Not the end of history

It is thirty years since Francis Fukuyama’s essay “The End of History?” was published in the magazine The National Interest. It was subsequently fleshed out into a book which elevated Fukuyama to the first rank of commentators on global geopolitical issues. Viewed from the perspective of three decades later, it is an idea that has not aged well. Fukuyama’s thesis was that liberal democracy had achieved such dominance as a form of government around the world that we had reached “the end point of mankind's ideological evolution and the universalization of Western liberal democracy as the final form of human government.” This was pretentious hubris in 1989. Today, the argument just looks crass.

There is no doubt that the argument has been hugely influential amongst western leaders. The likes of Bill Clinton and Tony Blair went to great lengths to use foreign policy as a tool to promote western values. The “end of history” mind-set also underpinned the development of the EU. Following the fall of the Iron Curtain, the European Economic Community – whose aim was to promote economic integration amongst its 12 member states – opted to ratify the Maastricht Treaty to create the European Union thus marking a further step on the road to creating an “ever closer union” between the peoples of Europe. It also facilitated an eastward expansion to incorporate 16 new members, many of which had little recent experience of the forms of government practiced in the west. Expansion was based on the idea that membership is open to "any European State which respects the values referred to in Article 2 and is committed to promoting them." Those Article 2 values are "respect for human dignity, freedom, democracy, equality, the rule of law and respect for human rights, including the rights of persons belonging to minorities." Very Fukuyama-esque.

All seemed to be proceeding on track until the crash of 2008. Unfortunately, governments over-promised and under-delivered on what they were able to do to stimulate a lasting economic recovery following the great recession, thus paving the way for populists to make political headway and helping to undermine Fukuyama’s ideas. But it is the rise of China that has had a bigger impact on the post-1989 hubris. China can in no way be defined as a liberal democracy, yet the performance of its economy has been the most significant economic event since the dawn of the industrial revolution in the eighteenth century. It would be a major stretch to assume that the majority of Chinese would be prepared to swap their system of government for the rapid rise in living standards experienced over the past three decades. An even more extreme example is Russia where moves towards a more democratic system of government coincided with a period of hardship which tilted the scales back towards authoritarianism.

Fukuyama supporters would no doubt point out that there is a distinction between “history” and ”events” where the former represents an overall narrative and the latter are the individual occurrences which go up to make the whole picture. But this is to overlook the fact that events can have a significant impact on the overall course of history. Fukuyama’s thesis rests on the notion that even if we deviate from the path of liberal democracy, it will eventually reassert itself in the long run, but this is not particularly helpful if we end up in a prolonged period of deviation from the “ideal” – as those who lived through the period 1914 to 1945 might testify.

Fast forward to the present day and the takeaway is that those who dismiss concerns regarding the behaviour of Donald Trump or the fragmentation of European politics as a short-term problem may be missing the point. Trump clearly has no interest in finding an accommodation with China on trade issues and indeed has ratcheted up the pressure in recent months. Tempting though it is to put this down to posturing ahead of the 2020 election, it would be naïve in the extreme to expect him to change his position in his second term as President (assuming he is re-elected). Rules-based liberal democracy is not part of Trump’s makeup and even if he does prove to be an aberration from the US presidential norm, he could do sufficient damage to Sino-US relations in the interim that ends up inflicting significant long-term damage on the US and undermining the cause of liberal democracy on both sides of the Pacific.

In a similar vein, those expecting the current shenanigans over Brexit to be resolved easily and quickly will also be disappointed. The idea that “something will turn up” is a Micawberish way of thinking that does not do justice to the magnitude of the problem. Too many politicians have signed up to the Fukuyama view that politics will quickly tend towards the liberal democratic norm. But the grand sweep of history suggests that societies are often plunged into chaos by sudden and unexpected events which overwhelm the system’s capacity to respond and a long period of adjustment then ensues. In the case of Brexit, politicians cannot hide behind the excuse that a no-deal Brexit is unexpected. Indeed, many of them have advocated it. But a generation of politicians that has grown up without bad things happening because something always turns up may be pushing their (and our) luck too far.

