Water, water ...

One of the motivations for setting up this blog eight years ago was to highlight that continued reliance on the private sector for solutions to economic problems is a far from optimal strategy (see my June 2016 post, here). The recent furore regarding the failings of the UK water industry, along with the vexed problem of how to organise the rail network, are examples in a long line of businesses which have failed to live up to post-privatisation expectations. At a time when government is vexed by the problem of persistently low productivity, this makes it all the more important that infrastructure works efficiently.

Looking back to the 1980s and 1990s, you might recall that one of the main arguments advanced by the Conservative governments of the time was that the private sector would run businesses more efficiently and productively than the public sector. By introducing market discipline, competition, and incentives for innovation, this would lead to cost reductions and improved performance. In addition, private companies would have stronger incentives to improve service quality and customer satisfaction in order to attract and retain customers. While there were examples of industries which did benefit from a return to the private sector – telecoms being the prime candidate, which gained from a technological revolution – in many instances, privatisation simply meant swapping a public sector monopoly for one in the private sector. As a result, they had little incentive to innovate and could rely on a captive market to sustain revenues.

Where did it all go wrong?

Evidence to suggest that the water industry has not generated the post-privatisation efficiency gains that were claimed for it comes from a study by the consultancy Frontier Economics published in 2017 (chart below). Their analysis suggests that total factor productivity in the water industry did pick up immediately after privatisation but that it quickly slowed thereafter, doing nothing to dispel the suggestion that the industry has lived off the assets it inherited at the time of privatisation in 1989.

Yet the failings of the privatisation model introduced in the UK over the last thirty-odd years go far beyond the shoddy way in which customers are treated (overpriced train journeys, effluent being dumped in rivers, electricity companies that went bust at the first sign of trouble in global energy markets). One of the issues that privatisation was meant to tackle was reduced reliance on a pay-as-you-go model, in which the current generation of taxpayers stumped up for investment from which the next generation would benefit. Under a pay-when-delivered model, it was planned that balance sheets be used to pay for the initial cost of investment and future customers pay for the services they consume and so long as prices were set appropriately, the business would generate a decent rate of return. In addition to this being a sound economic basis, there was also a political motive for doing this as far as water was concerned. Planned EU legislation in the 1980s and 1990s required a significant rise in future investment which the government did not want to pay for, nor did it want customers (aka voters) to have to pay for it either. Getting private companies to use their debt-free balance sheet to pay for investment seemed like an expedient solution (water companies were debt free on privatisation).

But as the Thames Water debacle shows, that is not what happened. Newly privatised companies resorted to borrowing against assets on the balance sheet, much of which was ultimately used to pay shareholder dividends. As a result, Thames Water now has huge debts which threaten it with bankruptcy. This has forced a return to a pay-as-you-go model with today’s customers being asked to fund investment while servicing today’s debt.

Regulatory failure

While the public rightly puts most of the blame for the failures of privatised utilities on its managers, we should not ignore the fact that in many cases regulators have been remarkably complacent. First off, regulators in the electricity and water industries failed to stop companies from leveraging up their balance sheet from the 1990s. The companies perhaps ought to have behaved more responsibly but it is the duty of regulators to step in when irresponsible behaviour occurs.

Second, regulators did what they often do, and conduct regulation by rule book. As the economist Dieter Helm points out, the periodic reviews they conducted generated huge amounts of admin which companies struggled to process. As Helm notes: “company boards find that they are essentially asking the regulators to make decisions for them. In recognition that the “customer” is Ofwat rather than the household and business users, utilities engage in lots of lobbying, and try to work out what answer the regulator wants, rather than what their customers want and the wider environment needs ... Utilities start by trying to guess the answer the regulator (and the government of the day) might want, and then shape their business plans around them.” Both these elements chime with the situation in the financial services industry pre-2008 when regulators failed to rein in the (dubious) actions of many banks and issued vague directives without giving clear guidance as to whether institutions were compliant. And as we know, the UK regulator ended up being abolished and a large part of its responsibilities transferred to the BoE.

