Cool it (for now)

After years of resistance, I recently signed up for Twitter. After all, if the leader of the free world uses it to conduct policy, it’s where anyone with an interest in current affairs needs to be. And what a revelation! I was previously aware of the phenomenon of homophilous sorting (the tendency of people with similar interests to group together) but it is quite incredible how Twitter enables social divisions to occur. The people I tend to follow are very much anti-Brexit and given the torrent of commentary which they tweeted and retweeted in the wake of the Article 50 letter, it is hard to see how the electorate ever voted for Brexit in the first place. But in the interests of balance, I had to check out what the other side was saying – and yes, it was as bad as I feared.

This highlights that both sides in the Brexit debate talked past each other in the run-up to the referendum and clearly are still doing so today. Theresa May’s hope that the country will emerge more united after the EU negotiations, appears forlorn. Regular readers will know that I am totally opposed to the notion of Brexit but I can see why those in favour express irritation with people who argue that “Article 50 can still be stopped” or “we need another referendum to verify the terms of the deal.” Not that I necessarily disagree with the sentiments, but this is not the right time to make such arguments because it does come across as “Bremoaning” (such an ugly word) and merely hardens the position of those who are going all out for Brexit.

Indeed, it may be time to let the EU27 take up the cudgels on behalf of the Remainers. Already, German Chancellor Angela Merkel has suggested that the issue closest to the UK’s heart – securing a trade deal with the EU – will have to wait until exit terms are agreed whereas the UK’s position is that the two should run in parallel. For all the domestic bravado since June, we have known all along that the terms of engagement would change once the Article 50 letter was delivered. The pressure is now on those who argued that Brexit would result in a bright new future, to deliver on their promises (Boris Johnson, David Davis, and Liam Fox to name but three). Now we will see what they are made of, and if they are perceived to be failing to deliver, that is the time to really turn up the pressure because that is when some of the cracks in support for Brexit may begin to show.

Whatever happens after the EU negotiations have been concluded, and whether it is a “good” deal or not, it will be mighty hard to convince me that we will be as well placed as we were in the EU. Indeed, as Simon Wren-Lewis wrote in his latest blog post, “those who voted Leave didn’t win. If they wanted immigration to quickly fall, it won’t ... If they think their wages will rise because of Brexit they will see - are seeing - the opposite. £350 million to the NHS will become £50 odd billion to the EU ... In other words the big news is that Leave voters were conned.” Unfortunately, it will take many years for the full effects of the damage to become evident. If the economy grows 0.3% per year slower than it would have done otherwise, it will take 15 years to produce a 5% reduction in relative living standards. The real tragedy, of course, is that it is the children (and more likely grandchildren) of today’s Brexit supporters who will have to live with the folly of the vote (“tell me again grandad, how did you vote in the referendum?”).

In the longer term, of course, the sun will continue to rise and the world to turn and we will all have to deal with many personal heartbreaks which put Brexit into perspective. But Brexit will change Britain – and indeed will likely change the EU, and nowhere will the loss be more keenly felt than in Ireland and Germany.

Nonetheless, I do wonder how the political map of Britain will evolve on a 5-10 year horizon. If the UK does indeed suffer economically from Brexit, the right-wing of the Conservative Party will undoubtedly blame the current leadership for failing to deliver the right deal. This will probably push the Tories further to the right which could produce one of two outcomes. Either the Conservatives maintain their dominance with a leader who is even more in thrall to the Eurosceptics than anyone we have seen so far, and condemns the Labour Party to the irrelevance which is often predicted. Or – and history suggests this is more likely – the pendulum will swing, leaving space for the Labour Party to move towards the centre ground and capture the popular vote. However, they won’t do this as long as Jeremy Corbyn remains leader and it relies on regaining some ground in Scotland (I assume that Scotland will not be independent within five years though further ahead, I wouldn’t like to guess). An alternative prospect is that an element of the Conservative Party splits off to form a new political group, just as the Labour Party split in 1981 with key figures going off to form the centrist Social Democratic Party.

Whilst all this is necessarily speculative, it is a recognition that something is going to have to give in the political landscape. Too many people have too much political capital invested in Brexit (either for or against), for events not to go their way. And then there is the electorate in whose name all these shenanigans have taken place. My guess is voters care less about ideology than income and if Brexit fails to deliver the goods, it will not be the “experts” who have to answer questions – it will be the politicians.

Now what?

Today’s delivery of the letter triggering Article 50 has set the UK on a road to a far less certain future. I have been through the economic arguments countless times as to why Brexit is a thoroughly bad idea – indeed I have been making them since January 2013 – but that is an argument which has been lost and there is no point in raking over old coals. Theresa May’s speech to parliament tried to sound convincing but I suspect it fell flat on the near half of voters who do not share this government’s vision.