In my view, Fukuyama’s assertion of an end of history makes the mistake of assuming history as some form of linear progression. Perhaps it should be thought of as a 3D spiral, in which we appear to be making progress in one dimension whilst going over the same old ground in another (see chart). Or as Mark Twain (allegedly) said, “history doesn’t repeat itself but it often rhymes” which is why we should wake up to the damage that Trump or a no-deal Brexit might cause rather than assume it will quickly pass.

Is that a B'Stard I see before me?

A crowded field but where is the quality?

They say that fact is stranger than fiction and nowhere is this more true than in British politics right now. Thirty years ago, the TV scriptwriters Laurence Marks and Maurice Gran satirised the Conservative Party of the 1980s in the TV sitcom The New Statesman. It was based around the fictional hard-right Tory MP, Alan B’Stard, who was portrayed as an unscrupulous, amoral individual who would stop at nothing to fulfil his ambitions. It is difficult to watch this clip and avoid the impression that many of the current candidates for the Tory leadership are aping B’Stard’s fictional rhetoric.

Nominations for the Conservative Party leadership closed today, with 10 candidates on the ballot paper and with the first round of voting due to take place on Thursday. Just as a reminder of what is at stake, 314 Tory MPs are due to choose two candidates to succeed Theresa May who will then face a ballot of all Party members. What this means is that 124,000 people will choose the person who will attempt to negotiate the UK’s departure from the EU. Or, to put it another way, this choice will be made by 0.27% of the total electorate. Moreover, if only one candidate emerges from the parliamentary process, as happened in 2016, the new PM will be chose by less than 0.01% of all eligible voters[1]. To highlight the New Statesman-like surrealism of the debate, three of the candidates (Rory Stewart, Andrea Leadsom and Michael Gove) have all admitted to past drugs misdemeanours. Two of the hardline Brexiteer candidates (Dominic Raab and Esther McVey) have suggested suspending parliament to ensure that it cannot block Brexit on 31 October. And this is before we get to Boris Johnson whose strained relationship with the truth is legendary. Welcome to democracy in 21st century Britain.

Reviewing the fiscal options

But for all the lack of quality on display to inherit the office held by substantial politicians such as Winston Churchill and Margaret Thatcher, the economic issue of interest concerns the fiscal policy options suggested by the candidates. Let’s start with Boris Johnson. He has already threatened to withhold the £39 billion payment for incurred liabilities unless the EU gives the UK better exit terms. But assuming this is paid over a period of 3 years, it only amounts to around 10% of the EU’s annual budget revenues (or 0.1% of EU GDP). Not only is it a trifling sum in the grand scheme of things but lawyers suggest that such a move is probably illegal. It would also be the first time since the UK came into existence following the Act of Union in 1707 that it has defaulted on its credit obligations. The EU simply will not be threatened in this way and it would cost the UK far more than it gains. Whilst such a policy may play well with the Tory faithful, it would be an act of monumental economic stupidity.

Various leadership candidates have also promised tax cuts in the event they accede to 10 Downing Street. Johnson has promised to raise the threshold for the higher rate of income tax (40%) from a starting salary of £50,000 to £80,000, at an estimated cost of £10 bn (around 0.5% of GDP). Johnson claims that this can be funded from the £26.6 bn set aside by the Treasury as an insurance fund against a no-deal Brexit. But since Johnson has threatened that the UK would be prepared to walk away from the EU without a deal, he is surely going to need the emergency fund. Johnson’s team counter that the policy would be part funded by raising the upper limit on national insurance contributions. However, the Institute for Fiscal Studies has pointed out that this would benefit richer pensioners who do not pay NICs – which, oddly enough, maps onto the Conservative Party membership demographic.

Meanwhile, Brexiteer Dominic Raab has suggested reducing the basic rate of income tax by 5 percentage points over a period of five years. A rough rule of thumb based on Treasury calculations suggests that this will reduce revenues by more than 1% of GDP on a five-year horizon with no suggestion of how this will be funded. Foreign Secretary Jeremy Hunt, who is also in the running, has called for a huge increase in defence spending to “support our great ally, the United States.” Currently, the UK spends around 2% of GDP on defence – each one percentage point increase will raise outlays by £20 bn. Maybe former Health Secretary Hunt thinks he can find more for defence by taking something away from the health budget or perhaps in contrast to his rivals, he believes taxes should be raised. But like his rivals, he has failed to set out how his plans will be funded.