A final problem, though one which is perhaps only recognisable in hindsight, was that regulators applied the wrong cost of capital – a key metric used in determining the allowed rate of return and thus the appropriate prices for consumers. They applied a weighted average cost of capital (WACC) averaged across all areas of the business, rather than looking at each individual area separately. As a result, for each individual business WACC turned out to be too high for the cost of debt and too low for the cost of equity, providing an incentive for privatised utilities to switch from equity to debt and encouraging the gearing that proved to be so problematic for Thames Water (for more detail, see the work by Helm here or here). Here too, there are echoes of the failures of the VaR models which so underpriced financial risks prior to 2008.

 

Nationalisation is not (necessarily) the answer

Not surprisingly, this has caused a political uproar which threatens to rebound on the Conservative government which has long been an advocate of privatisation, while giving ammunition to those at the other end of the political spectrum who advocate taking assets into public ownership. However, nationalisation is not necessarily the best solution (it might be for rail, but that is a subject for another time). The arguments continue to rage as to whether renationalisation would result in an industry which is better aligned with customer interests. But the biggest argument against it is the fact that the state currently does not have the funds available to buy the utilities without issuing significant amounts of additional debt, and certainly does not have the cash available to fund the necessary investment. Many utilities are foreign owned (over the last 20 years Thames Water has had German, Australian and Canadian owners) and nationalisation would sit uncomfortably with efforts to attract foreign investment. As Helm has consistently pointed out, the UK suffers from a sizeable savings deficit – the current account deficit is a measure of the excess of domestic investment over savings – which implies that it is already reliant on the kindness of strangers to fund investment.

What to do?

Since we cannot easily nationalise Thames Water, and imposing yet more red tape would not seem to be a viable option, we may be left with little option other than to place it in administration. This is effectively what happened to the privatised rail operator Railtrack in 2001. Rather than nationalise the whole operation, however, there is a strong case for splitting it into smaller parts with different regional responsibilities and maybe with different functional responsibilities (e.g. one for water supply and one for treating sewage), selling off the good bits and putting the bad bits into special administration.

Either way, it seems socially irresponsible to allow a company that has failed to properly manage the largest water company in Europe to be allowed another go at getting it right. This may be the right time to redraw the contract between the state and the market, and learn some of the lessons of the last thirty years. In short, the companies must strike a better balance between serving their shareholders and their customers, entailing effective regulation (not simply more of it, but better targeted regulation); breaking up private sector monopolies; more strict controls over pricing and more effective sanctions against those who transgress. On the assumption that a new government will have to pick up the pieces of this problem in the not-too-distant future, the Thames Water problem could provide a good opportunity to reimagine how utilities should be run in the twenty first century.

Ferry bad news

Companies spend a lot of time these days trying to sell themselves as paternalistic guardians of their employees’ well-being with their mission statements, counselling sessions and monitoring programmes. In truth, it often feels like self-justifying fluff and to those of us who remember when capital and labour were frequently at odds with other, it can sometimes strike a jarring note. Nonetheless, it makes for a vastly superior workplace environment to the red in tooth and claw capitalism espoused by many extreme free-marketeers. For a reminder of the kind of outcomes this model can produce, we do not need to reach back to the go-go days of the 1980s. Earlier this month, P&O Ferries summarily dismissed 800 employees, announcing that it was replacing them with cheaper alternatives, in a message that was as crass as it was insensitive (here for a copy of the video).

This case matters for a number of reasons. The first concerns the legal implications. A second issue is the extent to which it is (or is not) entangled with Brexit. A third issue concerns the nature of employee protection and the economic implications of lax labour laws. Finally it is worth touching on national security issues raised by P&O Ferries’ parent company (note: P&O Cruises is a completely separate company that happens to share the same name).