All the challenges it faces were contained in one sentence from the prime minister: “I want this United Kingdom to emerge from this period of change stronger, fairer, more united and more outward-looking than ever before.” It’s hard to see how we will emerge stronger given that most of the evidence suggests that there will be significant economic costs. Unless, of course, any trade deal with the EU offers most of what we have already, in which case what is the point? More outward-looking? We have just announced a withdrawal from the largest, and arguably most successful, single market in the world. I am not sure how that is consistent with the outward-looking vision she espouses. As for being united, that is a bitter irony. Almost half those who voted do not want this policy at all, and the Scots want to secede altogether. The UK will have to negotiate a hell of a deal with the EU to persuade the disaffected minority that Brexit is a risk worth taking.

The biggest problem that the government will face in the long-run is how to take back control in an increasingly globalised world. One of the great ironies of the post-Brexit world is that sterling is around 10% weaker than it was pre-referendum. Aside from the fact that this impacts upon the living standards of ordinary citizens by raising the costs of imported goods, it also makes British companies more attractive takeover targets by reducing their price in foreign currency terms. An article in The Economist noted three weeks ago that although the UK accounts for 3% of world GDP and its companies account for just 5% of global market cap, UK corporates have accounted for a quarter of all cross-border M&A activity since 1997.

This is a result of the laissez-faire approach of successive British governments towards market intervention. Moreover, over the last 10 years, foreign companies have bought significantly more UK companies than the other way around. The most high profile of these cases was the purchase of Cadbury’s plc by Kraft Inc in 2010. Just a week after promising to keep one of Cadbury's local plants open, Kraft backtracked and said it would close it. Although this resulted in a major revamp of the takeover code in 2011, it came too late for Cadbury’s workers and prompted howls of popular outrage. But here’s the rub: The UK is running out of attractive takeover targets. Admittedly, it still has attractive companies such as AstraZeneca, which beat off a bid from Pfizer in 2014, or the London Stock Exchange, whose proposed merger with Deutsche Börse was today blocked by the EU competition commissioner (of all people).

All this is a prelude to the question of what will attract global capital to the UK in future? It has fewer takeover targets and it is about to leave the EU, which will make it less attractive to firms which want a European base when they can go elsewhere. The attractiveness of London as a business location will not diminish easily: It is still a world-class city with all the amenities that the global community requires. The attractiveness of the legal system and use of the global lingua franca are added bonuses.  But depending on the nature of the deal with the EU, the London financial services industry may be in for a torrid time which will impact on the ancillary services that depend on it. Only time will tell how the likes of the Japanese and Americans will react to the prospect of having their European headquarters located outside the EU. Tax competition would certainly be one option to enhance the attractiveness of the UK but that is a race to the bottom which could put even bigger holes in the public finances.

The Economist notes that “even the free-market wing of the ruling Conservative Party … backs a change [to the takeover code] ... Britain’s 30-year experiment with a free market for takeovers is quietly coming to an end.” But the real irony is that if Brexit is at least in part a backlash against globalisation, this policy change could have been implemented years ago and saved us a lot of grief. And to double the irony, making it more difficult for foreign investors to buy UK companies is now precisely the wrong policy response when (a) most of the assets have already been sold and (b) the UK needs the capital inflows. You almost couldn’t make it up. Unfortunately that is the result of 30 years of short-sighted policy.

The big day dawns

We are less than a day away from the triggering of the Article 50 process which will signal the UK government’s determination to leave the EU. It is the equivalent of serving the divorce papers, and like most divorces it is unlikely to run smoothly. It was thus rather depressing to watch the BBC’s pre-Article 50 debate (here for those in the UK, and those outside the UK may have to be content with this). Having watched with increasing despondency the debates in the run up to the June referendum, I took no comfort from the fact that the country is still as divided on the issue as it was nine months ago and continue to believe that the government’s public position on its negotiating stance is naïve.

After the UK government communicates its desire to leave the EU, everything changes. The UK no longer has any control over how the negotiations will proceed and the ball will be very much in the court of its (soon-to-be erstwhile) EU partners. Although Theresa May has set out her 12 key negotiating points, I maintain that they are little more than a wish list. And if the key issue at the heart of the Brexit campaign was immigration, the UK government does not appear to have developed a clear strategy on how to proceed from here. Brexit minister David Davis yesterday confirmed that the government will not seek to cap the number of EU migrants working in the UK after Brexit, but expects that the government will eventually meet its target of cutting net migration to the “tens of thousands.” Short of redefining the migration statistics to exclude students, it most certainly will not be able to do so. I won’t bore you with the economic arguments about immigration again – suffice to say many people have it wrong about the balance of costs and benefits.