We should also not forget Michael Gove’s plan to abolish VAT and replace it with a lower, simpler sales tax. Interesting theory but a bad policy. For one thing, it is one of the government’s biggest revenue generators, delivering £138 bn per year to the Exchequer (6.3% of GDP). Moreover it is a general tax involving the production and distribution of goods and the provision of services, and whilst it is borne by the final consumer it is more than simply a sales tax. VAT is also efficient, in contrast to Purchase Tax which it replaced and which was levied on a range of goods at differing rates. It was certainly not efficient. If Gove’s proposed tax is “simple” it will have to be applied to a wide range of goods in order to generate the kind of revenue that VAT does currently, which raises questions of whether items such as food will remain exempt.

Then there is the question of how it impacts on the supply chain. If it is levied at every stage of the process, a “simple” 5% rate on a chain with five links results in a 27% tax rate compared to the current VAT rate of 20%. Moreover, if an exporter is the final link in the chain they will not be able to recoup the tax paid without raising their international selling price, which would render their product uncompetitive. In short, switching away from VAT would involve far more complexity than Gove believes. A simpler tax which is revenue neutral would require a lot of thought and would almost certainly prove impossible to implement before the next election. There is a reason why 166 of 213 UN members have adopted VAT and why India has just rolled it out. It is simple and more efficient than the alternatives.

The fact that the Tory front-runners have made taxation such a big part of their leadership bids reflects the lack of new ideas coming from the political right. Reducing direct taxes worked in the 1980s because previous levels of tax were too high so there were some incentive effects derived from cuts. In addition, there was a large rise in female labour force participation which helped swell income tax coffers. However, the UK did not face the problem of an ageing society which it does today. As a consequence the UK does not have the same scope to cut taxes without major consequences for future public liabilities. Having endured nine years of austerity to bring public finances back into line, it would be fiscally irresponsible to waste all the hard work on unfunded tax cuts which benefit particular interest groups simply to win the race for Number 10.

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[1] Admittedly, voters do not vote for the PM directly since they only get to choose their local representative. But there is no doubt that their local choices are determined by national level issues.

The NHS and a US trade deal

It may or may not be the case that in order to facilitate a post-Brexit trade deal between the US and UK that will deliver “two and even three times what we’re doing now … everything will be on the table – the NHS, everything.” What is beyond dispute is that Donald Trump said it. Even though Trump appeared to backtrack from this position in a subsequent TV interview, he nonetheless articulated the reality of the UK’s post-Brexit choices. Without the heft that comes from being part of a larger economic bloc, the UK is going to look pretty puny in comparison to the likes of the US and China whose economies are respectively 7.3 and 4.8 times larger than the UK. Brexit supporters still cling to the fiction that the UK will be able to negotiate better deals with third countries than it currently enjoys as a member of the EU. Those with experience of conducting trade negotiations know this to be false. When it comes to opening up new markets, might is right.

This is going to put many of the contenders for the Tory leadership in an invidious position. Those who argue that the UK must leave the EU on 31 October, come what may, are in effect saying that they don’t care about the economic consequences and that the politics matters above all else. Boris Johnson has argued that the Conservatives face “potential extinction” if they cannot deliver Brexit. What he fails to point out is that they will face much the same fate if they get Brexit wrong. And risking the NHS, which is one of the few national institutions which the electorate continues to trust, would be one of the touchstone issues that could undermine them, allowing them to be outflanked by Labour. Indeed, a survey conducted by the Kings Fund found that a higher proportion of respondents thought leaving the EU would be bad for the NHS than those who believed it would be a good thing,

In what ways might a US trade deal put the NHS at risk? The most obvious concern is that US health service providers may be granted preferential access to the British market. This would imply the outsourcing of services currently provided by the state to the private sector – in other words, privatisation of large parts of the health service. As it happens, the NHS does already pay private contractors to run parts of the service. In fiscal 2017-18, almost 11% of NHS England’s outlays went to non-NHS organisations, with 2/3 of that figure going to private health providers (around 7.6% of total outlays). But figures compiled for the FT suggest that spending on non-NHS provided care has remained flat in real terms in recent years.

