Truce or dare?

With every day that passes the economic case for Brexit crumbles before our eyes. Sensible politicians look on in horror as the zealots pursue a Brexit that satisfies “the will of the people” despite the fact that the Brexit they are proposing is nothing like the one promised almost three years ago. People were asked to vote on where they wanted to go, but not how they expected to get there. As we are now learning, the journey is likely to prove far more damaging than they were led to believe. I, for example, would very much like to climb Everest and would happily cast my vote for someone who could promise to get me there easily and safely. I am less keen on slogging up 8848 metres in the teeth of some of the worst weather on the planet whilst running the risk of hypoxia.

The events of today have made it clear just how the path towards the sunlight uplands of Brexit is crumbling beneath our feet. Let’s start with the politics and the news that seven MPs have resigned from the Labour Party to set up The Independent Group. This is a measure of the sheer helplessness felt by many Labour MPs who see their party drifting away on a sea of left-wing irrelevance following Jeremy Corbyn’s unwillingness to use his position to stand up to the damaging form of Brexit proposed by many on the opposition benches. Let us not forget that in summer 2016 Labour MPs called a vote of no confidence in leader Jeremy Corbyn following the EU referendum, which he lost by 172 votes to 40. However, he remained as party leader by a margin of 61% to 39% following a ballot of all party members in September 2016.

But we have been here before. In 1981 four MPs left the Labour Party as it drifted inexorably to the left, to form the Social Democratic Party. Whilst this was instrumental in forcing Labour to confront its internal issues, it was a multi-year process which succeeded in splitting political opposition to the Conservative Party which remained in office until 1997. As it is, current opinion polls suggest that the Conservatives are marginally ahead and unless the new political centre can rapidly gain significant momentum it is hard to see how this will change the political dynamics, unless it can gain support from Conservative dissidents (which currently looks unlikely).

It is far from sure that this will have much impact on the Brexit debate either. Seven MPs are hardly enough to change the world and there are just 39 days (936 hours) until the default option is triggered which will force the UK out of the EU unless something changes radically. Perhaps they will be able to put forward parliamentary amendments (e.g. attempts to postpone the Article 50 deadline) which will be easier to accept on a cross-party basis as they are seen to come from independent MPs and not those attached to any of the major political parties. But I will not be holding my breath. Nonetheless, as I noted in my previous post, today’s move is a belated recognition that the established political parties are more interested in appealing to the ideologues who form the core of party membership than the interests of centrist voters (something which is true of both parties).

However, it was the news that Honda is planning to shut its Swindon plant in 2022 that really should cause eyebrows to be raised. Local MP Justin Tomlinson noted in a tweet that Honda “are clear this is based on global trends and not Brexit, as all European market production will consolidate in Japan in 2021.” I refuse to accept that it has nothing to do with Brexit but there is a very good reason why Honda might want to consolidate production at home: Towards the end of last year Japan signed a trade deal with the EU that removes the 10% import tariff on Japanese cars and the 3% tariff on most car parts. So they don’t need the UK any more. And don’t say you weren’t warned. I pointed out in 2015 that “international companies already have to carefully balance the net benefits of operating in the UK given that business operating costs are higher than in the EU8 countries. Brexit may make this calculation more clear cut.”

Without wishing to compare the ideologies underlying the two processes or trivialise historical events, I have been struck in recent months by the logistical parallels between the progress of the Nazi invasion of Russia in 1941 and the Brexit process. Both were the product of an ideologically motivated desire to achieve bigger goals (the defeat of Communism/throwing off the yoke of the EU), which were preceded by intense planning but both were under-resourced campaigns (logistically in the Russia case; intellectually in the Brexit case). You can argue that both campaigns started well, achieving many of their initial goals, before becoming bogged down by harsher conditions (weather/economic reality) and the sheer weight of the opposition (Soviet troops/the EU’s economic heft). But the key point is that the military campaign ran out of steam following defeat at the Battle of Stalingrad when the magnitude of the task facing the Wehrmacht became startlingly clear.

I wonder whether the Brexit campaign has yet reached its Stalingrad moment. The Nazis clearly learned nothing from Napoleon’s attempt to invade Russia in the same way the Brexiteers appear not to have learned the lesson of those countries which tried to throw their weight around with the EU. Just to push the parallel further, both campaigns kicked off in June (almost to the day). Thirty two months after the start of the Russian campaign the tide had decisively turned in the Soviets favour, although it was to be another 15 months before the whole episode was concluded. After a similar period since the EU referendum, Brexiteers also appear to be fighting a losing battle and whilst they clearly will not give up, they cannot win. They might force the UK out of the EU without a deal, although I still maintain that they will be prevented from doing so, but they cannot deliver on their promise to deliver an economically brighter future.

Each decision by the likes of Honda or Nissan to scale back production or to abandon expansion plans represents potential jobs that will not be created. Each decision by politicians to abandon the ideological path which their leaders are trying to follow represents a step away from the cliff edge. Rather than fight Brexit battles which threaten to damage the economy, it is time to call a truce.

Left or right?

