive voting becomes a rather selfish act when voting is done secretly. You vote to make yourself feel better about yourself, rather than for the good of society as a whole. It also follows that we should vote for the party that would make society (or a group of that society like a class) as a whole better, rather than voting for the party that would make ourselves individually better off. This is because the latter is voting based on the outcome for one individual, where the paradox of voting still applies.

If we should vote instrumentally to make society (in our personal view) better, then it almost follows automatically that tactical voting under FPTP is the only sensible way to vote. By the same logic, you will often, under FPTP, end up voting for the lesser evil, because even if there is a party you could vote for that is better than the lesser evil, voting for it will be a wasted vote because that party cannot win. If you don’t like voting for the lesser evil that probably means either you prefer expressive voting or you don’t like FPTP systems..

Why do I say that it almost follows automatically? There are two common arguments against voting tactically, which in particular (and I would say pretty exceptional) circumstances are valid. The first arises from voting being a repeated activity (a repeated game). This brings in the possibility that voting one way today may influence our choice in the next election. Suppose X>Y, but X is still pretty awful, and if X lost this time it might be replaced by Z, where Z>X>Y and Z was a lot better than X. In those circumstances the best social choice might be to allow X to lose, because it would allow Z to emerge next time (see here).

This is a way you can try and rationalise why some of those on the right of the Labour party, for example, might have worked to enable Corbyn to lose in 2019, because they believed that would allow a much better Labour party to emerge from the ashes of his defeat that wouldn’t have emerged if Labour had won.

The problems with this argument come from both the many ifs involved and from the present sacrifice made (party Y gets to rule badly for 5 years). The many ifs include whether defeat for X does lead to Z, and whether Z would have happened even if X had won, and that Z will win against Y in 5 years time. (The problems are intensified if during that 5 years party Y changes the rules of the game to make a future victory for Z less likely.) The argument has some similarities to accelerationism, which argues that the best way to achieve a 'good society' in the future is to intensify rather than try to ameliorate the current bad features of society. In my view it’s an argument that is not always wrong, but most of the time it is. On the particular example of the Labour right and Corbyn, I think the cost of a hard Brexit should pretty well dominate any perceived advantages that the Labour right might have imagined getting their party back might involve.

A second argument against tactical voting goes like this. If voters make their vote for party X conditional on X adopting some policy, then voters have some power over policy. If instead they always vote for X, they have no power. However, for this power to have any credible influence on party X, individuals have to be prepared not to vote for X if X doesn’t adopt their policy. It then becomes an argument like the one above but related to individual policies rather than party leadership or complete parties. (Because people didn’t vote for X because of some policy, X does badly and is forced to adopt the policy in the next election.)

The main problem with this argument is credibility: on most issues most voters for X will not be prepared to carry out the threat of not voting for X if they don’t get their way. For that reason most of the time those that do make this threat will be ignored. Equally there are very few issues where enough people can make common cause to pose a sufficient threat to X. But just occasionally the argument might work if the issue is central enough, voters feel strongly enough and they have a means to demonstrate the threat. The run up to the 2019 election provides one possible example, where the policy was Labour’s position on a second referendum. Voters who would normally vote for Labour voted against them in local and EU elections, and threatened to not vote for them in general election polls, and this did change Labour’s policy on a second referendum, for better or worse.

Putting these two exceptions against tactical voting aside, I want to end by saying something about responsibility. If voting is a social norm or duty, then with that goes the idea of responsibility for outcomes. (I’m indebted to @spinninghugo for thinking about this, although he has no responsibility for my current views!) If we go back to my example of people who voted LibDem (say) in a Lab/Con marginal because they didn’t trust Corbyn on Brexit, in what sense if any are they responsible for what Johnson’s government subsequently did?

The first and obvious point is that they share that responsibility with everyone who didn’t vote tactically against the Conservatives in 2019, and those who voted for the Conservatives have a greater responsibility. However pointing this out does not avoid the issue of responsibility. To see why, imagine someone was murdered by 100 people, each of whom struck once with a dagger. You would certainly say that each of the 100 was responsible for the death of the victim, and the fact that ‘he would have died anyway even if I hadn’t been one of the 100’ doesn’t absolve anyone of their responsibility for the murder. Suppose you were not one of the 100, but had the opportunity of trying to prevent the murder, but had chosen not to. You too would have some responsibility for allowing the murder to happen. It remains the case that anyone who didn’t vote tactically against the Conservatives in 2019 remains in some small way partly responsible for things the Conservative government did that Labour would not have done.

In contrast, as tactical voting is the choice of the lesser evil, it is not the case that the voter is responsible (among millions) for everything the winning party does. Instead they are just responsible for what the winning party does differently from the only credible alternative party (X-Y in implemented policy space, if that helps).

What the only credible alternative party would have done is a counterfactual, so it allows people to try and avoid responsibility by making claims about that counterfactual. It is why, for example, those who supported the Conservatives in 2019 like to make the unlikely claim that a Corbyn led government would have been even worse than a Johnson et al government, because otherwise they would bear some responsibility for the mess we are currently in. The fact that people make such incredible claims shows that the idea that voting is a choice we should be responsible for has some force. 

[1] To drill down a little more, the paradox of voting assumes that your action of not voting is peculiar to you, and will not be followed by anyone else. If instead you assume that other people will make the same calculation as you do, then you would want to vote to avoid the irrational party always winning. More generally social norms that voting is part of being a good citizen can be seen as a social response to the paradox of voting.

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Introduction

Brexit is the main reason the SNP give for wanting another referendum so soon after the last. While an independent Scotland as part of the EU would enjoy a larger single market than it enjoys as part of the UK, leaving the UK’s single market would impose short term costs almost certainly greater than the costs of Brexit. The government that enacted Brexit refuses to allow another independence referendum. A future Labour government might be less inclined to deny the Scottish people any say on independence, but that government could also start a process that would undo much of the harm caused by Brexit.

With Conservatives in power independence involves short term pain and long term gain

I cannot comment on the legal reasoning that lay behind the Supreme Court ruling that a referendum on Scottish Independence would be illegal without the cooperation of the UK government. (On that, see Dave Allen Green here and here.) However I cannot defend the decision of the UK government to refuse a referendum, or any law that says this is sufficient to prevent a referendum on independence.

The UK government’s reason to refuse another referendum is that it is too soon after the last one. But the reason that the SNP give as justification for pushing for it is Brexit. In a very important sense they are right. Not only did Scotland not vote for Brexit, and the economic damage it is doing, but Brexit gives the SNP’s claim that the economic future will be brighter after independence something beyond mere wishful thinking. The EU Single Market is a lot bigger than the UK’s Single Market.

I wrote about this four years ago here. There is no doubt that in the short term Scottish Independence will be very costly for the people of Scotland. In 2014 the only real economic compensation on offer was that different governance after Independence would bring a fairer but poorer society. So the economic trade-off independence offered was clear and certain short term pain set against the hope of possible long term benefit. But if Scotland was part of the EU’s Single Market and Customs union, it could eventually avoid the long term pain that Brexit will bring the rest of Great Britain.

But there is a counterpoint to that, which is that when Scotland does join the Single Market and Customs Union, they will have the considerable short term pain of creating a border with their largest market: the rest of the UK (rUK). That is in addition to the cost that dominated the 2014 referendum, which was the loss of the fiscal transfer from the rUK to Scotland. Scotland might still be better off in the long run, as its exports reorientate from rUK to the larger EU market, but that takes decades to happen.

So in terms of the economics, what was in 2014 a trade-off between certain and pretty large costs in the short run versus the hopeful possibility of benefits in the longer term becomes much larger and still certain short term costs against more tangible long term [1] benefits of being part of the EU. Adopting the Euro also carries clear risks as long as the Eurozone’s fiscal rules remain a mess.

However the prospect of a Labour government changes that trade-off in a critical way. To see why, it is useful to first talk about inevitable Brexit stasis under the Conservatives.

Over the next decade at least, only one party can reduce the costs of Brexit

In the last few weeks there have been two changes that represent a turning point for Brexit. The first was the humiliation of Prime Minister Truss, coupled with her successor being chosen by MPs alone. Truss was the candidate of the Conservative party’s European Research Group (ERG), who have consistently pushed for the most extreme form of Brexit. The second is that we are finally seeing across the broadcast media discussion of the costs of Brexit. With the UK economy being alone among the G7 in failing to regain output levels seen before the pandemic, and about to go into recession, it just wasn’t possible to avoid the subject any longer.

But last week it also became clear (if it was ever doubted) that the Conservative government cannot change the Brexit deal that Johnson agreed in 2020, because it is hopelessly divided. The ERG may have lost their leader with the downfall of Truss, but they are still powerful enough to stop any attempt to change that deal. Leaks suggesting the government were looking for a Switzerland type deal have been met by a chorus of denials from ministers and Sunak himself. Given the party’s terrible position in the polls, and a general election not that far away, Sunak cannot afford to risk the internal division that any attempt to rewrite Johnson’s deal would cause. The best we can hope for is that he is able to come to an agreement with the EU on the Irish protocol.

Nor would anything change if he was able to win that General Election. Not only has he to pacify the ERG, both the right wing press and his party members remain solidly pro-Brexit. Even if that was not enough deterrent, there is the ever present threat of Farage or someone similar threatening to take Tory votes and even some Tory MPs. All this means that for the next decade at least, no progress in reversing the economic and political harm caused by Brexit can be made while the Conservative party is in power.

So just as a Conservative government will not allow another independence referendum, it will also do nothing to alter the heavy costs of Brexit that the UK is experiencing.

However we now have the strong prospect of a Labour government. In opposition Labour have been extremely cautious. The last thing they want to do is unite a divided Conservative party and revitalise the right wing press in labelling Starmer a rejoiner. With polls like this, it is far safer for him to talk about improving relations with the EU, without being specific about how that would be done. With the Conservatives offering nothing, while Labour offer hope, only Remain voters who have learnt nothing from 2019 would refuse to vote tactically against the Conservatives.

Once in government, however, the trade-offs for a Labour government will change. It will become clear that the economic gains from a closer relationship with the EU while still outside its customs union and single market are pretty small. Labour will become responsible for the health of the economy, and just as the costs of leaving the EU are now becoming clear, so will the economic benefits become clear of rejoining the EU’s Custom Union and particularly their Single Market. The political risk of doing either noted above will still be there, but they will diminish in size over time. For both reasons, becoming part of the EU’s single market will become more attractive over time, and the pressure on Labour to move in that direction will only grow.

Brexit has encouraged independence, but could also mean it fails

Brexit was missold to the UK. Almost everything the Leave campaign said was a lie. Saying there would be no economic costs and only benefits was a lie. Saying there would be more money for the NHS was a lie. Saying UK trade would flourish under ‘global Britain’ was a lie. Saying we could negotiate trade deals more advantageous to the UK was a lie. Saying prices would fall was a lie. Saying immigration would be lower was a lie. The list is endless. Whenever evidence that these were lies was put into the public domain during the referendum campaign Leavers had a simple response: they called it Project Fear. Project Fear became synonymous with don’t worry about the facts, just believe the lies.

But the term Project Fear did not originate with Brexit, but in the first Scottish Independence referendum. The short term fiscal costs of independence were large and undeniable, yet the Yes side, like Leavers, preferred to use denial and misdirection rather than acknowledge this fact. As with the Brexit referendum, they could get away with this because what was being proposed had not been done before. [2]

However the similarities between Brexit and an independent Scotland joining the EU are too great and too recent to dismiss as Project Fear. Leaving the EU’s Single Market has caused the UK significant economic loss, and there is every reason to expect that Scotland leaving the UK single market would cause even more in the short term. In the long term firms in an independent Scotland that was part of the EU would have a larger market, but it takes considerable time to reorientate firms from one market to another, including the time and costs involved in persuading that new market that you have something worth selling. That time period will at best involve Scottish firms producing less and employing less people, and at worst it means these firms might no longer exist.

It will be very hard for the proponents of Scottish Independence to on the one hand give Brexit as a key reason for wanting independence, and on the other hand to deny the costs of leaving a large single market on which Scotland is currently so dependent.

If the independence referendum had taken place under a Conservative led UK, then the UK government would have been in a bind, because it would not want to point to Brexit as evidence of the short term costs of leaving a single market. [3] But we now know that will not happen, because a Conservative government will not allow another independence referendum.

A Labour government would be less inhibited, but could still face difficulties if it was trying to pretend it could make a success of Brexit. As long as it stayed doing that for fear of opposition from Leavers, it would find it hard to fight an independence referendum and would therefore be disinclined to grant one. However the moment a Labour government became committed to seriously undoing parts of Brexit (by joining the EU’s single market, for example), the case for a second Scottish independence referendum becomes much weaker.