In the face of this evidence, why do people believe that NHS privatisation is rampant? John Appleby, chief economist of the Nuffield Trust, has suggested that one of the reasons for this is that many of the frontline services which people regularly come into contact with, such as community nursing and health visiting, already have a significant private sector presence. Nonetheless, the public would not regard further outsourcing of public services very favourably since there is a deeply entrenched view that the private sector should not make money out of the suffering of others. In addition, there is a commonly held view on this side of the Atlantic that the US health system fails to adequately look after the less well-off members of society and there is horror in some policy circles at the Trump Administration’s efforts to repeal Obamacare.

Another potential issue is that of opening up the UK market to American pharma companies, with all the attendant consequences for drug pricing. The National Institute for Health and Care Excellence (NICE) measures NHS expenditure to assess the relative cost effectiveness of various treatments against the next best treatment that is currently in use. As a result, the NHS pays significantly less for medicines from American companies than US healthcare providers. The concern is that any trade deal would be used as an excuse to ramp up the prices charged to the NHS. This fear is not unjustified. Alex Azar, Trump’s secretary of health, declared last year that the US would use trade negotiations to demand that “socialised” healthcare systems pay more since they currently pay “unfairly low fees to US companies.” This would allow a reduction in drug costs for US consumers. We should not kid ourselves that Trump’s America First policy will take an altruistic view of healthcare provision to foreign citizens – even those which supposedly enjoy a “special relationship.”

Some prominent Brexit supporters do not have a problem with the outsourcing of NHS services. Nigel Farage has recently been criticised for suggesting that those who can afford private health care should pay for it, as it would "relieve some of the burden on the National Health Service for everyone else." This is not a new position: He was recorded in 2012 suggesting that the NHS should move towards an insurance-based system run by private companies. Another hardline Brexiteer, Daniel Hannan MEP, remarked in 2009 that he “wouldn't wish it [the NHS] on anybody." It’s not exactly man-of-the-people stuff that Brexit supporters are likely to go for.

As it happens, there is a good case to be made for a grown-up debate about how to fund the NHS. But if Brexit is all about taking back control, this debate should be conducted in a cross-party manner and take into account the views of the general public. It should not be forced on the UK government as the result of a trade deal that would benefit the US far more than it would the UK.

Don't bet on it

It is a truism in the gambling industry that the house always wins (although Donald Trump famously bankrupted his Atlantic City casino more than once). Being a bookmaker is generally viewed as a licence to print money although they don’t always get it right. One of the more famous examples in recent years was Leicester City’s Premiership win in 2016, despite having been priced as 5000-1 outsiders at the start of the football season, which cost bookmakers £25 million. It is in this light that we should treat the bookmakers odds for the Conservative leadership campaign, nominations for which close next week.

Just to put the numbers into context, the bookmakers are offering odds on 116 candidates, of whom 20 do not sit in the House of Commons whilst four are not even members of the party (one of them being Nigel Farage). This should make us a little bit suspicious as to the accuracy of the odds that are being quoted. At the time of writing, the bookies are offering odds of 2-1 on Boris Johnson making it to Downing Street (a probability of 37.5% derived from 24 different quotations) whilst second-favourite Michael Gove is being quoted at 4-1 (probability of 12%). Dig a little deeper and you find that the cumulated probability of the top six candidates sums to almost 100%. Given that there are 13 declared candidates , it is pretty clear that the sum of the implied probabilities exceeds 100%. Indeed, across all 116 candidates it sums to 181%. People are often surprised that this should be the case but this is to miss the point of what the bookies odds are telling us. 