Party conferences are usually best avoided apart from those with a genuine interest in the minutiae of party politics. This does not prevent the UK media from dissecting the speeches of senior figures for clues as to what policies are likely to be presented (or more likely ignored) by the time the next general election comes round. But this year is different. The world’s media paid attention to last week’s Labour Party conference, and will focus on next week’s Tory conference for the same reason: They want to understand what the UK political establishment plans to do about Brexit.

Dealing first with the Conservatives, because that is the easiest part, we pretty much know that Theresa May will sound hawkish to reassure the party faithful that her government has no intention of backing down in the face of intimidation from Brussels. Expect a show of bravado with the underlying theme of “no surrender”, partly because that is what the party wants to hear but also because May is under pressure to save her political skin following repeated attempts by Boris Johnson to convince the electorate that he is the man to deliver Brexit (yawn!).

But Labour’s conference was a genuinely fascinating affair as it struggled to deal with the Brexit question. It is well known that leader Jeremy Corbyn is a Eurosceptic but a large majority of party members are opposed to Brexit. To complicate matters further, a large proportion of voters in Labour’s strongholds outside London were in favour of Brexit. Consequently, the party has struggled to come up with a coherent policy over the past couple of years. Last weekend, there was apparently much heated discussion as senior party officials wrestled with a compromise wording for the conference Brexit motion. Eventually, Labour agreed to keep a second referendum on the table but there was disagreement as to whether this included an option to remain in the EU. The shadow chancellor, John McDonnell, who is regarded by many as the keeper of the socialist flame, insisted that a referendum would only be called on the terms of any deal agreed with Brussels. But Keir Starmer, shadow Brexit secretary, won a standing ovation from the conference when he declared in an off-script speech that “no one is ruling out Remain.” So that’s all clear. Or not!

Irrespective of what is actually on the ballot paper, Labour appears to be committed to a referendum on something. There again, Tony Blair promised a referendum on euro membership that never happened. Indeed, it made it into Labour’s 1997 election manifesto. This has heightened the widespread belief that what Labour really wants is to get its hands on the levers of power – quite rightly, as that is what politicians are supposed to want. But at what price? Corbyn has spent 35 years in parliament protesting against the status quo. So whilst we know what he is against, voters do not know what he stands for.

John McDonnell’s speech to the conference this week revealed a radical economic platform. There is a general belief within the Labour hierarchy that the Conservatives’ social policy plans are so unpopular that Labour can afford to be upfront about its economic plans (they are probably right about the former but I am less sure of the latter). McDonnell outlined a compulsory share ownership scheme under which 10% of the equity in the UK’s large companies would be gradually handed over to workers. In addition, he announced plans to give workers one-third of the seats on company boards, and offered fresh details of proposals to nationalise utilities in the water industry. It is an agenda designed to frighten corporate Britain and the dilemma for many voters is whether this radical agenda is a price worth paying for reversing Brexit. For sure, the worst of all possible economic outcomes would be Labour’s economic plans AND Brexit, and the polls suggest that neither Labour nor the Conservatives are able to command a lead. Voters appear to be turned off by Tory infighting over Brexit and their inability to deliver what they promised, but equally they do not trust Labour in key areas of policy.

The international press also took a sceptical view. The respected Neue Zürcher Zeitung spoke for many by suggesting that Labour is putting a desire for power ahead of the national interest. Corbyn’s inability to articulate what he wants from a second referendum suggests it is a prospect to be dangled in front of the electorate in order to realise his true objective of taking Britain in a new direction. Le Monde also questioned whether the chaos of Brexit could indeed bring Labour to power.

Perhaps more than anything, the events of the past two years reveal the extent to which the policy failures of successive governments have been laid bare. Brexit was in part the result of the failure of governments to listen to the electorate on a wide range of issues, against a backdrop of extreme austerity. This has created a policy vacuum in which policies advocated by extreme free-marketeers and old-style socialists compete with each other in a way we have not seen for 40 years. It sometimes feels that taking back control really means taking the UK back to the 1970s. But much as I enjoyed that decade - it defined the music I grew up with for one thing - I would much rather look forward than backwards.

A last word on election economics

I was asked last week by the Sunday Telegraph to rank the economic policies of Labour and the Conservative parties as part of a larger survey group. The story duly appeared under the heading “Economists back the Tories - but remain underwhelmed” in which it was suggested that while Dixon’s “criticism of the Tories centres around their fixation on austerity, he is more scathing about Labour’s plans.” Whilst I am grateful for the press coverage, and my comments were reported accurately, I do believe they were given a spin which was not warranted by the totality of my remarks. In the interests of balance, therefore, I reproduce below the full transcript of my answers to the Telegraph’s survey. 