The legal aspects

Turning first to the legal issues, the Trade Union and Labour Relations (Consolidation) Act 1992 states: “An employer proposing to dismiss as redundant 100 or more employees at one establishment within a period of 90 days or less shall notify the Secretary of State, in writing, of his proposal … at least 45 days before the first of those dismissals takes effect.” On the surface, therefore, P&O Ferries appears to be in direct breach of the law. Indeed, the company’s CEO admitted in testimony to MPs that there was “absolutely no doubt” the company had broken UK employment law. Or has it? It has since come to light that due to a change in the law in 2018 “if the employees concerned are members of the crew of a seagoing vessel which is registered at a port outside Great Britain … The employer shall give the notification required … to the competent authority of the state where the vessel is registered.” Sure enough, eight of the company’s ships are registered abroad, including those which ply the Dover-Calais route.

Legally, therefore, P&O Ferries can argue that they have complied with the letter if not the spirit of the law. An excellent blog post by Darren Newman, an employment lawyer, makes the point that “UK employment law seeks to punish employers who act in breach of it – but does not stop them from doing so. If an employer makes the calculation that the financial consequences of ignoring the law are outweighed by the business benefits of doing so then it is free to go ahead.” Newman points out that this problem has not been confined solely to the UK, and EU efforts at the turn of the century to introduce tougher legislation were blocked by a group of countries including the UK. Nonetheless, the degree of worker protection is far higher in the EU than in the UK and many lawyers believe that the British laws are so weak as to be near useless. Whilst accepting that the degree of labour market rigidity that characterised the 1970s was a primary feature of the British economy’s underperformance during that decade, it is not clear that swinging the pendulum too far in the other direction has improved the position of workers.

Is this anything to do with Brexit?

The short answer is no, at least not directly: The UK’s labour laws have not changed since it left the EU in 2020. That said, by reducing cross-channel freight volumes which pressure P&O’s finances, it did play an indirect role.  It is ironic that the RMT union, which represents maritime workers, advised its members to vote for Brexit in 2016 arguing among other things “it’s a myth that the EU is in favour of workers. In fact the EU is developing a new policy framework to attack trade union rights, collective bargaining, job protections and wages.” In fact, the consultation element of the process, which was so blatantly ignored in this case, was introduced partly in response to EU concerns and highlights the lack of understanding of the EU’s role in large areas of British life prior to the referendum.

Limits of the free market

P&O claims that if it had not taken action to reduce costs the business would have gone under, with the CEO telling a parliamentary committee that he would make the same decision if the same circumstances were to arise. The fact that P&O received £10 million in furlough payments from the British government during the lockdown seems to have slipped his memory. Nobody would suggest that companies do not have a right to make adjustments to turn around a failing business, but by failing to adhere to due process P&O has offended public opinion which may yet rebound on their business fortunes. Ironically, the company’s most recent strategic report contained the priceless gem that “the directors practice a culture of regular engagement with employees … the effect of these measures is an open dialogue across the organisation.”

The company has admitted that it will pay the replacements for the sacked workers a rate less than the British minimum wage, offering just £5.50 per hour compared to a rate of £6.83 for those aged 18-20 rising to £9.50 for those aged over 23 (this at a time of the biggest squeeze on living standards in decades). This action comes just a few months after the government blocked efforts by the opposition to introduce legislation preventing firing and rehiring following a similar tactic by British Gas last year, claiming that legislation was not the appropriate way to tackle the problem. A series of articles by the FT journalist Sarah O’Connor (here and here) highlighted similar disregard for the law in the UK clothing industry. Such was the resonance of her analysis that she was invited to testify before a parliamentary committee which made a series of recommendations, all of which were rejected by the government. It does not exactly give the impression of a government that cares.

Ironically, the empirical evidence from the economics literature suggests that minimum wages have little adverse impact on aggregate employment although their existence does have a small impact on profitability. There are some upsides associated with the presence of a minimum wage, notably it can lead to an increase in productivity by reducing worker turnover and increasing the incentive to invest in labour saving technology. If a company believes that slashing wages so far below the legal minimum is necessary to return to profitability, there is a lot more wrong with the business than its cost structure.

Does it serve the national interest?