Bookies odds should be treated as a payout ratio rather than as the actual probability of winning. After all, bookmakers’ objective is to make money from the volume of money placed on wagers rather than a rigorously objective assessment of the likely outcome. One of the ways which they do this is to take a slice of each bet in the form of a commission charge. In market terms, we can think of this as a bid-ask spread between the price the bookmakers are prepared to accept and the price at which they will pay out. In this case, however, the bookies appear to be charging a huge margin of 81% between the payout ratio and the true odds of the outcome (which by definition are limited to 100%). Ahead of the 2018 World Cup finals, the sum of probabilities across all participants was 115% which implies a much more reasonable bid-ask spread of 15%. But to see why this is the case, we need to consider some basic betting arithmetic and how this is affected by sample size.

The only thing we can say for certainty about the published odds is that they are designed to ensure that the bookies make a profit. The decisive factor determining the odds is the weight of money in favour of one or other bet. Imagine a case where there are 50 punters each paying £1, and 40 choose outcome A with a payoff of £1.2 and the remaining 10 choose outcome B with a payoff of £4.9. The bookmaker broadly breaks even in both cases (in outcome A, outlays are £48 and in the case of outcome B they are £49 - both less than the £50 of revenue). But if the balance shifts, with 30 people opting for outcome A and 20 for outcome B, the bookie makes a bigger gain in the event of outcome A (50 - 30 * 1.2 > 50 – 40 * 1.2) but will lose money in the event that B materialises (50 - 20 * 4.9 < 0). In order to reduce the losses on outcome B, the bookmaker is forced to reduce the outlays to £2.5 in order to break even (see chart) – in betting parlance the odds against have shortened. This has nothing to do with the fact that the bookie believes option B is now more likely. It simply reflects the weight of money switching to option B necessitating a change of odds to minimise losses.

The odds are also affected by the bookies’ need to make a profit. If, in our first example, the bookmaker targets a 10% return, they need to reduce the odds on outcomes A and B from 1.2 and 4.9 to 1.125 and 4.5 respectively which of course raises the implied probability (scenario 1a in the chart). Matters become more complicated when we extend the number of options: If our 50 punters can choose from 20 different outcomes, the sum of probabilities across the whole range of outcomes rises. It appears as though this is where we are in the Tory leadership race now: A long tail of outcomes quoted at long odds has raised the sum total of probabilities across the whole field. It is this combination of setting odds in order to minimise losses, together with the commission charged in order to make a given return whilst being spread across a wide field which gives the appearance of a very wide bid-ask spread.

If we were to constrain the bookies odds to sum to 100% and normalise the quoted outcomes appropriately, the odds on Boris Johnson taking over the job widen from 2-1 to 4-1 with Michael Gove widening from 4-1 to 7-1 and Andrea Leadsom (third favourite) from 6-1 to 11-1. What is interesting, however, is that the favourite for the top job almost never wins the crown. In the 54 years since the Party leadership competition was opened up to an election, rather than emerging as some sort of backroom deal, only once (2003) has the favourite won. And Johnson knows from bitter experience that the path to the top does not always run smoothly. We should treat the bookies odds with caution.

As the dust settles, the battles begin

This year’s European Parliament elections were a big deal and generated a lot of coverage across the continent. There was certainly a lot to digest. As predicted in advance, the European People’s Party (centre-right) remained the largest faction but it lost a significant number of seats (down from 221 to 177, or from 29.4% to 23.6% of the total). The representation of the centre-left S&D bloc also declined, from 187 seats to 149 (24.9% to 19.8%). This means that the two main groups that have dominated the European Parliament since direct elections were introduced in 1979 now have a combined vote share of less than 50%. The big winners were the centrist Liberal alliance (ALDE) and Greens, but also the Eurosceptics and nationalists (comprised of three separate blocs).

Whilst the swing away from the nationalist parties was not wholly directed towards the Eurosceptics, which probably did less well than they might have hoped, they nonetheless found a lot of support, taking almost a quarter of the total number of seats. Such parties topped the polling in three of the largest EU countries: Italy (where they took 58% of the votes); the UK (44%) and France (36%) whilst they also did well in Hungary, the Czech Republic and Poland (62%, 54% and 54% respectively).