Tax & spending 

CON 3; LAB 3 (Marks out of 10 where 10 is good and 1 is poor)

There are many good things about the  Labour plans: (i) they are semi-costed so we have some indication of how much they want to spend; (ii) There  is also something to be said for establishing a National Investment Bank even though it will not be able to generate the £250bn in infrastructure spending that Labour plans. Far better to use it as a conduit to fund SME lending as in Germany and the US, where the KfW and SBA operate.  The bad news (and the reason I give the overall plan such low marks) is that too much emphasis is placed on taxing higher earners and corporates. In other words, the tax base is too narrow. For a party which seeks to promote equality, this is merely a “soak the rich strategy” which will change the behaviour of those caught in the tax net. It is thus unlikely to generate as much revenue as planned. In any case a penny on the basic income tax rate yields 4x as much revenue as a penny on higher earners. And whilst the idea of renationalising parts of the infrastructure sounds attractive, this will result in as many problems as it solves. The education pledge is too expensive given the  current numbers going into education. Abolishing university tuition fees is a good thing, but it would have been more affordable 20-30 years ago. However, Labour deserves credit for sparking a debate on the role of the state in the economy.

This is more than can be said of the Conservatives, whose economic manifesto offered nothing new. The commitment to balance the budget only by the mid-2020s does raise a question of whether the austerity of the last 7 years has been worthwhile. The public sector is creaking at the seams and it is not in any position to withstand a further round of austerity. As the Institute for Government has pointed out “the Government is struggling to successfully implement the 2015 Spending review … [with] clear signs of mounting pressures in public services.” A policy of more austerity will be self-defeating and I would like to think that Philip Hammond will take a  less draconian stance than George Osborne (the jury is out but his hands are tied by Brexit). I maintain that the commitment to reducing corporate tax to 17% is a mistake because it robs the Treasury of revenue and it is not as if HMRC is getting the corporate tax receipts it already believes it is owed. 

Immigration 

CON: 3; LAB 5

The idea that we can get net immigration back to the tens of thousands is economically illiterate and ultimately self-defeating although I understand why the Conservatives made the pledge for political reasons. However, targeting net immigration by focusing only on inflows, and continuing to classify students in the numbers makes little sense. It remains to be seen how a policy of “allowing us to attract the skilled workers our economy needs” is compatible with the targets. Labour is vague on immigration although they have sensibly resisted giving a pledge on numbers. The commitment to protecting the rights of EU workers already in the UK will play well in Brussels. 

Jobs & pay 

CON: 2 ;  LAB: 2

In this day and age, governments don’t really deliver jobs – other than by setting overall conditions – and have little influence over pay, except by controlling the minimum wage. Labour’s planned figure of £10/hour is probably not unreasonable although it is a big stretch from where we are today which will squeeze smaller businesses. The Conservative strategy which does not give an outright figure, but plans 60% of the median wage, is probably less of a hostage to fortune. The Conservatives are probably more realistic in the sense that they did not talk about creating jobs but it is difficult to give marks to either side because I am not convinced that they said very much, However, both get credit for recognising worker rights though the Labour plans have a whiff of the 1970s about them (“empower workers and their trade unions”). 

Industrial strategy 

CON: 6; LAB: 4

Both parties sound good on paper but there is little new here. Both sides offer a tinkering at the margin approach – nobody would dispute Labour’s view that we need to improve the economy’s skill levels but this will take years to show any improvement and it was vague on how to achieve it. The Labour manifesto had nothing substantive to say on productivity, which is the UK’s Achilles Heel at present and the Conservatives score a little higher, having already announced their National Productivity Investment Fund. My concern, however, is that neither party will be able to do much in an environment where global forces will play a major role (e.g. automation).

Social care & pensions 

CON: 3; LAB: 5

The Conservatives scored an absolute own goal with their initial plan on old age care provision, which was far less generous than that scheduled to come into operation in 2020. It ignored the Dilnot Commission proposal which advocated a cap on costs, thus mitigating against efforts to create a market for insurance in this area. Although they have backtracked, the damage is done. Sensible to remove the pension triple lock. Labour sound more convincing on this issue but the problem is how to pay for it. They are relying on squeezing higher earners and it is not clear whether they can afford all their commitments given the demands from other areas.

Totting up the marks, that amounts to 17/50 for the Conservatives and 19/50 for Labour (versus average marks of 23/50 for the Conservatives and 18/50 for Labour). Not exactly a ringing endorsement for either party, as the headline suggested, but not enough in my case to suggest a bias towards the Conservatives.

Nearly there ...

As the UK election race unfolds, latest evidence continues to point to the Conservatives winning next week’s ballot.  However, the analysts at Electoral Calculus currently reckon that their majority will come in at 74 seats compared to an estimate of 168 three weeks ago (the current margin is 17). One poll released earlier this week even indicated that the Tories might lose their overall majority by winning fewer seats than they have now, although this was generally dismissed as an outlier. But the shift in the polls has rattled the markets, and foreign investors now see a risk that the election will not be the foregone conclusion it seemed a few weeks ago (see chart).

As I noted back in April (was it really that long ago?) this election is being fought purely for tactical reasons – and indeed the prime minister admitted yesterday that the decision to call yet another plebiscite was driven by Brexit-related reasons. In my view, this is nonsense. The rest of the EU does not care how large the PM’s majority is: The UK will still be in a minority of one in the Brexit negotiations. But the size of the majority matters for May herself. A parliamentary majority around 50 (still decent, let’s not forget) would be seen as the equivalent of a draw. Anything less would put the PM in a difficult position as she has to deal with the right-wing of her party, which has a habit of making life difficult for Conservative prime ministers. In effect, she needs a big win to give her a personal mandate.