It would become weaker because Brexit could no longer be used as a justification for another referendum. But it also becomes weaker because the long term gains of an independent Scotland as part of the EU having a larger single market also disappear, because these gains could be had by staying in the UK. Finally, using Project Fear to discount the short term fiscal costs of independence becomes weaker because Brexit has discredited that form of defence.

Brexit has given Scotland a reason for having another referendum, and has also given some credibility to the long term economic future being brighter after independence. Unfortunately for those advocating independence, those arguments only work if Brexit in its current hard form is permanent. That would be the case for at least a decade if the UK is led by the Conservatives, but the Conservatives will not allow a referendum. The UK under Labour might, but it would only be wise to do so if that Labour government could admit that any hard Brexit is bound to bring large economic costs. A Labour government that was seeking to rejoin parts of the EU would severely undermine the case for another independence referendum. Thus Scottish independence and Brexit have become inextricably intertwined.

[1] Here long term means a few decades at least before there is any chance of the benefits of EU membership exceeding the costs.

[2] Some have suggested that the short term fiscal costs of independence could be overcome if an independent Scotland had its own currency. Then, it is claimed, having a large budget deficit would not be a problem , because all the new Scottish central bank needs to do is create the money equivalent to the previous transfer from the rUK. Because there would be no greater claim on Scottish resources, it is argued there would be no inflationary pressure.

This ignores the fact that an end to the rUK transfer doesn’t just create a budget deficit, it also creates a current account deficit. At present Scotland is consuming more goods and services than it produces because of the transfer. The rUK is financing both a Scottish current account deficit and a budget deficit. There is every reason to believe that this Scottish current account deficit is not sustainable (the private sector would not replace the rUK transfer by capital inflows), and so the Scottish real exchange rate would depreciate on independence.

That depreciation would help Scottish exports and diminish its imports such that the current account became sustainable. However a depreciation means a reduction in the purchasing power of Scottish consumers, making everyone in Scotland poorer. Higher exports and lower imports also means a larger demand on Scottish resources, creating inflationary pressure.  

[3] In many ways we may see a repeat of 2016, where Cameron having set immigration targets and having failed to meet them, left himself wide open to claims that immigration can only be controlled by ending free movement. The obvious retort that immigration was good for the economy was not open to him. The Brexiters, having created a customs border between Great Britain and the EU, will find it hard to wax lyrical about the harm an English/Scottish border will do.

This post is prompted by the discussion around the Autumn Statement, but also in particular a postby Ian Mulheirn. Here is the key diagram from his post.

I think the diagram is useful because it distinguishes three aspects of aggregate fiscal policy that can easily become confused. However it is worth talking a bit about its limitations lest the diagram itself adds to confusion.

Each of the three circles above represents a non-central point on a spectrum. Take the ‘support short term growth’ for example. At one extreme (near to my own position [1]) you can believe that in a recession, or before an expected recession, or during the recovery from a recession, the need to stimulate the economy should take absolute priority over all other objectives. The other extreme would be to ignore the macroeconomic situation entirely, which Osborne/Cameron in 2010. There are plenty of intermediate positions between those two extremes, like Balls/Miliband over the same period.

The same is true for public services. I would go further and make a conceptual distinction between what you might call the ‘scope of the state’ and ‘how well the existing state is funded’. These both have to be continuums. My own view on the latter is that we are currently not even at an extreme point, but one which is not tenable.

What does fiscally conservative mean? I think the label here is misleading, because fiscal conservatism could equally be the label for the other circles. In my view the issue here is about the expected path of public debt, or public sector net wealth, over the long run. One extreme on this would be that public debt doesn’t matter at all. The other might be that debt should be reduced rapidly, and there are plenty of intermediate positions between these two extremes. Any good medium term current deficit fiscal rule will have to make a choice about where on this continuum it wants to go.

I would not include under this heading debates about the form of fiscal rules. This debate is more technical in nature, and involves whether it is better to target the current deficit or the total deficit, or whether some particular change in the debt/GDP ratio is a good target, and so on. Discussion often confuses the form of a target with the value it is set at. For example, a target for the medium term current deficit is a good rule in my view, but there is still a debate about what level the target should be at, and that will depend on how quickly public debt should fall or rise in the long run.

Making these distinctions help us see historical events in a clearer light. 2010 austerity, for example, combined two of these circles: a large contraction of public services, and ignoring the need for fiscal stimulus in a recession. It is also interesting to note that the level of taxes is influenced by at least two of these aspects of fiscal policy: higher public spending implies higher taxes, as does (for given public spending) a more conservative debt policy.  

The correct way to locate past Chancellors in all three dimensions of fiscal policy would be a three dimensional chart, with the three axes being ‘how high is public spending’, ‘the priority given to the macroeconomy during economic downturns’, and ‘how quickly should debt rise or fall over the long run’. But three dimensional diagrams are not easy to look at, which is why I suspect Ian uses the simpler formulation above. But that also creates problems.

While I have no problem with the classification of Osborne/Cameron, you could question whether Balls/Miliband were suggesting higher public spending or just less cuts than Osborne. Equally by putting Johnson/Sunak in the higher public spending circle, it’s clear that Ian is taking a conservative definition of ‘higher’. With Hunt/Sunak a budget that back loaded spending cuts and immediate energy subsidies could be spun as worrying about the economy in the short run, but they are still putting up taxes in a recession. I suspect the real reason that spending cuts have been delayed is not the coming recession but just that spending cannot be cut further, and the real reason for energy subsidies is political.

I think it’s clearer if we try and use one straight line and a 2D chart

Osborne   Hunt      Sunak      (Darling)              Brown

_______________________________________________________ more G

The straight line just looks at the amount of government spending, and I’ve only included actual Chancellors, not PMs or shadows, and excluded Hammond and Javid for space. Brown is out in front for creating an NHS that worked, Sunak (under Johnson) increased spending as a share of GDP in a few public services but not others. Hunt gets to be to the right of Osborne mainly because his spending cuts have not happened yet. (I have put Darling in brackets because his period was dominated by the GFC.)

The second diagram plots the remaining two aspects of fiscal policy. Here I have only included four Chancellors, because Brown didn’t have a recession to deal with as Chancellor, and the GFC blew up his fiscal rules. Darling wins on stimulus in a recession because he did exactly that, while Sunak is next because of furlough. On debt reduction speed Osborne is clearly on top because of what he did once the deficit was brought down, and Darling is where he is because of plans he never got a chance to implement.

I think this is a more informative way to compare what Chancellors did, but it is a lot less pretty than Ian’s original.

I want to end by disagreeing with the main policy point that Ian makes, which is that Labour should aim for the intersection of his three circles. I have no problem with ‘higher government spending’ and ‘stimulus in recessions’. Indeed I think all good governments, from the starting point we are currently in, should increase public spending, and every government should follow basic macroeconomics. Where I differ is on a conservative policy towards public debt.

I understand that in opposition it may make political sense to match the government’s rolling target for falling debt to GDP. But I would hope, once in government, Labour would commission HMT (or the OBR) to do the kind of in depth analysis they did in 1998. This should show the drawbacks of that particular target that I outline here. The most pertinent from Labour’s point of view is that by focusing on debt rather than assets this target discourages the kind of Green investment that is a centrepiece of Labour’s economic policy offering. It is no good hoping these two things don’t conflict based on current forecasts, because at some point they almost certainly will.

Much more difficult is the judgement about the desirable path for net public sector wealth over the long run. Again a good analysis has to look at the costs of getting the judgement wrong. The costs of underfunding public services are today painfully clear. The cost of not reducing the current negative level of net public sector wealth is less clear, once you move beyond nonsense involving market pressure.

[1] I would not argue for immediate fiscal stimulus right now because it could be immediately offset by higher interest rates, but nor would I agree with tax increases. But I am probably at the extreme in believing fiscal stimulus should apply until the recovery from a recession is complete, which is why I think the Biden stimulus was a good idea.

This was not quite the Autumn Statement many people were expecting. Public spending on health and schools was increased a bit in the short term, welfare payments were indexed to inflation with some icing on top, and cuts to public spending were postponed to after the next election so may never happen. If we discount the latter, the fiscal tightening was all about raising taxes by not indexing allowances. By 2023/4, the ratio of taxes to GDP (national accounts definition) will be nearly 37'5%, compared to just over 33% in 2019/20.

Of course none of that means that most public services are not still in crisis, or that the government’s assumptions about public sector pay are any less painful (and strike creating), or that higher food and energy prices are not going to stretch many people’s budgets beyond their limits. The OBR’s forecast for falling average real disposable income last March was terrible (the worst since WWII), but their forecast yesterday (with less energy subsidy from the government) was a lot worse.

The coming recession

The OBR has predictably followed the Bank in forecasting a recession, which we have already started. What is most eye-catching about their short term forecast is what they expect to happen to inflation. The chart below looks complicated but focus on the black line, which is their forecast for inflation.

The OBR expects inflation is currently near its peak, but it will soon come crashing down. Indeed during 2024 it will fall to zero, and be negative during 2025/6, helped by modest falls in energy and food prices.

If you think that is implausible, here is the reason (bottom left quadrant).

The OBR are following their normal practice of taking their forecast of interest rates from market expectations. These expectations have Bank rate rising to 5% early next year, and then falling back to about 3.5% by 2028. There is no way this will happen if inflation follows the path the OBR are predicting. As the Bank themselves say they don’t believe these market expectations about what they will do, it is slightly surprising that the OBR have stayed with them. It makes the OBR’s forecast a bit weird, but I will try and rescue what I can in the comments below.

The OBR’s forecast for GDP is similar to the Bank’s latest forecast until about the middle of next year (their Chart 14), with both predicting falling GDP. Thereafter the OBR is much more optimistic, forecasting a recovery in output of 1.3% GDP growth in 2024 compared to a predicted further fall of 0.9% by the Bank. But the OBR are much more pessimistic about the path of GDP than they were in March (see Chart 1), which in the short term is because in March they were not forecasting a recession, and in the medium term because they now think energy prices will be permanently higher which will reduce potential GDP. This is one of the reasons for the need for fiscal consolidation in the Autumn Statement.

Another is higher debt interest payments caused by higher interest rates and higher debt. But here the implausibility of the path for short term rates assumed by the OBR matters. These rates will undoubtedly be lower, which will reduce borrowing costs particularly into the medium term. So some if not all of the cuts to government spending pencilled in for later years might not be necessary even if Sunak remains PM by then (see Table 3 and page 51).

Of course with cuts to personal income like those forecast, higher interest rates and rising taxes (excluding energy subsidies), the recession could easily be deeper than the OBR or Bank are forecasting. Is the OBR’s forecast for the recovery plausible? Well lower interest rates than they are assuming would help, but much depends on consumers. The OBR have the savings ratio falling to just under 5% next year and 2024, but then only recovering slightly to just over 5% thereafter. That is below the historic average, but may be reasonable given how much consumers saved during the pandemic.

The fiscal stance

The Chancellor has sensibly avoided calls from some of his MPs and others to cut spending in the short term, as such cuts would not have been credible. His income tax increases over the next few years will not help ease the coming recession and subsequent recovery, but their demand impact will be smaller than spending cuts, and they are probably necessary in the longer term. His failure to allow more for public sector pay will cause considerable disruption in the short term.

The government likes to say it is fiscally responsible. But one definition of fiscal responsibility is sticking to your own fiscal rules. It’s worth remembering that in 1998 Labour set out fiscal rules which guided policy for 10 years until the Global Financial Crisis. In contrast, since 2010 I have lost count of the number of times the government has broken and then changed its own fiscal rules, and today added to that count as we regress from a current deficit to a total deficit target so public investment could be cut a little (it falls from 2024 onwards).

So in the short term this Autumn Statement does very little to end the crisis in most public services, and we will have public sector strikes to look forward to. It also does nothing to moderate the forthcoming recession or help the subsequent recovery, although responsibility for the former has to be shared with the Bank. In the medium term, more sensible fiscal rules (see here) plus likely changes in the forecast will reduce or eliminate the need for public spending cuts after the election.

In political terms this Autumn Statement does nothing to enhance the Conservatives chances at the next election. Far from setting traps for Labour, promising spending cuts after the election is not a winning strategy when public services are already on their knees. If the OBR is right, and 2024 does bring a recovery in output along with falling inflation and interest rates, it gives the government something to talk about, but with real personal disposable income having fallen by 3% in each of the previous two years then voters’ memories will have to be very short to celebrate this.

Although the Autumn Statement has been postponed until this week, talk about black holes in the public finances continues unabated. I have always hated this term, which now seems almost de rigueur among economic and political journalists. A black hole in the public finances is just the amount by which the government is forecast to miss some fiscal rule. Connections between a real black hole and a black hole in the public finances is an empty set.