We should thus be under no illusions that the electorate in a number of countries has expressed dissatisfaction with the status quo and that it will be difficult to continue along the same path that we have been following for the past forty years. No one group can dominate the European Parliament, and a number of what might in the past have been seen as strange coalitions will have to be formed. The EPP will need the support of the Greens and Liberals, but even these three blocs will not be sufficient to command a parliamentary majority without the support of at least one of the smaller groups. This highlights just how difficult things are going to get in dealing with many of the big issues which confront Europe. On the one hand it is going to be difficult to find common cause on geopolitical relationships with the likes of the US, China and Russia. Then there are economic problems such as the environment and dealing with competition issues. If Europe has struggled with these issues before, life is about to get far tougher.

The horse trading that has already begun over the numerous positions in European institutions does not fill me with confidence. Key positions, such as the President of the European Commission, are supposed to be filled via the Spitzenkandidat (or leading candidate) principle. This principle was first established following the 2014 elections in which the candidate proposed by the leading political faction was in pole position to take over as Commission President. This is how Jean-Claude Juncker got the gig in 2014 despite opposition from the British and Hungarian governments. On this basis, Manfred Weber (EPP) would be expected to be one of the front runners. But the French have decided that they don’t like the idea of Weber getting the job, with President Macron apparently in favour of someone else (though we are not quite sure who).

Having put the Spitzenkandidat principle under strain, it raises the justifiable concerns of those who see the process of appointing the EU’s top jobs as a Franco-German carve-up, which will certainly not go down well with the large number of Eurosceptics in parliament. This dispute will also have implications for other jobs which are up for grabs. If Weber fails to get the job as Commission President, it would not be a surprise if Germany put forward Jens Weidmann as the new ECB President in succession to Mario Draghi who leaves in November. That would certainly not be welcomed in southern European countries, given Weidmann’s opposition to unconventional monetary measures such as QE. The more we look at the job allocation process, the messier it becomes.

All this comes against the backdrop of further disquiet on the part of the European Commission regarding Italy’s fiscal position. The Commission today wrote a letter to the Italian government warning that “Italy is confirmed not to have made sufficient progress towards compliance with the debt criterion for 2018.” This could trigger another excessive deficit procedure against Italy, following last year’s issues which were ultimately resolved when the Italian government softened its position a little, and which might ultimately lead to financial sanctions. Bearing in mind that the Italian electorate voted on Sunday for parties with a strong anti-EU bias, this will not go down well in Rome. It also puts the various actors in this drama in a tricky position. On the one hand, it is likely to reinforce Italian resentment regarding the actions of the EC to stifle GDP growth, which has averaged just 0.4% per annum during Italy’s membership of the single currency. On the other hand, the likes of Germany are becoming increasingly intolerant of Italy’s fiscal position and it continues to push for the southern European nations to play by the rules. This fault line running through the euro zone shows signs of growing wider, rather than narrowing, as the splits between federalists and nationalists and northern Europe and southern Europe grow wider.

Then, of course, there is the issue of Brexit. At the EU level, the change in the composition of parliament might have some bearing on whether it is possible to reopen negotiations between the UK and EU as some prominent UK politicians believe. A change in the Commission President could have a similar effect, whilst the departure of Donald Tusk as European Council President will rob the UK of a staunch ally in Brussels. As for what the election results meant domestically, everyone has a view based on their prior belief. Brexiteers argue that since the Brexit Party got the largest number of seats of any party, this is a strong signal that the UK should get out of the EU as quickly as possible. Remainers argue that the total vote share accounted for by Remain-supporting parties was larger than that of the Brexit Party and that the number of votes obtained by the Brexit Party (5.2 million) was smaller than the number signing a petition calling for Brexit to be stopped (5.8 million signatures). Both arguments have some validity but as we saw in 2014, it pays not to extrapolate the European election results too far.

But however we look at it, the events of the past few days have highlighted that the EU has a lot of soul-searching to do. It does need to do more to convince the people of Europe that its direction of travel is the right one. This parliamentary session will thus prove to be the most important in recent history as the EU figures out how to proceed. It is important to get it right, for otherwise it is easy to foresee rising tensions putting further strains on the workings of the single currency and the fabric of the EU itself.