So why are the polls narrowing? It can simply be boiled down to two factors: personality and policies. As George Parker wrote in the Financial Times today, “Theresa May thought a snap election would empower her, but what started in April as a quest for a “strong mandate” to deliver Brexit is threatening to leave her diminished. Polls suggest the more people see of her, the less popular she becomes.” Her main opponent, Jeremy Corbyn, started out as a no-hoper who couldn’t be trusted to run a bath, let alone the country, yet he is the one who has looked at ease in dealing with the hostile questioning (the odd brain fade during interviews notwithstanding). Corbyn has had to deal with questions about his past support for terrorist organisations and his willingness to press the nuclear trigger in the event it becomes necessary, and all-in-all has come out of it rather better than most people expected. This does not make him prime minister-in-waiting, however. Corbyn has spent the whole of his parliamentary career (34 years) opposing the mainstream of his party on most key issues. He will struggle to find sufficient MPs loyal to him in the unlikely event he becomes PM.

So if the personalities are not very appealing, we must judge them on their policies. Here again, both sides are found wanting. In summary, the Conservatives propose too much austerity and Labour promises too much tax-and-spend. Neither has talked enough about the single biggest issue facing the UK during the next parliamentary term – Brexit. Indeed, the prime minister seems to be asking the electorate merely to trust that she will “deliver the best deal for Britain.” That is not good enough. I would be more inclined to listen to a politician who acknowledges what economists have been saying for the last four years, that Brexit comes with a cost – a big one – and that they have a plan to deal with it. A party which proposes that “no deal is better than a bad deal” does not cut it.

Meanwhile, Labour’s tax-and-spend policy is open to the criticism levied by Conservative politicians that “there isn’t a magic money tree” to fund their plans. This is, of course, spot on although if I were Jeremy Corbyn, I would be pointing out that senior Conservative politicians such as the Foreign Secretary only twelve months ago supported the idea that leaving the EU would immediately mean that the UK could devote an additional £350m per week to the NHS.  The manifesto analysis conducted by the IFS last week provided a pretty damning assessment of the fiscal plans of both sides arguing that “neither sets out an honest set of choices.” Though as an aside, I found this blog piece by John Weeks an interesting insight into the shortcomings of the IFS’s analysis.

As we head towards polling day, I get the sense that many people are unenthused by the choices on offer. I almost have feelings of nostalgia for Screaming Lord Sutch and his Monster Raving Loony Party. Unlike Lord Sutch, the MRLP is still with us, however, and amongst their manifesto (or as they call it, manicfesto) commitments for 2017 are a pledge to “nationalise crime to make sure it doesn’t pay,” “reducing the alphabet to 23 characters. This will start by cutting the letters N. H. and S” and giving atheism charitable status on the grounds that it is a “non-prophet organization.” I’ve heard worse.

Labour's fiscal policy: Marks for effort

The UK election campaign, which is being met with indifference at home never mind abroad, took a radical turn today with the publication of the Labour Party’s manifesto. Much of what was leaked last Thursday was included in today’s plan, with one or two additions, and it is very much a series of tax and spend proposals which offers a radical alternative to the economic status quo of market over state. It is, I suspect, the economic plan of a party which does not expect to win an election: Many of the proposals would simply not be acceptable to higher earners or corporates, which will bear the brunt of additional tax rises. At a time when companies have to think about where they want to be located post-Brexit, it is a plan which will encourage footloose capital to move elsewhere. Nonetheless, it does raise very big questions about the nature of the state and the role of fiscal policy, which have been neglected for too long.

The philosophy which the UK electorate has bought into since Thatcher’s time is that a relatively small state is a good thing and that markets provide freedom of choice. But this is not always true. For one thing, private companies are not always as efficient as their proponents claim because they waste resources in the competitive process which could otherwise be used more effectively for service provision – a bit like moving parts which generate heat rather than mechanical energy. Whilst on the whole, they do deliver lower cost services there are real questions as to whether private entities are run for the benefit of shareholders or their customers.

In a competitive market the two sets of interests are aligned, but certain industries are best viewed as natural monopolies. Gas, electricity and water supply all fall into this category and so unpopular is the notion that private sector energy companies are ripping off the consumer, that the Conservatives have stolen one of Labour’s old ideas by planning to impose price caps (what price free markets?). Nor are huge infrastructure projects  necessarily suited to a private sector which does always not have the scale to manage them properly. For example, the UK has outsourced the construction of the Hinkley Point nuclear power station to EDF – a French state-owned company – and a state-backed Chinese entity. The first decade after the privatisation of the UK rail network was characterised by a shambolic series of events which means that today, the Labour Party’s policy of re-nationalising the rail network is actually very popular (it plans to do this as local franchises expire which means that the cost to the Exchequer is limited).