There are those who argue that the weakness of the EU is a good opportunity for PM May to press hard for a deal which will benefit the UK. Allister Heath in the Telegraph argues that “the rise of populism on the continent, the strength of Britain's economy and Europe's fear of terrorism all make a good deal for the UK more likely.” I’m not sure I agree that the EU is as weak as he makes out. The Dutch election earlier this month showed that Geert Wilders’ brand of populism was decisively rejected and latest polls put Emmanuel Macron ahead in the French election, suggesting that he will breeze the second round. The EU is not, in Heath’s words, “on the verge of the abyss.” It is weakened, for sure. But Brexit may even act as a catalyst to force it to rethink its strategy.

For those Brexit supporters who claim that it is not curbing immigration which is the real prize but the opportunity to strike new trade deals, Gideon Rachman’s recent column in the FT nicely skewers some of that thinking. Rachman argues that the UK establishment suffers from collective amnesia in which the national story is centred around the war against the Nazis rather than focusing on Britain’s imperial past. In Rachman’s words “Most British people, including leading politicians, are profoundly ignorant of the country’s imperial history. This imperial amnesia … means that leading Brexiters and advocates of “Global Britain” … speak warmly of returning to Britain’s historical vocation as a “great trading nation”, when it was actually a great imperial nation. That important distinction leads to overconfidence about the ease of re-creating a global trading destiny, in a world in which Britannia no longer rules the waves.”

In the first Brexit presentation I made, back in 2013, when I shared a platform with former Europe Minister Denis MacShane (before his conviction for expenses fraud), I recall making a similar point. Those who believe that the UK will be able to rely on our Commonwealth partners, claiming special historical ties, clearly do not see the imperial position through Indian (or Pakistani or Kenyan etc) eyes. The former British colonies have emerged from the shadow of their imperial past and have no desire to return to it. Indeed, Theresa May’s efforts to conduct a trade deal could be threatened by her refusal to reform visa restrictions for Indian citizens (here). 

For the 48.1% of us who voted in favour of Remain in June, the decision to trigger Article 50 will signal another step on the path away from the common Europe of which we hoped to remain part. I would like to think that whatever deal is struck, it will not inflict too much pain on the UK. But much will depend on the magnanimity of the EU, for what I have heard so far gives me little confidence in the UK’s negotiating strategy. When our own prime minster reckons “no deal for Britain is better than a bad deal for Britain” you really have to wonder what we are letting ourselves in for.

What drives politicians?

Human actions can broadly be understood in the context of three forces which act to offset each other in order to produce balanced outcomes. On the one hand, we are motivated by self-interest which is the driving force propelling individuals forward and helps societies to develop. But this is constrained by the loyalty to the tribe to which we belong, and by the responsibility to the wider society. So it is with politicians in a democratic society: Self-interest is tempered both by party loyalty and a responsibility to represent the people which put them in office.

The actions of someone like President Trump are a bit harder to fathom, particularly since he appears to owe no fealty to the Republican Party. I would venture to suggest, however, that he was motivated to run for the presidency out of ambition but his actions will be constrained by what the American people – or more properly, Congress – allow him to get away with. Trump’s attempt to repeal Obamacare should be seen as a policy of self-interest, designed to ensure that he is seen to be fulfilling his election promises. Equally, Congressional action to block this attempt should be celebrated as an example of how this self-interest can be held in check. (For anyone interested in a more detailed analysis of the difficulties the Trump Administration will face in trying to push through its legislative programme, this article from the New York Times is well worth a read).

On this side of the Atlantic the British political scene offers a number of fascinating insights into the motivations of politicians. The news over the weekend that UKIP’s only sitting MP is to leave the party is a case in point. Douglas Carswell is a former Conservative MP, and a well-known Eurosceptic, who defected to UKIP in 2014. Carswell’s reasons for leaving UKIP are unclear. He obviously did not see eye-to-eye with former leader Nigel Farage (who has never managed to be elected as an MP) but Carswell posted on his blog that “I switched to UKIP because I desperately wanted us to leave the EU. Now we can be certain that that is going to happen, I have decided that I will be leaving UKIP.” A cynic might say that a cause he believed in so strongly has been achieved that, for the second time in three years, he has decided to leave a party which no longer suits his purpose. Or, as the Huffington Post put it,  “He’s just another hypocritical politician. Just another MP motivated by self-interest, who picks and chooses his principles to match whatever he has already decided to do.” 

There again, the same could be said of Winston Churchill who was elected as a Conservative MP in 1900, before defecting to the Liberal Party in 1904 only to rejoin the Conservatives in the 1920s. As the great man put it, “anyone can rat, but it takes a certain ingenuity to re-rat.” With political tribal loyalty these days much stronger than in Churchill’s day, Carswell may not be welcomed back quite so warmly if he were to rejoin his former Conservative colleagues, as has long been rumoured. But whilst one can question Carswell’s personal motivation, he was tapping into a groundswell of anger felt by a large part of the electorate. Like Trump, he was prepared to put other factors ahead of party loyalty and perhaps Carswell really believed that he was acting in the interests of a wider society.