One aspect of this case that has gone unremarked are the complications of contracting out vital parts of the infrastructure to the private sector. Cross channel ferry links constitute a vital element of the UK supply chain, with Dover handling 14% of UK merchandise trade prior to 2020. P&O Ferries is owned by DP World – the same company that in 2006 was barred from taking control of six US seaports on national security grounds. There is nothing necessarily wrong per se in allowing DP World to have a significant degree of control over the cross channel link, but the fact that it operates very close to the limits of employment law does raises questions about its probity. To add insult to injury, DP World is in line for £50 million of taxpayer support for its role in setting up freeports. Following recent concerns about the degree of Russian influence in areas of British public life, this case raises further questions about whether the UK government conducts sufficient due diligence when contracting out areas of national interest.

The case highlights the limits of untrammelled free markets, demonstrating that the absence of constraints can result in very bad social outcomes. It also highlights the weaknesses in employment law where employee protection is a lot weaker than often appreciated. A government that has taken a laissez faire attitude towards actions of the private sector in the past may believe that P&O has gone a step too far – the electorate seems to think so.

Something of value

The Reith Lectures are a long-standing tradition in British radio broadcasting, running back to 1948, in which a leading figure of the day tackles a subject of contemporary interest. One of the consequences of the lockdown is that I had a chance to listen to this year’s lecture series given by Mark Carney, former BoE Governor, and very interesting it was too, for it tackled the issue of how financial value has usurped human value and what we can do to turn this around (the transcripts of his lecture series are also available at the link shown above).

What is value?

This subject is of relevance to all economists, but it is of particular interest to me because as I have noted previously, it is one of the motivating factors behind starting this blog in the first place. Carney’s jumping-off point is to acknowledge that the moral sentiments espoused by Adam Smith, the father of the invisible hand, have become financial sentiments and that “societies’ values became  equated  with  financial  value.” I have raised similar points over the years, arguing in 2017 that Smith “never advocated the devil-take-the-hindmost policy which many of his adherents claim.” Indeed, Carney notes that Smith uses the phrase “invisible hand” only once in his magnum opus The Wealth of Nations. My own introduction to Smith’s work (more years ago than I am prepared to admit) focused on his role in developing the idea of comparative advantage in trade rather than his espousal of free markets – a point that Carney reiterated: “the central concept that links all of Smith’s works is the idea that continuous exchange forms part of all human interactions.”

A few weeks ago I referenced a study conducted by the ESCoE into public attitudes towards economics in which those questioned “often associated the economy with money.” Carney highlights that “Smith’s writings warn of the mistakes of equating money with capital.” Somewhere along the line we appear to have drifted a long way from the original ideas sketched out by one of the founding fathers of modern economics. One of the underpinnings of this shift has been a change in the nature of value. In Carney’s interpretation of Smith’s world, value is derived from our desire to be well regarded by others which creates “incentives to achieve mutual sympathy of sentiments.” In recent years, however, value has taken on a more subjective hue as the neoclassical revolution has gone mainstream. In this scheme, people are encouraged to assign a value according to the utility they assign to a particular good (or service). In other words, value becomes what people are willing to pay. What complicates matters enormously is that since tastes can change very quickly, these values are not stable over time. But following the Reaganite/Thatcherite revolution of the early-1980s which unleashed the power of markets as the ultimate arbiter of choice, this model of value generation has become extremely well entrenched.

However, markets are underpinned by the laws and values of the society in which they operate. They do not spring out of nowhere – the invisible hand must be attached to an invisible arm. A good example of this is the Glass-Steagall Act of 1933, which separated the deposit taking activities of US banks from more risky investment banking operations. It came into being because society was not prepared to condone a repeat of the 1929 Wall Street Crash and the associated economic hardship. Fast forward to 1999 and society’s concerns about the risks associated with banking had diminished to the point at which the US Congress felt able to repeal it. Quite clearly the law operated in the context of the prevailing social norms.