Of course, not all privatised utilities are bad. No-one would seriously advocate renationalising the telecoms network. But it is right to have a debate about which industries require more state involvement, and we should not dismiss the issue as being one for the socialists. Incidentally, the privatisation programme sparked by the Thatcher government in the 1980s was designed to create a nation of small shareholders, in which households held a stake in the nationalised utilities. But that idea faded quickly as shares were snapped up by institutions which in turn sold out to foreign utilities. Whatever the rights and wrongs of today’s energy and water markets in the UK, what we have now is not what was envisaged in the 1980s.

Looking more closely at Labour’s plans, there was more detail on the tax and spending pledges which will result in a tax rise of £48.6bn by the end of the next parliament, or just over 2% of GDP. According to the sober analysis of the Financial Times, this would put taxes relative to GDP at their highest since 1949. But even then, the state will still be significantly smaller than in many other European countries. As I noted last week, a large chunk of the additional taxes will fall on corporates, which are expected to contribute almost £20bn of the £48.6bn increase, and another £6.4bn from higher income taxpayers in what the Daily Mail helpfully described as Corbyn’s class war. What was truly radical was the idea that a Labour government would “consider new options such as a land value tax” which ironically was supported by the likes of Adam Smith, a hero of many on the Conservative right.

It is questionable whether these figures would ever be realised, however. Raising taxes changes the behaviour of those on whom the tax is levied so if tax elasticities are high, revenues may well be far lower than anticipated. Nonetheless, Labour did a good job of allaying fears of an unfunded rise in current spending, even if many people will be less than happy about the prospect of higher taxes. A potential Labour government will, of course, have to borrow to fund its capital spending plans. That is normal. At issue is how much it would need to borrow and what would the market charge. I suspect we will never get the chance to find out.

Even if one does not like the ideas presented today, they represent a rather more grown-up approach to the question of fiscal policy than we have become used to in recent decades. If we want a better healthcare system, we are going to have to pay for it. More policemen? Fine, but the money has to come from somewhere. There is, however, a whiff of the 1970s about the plan. It fails to account for the fact that more money does not necessarily mean better services. It also treats the UK as a small closed economy whereas in reality a globalised environment will pose limits on the government’s ability to operate the fiscal levers. A former Labour prime minister, Jim Callaghan, recognised as such in 1976 when he said “We used to think that you could spend your way out of a recession, and increase employment by cutting taxes and boosting Government spending. I tell you in all candour that that option no longer exists.” Still, I will give Labour marks for trying, and we should not be too surprised if some its ideas ultimately end up being adopted by the Conservatives. It would not be the first time.

The case for a National Investment Bank

One of the policy proposals put forward in the leaked Labour Party manifesto last week was the establishment of a National Investment Bank (NIB) to facilitate £250bn of spending on infrastructure over the next ten years. There was no detail in the document about how this might be set up, but there is some merit to the idea if done properly and in this post I offer a look at how it might work.

It is important to be clear at the outset what it should not be. It should not be a conduit for monetary creation by the Bank of England – the so-called People’s QE plan proposed by Jeremy Corbyn when he took over as Labour leader in 2015. PQE essentially requires the central bank to buy the bonds necessary to capitalise such an institution. But this policy is fraught with danger primarily because it erodes the boundaries between government and central bank to an unacceptable degree. In the form envisaged, it allows government to force the central bank to create money to finance whatever projects it deems fit. Moreover, a policy which requires monetary creation on such a scale would also have potential inflationary consequences and no central banker worth their salt is ever likely to endorse such a plan.

That said, there is no reason why a NIB should not work. The UK has tried it before and it was remarkably successful though perhaps not in the way initially envisaged. The Industrial and Commercial Finance Corporation (ICFC) was set up in 1945 by the Bank of England with funding from major commercial lenders to provide capital to small and medium-sized companies. In order to free itself from the constraints of relying on the clearing banks for funds, the ICFC began to tap the market to raise capital. This had an adverse side effect in as much as it raised pressure to generate greater returns on equity, which in turn led to a shift away from longer term, less attractive returns which its core mission delivered, to shorter term higher return projects, which caused problems during times of economic downturn. But by the 1980s it had shifted focus to become a leading provider of finance for management buyouts and had expanded internationally. It became a public limited company in 1987, when the banks sold their stakes, and it was fully privatised in 1994.

Currently, the UK is the only G7 economy not to have an institution which provides finance to the SME sector. In Germany, the Kreditanstalt für Wiederaufbau (KfW) has supported industry since 1948 and in the US, the Small Business Administration (SBA) has operated since 1953. Admittedly, the UK government did dip its toes into the water recently when it established the Green Investment Bank (GIB) in 2012. But despite apparently being successful, it was sold to Macquarie Bank last month for a price (£2.3bn) less than the initial £3.8bn of capital injected by the government.