Why do journalists talk about mythical ‘black holes in the public finances’, rather than ‘forecasts of how much fiscal rules will be missed’? I suspect a headline involving the term ‘fiscal rule’ will turn many readers off, whereas everyone knows what a hole in a budget means, and calling it a black hole makes it sound serious enough to demand the reader’s attention. But this attempt to make the public finances sound like household finances is the essence of what I call mediamacro. [1] Unlike real budget holes, public sector black holes are only as good as the fiscal rules that give rise to them. [2] In the last week, thanks to groups like PEF and some good journalism, this fact has at last been given some media coverage.

While fiscal rules have advanced beyond the crude and harmful balanced budget at all times idea, there has been for at least a decade a serious disconnect between what politicians do and what sensible macroeconomics suggests. I wrote a short post about all this two and a half years ago, and will not repeat that here, but instead focus on the problems involved with two fiscal rules that may be the origin of black hole headline numbers: targets for the current deficit, and for a falling debt to GDP ratio. But before doing either, I need to discuss the overall macroeconomic situation. One of the reasons black hole language is an example of mediamacro is that it makes fiscal policy a matter of accounting, when it should always be about the health of the macroeconomy.

The macroeconomic situation

The big mistake Osborne made in 2010 was to try and achieve a deficit target while the economy was in a recession and interest rates were at their lower bound. In that situation deficit or debt targets should be thrown out of the window, and fiscal policy needs to take the place of interest rates in helping to achieve a strong recovery. Labour’s idea at that time, of trying to go less ‘far or fast’ with fiscal consolidation, would have been better than Osborne’s policy but still missed the key point. In a recession you need fiscal stimulus, and only when the recovery is complete do you start worrying about deficits. As generally in life, you do the important thing first, and the less important thing later.

The situation today is more complex than it was in 2010. We seem to be heading for a serious recession, but interest rates are well above their lower bound because the Bank of England thinks that is necessary to make the labour market less tight. That means that any immediate fiscal stimulus (that will impact demand next year, say) would be in danger of being counteracted by higher interest rates. Does that mean that some immediate fiscal consolidation, in the form of tax increases rather than spending cuts for reasons given here, to make a start on achieving a medium term target for the current deficit would be sensible as long as the Bank responds, as it should, by having lower interest rates?

This is where the complexity comes in. The Bank’s own forecasts suggest inflation will be going below target in 2025 or earlier, implying the Bank will be cutting rates in 2024 or earlier. Of course the OBR may come to a different view, but I doubt this as the reasons for a recession (higher interest rates today combined with a large income cut caused by higher energy and food prices) are pretty compelling. There has to be a clear danger that we may in a year or so’s time find interest rates heading towards their lower bound once again, and the economy will need fiscal stimulus rather than fiscal consolidation.

The Chancellor could do fiscal consolidation now, but then reverse this with fiscal stimulus when rates are at or near their lower bound. However such fiscal fine-tuning rarely works as intended. For example, we may experience a much deeper recession next year than the Bank is predicting, and that will only be intensified by any fiscal consolidation now. From a macroeconomic point of view the safer rule is not to tighten in a recession and to only raise taxes when the economy is healthy again.

An impending recession also creates difficulties for the OBR and any fiscal rules. A good fiscal rule aims to hit some target for the current deficit (see below) when the economy is at trend. Normally forecasts have the economy going to trend after five years, which is why policy should aim to achieve a target in five years time. Yet if the economy is still at the bottom of a recession in 2025, will the recovery really be complete by 2027? If the forecast suggests not, then trying to hit a 5 year target makes no sense. [3] It would be far better to extend the forecast by enough to ensure the economy is expected to be running at trend for a few years at the end of that forecast, and delay fiscal consolidation until those years.

The government will almost certainly ignore these macroeconomic fundamentals, as they have mostly done since 2010. Even then, it could square immediate tax increases with good macroeconomic policy in two ways. The first is to raise taxes where the immediate demand impact is negligible, such as taxes on companies (like those producing energy, obviously), on the rich or on wealth. The second is to combine tax increases with larger increases in public investment. If fiscal rules constrain worthwhile public investment then they are poor fiscal rules. [4] Higher public investment is an excellent way of stimulating the economy, and is also necessary to rapidly green the economy.

Current deficit targets

One of the things George Osborne (or more likely Rupert Harrison and the IFS) got right in 2010 was to have a fiscal rule that focused on the current deficit rather than the total deficit. The difference between the two is net public investment (the current deficit + net investment = the total deficit). The big danger with targets for the total deficit is that the easiest way to achieve them in political terms is to cut public investment, but that is an anti-growth measure and a classic case of increasing the burden on future generations.

Targets for the current deficit just one or two years out make no sense, and my own view is that the best target is to set policy so the forecast meets the target five years into the future, as long as there is little chance of a recession where interest rates hit their lower bound in the meantime (see above). But what should that target for the current deficit in five years time be?

In the past governments have suggested a target of zero for the current deficit. This has the superficial attraction that the government is only borrowing to invest. However economists talk about the need for the public finances to be sustainable in the medium to long run, by which they mean that the ratio of some stock like public debt (or public sector net worth - see below) to GDP should be constant. If the government only borrows to invest (a current deficit target of zero), then this ratio will tend to fall over time because of nominal GDP growth. The higher the value of public debt, the more rapidly the ratio will fall as nominal GDP grows.

This means that having a target for a zero current deficit is arbitrary. What the target should be is a matter of economic judgement. Critical to that judgement is the observation that negative shocks to the public finances, like the financial crisis and the pandemic, tend to be larger than positive shocks. That means it is not very prudent to aim for, say, a constant ratio of some stock to GDP ratio, because in practice that will mean the ratio gradually rises following unexpected shocks. On the other hand many have argued that the climate emergency is exactly the time when it makes sense to let government debt to GDP rise.

Whatever your view, there are sound theoretical reasons for not planning on changing the debt/GDP ratio (or similar) too rapidly. In the current context I think a current deficit target of 1-2% of GDP would still be fiscally prudent. Any ‘black hole’ calculation based on getting the current deficit to zero in five years time is therefore questionable, even if we ignore the macroeconomic outlook. If hitting that target becomes the basis for not increasing spending on public health, it means the Chancellor is prioritising fiscal prudence over saving lives and expanding the economy. Fiscal prudence is just much less important than either saving lives or expanding the economy.

Falling debt to GDP?

Of the fiscal rules we have seen over the last decade or so, targeting a falling level of debt to GDP is one of the worst. The first reason is that It refers to government liabilities but not its assets. If households had a fiscal rule that their debt should always be falling they would never take out a mortgage to buy a house. Equally it is absurd to stop a government investing in worthwhile public projects just because this pushes up its debt, and the lack of public investment in what was until recently an era of very low real interest rates is one more failure to lay at the door of this government.

As I have already noted above, this point is recognised when we talk about flows, which is why we have targets for the current deficit rather than the total deficit. But that logic should be applied to stocks as well as flows. Targeting government debt relative to GDP, or its change, is inconsistent with targeting the current deficit.

The stock measure that is essentially the counterpart to the government’s current deficit is not government debt but the public sector’s net worth, which is the difference between all government assets and liabilities. This is because net investment funded by borrowing adds equally to the government’s assets and liabilities. The OBR has a nice working paper about public sector net worth, and its figure 2.3 makes this correspondence clear.

In 2020 general government net worth was large and negative according to the ONS, because debt greatly exceeded assets. The OBR can forecast the future level of public sector net worth just as much as it can forecast future levels of public debt. So why is all the talk about government debt rather than government net worth? Not only does this make no economic sense [5], having targets for debt rather than net worth can constrain otherwise socially beneficial public investment.

Should we therefore have targets for both the government’s current balance as a share of GDP and a target for public net worth to GDP to be falling at some date? The answer is no, because the change in government net worth is the current balance! This is a second reason why having a target for falling net worth/GDP or debt/GDP makes no sense. At best we have two targets for the same thing, and at worst we have two contradictory targets. Why not just have a target for the current deficit, which can be informed by where we want public sector net worth to move to over the long run? In my own experience, governments that have multiple fiscal targets are governments that are trying to please lots of different people rather than thinking things through.

Any ‘black hole’ based on the need to have debt to GDP falling at some date is therefore not a good basis for government decisions on spending and taxes. [6]

What about the markets

One of the many unfortunate consequences of the Kwarteng ‘fiscal event’ and the market reaction to it is that journalists, commentators, and some politicians will once again suggest that we need to make bad fiscal policy because otherwise the markets will punish us. Comments of this kind fail to understand why the market reacted the way it did recently. Worse still, the Prime Minister and Chancellor are pretending that the markets will only stay calm if there are large public spending cuts. This repeat of one of the lies of 2010 onwards is the opposite of reality: the market reaction to Kwarteng's tax cuts was in part because cuts to public spending were not credible.

I set out in detail the reasons for the market reaction to unfunded tax cuts here. In short, announcing tax cuts without saying if and when they would be supported by spending cuts, together with the likelihood that announced spending cuts could not be delivered in practice, greatly increased the uncertainty surrounding the future path of UK interest rates, which made sterling assets less attractive to hold.

The lesson from this was not ‘don’t run deficits’! The UK government in 2009, while the economy was collapsing and the deficit was rising rapidly, engaged in a fiscal stimulus and we didn’t get the market reaction we saw after the Kwarteng tax cuts. As Ben Chu has pointed out, other major countries have larger deficits and debts than the UK. Indeed the Eurozone has suspended their fiscal rules, so why cannot the UK do the same? The lesson from Truss/Kwarteng is to have clear and credible plans for both taxes and spending, and announce both at the same time. If the markets know what all parts of fiscal policy are doing and those plans are credible, this reduces uncertainty about future UK interest rates and keeps UK assets attractive.

Summary

Headlines involving black holes in the public finances are misleading at best. The numbers involved are only as good as the fiscal rules used to generate them. A fiscal rule for the current deficit to be zero may be too restrictive, and a falling debt to GDP target has many serious problems and should be abolished.

However, fiscal rules of this kind should not be chased just before the economy is likely to experience a recession which could be severe [7]. Although interest rates are not at their lower bound right now, as we have seen in the past rates can fall rapidly. Attempts at fiscal fine tuning (fiscal consolidation now and stimulus when/if rates fall to zero) are unwise. Those that appeal to recent market turbulence to say we have to have fiscal consolidation now and spending cuts are at best misreading what caused that turbulence, or at worst making up stories to achieve political ends.

[1] While knowledge about fiscal rules is scarce, everyone knows that a black hole has to be filled with either spending cuts or tax increases. But those spending cuts or tax rises are only as sensible as the fiscal rules that motivate them, so if you want to say something intelligent about the consequences of black holes you should really have some view on how good the government’s fiscal rules are. In contrast the black hole terminology in effect tries to translate household accounting concepts to the public finances, plus some allusions to frightening solidity or mass. The black hole language is not a useful shorthand, but is instead misleading journalism.

[2] While some economists have made this point, they often add ‘and only as good as the forecasts used to produce them’. While technically true, I think this observation has less practical significance. The whole point of having an independent body to produce forecasts is that the government should accept them, unless they have a compelling forecasting reason not to. Ignoring the forecasts because they are very imprecise is just a recipe for deficit bias.

[3] One way to avoid that issue would be to target ‘cyclically adjusted’ deficits five years out, but cyclical adjustment has its own problems.

[4] Having an arbitrary target for public investment as a share of GDP, as this government has done, is particularly daft.

[5] One argument for focusing on government debt rather than net worth is that a government’s assets often do not produce a financial return to the government, while public debt has to be financed. While a government that borrows in its own currency cannot be forced to default, there might be some level of taxes where it chooses to do so, as the higher is debt interest the higher taxes have to be. However as UK levels of taxation are well below those of many other European countries, this argument hardly applies to the UK in the foreseeable future.

[6] These are not the only problems with falling debt to GDP targets. In the past such targets have failed because they have applied to a specific date, and are therefore very vulnerable to shocks hitting the economy on or just before that date. In addition, as Rob Calvert Jump and Jo Michell have shown, the target is very sensitive to whether debt held by the Bank of England is included.

[7] It is generally recognised that macroeconomic forecasts tend to miss recessions. The fact that one is being forecast now may well mean its severity is being underestimated. The combination of a large cut in personal incomes, higher interest rates, fiscal tightening and a possible recession in major Euro area countries is a powerful combination of deflationary forces.

The Monetary Policy Committee of the Bank of England (hereafter ‘the Bank’), by raising interest rates over the last six months, intends to play its part in creating a prolonged UK recession. This is not speculation but a statement of fact. The Bank’s latest forecast, similar to the one in August thatI highlighted in an earlier post, suggests negative growth in GDP in the third quarter of this year, forecasts a further fall in the fourth quarter, with further falls during the first half of next year.