By contrast, Milton Friedman was an arch-proponent of free markets who argued that we could separate market outcomes from their social context. In a famous article published in the New York Times 50 years ago he argued that a business executive who exercises social responsibility in the course of their work “must mean that he is to act in some way that is not in the interest of his employers.” Businesses that do anything other than maximise profits are “unwitting puppets of the intellectual forces that have been undermining the basis of a free society these past decades” and are guilty of “analytical looseness and lack of rigor.” But Friedman’s failure to take account of social context is a major omission. What might have been acceptable corporate behaviour in  the 1970s and 1980s no longer is. Moreover, a purely market oriented policy that fails to take account of social norms would damage a company’s image and be harmful to its long-term survival prospects.

One of the problems with our current system of value setting is that since we define the worth of activity purely in financial terms, we cease to value that which we cannot price. Accordingly mainstream economics now tries to assign a price to civic and social virtues in order to give them meaning. In this way, we have gone beyond operating in a market economy and we are now operating in a market society. But as Carney points out, “there is considerable evidence that commodification, putting a good or service up for sale, can corrode the value of the activity being priced.” The standard example of this are charitable events which seek to raise money for good causes. The primary motivation is altruism, but would more money be raised if participants were paid? The answer, it turns out, is no.

Will Covid change how we value things?

These philosophical ramblings are all very interesting but what bearing do they have on the issues we face today? In a world where all members of society have been affected in one way or another by Covid, many people have done extraordinary things to help their communities, for which they received no payment. Milton Friedman might have argued that they were crazy, giving away their labour for no monetary reward. But they did so because they believed in the cause for which they were working. In a wider sense, Covid will force societies to re-evaluate their priorities. In the Anglo Saxon world, the burden of risk has increasingly been shifted onto the individual as the state has reduced its role in the economy. For example, if you lose your job, you have to find another one quickly because the state will not provide for you. But during the pandemic, that is precisely what the state has been forced to do. Does society really want to revert to what went before?

I recently gave a presentation in which I suggested we may be about to relive a 1945 moment. At that time in the UK, memories of high unemployment in the 1930s were still vivid and voters in the first post-war election opted for a government that promised radical social change. Radical post-Covid change will likely be driven by younger voters who wish to see changes to an economic model that has benefited their parents’ generation but done little for them. For example, voters may demand that the state plays a bigger role in the economy in future, since one of the things the state does well is to correct the market failure from negative externalities (e.g. ensuring widespread access to healthcare and education). This in turn could have a major bearing on the way in which society assigns values and would give the green light for future governments to adopt a slow course back to fiscal rectitude rather than a headlong rush.

Obviously we do not know what the future holds but I have long argued that more market-type solutions are not the answer to the mounting economic problems faced by European economies. This is not to say that we should revert to 1970s-style efforts to centralise economic decision-making. But as we learned in 2008 and again in 2020, markets can fail without the right kind of support. The fact that we value intervention in order to avoid worst case spillover effects suggests that we should not be afraid to impose limits on the extent to which we allow free markets to make our value judgements for us

Should British Steel be nationalised?

The recent problems encountered by British Steel, which today entered insolvency, is an echo of the case three years ago when Tata Steel announced it was to pull out of its UK operations. In the end a rescue package was agreed, based upon a reform of the company’s pension scheme which was acting as a serious drag on the profitability of steelmaking at Tata's Port Talbot facility. Faced with a similar situation at British Steel’s Scunthorpe plant, the Labour Party has called for the company’s operations to be nationalised in a bid to save the jobs of 5000 workers who are directly involved in production, and a further 20,000 who are employed in the supply chain.

The threat to the Port Talbot production facilities in 2016 was one of the first topics I tackled on this blog. Indeed, this blog is partially motivated by concerns that successive governments’ adherence to the untrammelled operation of free markets results in market failures that have wider social consequences. It is not just me who expresses such concerns. Whatever else people may not like about the Labour Party’s economic policy (and there is a lot to dislike) the electorate does like the idea of renationalising industries such as the rail network. One reason for this is that the electorate is opposed to the idea of private investors creaming off monopoly profits whilst walking away from their obligations if events do not run as planned (as happened on one of the country’s main rail routes in late 2017).