In an excellent paper commissioned for the Labour Party in 2011, the lawyer Nick Tott outlined the case for a NIB.  But just to show that the case was not party political, former MPC member Adam Posen made a similarly excellent case in a 2011 speech which suggested that not only was there a case for a NIB, but that there was a need for an “entity to bundle and securitize loans made to SMEs … to create a more liquid and deep market for illiquid securities.” The biggest question remains how to capitalise such an institution. The government could commit up to £5bn as initial seed capital – after all it put almost £4bn into the GIB – and it could issue another (say) £5bn of bonds backed by Treasury guarantee. In future years it could divert part of the income generated by National Savings and Investments (NS&I) which raised £11.3bn for the Exchequer in 2015-16 and has assets of £120bn.

Admittedly, this is pretty small scale stuff and would be in no way able to fund the £25bn per annum of infrastructure which the Labour Party is calling for. This is probably a good argument in favour of limiting the remit of such an institution to SME lending rather than big public infrastructure projects. That, after all, is what such institutions do in other countries. Moreover, as Tott points out, it “would need a wide measure of independence from government.” It cannot simply be an arm of government to finance all sorts of pet projects, otherwise those who brand it a return to 1970s-style profligacy will likely be proved right.

A NIB would have to be run along commercial lines. As Posen pointed out, “The existing banks will scream about the unfair cost of capital advantage such an institution would have, but ... since the major banks in the UK have benefitted from a too-big-to-fail situation, any disadvantage they have in funding conditions is offset by the funding advantage they have over smaller or newer financial institutions, which they have gladly accepted. [Admittedly] public sector banks do tend to underperform private banks in credit allocation, and do tend to erode private banks’ profits. Yet most if not all countries have ongoing public lenders of various types (even the US has the SBA), and their existence on a limited scale, while perhaps wasteful at the margin, does not lead to the destruction of the private-sector banking systems in those countries … Let us remember that the UK and other western private-sector banks did that themselves during a period of financial liberalization and privatization unprecedented in postwar economic history.”

There are good reasons why the UK needs to do something to raise investment. For one thing, it is about to lose its EU funding which will put a hole in the transfers to many of the English regions (places like Hartlepool, which were very much pro-Brexit, have received considerable funding in recent years). A more generic macroeconomic problem is that the rate of business investment growth has been below the rate of depreciation since the great recession. This is not an issue which gets much airplay in the big picture story, and I am not sure of the extent to which it represents a change in business behaviour or whether it is a measurement problem. But it means in effect that the UK capital stock is declining, which may be one explanation behind the slowdown in potential growth in recent years. The UK needs to raise its investment levels. Whether a NIB is the right way to go about it remains to be seen. But it is an idea which should not be dismissed out of hand.

High Labour costs

Four weeks from today, the main UK political parties will go head-to-head in an election we do not really need to have. No prizes for guessing that Brexit will be the key battleground on which it will be fought. But with changes in the leadership of all main parties since 2015, this really should be an opportunity to address many of the key economic issues which have plagued the UK over the last seven years. The lack of investment; the over-reliance on austerity and a chance to reset the terms of the EU debate which David Cameron got so totally wrong and which Theresa May is not helping to improve. One might have thought that by now, the parties would have their economic plans ready to roll in order to give us time to assess the issues. Well, not exactly. The Conservatives are not planning to publish their manifesto until next week, and the best we have from Labour is a leaked draft which was splashed all over the press, framed as a socialist document worse than the longest suicide note in history, as their 1983 agenda was dubbed.

If you actually read through the leaked draft of the Labour Party manifesto, rather than rely in the headlines which tell us how very socialist it is, there are some rather interesting ideas in there. Jeremy Corbyn, for all his many faults, is trying to fight an election on issues of fairness and responsibility. The key message is that the vast majority of the electorate has been squeezed since the financial crisis-induced economic collapse, and Labour wants to do something about rectifying it. Thus the plans outlined so far indicate more spending on the NHS and the creation of a National Care Service; the building of more new houses; the scrapping of university tuition fees and the reintroduction of student maintenance grants. Add in the prospect of establishing a National Investment Bank to facilitate £250bn of spending on infrastructure over the next ten years (which is not a bad idea and I will deal with it another time), and you have what sounds like a classic fiscal stimulus. I would use the phrase “pump priming” but Donald Trump has apparently just invented it. (“Have you heard that expression used before? Because I haven’t heard it. I mean, I just…I came up with it a couple of days ago and I thought it was good”).

There is just one tiny problem: The plan sounds horrendously expensive – and that is before we even talk about the renationalisation of rail and energy. Let’s start with education. The Institute for Fiscal Studies reckons that Labour’s Higher Education policy would raise the deficit by over £8bn (about 0.5% of GDP at current prices). Investing £250bn in infrastructure over a ten year period implies a boost equivalent to 1.5% of GDP per year. To secure the financing, taxes must inevitably go up. Labour has suggested that it will raise income taxes on those earning over £80,000 per year (the top 5%), though has not said by how much, and “will ask large corporations to pay a little more.”