Why does the Bank think it needs to help create a prolonged recession? It is not because energy and food prices are giving us around 10% inflation, because a UK recession will do almost nothing to bring energy and food prices down. Instead what has worried the Bank for some time is that the UK labour market appears pretty tight, with low unemployment and high vacancies, and that this tight labour market is leading to wage settlements that are inconsistent with the Bank’s inflation target. Here is the latest [1] earnings data by sector.

Earnings growth is around 7.5% in the wholesale, retail, hotels and restaurants sector, about around 6% in finance and business services and the private sector as a whole.

Of course these numbers still imply large falls in real wages for most. For many it seems odd to describe the UK labour market as overheated when real wages are falling. Perhaps the easiest way of thinking about it is to imagine what would happen if the labour market was slack rather than tight, and as a result firms had complete discretion over what wage increases it would pay. Domestic firms are under no obligation to compensate their employees for high energy and food prices, over which they have little control and which are not raising their profits. As a result, if firms were free to choose and there was abundant availability of labour, they would offer pay increases no higher than the increases we saw during 2019. The fact that in the real world firms feel they have to offer more is consistent with a tight labour market where many firms are finding it difficult filling vacancies.

Average private sector earnings running at around 6% are not a problem for the Bank because it is anti-labour, but because it believes wage growth at that level is inconsistent with its inflation target of 2%. It's not the kind of wage-price spiral we saw in the 1970s, but if earnings growth were to continue at 6% over the next few years then the Bank would almost certainly fail to meet its mandate. But earnings growth will slow as the UK recession bites. The big question for the Bank is whether they are overreacting to a tight labour market by creating a prolonged UK recession. Are they using a sledgehammer to crack a nut?

To try and answer this question, we can look at the Bank forecast based on no further increases in interest rates. The reason for looking at this forecast, rather than the ‘headline’ forecast based on market expectations of further rate increases, is that the Bank has been explicit in its scepticism about these market expectations. (Why the Bank cannot tell us how they expect rates to change in the future remains a mystery to many of us.)

The blue line is the Bank’s forecast for year on year consumer price inflation. It is expected to come back down rapidly, ending up close to target in mid 2024. The red line is GDP relative to the pre-Covid peak quarter in 2019. [3] It shows a recession hitting its bottom in around a year’s time, but then recovering at a snail’s pace subsequently, so that GDP by the end of 2025 is still below the 2019 peak! This prolonged recession implies steadily rising unemployment, increasing from current levels of about 3.5% to over 5% and rising by the end of 2025.

If we take this forecast seriously, and we presume the Bank does, then there is little need for rates to increase further than 3%, and we would expect the Bank to start cutting rates by 2024 at the latest. The reason to expect this is that inflation is undershooting its target by the end of 2025, suggesting unemployment of 5% is too high to achieve stable inflation. We will have gone from an overly tight labour market to one which is overly weak. Interest rates influence inflation with a significant lag, so to stop this undershooting and get a stronger recovery interest rates need to start falling by 2024 if not before.

This observation invites another. Rather than raising rates now, and creating a significant recession, only to have to cut them again after a year or two, wouldn’t it be more sensible to not to raise rates by so much right now? [2] That might mean inflation takes an additional year to go back to a target, but after a massive energy price shock that would be more than understandable. If the Bank thinks their remit requires them to get inflation down below 3% within two years, that remit looks far too ambitious after double digit inflation.

Is the Bank’s forecast of a recession an inevitable result of having 10% inflation today? The short answer is no. To repeat the point made at the start, the Bank cannot control energy and food prices which are the main cause of 10% inflation. The correct question is does a tight labour market now inevitably require a recession to correct it?

In the 60s and 70s macroeconomists used to think that an economic boom (in this case an over tight labour market) had to be followed by an economic downturn (or even recession), because that was the only way to get inflation back down. It was the logic behind the phrase ‘if it’s not hurting it isn’t working’. But nowadays macroeconomists believe it is possible to end a boom and bring inflation down without creating a downturn or recession, because once the boom is brought to an end a credible inflation target will ensure wage inflation and profit margins adapt to be consistent with that target.

The Bank might argue that this will only happen if interest rates are increased now, because otherwise the inflation target loses credibility. But as Olivier Blanchard observes here, the lags in the economic system mean a central bank should stop raising rates while inflation is still increasing. If a central bank believes it will lose credibility by doing this, and feels it has to continue raising rates until inflation starts falling, this will lead to substantial monetary policy overkill and an unnecessarily recession.

If that is why central banks in the UK and the Euro area keep raising interest rates as the economy enters a recession, then the truth is central banks are throwing away a key advantage of a credible inflation target. Credibility is not something you constantly have to affirm by being seen to do something, but something you can use to produce better outcomes. Furthermore central banks are more likely to lose rather than gain credibility by causing an unnecessary recession.

Of course raising interest rates to 3% is not enough on its own to cause a prolonged recession. Probably more important is the cut to real incomes generated by higher energy and food prices, which is enough on its own to generate a recession. On top of that we have a restrictive fiscal policy involving tax increases and failing public services (more on that next week). Both together should be more than enough to correct a tight labour market. To have higher interest rates adding to these already large deflationary pressures seems at best very risky, and at worst extremely foolish. The question we should be asking central banks is not why they are raising interest rates in response to higher inflation, but instead why they are going for inflation overkill by making an expected recession even worse.

[1] Data up until September should become available this week.

[2] A policy of raising rates when you can see a weak recovery and below target inflation in three years time, because you think you can deal with those problems later, is a good example of what macroeconomists call ‘fine tuning’. Fine tuning makes sense in a system where you have exact control and can forecast accurately, but makes much less sense for a macroeconomy where neither is true. The danger of trying to fine tune the macroeconomy is that errors in timing mean the economic cycle gets amplified.

[3] I chose this way to show GDP because it illustrates just how poor the economy has performed in recent years, reflecting a decline relative to most other G7 countries that began over a decade ago. 

Since Chancellor Hunt cancelled his predecessor’s cancelling of the rise in corporation tax and postponed indefinitely the cut in income taxes, but did not cancel the cancellation of the rise in national insurance contributions, there has been much talk of Austerity 2.0. I’m not sure I like the label Austerity 2.0 as a description of possible future public spending cuts. The label austerity for the cuts after 2010 made some sense to me because it was about cutting public spending at just the wrong time in the economic cycle. It ignored everything we learnt from The General Theory that is now embodied in state of the art macroeconomics. It didn’t just make users of public services worse off, but it made everyone worse off by reducing national income. Some of that income loss was probably permanent.

This will not be the case for any spending cuts announced in the Autumn Statement, because we are at a different point in the business cycle. It may not feel like an economic boom, but the Bank of England is raising interest rates because it thinks there is excess demand in the labour market. To a first approximation the more public spending is cut, the less the Bank needs to raise rates. So spending cuts need not reduce everyone’s income, as they did from 2010 onwards. In that sense it’s not austerity 2.0, but just cuts in public spending.

There is another crucial difference between any public spending cuts announced in the Autumn Statement and what happened after 2010, and that is the state of public services and the extent of poverty. Because of what happened from 2010 onwards, plus inflation squeezing recent budgets set in nominal terms, plus public pay rising a lot less than private pay, most public services are in a critical state right now. As I have said before, talk of further cuts is an abomination. We should instead be talking about spending increases.

Take the largest component of public services, health. The NHS and social care desperately need more money to reduce record waiting times for ambulances and routine operations, and that money has to include paying more to nurses, doctors and care workers to stop staff leaving. We also should allocate more money to start training the number of nurses and doctors we need. Making cuts to planned health spending is unthinkable for any government that cares about the welfare of its citizens. Talk of efficiency savings is just another way of making cuts.

But health is not unusual. Delays in the courts are at record levels, and the police are solving less crimes. Many/most schoolswill have to cut back on staff next year because they have had no money to pay higher energy bills. Cutting public investment and maintenance just creates problems for the future: the Institute for Government estimatesmaintenance backlogs for Schools, the NHS, courts and prisons stands at £23.7bn.Equally cutting welfare spending when real incomes are squeezed by high food and energy prices and real wages are falling is also unthinkable for any decent government.

It seems fashionable for many in the media to say that public spending cuts are inevitable. Not only do statements like this show how completely out of touch those making them are with what is happening to public services, but it is also a highly partisan proposition. But just as important, the idea that there is no alternative is just false. There is a clear alternative, which is to raise taxes.

We are so used in the party political arena to debates about more or less public spending that there is a danger of forgetting some basic economics. With goods produced by the private sector, we think it obvious and beneficial that the amount provided reflects the preferences of those buying. If I asked why a certain percentage of total consumption was on food and drink, while another percentage was for clothing, the obvious and correct answer is that those percentages reflect the average preferences of UK consumers.

However people also have preferences over how much health provision they want, and how much education or law and order. If the state is doing its job properly, it will allocate spending over the public services to reflect those preferences and needs, bearing in mind costs (paid for through taxes) and available resources. We may be sceptical that the political process is capable of doing that, but what evidence we have suggeststhat broadly it does. Take health for example. As people have become wealthier and are living longer, and as what medicine can do has improved, the amount spent on health has steadily increased in most OECD countries, even though the role of the state in health provision varies widely among those countries.

We can see this problem clearly when there exists both state and private provision of the same service. Here is the ratio of spending per pupil in 'public' schools compared to state schools since 2003: source IFS.

There is a perfectly legitimate argument about whether certain services should be provided by the state or the private sector. The debate over the size of the state should fundamentally be about what the state does. But once the decisions about who provides these services are made, then those services provided by the state should be at a level to reflect the preferences and needs of the state’s citizens. That implies clear limits to how much or little is spent on the services the public sector provides. If spending is below that lower limit, then the government is failing in its duty to provide the services it is required to provide.

With people dying in ambulances while queuing up at A&E, with victims of violent crimes waiting over a year before cases come to trial, with headteacherstalking of school children crying from hunger, it is clear we are well below acceptable levels of provision of what the state provides today. To the extent this is a political statement, it is about government failure rather than the size of the state. [1]

Like many of our current problems, this government failure stems from the Cameron/Osborne period. They remembered how Thatcher had reduced the role of the state, and wanted to do the same. But a lot of what Thatcher did to reduce the role of the state involved transferring tasks from the public to the private sector, like provision of energy and water. Cameron/Osborne did very little of this, but instead just reduced the amount of money available for existing state provision. It is as if Thatcher, rather than privatising the water industry, had just rationed how much water people are allowed to have each day.

The same point applies to those who say that the share of government spending (whether on public services or redistribution, including from young to old) or the share of taxes in GDP has to be less than some arbitrary number, or that a growing share is somehow indicative of excessive public spending. If we are talking about public services this is equivalent to saying that households should only be spending some arbitrary amount on eating out as a share of total income. The reality is that over time as incomes rise people want to spend a higher proportion of their income on eating out, and as incomes and life expectancy rises and medicine improves [2] they also want to spend more as a share of national income on their health. As health is provided by the state, the only way they can do that is through higher public spending funded by higher taxes.

A favourite phrase that journalists use is that UK voters want to pay American levels of tax but want European levels of public services. But this comparison makes no sense, because most health in the US is provided privately. The reality is that UK taxes are well below that of most European countries. The reason for this is that since 2010 Conservative governments have believed they can get away with providing either very poor or downright dangerous levels of public services because they are obsessed with low taxes. [3] Any sensible discussion around the Chancellor’s Autumn Statement, and future budgets, would be about what taxes should be raised to restore our public services to a reasonable level..

[1] If you think the state should pay but some services should be provided by the private sector, which seems close to the current government view, then you have to accept the quid pro quo that this option will be more expensive for the state, because private companies need to make a profit and this is not normally offset (if offset at all) by greater efficiency. Of course in health this privatisation of provision together with inadequate funding may be a prelude to moving to an insurance based system. To say such a strategy is dishonest is the least of its problems. Rather more serious is that it kills people.

[2] Unfortunately the pandemic means we may need to add ‘as new diseases emerge’ to that list. A point that is hardly ever made is that if Covid becomes endemic then we need a step up in the share of health spending to GDP, otherwise other health services are bound to deteriorate.

[3] Thatcher was able to reduce taxes in part by not investing North Sea Oil revenues and selling public assets.

Fed up with the Conservative Party’s current psychodrama? This could be a useful distraction.

Aeron Davis has a new book outthat is a 40 year history of the UK Treasury (HMT). As I found his previous book‘Elites at the End of the Establishment’ fascinating, and as I’m always interested in anything about the most powerful economic institution in the UK which also gave me my first job, I was looking forward to reading this. It does not disappoint.