People also do not like the fact that markets fail to adequately price the non-financial costs associated with industrial restructuring. Whilst the costs associated with any job losses in Scunthorpe and other towns are of no direct concern to British Steel, they are a huge problem for the local community suggesting an unequal distribution of the costs and benefits associated with closing down the plant. However, this alone is not enough to justify nationalising the steel industry.

A much better case can be made that industries such as steel represent industries of strategic national interest where the economy has an interest in ensuring that the skillset embodied in the industry can be maintained. An example of why it may pay to retain the skillset is provided by the construction of the controversial Hinkley Point power station: The government claimed that since the UK has not built any nuclear power stations in thirty years, the skills required to build the station could not be found in the UK, forcing it to turn to a state-owned French company to supply the reactor. The steel industry is more than just about turning out metal rods – some very complex metallurgy is involved in making some of the high-spec alloys required in advanced industrial applications. The issue facing the UK is whether it wants to remain involved in this business or whether it is prepared to outsource it to foreign suppliers.

This highlights two of the concerns I expressed three years ago: First, the government’s repeated policy of non-interference in corporate actions means that the decisions which affect people’s lives will increasingly be taken outside the UK. In addition it raises the question whether countries like the UK can continue to rely on the stability of the international order to ensure that it will always be able to source its needs from foreign suppliers. If we have learned anything since 2016 it is that the global order is anything but stable, as the likes of Donald Trump continue to rip up the rule book. Indeed, steel was one of the first product groups to be hit by higher tariffs as the US introduced a 25% levy on imports. But it is China that has disrupted the global steel market, having produced more steel in the last two years than the UK has done in its entire history (see chart for data covering the last three decades). Ironically Mao Zedong’s stated aim in the 1950s was merely to boost annual Chinese steel output above that of Britain’s – things have moved on a long way since then.

Clearly the UK, nor indeed any European country, can compete with this kind of industrial muscle which suggests that if governments want to retain the industrial skills inherent in the steel industry, the state may have to play a bigger role. This does not necessarily mean that steel-making facilities should be directly taken under state control. But efforts to relieve some of the industry’s burden in the form of lower business rates or energy costs are measures that might need to be considered. Environmental issues are a further complicating factor – indeed, British Steel has already been loaned a considerable amount of money by the government to pay an EU bill for its carbon emissions. Environmentalists would say that this is not an industry that we need to save but the people of Scunthorpe may have a different view.

We also cannot ignore the fact that British Steel’s current woes have been hugely exacerbated by Brexit, and Brexit-related uncertainty is blamed for a significant drop in orders. The good people of Scunthorpe voted 2-1 in favour of Brexit so it is highly ironic that the policy they voted for looks set to impose significant harm on the local economy. Moreover, one of the reasons cited by the UK government for not providing additional finance is that it does not want to fall foul of EU state aid rules. But even if the UK were to leave the EU, it is doubtful that it would stump up to support British Steel, since the bills would start to run up very quickly if every region that suffered as a result of Brexit were to receive public support.

This leaves the steel industry between a rock and a hard place. There is a good case for state intervention to support an industry of critical national importance and there is also an environmental case for letting it go. But since the problems have been exacerbated by Brexit, with the result that British Steel’s overseas customers do not know what tariffs will apply to any steel they buy – nor indeed when the UK will leave the EU – and to the extent that this has been exacerbated by the government’s indecision, there is a stronger case for support from the public purse. Having seen at first-hand what deindustrialisation did to the part of the world where I grew up, I understand the fears of the local community – and they are right to be afraid.

Would I lie to you? Part 1

According to former US President Ronald Reagan, the nine most terrifying words in the English language are “I’m from the government and I’m here to help.” Indeed over much of the past 40 years, Anglo Saxon economies have tried to shrink the size of the state in the belief that the markets are more efficient at allocating resources. In a narrow sense this may be true since the private sector has an incentive to generate the lowest cost solution in order to maximise profit.