Some back-of-the-envelope calculations suggest that there are 1.1 million taxpayers earning between £80k and £150k per year paying higher rate tax at 40%, and 0.3 million earning above £150k paying a 45% rate. This means that only 25% of all higher rate taxpayers earn more than £80k. We can thus take the HMRC’s tax rate elasticity multiplier which calculates the full effect of raising higher rates taxes, and assume a 25% efficiency rate compared to the full impact. Running through the numbers, each 1% rise in tax on those earning above £80k per year will yield around £0.5bn in revenue per year. If the tax rate is whacked up by 4 to 5 percentage points, we could thus fund the education costs. The ready reckoner also suggests that each 1% on the corporate rate will reap around £2.4bn per annum. Thus, reversing the planned 3 percentage point cut in corporate taxes by 2020 yields another £7.2bn over three years. A Labour government could even raise corporate taxes back towards 25% over (say) five years, yielding an extra £12bn by 2022. Adding up these numbers (an effective 8 percentage point rise in corporate taxes and 5 points on taxes for higher earners), we thus start to get close to the £25bn needed for annual infrastructure spending.

But funding the reprivatisation would be enormously expensive. A brokerage report by Jefferies in 2015 put the cost of renationalising the energy sector at £185bn (~11% of GDP). They also pointed out that “if a future Labour government restricted itself to just acquiring the UK assets of the big six generators plus National Grid, the cost would be £124bn.” I have no idea what renationalising the rail sector would cost but let’s say £60bn for the sake of argument. An increase of £184bn in public outlays would raise the debt-to-GDP ratio by 11% at one stroke. Even assuming this is not a problem, the markets would almost certainly demand a higher risk premium on gilts, so debt servicing costs would rise. But here is the kicker: Labour has proposed a Fiscal Credibility Rule which plans to reduce the current balance to zero on a five year rolling timescale (which sounds to me like a never-never rule), but also that the debt-to-GDP ratio be lower at the end of the parliamentary term than at the beginning. Nationalising rail and energy would blow a hole in that, but fortunately Labour proposes to suspend the operation of the rule so long as monetary policy is operating at the lower bound. So that’s all right then!

All of these numbers are back of the envelope calculations and in no way constitute a detailed analysis of the costs.  Although many commentators liken this document to Labour’s 1983 election manifesto, its 1974 document which called for “more control over the powerful private forces that at present dominate our economic life” was at least as damaging because the party was actually in government. Labour’s main failure in the 1970s was to recognise that the poor performance of the British economy was not due simply to the failings of the capitalist system: It was largely due to an insular view of the economic problems. It feels very much like we are at that point again today.

Abbott without the Costello

For many years I have tried to keep politics separate from economics but these days it is virtually impossible, particularly when looking at UK related issues. Regular readers will know that I do not have a lot of time for the current UK government’s Brexit strategy. But, in the spirit of impartiality, never let it be said that I do not apply the same rigorous standards to the policies of all parties. This morning’s car-crash radio interview  by shadow Home Secretary, Diane Abbott, highlighted once again that it is not only the Conservatives who struggle to get their economic policies across.

In the interview, Abbott tries to explain how the opposition Labour Party plans to fund an expansion to the number of serving police officers. You really have to listen to the interview to do it full justice, but for the record I set out parts of the transcript below. 

Nick Ferrari (interviewer): Where will the money come from Diane Abbott? Good morning. 

Diane Abbott: The money will come from reversing some of the tax cuts for the rich that the Tories have pushed through. And the tax cut we're specifically identifying to pay for the 10,000 policemen is the cut in capital gains tax. 

NF: So how much would 10,000 police officers cost? 

DA: Well, if we recruit the 10,000 policemen and women over a four-year period, we believe it will be about £300,000. 

NF: £300,000 for 10,000 police officers? What are you paying them? 

DA: No, I mean, sorry... 

NF: How much will they cost? 

DA: They will cost, it will cost about, about £80 million. 

NF: About £80 million? How do you get to that figure? 

DA: We get to that figure because we anticipate recruiting 25,000 extra police officers a year at least over a period of four years. And we are looking at both what average police wages are generally but also specifically police wages in London. 

NF: And this will be funded by reversing, in some instances, the cuts in capital gains tax. But I'm right in saying that since Jeremy Corbyn became leader of the party, that money has also been promised to reverse spending cuts in education, spending cuts in arts, spending cuts in sports. The Conservatives say you've spent this money already, Diane Abbott. 

DA: Well the Conservatives would say that. We've not promised the money to any area, we've just pointed out that the cuts in capital gains tax will cost the taxpayer over £2 billion and there are better ways of spending that money. But as we roll out our manifesto process, we are specifically saying how we will fund specific proposals. And this morning I'm saying to you that we will fund the 10,000 extra police officers by using some - not all, but just some - of the £2 billion. 

NF: But I don't understand. If you divide £80 million by 10,000, you get £8,000. Is that what you are going to pay these policemen and women? 

DA: No, we are talking about a process over four years. 

NF: I don't understand. What is he or she going to get? Eighty million divided by 10,000 equals 8,000. What are these police officers going to be paid? 

DA: We will be paying them the average... 

NF: Has this been thought through? 

DA: Of course it's been thought through. 

NF: Where are the figures? 

DA: The figures are that the additional cost in year one, when we anticipate recruiting about 250,000 policemen, will be £64.3 million. 

NF: 250,000 policemen? 