Like that previous book it is based on lengthy interviews, in this case with the key political and civil service people at the top of the Treasury over this period. As a result, it is very far from a jargon filled analysis of the details of macroeconomic policy over 40 years. Its brush is much broader, covering many themes from the growing influence of finance (financialisation), neoliberal ideas, and an internationalist viewpoint, but also dealing with the big historical crises of the period. As the book also roughly covers the years I have been working as an economist, what follows is not so much a review as a selected mixture of my own thoughts and those of the author. I’ll do my best to distinguish between the two.

The book starts, appropriately, in 1976 after the IMF crisis. I’ve written about this before based on Richard Robert’s book, and I agree with Robert’s interpretation of that crisis as mainly about fear of devaluation rather than the government no longer being able to borrow. Aeron is right that HMT used the shock of that crisis to re-establish its control of government spending, much as it did later in 2010. However I think the 1970s is more significant because of three large intellectual failures within HMT.

The first, which I discuss in that earlier post, was the pervasive view in the Treasury that it could cheat the Phillips curve using various forms of prices and incomes policy. The second, again touched on in that earlier post, was a failure to adjust to a floating exchange rate regime. It was clear to me while I was working there that while many junior economists understood how floating rates worked, those at the most senior levels did not. Both failures were central to understanding 1976, but were largely corrected by the end of that decade. [1]

A third failure that was not corrected was how to deal with the bonanza of North Sea Oil. It is today standard in the macroeconomics of resource rich countries that any temporary gain due to the discovery of a finite resource should be largely invested. That macroeconomics was not as developed at the time, but the basic choice for the government of consumption (cutting taxes) or investment was discussed at reasonably senior levels while I was there. Norway made the right choice but the UK did not, although how much that was down to politicians at the time is difficult to tell.

As Davis points out, this failure wasn’t just about North Sea Oil revenues, but was repeated with privatisation and council house sales. During the Thatcher period selling off public capital was treated as just another form of revenue, which is nonsense because unlike taxes it is not permanent. Sometimes people question why the OBR does 50 year forecasts for government borrowing, an innovation that started under Gordon Brown, and the abuses of the Thatcher period are one obvious answer.

A recurrent problem here and throughout any discussion of HMT is to separate out the views of officials and the politicians they served. In my own rather limited and out of date experience, those working in HMT have very varied views, and in a way this is helpful when the government changes. The arguments against can quickly become the arguments for when the political tide turns. One of the strengths of this book and the many interviews on which it is based is to try and tease out what decisions were political and which were down to thinking within HMT.

A good example, which Davis is right to discuss at length, is the pervasive doctrine within HMT that national firm ownership didn’t matter. A quote from an interview with John Grieve sums up the issue:

“On ownership, right from the ’80s, from Big Bang onwards, and indeed before, there’s been a running worry in government and in commentary about are we wise to let foreigners buy everything? … but in fact, there’s been a longstanding policy, successive governments have decided not to do anything about it … And, you know, of course most other countries think this is mad, and that ownership does matter.”

Aeron correctly links this to internationalist, finance orientated and free markets attitudes within HMT, but I also suspect there is a hangover from the period before 1976, when poor UK management, leading to deteriorating export performance and productivity growth, was a constant concern.

One of the points often made about the people working in HMT is how clever they are. That of course does to necessarily translate into good policy. I can think of two examples that illustrate this point which are not covered at length by Aeron Davis: ERM entry in 1990 and Euro non-entry in 2003. In the first case the good work done outside HMT on an appropriate exchange rate for the pound was ignored, and the debacle of Black Wednesday was a direct result. In contrast the opposite happened in 2003, and the intellectual weightof HMT work helped Brown to convince Blair not to join the Euro.

The end of the book is dominated by three crises. The first is the Global Financial Crisis. Aeron effectively shows that no one wanted to hear warnings about the growing fragility of the UK banking sector, but my own personal view is that there was one person in particular who was best placed to react to these warnings, and that was Mervyn King. The book includes the following quote from an official.

“[King] managed to spin a narrative over the next few years that the Bank of England lacked the tools and powers to do anything about it … I call him the Keyser Soze of the financial crisis. The greatest trick he ever pulled was persuading everyone that his responsibility for the financial crisis didn’t exist … Mervyn, can you point to where you said that prior to the financial crisis? Why did you cut the financial stability stuff? You were obsessed with monetary policy, weren’t you?”

Aeron also deals with how the Labour government failed to hold an inquiry into how the crisis had been allowed to happen.

The second crisis is austerity. There are some lovely quotes here, illustrating that what Aeron Davis calls the ‘posh boys’ regarded economics as a political means to an end. Here is a quote from his text.

“Those who had been part of the New Labour regime, such as Ed Balls, Dan Corry or Gus O’Donnell, got rather excited when speaking about economics, even with a noneconomist academic. It was the same with Alan Budd, Terry Burns and Nigel Lawson when talking about the Thatcher years. But for those leading the Coalition, economics was just another consideration in the wider matrix of Westminster party strategizing and news media lobby management.”

What Osborne and Cameron were interested in was media management, and they were experts at it. Unfortunately the advice they were getting proved no corrective to their macroeconomic ignorance. Here is a quote from Aeron reflecting on his interview with Rupert Harrison, Osborne’s economics advisor and now advising Jeremy Hunt.

“When I asked him directly about the broader inspirations of his economic thinking, Harrison responded that he had no interest in macroeconomic thought. His policy views were ‘shaped by more general reading’ and by being ‘a centre-right leaning person’.”

I’m afraid this was painfully obviousfrom Osborne’s speeches at the time. [2] The origin of the last twelve years of economic decline can be found in politicians who put party political interest above the health of the economy.

Unfortunately that gap in knowledge and concern was not filled by HMT. Senior HMT officials at the time were more than happy to go along with fiscal consolidation at the low point of a recession. In this sense austerity was also another massive intellectual failure for HMT. However I also think it reflects a key power dynamic within the department, a battle between those trying to control government spending and those managing the economy. This tension has been there since the advent of Keynesian economics, and is the basis for repeated calls for the two roles to be split into separate departments.

I have set out my own views on this, as part of the Kerslake review, in a post here. As Aeron Davis notes, one of the unintended consequences of first Bank of England independence, and then the creation of the OBR, was to diminish the weight of macroeconomists within HMT. Nevertheless, all those running HMT should have had a good understanding of Keynesian economics. I accept that they could do little to change the overall policy of Osborne/Cameron, but the cuts in public investment in 2011 and 2012 that did so much damage to the recovery were not a core part of that policy, and I think the HMT could at least have tried to prevent them.

The third crisis was the Brexit vote in 2016. Aeron Davis argues that the Leave vote was not only devastating to most Treasury officials (many were economists, after all) but also that it reflected past failures in Treasury management. To quote

“For one, I hold the Treasury (and successive governments) responsible for ushering in an economy that was so unbalanced and unequal. Years of trickle-down economics, and years of favouring finance over manufacturing, large foreign multinationals over home-grown companies, large asset-holders and rentiers over others, London over the regions, monetary rather than fiscal activism had had a cumulative impact. Austerity economics only exacerbated such trends, with several commentators linking that to the vote outcome.”

Of course any vote that close can have many things that help tip the balance. To the extent he is right, the Brexit vote represents a fitting ending for the book, as it represents many of the themes the author examines coming home to roost. In fact it is not the end, as there is a postscript entitled ‘reckless opportunists gain control’, which covers Johnson and partygate but not Truss’s ill-fated reign.

It should be clear from this short review that this book is not just an interesting overview of the Treasury over the last 40+ years. It is also an invaluable record of what some of the key political and official actors involved in UK economic policy thought they were doing at the time and how they view that in retrospect. I thoroughly recommend reading it to anyone interested in the recent economic history of the UK.

[1] I say largely because the new Conservative government’s advisors did not foresee that money supply targets would lead to a large appreciation in sterling a la Dornbusch, which decimated UK manufacturing.

[2] Austerity, by which I mean embarking on spending cuts in a liquidity trap recession, represented ignorance of everything Keynes talked about in the General Theory, as well as state of the art macroeconomics. On the positive side a form of fiscal council (the OBR), something that I had argued strongly for, was created after being rejected by Gordon Brown. On the whole it seems easier for new rather than existing governments to introduce reforms that take away discretion from politicians.

Introduction

The media sometimes uses a financial crisis in much the same way as religious leaders might have once used natural disasters. Because market moves are the result of the actions of large numbers of traders, who have heterogeneous views and are mainly interested in predicting each other, this allows commentators to say almost whatever they like about the causes of these moves without much fear of being quickly proved wrong. Mysterious or vague language is used, like ‘credibility’. In addition and for the same reason it encourages hysterical pronouncements like ‘there is no floor to sterling’ or ‘no ceiling for interest rates’. In short, financial markets are sometimes treated as a vengeful god, with no shortage of priests around to tell us why it is displeased.

As the commentators the media generally uses to interpret market movements are City economists, this leads to a rightwing bias in such commentary. (It is just a bias: there are of course some very good City economists who are not right wing.) We saw the worst side of this in the UK in 2009 and 2010, when too many City commentators said the markets ‘were looking for austerity’ and without it various disastrous things would happen. As I noted here, half the City economists surveyed by the Financial Times agreed with the nonsensical statement that the 2013 UK economic recovery proved austerity was vindicated.

The market reaction to the Truss/Kwarteng fiscal event was different from this for two reasons. First, because large market moves happened just before and after what was in effect a budget, it was less easy to make up nonsense stories, and in addition many of the economic correspondents commenting on the budget nowadays are rather more grounded than the City economists who thought austerity was a great idea. Second, we have good reasons for thinking that the immediate interpretation of what was happening in the markets as a result of September's ‘fiscal event’ was correct.

September’s market reaction

As there is still some confusion about why the budget led to these market moves, in the appendix I go through the reasons for thinking that the fiscal event substantially increased the uncertainty involved in predicting UK short term interest rates, and therefore in holding sterling assets more generally, using as simple language as I can. However the fiscal event did not increase the chances of the UK government defaulting on its debt, or increase the chances of ‘fiscal dominance’, and nor was it just about the expectation of higher interest rates.

Instead the increase in uncertainty caused by September’s tax cuts was fundamentally about announcing tax cuts without making clear whether or how this would be matched by spending cuts. But it goes further than that. Whatever spending cuts might have been announced, cuts to spending right now are far from credible. A government may promise spending cuts, but with levels of public spending already so low following 2010 austerity, and further squeezed by recent inflation, these cuts may not actually happen. Equally they may be offset by the government being forced to give in to public sector workers whose real pay has steadily fallen in recent years compared to the private sector.

The net result is that tax cuts have produced great uncertainty about the size and economic impact of the spending side of fiscal policy, which translates into uncertainty about the future path of short term UK interest rates, which in turn influences the future return on UK government debt (gilts) and the exchange rate itself. When the future price of a currency’s assets suddenly becomes more uncertain, because most people in the market are risk averse, they want to reduce their exposure to those assets or demand a higher return. Anyone selling those assets, like pension funds, suddenly finds a reluctance to buy.

You can certainly raise a question about whether pension funds should have exposed themselves to this kind of risk, but the risk arose because of the tax cuts in September. However the fact that the Bank of England had to step in as ‘market maker of last resort’ raises uncertainty again, because of what is sometimes called ‘financial dominance’. This is the idea that future Bank monetary policy actions will be compromised because it might lead particular UK financial institutions to get into difficulties. It is an additional level of uncertainty for UK assets above and beyond uncertainty over spending cuts.

Unfortunately I think there is a third and final level of enhanced uncertainty created by September’s tax cuts which goes deeper than those described above. When a group of politicians commit one important act of self-harm, Brexit, you can tell yourself it’s a one off and otherwise the government remains competent. When they do it again, September’s tax cuts, you begin to worry there may be yet more along the line. That is not because the markets are interested in economic competence per se, but because it too could have an impact on the future path of the interest rate the Bank of England sets, and so that also increases the uncertainty involved in holding sterling assets.

The “power of the markets”

When I talked about the market reaction to September’s fiscal event in earlier posts, I received some criticism that I was using a right wing narrative. This was just nonsense: the market reaction happened, and a theme of this post is that it is important to understand why it happened rather than leave that field open to others with an axe to grind. The idea that talking about unsustainable deficits is pandering to an austerity narrative is also nonsense: I have always made it clear that my passionate opposition to austerity does not imply deficits never matter. However there is an ever present worry on the left about the power markets seem to have to occasionally dictate and perhaps even reverse government policy, because it stands in opposition to power won democratically?