But it is increasingly evident that rolling back the state does not always generate outcomes that are in the interests of wider society. The Private Finance Initiative (PFI) in the UK has incurred billions of pounds in extra costs to deliver infrastructure projects for no clear benefit. Indeed, recent PFI contracts – for schools, hospitals and other facilities – are between 2 and 4 per cent more expensive than other government borrowing, and involve significant additional fees. There is also widespread criticism that the chief executives of formerly publicly-owned utilities receive huge salary packages whilst not delivering any improvement in services.

In other words, the ideological basis of Anglo Saxon economic policy over the past four decades is not all it is cracked up to be. The model took a massive hit following the financial crisis of 2008 and governments around the world are still struggling to cope with the changed economic and political realities. Efforts to resume business as usual have struggled to gain traction and governments are increasingly struggling to retain the trust of their electorates. We see it in the populist surge across Europe and in the conduct of US politics, and it is evident in the rise of strongman administrations in places such as Turkey and the Philippines. In some ways the perception of government failure is unfair – in other ways not. But the widening gap between the perceptions of politicians and the electorate is both unfortunate and dangerous.

It is unfortunate because in western democracies politicians are representatives of the people. They are us and we are them – something that is too often forgotten by the body politic. It lies within the power of the people to change the status quo. In France, this led to the formation of a new political party which in the space of a year had propelled Emmanuel Macron to the presidency, although it has proven more difficult to replicate this strategy elsewhere. But the widening gap between people and politicians is also dangerous because it creates space for populists who advocate simplistic solutions to complex problems. The inability of the established political powers to counter these problems runs the risk that nominally sensible politicians will be forced to ape populist measures in order to stay relevant, thus taking politics in an unfortunate direction. Moreover, when the populist solutions are shown to have failed how will electorates respond?

Despite the strains which have been placed on western economies in recent years, they have just about managed – and so far, at least, rather better than in the 1930s. But continued fiscal austerity threatens the social fabric in ways that will only become evident in the longer-term. Greece and Ireland have emerged from a period of EMU-imposed belt-tightening, which has left the Greeks in particular significantly worse off. And I have long pointed out that the fiscal austerity imposed in the UK is outright regressive as it takes the axe to welfare spending. But for an example of how fiscal austerity can be taken to unacceptable limits, recall the experience of the city of Flint in Michigan.

To summarise, Flint had suffered huge employment losses over a period of many years as GM, the city’s main employer, cut back on local jobs. This adversely affected tax revenues and by 2011 things were so bad that the governor of Michigan declared a state of financial emergency, appointing an emergency manager to cut costs to the bone. Alongside such measures as reducing the size of the police and fire departments, the authorities decided in 2014 to cut costs by switching the city’s water source from Lake Huron to the heavily polluted Flint River. In order to save yet more cash, the authorities opted not to add anti-corrosion agents to the water which would have prevented the pollutants from causing lead to leach into the town’s water supply.

Despite mounting evidence to the contrary, officials continued to deny that the drinking water in Flint was unsafe. When Dr Mona Hanna-Attisha published her work in September 2015 highlighting the health risks associated with high lead concentrations in the drinking water, her research was initially ridiculed. A Michigan Department of Environmental Quality spokesperson accused her of being an "unfortunate researcher … splicing and dicing numbers" and causing "near hysteria.” But she was right and they were wrong. As a result, huge amounts of extra spending were required to replace pipes and ensure a supply of clean drinking water until the operation was complete, and criminal proceedings were launched against a number of officials involved in the scandal. Ironically, the cost of adding anti-corrosion agents to the water in the first place would have cost only around $36,500 per year versus an estimated $97 million over three years to replace the plumbing.

This is a classic example of short-sighted policies that are consistent with the Bluffocracy. By focusing only on one policy objective – saving money – the authorities ignored the non-pecuniary costs associated with their strategy. Worse still, the authorities failed to address residents’ concerns – the very people who they are supposed to represent. When this happens on a national scale you get politicians like Trump filling the gap. A decade ago, we were concerned with market failure as the global financial system tottered on the brink of disaster. Today, we are more concerned with government failure and nowhere is this more evident than in the case of Brexit – the subject of my next post.