Theresa May, on the other hand, appears to have put the party above all else. She did vote “remain” in the EU referendum (albeit reluctantly, apparently) but has clearly decided that it is more important to keep the party together than allow her personal view on Brexit to determine her course of action. As a result, we appear set for the hard Brexit that many members of the party have long called for. As for her opposite number in parliament, it is hard to know where Jeremy Corbyn stands. It seems that he is not acting in the interests of his party, after his parliamentary colleagues virtually disowned him last year (although he can at least claim that the party’s rank-and-file membership backs him – for now). Most of the polling evidence suggests he is unelectable and as a result he would do his party a favour by stepping aside for someone who is. Arguably, Corbyn is putting personal ambition and his apparently genuine belief in some of the causes he espouses, ahead of party loyalty.

In a world where many of us express irritation at the actions of politicians, it is important to be aware of the forces which drive them. On the one hand, doing so might help to narrow the chasm which has emerged between politicians and the electorate, which is an important factor driving the populist movement and is driving us towards a resurgence of economic nationalism. In addition, it may help counter the more extreme positions adopted by some of the populists. The prejudice of the Brexiteers, for example, could have been fought far more effectively if their opponents had tried to engage with the electorate’s fears rather than dismiss them. Sun Tzu’s The Art of War recommends that we know our enemy.  What was true in the 5th century BC still holds today: Good ideas never die – they just get recycled.

Fund the police

The terrible attack on the UK parliament last week which claimed the lives of four innocent people would have been a lot worse were it not for the actions of the security and other emergency services. As it was, one police officer was killed in the line of duty and politicians from all sides were quick to praise the work of the police on the front line in maintaining law and order. But we should not allow these warm words to deflect us from the fact that the police service, like many other publicly funded bodies, has had its funding slashed over the past seven years.

The Mayor of London warned in January (here) that  “it would become increasingly difficult to keep Londoners safe from growing security threats if the Government continues to underfund the Met, or makes further cuts in funding” and this is a message which is being heard up and down the country. A report last year from the impartial House of Commons Library (here) noted that between fiscal 2010-11 and 2015-16, the central government grant to police was cut by 22% in real terms. Although the police in England are able to rely on some local government funding, the report notes that two-thirds of its revenue derives from central government. The total number of full-time police officers in England and Wales has fallen by 11.8% since 2010 compared with a planned decline of 11.2% and total staff numbers are down by 15.6% versus a planned 12.7%. In fairness, the report also notes that most police forces have coped well with the additional austerity. But this does not disguise the fact that there are limits as to how much further budgets can be cut.

Another report issued by the HoCL around the same time (here) reported that since 2010-11, funding for the fire and rescue services has been slashed by between 26% and 39%.  Taken together with the cuts to police funding, it is clear that these are not insignificant cuts and they underline the belief of a growing number of people that we have gone way beyond the point of trimming fat from the public sector and we are now cutting into the bone and muscle. A recent article in The Economist  – not exactly a supporter of big government – made the point that the public sector is under increasing strain and that it may be about to break under the load. Citizens Advice – a voluntary organisation that provides help and support to those who are struggling to get what they need from the state – has seen a sharp rise in demand for its services. The government’s decision to cut back on its Legal Aid budget has left many people with no recourse to legal representation, with CA taking up the slack, and changes to the benefits system have resulted in many people falling through the cracks.

I have highlighted before the excellent report by the Institute for Government which argues very strongly that recent additional cuts in government spending are beginning to erode the fabric of public services. The evidence-based analysis makes the point that although there has been a big rise in real spending on hospitals since 2010, admissions rose at an even faster pace. Or take the case of prisons, where the prison population has remained unchanged since 2010 but the number of officers has fallen by almost 25% with the result that assaults on staff have risen by 70%.

None of this is news. Nor is it an ideological point about how we have to spend more money on public services. However, the evidence before our eyes is mounting to suggest that public services are struggling to cope and they are increasingly unable to offer the level of service which the public demands of them. With the best will in the world, a police officer cannot be in two places at once.  If we continue to starve our public services of resources, this will continue to eat away at morale and they may reach a tipping point beyond which it is very difficult to recover. Indeed, taxpayers as a group are not finding that the exchequer is taking any less tax yet they are getting far less in return.

I am reminded of the story that was frequently told of British Rail – the old and (at the time) unloved nationalised body responsible for running Britain’s railways – about how in the 1970s it was one of the world’s most cost-effective railways in terms of spending per passenger mile (even today, UK railways still receive far less public money per passenger mile than other major European networks – see chart). But it was criticised for poor service; lack of staff morale; the frequency with which workers went on strike; the quality of the food served and the general state of the trains. It did, however, get people from A to B, even if it was a utilitarian service, before it was abolished in the 1990s when the railways were privatised.