I remember being invited to speak at a Labour conference fringe meeting after we had been forced out of the Exchange Rate Mechanism in 1992. That was another occasion where markets struck a fatal blow to the Conservative Party’s economic reputation, yet when I pointed out that currency speculators had done the UK economy a huge favour, there were howls of disapproval from the audience. What I said was true, but to point out that currency speculators had forced sterling to where it ought to be was not popular among that audience.

But that episode and the current one show clearly that the idea that financial markets impose right wing policies on left wing leaders in advanced countries is inaccurate. What financial markets mainly do is try to anticipate future events, and so they can expose the implications of, or ambiguity with, macro policy before either becomes clear to others. The problem, as we have just seen, is invariably with the government’s policy and not the markets. No one would say that firms have illegitimate economic power when they fail to invest because of uncertainty, so why does it make sense to make this statement about financial markets? [1]

What is a problem is treating the markets like a vengeful god, rather than just one part of a macroeconomic system with understandable behaviour. Doing so allows commentators to constantly invoke imagined market reaction as a way of judging policy. In the last week we have seen plenty of this, from those absurdly claiming that September’s market reaction justified austerity [2], to those suggesting the markets are demanding spending cuts. No sensible economist would ever recommend doing what Kwarteng did in his September event, and all the markets did was confirm this fact. It is obvious, therefore, that the best way of restoring market confidence is to reverse all the permanent tax cuts announced in September. It is therefore not surprising that this is what the new Chancellor partially did on Monday.

Does September’s market reaction have lessons for a Labour government after the next general election? In short, no. Nothing in the market reaction to unfunded tax cuts says you cannot borrow to invest in greening the economy. Nothing in the market reaction to unfunded tax cuts says you cannot spend more on public services as long as you raise taxes to do so. What the market reaction to unfunded tax cuts does tell us is that your macroeconomic policy should be transparent, credible and sustainable, and that is something that Labour Chancellors and shadow Chancellors normally understand.

If I had to pinpoint one weakness in a future Labour government’s macro framework, it is maintaining a goal for falling public debt to GDP in the medium term. Nothing in the market reaction to unfunded tax cuts says you need this particular target: Kwarteng said he was going to achieve it in his fiscal event and it made no difference. Such a target potentially conflicts with large scale public investment, and that conflict itself increases uncertainty. Setting targets for medium term current deficits that are sustainable, and implementing tax and credible spending decisions consistent with that, is all fiscal policy needs to maintain market confidence.

To summarise, just as people should have been pleased that the markets forced the government to abandon a ruinous exchange rate peg in 1992, we should also be pleased that the markets have inflicted pain on a government that thought unfunded tax cuts made sense when public services are in dire trouble. The entire Conservative party’s obsession with tax cuts, in an environment where many factors mean the demand for health services will rise as a share of GDP over time, has been and always will be damaging to the UK economy. Brexit, and ‘living with Covid’, have just made that harm more acute. Unfortunately it will require much more than recent events for the Conservative party to understand their error.

[1] There is an entirely separate question about how much an economy should want to expose itself to financial market uncertainty, particularly when that uncertainty might have little to do with your own economy.

[2] To suggest that the only alternative to 2010 austerity were unsustainable deficits is just silly. Good macroeconomic policy is about doing the right thing at the right time. In 2010 the priority was a strong recovery from the deepest recession since WWII, not balancing the books. If,once a strong recovery was complete, deficits were unsustainable then raise taxes or cut spending. By getting the timing horribly wrong, 2010 austerity killed the recovery and we are probably all poorer as a result.

Appendix: why September’s budget influenced the markets

While only the most biased commentators in the media have tried to suggest that the market moves immediately before and after September’s budget had nothing to do with that budget, there remains some disagreement still about the reason why the budget had such a marked effect. At one extreme we have Larry Summers saying“I cannot remember a G10 country with so much debt sustainability risk in its own currency.” At the other we have some saying the reaction was just about anticipation of higher interest rates. While it is impossible to know for sure who is right, I think it is important to be clear what explanations are reasonable and what are not.

There are two ways a government that sells debt in its own currency (called ‘gilts’ in the UK) can default. The first (legal default) is that the government chooses to no longer pay the interest on its debt (or even repay the debt) that it has previously contracted to pay. The second (economic default) is that it inflates away the value of the part of its debt that is fixed in nominal terms. There is no chance that the UK government will legally default, and there is equally no chance that the government will stop the Bank of England using interest rates to try and control inflation. Therefore we can be reasonably sure that the rise in gilt yields just before and after the fiscal event does not reflect changes in expectations about default.

What about the alternative explanation, which is that the market was just anticipating higher short term interest rates. To be clear, the logic is as follows. The ‘fiscal event’ cut taxes. (It also subsidised energy bills, but that had been leaked well before the budget so it cannot explain what happened just before or after the budget. Markets respond only to news.) Lower taxes, if they are not saved, will lead to higher consumption or (with corporation taxes) perhaps investment, which increases aggregate demand. But higher aggregate demand will tend to raise inflation, and the Bank of England is currently raising rates to bring inflation down. So anything that increases aggregate demand will mean the Bank has to raise interest rates further.

We know this is part of the story of what happened, because expectations about short term interest rates did increase. But we also know it is not the full story because of what happened to sterling. If it had been the full story, then expectations of higher short term interest rates would have led to an immediate appreciation in sterling. In fact the opposite happened. Sterling depreciated against the Euro as well as the Dollar. So something else was also going on.

Various people have described the combination of exchange rate depreciation and higher interest rates on UK government debt as reflecting a higher risk premium on UK assets: Krugman (following @darioperkins) called it a ‘moron risk premium’. But what risks are we talking about here, if it isn’t legal default risk or inflation risk? I think it all goes back to the unique feature (at least for the UK over the last few decades) of the ‘fiscal event’, which is that the announced tax cuts were completely unfunded, by which we mean that we had no idea whether they would be paid for by cutting spending or permanently higher borrowing.

That last sentence is a little unfair on the Chancellor. He did say that he remained committed to seeing the government debt to GDP ratio falling in the medium term. If we are being generous in thinking that the Chancellor would not be so foolish to believe that tax cuts paid for themselves, then his statement does imply spending cuts at some time. But that leaves markets with a lot of guesswork to do. We could think about two extreme possibilities.

The first is that the spending cuts would all be pencilled in to occur after the election, with no spending cuts this year or next. The second is that the tax cuts are entirely matched, £ for £, with spending cuts that will take place in each and every year before the election. It is this second possibility which causes the problems, because tax cuts matched by equal spending cuts could reduce aggregate demand, and therefore lead to lower short term interest rates.

The reason goes back to the point that tax cuts can be saved as well as spent. Now if you think a tax cut is permanent, you are inclined to spend all of it, because your post-tax income will be permanently higher. On the other hand if you think a tax cut is temporary, perhaps because the government that made it will lose the next election and the party that wins the election might raise taxes, you will be inclined to save most of the tax cut, unless your income is so low that you need to spend all the money. With the tax cuts in the fiscal event this latter possibility must be quite high, so a lot of the tax cut will be saved.

In contrast, spending cuts tend to feed straight through into aggregate demand. (This includes cuts to welfare payments, because they mainly go to poorer people who have little in savings and so will reduce spending by something close to the amount of the welfare cut.) So tax cuts matched by equal spending cuts will almost certainly reduce aggregate demand, which reduces inflationary pressure and should lead the Bank of England to reduce interest rates.

So we have two possible extremes, and the possibility of some mixture of the two happening. We know that on average markets expected the net effect of the fiscal event and any subsequent budget to be inflationary, but the possibility that after the budget interest rates might be lower cannot be ruled out. What the fiscal event did, therefore, was to increase the uncertainty around future short term interest rates. While the market expected short term interest rates to rise as a result of the fiscal event, there was also the possibility that they might fall because of the subsequent budget.

That uncertainty about what would happen to short term interest rates made sterling assets more risky. If sterling assets become riskier, then we get a depreciation in sterling. Furthermore, unless gilts are held to maturity, their future price becomes more uncertain (because the price of gilts depends on expected future short term interest rates), so you would want a higher return to holding them.

To summarise, because the fiscal event was one sided (unfunded), it increased the uncertainty involved in holding sterling assets, which would lead to a depreciation in sterling and higher returns on UK government debt. This is why calling this effect a moron risk premium is justified, because normally UK governments are not so stupid as to announce tax cuts without saying how they will be paid for.

Forecasting which political party will win the next election three or more years out, much like economic forecasts of what growth or inflation will be in two years’ time, is setting yourself up to fail [1]. But learning from errors can still be useful. Only a year and a half ago, I wrote a long postentitled “As things stand, the chances of defeating Johnson at the next election are minuscule”. It was full of analysis about why Johnson had won in 2019, about how Labour would have to appeal to social conservatives to win and how difficult that would be without, at least, some form of progressive alliance.

I stand by that analysis, and indeed by being friendlier to the Liberal Democrats and social conservatives Labour have gone down the route I suggested they needed to do (given a FPTP electoral system). [2] However the title of that post now looks embarrassing, with Johnson forced out and the polls suggesting an overall majority for Labour if an election was held today.

I made two big mistakes in that post. The first was not anticipating a global cost of living crisis. I did expect the V shaped recovery we got. What I didn’t foresee (along with pretty well everyone else) was the extent of commodity price increases that this global recovery would bring, now exacerbated by Putin’s war against Ukraine. It was clear from the analysis in that article that a Labour opposition would do better fighting on economic rather than social terrain when economic events were not being helpful to the government.

The second mistake is what I want to focus on in this post. What I missed was the ability of a plutocratic populist right of the Johnson/Trump ilk to self-destruct through overconfidence. In mitigation I began to suspect my mistake just three months later, when I wrote a post entitled “Will the Trump/Johnson base lead to its destruction?”.

In the US Trump and large parts of the Republican party, by pandering to their base through denying the severity of the attack on Congress and elsewhere, were alienating everyone else. In the UK the political right’s obsession with wokeness was winning them few votes. But I made a mistake in that second post too. What I got wrong was that the growing distance between Johnson (and Conservatives generally) and expert opinion on the pandemic would also be an own goal. It was in medical terms, but politically I underestimated how much most people wanted to believe the pandemic was over.

However it was another part of Johnson’s attitude towards the pandemic that would confirm the idea of the plutocratic right’s ability to self-destruct. What still seems extraordinary about No.10 breaking their own rules by holding parties is that they thought they could get away with it. People tend to focus on Johnson’s own belief that he was above the rules, but more surprising was that the very people giving political advice to Johnson were taking actions that would not only lead to his growing unpopularity, but ultimately would cost him his job. I suspect that can only come from overconfidence, encouraged by a large majority and a largely biased or tame media.

Since then other developments on both sides of the Atlantic have confirmed the ‘self-harm through overconfidence’ idea. In the US we had the Supreme Court overturningRoe vs Wade. Of course the SCOTUS is not supposed to be political, but the Republican majority on it certainly are. As I speculatedat the time, doing this before Republicans had taken back either Congress or the Presidency risked bringing out the Democrat vote, and the polls so far suggest that might happen.

In the UK we have the more recent events of Truss winning the leadership and her Chancellor’s ill-fated budget. As I noted here, as has Chris Grey at greater length, it was the most right wing, pro-Brexit MPs that got Truss onto the party members ballot for leader. Letting party members choose the party leader will not inevitably lead to the selection of a politician who is far better at pleasing party members than the wider electorate, but it does seem that is more likely to happen the more recently that party has been in power. That Truss and Kwarteng thought they could get away with an unfunded budget that cut taxes for the better off when most people are finding it harder to make ends meet suggests self-destructive overconfidence.

In an Annex to that original post, I included a diagram from the Financial Times of where the majority of voters from different parties were clustered in the space of their economic and social views. It was designed to show how the Conservatives had been so successful in 2019 by attracting the votes of many left wing social conservatives through the means of ‘getting Brexit done’. Thankfully John Burn-Murdoch has recently updated the diagram, shifting the economic axes to allow for the election of Truss.

Conservative MPs may be attracted to the idea of lower taxes and public spending, but as I noted herethis puts them to the right of not only most voters, but also Conservative voters and even party members. This is the main reason why both Conservatives and Republicans prefer to fight elections on ‘culture war’ issues. Johnson understood that, which is why he was prepared to raise taxes and some areas of public spending. [3] [4]

Truss and Kwarteng with their budget not only made this gulf between Conservative MPs and voters explicit, but it was probably to the right of where most Conservative MPs dared to go. This is the core analysis behind why Truss and the Conservatives are now so unpopular.[5] And if you are going to advertise your small state, help the rich ambitions, the time not to do it is when everyone is being hit by higher energy and food prices after a decade of stagnation.