DA: And women. 

NF: So you are getting more than 10,000. You're recruiting 250,000? 

DA: No, we are recruiting two thousand and - perhaps - two hundred and fifty. 

NF: So where did 250,000 come from? 

DA: I think you said that, not me. 

NF: I can assure you you said that, because I wrote it down.

It was shambolic and described by one journalist as the worst interview from a front line politician he has ever heard. There is, actually, a policy in there. Indeed, I have raised the issue of police funding in a previous post (here). But the whole affair gave the impression of a politician who was ill-prepared and a policy which was badly thought-out. I have done my share of media interviews in my time, and I know how easy it is to have a brain fade. But this is a politician seeking high office, trying to put across one of their key policies. Despite the fact that the apologists will say we should not allow the presentation to get in the way of the message, the fact is if a senior politician cannot prepare for a radio interview and get their facts straight, what chance would they have when faced with the difficulties of Brexit negotiations?

All this undermines the opposition’s case to be taken seriously at a time when the government is open to criticism on its track record in managing public spending, and will reinforce the media view that Labour cannot be trusted on key policy matters. Now more than ever, the UK needs effective government and a strong opposition able to hold it to account. On matters of economic policy, the government is getting off far too easily. The prime minister struggles to answer when pinned down on points of detail, but wriggles out of it by repeating to her interviewer that she will bring “strong and stable government.” It is the soundbite of the election campaign so far.

But it is a slogan, not a policy. Faced with the Scylla of the prime minister’s position and the Charybdis of Diane Abbott’s, it is hard to avoid the view that the electorate is not being well served by its politicians. Twenty years ago today it all seemed so different, when a freshly minted prime minister in the form of Tony Blair, marched into Downing Street promising to bring a fresh approach to government. Blair has come and gone, and is widely reviled - even by his own party. But his ability to communicate was first rate. The inarticulacy which characterises today's policy debate would simply not be allowed to stand.

Labour pains

The announcement that Jeremy Corbyn has been re-elected as Labour Party leader here in the UK reflects the profoundly depressing state into which Western European politics has sunk. He professes to offer "a new kind of politics." In reality he is offering the same left wing ideas which were decisively rejected more than 30 years ago. Many people do indeed want a new kind of politics. But I suspect they don't want his.

Corbyn is nothing more than an idealist, which would be great if he were not the Leader of Her Majesty's Loyal Opposition charged with holding the government to account and seeking to form the next government. We know what he is against but less about what he stands for. Corbyn is opposed to the market capitalism espoused by the Conservatives and which so many people have railed against, and he taps into those who believe that the fiscal policy offered by George Osborne was brutal and regressive. Whilst it is perceived to have favoured the rich at the expense of the poorer elements of society far more than it actually did, it created the conditions for a political alternative to act as a counterbalance to try and heal some of the social divisions which it created. But nobody has a clue what sort of policies Corbyn actually advocates, and his leadership performance after one year in the job has been dreadful. Over the summer Labour MPs refused to back their leader following his dismal non-performance in the EU referendum and this was followed by the likes of Thomas Piketty, Simon Wren-Lewis and David Blanchflower, who all sat on Labour's economic advisory committee, distancing themselves from Corbyn’s team. 

In Blanchflower's words "Corbyn doesn't seem to care about being a leader of an opposition party. He seems more interested in addressing crowds of supporters around the country. It doesn’t seem to matter to him – although it should – that three-quarters of his MPs, who doubt his leadership qualities, rightly passed an overwhelming vote of no confidence against him. He should have quit. He doesn’t have enough MPs who support him to be able to form a complete shadow cabinet. Incidentally, if there were even the slightest prospect that he could become prime minister, the bond and equity markets would eat him for lunch."

It strikes me as bizarre that 313,000 of the Labour Party’s 600,000 members have chosen a leader who will almost certainly be soundly beaten in any election. If party members really  care about choosing someone who can achieve the things the party proclaims to stand for, they should at least choose a leader who has a fighting chance of winning the popular vote. When the majority of the party's MPs do not back their leader, they have no chance.

The UK’s domestic political shenanigans have not gone unnoticed abroad, and the German newspaper Die Welt notes that Labour's irrelevance is dangerous for Europe. At a time when the government is trying to negotiate an exit from the EU, the Labour Party is so self-absorbed that it is in no position to hold the government to account. When we live in a surreal world where  arch-Brexiteer Boris Johnson is the foreign secretary and he is still not the biggest incompetent in the House of Commons, you know that something is sadly wrong with the state of British politics. That said, when Beppe Grillo, an Italian comedian, can turn his Five Star movement into a national political force, you realise that the malaise runs throughout European politics.

Tony Blair may be reviled as Labour leader but he knew very well that British elections are won by capturing the political centre. As he put it, the Labour Party needs to be “the face on the placard” rather than the protester holding it for a chance in government. People in the party today "don’t really want to be in power, they want to make the people in power respond to their concerns." Until that changes Labour will not be a serious political party, they will simply be seen as a protest movement. And in the current political climate, that is very dangerous for the health of our democracy.