Today, people look back to the halcyon days of an integrated railway network which conducted world class research and built its own rolling stock, providing jobs for many thousands. This demonstrates that if governments do not put money into public services, the quality of service deteriorates and public trust is eroded, even if in accounting terms it offers good value for money. But when you replace it with something else, it is often not perceived to be as good. As Joni Mitchell put it, “You don’t know what you’ve got till it’s gone.”

The games people play

Brexit is often described as an economic game-changer, whilst Prime Minister Theresa May has accused the Scottish First Minister of playing a game with her call for a second Scottish independence referendum. But politics is a form of game and Brexit certainly warrants examination in a game theoretic context, which can be described as “the study of mathematical models of conflict and cooperation between intelligent rational decision-makers.” Leaving aside the question of the rationality of the Brexit decision, we can perhaps use it to gain some additional insight on what the optimal (or least sub-optimal) outcomes are likely to be, not only for the UK but also for the rest of Europe.

Mathematical games can be split into two broad categories: cooperative and non-cooperative. Whatever the EU may be, it is a consensus based institution in which decisions are traditionally arrived at in a cooperative manner (although the Greeks may not see it in this way). In principle, the EU is a cooperative environment in which players are constrained to act according to the legal rules. Those who breach the rules are subject to sanctions. To take the example of environmental protection, there were 3464 infringements of EU law over the period 2007 to 2015, of which the UK accounted for 179, or 5%. Italy was the biggest offender accounting for 9% of all infringements followed by Spain (8.6%) and Greece (7%). Without making any judgement on individual nations’ degree of compliance with the law, the rules are known and the EC publishes data to name and shame the transgressors who are expected to comply with sanctions.

Similar rules apply to trade. But not everyone thinks the EU applies the rules consistently. Alan Halsall owns a company (Silver Cross) which makes prams, and in 2015 the French government banned his company from selling its products in France on safety grounds despite being cleared for sale elsewhere across the EU. Not surprisingly, Mr Halsall argued strongly in favour of Brexit. But the problem is not the EU rules: it is that the French government applies higher safety standards than other countries. In fact, Mr Halsall had a case for applying to the European Commission to appeal this decision although he chose not to do so, arguing that he will benefit more from applying his energies to markets where he is able to generate sales.

But if he thinks the current rules are stacked against him, Brexit will change the rules of the game completely. The process of renegotiating trade deals with the rest of the EU implies entering into a non-cooperative bargaining “game” where the EU has no incentive to cooperate with the UK, primarily because it wishes to avoid giving support to the idea that leaving the EU is an easy option. Although the ultimate outcome is likely to result in a cooperative situation in which a new set of rules apply, the process of getting there will be non-cooperative. And even if we do reach a cooperative solution, the end result is likely to produce an outcome which is worse than the position we started from. In game theoretic terms, the outcome will be inefficient – at least for the UK.

Those of you who have seen the film A Beautiful Mind will be aware of the work of John Nash, who offered significant insights into the mathematics of bargaining problems. His key insight was that equilibrium is reached when no player can unilaterally change their strategy and get a better result, given that they know the strategy of the other player(s).   In other words two parties should cooperate when non-cooperation leads to results where at least one side is worse off (so-called Pareto inefficient outcomes). Clearly, the EU is not going to allow the UK to have free access to the single market: such a strategy will weaken the EU because it implies there is no cost to exit, which will endanger the EU’s long-term existence. But the UK cannot accept access to the single market whilst continuing to pay into the EU budget and accept ongoing free movement of labour (the Norwegian solution), because this gives the UK the same system as before Brexit but without any control over the legislative process.

The problem the EU faces is to trade off punishing the UK against the harm that non-cooperation inflicts upon itself. Likewise, the UK must trade off the best deal against the political costs of giving away too many concessions. Abstracting from deals regarding the exit costs, one possible Nash equilibrium is for the EU to offer the UK continued access to the single market for an annual fee which is lower than the UK's current net EU contributions but which offers no say over drafting legislation. The UK should accept this because although it is a worse deal than the current arrangements, it is economically less damaging than relying on WTO tariffs and preserves market access for exporters on both sides of the table.

One of the best known forms of game is the zero sum option. Many Brexit supporters appear to believe they are operating in a positive-sum game: if the UK leaves the EU, any disadvantages from leaving will be more than offset by the gains. There is no evidence to support this sunny optimism. Indeed any action which harms UK trade with the rest of the EU, such as the imposition of trade tariffs, will result in a negative sum outcome. 