However, with over two years to go before an election, there is time for the Conservatives to claw back some support. The likelihood is that 2024 will see much lower inflation and interest rates. In addition, it’s possible we may see lower energy prices and a recovery in the economy. But the economy had been reasonably healthy for some years before 1997, and the Conservatives still lost. [6] The big worry for the Conservatives must be that Truss and those around her seem intent on doing many of the stupid things she promised party members in the summer, and yet more things that are just politically dumb. Yet their biggest fear must be that she seems unwilling or unable to bend her policies and those of her cabinet of like-minded loyalists to the very different views of the vast majority of voters.

[1] As ever, we have to distinguish this unconditional forecasting from conditional forecasting. Conditional forecasting is where you say how an event will change things, like ‘this budget will reduce the Prime Minister’s popularity’. Conditional forecasting is easier, and as Brexit and austerity showed with economics, has a much better track record.

[2] Social liberal voters are concentrated in big cities, and their vote is divided among three UK based parties, so an election fought between social liberals and social conservatives would almost certainly lead to a Tory majority. As Brexit was supported overwhelmingly by social conservatives, that is what happened in 2019.

[3] Osborne got away with austerity because he reframed it after the Global Financial Crisis as an issue of responsible budgeting rather than the desire for a smaller state.

[4] If it hadn’t been for the pandemic, this strategy might have worked for Johnson. Unfortunately, even without the parties, Johnson’s wish to ‘live with Covid’ (in practice doing almost nothing to prevent infection once the country was vaccinated) meant there was a step up in the demand for NHS services to treat those with Covid, with no corresponding step-up in resources to do so. Thus a large increase in NHS spending, paid for by higher national insurance contributions, turned out to be completely inadequate, leading to ever growing waiting lists for treatment.

[5] Unfortunately for Truss there is more besides. The market reaction to the budget shattered what remained of the Conservatives erroneous reputation for economic competence, much as Black Wednesday had done before.

[6] In contrast, growth (in wages as well as the economy) did help Cameron to victory in 2015. However, it is easy to think of many reasons why the Major loss is a better analogy than Cameron’s victory.

Did the dreadful budget of 24th September create a crisis? It all depends on how you define a crisis, of course, but some of the commentary which focused on sterling was looking in the wrong place. It was interesting that sterling depreciated, but it only looked like a crisis if you mixed up dollar strength with that depreciation. Here is what happened to the Sterling Euro rate.

There was a significant depreciation around the budget, for sure, but of a similar magnitude to what happened at the end of August or the beginning of May.

What was far more dramatic was the rise in yields on UK government debt. On the 22nd of September, the day before the ‘fiscal event’ was announced, the interest rate on 5 year government bonds was 3.4%. By the 28th it had risen to 4.7%, at which point the Bank of England stepped in to buy government debt because the market was ‘disorderly’, which in this case meant some pension funds were getting into serious difficulties. [1] That is a dramatic move, and would come under most people’s definition of a small crisis.

The combination of falls in sterling and higher interest rates on government debt tells us that the UK government’s budget seriously damaged the government’s credibility. A fiscal stimulus would normally imply higher short term interest rates when the central bank is trying to control inflation, which would in turn imply higher interest rates on government debt but also an appreciation in sterling (anticipating the central bank setting higher rates). The fact that sterling depreciated tells us that the biggest impact of the budget was to increase the risk premium associated with this UK government, or “doomsday cult” as one City economist called it.

The ‘starve the beast’ strategy is to cut taxes today, and then wait for the deficit to increase. A year or two later that strategy involves saying we have to do something about the deficit, so let’s cut government spending. For the strategy to work in political terms (in the UK at least) you need that gap between cutting taxes and cutting spending so that the media and voters do not link the two actions. (In the UK, cutting taxes to cut spending is pretty unpopular, but to cut spending to cut taxes on the rich is very unpopular, which is why the idea of cutting the top rate of income tax has been abandoned.)

If the government’s strategy was to ‘starve the beast’, or (incredibly) wait until rapid growth generated by tax cuts made spending cuts unnecessary, the market reaction to the tax cutting part has blown that out of the water. The government will now have to be explicit about ‘where the money is coming from’ in November, when the OBR will publish. (Abandoning cuts to the top rate of tax has little impact on the size of the overall package of lower taxes.) The problem the government has is that the negative market reaction was not just about the unfunded part of tax cuts (and not wanting the OBR to quantify the medium term funding gap), but also any guess the markets made about paying for the tax cuts looked very damaging for the economy. Looking at all the problems facing the UK economy, how much public services have been cut since 2010 and noting that inflation itself is producing a squeeze anyway, I wrote herethat “tax cuts are an abomination”, and it looks like markets agreed.

This market reaction has made the government’s predicament [2], and more importantly that of the UK economy, worse for a number of reasons. First, the OBR forecast will now have to integrate higher borrowing costs into its forecasts, creating a bigger medium term gap for the government to fill. Second, using November to just pencil in large spending cuts starting after the election (replicating in economic if not political terms the starve the beast strategy) is a can kicking exercise that rather reinforces the market view that the smaller state policy is currently toxic.

Third, any hopes that the government might be open to compromise when it comes to public sector pay now look remote, and so the government will be trying to impose much larger real wage cuts on the public sector than are happening in the private sector. (Nurses will no doubt respond to government claims that any strike is irresponsible by asking why they think tax breaks for the well off are more important than paying them a living wage.) Big wage cuts will in itself reduce demand, but it will also lead to strikes across the public sector which will also be damaging. If we get another Covid wave this autumn/winter, the government will not provide the resources required to stop waiting times increasing still further, which among other things will reduce growth.

Fourth, the Bank of England will feel pressure to raise rates by more than they might otherwise have done to show that their gilt buying after Friday’s budget was not the monetary financing of tax cuts. The Bank was always going to try and neutralise any short run fiscal stimulus in the budget (although arguablythey had already anticipated some energy support), but the fear now must be that they go further than that.

For all these reasons and more [3], a short term economic outlook for the UK that already looked grim just got significantly worse. At the best of times spending cuts matched by tax cuts are likely to reduce demand and output, because some of the tax cuts will be saved. However when the tax cuts benefit the better off, and may be reversed after a general election, the negative effect on the economy will be that much bigger because more of the tax cuts will be saved. This remains true if a large part of any spending cuts involvereduced welfare payments. The net result will no longer be a tug of war between fiscal and monetary policy, but instead both will be pulling the economy down. [4]

As I have pointed out many times, macro forecasting is a mugs game: the world is so unpredictable that unconditionalforecasts are only ever right through luck. However what we can say is that the chances of a UK recession, which were already quite high, just got significantly higher, and the chances of a deep recession also increased. This is for an economy that is the only one of the G7 not to have regained pre-pandemic output levels. This will be the third time in the last twelve years that the UK government has made a recession much more painful than it needed to be, with austerity and failing to lockdown quickly during the pandemic being the other two.

How can a government keep doing so much damage? The answer for the recent budget is not difficult to find, but it all ultimately comes back to Brexit. First, as I have often stressed, Brexit was an excellent sorting device. Those politicians who followed the evidence lost out, and those that ignored evidence got into power. (As the pandemic showed, if you ignore the evidence on what determines international trade you are also likely to ignore evidence on how to best deal with a new virus.) The evidencethat tax cuts for the well off certainly don’t increase growth, and might well reduce it, was never going to matter much to this government run by Brexiters.

Policy made by Brexiters was therefore always going to be fantasy-based policy. This is how to understand the government’s attack on ‘economic orthodoxy’. The orthodoxy they attacked with Brexit were two very robust empirical relationships: international trade’s gravity equation that says you trade most with your nearest neighbours, and additional bureaucracy in trading adds to costs and so inhibits trade. Equally the idea that cutting taxes on the rich reduces growth is not based on some arcane economic theory but instead comes from the data. For ‘orthodoxy’ read ‘evidence’. In addition the idea that since 2010 governments have been putting up taxes on the wealthy and on firms will come as news to George Osborne who did the opposite, and the UK’s economic decline started with or just before Chancellor Osborne.

But what determines the fantasy they push? What helped get us Brexit and what has had a major influence on policy ever since has been very rich party donors or newspapersowned by the very rich. The Mail cried “At last. A True Tory Budget” as the markets gave their emphatic thumbs down. What rich donors want from their political party are lucrative contracts (see the pandemic again) and tax cuts. The one major policy that Trump and a Republican Congress got done was tax cuts focused on the rich, and so it is hardly a surprise that a UK plutocracy would do the same. Truss/Kwarteng may well actually believe that cutting taxes for the rich is the key to unlocking growth, but they are where they are because they believe it.

Which brings us to the second reason why Brexit is the ultimate cause of the current debacle, which is that the ERG section of Tory MPs got Truss into the leadership run-off because she seemed closest to being a Brexit fanatic. (Converts often are the most devout.) She won that run-off because she said warnings from Sunak about the dangers of cutting taxes immediately were project fear, and that’s what the well off Brexit supporting Conservative party members wanted to hear.

But Johnson too was a convert to Brexit, so why is Truss so much worse. The warning signs should have been clear when Truss said she didn’t mind being unpopular if she was doing (in her mind) the right thing. Truss’s combination of right wing economics and socially liberal (libertarian) beliefs are shared by only a small section of the population, and previous Conservative leaders including Johnson understood that. Whatever their personal views they had to act as social conservatives and not make right wing economics their main story. Indeed Johnson started by saying austerity was over and increased some areas of public spending. In short, whatever their own views, previous Conservative leaders knew that they had to compromise to win elections.

In contrast Truss failed to adjust from trying to please one electorate (Conservative party members) to trying to please the wider electorate. [5] That was something Johnson could do easily because his only strong opinion was his own self-worth. In contrast Truss seems not only to believe the nonsense she is fed by right wing think tanks, but seems willing to pursue these very unpopular ideas in the belief that she will be vindicated in the long run. The market reaction to her Chancellor’s budget told her she will not be vindicated, and what the polls are reminding her is that she doesn’t have a long run. Unfortunately the UK economy will also pay the price of her mistake.

[1] The Bank was not buying government debt to ease monetary policy, but buying government debt the pension funds needed to sell. It was a classic ‘lender of last resort’ action, providing liquidity to otherwise solvent institutions. Ironically higher interest rates on government debt make pension funds more solvent rather than less in the long term, but their financial engineeringproved dangerously unrobust to large market moves. Frances Coppola argues herethat the Bank’s real concern was not pension funds but banks. On how pensions funds evolved over the last thirty years see here.

[2] The political problems for the government are obvious and have been discussed at length elsewhere. Cutting spending and taxes together is very unpopularoutside parts of the commentariat, but cutting services that are already on their knees to fund tax cuts for the very rich is a political disaster. Higher interest rates, leading to lower house prices, are also a vote loser.

[3] The sterling depreciation increases import prices and inflation, adding to interest rate pressure. Normally that might be offset by higher exports, but after Brexit our export sector looks much weaker. Higher long term interest rates will also add additional deflationary pressure on firms.

[4] Kicking the can down the road on spending cuts would be best for the economy, if we assume a change in government after the election. Is it possible to cut spending without hitting the economy? They could scrap overseas aid, but that is too small on its own. Cutting defence procurement if those cuts meant not purchasing goods made overseas works, but this government is committed to increase defence spending. I cannot think of anything else. The easiest thingfor the Chancellor to do is cut public investment, but that would also be the cut that would hurt growth the most, as Osborne found out in 2011/2.

[5] Many have made comparisons between the election of Truss and Corbyn: in both cases, it’s suggested, party members chose a leader that matched their views rather than those of the electorate. However the analogy ignores the 2017 election, when the combination of many social liberals accepting the referendum result and a left wing economic programme gained large support. As the diagram in this FT articlemakes clear, there is widespread support for left wing economic ideas, and almost none for those Truss is championing.

Before getting distracted by the spin put on Friday’s budget, it is important to be clear what the motivation for it is. It’s not a budget for growth, it’s a budget for the rich and those who fund the Conservative party. Abolishing the 45% tax band obviously benefits only the very well off, dropping the increase in corporation tax will mainly benefit shareholders who are mostly at the top of the income distribution, not extending the windfall tax on energy producers will exclusively benefit shareholders, not increasing NI rates benefit the better off far more than anyone else, ending the cap on bankers bonuses benefits the already very rich, and so on. Conservative MPs are much more right wing on economics than Conservative voters or even party members, and this is a budget for them, as long as it doesn’t mean they lose their jobs.