Looking at this in a wider perspective, it is evident from recent polling evidence that the degree of dissatisfaction with the EU is rising across the whole continent. We can thus perhaps think of the decision of whether to leave as a sequential game, in which the action of one country influences the decisions of others. It is yet possible that the UK’s decision to be the first mover in this game will trigger other countries to go down the same path. But it is not in the UK’s interest to be the first mover because it will face all the adverse consequences as a result. Far better in this case to allow others to make the first move – this may be a game where there is no first mover advantage.

Contrary to what politicians tell us, Brexit really is a game – admittedly one with high stakes. However, a central assumption in many variants of game theory is that the players are rational. In other words, they always choose an action which gives their most preferred outcome, given what they expect their opponents to do. I have a pretty fair idea how the European Commission is likely to act: Based on recent rhetoric I am less certain of the rationality of the British position.

When politics and economics collide

In recent months, I have spent more time than I would have liked on political issues which appear only to have a tangential connection with the economic issues I originally wanted to write about. There is, of course, a good reason for this. The big economic issues of the moment are being driven more by politics than the underlying economics – indeed, we would not have seen a vote for Brexit otherwise. The causality also runs in the opposite direction, of course, with many political decisions influenced by the underlying economics, notably fiscal policy. In any case, economics does not exist in a vacuum: Economic decisions are taken against the backdrop of the prevailing institutional circumstances.

But there is an increasing divergence between the way economists and politicians view the world. We saw that during the Brexit and Trump election campaigns. In a very thoughtful piece, Tim Harford (here) outlines the reasons why post-truth currently has the upper hand. In short, a simple lie is easier to distil than a complicated truth. Moreover, facts are often boring – this is why “newspapers” such as The Sport are able to get away with ludicrous stories like ‘World War II bomber found on the moon.’  It’s clearly nonsense, and 99% of readers know it, but it is enjoyable nonsense rather than the prosaic realities which make up our everyday lives. Finally, Harford points out that the truth can feel threatening, and threatening people tends to backfire: remember Project Fear?

Given where we are today, it is easier to sell a story that if we follow a simple course of action we will find a way back to the path of economic righteousness, rather than tell one of two truths: (i) that the pre-2008 model is not going to be resurrected anytime soon and (ii) it will take a lot of time, effort and sacrifice to get our economies back on an even keel. Indeed, the failure of governments to level with the electorate from around 2012 onwards, and the fact that they have tried to use the old repair kit to fix a system which is broken beyond repair, has played into the hands of the populists. After all, their view is that if the status quo is not producing the desired results it is time to overthrow it.

Yet when we think about it rationally, it may seem strange that people in the western world are quite as angry as they seem to be. After all, most of us enjoy a decent standard of living, even if it is not improving at the rate that it once was; we are reasonably well off, comfortable and secure. Instead we worry about immigration, terrorism and the future of our society at a time of unprecedented change. Ultimately, perhaps what we are worried about is the effect of globalisation, and we are assailed on a regular basis about how people will be better off if the barriers go up. That is, after all, how Trump won the US election. Raising the barriers is also the way that the current Scottish government intends to push for its objective of independence, by highlighting the differences between Scotland and England rather than admitting there is more that unites than divides them. Marine Le Pen is employing exactly these tactics in a bid to win the French presidency, though as this week’s Dutch election showed, playing the insider-outsider card is not a guaranteed vote winner.

However, politicians do themselves no favours with some of their own actions (and I am not going to even go near the subject of Jeremy Corbyn’s performance, which is worthy of a post of its own). Francois Fillon is battling to preserve his campaign to be the next French president following revelations that he accepted state aid to fund his wife’s employment as a political assistant, despite no evidence that she has actually done any work. Not so very long ago, such a revelation would have ended his political career but he is still on the ballot paper.

In another demonstration of his tin ear for public opinion, it was announced on Friday that former UK Chancellor George Osborne is to become editor of the London Evening Standard, despite the fact that (i) he is still a sitting MP (so no conflict of interest there); (ii) he has no journalistic experience – the closest he got was an interview with The Economist in 1997 (he didn’t get the job) and (iii) he already earns £650k per year from the hedge fund BlackRock by working just four days a month. This from a Chancellor who imposed the most draconian public sector squeeze since the wielding of the Geddes Axe in the 1920s.

Nothing would please me more than getting back to some good old fashioned economics (and I will). But so long as politicians fail to live up to the economic standards which they demand of others, and so long as their actions continue to conflict with the way in which economists think about many of today’s big issues, politics will always provide a lot of source material for economists. But if you think that I am too harsh on politicians’ actions, I would recommend you take a look at the blog at Another Angry Voice and you will realise what a model of restraint I am.

The popularity contest

I had the pleasure today of participating in a roundtable discussion on the subject of (yes, you guessed it) Brexit. In the course of chatting with some of the attendees, I happened across a senior and very well-connected businessman who told me that in the past he had dealings with Theresa May and her department in her capacity as Home Secretary. What was shocking was the story he told of how he had tried to make certain policy suggestions in order to improve business operations, only to be told to get them in the Daily Mail first and then government would listen (I am not making this up).