The Resolution Foundation calculatesthat almost two thirds of the tax gains go to the richest fifth of the population, with almost half going to the top 5%. They also point out that the stamp duty changes mainly benefit richer households in the South East. Of course poorer households will get a small amount of this giveaway, but less than is needed to cover the increased costs of essentials according to NEF. The IFS have looked at all the forthcoming tax changes (including frozen income tax allowances), and they calculatethat your income would have to exceed £155,000 before you are better off, and if you earn a million a year you gain £40,000

It is also a budget that is highly likely to mean cuts in public spending after the next election. The OBR were not allowed to publish their post-budget forecast, for the first time in their 12 year existence, because if they had been their budget deficit projections would have shouted ‘not sustainable’. Not sustainable is just a shorthand way of saying that taxes will have to rise or spending will have to be cut, unless something very beneficial for the public finances turns up. But of course it’s equally likely that something detrimental to the public finances will turn up. You don’t get to announce the biggest tax cut for 50 years in a deteriorating economic climate without severe implications for future spending.

Here are the Resolution Foundation’s assessment of the deficit and debt, and hereis the assessment by the IFS. Both suggest deficits in the medium term that are unsustainable. The new Chancellor also committed himself to reducing government debt relative to GDP in the medium term, meaning that if these deficit projections turn out to be even roughly right he is going to have to raise taxes or cut spending.

It cannot be stressed often enough that cutting taxes and spending less is a very unpopular policy to pursue, unless you are a Conservative party member or a large part of the commentariat. This is from the latest British Social Attitudes survey.

Just 6% of the population want lower taxes and lower spending on health, education and welfare, while 52% want the opposite.

So to the spin. What the government would like you to think is that this is about fairness vs growth. These measures are very unfair, but they say they are designed to increase long run growth so everyone will be better off (just the rich will be a lot better off than the poor). The spin, like the deficit spin that these same politicians lectured us with for the last 12 years but have now abandoned, is a load of nonsense. There is no relationship between tax levels and prosperity. Worse still, as I outlined here, the evidence clearly suggests that increasing inequality at the top reduces growth. Either the government is blind to the evidence, or they have to pretend it’s all about growth as a cover for the true reason for tax breaks for the rich: their ideology and party donors.

If this government really wanted to increase growth it would make trade with the EU easier, but right now it is doing the opposite. It would be focusing only on encouraging the energy of the future, green energy, which is now much cheaper than gas, Instead they are encouraging fracking (and saying you shouldn’t worry about small earthquakes) and more investment in getting oil out of the North Sea. If this government really wanted to increase growth, it would be helping the NHS reduce the number of people not working because they are sick by training more nurses and doctors and paying them more. Instead tax cuts now mean that in the future the NHS, with its record waiting lists, will be even worse than it is now, if it has a future at all.

If you (erroneously) think the markets know more about growth than researchers who examine the evidence at the IMF, then they too think the government is doing nothing for growth. If the markets believed this budget would increase long run growth, sterling would appreciate. Instead the uncertainty created by an unfunded tax giveaway for the better off has led to the cost of government borrowing rising substantially both just before and following the budget, and sterling has fallen against the Euro. (The latter is particularly significant, as you would normally expect an unfunded tax giveaway to appreciate sterling because of expectations of higher interest rates.)

Some of the criticism of this budget is also missing the point. It's very unlikely we will see a repeat of the Barber boom of the 1970s for two reasons. First and most importantly because we now have an independent Bank of England. Instead what this budget ensures is higher interest rates. (Can there be much doubt that if it was Kwarteng rather than the Bank that decided interest rates, then a short term inflationary boom would be a bigger possibility.) But as I noted in my last post, offsetting a short term inflationary boom with higher interest rate is not a precise art, so there is a possibility that the government might get lucky with three or six months of 2.5% annualised growth (or more) before the next election. The second reason we will not get anything like a Barber boom is that most of the tax cuts are going to the better off who save most of their extra money.

What has to be added is what was absent from this budget giveaway. There was only the smallestadditional help beyond the price cap for those struggling to make ends meet, and instead more use of sanctions for claimants, sanctions which the government’s own research says caused more harm than good so theyrefused to publish it. Alongside higher energy prices, we have sharply higher food prices which the government is ignoring. It is indicative of where this government’s priorities are that their first fiscal actions have focused on giving the most money not to those who need it most, but those who need it least.

Why was this a uniquely awful budget, that led to higher government borrowing costs and a falling currency. Tax cuts aimed at the wealthy at a time when many less wealthy are finding it hard to make ends meet is pretty bad, but it is not unique in recent times. George Osborne cut the top rate of tax in 2012 in the middle of a sustained period of austerity, and cut corporation tax too. Nor is justifying tax cuts aimed largely at the rich by pretending they will boost long term growth a new excuse. Trickle-down economics has been growing as part of Conservative DNA since Thatcher. The growing evidence that it doesn’t work and will probably reduce growth has little chance when set beside growing party donations from the very rich.

What made this budget stand out from any UK budget over the last 30 years was the absence of any attempt to match taxes to day to day spending over the medium term. I’m not talking about the deficit fetishism of Osborne, Hammond and Sunak: that had long passed its sell by date. However for the last thirty years Chancellors have attempted to put their decisions within some kind of overall fiscal framework. Kwarteng not only failed to do that, but he stopped the OBR making that clear. That matters not just because it raised borrowing costs and depreciated sterling, but because it almost certainly means, if this government remains in power, spending cuts on the horizon. Cuts in spending that will be far deeper than anything George Osborne did, because UK public service provision is already at rock bottom and in some cases close to collapse.

When the mainstream media and non-partisan think tanks talk about this budget being a big gamble, they are going as far as they feel they can in condemning it. What the country and the economy needs right now is reducing the record delays for standard NHS treatments, reducing appalling waiting times for ambulances and A&E, allowing schools to fill the gaps left by the pandemic rather than not replacing teachers to pay energy bills, and so on. An economy where the public sector no longer works is an economy that no longer works. What this budget showed is a Chancellor who not only doesn’t understand this, but intends to make it worse.

In my last post, I missed out one potential benefit from the switch in emphasis from the deficit to growth under Truss and Kwarteng. During the dark days of Osborne’s austerity, the idea that the ultimate goal of fiscal policy was to manage the deficit became firmly established in the media. This idea was always absurd, although I analyse the origin of this belief here. The primary aim of fiscal policy, along with economic policy more generally, should always be to increase social welfare. While it is up to politicians how they weigh the welfare of different parts of society, pretending the government’s deficit is a proxy for this welfare was always nonsense.

Economic growth is related to social welfare, but we should never forget that they are not the same thing. The most obvious example of that, which I will talk about below, is a demand led boom that leads to higher inflation. In addition aggregate growth figures ignore how income gains are distributed among different groups. Furthermore, additional growth achieved today at the cost of yet lower growth tomorrow is not worth having. An obvious example of this is extraction of oil or gas that would add to growth today, but because of global warming would reduce the social welfare of future generations.

Before discussing the merits of Truss/Kwarteng saying they are targeting growth, we should ask why they are doing this. After all, and with the caveats above in mind, all governments before 2010 tried to raise the growth rate in various ways, so this is hardly something new. So why are Truss/Kwarteng making a big deal of it?

Part of the answer comes from the first paragraph of this post. They want to signal a departure from policy that placed a high weight on deficit targets. But another reason is also important. As many have noted recently (see myself herein February), at some point after the Global Financial Crisis the UK economy went from being a success story in terms of growth relative to other G7 countries to being a failure. For a long time the government successfully (in terms of the mainstream media) hid this decline by talking about the deficit (see first paragraph again) and repeatedly pretending we had ‘strong economy’, but now the decline has become undeniable. In addition it is also clear that this decline has happened under Conservative (or Conservative led) governments.

The implication Truss/Kwarteng would like you to draw is that the Conservative governments of the recent past allowed this era of decline to happen because they didn’t prioritise growth, and this new Conservative government will be different because it is going to prioritise growth. While I think there is a lot of truth in the first part of that sentence, I see nothing to suggest the second part is true.

Take, for example, the two major policy mistakes that in my view played a large role in creating this recent era of UK decline. Austerity at the depth of the GFC recession both killed any chance of a normal recovery and probably also reduced the long run level of UK output, but implicitly Sunak had already acknowledged that mistake by not repeating it during the recession caused by the pandemic. In contrast the second major policy mistake, Brexit, continues and neither Kwarteng or Truss show any sign of acknowledging the negative impact of Brexit on growth.

So compared to the last 12 years of economic decline, this new administration is keeping one of the main reasons why it happened and is agreeing with the last government about not repeating the other. In addition, its big idea about how to raise growth, tax cuts including low corporation tax, had already been tried without success by Osborne during this period of UK economic decline.

Behind the unashamed promotion of fiscal measures that increase inequality (not just tax cuts but not imposing additional windfall taxes on energy producers and lifting the cap on bankers bonuses) is the idea that greater inequality encourages growth. The evidence suggests either no such association or the exact opposite. Here, for example, is a quote from one IMF study: “Thus the combined direct and indirect effects of redistribution - including the growth effects of the resulting lower inequality - are on average pro-growth.” More recently the IMFpoints to a robust result that higher inequality at the top of the income distribution reduces growth. There are many reasons why greater equality might promote growth.

Tax cuts aimed at the rich, therefore, are if anything a growth reducing measure, and almost certainly reduce social welfare. That is why removing the cap on bankers bonuses, or not imposing a windfall tax on energy companies, is more likely to reduce rather than increase growth. The idea that the last 12 years of economic decline under Conservative governments were because those governments prioritised redistribution over growth is nonsense, as Jonathan Portes shows. Once again, fiscal measures that favour the rich were tried by Osborne and it did nothing to stop, and may even have assisted, the last 12 years of UK economic decline.

Its other big idea is to reduce the ‘red tape’ that they believe is holding back UK business. First, we should note the huge increase in red tape for our exporters to the EU created by Brexit, which the current government intends to continue. Second, there is no general relationship between regulations and economic growth. For example, the government has ordered a review into anti-obesity measures. It is not obvious why these measures hold back economic growth, but it is clear that more obese people implies a greater burden on the NHS, requiring either higher taxes to fund it or a reduction in social welfare as other care is rationed. Or take the absence of regulations, since Brexit, to keep our beaches and rivers clean, which benefits monopolies and their shareholders but is likely to encourage imports and reduce exports (UK residents taking holidays to cleaner beaches overseas and less overseas tourists coming to the UK) implying less growth.

The idea that less regulation always increases growth, just like the idea that lower taxes always raise growth, is just right wing wishful thinking. However, like much right wing wishful thinking, there is a whole industry out there trying to manufacture evidence to support these ideas sponsored by those that benefit from such measures. It should be no surprise, therefore, that Conservative governments keep enacting measures that favour wealthy interests rather than favouring growth, when they are advised by newspapers and think tanks funded by those interests. It’s very important that we avoid right wing wishful thinking becoming received wisdom in the mainstream media, as the wisdom of austerity was allowed to do.

Where there is good evidence that fiscal measures can assist growth tend to be on the government spending side: investing in certain types of skill for example. Right now the UK appears to be suffering a negative labour supply shock caused by a rise in long term illness, due partly to Long Covid but also because of the growing waiting lists for other treatments in our overstretched and understaffed NHS. Improvements in these areas can be achieved from more public investment or targeted incentives for private investment (better ventilation for example) but they also require permanent increases in public spending and therefore higher, not lower, taxes.

An indication that nothing has really changed is empty gestures. Having a target for 2.5% growth is just nonsense for two reasons. First, it’s GDP per head that influences social welfare, not GDP, so the target is for the wrong thing! Second, setting a target does nothing to help you achieve higher growth. At best it is an attempt to pass off measures that are rightly unpopular, like removing the cap on bankers bonuses or not extending windfall taxes on energy producers, as necessary to achieve the growth target, but of course neither will have any positive impact on economic growth. Equal nonsense is removing the Treasury’s permanent secretary for no other reason than wanting to show things have changed. One empty gesture might be an accident, but two perhaps suggest there is in reality little substance to this proclaimed change in direction.

If a growth target makes no sense, and none of the measures advertised so far will help increase growth, how will this work politically? It is possible that Truss/Kwarteng may try to cut taxes and increase spending, producing a sufficiently big enough increase in effective demand such that output growth exceeds their target just before the next election, allowing them to proclaim their policies a success. Comparisons have been made with the Barber boom of the early 1970s, a boom that helped create the largest rise in inflation in UK post-war history.

Today, with an independent central bank, such a policy combination would create a rapid increase in UK interest rates. For this reason among others, manufacturing an unsustainable short term boom is likely to damage long term growth rather than improve it. However raising interest rates to counteract fiscal largesse is not a precise science, and it is possible that for a quarter or two annualised growth could exceed 2.5%. If it does, expect many proclamations of a new dawn from Conservative politicians and their press. But even if that does happen, and it may well not, it will be yet another deception. This decade or more of economic decline will not end by cutting taxes, deregulation, making exporting harder, and increasing inequality.