His reaction was the same as mine: How on earth can a government whose job it is to manage the country in the interests of its people possibly think that policy can best be served by courting the tabloid press? All politicians know that you can’t please all the people all the time but sometimes you have to take unpopular decisions in order to do the right thing. I am reminded of the great quote from the BBC satire The Thick of It (here), which I must confess to having used before but it is so accurate in this instance, which states that many political decisions are taken by “a political class, which has given up on morality and simply pursues popularity at all costs.”

With this little snippet of information in mind, many aspects of government policy now become a lot clearer. It explains, for example, why Theresa May has suddenly gone from being a nominal supporter of the Remain campaign to one of the most ardent advocates of a hard Brexit. And it certainly explains today’s decision by Chancellor Philip Hammond to reverse the increase in National Insurance Contributions for the self-employed. As I noted a few days ago (here), the economic rationale for raising NICs was sound enough. Indeed, the Chancellor reiterated that “the government continues to believe that addressing this unfairness is the right approach … However, since the budget, parliamentary colleagues and others have questioned whether the increase in class 4 contributions is compatible with the tax lock commitments made in our 2015 manifesto."

But if the rationale for implementing the policy was correct, then it logically follows that he has made an economic mistake by reversing the decision. Quite clearly, the decision has been made on political grounds, with the manifesto commitment used as justification. That in itself raises a question of whether the government – and don’t forget that the decision to raise NICs in the budget would have been approved by the prime minister – recalls what it promised in the 2015 election campaign? Or did they just think that no one would notice? Having caved in to populism on this issue, what is to stop the tabloid press making life even more difficult for the government in future? Flip-flops on policy issues like this do not bode well for the government’s policy credibility and should be avoided at all costs.

It also raises a bigger question, which one of the participants raised at today’s event. If in, say, 2019 or 2020 the UK economy has been severely damaged by the prospect of Brexit and the electorate is restive, would the government be tempted to backtrack on its Brexit promise? My answer to that question was, given what we have heard on the issue so far, it would be most unlikely to do so. But knowing what I know now, if the Daily Mail were to change its mind, you would not bet on a change of heart from the government either. Or as Carole King put it, in the song Change in Mind, Change of Heart, “The things that once held meaning / We're no longer sure about.”

Just another day in Brexit Britain

As the self-imposed deadline for triggering the Article 50 legislation draws nearer, it has been a fascinating day of political developments in the UK. First, we had the spectacle of Scottish First Minister Nicola Sturgeon issuing a demand for a second referendum on independence following the plebiscite in 2014. This was followed by the House of Commons voting against any amendments proposed by the House of Lords to the Brexit bill. It thus looks set to be passed into law tonight which in theory will allow the prime minister to formally launch the UK’s departure from the EU tomorrow. One of these events is historic enough, but the prospect of both coming to pass will irrevocably change the nature of the UK. No more United Kingdom, more Little Britain.

First, the Article 50 legislation. Regular readers will know my views: Leaving the EU is a leap in the dark which no amount of breezy confidence from politicians can conceal. Anyone who has ever done a parachute jump will know that for all the pre-jump training, nothing compares to that moment when you leap out of the aircraft for the first time and hope that nothing goes wrong with the chute. So it is with Article 50. If the EU does not play ball on the terms envisaged by the UK government, we could hit the ground with a big thump.

A fine article in The Times today by Clare Foges (here, although apologies for the fact it is behind a paywall) reiterated a point which I have long made, that far too many British politicians hark back to the way which Margaret Thatcher dealt with the tricky subject of UK-EU relations more than 30 years ago, and misinterpret what happened. Thatcher may have thumped the table in order to get her “money back” at the Fontainebleau Summit in 1984 but she did so knowing how far she could push German Chancellor Kohl and French President Mitterrand. She well understood that both Kohl and Mitterrand needed something in return which they could sell to their domestic electorates. In fact, Thatcher got less than she wanted – she was forced to settle for the minimum rebate – and she subsequently became a passionate advocate of the Single European Market. Moreover, as Foges points out, the UK was in the club looking forward to a future in Europe, and although the path was rocky the UK was broadly travelling in the same direction as other EU members.

Fast forward more than three decades to the tin-eared politicians braying that Theresa May should remember the spirit of Fontainebleau. The prime minister can recall the spirit of Nikita Khrushchev to her heart’s content by banging one of her many pairs of shoes on the conference table, but the EU will not listen to threats. The experience of Greece, which tried to dictate terms to the EU over its bailout package in 2015 but was humiliatingly forced to accept austerity conditions worse than those previously rejected, should serve as a salutary reminder that a confrontational approach will not work – even if the UK is not in quite the same position as Greece.

It is against this backdrop that Nicola Sturgeon has reactivated the prospect of another referendum on Scottish independence. Sturgeon’s position appears to be motivated by the fact that the Scottish people overwhelmingly voted to remain in the EU and they are certainly not keen on the hard Brexit option being driven by Westminster. In Sturgeon’s words, “all of our efforts at compromise have been met with a brick wall of intransigence.” And whilst many people will have sympathy with Sturgeon’s view on Brexit, there is also a sense that she is using this as a device to push for what the Scottish National Party really wants – and all it has ever wanted – which is independence from the rest of the UK. But under the terms of the Scotland Act, a referendum can only be held with the consent of Westminster – it is not in the gift of the Scottish government to call it. And with Whitehall likely to be completely preoccupied in dealing with Brexit, it certainly will have no appetite for a referendum within the next two years, as Sturgeon is demanding.

As for what the people of Scotland want, there appears to be no great appetite for independence amongst the electorate at present, according to recent polls. Nor is Scotland’s economic position any better than in 2014 – arguably it is worse (I will deal with the economic situation another time). But just like 2014, any referendum will ultimately not be fought on the basis of economic logic. Already up to a third of voters retain an open mind on the prospect of independence and it will likely to be an easier sell than it was the first time round, so it could yet gain a great groundswell of support.

All in all, Brexit threatens to turn the UK political scene into an unholy mess (if it has not done so already). There is a sense that the government only cares about the views of the 52% who voted for Brexit; the Labour Party, which is nominally the opposition holding the government to account, has gone missing in action, and the SNP wants only to distance itself from the whole show. There is nothing United in the Kingdom nor Great about Britain, and if we get the politicians we deserve, what does that say about the voters?

GDP: A question of input and output

The focus on headline GDP growth is a highly misleading macroeconomic indicator and is routinely used and abused by politicians, journalists and (some) economists. It is an aggregate measure of all output, income and expenditure activity and has numerous shortcomings, as I have discussed in previous posts (here, for example).

Precisely because it is an aggregate measure, the more rapid the growth in factor inputs, the more rapid is growth in headline GDP. Thus, for example, the more labour we allocate towards productive output, the more quickly will GDP grow. In the early stages of its expansion, the extraordinary rates of growth in China were due to rapid rates of population expansion which, between 1980 and 2000, boosted economic output by more than 20%. Strictly speaking, of course, we should use employment or labour force growth rather than headline population, but this is a decent proxy and in any case is easier to obtain on a cross-country basis. This methodology essentially gives a rough measure of the extent to which growth is driven by productivity and how much is simply attributable to labour expansion.

In a 1994 book, Paul Krugman noted that “productivity isn’t everything, but in the long run it is almost everything.  A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker.” So it is perhaps surprising to note that in the US between 1980 and 2007 fully one quarter of the increase in GDP was the result of an expansion of labour input, just as in China (see chart). This may go a long way towards explaining why although the US economy appeared to be growing rapidly and creating huge numbers of jobs, it never created the prosperity that politicians claimed.  By contrast, over the period 1980 to 2007, the UK experienced an average real GDP growth rate of 2.7% with GDP per capita growing at 2.4%. Thus, population accounted for just 9% of the rise in UK output over that period.

What is remarkable is how much of a change we seen across many industrialised economies since 2008. US GDP per head has slowed from 2.1% over the period 1980-2007 to 0.7% between 2008 and 2016. The corresponding figures for Germany are 1.7% to 0.9% and in the UK 2.4% and 0.4%. This is the much-discussed productivity puzzle which has exercised many fine minds over recent years. Nobody has a convincing explanation for such a slowdown, let alone how to resolve it, but a slowdown there has definitely been. If we accept Krugman’s view, the western economies appear to have a substantial problem in boosting living standards at the same pace as they did prior to the recession. And it is perhaps no surprise that people are unhappy with their economic circumstances with the result that we saw electorates vote for Brexit and Trump.

Indeed, although UK per capita GDP growth has slowed sharply since 2008, to the point that it took until 2015 for output per head to recoup the losses suffered during the recession, the slowdown in measured GDP has been less dramatic. What this implies, as the economist Simon Wren-Lewis has pointed out, is that immigration into the UK has helped to support measured GDP growth in recent years. Moreover, if immigration is curbed as a result of Brexit, an absence of any pickup in productivity suggests that UK measured GDP will also slow. With the UK government possibly poised to trigger Article 50 proceedings as early as next week, this is a message worth taking on board.

It also suggests that we should beware the pronouncements of politicians who extol the virtues of rapid GDP growth, as UK Chancellors are wont to do. An economy’s output performance depends on the quality of its inputs. GDP is not necessarily a measure of living standards: It just means that we produce more, but if there are more of us that is what we should expect – as anyone who regularly battles London commuter traffic will know only too well.